ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File Number 000-14940
HealthSouth Corporation (Exact Name of Registrant as Specified in its Charter)
(205) 967-7116 (Registrant’s telephone number)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $0.01 Par Value
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes � No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes �
No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes � No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer � Non-Accelerated filer �
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes � No
The aggregate market value of common stock held by non-affiliates of the registrant as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $2.2 billion. For purposes of the foregoing calculation only, executive officers and directors of the registrant have been deemed to be affiliates. There were 398,229,960 shares of common stock of the registrant outstanding, net of treasury shares, as of February 28, 2006.
DOCUMENTS INCORPORATED BY REFERENCE
The definitive proxy statement relating to the registrant’s 2006 Annual Meeting of Stockholders is incorporated by reference in Part III to the extent described therein.
Delaware 63-0860407 (State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
One HealthSouth Parkway Birmingham, Alabama 35243
(Address of Principal Executive Offices) (Zip Code)
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Index to Financial Statements
TABLE OF CONTENTS
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Page
Cautionary Statement Regarding Forward-Looking Statements ii
PART I
Item 1. Business 1 Item 1A. Risk Factors 36 Item 1B. Unresolved Staff Comments 43 Item 2. Properties 43 Item 3. Legal Proceedings 45 Item 4. Submission of Matters to a Vote of Security Holders 57
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 58 Item 6. Selected Financial Data 60 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 64 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 122 Item 8. Financial Statements and Supplementary Data 122 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 122 Item 9A. Controls and Procedures 123 Item 9B. Other Information 128
PART III
Item 10. Directors and Executive Officers of the Registrant 129 Item 11. Executive Compensation 129 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 129 Item 13. Certain Relationships and Related Transactions 129 Item 14. Principal Accountant Fees and Services 129
PART IV
Item 15. Exhibits and Financial Statement Schedules 130
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STAT EMENTS
This annual report contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to future events, our future financial performance, or our projected business results. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “targets,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Such forward-looking statements are necessarily estimates based upon current information and involve a number of risks and uncertainties. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include:
The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.
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• each of the factors discussed in Item 1A, Risk Factors ;
• the outcome of continuing investigations by the United States Department of Justice and other governmental agencies regarding our
financial reporting and related activity;
• the final resolution of pending litigation filed against us, including class action litigation alleging violations of federal securities laws
by us, as discussed in Item 1, Business , “Securities Litigation Settlement;”
• our ability to successfully remediate our internal control weaknesses;
• changes or delays in or suspension of reimbursement for our services by governmental or private payors;
• changes in the regulations of the health care industry at either or both of the federal and state levels;
• changes in reimbursement for health care services we provide;
• competitive pressures in the health care industry and our response to those pressures;
• our ability to obtain and retain favorable arrangements with third-party payors;
• our ability to attract and retain nurses, therapists, and other health care professionals in a highly competitive environment with often
severe staffing shortages; and
• general conditions in the economy and capital markets.
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PART I
General
HealthSouth is the largest provider of ambulatory surgery and rehabilitative health care services in the United States, with 1,070 facilities and approximately 37,000 full- and part-time employees as of December 31, 2005. As used in this report, the terms “HealthSouth,” “we,” “us,” “our,” and the “company” refer to HealthSouth Corporation and its subsidiaries, unless otherwise stated or indicated by context. In addition, we use the term “HealthSouth Corporation” to refer to HealthSouth Corporation alone wherever a distinction between HealthSouth Corporation and its subsidiaries is required or aids in the understanding of this filing.
HealthSouth Corporation was organized as a Delaware corporation in February 1984. Our principal executive offices are located at One HealthSouth Parkway, Birmingham, Alabama 35243, and the telephone number of our principal executive offices is (205) 967-7116.
Recent Significant Events
Over the past three years, we have focused substantial time and attention responding to various legal, financial, and operational challenges resulting from the financial fraud perpetrated by certain members of our prior management team. This fraud was uncovered as a result of a series of governmental investigations into our public reporting and related matters, which investigations we became aware of beginning in late 2002 and early 2003. In connection with these investigations, on March 19, 2003, the United States Securities and Exchange Commission (the “SEC”) filed a lawsuit against us and our then-Chairman and Chief Executive Officer, Richard M. Scrushy, alleging among other things that we overstated earnings by at least $1.4 billion since 1999.
Public disclosure of these investigations and the SEC’s lawsuit precipitated a number of events that had an immediate and substantial negative impact on our business, financial condition, results of operations, and cash flows. These events, which began within weeks of the SEC’s lawsuit, included the following:
As summarized below, we have made significant progress in addressing many of the more significant obstacles created by the March 2003 crisis, including the following:
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Item 1. Business
• The SEC ordered a two-day halt in trading of our securities.
• The New York Stock Exchange (“NYSE”) delisted our common stock.
• Our lenders froze the line of credit under our $1.25 billion credit agreement, and instituted a payment blockage that, among other
things, prohibited us from making an approximately $350 million payment due April 1, 2003. They subsequently claimed we were in default under that agreement, substantially impairing our liquidity.
• Certain bondholders delivered notices of technical default.
• A number of lawsuits were filed against us and some of our current and former employees, officers, and directors in the United States District Court for the Northern District of Alabama, generally purporting to be class actions under the federal securities laws, on behalf of those who purchased our common stock and other securities during a period beginning February 25, 1998 and ending March 19, 2003.
• Approximately 14 insurance companies, including the primary carriers for our director and officer liability policy, filed complaints
against us in an attempt to rescind or deny coverage under various insurance policies.
• We have replaced our board of directors and senior management team and improved our corporate governance policies and practices.
See this Item, “Our New Board of Directors and Senior Management Team.”
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Although we have made significant progress since March 2003, we continue to face many challenges. We encourage you to read the discussions contained in Item 1A, Risk Factors , and in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , which highlight additional considerations about HealthSouth.
Our New Board of Directors and Senior Management Team
On April 4, 2003, we established the Special Committee of our board of directors (the “Special Committee”), which consisted of all of our then-current directors except Richard M. Scrushy and William T. Owens, our former chief financial officer. Our board of directors delegated to the Special Committee, to the fullest extent permitted by Delaware law, all authority that could have been delegated to the Special Committee, and authorized the Special Committee, to the fullest extent permitted by Delaware law, to exercise all of the powers and authority of the board of directors in the management of the business and affairs of HealthSouth when the board of directors was not in session. Mr. Owens resigned from the board of directors in October 2003. The Special Committee was disbanded effective December 29, 2005 following our 2005 Annual Meeting of Stockholders, at which meeting Mr. Scrushy was not elected as a member of the board of directors.
Of our current ten-person board of directors, nine members were added since March 2003: Steven R. Berrard (effective January 31, 2004), Edward A. Blechschmidt (effective January 31, 2004), Jay Grinney (effective May 10, 2004), Leo I. Higdon, Jr. (effective August 17, 2004), John E. Maupin, Jr. (effective August 17, 2004), Charles M. Elson (effective September 9, 2004), Yvonne Curl (effective November 18, 2004), L. Edward Shaw Jr. (effective June 29, 2005), and Donald L. Correll (effective June 29, 2005). Jon F. Hanson
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• We have completed a substantive reconstruction of our accounting records and filed annual reports on Form 10-K for the fiscal years (including this filing) ended December 31, 2005, 2004, 2003, and 2002 (including a restatement of previously issued consolidated financial statements for the fiscal years ended December 31, 2001 and 2000). In December 2005, we held our first Annual Meeting of Stockholders since 2002.
• We have prepaid substantially all of our prior indebtedness with proceeds from a series of recapitalization transactions and replaced it
with approximately $3 billion of new long-term debt, which we believe will produce enhanced operational flexibility, reduced refinancing risk, and an improved credit profile. See this Item, “Recapitalization Transactions.”
• We have reached a global, preliminary agreement in principle with the lead plaintiffs in the federal securities class actions and the
derivative litigation, as well as with our insurance carriers, to settle claims filed against us, certain of our former directors and officers, and certain other parties. See this Item, “Securities Litigation Settlement.”
• We have settled with the Department of Justice’s (the “DOJ”) civil division and other parties regarding their allegations that we submitted various fraudulent Medicare cost reports and committed certain other violations of federal health care program requirements. Although this settlement does not cover all similar claims that have been or could be brought against us, it settles the primary known claims that have been pending against us relating to our participation in federal health care programs. The DOJ and the Office of Inspector General (the “HHS-OIG”) of the United States Department of Health and Human Services (“HHS”) continue to review certain other matters, including self-disclosures made by us to the HHS-OIG. See this Item, “Medicare Program Settlement.”
• We have settled with the SEC regarding its allegations that we violated and/or aided and abetted violations of the antifraud, reporting,
books-and-records, and internal controls provisions of the federal securities laws. See this Item, “SEC Settlement.”
• We continue to cooperate with federal law enforcement officials and other federal investigators, including the DOJ and the SEC, as
they work to conclude their investigations, which are still ongoing.
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joined the board of directors on September 17, 2002, after the principal events previously under investigation by the SEC occurred. All members of our current board of directors other than Mr. Grinney, our CEO, qualify as “independent directors” under our Corporate Governance Guidelines. For more information about our directors, including the name of each independent director, see the section entitled “Directors and Executive Officers of the Registrant” in our 2006 proxy statement.
In addition to our new board of directors, since March 2003 we have recruited a new management team of experienced professionals, including the following new members of our senior management team:
Except for Mr. Tarr, none of the members of our senior management team has been employed by HealthSouth in the past. In addition to our senior management team, we have substantially replaced and expanded the management of our accounting and finance, internal audit (including appointing an Inspector General), and compliance functions, and we have replaced or added key management personnel in each of our divisions.
In addition to replacing our board of directors and senior management team, we have made substantial changes to our corporate governance policies and practices. For example, we have developed internal governance devices including an annual calendar that specifies certain issues that must be reviewed by the board of directors and its committees, a decision protocol that defines the levels of expenditures above which approval must be sought from the board of directors, and comprehensive charters for the board of directors and each standing committee that detail their mission, organization, and principles of operation. We have also established a strong Code of Business Conduct as well as a set of implementing measures, including the designation of a chief compliance officer and extensive compliance training, to ensure that the standards are accepted and practiced by our employees. In addition, our directors are in regular contact with both our chief executive officer and our senior management team, and we believe we have established a governance culture that places a premium on informed director oversight of executive action and company behavior.
Recapitalization Transactions
On March 10, 2006, we completed the last of a series of recapitalization transactions (the “Recapitalization Transactions”) enabling us to prepay substantially all of our prior indebtedness and replace it with approximately $3 billion of new long-term debt. Although we remain highly leveraged, we believe these Recapitalization Transactions have eliminated significant uncertainty regarding our capital structure and have improved our financial condition in several important ways:
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• Jay Grinney—President and Chief Executive Officer
• Michael D. Snow—Executive Vice President and Chief Operating Officer
• John L. Workman—Executive Vice President and Chief Financial Officer
• John Markus—Executive Vice President and Chief Compliance Officer
• Gregory L. Doody—Executive Vice President, General Counsel and Secretary
• James C. Foxworthy—Executive Vice President and Chief Administrative Officer
• R. Gregory Brophy—President, Diagnostic Division
• Joseph T. Clark—President, Surgery Centers Division
• Diane L. Munson—President, Outpatient Division
• Mark J. Tarr—President, Inpatient Division
• Reduced refinancing risk—The terms governing our prior indebtedness would have required us to refinance approximately $2.7
billion between 2006 and 2009, assuming all noteholders holding options to require us to repurchase their notes in 2007 and 2009 were to exercise those options. Under the terms
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Index to Financial Statements
The Recapitalization Transactions included (1) entering into credit facilities that provide for extensions of credit of up to $2.55 billion of senior secured financing, (2) entering into an interim loan agreement that provides us with $1.0 billion of senior unsecured financing, (3) completing a $400 million offering of convertible perpetual preferred stock, (4) completing cash tender offers to purchase $2.03 billion of our previously outstanding senior notes and $319 million of our previously outstanding senior subordinated notes and consent solicitations with respect to proposed amendments to the indentures governing each outstanding series of notes, and (5) prepaying and terminating our Senior Subordinated Credit Agreement, our Amended and Restated Credit Agreement, and our Term Loan Agreement. In order to complete the Recapitalization Transactions, we also entered into amendments, waivers, and consents to our prior senior secured credit facility, $200 million senior unsecured term loan agreement, and $355 million senior subordinated credit agreement.
We used a portion of the proceeds of the loans under the new senior secured credit facilities, the proceeds of the interim loans, and the proceeds of the $400 million offering of convertible perpetual preferred stock, along with cash on hand, to prepay substantially all of our prior indebtedness and to pay fees and expenses related to such prepayment and the Recapitalization Transactions. The remainder of the proceeds and availability under the senior secured credit facilities are expected to be used for general corporate purposes. In addition, the letters of credit issued under the revolving letter of credit subfacility and the synthetic letter of credit facility, each described below, will be used in the ordinary course of business to secure workers’ compensation and other insurance coverages and for general corporate purposes. We anticipate refinancing the $1 billion interim loans in the second quarter or third quarter of 2006 through an issuance of high-yield debt securities.
In addition, on March 10, 2006, we announced the results of our cash tender offers and consent solicitation. As of the expiration of the tender offers, approximately $2.0 billion in aggregate principal amount of our senior notes, representing 98.4% of the senior notes, and approximately $289.0 million in aggregate principal amount of our senior subordinated notes, representing 90.5% of the senior subordinated notes, were validly tendered for purchase and not withdrawn, and we accepted such notes for purchase. The aggregate purchase price, including accrued and unpaid interest and the consent payment, was approximately $2.5 billion.
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governing our new indebtedness, we have minimal maturities until 2013 when our new term loans come due. The extension of our debt maturities has substantially reduced the risk and uncertainty associated with our near-term refinancing obligations under our prior debt.
• Improved operational flexibility—We have negotiated new loan covenants with higher leverage ratios and lower interest coverage
ratios. In addition, our new loan agreements increase our ability to enter into certain transactions (e.g. acquisitions and sale-leaseback transactions).
• Increased liquidity—As a result of the Recapitalization Transactions, our revolving line of credit has increased by approximately
$150 million. In addition, the increased flexibility provided by the covenants governing our new indebtedness will allow us greater access to our revolving credit facility than we had under our prior indebtedness.
• Improved credit profile—By issuing $400 million in convertible perpetual preferred stock and using the net proceeds from that offering to repay a portion of our outstanding indebtedness and to pay fees and expenses related to such prepayment, we were able to reduce the amount we ultimately borrowed under the interim loan agreement. Accordingly, we have improved our capital structure. In addition, by increasing the ratio of our secured debt to unsecured debt, our capital structure is now closer to industry norms. Further, a substantial amount of our new indebtedness is prepayable without penalty, which will enable us to reduce debt and interest expense as operating and non-operating cash flows allow without the substantial cost associated with the prepayment of our prior public indebtedness.
• Reduced interest rate exposure—By completing the Recapitalization Transactions we have taken advantage of current interest rates, which are relatively low compared to historical rates, and eliminated the need to refinance our debt over the next four years in what we perceive to be a rising interest-rate environment. In addition, we have entered into an interest rate swap to reduce our variable rate debt exposure.
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Index to Financial Statements
Credit Agreement
On March 10, 2006, we entered into a credit agreement (the “Credit Agreement”) with a consortium of financial institutions (collectively, the “Lenders”), JPMorgan Chase Bank, N.A., as the administrative agent and the collateral agent (“JPMorgan”), Citicorp North America, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as co-syndication agents, and Deutsche Bank Securities Inc., Goldman Sachs Credit Partners L.P. and Wachovia Bank, National Association, as co-documentation agents.
The Credit Agreement provides for extensions of credit of up to $2.55 billion of senior secured financing. The $2.55 billion available under the Credit Agreement includes (1) a six-year $400 million revolving credit facility (the “Revolving Loans”), with a revolving letter of credit subfacility and swingline loan subfacility, (2) a six-year $100 million synthetic letter of credit facility and (3) a seven-year $2.05 billion term loan facility (the “Term Loans”). The Term Loans amortize in quarterly installments, commencing with the quarter ending on September 30, 2006, equal to 0.25% of the original principal amount thereof, with the balance payable upon the final maturity. The Term Loans and, prior to the “Leverage Pricing Date” (as defined in the Credit Agreement), the Revolving Loans bear interest (1) if we have received an initial corporate credit rating after entering into the Credit Agreement of B+ or better by S&P and B1 or better by Moody’s (in each case with at least a stable outlook), at a rate of, at our option, (a) LIBOR, adjusted for statutory reserve requirements (“Adjusted LIBOR”), plus 2.50% or (b) 1.50% plus the higher of (i) the federal funds rate plus 0.50% and (ii) JPMorgan’s prime rate, (2) if we have received an initial corporate credit rating after entering into the Credit Agreement of B or better by S&P and B2 or better by Moody’s (in each case with at least a stable outlook), at a rate of, at our option, (a) Adjusted LIBOR plus 2.75% or (b) 1.75% plus the higher of (i) the federal funds rate plus 0.50% and (ii) JPMorgan’s prime rate or (3) if we have not received an initial corporate credit rating from either or both of S&P and Moody’s after entering into the Credit Agreement, or have not received an initial corporate credit rating of at least B by S&P and B2 by Moody’s (in each case with at least a stable outlook), at a rate of, at our option, (a) Adjusted LIBOR plus 3.25% or (b) 2.25% plus the higher of (i) the federal funds rate plus 0.50% and (ii) JPMorgan’s prime rate. After the Leverage Pricing Date, the revolving loans will bear interest at a rate of, at our option, (1) Adjusted LIBOR or (2) the higher of (a) the federal funds rate plus 0.50% and (b) JPMorgan’s prime rate, in each case, plus an applicable margin that varies depending upon our leverage ratio and our initial corporate credit rating after entering into the Credit Agreement.
The Credit Agreement contains customary representations, warranties, and affirmative and negative covenants. The Credit Agreement also includes customary events of default, including, without limitation, payment defaults, cross-defaults to other material indebtedness and bankruptcy-related defaults. If any “event of default” (as defined in the Credit Agreement) occurs and is continuing, JPMorgan may, and at the request of the required Lenders will, terminate the commitments and declare all of the amounts owed under the Credit Agreement to be immediately due and payable.
Pursuant to a Collateral and Guarantee Agreement (the “Collateral and Guarantee Agreement”), dated as of March 10, 2006, between us, our subsidiaries identified therein (collectively, the “Subsidiary Guarantors”) and JPMorgan, our obligations under the Credit Agreement are (1) secured by substantially all of our assets and the assets of the Subsidiary Guarantors and (2) guaranteed by the Subsidiary Guarantors. In addition to the Collateral and Guarantee Agreement, we and the Subsidiary Guarantors agreed to enter into mortgages with respect to certain of our material real property (excluding real property owned by the surgery centers division or otherwise subject to preexisting liens and/or mortgages) in connection with the Credit Agreement. Our obligations under the Credit Agreement will be secured by the real property subject to such mortgages.
Interim Loan Agreement
On March 10, 2006, we and the Subsidiary Guarantors also entered into the Interim Loan Agreement (the “Interim Loan Agreement”) with a consortium of financial institutions (collectively, the “Interim Lenders”), Merrill Lynch Capital Corporation, as administrative agent (“Merrill”), Citicorp North America, Inc. and
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JPMorgan, as co-syndication agents, and Deutsche Bank AG Cayman Islands Branch, Goldman Sachs Credit Partners L.P. and Wachovia Bank, National Association, as co-documentation agents. The Interim Loan Agreement provides us with $1 billion of senior unsecured interim financing. The loans under the Interim Loan Agreement will mature on March 10, 2007 (the “Initial Maturity Date”). Any Interim Lender who has not been repaid in full on or prior to the Initial Maturity Date will have the option to receive exchange notes (the “Exchange Notes”) issued under an indenture (the “Exchange Note Indenture”) in exchange for the outstanding loan. If any such Lender does not exchange its loans for Exchange Notes on the Initial Maturity Date, the maturity date of the loans will automatically extend to March 10, 2014, prior to which such Lender may exchange its loans for Exchange Notes at any time. The proceeds of the loans under the Interim Loan Agreement were used to refinance a portion of our prior indebtedness and to pay fees and expenses related to such refinancing. Our obligations under the Interim Loan Agreement are guaranteed by the Subsidiary Guarantors.
Prior to the Initial Maturity Date, subject to certain agreed upon minimum and maximum rates, the loans will bear interest at a rate per annum equal to: (1) Adjusted LIBOR, plus 4.50% for the period following the closing date on March 10, 2006 and ending prior to September 10, 2006 and (2) Adjusted LIBOR plus 5.50% as of September 10, 2006 and an additional 0.50% at the end of each three-month period commencing on September 10, 2006 until but excluding the Initial Maturity Date. After the Initial Maturity Date, subject to certain agreed upon minimum and maximum rates, the loans that have not been repaid or exchanged for Exchange Notes will bear interest at the rate borne by the loans on the day immediately preceding the Initial Maturity Date plus 0.50% during the three-month period commencing on the Initial Maturity Date and an additional 0.50% at the beginning of each subsequent three-month period.
The Interim Loan Agreement contains representations and warranties, affirmative and negative covenants, and default and acceleration provisions that are substantially similar to the provisions contained in the Credit Agreement. However, following the Initial Maturity Date, most of the affirmative covenants will cease to apply to us or the Subsidiary Guarantors and the negative covenants and the default and acceleration provisions will be replaced by those contained in the Exchange Note Indenture (such provisions are customary for high yield transactions).
As described above, a portion of our proceeds from the series of Recapitalization Transactions were used to prepay substantially all of our prior indebtedness. Our prepayment of indebtedness included loans under the following agreements: (1) Senior Subordinated Credit Agreement, dated as of January 16, 2004, by and among us, the lenders party thereto, and Credit Suisse, as administrative agent and syndication agent (the “Senior Subordinated Credit Agreement”); (2) Amended and Restated Credit Agreement, dated as of March 21, 2005, by and among us, the lenders party thereto, JPMorgan, as administrative agent and collateral agent, Wachovia Bank, National Association, as syndication agent, and Deutsche Bank Trust Company Americas, as documentation agent (the “Amended and Restated Credit Agreement”); and (3) Term Loan Agreement, dated as of June 15, 2005, by and among us, the lenders party thereto, JPMorgan, as administrative agent, Citicorp North America, Inc., as syndication agent, and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc. as co-lead arrangers and joint bookrunners (the “Term Loan Agreement”).
Upon the closing of the Recapitalization Transactions on March 10, 2006, we prepaid and terminated the Senior Subordinated Credit Agreement, the Amended and Restated Credit Agreement, and the Term Loan Agreement. Descriptions of each of the terminated agreements follow.
Senior Subordinated Credit Agreement
On January 16, 2004, we entered into the $355 million Senior Subordinated Credit Agreement, which had an interest rate of 10.375% per annum, payable quarterly, with a 7-year maturity, callable after the third year with a premium.
On February 15, 2006, we entered into a consent and waiver (the “Consent”) to the Senior Subordinated Credit Agreement. Pursuant to the terms of the Consent, the “required lenders” (as defined in the Senior
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Subordinated Credit Agreement) consented to the prepayment of all outstanding loans in full (together with all accrued and unpaid interest) on or prior to March 20, 2006 and waived certain provisions of the Senior Subordinated Credit Agreement to the extent such provisions prohibited such prepayment. Pursuant to the Consent, along with the payment-in-full of all principal amount of loans and accrued and unpaid interest thereon owed under the Senior Subordinated Credit Agreement, we paid a prepayment premium equal to 15.00% of the principal amount of the loans.
Amended and Restated Credit Agreement
The Amended and Restated Credit Agreement amended and restated the Credit Agreement dated as of June 14, 2002, as amended on August 20, 2002 (the “2002 Credit Agreement”), among us, the lenders from time to time party thereto, JPMorgan, as administrative agent, Wachovia Bank, National Association, as syndication agent, UBS Warburg LLC, ScotiaBanc, Inc., and Deutsche Bank AG, New York Branch, as co-documentation agents, and Bank of America, N.A., as senior managing agent.
Pursuant to the Amended and Restated Credit Agreement, the lenders converted $315 million in aggregate principal amount of the loans outstanding under the 2002 Credit Agreement into a senior secured term facility which would have matured on June 14, 2007 (the “Senior Term Loans”). Such maturity date for the Senior Term Loans, however, would have automatically been extended to March 21, 2010 in the event that (1) such extension became permitted under our Senior Subordinated Credit Agreement or (2) the Senior Subordinated Credit Agreement ceased to be in effect. The Senior Term Loans amortized in quarterly installments, commencing with the quarter ended on September 30, 2005, equal to 0.25% of the original principal amount thereof, with the balance payable upon the final maturity. Until we had obtained ratings from Moody’s and S&P, the Senior Term Loans carried interest, at our option, at a rate of (1) Adjusted LIBOR plus 2.50% or (2) 1.50% plus the higher of (a) the Federal Funds Rate plus 0.50% and (b) JPMorgan’s prime rate. After we had obtained such ratings, the Senior Term Loans carried interest, at our option, (1) at a rate of Adjusted LIBOR plus a spread ranging from 2.00% to 2.50%, depending on our ratings with such institutions or (2) at a rate of a spread ranging from 1.00% to 1.50%, depending on our ratings with such institutions, plus the higher of (a) the Federal Funds Rate plus 0.50% and (b) JPMorgan’s prime rate.
In addition, the Amended and Restated Credit Agreement made available to us a senior secured revolving credit facility in an aggregate principal amount of $250 million (the “Revolving Facility”) and a senior secured revolving letter of credit facility in an aggregate principal amount of $150 million (the “LC Facility”). The commitments under the Revolving Facility and the LC Facility would have expired, and all borrowings under such facilities would have matured, on March 21, 2010.
Pursuant to the Collateral and Guarantee Agreement (the “2005 Collateral and Guarantee Agreement”), dated as of March 21, 2005, between us and JPMorgan, our obligations under the Amended and Restated Credit Agreement were secured (1) by substantially all of our assets and (2) from and after the date on which the Restrictive Indentures (as defined in the Amended and Restated Credit Agreement) and the Senior Subordinated Credit Agreement permitted the obligations (or an amount thereof) to be guaranteed by or secured by the assets of certain of our existing and subsequently acquired or organized material subsidiaries by substantially all of the assets of such subsidiaries. The 2005 Collateral and Guarantee Agreement, along with the guaranty obligation made and the security interests granted therein terminated automatically upon the termination of the Amended and Restated Credit Agreement.
On February 22, 2006, we entered into an amendment and waiver (the “Waiver”) to the Amended and Restated Credit Agreement. Pursuant to the terms of the Waiver, the “required lenders” (as defined in the Amended and Restated Credit Agreement) waived, in the event that all the transactions contemplated by the Recapitalization Transactions did not occur substantially simultaneously, certain provisions of the Amended and Restated Credit Agreement, to the extent such waiver was required to permit us to apply 100% of the net
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proceeds of the issuance of the convertible perpetual preferred stock to the prepayment or repayment of other prior indebtedness. In connection with the Waiver, we paid to each lender executing the Waiver on or prior to 5:00 p.m., February 22, 2006, a waiver fee equal to 0.05% of the principal amount of such lender’s loans.
Term Loan Agreement
On June 15, 2005, we obtained a senior unsecured term facility consisting of term loans (the “Term Loan Agreement”) in an aggregate principal amount of $200 million (the “Term Loans”). The Term Loans initially carried interest at a rate of Adjusted LIBOR plus 5.0% per year (the “Initial Rate”) and thereafter, at our option, at a rate of (1) the Initial Rate or (2) 4.0% per year plus the higher of (a) JPMorgan’s prime rate and (b) the Federal Funds Rate plus 0.50%. The Term Loans would have matured in full on June 15, 2010.
On February 15, 2006, we entered into an amendment and waiver (the “Amendment”) to the Term Loan Agreement. Pursuant to the terms of the Amendment, the “required lenders” (as defined in the Term Loan Agreement) amended certain provisions of the Term Loan Agreement to the extent such provisions prohibited a prepayment of the loans thereunder prior to June 15, 2006. In connection with the Amendment, we paid to each lender executing the Amendment on or prior to 5:00 p.m., February 15, 2006, an amendment fee equal to 1.00% of the principal amount of such lender’s loans. In connection with the prepayment-in-full of the principal amount of loans and accrued and unpaid interest thereon owed under the Term Loan Agreement, we paid a prepayment fee equal to 2.00% of the aggregate principal amount of the prepayment.
The foregoing descriptions of each of the agreements referenced above are qualified in their entirety by the complete text of the agreements, which are referenced in Item 15, Exhibits and Financial Statement Schedules , and are incorporated herein by reference.
Status of Long-Term Indebtedness and Liquidity
The face value of our long-term debt (excluding notes payable to banks and others, noncompete agreements, and capital lease obligations) before and after the Recapitalization Transactions is summarized in the following table:
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As of
December 31, 2005 As of
March 10, 2006 (In Thousands) Revolving credit facility $ — $ 50,000 Term loans 513,425 3,050,000 Bonds payable 2,720,907 80,101
$ 3,234,332 $ 3,180,101
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The following charts show our scheduled payments on long-term debt (excluding notes payable to banks and others, noncompete agreements, and capital lease obligations) for the next five years and thereafter before and after the above described Recapitalization Transactions. The charts also exclude the convertible perpetual preferred stock, which is described in Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities .
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* Interim Loan Agreement maturity, which is subject to automatic extension
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As noted above, we have negotiated new debt covenants as part of the Recapitalization Transactions. These covenants include higher leverage ratios and lower interest coverage ratios. The following chart shows a comparison of these two restrictive covenants as of March 31, 2006 under our former Amended and Restated Credit Agreement and our new Credit Agreement:
As of December 31, 2005, we had approximately $175.5 million in cash and cash equivalents and $23.8 million in marketable securities. We also had approximately $242.5 million in “restricted cash,” which is cash we cannot use because of various obligations we have under lending agreements, partnership agreements, and other arrangements primarily related to our captive insurance company. For more information about our liquidity, please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , “Liquidity and Capital Resources,” Note 1, Summary of Significant Accounting Policies , Note 2, Liquidity , and Note 8, Long-term Debt , to our accompanying consolidated financial statements.
Securities Litigation Settlement
On June 24, 2003, the United States District Court for the Northern District of Alabama consolidated a number of separate securities lawsuits filed against us under the caption In re HealthSouth Corp. Securities Litigation , Master Consolidation File No. CV-03-BE-1500-S (the “Consolidated Securities Action”). The Consolidated Securities Action included two prior consolidated cases ( In re HealthSouth Corp. Securities Litigation , CV-98-J-2634-S and In re HealthSouth Corp. 2002 Securities Litigation , Consolidated File No. CV-02-BE-2105-S) as well as six lawsuits filed in 2003. Including the cases previously consolidated, the Consolidated Securities Action comprised over 40 separate lawsuits. The court divided the Consolidated Securities Action into two subclasses:
On February 22, 2006, we announced that we had reached a global, preliminary agreement in principle with the lead plaintiffs in the Stockholder Securities Action, the Bondholder Securities Action, and the derivative litigation, as well as with our insurance carriers, to settle claims filed in those actions against us and many of our former directors and officers. Under the proposed settlement, claims brought against the settling defendants will be settled for consideration consisting of HealthSouth common stock and warrants valued at approximately $215 million and cash payments by our insurance carriers of $230 million. In addition, we have agreed to give the class 25% of our net recovery from any future judgments won by us or on our behalf against Richard M. Scrushy, our former Chairman and Chief Executive Officer, Ernst & Young LLP, our former auditor, and certain affiliates
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Required Ratios at March 31, 2006
New Credit
Agreement
Former Amended and
Restated Credit Agreement
Minimum interest coverage ratio 1.65 to 1.00 2.00 to 1.00 Maximum leverage ratio 7.25 to 1.00 5.50 to 1.00
• Complaints based on purchases of our common stock were grouped under the caption In re HealthSouth Corp. Stockholder Litigation , Consolidated Case No. CV-03-BE-1501-S (the “Stockholder Securities Action”), which was further divided into complaints based on purchases of our common stock in the open market (grouped under the caption In re HealthSouth Corp. Stockholder Litigation, Consolidated Case No. CV-03-BE-1501-S) and claims based on the receipt of our common stock in mergers (grouped under the caption HealthSouth Merger Cases , Consolidated Case No. CV-98-2777-S). Although the plaintiffs in the HealthSouth Merger Cases have separate counsel and have filed separate claims, the HealthSouth Merger Cases are otherwise consolidated with the Stockholder Securities Action for all purposes.
• Complaints based on purchases of our debt securities were grouped under the caption In re HealthSouth Corp. Bondholder
Litigation , Consolidated Case No. CV-03-BE-1502-S (the “Bondholder Securities Action” ).
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of UBS Group, our former lead investment banker, none of whom are included in the settlement. The proposed settlement is subject to a number of conditions, including the successful negotiation of definitive documentation and final court approval. The proposed settlement does not include Richard M. Scrushy or any director or officer who has agreed to plead guilty or otherwise been convicted in connection with our former financial reporting activities.
There can be no assurances that a final settlement agreement can be reached or that the proposed settlement will receive the required court approval. For additional information about the Consolidated Securities Action, see Item 3, Legal Proceedings , “Securities Litigation.”
Medicare Program Settlement
The Civil DOJ Settlement
On January 23, 2002, the United States intervened in four lawsuits filed against us under the federal civil False Claims Act. These so-called “ qui tam ” ( i.e. , whistleblower) lawsuits were transferred to the Western District of Texas and were consolidated under the caption United States ex rel. Devage v. HealthSouth Corp., et al. , No. 98-CA-0372 (DWS) (W.D. Tex. San Antonio). On April 10, 2003, the United States informed us that it was expanding its investigation to review whether fraudulent accounting practices affected our previously submitted Medicare cost reports.
On December 30, 2004, we entered into a global settlement agreement (the “Settlement Agreement”) with the United States. This settlement was comprised of (1) the claims consolidated in the Devage case, which related to claims for reimbursement for outpatient physical therapy services rendered to Medicare, the TRICARE Management Activity (“TRICARE”), or United States Department of Labor (“DOL”) beneficiaries, (2) the submission of claims to Medicare for costs relating to our allegedly improper accounting practices, (3) the submission of other unallowable costs included in our Medicare Home Office Cost Statements and in our individual provider cost reports, and (4) certain other conduct (collectively, the “Covered Conduct”). The parties to this global settlement include us and the United States acting through the DOJ’s civil division, the HHS-OIG, the DOL through the Employment Standards Administration’s Office of Workers’ Compensation Programs, Division of Federal Employees’ Compensation (“OWCP-DFEC”), TRICARE, and certain other individuals and entities which had filed civil suits against us and/or our affiliates (those other individuals and entities, the “Relators”).
Pursuant to the Settlement Agreement, we agreed to make cash payments to the United States in the aggregate amount of $325 million, plus accrued interest from November 4, 2004 at an annual rate of 4.125%. The United States agreed, in turn, to pay the Relators the portion of the settlement amount due to the Relators pursuant to the terms of the Settlement Agreement. Through December 31, 2005, we have made payments of approximately $155 million (excluding interest), with the remaining balance of $170 million (plus interest) to be paid in quarterly installments ending in the fourth quarter of 2007.
The Settlement Agreement provides for our release by the United States from any civil or administrative monetary claim the United States had or may have had relating to Covered Conduct that occurred on or before December 31, 2002 (with the exception of Covered Conduct for certain outlier payments, for which the release date is extended to September 30, 2003). The Settlement Agreement also provides for our release by the Relators from all claims based upon any transaction or incident occurring prior to December 30, 2004, including all claims that have been or could have been asserted in each Relator’s civil action, and from any civil monetary claim the United States had or may have had for the Covered Conduct that is pled in each Relator’s civil action.
The Settlement Agreement also provides for the release of HealthSouth by the HHS-OIG and OWCP-DFEC, and the agreement by the HHS-OIG and OWCP-DFEC to refrain from instituting, directing, or maintaining any administrative action seeking exclusion from Medicare, Medicaid, the FECA Program, the TRICARE Program, and other federal health care programs, as applicable, for the Covered Conduct. The DOJ continues to review certain other matters, including self-disclosures made by us to the HHS-OIG.
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The Administrative Settlement Agreement
In connection with the Settlement Agreement, we entered into a separate settlement agreement (the “Administrative Settlement Agreement”) with the Centers for Medicare & Medicaid Services (“CMS”) acting on behalf of HHS, to resolve issues associated with various Medicare cost reporting practices.
Subject to certain exceptions and the terms and conditions of the Administrative Settlement Agreement, the Administrative Settlement Agreement provides for the release of HealthSouth by CMS from any obligations related to any cost statements or cost reports that had or could have been submitted to CMS or its fiscal intermediaries by HealthSouth for cost reporting periods ended on or before December 31, 2003. The Administrative Settlement Agreement provides that all covered cost reports be closed and considered final and settled.
The December 2004 Corporate Integrity Agreement
On December 30, 2004, we entered into a new corporate integrity agreement (the “CIA”) with the HHS-OIG. This new CIA has an effective date of January 1, 2005 and a term of five years from that effective date. It incorporates a number of compliance program changes already implemented by us and requires, among other things, that not later than 90 days after the effective date we:
On April 28, 2005, we submitted an implementation report to the HHS-OIG stating that we had, within the 90-day time frame, materially complied with the initial requirements of this new CIA.
The CIA also requires that we engage an Independent Review Organization (“IRO”) to assist us in assessing and evaluating: (1) our billing, coding, and cost reporting practices with respect to our inpatient rehabilitation facilities, (2) our billing and coding practices for outpatient items and services furnished by outpatient departments of our inpatient facilities and through other HealthSouth outpatient rehabilitation facilities; and (3) certain other obligations pursuant to the CIA and the Settlement Agreement. We have engaged PricewaterhouseCoopers LLP to serve as our IRO.
Failure to meet our obligations under our CIA could result in stipulated financial penalties. Failure to comply with material terms, however, could lead to exclusion from further participation in federal health care programs, including Medicare and Medicaid, which currently account for a substantial portion of our revenues.
SEC Settlement
On June 6, 2005, the SEC approved a settlement (the “SEC Settlement”) with us relating to the action filed by the SEC on March 19, 2003 captioned SEC v. HealthSouth Corporation and Richard M. Scrushy , No.
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• form an executive compliance committee (made up of our chief compliance officer and other executive management members),
which shall participate in the formulation and implementation of HealthSouth’s compliance program;
• require certain independent contractors to abide by our Standards of Business Conduct;
• provide general compliance training to all HealthSouth personnel as well as specialized training to personnel responsible for billing,
coding, and cost reporting relating to federal health care programs;
• report and return overpayments received from federal health care programs;
• notify the HHS-OIG of any new investigations or legal proceedings initiated by a governmental entity involving an allegation of
fraud or criminal conduct against HealthSouth;
• notify the HHS-OIG of the purchase, sale, closure, establishment, or relocation of any facility furnishing items or services that are
reimbursed under federal health care programs; and
• submit regular reports to the HHS-OIG regarding our compliance with the CIA.
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CV-03-J-0615-S (N.D. Ala.) (the “SEC Litigation”). That lawsuit alleges that HealthSouth and our former Chairman and Chief Executive Officer, Richard M. Scrushy, violated and/or aided and abetted violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. The civil claims against Mr. Scrushy are still pending.
Under the terms of the SEC Settlement, we have agreed, without admitting or denying the SEC’s allegations, to be enjoined from future violations of certain provisions of the securities laws. We have also agreed to:
We retained a qualified governance consultant to perform a review of the adequacy and effectiveness of our corporate governance systems, policies, plans, and practices, which review is now complete. The consultant’s report of that review concludes, among other things, that “[t]he company’s current practices, created by the new directors and executives, meet contemporary standards of corporate governance.” In addition, we have chosen to provide the SEC all communications between our independent auditor and our management and/or Audit Committee rather than retaining an accounting consultant to review the effectiveness of our internal controls. Further, we hired Shirley Yoshida, formerly Vice President, Internal Audit at Safeway Inc., to serve as our Inspector General and to lead our internal audit department. We continue to comply with the other terms of the SEC Settlement.
The SEC Settlement also provides that we must treat the amounts ordered to be paid as civil penalties as penalties paid to the government for all purposes, including all tax purposes, and that we will not be able to be reimbursed or indemnified for such payments through insurance or any other source, or use such payments to set off or reduce any award of compensatory damages to plaintiffs in related securities litigation pending against us.
In connection with the SEC Settlement, we consented to the entry of a final judgment in the SEC Litigation (which judgment was entered by the United States District Court for the Northern District of Alabama, Southern Division) to implement the terms of the SEC Settlement. However, Mr. Scrushy remains a defendant in the SEC Litigation.
For additional information about the SEC Settlement, see Note 22, SEC Settlement , to our accompanying consolidated financial statements.
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• pay a $100 million civil penalty and disgorgement of $100 to the SEC in the following installments: $12,500,100 by October 15,
2005, $12.5 million by April 15, 2006, $25 million by October 15, 2006; $25 million by April 15, 2007, and $25 million by October 15, 2007;
• retain a qualified governance consultant to perform a review of the adequacy and effectiveness of our corporate governance systems,
policies, plans, and practices;
• either (1) retain a qualified accounting consultant to perform a review of the effectiveness of our material internal accounting control structure and policies, as well as the effectiveness and propriety of our processes, practices, and policies for ensuring our financial data is accurately reported in our filed consolidated financial statements, or (2) within 60 days of filing with the SEC audited consolidated financial statements for the fiscal year ended December 31, 2005, including our independent auditor’s attestation on internal control over financial reporting, provide to the SEC all communications between our independent auditor and our management and/or Audit Committee from the date of the judgment until such report concerning our internal accounting controls;
• provide reasonable training and education to certain of our officers and employees to minimize the possibility of future violations of
the federal securities laws;
• continue to cooperate with the SEC and the DOJ in their respective ongoing investigations; and
• create, staff, and maintain the position of Inspector General within HealthSouth, which position shall have the responsibility of
reporting any indications of violations of law or of HealthSouth’s procedures, insofar as they are relevant to the duties of the Audit Committee, to the Audit Committee.
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Our Business
We have spent more than three years responding to the various legal, financial, and operational challenges resulting from the financial fraud perpetrated by certain members of our prior management team. During that time we have also developed and begun implementation of a three-phase strategic plan to reposition HealthSouth as a leading provider of post-acute care and select ambulatory services. To achieve this goal we have established a multi-year operational plan that strives to improve our business in five key areas: revenue, cost, quality, people, and infrastructure.
In 2005, the first year of our strategic plan, we made improvements in each of the five key areas listed in our operational agenda:
We are now in the second year of our strategic plan. In our inpatient division, we remain committed to growth in the inpatient rehabilitation market and anticipate exploring both consolidation and new development opportunities as they arise. In addition, we are planning to expand the post-acute care services provided at or complementary to our inpatient facilities, such as long-term acute care, skilled nursing, and home health services. We continue to evaluate which services to expand, and we are analyzing recent proposed reimbursement changes, such as those affecting long-term acute care hospitals, as part of our evaluation process. In our outpatient divisions (surgery, outpatient rehabilitation, and diagnostic) we are (1) focusing on key markets, and where necessary, divesting under-performing facilities, (2) standardizing operating performance and
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• Revenue—We helped advocate a slower phase-in of the 75% Rule and, we believe, outperformed the industry in mitigating the impact of the 75% Rule. We consolidated outpatient revenue centers and overhauled our outpatient sales and marketing function. We also piloted various new programs to enhance our marketing and have hired a new senior vice president to improve our managed care contracting function.
• Cost—We substantially reduced unnecessary overhead expense and closed or sold under-performing facilities. We have also hired a new senior vice president to manage and streamline our supply chain. We will continue to work to reduce costs by reorganizing and flattening each operating division and implementing standardized labor management metrics and performance expectations. In addition, we are closely monitoring our business and will, when necessary, close or sell additional under-performing facilities.
• Quality—We began an inpatient clinical information assessment, increased production of our AutoAmbulator, and participated in various clinical research projects. We are also working to enhance strong quality assurance programs within our facilities and divisions. We plan to supplement these programs by improving our company-wide quality agenda that will include standardized division-specific quality metrics and improved clinical information through the use of technology.
• People—We completed our senior management team and hired a number of other management personnel. We also completed a
human resources strategic plan and increased 401(k) contributions for our employees. Our goal is to build a culture of integrity, transparency, diversity, and excellence, while simplifying and flattening our organizational structure.
• Infrastructure—We invested significant resources to evaluate and improve our financial, reporting, and compliance infrastructure, and will continue to invest heavily in our infrastructure throughout this turnaround period. Although our infrastructure needs further improvement in many areas, we are specifically focused on implementing required internal controls (e.g., compliance with Section 404 of the Sarbanes-Oxley Act of 2002), enhancing our financial infrastructure (e.g., improving financial and operational reporting and establishing a formal capital expenditure process and formal budget process), enhancing our management reporting capabilities (e.g., standardizing our monthly reporting and analysis, standardizing our financial projections, and implementing a faster month-end close), developing regulatory compliance programs, enhancing our information systems (e.g. upgrading our patient accounting systems), and implementing an information technology strategic plan.
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implementing best practices across our divisions, and (3) exploring growth opportunities in both core markets and new markets. We also have received inquiries from parties interested in acquiring our diagnostic division and have hired an investment bank to assist us in evaluating those opportunities. As we continue to implement our strategic plan, we will evaluate the role of each division, including the diagnostic division, in that plan. Even if consistent with our strategic plan, an important consideration in our decision to divest any material asset from our portfolio would be whether the transaction would help to deleverage the company and add value for our stockholders.
Industry Trends
As a provider of rehabilitative health care, ambulatory surgery, and diagnostic services, our revenues and growth are affected by trends in health care spending. According to estimates published by CMS, the health care sector is growing faster than the overall economy. The United States’ estimated gross domestic product (“GDP”) was $12.5 trillion in 2005, representing a 6.1% increase since 2004, while national health care spending in 2005 was an estimated $2 trillion, representing a 7.4% increase over the prior year. Health care spending is expected to continue to grow as a percentage of GDP over the next ten years. CMS estimates that health care spending constituted 16.2% of GDP in 2005, up from 16% in 2004 and 13.8% in 2000. By 2015 health care spending is projected to reach $4 trillion, or 20% of GDP. The rate of health care spending growth is projected to remain relatively stable at an annual rate of 7.2% per year on average.
Demographic factors contribute to long-term growth projections in health care spending. According to the U.S. Census Bureau’s 2004 interim projections, there were approximately 35 million Americans aged 65 or older. The number of Americans aged 65 or older is expected to increase to approximately 40 million by 2010 and approximately 54 million by 2020. By 2030, the number of Americans aged 65 or older is expected to reach approximately 70 million, or 20% of the U.S. population.
We believe that the aging of the U.S. population and the continuing growth in health care spending will increase demand for the types of services we provide. First, many of the health conditions associated with aging—such as strokes and heart attacks, neurological disorders, and diseases and injuries to the muscles, bones, and joints—will increase the demand for ambulatory surgery and rehabilitative services. Second, pressure from payors to provide efficient, high-quality health care services is forcing many procedures traditionally performed in acute care facilities out of the acute care environment. However, as discussed in this Item, “Sources of Revenues,” decreasing Medicare spending remains a major focus of the federal government and any reduction in reimbursement rates applicable to the services we provide will have a negative impact on our business.
Operating Divisions
We believe that demographics, regulation, payor pressures to reduce cost, technological advancements, and increased quality requirements will continue to fuel demand for our services because our post-acute and select ambulatory services are, on the whole, more cost effective. We believe we can take advantage of these health care trends in the markets we currently occupy as well as leverage our size and expertise to expand our services and increase our influence in new markets.
We currently provide various patient care services through four primary operating divisions and certain other services through a fifth division, which together correspond to our five reporting segments. Although we have no current plans to change our operating divisions, we are continually evaluating and looking to optimize our operational structure and the mix of services we provide, which may lead to future changes in our operating divisions. Our consolidated net operating revenues were $3.2 billion for the fiscal year ended December 31, 2005. We had a diversified payor mix across all our reporting segments, with Medicare representing the highest percentage of revenues.
For additional information regarding our business segments and related information, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , “Segment Results of Operations,” and Note 25, Segment Reporting , to our accompanying consolidated financial statements.
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Inpatient
We are the nation’s largest provider of inpatient rehabilitation services. Our inpatient division operates inpatient rehabilitation facilities (“IRFs”) and long-term acute care hospitals (“LTCHs”) and provides treatment on both an inpatient and outpatient basis. Our inpatient facilities are located in 28 states, with a concentration of facilities in Texas, Pennsylvania, Florida, Tennessee, and Alabama. We also have facilities in Puerto Rico and Australia.
As of December 31, 2005, our inpatient division operated 93 freestanding IRFs (65 of which are wholly owned and 28 of which are jointly owned). As of December 31, 2005, our inpatient division also operated 10 LTCHs (9 of which are wholly owned and 1 of which is jointly owned), 7 of which are freestanding and 3 of which are hospital-within-hospital facilities. As of December 31, 2005, our inpatient division also provided outpatient services through 101 facilities (81 of which are wholly owned and 20 of which are jointly owned) located within our IRFs or in satellite facilities near our IRFs. In addition to facilities in which we have an ownership interest, our inpatient division operated 14 inpatient rehabilitation units, 11 outpatient facilities, and 2 gamma knife radiosurgery centers through management contracts as of December 31, 2005.
Our IRFs provide services to patients who require intensive inpatient rehabilitative care. Inpatient rehabilitation patients typically experience significant physical disabilities due to various conditions, such as head injury, spinal cord injury, stroke, certain orthopedic problems, and neuromuscular disease. Our IRFs provide the medical, nursing, therapy, and ancillary services required to comply with local, state, and federal regulations, as well as accreditation standards of the Joint Commission on Accreditation of Healthcare Organizations (the “JCAHO”) and, for some facilities, the Commission on Accreditation of Rehabilitation Facilities.
Although the market for inpatient rehabilitation services is highly competitive, it is also highly fragmented. This fragmentation creates potential consolidation opportunities for us. In addition, because of our size, we believe we differentiate ourselves from our competitors in the following ways:
Our inpatient division’s payor mix is weighted toward government-funded sources, particularly Medicare. For the years ended December 31, 2005, 2004, and 2003, Medicare represented 71.2%, 70.6%, and 71.1%, respectively, of the inpatient division’s net operating revenues, which totaled $1.8 billion, $2.0 billion, and $2.0 billion, respectively.
As discussed later in this Item, “Sources of Revenues,” two recent changes in regulations governing IRF reimbursement have combined to create a very challenging operating environment for our inpatient division. The first change occurred on May 7, 2004, when CMS issued a final rule stipulating revised criteria for qualifying as an IRF under Medicare. This rule, known as the “75% Rule,” has created significant volume volatility in our inpatient division. The second change, which became effective on October 1, 2005, relates to reduced unit pricing applicable to IRFs.
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• Quality . Our IRFs provide a broad base of clinical experience from which we have developed clinical best practices and protocols.
We believe these clinical best practices and protocols help ensure the delivery of consistently high quality rehabilitative services across all of our IRFs.
• Cost Effectiveness . Our size also helps us provide inpatient rehabilitative services on a very cost-effective basis. Specifically,
because of our large number of inpatient facilities, we can utilize standardized staffing models and take advantage of certain supply chain efficiencies. We continue to try to reduce our costs by leveraging our size.
• Technology . As a market leader in inpatient rehabilitation, we have devoted substantial resources to creating and leveraging
rehabilitative technology. For example, we have developed an innovative therapeutic device called the “AutoAmbulator,” which can help advance the rehabilitative process for patients who experience difficulty walking.
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The volume volatility created by the 75% Rule has had a significantly negative impact on our inpatient division’s net operating revenues in 2005. Thus far, we have been able to partially mitigate the impact of the 75% Rule on our inpatient division’s operating earnings by implementing the following strategies:
In addition to the specific mitigation strategies discussed above, we are participating with the rest of the inpatient rehabilitation industry to sponsor research evaluating the efficacy of inpatient rehabilitative care and to inform Members of Congress and other government officials of the adverse effect of the 75% Rule on patients and providers.
The combination of volume volatility created by the 75% Rule and lower unit pricing resulting from recent changes to the prospective payment system applicable to IRFs reduced our operating earnings in 2005 and will have a continuing negative impact on our operating earnings in 2006. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , for additional information about the impact of these changes. In addition, because we receive a significant percentage of our revenues from our inpatient division, and because our inpatient division receives a significant percentage of its revenues from Medicare, our inability to achieve continued compliance with or continue to mitigate the negative effects of the 75% Rule could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Based on recent industry data, we believe the impact of the 75% Rule on the inpatient rehabilitation industry will be significantly greater than CMS estimated when the rule was promulgated. However, Congress has approved a one-year extension of the phase-in period for the 75% Rule and delayed implementation of the 65% compliance threshold until July 1, 2007. In addition, we believe that we are doing better than the industry as a whole in mitigating the effects of the 75% Rule. We anticipate growth in our inpatient division once the 75% Rule is fully implemented and the division’s operations are re-based to maximize admission of higher acuity compliant cases. In addition, we believe continued phase-in of the 75% Rule will cause certain competitors to exit the market which will create consolidation opportunities for us.
Surgery Centers
We operate one of the largest networks of ambulatory surgery centers (“ASCs”) in the United States. As of December 31, 2005, our surgery centers division provided ambulatory surgery services through 158 freestanding ASCs and 3 surgical hospitals in 35 states, with a concentration of centers in California, Texas, Florida, and North Carolina.
Our ASCs provide the facilities and medical support staff necessary for physicians to perform nonemergency surgical procedures. Our typical ASC is a freestanding facility with two to six fully equipped operating and procedure rooms and ancillary areas for reception, preparation, recovery, and administration. Each of our ASCs is licensed by the state and certified as a provider under federal programs, including Medicare and Medicaid. Our ASCs are available for use only by licensed physicians, oral surgeons, and podiatrists. To ensure consistent quality of care, each of our ASCs has a medical advisory committee that implements quality control procedures and reviews the professional credentials of physicians applying for medical staff privileges at the center. In addition, all but a few unique specialty centers are certified by the JCAHO.
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• Refocus Marketing . The 75% Rule reduces the number of patients seeking treatment for orthopedic and other diagnostic conditions that we can accept at our IRFs. Consequently, we are focusing our marketing efforts on neurologists, neurosurgeons, and internists who can refer patients that require treatment for one of the 13 designated medical conditions identified by the 75% Rule, such as spinal cord injury, brain injury, and various neurological disorders.
• Broaden Services . To make up for a potentially reduced inpatient rehabilitation patient census, we are increasing the number of other
post-acute care services performed at or complementary to our IRFs, such as long-term acute care, skilled nursing, and home health services.
• Reduce Costs . We are aggressively reducing our costs in proportion to patient census decline at our IRFs.
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Like most other ASCs, the majority of our centers are owned in partnership with surgeons and other physicians who perform procedures at the centers. As a result of increased competition in the ASC market and other factors, physicians are demanding increased ownership in ASCs. Consequently, we expect an increasing level of physician ownership in our ASCs, and thus our percentage ownership of centers within our ASC portfolio will decline over time. Currently, our ownership interest in centers within our ASC portfolio varies from 20% to 100%. Our average ownership is over 50%.
A critical component of this division’s performance depends upon our ability to periodically provide physicians who use our ASCs with the opportunity to purchase ownership interests in our ASCs. This so-called “resyndication” of ownership interests is important because it enables us to increase the ownership participation of physicians who use our ASCs as well as attract new physicians to our ASCs. Attracting new physician investors who intend to maintain an active practice promotes, we believe, partnership interest in and support for continuing investments in necessary facility improvements as well as a general focus on quality. Prior to 2005, we had difficulty resyndicating our ASCs primarily because we were unable to produce reliable financial statements for individual partnerships. We assembled a dedicated team of accountants, attorneys, and other specialists to expedite the resyndication effort and were able to achieve our resyndication objectives in 2005, although many of our resyndications were completed near the end of the year.
Our surgery centers division has a diversified payor mix with managed care and other discount plans representing the highest percentage. For the years ended December 31, 2005, 2004, and 2003, managed care and other discount plans represented 59.2%, 55.5%, and 55.1%, respectively, of the division’s net operating revenues, which totaled $773.4 million, $817.7 million, and $871.3 million respectively.
The ASC market continues to grow, due in part to improved anesthesia, new instrumentation, payor pressure to reduce costs, and other factors. Because the market is highly fragmented, however, it is highly competitive. We plan to combat this competition (1) by increasing our concentration in specific markets, (2) by affiliating with acute care networks in selected markets, (3) by leveraging the size of our network to realize improved operating efficiencies, increased marketing opportunities, and better payor contracting, and (4) by using technology such as standardized e-coding to improve division performance.
Outpatient
We are one of the largest operators of outpatient rehabilitation facilities in the United States. As of December 31, 2005, our outpatient division provided outpatient therapy through 620 facilities (576 of which are wholly owned and 44 of which are jointly owned). These facilities are located in 40 states, with a concentration of centers in Florida, Texas, New Jersey, Missouri, and Connecticut. In 2005, in part to focus operations on core markets and in part to divest under-performing facilities, the outpatient division closed 157 facilities and sold 10 facilities. We plan to begin exploring selected development opportunities in core markets in 2006.
Our outpatient rehabilitation facilities are staffed by physical therapists, occupational therapists, and other clinicians and support personnel, depending on the services provided at a particular location, and are open at hours designed to accommodate the needs of the patient population being served and the local demand for services. Our centers offer a range of rehabilitative health care services, including physical therapy and occupational therapy, with a particular focus on orthopedic, sports-related, work-related, hand and spine injuries, and various neurological/neuromuscular conditions.
Our outpatient division has a diversified payor mix with managed care and other discount plans representing the highest percentage. For the years ended December 31, 2005, 2004, and 2003, managed care and other discount plans represented 47.2%, 49.6%, and 44.6%, respectively, of the division’s net operating revenues, which totaled $379.4 million, $441.8 million, and $519.9 million, respectively.
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Diagnostic
We are one of the largest operators of freestanding diagnostic imaging centers in the United States. As of December 31, 2005, our diagnostic division operated 85 diagnostic centers (78 of which are wholly owned and 7 of which are jointly owned) in 27 states and the District of Columbia, with a concentration of centers in Texas, Georgia, Alabama, Florida, and the Washington, D.C. area. In addition to the locations that provide diagnostic scanning services, there are also five electro-shock wave lithotripter units that began operating under our diagnostic division in 2005.
Our diagnostic centers provide outpatient diagnostic imaging services, including MRI services, CT services, X-ray services, ultrasound services, mammography services, nuclear medicine services, and fluoroscopy. We do not provide all services at all sites, although approximately 71% of our diagnostic centers are multi-modality centers offering multiple types of service. Our diagnostic centers provide outpatient diagnostic procedures performed by experienced radiological technologists. After the diagnostic procedure is completed, the images are reviewed by radiologists who have contracted with us. Those radiologists prepare an interpretation which is then delivered to the referring physician.
Our diagnostic division has a diversified payor mix with managed care and other discount plans representing the highest percentage. For the years ended December 31, 2005, 2004, and 2003, managed care and other discount plans represented 60.1%, 61.0%, and 63.5%, respectively, of the division’s net operating revenues, which totaled $226.5 million, $234.7 million, and $262.0 million, respectively.
Although the market for diagnostic services is highly competitive, we are expanding our focus on referring physicians outside of the orthopedic specialty to broaden our base of referrals. We also have received inquiries from parties interested in acquiring our diagnostic division and have hired an investment bank to assist us in evaluating those opportunities. As we continue to implement our strategic plan, we will evaluate the role of each division, including the diagnostic division, in that plan. Even if consistent with our strategic plan, an important consideration in our decision to divest any material asset from our portfolio would be whether the transaction would help to deleverage the company and add value for our stockholders.
Corporate and Other
This division comprises all revenue producing activities that do not fall within one of the four operating divisions discussed above, including other patient care services and certain non-patient care services.
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• Medical Centers . This category formerly included our acute care business which, for all practical purposes, we have now exited. Specifically, as described later in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , “Results of Discontinued Operations,” we have signed an agreement to sell our acute care hospital located in Birmingham, Alabama. In addition, on January 4, 2006, we executed a letter of intent with an undisclosed party regarding the sale of the property and equipment which were to have comprised our Digital Hospital in Birmingham, Alabama. Any sale of the Digital Hospital will not involve conveyance of our interest in any certificate of need from our acute care hospital. The letter of intent expires, subject to certain conditions, on March 31, 2006 unless otherwise extended in accordance with the terms of the letter of intent. As of December 31, 2005, we had invested approximately $210 million in the Digital Hospital project. We have not signed a definitive agreement with respect to the Digital Hospital, and there can be no assurance any sale will take place. See Note 5, Property and Equipment , to our accompanying consolidated financial statements, for a discussion of the impairment charge we recognized in 2005 relating to the Digital Hospital. As of December 31, 2005, this “Medical Centers” category continues to include a physician practice located at the University of Miami Sports Center.
• Other Patient Care Services . In some markets, we provide other limited patient care services. We evaluate market opportunities on a
case-by-case basis in determining whether to provide additional services of these types. We may provide these services as a complement to our facility-based businesses or as stand-alone businesses.
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For the years ended December 31, 2005, 2004, and 2003, respectively, the division’s net operating revenues totaled $79.1 million, $85.5 million, and $80.2 million, respectively.
Competition
Inpatient
Our IRFs and LTCHs compete primarily with rehabilitation units and skilled nursing units, many of which are within acute care hospitals in the markets we serve. In addition, we face competition from large privately and publicly held companies such as Rehabcare Group, Inc., Select Medical Corporation, and Kindred Healthcare, Inc.
Some of these competitors may have greater patient referral support and financial and personnel resources in particular markets than we do. We believe we compete successfully within the marketplace based upon our size, reputation for quality, competitive prices, and positive rehabilitation outcomes.
Surgery Centers
We face competition from other providers of ambulatory surgical care in developing ASC joint ventures, acquiring existing centers, attracting patients, and negotiating managed care contracts in each of our markets. There are several publicly held companies, divisions or subsidiaries of publicly held companies, and several private companies that operate ASCs. Further, many physician groups develop ASCs without a corporate partner, utilizing consultants who typically perform management services for a fee and who may not require an ownership interest in the ongoing operations of the center. We believe that we compete effectively in this market because of our size, experience, and reputation for providing quality care.
Outpatient
Our outpatient rehabilitation facilities compete directly or indirectly with the physical and occupational therapy departments of hospitals, physician-owned therapy clinics, other private therapy clinics, and chiropractors. We also face competition from large privately held and publicly held physical therapy companies such as U.S. Physical Therapy, Inc. and Benchmark Medical, Inc., as well as mid-sized regional companies. It is particularly difficult to compete with physician-owned therapy clinics because physicians have traditionally been our customers, rather than our competitors. Consequently, in addition to competing with those physicians who offer physical therapy services as in-office ancillary services, we lose them as a referral source.
Some of these competitors may have greater patient referral support and financial and personnel resources in particular markets than we do. We believe we compete successfully within the marketplace based upon our reputation for quality, competitive prices, positive rehabilitation outcomes, and innovative programs.
Diagnostic
The market for diagnostic services is highly fragmented and highly competitive. Many physicians and physician groups have opened diagnostic facilities as an in-office ancillary service. Our diagnostic centers also
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• Non-Patient Care Services . We also provide certain services that do not involve the provision of patient care, including the operation
of the conference center located at our corporate campus, operation of medical office buildings, various corporate marketing activities, our clinical research activities, and other services that are generally intended to complement our patient care activities.
• Corporate Functions . All our corporate departments and related overhead are contained within this division. These departments,
which include among others accounting, communications, compliance, human resources, information technology, internal audit, legal, payor strategies, reimbursement, tax, and treasury, provide support functions to our operating divisions.
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compete with local hospitals, other multi-center imaging companies, and local independent diagnostic centers. Because of the age of equipment at many of our facilities, competition will become increasingly intense if we do not make substantial capital expenditures in future periods for the purchase of new equipment or the upgrading of existing equipment.
Other Competition
In some states where we operate, the construction or expansion of facilities, the acquisition of existing facilities, or the introduction of new beds or services may be subject to review by and prior approval of state regulatory agencies under a “certificate of need” program. Certificate of need laws often require the reviewing agency to determine the public need for additional or expanded health care facilities and services. Certificate of need laws generally require approvals for capital expenditures involving IRFs, LTCHs, acute care hospitals, and ASCs if such capital expenditures exceed certain thresholds. We potentially face competition any time we initiate a certificate of need project or seek to acquire an existing facility or certificate of need. This competition may arise either from competing national or regional companies or from local hospitals or other providers which file competing applications or oppose the proposed certificate of need project. The necessity for these approvals serves as a barrier to entry and has the potential to limit competition. We have generally been successful in obtaining certificates of need or similar approvals when required, although there can be no assurance that we will achieve similar success in the future.
We rely significantly on our ability to attract, develop, and retain physicians, therapists, and other clinical personnel for our facilities. We compete for these professionals with other health care companies, hospitals, and potential clients and partners. In addition, changes in health care regulations have enabled physicians to open facilities in direct competition with us, which has increased the choices for such professionals and therefore made it more difficult and/or expensive for us to hire the necessary personnel for our facilities.
Sources of Revenues
We receive payment for patient care services from the federal government (primarily under the Medicare program), state governments (under their respective Medicaid or similar programs), managed care plans, private insurers, and directly from patients. In addition, we receive payment for non-patient care activities from various sources. The following table identifies the sources and relative mix of our revenues for the periods stated:
Medicare is a federal program that provides certain hospital and medical insurance benefits to persons aged 65 and over, some disabled persons, and persons with end-stage renal disease. Medicaid is a jointly administered federal and state program that provides hospital and medical benefits to qualifying individuals who are unable to afford health care.
Our facilities generally offer discounts from established charges to certain group purchasers of health care services, including Blue Cross and Blue Shield (“BCBS”), other private insurance companies, employers, health
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Year Ended December 31, Source 2005 2004 2003 Medicare 47.5 % 47.4 % 44.6 % Medicaid 2.3 % 2.4 % 2.6 % Workers’ compensation 7.4 % 8.1 % 9.5 % Managed care and other discount plans 33.1 % 31.8 % 31.8 % Other third-party payors 5.4 % 5.1 % 6.5 % Patients 1.8 % 3.0 % 2.6 % Other income 2.5 % 2.2 % 2.4 %
100.0 % 100.0 % 100.0 %
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maintenance organizations (“HMOs”), preferred provider organizations (“PPOs”), and other managed care plans. These discount programs, which are often negotiated for multi-year terms, limit our ability to increase revenues in response to increasing costs.
Patients are generally not responsible for the difference between established gross charges and amounts reimbursed for such services under Medicare, Medicaid, BCBS plans, HMOs, or PPOs, but are responsible to the extent of any exclusions, deductibles, copayments, or coinsurance features of their coverage. The amount of such exclusions, deductibles, copayments, and coinsurance has been increasing each year. Collection of amounts due from individuals is typically more difficult than from governmental or third-party payors.
Medicare Reimbursement
Medicare, through statutes and regulations, establishes reimbursement methodologies for various types of health care facilities and services. These methodologies have historically been subject to periodic revisions that can have a substantial impact on existing health care providers. In accordance with authorization from Congress, CMS makes annual upward or downward adjustments to Medicare payment rates in most areas. Frequently, these adjustments can result in decreases in actual dollars per procedure or a freeze in reimbursement despite increases in costs.
We expect that Congress and CMS will address reimbursement rates for a variety of health care settings over the next several years. Any downward adjustment to rates for the types of facilities that we operate could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
A basic summary of current Medicare reimbursement in our service areas follows:
Acute Care . As a result of the Social Security Act Amendments of 1983, Congress adopted a prospective payment system (“PPS”) to cover the routine and ancillary operating and capital costs of most Medicare inpatient acute care hospital services. Under this system, the Secretary of HHS has established fixed payment amounts per discharge based on diagnosis-related groups (“DRGs”). With limited exceptions, reimbursement received for inpatient acute care hospital services is limited to the DRG payment rate, regardless of the number of services provided to the patient or the length of the patient’s hospital stay. Under Medicare’s acute care PPS, a hospital may retain the difference, if any, between its DRG payment rate and its operating costs incurred in furnishing inpatient services, and is at risk for any operating costs that exceed its DRG payment rate.
On August 12, 2005, CMS published its final rule for fiscal year 2006 acute care inpatient PPS payments. Acute care hospitals that report selected quality data will receive a 3.7% increase in payment rates under the inpatient PPS. Acute care hospitals that do not participate in the quality reporting initiative will receive only a 3.3% increase in payments. Because we receive very limited revenues from the acute care PPS, these changes are not material to us. The final rule also expands the number of DRGs that are subject to the post-acute transfer policy in order to reduce payment to acute care hospitals when the patient is prematurely transferred to a post-acute care setting. This transfer policy applies to 182 DRGs. This transfer policy has a direct impact on acute care hospital payments. In addition, the transfer policy indirectly affects our IRFs by changing the timing of when patients may be referred to our hospitals. At this time, we cannot determine whether the transfer policy will have a material adverse effect on net operating revenues in any of our facilities.
Inpatient Rehabilitation and the 75% Rule . Historically, freestanding and hospital-based IRF units received cost-based reimbursement from Medicare under an exemption from the acute care PPS. The Balanced Budget Act of 1997 and its implementing regulations replaced the traditional IRF cost-based methodology, however, with a PPS system that recognizes 21 “Rehabilitation Impairment Categories.” This IRF-PPS became effective on January 1, 2002.
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To qualify as an IRF under Medicare, a facility must show that a certain percentage of its patients are treated for at least one of a specified list of medical conditions. Under a May 7, 2004 CMS regulation, the “75% Rule” identifies the following 13 qualifying conditions:
CMS established an initial phase-in period for compliance with the 75% Rule, as follows:
On February 8, 2006, the Deficit Reduction Act of 2005 was signed into law as Public Law 109-171. The legislation redefined the phase-in period for compliance with the 75% Rule. The following phase-in schedule is now applicable:
Any IRF that fails to meet the requirements of the 75% Rule is subject to prospective reclassification as an acute care hospital. The effect of such reclassification would be to revert Medicare IRF-PPS payment rates to lower acute care payment rates for rehabilitative services (assuming that state certificate of need and licensing rules permit the use of the beds for acute care services).
Our inpatient division has begun to reduce or refocus admissions at most locations in response to the phase-in schedule for the 75% Rule. This has resulted in volume volatility that has had a significantly negative impact on our inpatient division’s net operating revenues in 2005. Thus far, we have been able to partially mitigate the impact of the 75% Rule on our inpatient division’s operating earnings by implementing the mitigation strategies discussed earlier in this Item, “Our Business—Operating Divisions.”
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• stroke
• spinal cord injury
• congenital deformity
• amputation
• major multiple trauma
• fracture of the femur (hip fracture)
• brain injury
• neurological disorders
• burns
• active, polyarthricular rheumatoid arthritis, psoriatic arthritis, and seronegative arthropathies
• systemic vasculidities with joint inflammation
• severe/advanced osteoarthritis involving two or more major weight-bearing joints (not counting joints with a prosthesis) with joint
deformity, substantial loss of range of motion, and atrophy of muscles surrounding the joint
• knee or hip joint replacement, with at least one of three specific circumstances
Cost Reporting Period
Minimum Qualifying
Patient Mix Patient Mix Affected
July 1, 2004—June 30, 2005 50 % Medicare or Total July 1, 2005—June 30, 2006 60 % Medicare or Total July 1, 2006—June 30, 2007 65 % Medicare or Total July 1, 2007 and Thereafter 75 % Total
Cost Reporting Period
Minimum Qualifying
Patient Mix Patient Mix Affected
July 1, 2006—June 30, 2007 60 % Medicare or Total July 1, 2007—June 30, 2008 65 % Medicare or Total July 1, 2008 and Thereafter 75 % Total
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On August 15, 2005, CMS published a final rule, as amended by the subsequent correction notice published on September 30, 2005, that updates the IRF-PPS for the federal fiscal year 2006 (which covers discharges occurring on or after October 1, 2005 and on or before September 30, 2006). Although the final rule includes an overall market basket update of 3.6%, it makes several other adjustments that we estimate will result in a net reduction in reimbursement to us. For example, the final rule (1) reduces the standard payment rates by 1.9%, (2) implements changes to Case-Mix Groups, comorbidity tiers, and relative weights, (3) updates the formula for the low income patient payment adjustment, (4) adopts the new geographic labor market area definitions based on the definitions created by the Office of Management and Budget known as Core-Based Statistical Areas, (5) implements new and revised payment adjustments on a budget-neutral basis, (6) implements a new indirect medical education teaching adjustment, (7) increases the rural add-on to 21.3%, and (8) incorporates several other modifications to Medicare reimbursement for IRFs. Although CMS predicted that overall payments to IRFs nationwide would increase by 3.4%, we estimate that the revised IRF-PPS will reduce Medicare reimbursement to our IRFs by 3.5% to 4%, primarily owing to the changes to Case-Mix Groups, comorbidity tiers, and relative weights. We estimate this net impact on reimbursement will reduce our inpatient division’s net operating revenues by approximately $10 million per quarter for the first three quarters of 2006 as compared to 2005. These estimates do not take into account potential changes in our case-mix resulting from our compliance with the 75% Rule, which could have the effect of increasing the acuity of our case-mix and therefore reducing the overall net impact of the IRF-PPS changes.
The combination of volume volatility created by the 75% Rule and lower unit pricing resulting from recent IRF-PPS changes reduced our operating earnings in 2005 and will have a continuing negative impact on our operating earnings in 2006. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , for additional information about the impact of these changes. In addition, because we receive a significant percentage of our revenues from our inpatient division, and because our inpatient division receives a significant percentage of its revenues from Medicare, our inability to achieve continued compliance with or continue to mitigate the negative effects of the 75% Rule could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Although the 75% Rule and changes to IRF-PPS represent the most significant operating challenge to our inpatient division, other coverage policies can affect our operations. For example, Medicare providers like us can be negatively affected by the adoption of coverage policies, either at the national or local level, that determine whether an item or service is covered and under what clinical circumstances it is considered to be reasonable, necessary, and appropriate. In the absence of a national coverage determination, local Medicare fiscal intermediaries may specify more restrictive criteria than otherwise would apply nationally. For instance, Cahaba Government Benefit Administrators, the fiscal intermediary for many of our inpatient division facilities, has issued a local coverage determination setting forth very detailed criteria for determining the medical appropriateness of services provided by IRFs. Other Medicare fiscal intermediaries also have implemented local coverage rules. We cannot predict how these local coverage rules will affect us.
Long-Term Acute Care Hospitals . LTCHs provide medical treatment to patients with chronic diseases and/or complex medical conditions. In order for a facility to qualify as an LTCH, patients discharged from the facility in any given cost reporting year must have an average length-of-stay in excess of 25 days. Historically, LTCHs have been exempt from the acute care PPS and have received Medicare reimbursement on the basis of reasonable costs subject to certain limits. However, this cost-based reimbursement has been transitioning to a PPS system over a 5-year period which began for twelve-month periods beginning on or after October 1, 2002. Providers were given the option to transition into the full LTCH-PPS by receiving 100% of the federal payment rate at any time through the transition period. We have elected to receive the full federal payment rate for all of our LTCHs. Under the new LTCH-PPS system, Medicare classifies patients into distinct diagnostic groups (“LTC-DRGs”) based upon specific clinical characteristics and expected resource needs. The LTCH-PPS also provides for an adjustment for differences in area wages as well as a cost of living adjustment for LTCHs located in Alaska or Hawaii.
Effective July 1, 2004, CMS expanded its interrupted stay policy to include a discharge and readmission to the LTCH within three days, regardless of where the patient is transferred upon discharge. Accordingly, if a
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patient is readmitted to an LTCH within three days of discharge, Medicare will pay only one LTC-DRG. This expanded, but did not replace, the prior interrupted stay policy which provides that if an LTCH patient is discharged to an acute care hospital, an IRF, or a skilled nursing facility and then is readmitted to the LTCH within a fixed period of time, the entire hospitalization, both before and after the interruption, will be considered one episode of care and thus generate one LTC-DRG payment.
Effective October 1, 2004, CMS promulgated regulations altering the separateness and control requirements pertaining to LTCHs which are located within a hospital. Such hospitals within hospitals (“HIHs”) must meet more stringent requirements as to their independence from the host hospital and further must follow additional HIH requirements based upon the percentage of admittances from the host hospital. These HIH policies are to be phased in over a four-year period which began on October 1, 2004. See this Item, “Regulation—Hospital Within Hospital Rules.”
On May 6, 2005, CMS published a final rule regarding LTCH-PPS rate updates and policy changes effective for discharges on or after July 1, 2005. The final rule increases LTCH-PPS standard payment rates by 3.4% and adopts revised labor market area definitions based on the Core-Based Statistical Areas designated by the Office of Management and Budget using 2000 census data. The final rule also lowers the eligibility threshold for hospitals to qualify for outlier payments. On August 12, 2005, CMS published its final fiscal year 2006 acute care inpatient PPS update rule, which impacts LTCH relative weights and LTC-DRG assignments for the period October 1, 2005 through September 30, 2006. This final rule reduces total Medicare payments to us as a result of the impact of the relative weight calculations on our LTCH reimbursement. We estimate that both final rule revisions will cause a reduction in net operating revenues of approximately $2.5 million for the period affected.
On January 27, 2006, CMS issued proposed regulations that would update the annual payment rates under the LTCH-PPS for rate year 2007, which is effective for discharges occurring on or after July 1, 2006 through June 30, 2007. The proposal would (1) provide no market basket increase for rate year 2007, (2) substantially reduce Short Stay Outlier payments, (3) increase the High Cost Outlier threshold, reducing outlier payments, (4) phase-out the Surgical DRG exception for interrupted stays, (5) implements a new method to determine future market basket increases, (6) increase the labor-related share, and (7) make certain other payment policy changes that would impact the LTCH-PPS. CMS has predicted that overall payments to LTCHs nationwide would be decreased by 11.1%, or $362 million, under the proposed rule. We estimate that the impact on reimbursement would be a reduction in our inpatient division’s net operating revenues of approximately $5.3 million in the third and fourth quarters of 2006 combined and of approximately $10.6 million on an annualized basis.
CMS has contracted with the Research Triangle Institute, International (“RTI”) to analyze the feasibility of further defining “facility and patient criteria to ensure patients admitted to LTCHs are medically complex and have a good chance of improvement.” This study has the potential to develop new admission criteria that may create tighter restrictions on LTCH admissions similar to the “75% Rule.” While difficult to predict, these changes could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Ambulatory Surgery Centers . ASC services are reimbursed by Medicare based on prospectively determined rates. Surgical procedures approved by CMS for ASC reimbursement are classified into nine payment groups based on cost for facility reimbursement purposes. All approved surgical procedures within the same payment group are reimbursed at a single rate, adjusted by the location of the facility and applicable wage index. On May 4, 2005, CMS published an interim final rule updating the list of approved surgical procedures. The interim final rule, which became effective on July 1, 2005, deletes five approved procedures and adds 65 new procedures to the list of approved surgical procedures.
Other significant changes in ASC reimbursement have been adopted in recent years, and more are being contemplated. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“MMA”)
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reduced the payment update for ASC services for fiscal year 2004, changed the update cycle from a fiscal year to a calendar year, and eliminated the updates for fiscal year 2005 through calendar year 2009. The MMA also directed HHS to implement a new payment system by 2008, taking into account a Government Accountability Office (“GAO”) report of ASCs to be completed by December 31, 2004. The report, which has not yet been issued, will examine the costs of providing the same services in ASCs versus hospital outpatient departments, the accuracy of ASC payment categories, and whether it would be appropriate to base a new ASC payment system upon the hospital outpatient system.
Both the Medicare Payment Advisory Commission (“Med PAC”) and the HHS-OIG have recommended greater coordination of payments for services performed in hospital outpatient departments (“HOPDs”) and those performed in ASCs. Such coordination could result in lower payments for certain procedures that receive higher reimbursement in ASCs than in a HOPD, but could result in higher reimbursement for those services currently priced lower in ASCs than in HOPDs. The Deficit Reduction Act of 2005 placed a cap on ASC payments paid above HOPD rates. The cap limits all ASC reimbursement that would otherwise exceed the HOPD payment to the amount of the HOPD price, effective for services furnished on or after January 1, 2007.
Further reductions in ASC Medicare reimbursement are possible. Any significant reductions in Medicare reimbursement could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Outpatient Rehabilitation . Most of our outpatient rehabilitation facilities are certified by Medicare. Therapy services are reimbursed by Medicare under the Physician Fee Schedule. A fixed fee is paid per reimbursable procedure performed. This fee is adjusted by the geographical area in which the facility is located. The Balanced Budget Act of 1997 changed the reimbursement methodology for Medicare Part B therapy services from cost based to fee schedule payments. It also established two types of annual per-beneficiary limitations on outpatient therapy services: (1) a $1,500 cap for all outpatient therapy services and speech language pathology services; and (2) a $1,500 cap for all outpatient occupational therapy services. Both of these amounts were indexed for inflation. The therapy caps do not apply to therapy services provided in hospital outpatient departments. Subsequent legislation suspended implementation of these caps through 2002. CMS began enforcing the therapy caps on September 1, 2003 (the inflation-adjusted amounts for 2003 were $1,590). The MMA suspended application of the therapy cap from the date of enactment (December 8, 2003) through calendar year 2005. Effective January 1, 2006, the therapy caps are effective and set at $1,740 per beneficiary per year. However, the Deficit Reduction Act of 2005 established an exception to the caps for medically necessary services for calendar year 2006. On February 15, 2006, CMS published procedures to implement the exception process. The process provides for two groups of exceptions, automatic and manual. Automatic exceptions, which do not require advance approval, apply to certain conditions or complexities that have a direct and significant effect on the need for additional therapy. CMS established a list of the diagnoses as well as certain clinically complex situations that qualify for automatic exceptions. Providers are required to document the basis for qualification for an exception. Manual exceptions require submission of a written request to the appropriate Medicare payment contractor ( i.e., fiscal intermediary or carrier). If the patient has a condition or complexity that does not qualify for an automatic exception, but the treatment is considered to be medically necessary, the provider or beneficiary may request up to 15 treatment days of service beyond the cap. If, at the end of 10 business days after the request, the Medicare payment contractor has not responded, the exception is deemed approved. We anticipate these therapy caps will have a negative impact on net operating revenues in our outpatient division. The extent of that impact will depend on both the administration of the medical necessity exception process by CMS and the response of possible deferral of therapy treatment by Medicare patients subject to the cap.
Outpatient rehabilitation professional services are reimbursed under the Medicare Physician Fee Schedule. Under a final rule published November 21, 2005, CMS proposed a 4.4% across-the-board reduction in Medicare reimbursement for physician fee schedule services in calendar year 2006. The Deficit Reduction Act of 2005 blocks the fee reduction for 2006 and instead provides for a payment freeze for 2006. In the absence of further legislative action, however, additional reductions in Medicare reimbursement for services provided under the physician fee schedule are expected beginning in 2007 and beyond.
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Diagnostic Facilities . Medicare allows diagnostic facilities that are independent of physician practices or hospitals to bill for approved diagnostic procedures as Independent Diagnostic Testing Facilities (“IDTFs”). Such procedures must be performed by licensed or certified nonphysician personnel under appropriate physician supervision or by physicians in accordance with detailed guidelines. IDTFs are reimbursed for approved tests with required physician orders on the basis of appropriate Current Procedural Terminology (“CPT”) codes under Medicare Part B. CPT reimbursement is geographically adjusted by CMS. Medicare uses the Physician Fee Schedule to pay for services provided in freestanding imaging centers. Each CPT code is assigned a set of relative value units (“RVUs”) that reflects the average time, effort, and practice costs (including a geographic adjustment) involved in performing a given procedure. Medicare payment amounts are based on a procedure’s total RVUs multiplied by a dollar conversion factor. Medicare makes payment determinations for diagnostic radiology procedures and imaging agents based on where the procedure is performed. More specifically, Medicare uses different payment methodologies for procedures performed in a hospital outpatient department versus an IDTF.
On November 21, 2005, CMS issued a final Physician Fee Schedule rule that reduces payment for the technical component of subsequent diagnostic imaging procedures performed in the same session on contiguous body areas. This reduction will be phased in over two years with a 25% reduction for the 2006 calendar year and a 50% reduction for the 2007 calendar year. Certain diagnostic tests conducted in IDTFs require multiple imaging procedures. Accordingly, this reduction could result in a significant reduction in IDTF Medicare reimbursement and may negatively affect our diagnostic division. The rule also called for a 4.4% across-the-board reduction in Medicare reimbursement for Physician Fee Schedule services in calendar year 2006. The Deficit Reduction Act of 2005 blocks the fee reduction for 2006 and instead provides for a payment freeze for 2006. In the absence of further legislative reforms, however, additional reductions in Medicare reimbursement for services provided under the Physician Fee Schedule are expected beginning in 2007 and beyond. The Deficit Reduction Act of 2005 also provides that payment rates for imaging services delivered in physician offices and independent diagnostic testing facilities may not exceed payment rates for identical imaging services delivered in hospital outpatient departments, effective for services furnished on or after January 1, 2007. Specifically, the technical component (including the technical component of the global fee) of a radiology service under the Physician Fee Schedule will be reduced if it exceeds (without regard to the geographic wage adjustment factor) the ambulatory payment classification reimbursement amount under the hospital outpatient prospective payment system (“OPPS”). Imaging services affected by this provision are: imaging and computer-assisted imaging services, including X-ray, ultrasound (including echocardiography), nuclear medicine (including positron emission tomography), magnetic resonance imaging, computed tomography, and fluoroscopy, but excluding diagnostic and screening mammography.
Hospital Outpatient Surgical Services . The Balanced Budget Act of 1997 authorized CMS to implement OPPS on July 1, 2000 for certain hospital outpatient services (excluding diagnostic laboratory services, ambulance services, orthotics, prosthetics, chronic dialysis, screening mammographies, and outpatient rehabilitation services). All services and items paid under the OPPS are classified into groups called Ambulatory Payment Classifications (“APCs”), with a per-service payment rate established for each APC. Our three surgical hospitals, which provide mostly outpatient surgical services, as well as our acute care hospital located in Birmingham, Alabama, are paid under the OPPS for outpatient surgical services.
On November 15, 2004, CMS published the 2005 OPPS final rule. The rule affected Medicare outpatient services furnished on or after January 1, 2005 and before January 1, 2006. The rate adjustments to the OPPS mainly affected the Birmingham Medical Center and our three surgical hospitals. The changes were expected to increase Medicare outpatient net operating revenues for these facilities.
On November 10, 2005, CMS published a final rule to update OPPS payment rates for calendar year 2006. CMS projects that the update will increase OPPS payments by 2.2% after taking into account changes in drug reimbursement. At this time, we are unable to quantify the impact this rule will have on our business.
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Fiscal Year 2007 Proposed Budget . On February 6, 2006, President Bush proposed a federal budget for fiscal year 2007. Among other things, the budget would eliminate Medicare payment increases for IRFs, LTCHs, SNFs, and home health services for the 2007 fiscal year. In 2008 and 2009, the budget proposes that IRFs and certain other providers receive a Medicare payment update of market basket minus 0.4%. These provisions are expected to reduce Medicare IRF spending by $1.59 billion in fiscal years 2007 through 2011. The President’s budget also calls for reductions in Medicare payments to IRFs for hip and knee replacements to decrease variances in payments based on site of care. Specifically, for services provided to hip and knee replacement patients, the proposal would pay IRFs the average amount paid to skilled nursing facilities (“SNFs”), plus one third of the difference between the average IRF payment amount and the average SNF payment rate. Each of these budget recommendations requires Congressional approval, with the exception of those relating to LTCH reimbursement which can be implemented administratively. Any of these budget recommendations, if approved, could have an adverse effect on our future operating results and financial condition.
The proposed budget also proposes to phase out all Medicare bad debt reimbursement to providers between 2007 and 2011. If enacted, we estimate that this phase out would reduce our Medicare reimbursement by approximately $1.8 million. The President’s budget also proposes the enactment of legislation that would impose across-the-board spending reductions of 0.4% for all Medicare payment systems if: (1) general revenues are projected to exceed 45% of total Medicare financing and (2) Congress fails to act upon recommendations to reduce that percentage below 45%. The 0.4% reduction would grow annually as long as general revenues exceed 45% of total Medicare financing. Legislation would be necessary to enact both of these changes.
Medicaid Reimbursement
Medicaid programs are jointly funded by the federal and state governments. As the Medicaid program is administered by the individual states under the oversight of CMS in accordance with certain regulatory and statutory guidelines, there are substantial differences in reimbursement methodologies and coverage policies from state to state. Many states have experienced shortfalls in their Medicaid budgets and are implementing significant cuts in Medicaid reimbursement rates. Additionally, certain states control Medicaid expenditures through restricting or eliminating coverage of certain services. Continuing downward pressure on Medicaid payment rates could cause a decline in revenues.
Cost Reports
Because of our participation in the Medicare, Medicaid, and TRICARE programs, we are required to meet certain financial reporting requirements. Federal and, where applicable, state regulations require the submission of annual cost reports covering the revenue, costs, and expenses associated with the services provided by our inpatient and certain surgery center hospitals to Medicare beneficiaries and Medicaid recipients.
Annual cost reports required under the Medicare and Medicaid programs are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due HealthSouth under these reimbursement programs. These audits are used for determining if any under- or over-payments were made to these programs and to set payment levels for future years. In addition, as a result of the reconstruction of our accounting records we are reviewing previously submitted cost reports to ensure that they accurately reflect the revenue, costs, and expenses associated with services provided at our facilities. The majority of our revenues are derived from prospective payment system payments, and even if we amend previously filed cost reports we do not expect the impact of those amendments to materially affect our inpatient division or surgery centers division results of operations.
On December 30, 2004, we announced that HealthSouth had signed an agreement with CMS to resolve issues associated with various Medicare cost reporting practices. Subject to certain exceptions, the settlement provides for the release of HealthSouth by CMS from any obligations related to any cost statements or cost reports which had, or could have been submitted to CMS or its fiscal intermediaries by HealthSouth for cost
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reporting periods ended on or before December 31, 2003. The settlement provides that all covered federal cost reports be closed and considered final and settled. Open state Medicaid cost reports still are subject to potential audits as described above. See this Item, “Medicare Program Settlement.”
Managed Care and Other Discounted Plans
Most of our facilities offer discounts from established charges to certain large group purchasers of health care services, including managed care plans, BCBS, other private insurance companies, and employers. Managed care contracts typically have terms of between one and three years, although we have a number of managed care contracts that automatically renew each year unless a party elects to terminate the contract. While some of our contracts provide for annual rate increases of three to five percent, we cannot provide any assurance that we will continue to receive increases.
Regulation
The health care industry is subject to significant federal, state, and local regulation that affects our business activities by controlling the reimbursement we receive for services provided, requiring licensure or certification of our facilities, regulating the use of our properties, and controlling our growth.
Licensure and Certification
Health care facility construction and operation are subject to numerous federal, state, and local regulations relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, maintenance of adequate records, fire prevention, and compliance with building codes and environmental protection laws. Our facilities are subject to periodic inspection by governmental and non-governmental certification authorities to ensure continued compliance with the various standards necessary for facility licensure. All of our inpatient facilities and substantially all of our ASCs are currently required to be licensed. Only a relatively small number of states require licensure for outpatient rehabilitation facilities. Many states do not require diagnostic facilities to be licensed.
In addition, facilities must be “certified” by CMS to participate in the Medicare program and generally must be certified by Medicaid state agencies to participate in Medicaid programs. All of our inpatient facilities participate in (or are awaiting the assignment of a provider number to participate in) the Medicare program. As of December 31, 2005, approximately 92% of our outpatient therapy facilities (including outpatient rehabilitation facilities and other outpatient facilities) participate in, or are awaiting the assignment of a provider number to participate in, the Medicare program. Substantially all of our ASCs and diagnostic centers are certified (or are awaiting certification) under the Medicare program. Our Medicare-certified facilities undergo periodic on-site surveys in order to maintain their certification.
Failure to comply with applicable certification requirements may make our facilities ineligible for Medicare or Medicaid reimbursement. In addition, Medicare or Medicaid may seek retroactive reimbursement from noncompliant facilities or otherwise impose sanctions on noncompliant facilities. Non-governmental payors often have the right to terminate provider contracts if a facility loses its Medicare or Medicaid certification. We have developed operational systems to oversee compliance with the various standards and requirements of the Medicare program and have established ongoing quality assurance activities; however, given the complex nature of governmental health care regulations, there can be no assurance that Medicare, Medicaid, or other regulatory authorities will not allege instances of noncompliance.
Certificates of Need
In some states where we operate, the construction or expansion of facilities, the acquisition of existing facilities, or the introduction of new beds or services may be subject to review by and prior approval of state
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regulatory agencies under “certificate of need” laws. Certificate of need laws often require the reviewing agency to determine the public need for additional or expanded health care facilities and services. Certificate of need laws generally require approvals for capital expenditures involving IRFs, LTCHs, acute care hospitals, and ASCs if such capital expenditures exceed certain thresholds. Most states do not require such approvals for outpatient rehabilitation, occupational health, or diagnostic facilities and services. However, any time a certificate of need is required, we must obtain it before acquiring, opening, reclassifying, or expanding a health care facility or starting a new health care program.
False Claims Act
Over the past several years, an increasing number of health care providers have been accused of violating the federal False Claims Act. That act prohibits the knowing presentation of a false claim to the United States government, and provides for penalties equal to three times the actual amount of any overpayments plus up to $11,000 per claim. In addition, the False Claims Act allows private persons, known as “relators,” to file complaints under seal and provides a period of time for the government to investigate such complaints and determine whether to intervene in them and take over the handling of all or part of such complaints. Because of the sealing provisions of the False Claims Act, it is possible for health care providers to be subject to False Claims Act suits for extended periods of time without notice of such suits or an opportunity to respond to them. Because we perform thousands of similar procedures a year for which we are reimbursed by Medicare and other federal payors and there is a relatively long statute of limitations, a billing error or cost reporting error could result in significant civil or criminal penalties under the False Claims Act or other laws. We have recently entered into a substantial settlement of claims under the False Claims Act. See this Item, “Medicare Program Settlement.” We remain a named defendant in certain unsealed suits under the False Claims Act where the United States did not intervene. See Item 3, Legal Proceedings , “Certain Regulatory Actions.”
Corporate Integrity Agreement
As described in this Item, “Medicare Program Settlement,” we entered into a new corporate integrity agreement (“CIA”) in December 2004, which is effective for five years beginning January 1, 2005. Failure to meet our obligations under our CIA could result in stipulated financial penalties. Failure to comply with material terms, however, could lead to exclusion from further participation in federal health care programs, including Medicare and Medicaid, which currently account for a substantial portion of our revenues. See Note 21, Medicare Program Settlement , in the accompanying consolidated financial statements for a description of the accounting treatment of the settlement relating to this CIA. On April 28, 2005, we submitted an implementation report to the HHS-OIG stating that we had, within the 90-day time frame, materially complied with the initial requirements of this new CIA.
Relationships with Physicians and Other Providers
The Anti-Kickback Law . Various state and federal laws regulate relationships between providers of health care services, including employment or service contracts and investment relationships. Among the most important of these restrictions is a federal criminal law prohibiting (1) the offer, payment, solicitation, or receipt of remuneration by individuals or entities to induce referrals of patients for services reimbursed under the Medicare or Medicaid programs or (2) the leasing, purchasing, ordering, arranging for, or recommending the lease, purchase, or order of any item, good, facility, or service covered by such programs (the “Anti-Kickback Law”). In addition to federal criminal sanctions, including penalties of up to $50,000 for each violation plus tripled damages for improper claims, violators of the Anti-Kickback Law may be subject to exclusion from the Medicare and/or Medicaid programs. In 1991, the HHS-OIG issued regulations describing compensation arrangements that are not viewed as illegal remuneration under the Anti-Kickback Law (the “1991 Safe Harbor Rules”). The 1991 Safe Harbor Rules create certain standards (“Safe Harbors”) for identified types of compensation arrangements that, if fully complied with, assure participants in the particular arrangement that the HHS-OIG will not treat that participation as a criminal offense under the Anti-Kickback Law or as the basis for an exclusion from the Medicare and Medicaid programs or the imposition of civil sanctions.
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The HHS-OIG closely scrutinizes health care joint ventures involving physicians and other referral sources for compliance with the Anti-Kickback Law. In 1989, the HHS-OIG published a Fraud Alert that outlined questionable features of “suspect” joint ventures, and has continued to rely on such Fraud Alert in later pronouncements. We currently operate some of our rehabilitation hospitals and outpatient rehabilitation facilities as general partnerships, limited partnerships, or limited liability companies (collectively, “partnerships”) with third-party investors, including other institutional health care providers but also including, in a number of cases, physician investors. Some of these partners may be deemed to be in a position to make or influence referrals to our facilities. Those partnerships that are providers of services under the Medicare program, and their owners, are subject to the Anti-Kickback Law. A number of the relationships we have established with physicians and other health care providers do not fit within any of the Safe Harbors. The 1991 Safe Harbor Rules do not expand the scope of activities that the Anti-Kickback Law prohibits, nor do they provide that failure to fall within a Safe Harbor constitutes a violation of the Anti-Kickback Law; however, the HHS-OIG has indicated that failure to fall within a Safe Harbor may subject an arrangement to increased scrutiny. While we do not believe that our rehabilitation facility partnerships engage in activities that violate the Anti-Kickback Law, there can be no assurance that such violations may not be asserted in the future, nor can there be any assurance that our defense against any such assertion would be successful.
Most of our ASCs are owned by partnerships, which include as partners physicians who perform surgical or other procedures at such centers. HHS has promulgated four categories of safe harbors under the Anti-Kickback Law for ASCs (the “ASC Safe Harbors”). Under the ASC Safe Harbors, ownership by a referring physician in a freestanding ASC will be protected if a number of conditions are satisfied. The conditions include the following:
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• The center must be ASC certified to participate in the Medicare program and its operating and recovery room space must be
dedicated exclusively to the ASC and not a part of a hospital (although such space may be leased from a hospital if such lease meets the requirements of the safe harbor for space rental).
• Each investor must be either (1) a physician who derived at least one-third of his or her medical practice income for the previous fiscal year or 12-month period from performing procedures on the list of Medicare-covered procedures for ASCs, (2) a hospital, or (3) a person or entity not in a position to make or influence referrals to the center, nor to provide items or services to the center, nor employed by the center or any investor.
• Unless all physician-investors are members of a single specialty, each physician-investor must perform at least one-third of his or her
procedures at the center each year. (This requirement is in addition to the requirement that the physician-investor has derived at least one-third of his or her medical practice income for the past year from performing procedures.)
• Physician-investors must have fully informed their referred patients of the physician’s investment interest.
• The terms on which an investment interest is offered to an investor are not related to the previous or expected volume of referrals,
services furnished, or the amount of business otherwise generated from that investor to the entity.
• Neither the center nor any other investor may loan funds to or guarantee a loan for an investor if the investor uses any part of such
loan to obtain the investment interest.
• The amount of payment to an investor in return for the investment interest is directly proportional to the amount of the capital
investment (including the fair market value of any pre-operational services rendered) of that investor.
• All physician-investors, any hospital-investor, and the center agree to treat patients receiving medical benefits or assistance under the
Medicare or Medicaid programs.
• All ancillary services performed at the center for beneficiaries of federal health care programs must be directly and integrally related
to primary procedures performed at the center and may not be billed separately.
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Because we invest in each partnership that owns an ASC and often provide management and other services to the ASC, our arrangements with physician investors do not fit within the terms of the ASC Safe Harbors. In addition, because we do not control the medical practices of our physician investors or control where they perform surgical procedures, in some of our ASCs, the quantitative tests described above have not been met and/or will not be met in the future, and certain other conditions of the ASC Safe Harbors have not been or will not be satisfied. We cannot ensure that all physician-investors will perform, or have performed, one-third of their procedures at the ASC or have informed or will inform their referred patients of their investment interests. Accordingly, there can be no assurance that the ownership interests in some of our ASCs will not be challenged under the Anti-Kickback Law.
Some of our diagnostic centers are also owned or operated by partnerships that include radiologists as partners. While those ownership interests are not directly covered by the Safe Harbor Rules, we do not believe that the structure of such arrangements violate the Anti-Kickback Law because radiologists are typically not in a position to make referrals to diagnostic centers. In addition, our mobile lithotripsy operations are conducted by partnerships in which urologists are limited partners. Because such urologists are in a position to, and do, perform lithotripsy procedures utilizing our lithotripsy equipment, we believe that the same analysis underlying the ASC Safe Harbor should apply to ownership interests in lithotripsy equipment held by urologists. There can be no assurance, however, that the Anti-Kickback Law will not be interpreted in a manner contrary to our beliefs with respect to diagnostic and lithotripsy services.
We have entered into agreements to manage many of our facilities that are owned by partnerships in which physicians have invested. A number of these agreements incorporate a percentage-based management fee. Although there is a safe harbor for personal services and management contracts, this safe harbor requires, among other things, that the aggregate compensation paid to the manager over the term of the agreement be set in advance. Because our management fee may be based on a percentage of revenues, the fee arrangement may not meet this requirement. However, we believe that our management arrangements satisfy the other requirements of the safe harbor for personal services and management contracts and that they comply with the Anti-Kickback Law. The HHS-OIG has taken the position that percentage-based management agreements are not protected by a safe harbor, and consequently, may violate the Anti-Kickback Law. On April 15, 1998, the HHS-OIG issued Advisory Opinion 98-4 which reiterates this proposition. This opinion focused on areas the HHS-OIG considers problematic in a physician practice management context, including financial incentives to increase patient referrals, no safeguards against overutilization, and incentives to increase the risk of abusive billing. The opinion reiterated that proof of intent to violate the Anti-Kickback Law is the central focus of the HHS-OIG. We have implemented programs designed to safeguard against overbilling and otherwise achieve compliance with the Anti-Kickback Law and other laws, but we cannot assure you that the HHS-OIG would find our compliance programs to be adequate.
While several federal court decisions have aggressively applied the restrictions of the Anti-Kickback Law, they provide little guidance as to the application of the Anti-Kickback Law to our partnerships, and we cannot provide any assurances that a federal or state agency charged with enforcement of the Anti-Kickback Law and similar laws might not claim that some of our partnerships have violated or are violating the Anti-Kickback Law. Such a claim could adversely affect relationships we have established with physicians or other health care
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• No hospital-investor may include on its cost report or any claim for payment from a federal health care program any costs associated
with the center.
• The center may not use equipment owned by or services provided by a hospital-investor unless such equipment is leased in
accordance with an agreement that complies with the equipment rental safe harbor and such services are provided in accordance with a contract that complies with the personal services and management contracts safe harbor.
• No hospital-investor may be in a position to make or influence referrals directly or indirectly to any other investor or the center.
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providers or result in the imposition of penalties on us or on particular HealthSouth facilities. Any conviction of a partnership for violations of the Anti-Kickback Law would have severe consequences on that partnership’s ability to be a viable entity and our ability to attract physician investors to other partnerships and could result in substantial fines as well as our exclusion from Medicare and Medicaid. Moreover, even the assertion of a violation of the Anti-Kickback Law by one or more of our partnerships could have a material adverse effect upon our business, financial condition, results of operations, or cash flows.
Stark Prohibitions . The so-called “Stark II” provisions of the Omnibus Budget Reconciliation Act of 1993 amend the federal Medicare statute to prohibit the making by a physician of referrals for “designated health services” including physical therapy, occupational therapy, radiology services, or radiation therapy, to an entity in which the physician has an investment interest or other financial relationship, subject to certain exceptions. Such prohibition took effect on January 1, 1995 and applies to all of our partnerships with physician partners and to our other financial relationships with physicians. Final Phase II Stark Regulations were published in the Federal Register on March 26, 2004 and had an effective date of July 26, 2004. The final regulations substantially clarified recruitment arrangements among health care facilities, individual physicians, and group practices and addressed compensation arrangements with physicians.
Ambulatory surgery is not identified as a “designated health service” under Stark II, and we do not believe the statute is intended to cover ambulatory surgery services. The Phase I Final Stark Regulations expressly clarify that the provision of designated health services in an ASC is excepted from the referral prohibition of Stark II if payment for such designated health services is included in the ambulatory surgery center payment rate. Likewise, the Stark Regulations expressly provide that a referral for designated health services does not include a request by a radiologist for diagnostic radiology services if the request results from a consultation initiated by another physician and the tests or services are furnished by or under the supervision of a radiologist. As a result, we believe that radiologists may enter into joint ventures for diagnostic imaging centers without violating Stark II in most circumstances.
Our lithotripsy units frequently operate on hospital campuses. CMS has indicated that lithotripsy services provided at a hospital would constitute “inpatient and outpatient hospital services” and thus would be subject to Stark II. However, a federal court decision does not support this interpretation. On January 3, 2003, CMS withdrew its appeal of Judge Henry Kennedy’s decision in American Lithotripsy Society and Urology Society of America v. Thompson , made in the Federal District Court for the District of Columbia. The Court of Appeals accepted the withdrawal, and, accordingly, the District Court decision is final. This order permanently enjoined CMS from implementing and enforcing its Stark II Regulations declaring lithotripsy a “designated health service.” However, according to CMS, even if lithotripsy provided under arrangement with a hospital is not a designated health service, this arrangement would result in an “indirect compensation relationship” between the urologist and the hospital with which the lithotripsy entity has an arrangement. Under that theory, referrals by the physician for designated health service other than lithotripsy (e.g. radiology, radiation oncology, etc.) are still prohibited unless the lithotripsy facility/hospital arrangement meets a Stark II exception. If Congress passes revised legislation on this topic, CMS adopts additional regulations or is otherwise successful in re-asserting its position on lithotripsy services and Stark, we would be forced to restructure many of our relationships for lithotripsy services at substantial cost.
While we do not believe that our financial relationships with physicians violate the Stark II statute or the associated regulations, no assurances can be given that a federal or state agency charged with enforcement of the Stark II statute and regulations or similar state laws might not assert a contrary position or that new federal or state laws governing physician relationships, or new interpretations of existing laws governing such relationships, might not adversely affect relationships we have established with physicians or result in the imposition of penalties on us or on particular HealthSouth facilities. Even the assertion of a violation could have a material adverse effect upon our business, financial condition, or results of operations. In addition, a number of states have passed or are considering statutes which prohibit or limit physician referrals of patients to facilities in which they have an investment interest. Any actual or perceived violation of these state statutes could have a material adverse effect on business, financial condition, results of operations, and cash flows.
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HIPAA
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) broadened the scope of certain fraud and abuse laws by adding several criminal provisions for health care fraud offenses that apply to all health benefit programs. HIPAA also added a prohibition against incentives intended to influence decisions by Medicare beneficiaries as to the provider from which they will receive services. In addition, HIPAA created new enforcement mechanisms to combat fraud and abuse, including the Medicare Integrity Program, and an incentive program under which individuals can receive up to $1,000 for providing information on Medicare fraud and abuse that leads to the recovery of at least $100 of Medicare funds. Federal enforcement officials now have the ability to exclude from Medicare and Medicaid any investors, officers, and managing employees associated with business entities that have committed health care fraud, even if the officer or managing employee had no knowledge of the fraud.
HIPAA also contains certain administrative simplification provisions that require the use of uniform electronic data transmission standards for certain health care claims and payment transactions submitted or received electronically. HHS has issued regulations implementing the HIPAA administrative simplification provisions and compliance with these regulations became mandatory for our facilities on October 16, 2003. Although HHS temporarily agreed to accept noncompliant Medicare claims, CMS stopped processing non-HIPAA-compliant Medicare claims beginning October 1, 2005. We believe that the cost of compliance with these regulations has not had and is not expected to have a material adverse effect on our business, financial condition, results of operations, and cash flows.
HIPAA also requires HHS to adopt standards to protect the privacy and security of individually identifiable health-related information. HHS released regulations containing privacy standards in December 2000 and published revisions to the regulations in August 2002. Compliance with these regulations became mandatory on April 14, 2003. The privacy regulations regulate the use and disclosure of individually identifiable health-related information, whether communicated electronically, on paper, or orally. The regulations also provide patients with significant new rights related to understanding and controlling how their health information is used or disclosed. HHS released security regulations on February 20, 2003. The security regulations became mandatory on April 20, 2005 and require health care providers to implement administrative, physical, and technical practices to protect the security of individually identifiable health information that is maintained or transmitted electronically. The privacy regulations and security regulations could impose significant costs on our facilities in order to comply with these standards.
Penalties for violations of HIPAA include civil and criminal monetary penalties. In addition, there are numerous legislative and regulatory initiatives at the federal and state levels addressing patient privacy concerns. Facilities will continue to remain subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These statutes vary and could impose additional penalties.
EMTALA
Our acute care hospital in Birmingham, Alabama and two of our surgical hospitals are subject to the Emergency Medical Treatment and Active Labor Act (“EMTALA”). This federal law requires any hospital that participates in the Medicare program to conduct an appropriate medical screening examination of every person who presents to the hospital’s emergency room for treatment and, if the patient is suffering from an emergency medical condition, to either stabilize that condition or make an appropriate transfer of the patient to a facility that can handle the condition. The obligation to screen and stabilize emergency medical conditions exists regardless of a patient’s ability to pay for treatment. There are severe penalties under EMTALA if a hospital fails to screen or appropriately stabilize or transfer a patient or if the hospital delays appropriate treatment in order to first inquire about the patient’s ability to pay. Penalties for violations of EMTALA include civil monetary penalties and exclusion from participation in the Medicare program. In addition, an injured patient, the patient’s family, or a medical facility that suffers a financial loss as a direct result of another hospital’s violation of the law can bring a civil suit against the hospital.
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Hospital Within Hospital Rules
Effective October 1, 2004, CMS enacted final regulations that provide if a long-term acute care “hospital within hospital” has Medicare admissions from its host hospital that exceed 25% (or an adjusted percentage for certain rural or Metropolitan Statistical Area dominant hospitals) of its Medicare discharges for its cost-reporting period, the LTCH will receive an adjusted payment for its Medicare patients of the lesser of (1) the otherwise full payment under the LTCH-PPS or (2) a comparable payment that Medicare would pay under the acute care inpatient PPS. In determining whether an LTCH meets the 25% criterion, patients transferred from the host hospital that have already qualified for outlier payments at the acute host facility would not count as part of the host hospital’s allowable percentage. Cases admitted from the host hospital before the LTCH crosses the 25% threshold will be paid under the LTCH-PPS. Under the final regulation, this “25% Rule” is being phased in over a four year period which began on October 1, 2004.
Additionally, other excluded hospitals or units of a host hospital, such as inpatient rehabilitation facilities and/or units, must meet certain HIH requirements in order to maintain their excluded status and not be subject to Medicare’s acute care inpatient PPS.
The majority of our IRFs and LTCHs are freestanding facilities. As such, many of HealthSouth’s facilities are not subject to these rules. However, HIH rules are complex and there can be no assurance that future CMS interpretations will not adversely affect our facilities. HealthSouth’s “hospital within hospital” LTCH or inpatient competitors or their referral sources could refer a certain number of patients to free-standing facilities for LTCH or inpatient rehabilitation services in order to comply with this policy, and thus HealthSouth facilities may benefit from increased referrals.
Patient Safety and Quality Improvement Act of 2005
On July 29, 2005, the President signed the Patient Safety and Quality Improvement Act of 2005 which has the goal of reducing medical errors and increasing patient safety. This legislation establishes a confidential reporting structure in which providers can voluntarily report “Patient Safety Work Product” (“PSWP”) to “Patient Safety Organizations.” Under the system, PSWP is made privileged, confidential, and legally protected from disclosure. PSWP does not include medical, discharge, or billing records or any other original patient or provider records but does include information gathered specifically in connection with the reporting of medical errors and improving patient safety. This legislation does not preempt state or federal mandatory disclosure laws concerning information that does not constitute PSWP. Patient Safety Organizations will be certified by the Secretary of HHS for three year periods after the Secretary develops applicable certification criteria. Patient Safety Organizations will analyze PSWP, provide feedback to providers and may report non-identifiable PSWP to a database. In addition, these organizations are expected to generate patient safety improvement strategies. We are presently evaluating our participation in this voluntary reporting process.
Risk Management and Insurance
We insure a substantial portion of our professional, general liability, and workers’ compensation risks through a self-insured retention program implemented through HCS, Ltd., which is our wholly-owned offshore captive insurance subsidiary. HCS provides our first layer of insurance coverage for professional and general liability risks (up to $6 million per claim and $60 million in the aggregate per year) and workers’ compensation claims (between $250,000 and $1 million per claim, depending upon the state). We maintain professional and general liability insurance with unrelated commercial carriers for losses in excess of amounts insured by HCS. HealthSouth and HCS maintained reserves for professional, general liability, and workers’ compensation risks that totaled $214.9 million at December 31, 2005. Management considers such reserves, which are based on actuarially determined estimates, to be adequate for those liability risks. However, there can be no assurance that the ultimate liability will not exceed management’s estimates.
We also maintain director and officer, property, and other typical insurance coverages with unrelated commercial carriers. Our director and officer liability insurance coverage for our current officers and directors is in the amount of $200 million, which includes $50 million in coverage for individual directors and officers in
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circumstances where we are legally or financially unable to indemnify these individuals. Examples of a company’s inability to indemnify would include derivative suits, bankruptcy/financial restraints, and claims that are against public policy. Of the $200 million coverage, we have a self-insured retention of $10 million for claims against us.
In addition to the standard industry exclusions, our director and officer liability policy also includes exclusions of coverage for (1) our former Chairman and Chief Executive Officer, Richard M. Scrushy, and our former Chief Financial Officer, William T. Owens and (2) a prior acts exclusion and a pending and prior litigation exclusion as of July 31, 2003. See Item 3, Legal Proceedings , “Insurance Coverage Litigation,” for a description of various lawsuits that have been filed to contest coverage under certain directors and officers insurance policies.
While to date we have not had difficulty in obtaining director and officer liability insurance coverage for our current directors and officers, the premium costs associated with this coverage have been dramatically higher than in the years prior to March 2003. We believe we will be able to continue to secure comparable coverage for the coming insurance year. We anticipate that, although the premium costs associated with our director and officer liability insurance coverage will be reduced during the coming insurance year, such premium costs will remain higher than in the years prior to March 2003. Despite these increased premium costs, we do not believe these costs are material to our results of operation or financial condition.
Employees
As of December 31, 2005, we employed approximately 37,000 individuals, of whom approximately 24,000 were full-time employees. We are subject to various state and federal laws that regulate wages, hours, benefits, and other terms and conditions relating to employment. Except for approximately 96 employees at one IRF (about 20% of that facility’s workforce), none of our employees are represented by a labor union. We are not aware of any current activities to organize our employees at other facilities. We believe our relationship with our employees is satisfactory. Like most health care providers, our labor costs are rising faster than the general inflation rate. In some markets, the availability of nurses and other medical support personnel has become a significant operating issue to health care providers. To address this challenge, we are implementing initiatives to improve retention, recruiting, compensation programs, and productivity. The shortage of nurses and other medical support personnel, including physical therapists, may require us to increase utilization of more expensive temporary personnel.
Available Information
Our website address is www.healthsouth.com. We make available through our website the following documents, free of charge: our annual reports (Form 10-K), our quarterly reports (Form 10-Q), our current reports (Form 8-K), and any amendments we file with respect to any such reports promptly after we electronically file such material with, or furnish it to, the SEC. Please note, however, that we have not filed any quarterly reports for periods after September 30, 2002. In addition to the information that is available on our website, you may read and copy any materials we file with or furnish to the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website, www.sec.gov, which includes reports, proxy, and information statements, and other information regarding us and other issuers that file electronically at the SEC.
Our business, operations, and financial condition are subject to various risks. Some of these risks are described below, and you should take such risks into account in evaluating HealthSouth or any investment decision involving HealthSouth. This section does not describe all risks that may be applicable to our company, our industry, or our business, and it is intended only as a summary of certain material risk factors. More detailed information concerning the risk factors described below is contained in other sections of this annual report.
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Item 1A. Risk Factors
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Risks Related to Pending Governmental Investigations and Litigation
Any adverse outcome of continuing investigations being conducted by the DOJ and other governmental agencies could have a material adverse effect on us.
While we are fully cooperating with the DOJ and other governmental authorities in their investigations, we cannot predict the outcome of those investigations. Such investigations could have a material adverse effect on us, the trading prices of our securities, and our ability to raise additional capital. If we are convicted of a crime, certain contracts and licenses that are material to our operations could be revoked which would materially and adversely affect our business, financial condition, results of operations, and cash flows.
Several lawsuits have been filed against us involving our accounting practices and other related matters and the outcome of these lawsuits may have a material adverse effect on our business, financial condition, results of operations, and cash flows.
A number of class action, derivative, and individual lawsuits have been filed against us, as well as certain of our past and present officers and directors, relating to, among other things, allegations of numerous violations of securities laws. Although we have reached a preliminary agreement in principle to settle these cases, there can be no assurances that a final settlement can be reached or that the proposed settlement will receive court approval. Substantial damages or other monetary remedies assessed against us could have a material adverse effect on our business, financial condition, results of operations, and cash flows. See Item 3, Legal Proceedings , for a discussion of these lawsuits.
Although we have entered into a settlement with various government agencies and other parties regarding our participation in federal health care programs, we remain a defendant in litigation relating to our participation in federal health care programs, and the outcome of these lawsuits may have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Qui tam actions brought under the False Claims Act are sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the federal government, and the court. Therefore, it is possible that additional qui tam actions have been filed against us that we are unaware of or which we have been ordered by the court not to discuss until the court lifts the seal from the case. Thus, it is possible that we are subject to liability exposure under the False Claims Act based on qui tam actions other than those discussed in this report.
CMS has been granted authority to suspend payments, in whole or in part, to Medicare providers if CMS possesses reliable information that an overpayment, fraud, or willful misrepresentation exists. If CMS suspects that payments are being or have been made as the result of fraud or misrepresentation, CMS may suspend payment at any time without providing us with prior notice. The initial suspension period is limited to 180 days. However, the payment suspension period can be extended almost indefinitely if the matter is under investigation by the HHS-OIG or the DOJ. Therefore, we are unable to predict if or when we may be subject to a suspension of payments by the Medicare and/or Medicaid programs, the possible length of the suspension period or the potential cash flow impact of a payment suspension. Any such suspension would adversely impact our business, financial condition, results of operations, and cash flows.
If the HHS-OIG determines we have violated federal laws governing kickbacks and self-referrals, it could impose substantial civil monetary penalties on us and could seek to exclude our provider entities from participation in the federal health care programs which would severely impact our financial condition and ability to continue operations.
If the HHS-OIG determines that we have violated the Anti-Kickback Law, the HHS-OIG may commence administrative proceedings to impose penalties under the Civil Monetary Penalties Law of up to three times the amount of damages and $11,000 per claim for each false or fraudulent claim allegedly submitted by us. If the
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HHS-OIG determines that we have violated the federal Stark statute’s general prohibition on physician self-referrals (42 U.S.C. § 1395nn), it may impose a civil monetary penalty of up to $15,000 per service billed in violation of the statute.
The HHS-OIG has been granted the authority to exclude persons or entities from participation in the federal health care programs for a variety of reasons, including: (1) committing an act in violation of the Anti-Kickback Law, (2) submitting a false or fraudulent claim, (3) submitting a claim for services rendered in violation of the physician self-referral statute, or (4) violating any other provision of the Civil Monetary Penalties Law. Thus, if the HHS-OIG believes that we have submitted false or fraudulent claims, paid or received kickbacks, submitted claims in violation of the physician self-referral law, or committed any other act in violation of the Civil Monetary Penalties Law, the HHS-OIG could move to exclude our provider entities from participation in the federal health care programs.
Limitations of our director and officer liability i nsurance and potential indemnification obligations could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Our director and officer liability insurance coverage for our current officers and directors is in the amount of $200 million, which includes $50 million in coverage for individual directors and officers in circumstances where we are legally or financially unable to indemnify these individuals. Examples of a company’s inability to indemnify would include derivative suits, bankruptcy/financial restraints, and claims that are against public policy. Of the $200 million coverage, we have a self-insured retention of $10 million for claims against us.
As discussed in Item 3, Legal Proceedings , several of our current and former directors and officers have been sued based on allegations that they participated in accounting fraud and other illegal activities during periods ended March 18, 2003. Several of our insurance carriers have filed lawsuits against us and are attempting to have our director and officer liability policies that provide coverage for those claims voided or cancelled or have advised us that they do not intend to provide coverage with respect to those pending actions. We have reached a preliminary agreement in principle with our insurance carriers to resolve our claims against each other. In the proposed settlement, the carriers for three of our prior policy periods will contribute $230 million in cash toward the settlement of certain federal securities and derivative litigation. In our settlement discussions, our insurance carriers for these periods are demanding a full policy release of any future claims against the policies, in which event, we will not be able to rely on any additional insurance proceeds to fund any settlements, judgments, or indemnification claims relating to actions occurring on or prior to July 31, 2003. See Item 1, Business , “Securities Litigation Settlement.”
Under our bylaws and certain indemnification agreements, we may have an obligation to indemnify our current and former officers and directors. Although we contest the validity of his claim, Richard M. Scrushy recently requested that we reimburse him for costs relating to his criminal defense, which he estimates exceed $31 million. If the settlement described in Item 3, Legal Proceedings , “Insurance Coverage Litigation” is approved on the terms contained in the preliminary settlement, we will not have insurance to cover expenses incurred or liabilities imposed in connection with the pending actions against certain of our past and present directors and officers who we may be required to indemnify.
Risks Related to Our Financial Condition
We are highly leveraged. As a consequence, a substantial down-turn in earnings could jeopardize our ability to make our interest payments and could impair our ability to obtain additional financing, if necessary.
We are highly leveraged. As of December 31, 2005 we had approximately $3.4 billion of long-term debt outstanding. As discussed in Item 1, Business , “Recapitalization Transactions,” we have prepaid substantially all of our prior indebtedness with proceeds from a series of recapitalization transactions and replaced it with approximately $3 billion of new long-term debt. Although we remain highly leveraged, we believe these
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recapitalization transactions have eliminated significant uncertainty regarding our capital structure and have improved our financial condition by reducing our refinancing risk, increasing our liquidity, improving our operational flexibility, improving our credit profile, and reducing our interest rate exposure.
We are required to use a substantial portion of our cash flow to service our debt. A substantial down-turn in earnings could jeopardize our ability to make our interest payments and could impair our ability to obtain additional financing, if necessary. Certain trends in our business, including declining revenues resulting from the 75% Rule, acute care volume weakness, recent IRF-PPS changes, and continued weakness in our surgery centers division, have created a challenging operating environment, and future changes could place additional pressure on our revenues and cash flow. In addition, we are subject to numerous contingent liabilities and are subject to prevailing economic conditions and to financial, business, and other factors beyond our control. Although we expect to make scheduled interest payments and principal reductions, we cannot assure you that changes in our business or other factors will not occur that may have the effect of preventing us from satisfying obligations under our debt.
We have significant cash obligations relating to government settlements that, in addition to our indebtedness, may limit cash flow available for our operations and could impair our ability to service debt or obtain additional financing, if necessary.
In addition to being highly leveraged, we have significant cash obligations we must meet in the near future as a result of recent settlements with various federal agencies. Specifically, we are obligated to pay $170 million (plus interest) in quarterly installments ending in the fourth quarter of 2007 to satisfy our obligations under a settlement described in Item 1, Business , “Medicare Program Settlement.” Furthermore, we are obligated to pay $87.5 million to the SEC in four installments ending in the fourth quarter of 2007 to satisfy our obligations under a settlement described in Item 1, Business , “SEC Settlement.”
We likely will not apply to relist our common stock on a major securities exchange until the middle of 2006, and do not expect to be able to meet the registration requirements of the Securities Act until the first quarter of 2007, at the earliest. Until we are relisted on a major securities exchange, the prices at which our common stock trades in the over-the-counter market may be much more volatile than if it traded on a major securities exchange. Until we can meet the registration requirements of the Securities Act, our access to capital will be limited.
We do not expect to apply for relisting on a major securities exchange until the middle of 2006. While our common stock is quoted on the OTC Bulletin Board and in the Pink Sheets, there is currently only a limited trading market for our shares and the market price of these shares may be volatile for the foreseeable future. The limited trading market for our common stock may cause fluctuations in the price and volume of our shares to be more exaggerated than would occur on a major securities exchange. We cannot assure you that prior to relisting our shares on a major securities exchange, you will be able to sell shares of our common stock without a considerable delay or significant impact on the sale price.
In addition, it will likely be the first quarter of 2007, at the earliest, before we can meet the registration requirements of the Securities Act and thereby have access to public capital markets. Because our internal controls are still ineffective, it may be difficult to file our annual report on Form 10-K and quarterly reports on Form 10-Q for 2006 on a timely basis, which could extend the time it will take for us to satisfy the registration requirements of the Securities Act. Consequently, we will not have access to public capital markets until the first quarter of 2007, at the earliest, which will make it more difficult to grow our business.
We have determined that our internal controls are currently ineffective. The lack of effective internal controls could adversely affect our financial condition and ability to carry out our strategic business plan.
As discussed in Item 9A, Controls and Procedures , our new management team, under the supervision and with the participation of our chief executive officer and chief financial officer, conducted an evaluation of the
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effectiveness of the design and operation of HealthSouth’s internal controls. As of December 31, 2005, they concluded that HealthSouth’s disclosure controls and procedures, including HealthSouth’s internal control over financial reporting, were not effective. Although we have made improvements in our internal controls, if we are unsuccessful in our focused effort to permanently and effectively remediate the weaknesses in our internal control over financial reporting and to establish and maintain effective corporate governance practices, our financial condition and ability to carry out our strategic business plan, our ability to report our financial condition and results of operations accurately and in a timely manner, and our ability to earn and retain the trust of our patients, physician partners, employees, and security holders, could be adversely affected.
Risks Related to Our Business
The continuing time, effort, and expense relating to investigations and implementation of improved internal controls and procedures, may have an adverse effect on our business, financial condition, results of operations, and cash flows.
In addition to the challenges of the various government investigations and extensive litigation we face, our new management team has spent considerable time and effort dealing with internal and external investigations involving our historical accounting and internal controls, and in developing and implementing accounting policies and procedures, disclosure controls and procedures, and corporate governance policies and procedures. The significant time and effort spent may have adversely affected our operations and may continue to do so in the future.
Current and prospective investors, patients, physician partners, and employees may react adversely to the continuing negative effects of the March 2003 crisis and the financial reporting and operational issues that were uncovered as a result of that crisis.
Our future success depends in large part on the support of our current and future investors, patients, physician partners, and employees. The various legal, financial, and operational challenges resulting from the financial fraud perpetrated by certain members of our prior management team has caused negative publicity, the delisting of our common stock from the NYSE, and has, and may continue to have, a negative impact on the market price of our securities. In addition, the reconstruction of our historical financial records has caused us to restate the financial statements of certain of our partnerships. While the process of communicating the effect of these restatement activities to our partners has begun, we anticipate the process of resolving issues arising from these restatements will continue at least through 2006, which may have a negative impact on our relationships with our current partners and may create an environment that is not conducive to attracting new partners. Finally, employees and prospective employees may factor in these considerations relating to our stability and the value of any equity incentives in their decision-making regarding employment opportunities.
If we fail to comply with the extensive laws and government regulations applicable to us, we could suffer penalties or be required to make significant changes to our operations.
We are required to comply with extensive and complex laws and regulations at the federal, state, and local government levels. These laws and regulations relate to, among other things:
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• licensure, certification, and accreditation,
• coding and billing for services,
• relationships with physicians and other referral sources, including physician self-referral and anti-kickback laws,
• quality of medical care,
• use and maintenance of medical supplies and equipment,
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In the future, changes in these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our investment structure, facilities, equipment, personnel, services, capital expenditure programs, operating procedures, and contractual arrangements.
If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including (1) criminal penalties, (2) civil penalties, including monetary penalties and the loss of our licenses to operate one or more of our facilities, and (3) exclusion or suspension of one or more of our facilities from participation in the Medicare, Medicaid, and other federal and state health care programs.
If we fail to comply with our new Corporate Integrity Agreement, we could be subject to severe sanctions.
In December 2004, we entered into a new corporate integrity agreement with the HHS-OIG to promote our compliance with the requirements of Medicare, Medicaid, and all other federal health care programs. Under that agreement, which is effective for five years from January 1, 2005, we are subject to certain administrative requirements and are subject to review of certain Medicare cost reports and reimbursement claims by an Independent Review Organization. Our failure to comply with the material terms of the corporate integrity agreement could lead to suspension or exclusion from further participation in federal health care programs, including Medicare and Medicaid, which currently account for a substantial portion of our revenues. Any of these sanctions would have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Reductions or changes in reimbursement from government or third-party payors could adversely affect our operating results.
We derive a substantial portion of our net operating revenues from the Medicare and Medicaid programs. In 2005, 47.5% of our consolidated net operating revenues was derived from Medicare, 2.3% was derived from Medicaid, 7.4% was derived from workers’ compensation plans, 33.1% was derived from managed care and other discount plans, 5.4% was derived from other third-party payors, 1.8% was derived from patients, and 2.5% was derived from other income. There are increasing pressures from many payors to control health care costs and to reduce or limit increases in reimbursement rates for medical services. Our operating results could be adversely affected by changes in laws or regulations governing the Medicare and Medicaid programs. See Item 1, Business , “Sources of Revenue.”
Historically, Congress and some state legislatures have periodically proposed significant changes in the health care system. Many of these changes have resulted in limitations on and, in some cases, significant reductions in the levels of, payments to health care providers for services under many government reimbursement programs. See Item 1, Business , “Regulation” for a discussion of potential changes to the health care system that could materially and adversely affect our business, financial condition, results of operations, and cash flows.
In particular, as discussed in Item 1, Business , “Sources of Revenues,” changes to the 75% Rule and IRF-PPS have combined to create a very challenging operating environment for our inpatient division. The volume volatility created by the 75% Rule has had a significantly negative impact on our inpatient division’s net operating revenues in 2005. Thus far, we have been able to partially mitigate the impact of the 75% Rule on our inpatient division’s operating earnings by implementing the mitigation strategies discussed in Item 1, Business , “Our Business—Operating Divisions.” However, the combination of volume volatility created by the 75% Rule and lower unit pricing resulting from IRF-PPS changes reduced our operating earnings in 2005 and will have a continuing negative impact on our operating earnings in 2006. See Item 7, Management’s Discussion and
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• maintenance and security of medical records,
• accuracy of billing operations, and
• disposal of medical and hazardous waste.
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Analysis of Financial Condition and Results of Operations , for additional information about the impact of these changes. In addition, because we receive a significant percentage of our revenues from our inpatient division, and because our inpatient division receives a significant percentage of its revenues from Medicare, our inability to achieve continued compliance with or continue to mitigate the negative effects of the 75% Rule could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
Our relationships with third-party payors, such as HMOs and PPOs, are generally governed by negotiated agreements. These agreements set forth the amounts we are entitled to receive for our services. We could be adversely affected in some of the markets where we operate if we are unable to negotiate and maintain favorable agreements with third-party payors. In addition, our third-party payors may, from time to time, request audits of the amounts paid to us under our agreements with them. We could be adversely affected in some of the markets where we operate and within certain of our operating divisions if the audits uncover substantial overpayments made to us. As part of the reconstruction of accounting records, we discovered the existence of substantial credit balances, which could represent posting errors, misapplied payments or overpayments due to patients and third-party payors, including the Medicare and Medicaid programs. We have reviewed these accounts to determine whether and to what extent we may be required to repay any of these credit balances to patients or third-party payors, including the Medicare and Medicaid programs. We could be adversely affected if the amount we are required to repay exceeds our current estimates.
The adoption of more restrictive Medicare coverage policies at the national and/or local levels could have an adverse impact on our ability to obtain Medicare reimbursement for inpatient rehabilitation services.
Medicare providers also can be negatively affected by the adoption of coverage policies, either at the national or local levels, describing whether an item or service is covered and under what clinical circumstances it is considered to be reasonable, necessary, and appropriate. In the absence of a national coverage determination, local Medicare fiscal intermediaries and carriers may specify more restrictive criteria than otherwise would apply nationally. For instance, Cahaba Government Benefit Administrators, the fiscal intermediary for many of our inpatient division facilities, has issued a local coverage determination setting forth very detailed criteria for determining the medical appropriateness of services provided by IRFs. We cannot predict whether other Medicare contractors will adopt additional local coverage determinations or other policies or how these will affect us.
Downward pressure on pricing from commercial and government payors may adversely affect the revenues and profitability of certain of our operations.
We have experienced downward pressure on prices in our markets, from both commercial and government payors, and we anticipate continuing price pressure in all our divisions. There can be no assurances that we will be able to maintain current prices in the face of continuing pricing pressures. We may be required to implement additional measures to mitigate these pressures and further enhance the efficiency of our operations or, in the alternative, dispose of inefficient operations. These pricing pressures have had, and if we are not successful in mitigating such pressures in the future, may continue to have, an adverse effect on the revenues and profitability of our surgery centers and our outpatient and diagnostic divisions, including certain operations which we are currently considering divesting. In the event that we decide to divest certain inefficient operations, we cannot assure you that we will be able to successfully do so at all, or on a timely basis or on terms acceptable to us. As discussed elsewhere in this report, we have signed an agreement to sell our acute care facility located in Birmingham, Alabama. That operation reported an approximate $35 million loss from operations, before provision for income tax expense, in 2005. This loss is included in our loss from discontinued operations (See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations ) for the year ended December 31, 2005. In addition, we have received inquiries from parties interested in acquiring our diagnostic division. That operation represented approximately 7.1% of our consolidated net operating revenues for the year ended December 31, 2005. The diagnostic division’s operating loss for 2005 was approximately $1.0 million (See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations ). No final decision has been made with respect to the divestiture of our diagnostic division at this time.
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Our facilities face national, regional, and local competition for patients from other health care providers.
We operate in a highly competitive industry. Although we are the largest provider of rehabilitative health care services, and one of the largest providers of ambulatory surgery and outpatient diagnostic services in the United States, in any particular market we may encounter competition from local or national entities with longer operating histories or other competitive advantages. There can be no assurance that this competition, or other competition which we may encounter in the future, will not adversely affect our business, financial condition, results of operations, or cash flows. In addition, weakening certificate of need laws in some states could potentially increase competition in those states.
Competition for staffing may increase our labor costs and reduce profitability.
Our operations are dependent on the efforts, abilities, and experience of our management and medical support personnel, such as physical therapists, nurses, and other health care professionals. We compete with other health care providers in recruiting and retaining qualified management and support personnel responsible for the daily operations of each of our facilities. In some markets, the availability of physical therapists, nurses, and other medical support personnel has become a significant operating issue to health care providers. This shortage may require us to continue to enhance wages and benefits to recruit and retain qualified personnel or to hire more expensive temporary personnel. We also depend on the available labor pool of semi-skilled and unskilled employees in each of the markets in which we operate. If our labor costs increase, we may not be able to raise rates to offset these increased costs. Because a significant percentage of our revenues consists of fixed, prospective payments, our ability to pass along increased labor costs is limited. Our failure to recruit and retain qualified management, physical therapists, nurses, and other medical support personnel, or to control our labor costs, could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
We depend on our relationships with the physicians who use our facilities.
Our business depends upon the efforts of the physicians who provide health care services at our facilities and/or refer their patients to our facilities and the strength of our relationships with these physicians. Each physician referring or treating patients at one of our facilities may also practice at other facilities not owned by us.
At each of our facilities, our business could be adversely affected if a significant number of key physicians or a group of physicians:
None.
Our principal executive offices are located in Birmingham, Alabama, where we own and maintain a headquarters building of approximately 200,000 square feet located on an 85-acre corporate campus. In addition to our headquarters building, as of December 31, 2005 we leased or owned nearly 1,100 facilities through various consolidated entities to support our operations. Our leases generally have initial terms of 5 years, but range from 1 to 99 years. Most of our leases contain options to extend the lease period for up to 5 additional years. Our
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• terminate their relationship with, or reduced their use of, our facilities,
• fail to maintain the quality of care provided or otherwise adhere to professional standards at our facilities, or
• exit the market entirely.
Item 1B. Unresolved Staff Comments
Item 2. Properties
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consolidated entities are sometimes responsible for property taxes, property and casualty insurance, and routine maintenance expenses. Other than our headquarters campus, our acute care hospital located in Birmingham, Alabama, and our Digital Hospital described below, none of our other properties is materially important. Each of our material properties is used by our corporate and other segment, except our Digital Hospital, which is not in use but is held by our corporate and other segment. We and our Subsidiary Guarantors have pledged substantially all of our property as collateral to secure the performance of our obligations under our Credit Agreement. . In addition, we and the Subsidiary Guarantors agreed to enter into mortgages with respect to certain of our material real property (excluding real property owned by the surgery centers division or otherwise subject to preexisting liens and/or mortgages) in connection with the Credit Agreement. Our obligations under the Credit Agreement will be secured by the real property subject to such mortgages. For additional information about our Credit Agreement, see Note 8, Long-term Debt , to our accompanying consolidated financial statements.
We also currently own, and from time to time may acquire, certain other improved and unimproved real properties in connection with our business. See Note 5, Property and Equipment , to our accompanying consolidated financial statements for more information about the properties we own and certain related indebtedness.
In 2005 we sold approximately $8.4 million in land and buildings, not including properties sold in connection with the sale of operating facilities. On July 20, 2005, we executed an asset purchase agreement with The Board of Trustees of the University of Alabama (the “University of Alabama”) for the sale of the real property, furniture, fixtures, equipment and certain related assets associated with our 219 licensed-bed acute care hospital located in Birmingham, Alabama. Simultaneously with the execution of this purchase agreement with the University of Alabama, we executed an agreement with an affiliate of the University of Alabama whereby this entity currently provides certain management services to our acute care hospital in Birmingham. On December 31, 2005, we executed an amended and restated asset purchase agreement with the University of Alabama. This amended and restated agreement provides that the University of Alabama will purchase our Birmingham acute care hospital and associated real and personal property as well as our interest in the gamma knife partnership associated with this hospital. We anticipate closing this transaction by the end of the first quarter of 2006. We will transfer the hospital and associated real and personal property at that time, but will transfer our interest in the gamma knife partnership at a later date. The proposed transaction also requires that we acquire and convey title to the University of Alabama for certain professional office buildings that we are currently leasing. Both the certificate of need under which the hospital currently operates, and the licensed beds operated by us at the hospital, will be transferred as part of the sale of the hospital under the amended and restated agreement. Upon consummation of the agreement with the University of Alabama, we would no longer have the ability to operate or sell the Digital Hospital project as an acute care hospital without obtaining an additional certificate of need or specific exception. On January 4, 2006, we executed a letter of intent with an undisclosed party regarding the sale of the property and equipment which were to have comprised our Digital Hospital in Birmingham, Alabama. Any sale of the Digital Hospital will not involve conveyance of our interest in any certificate of need from our acute care hospital located in Birmingham, Alabama. The letter of intent expires, subject to certain conditions, on March 31, 2006 unless otherwise extended in accordance with the terms of the letter of intent. As of December 31, 2005, we had invested approximately $210 million in the Digital Hospital project. We have not signed a definitive agreement with respect to the Digital Hospital, and there can be no assurance any sale will take place. See Note 5, Property and Equipment , to our accompanying consolidated financial statements, for a discussion of the impairment charge we recognized in 2005 relating to the Digital Hospital.
Our headquarters, facilities, and other properties are suitable for their respective uses and are, in general, adequate for our present needs. Our properties are subject to various federal, state, and local statutes and ordinances regulating their operation. Management does not believe that compliance with such statutes and ordinances will materially affect our business, financial condition, or results from operations.
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Investigations and Proceedings Commenced by the SEC, the United States Department of Justice, and Other Governmental Authorities
In September 2002, the Securities and Exchange Commission (the “SEC”) notified us that it was conducting an investigation of trading in our securities that occurred prior to an August 27, 2002 press release concerning the impact of new Medicare billing guidance on our expected earnings. On February 5, 2003, the United States District Court for the Northern District of Alabama issued a subpoena requiring us to provide various documents in connection with a criminal investigation of us and certain of our directors, officers, and employees being conducted by the United States Attorney for the Northern District of Alabama. On March 18, 2003, agents from the Federal Bureau of Investigation (the “FBI”) executed a search warrant at our headquarters in connection with the United States Attorney’s investigation and were provided access to a number of financial records and other materials. The agents simultaneously served a grand jury subpoena on us on behalf of the criminal division of the United States Department of Justice (the “DOJ”). Some of our employees also received subpoenas.
On March 19, 2003, the SEC filed a lawsuit captioned Securities and Exchange Commission v. HealthSouth Corp., et al ., CV-03-J-0615-S, in the United States District Court for the Northern District of Alabama. The complaint alleges that we overstated earnings by at least $1.4 billion since 1999, and that this overstatement occurred because our then-Chairman and Chief Executive Officer, Richard M. Scrushy, insisted that we meet or exceed earnings expectations established by Wall Street analysts.
The SEC states in its complaint that our actions and those of Mr. Scrushy violated and/or aided and abetted violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. Specifically, the SEC charged us with violations of Section 17(a) of the Securities Act of 1933 (the “Securities Act”) and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 (the “1934 Act”), and 1934 Act Rules 10b-5, 12b-20, 13a-1, and 13a-13. The SEC sought a permanent injunction against us, civil money penalties, disgorgement of ill-gotten gains and losses avoided, as well as prejudgment interest. On March 19, 2003, we consented to the entry of an order by the court that (1) required us to place in escrow all extraordinary payments (whether compensation or otherwise) to our directors, officers, partners, controlling persons, agents, and employees, (2) prohibited us and our employees from destroying documents relating to our financial activities and/or the allegations in the SEC’s lawsuit against us and Mr. Scrushy, and (3) provided for expedited discovery in the lawsuit brought by the SEC.
On June 6, 2005, the SEC approved a settlement (the “SEC Settlement”) with us relating to this lawsuit. Under the terms of the SEC Settlement, we have agreed, without admitting or denying the SEC’s allegations, to be enjoined from future violations of certain provisions of the securities laws. We have also agreed to pay a $100 million civil penalty and disgorgement of $100 to the SEC in installments over two years, beginning in the fourth quarter of 2005. We consented to the entry of a final judgment (which judgment was entered by the United States District Court for the Northern District of Alabama, Southern Division) to implement the terms of the SEC Settlement. See Item 1, Business , “SEC Settlement,” for additional information about the SEC Settlement. Mr. Scrushy remains a defendant in the lawsuit.
On November 4, 2003, Mr. Scrushy was charged in federal court on 85 counts of wrongdoing in connection with his actions while employed by us. A superseding indictment of 58 counts, released on September 29, 2004, added charges of obstruction of justice and perjury while consolidating and eliminating some of the 85 counts of conspiracy, mail fraud, wire fraud, securities fraud, false statements, false certifications, and money laundering that were previously charged. The superseding indictment sought the forfeiture of $278 million in property from Mr. Scrushy allegedly derived from his offenses. Mr. Scrushy was acquitted on June 28, 2005.
On April 10, 2003, the DOJ’s civil division notified us that it was expanding its investigation (which began with the lawsuit United States ex rel. Devage v. HealthSouth Corp., et al ., C.A. No. SA-98-EA-0372-FV, filed in the United States District Court for the Western District of Texas, as discussed in Item 1, Business , “Medicare
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Item 3. Legal Proceedings
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Program Settlement”) into allegations of fraud associated with Medicare cost reports submitted by us for fiscal years 1995 through 2002. We subsequently received subpoenas from the Office of Inspector General (the “HHS-OIG”) of the United States Department of Health and Human Services (“HHS”) and requests from the DOJ’s civil division for documents and other information regarding this investigation. As described in Item 1, Business , “Medicare Program Settlement,” on December 30, 2004, we announced that we had entered into a global settlement agreement with the DOJ’s civil division and other parties to resolve the primary claims made in the Devage litigation, although the DOJ continues to review certain other matters, including self-disclosures made by us to the HHS-OIG.
In the summer of 2003, we discovered certain irregular payments made to a foreign official under a consulting agreement entered into in connection with an October 2000 agreement between us and the Sultan Bin Abdul Aziz Foundation to manage an inpatient rehabilitation hospital in Riyadh, Saudi Arabia. We notified the DOJ immediately, and we cooperated fully with the investigation. One former executive pled guilty to charges of wire fraud in connection with the irregular payments, and another former executive pled guilty to charges of making a false statement to government investigators in connection with the investigation. Two additional former executives were acquitted by a jury of charges that they participated in the fraud. We terminated the October 2000 agreement and entered into a new agreement, effective January 1, 2004, to manage the Riyadh facility. Effective October 2004, we terminated our relationship with the Sultan Bin Abdul Aziz Foundation and the Riyadh facility entirely.
Many of our former officers, including all five of our former chief financial officers, have pleaded guilty to federal criminal charges filed in connection with the investigations described above. These individuals pled guilty to a variety of charges, including securities fraud, accounting fraud, filing false tax returns, making a false statement to governmental authorities, falsifying books and accounts, wire fraud, conspiracy, and falsely certifying financial information to the SEC. One former executive was convicted on November 18, 2005 of criminal charges filed in connection with the accounting fraud investigation.
On October 26, 2005, a federal grand jury issued a superseding indictment against Richard M. Scrushy, former Alabama Governor Don Siegelman, and others, in which Mr. Scrushy is charged with three counts of bribery and mail fraud. We are cooperating with the Office of the United States Attorney on that matter.
Securities Litigation
On June 24, 2003, the United States District Court for the Northern District of Alabama consolidated a number of separate securities lawsuits filed against us under the caption In re HealthSouth Corp. Securities Litigation , Master Consolidation File No. CV-03-BE-1500-S (the “Consolidated Securities Action”). The Consolidated Securities Action included two prior consolidated cases ( In re HealthSouth Corp. Securities Litigation , CV-98-J-2634-S and In re HealthSouth Corp. 2002 Securities Litigation , Consolidated File No. CV-02-BE-2105-S) as well as six lawsuits filed in 2003. Including the cases previously consolidated, the Consolidated Securities Action comprised over 40 separate lawsuits. The court divided the Consolidated Securities Action into two subclasses:
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• Complaints based on purchases of our common stock were grouped under the caption In re HealthSouth Corp. Stockholder Litigation , Consolidated Case No. CV-03-BE-1501-S (the “Stockholder Securities Action”), which was further divided into complaints based on purchases of our common stock in the open market (grouped under the caption In re HealthSouth Corp. Stockholder Litigation, Consolidated Case No. CV-03-BE-1501-S) and claims based on the receipt of our common stock in mergers (grouped under the caption HealthSouth Merger Cases , Consolidated Case No. CV-98-2777-S). Although the plaintiffs in the HealthSouth Merger Cases have separate counsel and have filed separate claims, the HealthSouth Merger Cases are otherwise consolidated with the Stockholder Securities Action for all purposes.
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On January 8, 2004, the plaintiffs in the Consolidated Securities Action filed a consolidated class action complaint. The complaint names us as a defendant, as well as more than 30 of our current and former employees, officers and directors, the underwriters of our debt securities, and our former auditor. The complaint alleges, among other things, (1) that we misrepresented or failed to disclose certain material facts concerning our business and financial condition and the impact of the Balanced Budget Act of 1997 on our operations in order to artificially inflate the price of our common stock, (2) that from January 14, 2002 through August 27, 2002, we misrepresented or failed to disclose certain material facts concerning our business and financial condition and the impact of the changes in Medicare reimbursement for outpatient therapy services on our operations in order to artificially inflate the price of our common stock, and that some of the individual defendants sold shares of such stock during the purported class period, and (3) that Richard M. Scrushy instructed certain former senior officers and accounting personnel to materially inflate our earnings to match Wall Street analysts’ expectations, and that senior officers of HealthSouth and other members of a self-described “family” held meetings to discuss the means by which our earnings could be inflated and that some of the individual defendants sold shares of our common stock during the purported class period. The consolidated class action complaint asserts claims under Sections 11, 12(a)(2) and 15 of the Securities Act, and claims under Sections 10(b), 14(a), 20(a) and 20A of the 1934 Act.
On February 22, 2006, we announced that we had reached a global, preliminary settlement with the lead plaintiffs in the Stockholder Securities Action, the Bondholder Securities Action, and the derivative litigation, as well as with our insurance carriers, to settle claims filed in those actions against us and many of our former directors and officers. Under the proposed settlement, claims brought against the settling defendants will be settled for consideration consisting of HealthSouth common stock and warrants valued at approximately $215 million and cash payments by our insurance carriers of $230 million. In addition, we have agreed to give the class 25% of our net recovery from any future judgments won by us or on our behalf against Richard M. Scrushy, our former Chairman and Chief Executive Officer, Ernst & Young LLP, our former auditor, and certain affiliates of UBS Group, our former lead investment banker, none of whom are included in the settlement. The proposed settlement is subject to a number of conditions, including the successful negotiation of definitive documentation and final court approval. The proposed settlement does not include Richard Scrushy or any director or officer who has agreed to plead guilty or otherwise been convicted in connection with our former financial reporting activities.
There can be no assurances that a final settlement agreement can be reached or that the proposed settlement will receive the required court approval.
On March 17, 2004, an individual securities fraud action captioned Amalgamated Gadget, L.P. v. HealthSouth Corp. , 4-04CV-198-A, was filed in the United States District Court for the Northern District of Texas. The complaint made allegations similar to those in the Consolidated Securities Action and asserted claims under the federal securities laws and Texas state law based on the plaintiff’s purchase of $24 million in face amount of 3.25% convertible debentures. The court denied our motion to transfer the action to the United States District Court for the Northern District of Alabama, and also denied our motion to dismiss. This action has been settled by the agreement of the parties and dismissed with prejudice.
On November 24, 2004, an individual securities fraud action captioned Burke v. HealthSouth Corp., et al. , 04-B-2451 (OES), was filed in the United States District Court of Colorado against us, some of our former directors and officers, and our former auditor. The complaint makes allegations similar to those in the Consolidated Securities Action and asserts claims under the federal securities laws and Colorado state law based on plaintiff’s alleged receipt of unexercised options and his open-market purchases of our stock. By order dated May 3, 2005, the action was transferred to the United States District Court for the Northern District of Alabama, where it remains pending.
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• Complaints based on purchases of our debt securities were grouped under the caption In re HealthSouth Corp. Bondholder
Litigation , Consolidated Case No. CV-03-BE-1502-S (the “Bondholder Securities Action” ).
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Derivative Litigation
Between 1998 and 2004, a number of lawsuits purporting to be derivative actions ( i.e. , lawsuits filed by shareholder plaintiffs on our behalf) were filed in several jurisdictions, including the Circuit Court for Jefferson County, Alabama, the Delaware Court of Chancery, and the United States District Court for the Northern District of Alabama. Most of these lawsuits have been consolidated as described below:
When originally filed, the primary allegations in the Tucker case involved self-dealing by Richard M. Scrushy and other insiders through transactions with various entities allegedly controlled by Mr. Scrushy. The complaint was amended four times to add additional defendants and include claims of accounting fraud, improper Medicare billing practices, and additional self-dealing transactions. On September 7, 2005, the Alabama Circuit Court ordered the parties to participate in mediation.
On January 3, 2006, the Alabama Circuit Court in the Tucker case granted the plaintiff’s motion for summary judgment against Mr. Scrushy on a claim for the restitution of incentive bonuses Scrushy received for years 1996 through 2002. Including pre-judgment interest, the court’s total award was approximately $48 million. The judgment does not resolve other claims brought by the plaintiff against Scrushy, which remain pending. On February 8, 2006, the Alabama Supreme Court stayed execution on the judgment and ordered briefing on whether or not the Alabama Circuit Court’s order was appropriate for certification as a final appealable order pursuant to Rule 54(b).
The plaintiffs in the Tucker action have reached a preliminary agreement in principle to settle their claims against many of our former directors and officers for $100 million in cash. This settlement amount is to be paid by our insurance carriers, and will be included in the aggregate cash payment of $230 million that is part of the proposed settlement of the Consolidated Securities Action. We are continuing to negotiate the other terms of a settlement with the other parties to this agreement; however, there can be no assurance that a final settlement agreement will be reached or that the proposed settlement will receive the required court approval.
On September 8, 2003, a derivative lawsuit captioned Teachers Retirement Sys. of Louisiana v. Scrushy , C.A. No. 20529-NC, was filed in the Delaware Court of Chancery. The complaint contains allegations similar to
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• All derivative complaints filed in the Circuit Court of Jefferson County, Alabama since 2002 have been consolidated and stayed in favor of the first-filed action captioned Tucker v. Scrushy , No. CV-02-5212, filed August 28, 2002. The Tucker complaint names as defendants a number of former HealthSouth officers and directors. Tucker also asserts claims on our behalf against Ernst & Young LLP, UBS Group, UBS Investment Bank, and UBS Securities, LLC, as well as against MedCenterDirect.com, Source Medical Solutions, Inc., Capstone Capital Corp., Healthcare Realty Trust, and G.G. Enterprises.
• Two derivative lawsuits filed in the United States District Court for the Northern District of Alabama were consolidated under the
caption In re HealthSouth Corp. Derivative Litigation , CV-02-BE-2565. The court stayed further action in this federal consolidated action in deference to litigation filed in state courts in Alabama and Delaware.
• Two derivative lawsuits filed in the Delaware Court of Chancery were consolidated under the caption In re HealthSouth Corp. Shareholders Litigation , Consolidated Case No. 19896. Plaintiffs’ counsel in this litigation and in Tucker agreed to litigate all claims asserted in those lawsuits in the Tucker litigation, except for claims relating to an agreement to retire a HealthSouth loan to Richard M. Scrushy with shares of our stock (the “Buyback Claim”). On November 24, 2003, the court granted the plaintiffs’ motion for summary judgment on the Buyback Claim and rescinded the retirement of Scrushy’s loan. The court’s judgment was affirmed on appeal. We have collected a judgment of $12.5 million, net of attorneys’ fees awarded by the court. The plaintiffs’ remaining claims are being litigated in Tucker .
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those made in the Tucker case, class claims, as well as a request for relief seeking an order compelling us to hold an annual meeting of stockholders. On December 2, 2003, we announced a settlement of the plaintiff’s claims seeking an annual meeting of stockholders. The Court of Chancery has stayed the remaining claims in favor of earlier-filed litigation in Alabama. This case was not consolidated with In re HealthSouth Corp. Shareholders Litigation .
On November 19, 2004, a derivative lawsuit captioned Campbell v. HealthSouth Corp., Scrushy, et al ., CV-04-6985, was filed in Circuit Court of Jefferson County, Alabama, alleging that we wrongfully refused to file with the Internal Revenue Service refund requests for overpayment of taxes and seeking an order allowing the plaintiff to file claims for refund of excess tax paid by us. This suit was filed just prior to the voluntary dismissal of a similar suit brought by the same plaintiff in the United States District Court for the Northern District of Alabama. On August 23, 2005, the court granted our motion to dismiss without prejudice.
Litigation by and Against Former Independent Auditors
On March 18, 2005, Ernst & Young LLP filed a lawsuit captioned Ernst & Young LLP v. HealthSouth Corp. , CV-05-1618, in the Circuit Court of Jefferson County, Alabama. The complaint asserts that the filing of the claims against us was for the purpose of suspending any statute of limitations applicable to those claims. The complaint alleges that we provided Ernst & Young LLP with fraudulent management representation letters, financial statements, invoices, bank reconciliations, and journal entries in an effort to conceal accounting fraud. Ernst & Young LLP claims that as a result of our actions, Ernst & Young LLP’s reputation has been injured and it has and will incur damages, expense, and legal fees. Ernst & Young LLP seeks recoupment and setoff of any recovery against Ernst & Young LLP in the Tucker case, as well as litigation fees and expenses, damages for loss of business and injury to reputation, and such other relief to which it may be entitled. On April 1, 2005, we answered Ernst & Young LLP’s claims and asserted counterclaims alleging, among other things, that from 1996 through 2002, when Ernst & Young LLP served as our independent auditors, Ernst & Young LLP acted recklessly and with gross negligence in performing its duties, and specifically that Ernst & Young LLP failed to perform reviews and audits of our financial statements with due professional care as required by law and by its contractual agreements with us. Our counterclaims further allege that Ernst & Young LLP either knew of or, in the exercise of due care, should have discovered and investigated the fraudulent and improper accounting practices being directed by Richard M. Scrushy and certain other officers and employees, and should have reported them to our board of directors and the Audit Committee. The counterclaims seek compensatory and punitive damages, disgorgement of fees received from us by Ernst & Young LLP, and attorneys’ fees and costs.
ERISA Litigation
In 2003, six lawsuits were filed in the United States District Court for the Northern District of Alabama against us and some of our current and former officers and directors alleging breaches of fiduciary duties in connection with the administration of our Employee Stock Benefit Plan (the “ESOP”). These lawsuits have been consolidated under the caption In re HealthSouth Corp. ERISA Litigation , Consolidated Case No. CV-03-BE-1700-S (the “ERISA Action”). The plaintiffs filed a consolidated complaint on December 19, 2003 that alleges, generally, that fiduciaries to the ESOP breached their duties to loyally and prudently manage and administer the ESOP and its assets in violation of sections 404 and 405 of the Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1001 et seq . (“ERISA”), by failing to monitor the administration of the ESOP, failing to diversify the portfolio held by the ESOP, and failing to provide other fiduciaries with material information about the ESOP. The plaintiffs seek actual damages including losses suffered by the plan, imposition of a constructive trust, equitable and injunctive relief against further alleged violations of ERISA, costs pursuant to 29 U.S.C. § 1132(g), and attorneys’ fees. The plaintiffs also seek damages related to losses under the plan as a result of alleged imprudent investment of plan assets, restoration of any profits made by the defendants through use of plan assets, and restoration of profits that the plan would have made if the defendants had fulfilled their fiduciary obligations. Pursuant to an Amended Class Action Settlement Agreement entered into on March 6, 2006, all parties have agreed to a global settlement of the claims in the ERISA Action. Under the terms of this
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settlement, Michael Martin, a former chief financial officer of the company, will contribute $350,000 to resolve claims against him, Richard Scrushy, former chief executive officer of the company, and our insurance carriers, will contribute $3.5 million to resolve claims against him, and HealthSouth and its insurance carriers will contribute $25 million to settle claims against all remaining defendants, including HealthSouth. In addition, if we recover any or all of the judgment against Mr. Scrushy for the restitution of incentive bonuses paid to him during 1996 through 2002, we will contribute the first $1 million recovered to the class in the ERISA Action. There can be no assurance that the settlement will be approved by an independent fiduciary appointed to review the settlement on behalf of the ESOP or that the settlement will receive the required court approval.
Insurance Coverage Litigation
In 2003, approximately 14 insurance companies filed complaints in state and federal courts in Alabama, Delaware, and Georgia alleging that the insurance policies issued by those companies to us and/or some of our directors and officers should be rescinded on grounds of fraudulent inducement. The complaints also seek a declaration that we and/or some of our current and former directors and officers are not covered under various insurance policies. These lawsuits challenge the majority of our director and officer liability policies, including our primary director and officer liability policy in effect for the claims at issue. Actions filed by insurance companies in the United States District Court for the Northern District of Alabama were consolidated for pretrial and discovery purposes under the caption In re HealthSouth Corp. Insurance Litigation , Consolidated Case No. CV-03-BE-1139-S. Four lawsuits filed by insurance companies in the Circuit Court of Jefferson County, Alabama have been consolidated with the Tucker case for discovery and other pretrial purposes. Cases related to insurance coverage that were filed in Georgia and Delaware have been dismissed. We have filed counterclaims against a number of the plaintiffs in these cases alleging, among other things, bad faith for wrongful failure to provide coverage. On February 22, 2006, we announced that we had reached a preliminary agreement in principle with our insurance carriers to resolve our claims against each other. In the proposed settlement, the carriers will contribute $230 million in cash toward the settlement of both the Consolidated Securities Action and the Tucker derivative litigation. However, there can be no assurances that a final settlement agreement can be reached.
Litigation by and Against Richard M. Scrushy
Richard M. Scrushy filed two lawsuits against us in the Delaware Court of Chancery. One lawsuit, captioned Scrushy v. HealthSouth Corp ., C.A. No. 20357-NC, filed on June 10, 2003, sought indemnification and advancement of Mr. Scrushy’s legal fees. The other lawsuit, captioned Scrushy v. Gordon, et al. , C.A. No. 20375, filed June 16, 2003, named us and our then-current directors as defendants and petitioned the court to enjoin the defendants from excluding Mr. Scrushy from board meetings and from conducting the business of HealthSouth exclusively through the meetings of the Special Committee. The second lawsuit also sought access to certain information, including meetings of the Special Committee. Both lawsuits were voluntarily dismissed without prejudice.
On December 9, 2005, Richard M. Scrushy filed a new complaint in the Circuit Court of Jefferson County, Alabama, captioned Scrushy v. HealthSouth , CV-05-7364. The complaint alleges that, as a result of Mr. Scrushy’s removal from the position of CEO in March 2003, we owe him “in excess of $70 million” pursuant to an employment agreement dated as of September 17, 2002. We have answered the complaint and filed counterclaims against Mr. Scrushy.
In addition, on or about December 19, 2005, Mr. Scrushy filed a demand for arbitration with the American Arbitration Association, supposedly pursuant to an indemnity agreement with us. The arbitration demand seeks to require us to pay expenses which he estimates exceed $31 million incurred by Mr. Scrushy, including attorneys’ fees, in connection with the defense of criminal fraud claims against him and in connection with a preliminary hearing in the SEC litigation.
In our counterclaim filed in the Alabama Circuit Court action, we have asked the court to prohibit Mr. Scrushy from having his claims resolved in arbitration, as opposed to a jury trial. After hearings on
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January 4, 2006 and January 23, 2006, the Alabama Circuit Court denied our motion to stay and enjoin the arbitration. However, the court ordered Mr. Scrushy to terminate the arbitration and withdraw his demand for arbitration, but left him the option of beginning arbitration at a later date on further order of the court. The court also granted Scrushy the right to petition the court to lift the stay after pre-trial discovery had occurred in the court proceeding between us and Mr. Scrushy.
On or about February 6, 2006, Mr. Scrushy filed a motion with the Alabama Supreme Court asking it to direct the Alabama Circuit Court to vacate its order requiring Scrushy to withdraw his arbitration demand, and to direct the Alabama Circuit Court to dismiss our counterclaim for a declaratory judgment and end “any further exercise of jurisdiction over this arbitration matter.” Mr. Scrushy’s motion is still pending.
Litigation by Other Former Officers
On August 22, 2003, Anthony Tanner, our former Secretary and Executive Vice President—Administration, filed a petition in the Circuit Court of Jefferson County, Alabama, captioned In re Tanner , CV-03-5378, seeking permission to obtain certain information through the discovery process prior to filing a lawsuit. That petition was voluntarily dismissed with prejudice on August 11, 2004. On December 29, 2004, Mr. Tanner filed a lawsuit in the Circuit Court of Jefferson County, Alabama, captioned Tanner v. HealthSouth Corp ., CV-04-7715, alleging that we breached his employment contract by failing to pay certain retirement benefits. The complaint requests damages, a declaratory judgment, and a preliminary injunction to require payment of past due amounts under the contract and reinstatement of the claimed retirement benefits. The parties have agreed to settle this case.
On December 23, 2003, Jason Hervey, one of our former officers, filed a lawsuit captioned Hervey v. HealthSouth Corp., et al., CV-03-8031, in the Circuit Court of Jefferson County, Alabama. The complaint sought compensatory and punitive damages in connection with our alleged breach of his employment contract. We settled this lawsuit in 2005.
Litigation Against Former Officers
On June 10, 2004, we filed a collection action in the Circuit Court of Jefferson County, Alabama, captioned HealthSouth Corp. v. James Goodreau , CV-04-3619, to collect unpaid loans in the original principal amount of $55,500 that we made to James A. Goodreau, our former Director of Corporate Security, while he was a HealthSouth employee. Mr. Goodreau has asserted counterclaims against us seeking monetary damages in an unspecified amount and equitable relief based upon his contention that he was promised lifetime employment with us by Mr. Scrushy. This case is still pending.
On August 30, 2004, we filed a collection action in the United States District Court for the Northern District of Alabama, captioned HealthSouth Corp. v. Daniel J. Riviere , CV-04-CO-2592-S, to collect unpaid loans in the original principal amount of $3,163,421 that we made to Daniel J. Riviere, our former President—Ambulatory Services Division, while he was a HealthSouth employee. Mr. Riviere filed a six-count counterclaim against us on April 5, 2005 seeking (1) severance benefits exceeding $2 million under a written employment agreement dated March 18, 2003, (2) a declaratory judgment that the noncompete clause in his employment agreement is void, (3) damages in an unspecified amount based on stock allegedly purchased and held by him in reliance on misrepresentations made by Richard M. Scrushy, (4) $500,000 in lost profits based allegedly on us forcing him to sell shares of our common stock after he was terminated, (5) damages in an unspecified amount based on our alleged conversion of the cash value of certain insurance policies after his termination, and (6) set off of any award from his counterclaim against unpaid loans we made to him. On April 5, 2005, Mr. Riviere commenced a Chapter 7 bankruptcy case in the U.S. Bankruptcy Court for the Northern District of Florida, Case No. 05-30718-LMK, and this lawsuit is stayed pending resolution of the bankruptcy proceedings. We entered into a settlement agreement with Mr. Riviere and his bankruptcy trustee settling the disputes made the subject of the lawsuit. Pursuant to the settlement agreement, Mr. Riviere has agreed to pay us $1.5 million, plus accrued interest at 6% per annum, within three years. The settlement was approved by the bankruptcy court on November 8, 2005.
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On July 28, 2005, we filed a collection action in the Circuit Court of Jefferson County, Alabama captioned HealthSouth Corp. v. William T. Owens , CV-05-4420, to collect unpaid loans in the original principal amount of approximately $1.0 million that we made to William T. Owens, our former Chief Financial Officer, while he was a HealthSouth employee. On March 16, 2006, the trial court granted from the bench our motion for summary judgment against Mr. Owens for the balance of the outstanding company loans, plus attorneys’ fees, and a written order to that effect should be issued shortly.
Litigation by Former Medical Director
On April 5, 2001, Helen M. Schilling, one of our former medical directors, filed a lawsuit captioned Helen M. Schilling, M.D. v. North Houston Rehabilitation Associates d/b/a HealthSouth Houston Rehabilitation Institute, Romano Rehabilitation Hospital, Inc. and Anne Leon , Cause No. 01-04-02243-CV, in the 410 th Judicial District Court of Montgomery County, Texas. The plaintiff claimed, among other things, that we wrongfully terminated her medical director agreement. On November 5, 2003, after a jury trial, the court entered a final judgment awarding the plaintiff $465,000 in compensatory damages and $865,000 in exemplary damages. We appealed the judgment and settled the case while on appeal in 2005.
Certain Regulatory Actions
The False Claims Act, 18 U.S.C. § 287, allows private citizens, called “relators,” to institute civil proceedings alleging violations of the False Claims Act. These so-called qui tam , or “whistleblower,” cases are sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the federal government, and the presiding court. We recently settled one qui tam lawsuit, Devage , which is discussed in Item 1, Business , “Medicare Program Settlement.” We are aware of one other qui tam lawsuit, Mathews , which is discussed below. It is possible that additional qui tam lawsuits have been filed against us and that we are unaware of such filings or have been ordered by the presiding court not to discuss or disclose the filing of such lawsuits. Thus, we may be subject to liability exposure under one or more undisclosed qui tam cases brought pursuant to the False Claims Act.
On April 1, 1999, a plaintiff relator filed a lawsuit captioned United States ex rel. Mathews v. Alexandria Rehabilitation Hospital , CV-99-0604, in the United States District Court for the Western District of Louisiana. On February 29, 2000, the United States elected not to intervene in the lawsuit. The complaint alleged, among other things, that we filed fraudulent reimbursement claims under the Medicare program on a nationwide basis. The district court dismissed the False Claims Act allegations of two successive amended complaints. However, the district court’s dismissal of the third amended complaint with prejudice was partially reversed by the United States Court of Appeals for the Fifth Circuit on October 22, 2002. The case was remanded to the district court, and our subsequent motion to dismiss was denied on February 21, 2004. The case is currently in the discovery stage on False Claims Act allegations concerning one HealthSouth facility during a specific timeframe.
Americans with Disabilities Act Litigation
On April 19, 2001 a nationwide class action now captioned Michael Yelapi, et al. v. St. Petersburg Surgery Center, et al. , Case No: 8:01-CV-787-T-17EAJ, was filed in the United States District Court for the Middle District of Florida alleging violations of the Americans with Disabilities Act, 42 U.S.C. § 12181, et seq. (the “ADA”) and the Rehabilitation Act of 1973, 92 U.S.C. § 792 et seq. (the “Rehabilitation Act”) at our facilities. The complaint alleges violations of the ADA and Rehabilitation Act for the purported failure to remove barriers and provide accessibility to our facilities, including reception and admitting areas, signage, restrooms, phones, paths of access, elevators, treatment and changing rooms, parking, and door hardware. As a result of these alleged violations, the plaintiffs sought an injunction ordering that we make necessary modifications to achieve compliance with the ADA and the Rehabilitation Act, as well as attorneys’ fees. We have entered into a settlement agreement with the plaintiffs that provides for inspection of our facilities and requires us to correct any deficiencies under the ADA and the Rehabilitation Act. The settlement agreement was approved by the court on December 29, 2005.
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General Medicine, P.C. and Meadowbrook Actions
Pursuant to a Plan and Agreement of Merger dated February 17, 1997, Horizon/CMS Healthcare Corporation (“Horizon/CMS”) became a wholly owned subsidiary of HealthSouth Corporation. At the time of the merger, there was pending against Horizon/CMS in the United States District Court for the Eastern District of Michigan a lawsuit captioned General Medicine, P.C. v. Horizon/CMS Healthcare Corporation , CV-96-72624 (the “Michigan Action”). The complaint in the Michigan Action alleged that Horizon/CMS wrongfully terminated a contract with General Medicine, P.C. (“General Medicine”) for the provision of medical directorship services to long-term care facilities owned and/or operated by Horizon/CMS. Effective December 31, 2001, while the Michigan Action was pending, we sold all of our stock in Horizon/CMS to Meadowbrook Healthcare Corporation (“Meadowbrook”) pursuant to a Stock Purchase Agreement dated November 2, 2001. Pursuant to the Stock Purchase Agreement, Meadowbrook agreed to indemnify us against losses arising out of the historic and ongoing operations of Horizon/CMS. The Michigan Action was disclosed to Meadowbrook in the Stock Purchase Agreement.
On April 21, 2004, Meadowbrook and Horizon/CMS entered into a settlement agreement with General Medicine in connection with the Michigan Action. Pursuant to the settlement agreement, Horizon/CMS consented to the entry of a final judgment in the amount of $376 million in favor of General Medicine in the Michigan Action on May 3, 2004 (the “Consent Judgment”). The settlement agreement between the parties provides that, with the exception of $300,000 paid by Meadowbrook, the Consent Judgment may only be collected from us. At the time of the Consent Judgment, we had no ownership or other interest in Horizon/CMS.
On August 16, 2004, General Medicine filed a lawsuit captioned General Medicine, P.C. v. HealthSouth Corp. , CV-04-958, in the Circuit Court of Shelby County, Alabama, seeking to recover the unpaid amount of the Consent Judgment from us. The complaint alleges that while Horizon/CMS was a wholly-owned subsidiary of HealthSouth Corporation and General Medicine was an existing creditor of Horizon/CMS, we caused Horizon/CMS to transfer assets to us thereby rendering Horizon/CMS insolvent and unable to pay its creditors. The complaint asserts that these transfers were made for less than a reasonably equivalent value and/or with the actual intent to defraud creditors of Horizon/CMS, including General Medicine, in violation of the Alabama Uniform Fraudulent Transfer Act. General Medicine’s complaint requests relief including the avoidance of the subject transfers of assets, attachment of the assets transferred to us, appointment of a receiver over the transferred properties, and a monetary judgment for the value of properties transferred. We have filed an answer denying that we have any liability to General Medicine.
On October 6, 2004, Meadowbrook filed a declaratory judgment action against us in the Circuit Court of Shelby County, Alabama, captioned Meadowbrook Healthcare Corporation v. HealthSouth Corp ., CV-04-1131, seeking a declaration that it is not contractually obligated to indemnify us against General Medicine’s complaint.
On February 28, 2005, the General Medicine case was transferred to the Circuit Court of Jefferson County, Alabama, and assigned case number CV-05-1483. On May 9, 2005, the Meadowbrook case was transferred to the Circuit Court of Jefferson County, Alabama, and assigned case number CV-05-3042.
On July 26, 2005, we filed an Answer and Verified Counterclaim for Injunctive and Other Relief in the Meadowbrook case seeking a judgment requiring Meadowbrook to indemnify us against the claims asserted by General Medicine in its complaint and other relief based upon legal and equitable theories. In August of 2005, both sides filed motions for summary judgment in the Meadowbrook case based upon the express language of the indemnification provision in the Stock Purchase Agreement. On November 15, 2005, the court entered a final order determining that Meadowbrook is not contractually obligated under the Stock Purchase Agreement to indemnify us against the claims asserted by General Medicine in its complaint. The final order did not adjudicate our equitable claims against Meadowbrook which, if successful, would require Meadowbrook to pay our liability, if any, to General Medicine. On December 21, 2005, we filed an appeal of the court’s ruling that Meadowbrook has no contractual obligation to indemnify us under the Stock Purchase Agreement, captioned HealthSouth Corporation vs. Meadowbrook Healthcare, Inc ., appeal no. 1050406 in the Supreme Court of Alabama.
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On December 9, 2005, we filed a Motion to Consolidate the Meadowbrook case and the General Medicine case. On January 26, 2006, the court entered an order consolidating the two cases for purposes of discovery and pre-trial matters.
On December 9, 2005, we filed a First Amended Counterclaim asserting counterclaims against Meadowbrook, General Medicine and Horizon/CMS for fraud, injurious falsehood, tortious interference with business relations, bad faith, conspiracy, unjust enrichment, and other causes of action. The First Amended Counterclaim alleges that the Consent Judgment is the product of fraud, collusion and bad faith by Meadowbrook, General Medicine and Horizon/CMS and, further, that these parties are guilty of a conspiracy to manufacture a lawsuit against HealthSouth in favor of General Medicine and to divert the assets of Horizon/CMS to Meadowbrook and away from creditors, including HealthSouth.
For additional information about Meadowbrook , see Note 20, Related Party Transactions , to the accompanying consolidated financial statements.
Massachusetts Real Estate Actions
On February 3, 2003, HRPT Properties Trust (“HRPT”) filed a lawsuit against Senior Residential Care/North Andover, Limited Partnership (“SRC”) in the Land Court for the Commonwealth of Massachusetts captioned HRPT Properties Trust v. Senior Residential Care/North Andover, Limited Partnership, Misc. Case No. 287313, in which it claimed an ownership interest in certain parcels of real estate in North Andover, Massachusetts and alleged that SRC unlawfully occupied and made use of those properties. On March 17, 2003, we (and our subsidiary, Greenery Securities Corp.) moved to intervene in this case claiming ownership of the disputed property pursuant to an agreement that involved the conveyance of five nursing homes. We seek to effect a transfer of title to the disputed property by HRPT to us or our nominee.
On April 16, 2003, Senior Housing Properties Trust (“SNH”) and its wholly owned subsidiary, HRES1 Properties Trust (“HRES1”), filed a lawsuit against us in Land Court for the Commonwealth of Massachusetts captioned Senior Housing Properties Trust and HRES1 Properties Trust v. HealthSouth Corporation, Misc. Case No 289182, seeking reformation of a lease pursuant to which we, through subsidiaries, operate the Braintree Rehabilitation Hospital in Braintree, Massachusetts and the New England Rehabilitation Hospital in Woburn, Massachusetts. HRES1 and SNH allege that certain of our representatives made false statements regarding our financial condition, thereby inducing HRES1 to enter into lease terms and other arrangements to which it would not have otherwise agreed. HRES1 and SNH have since amended their complaint to add claims for rescission and damages for fraud. HRES1 and SNH seek to reform the lease to increase the annual rent from $8.7 million to $10.3 million, to increase the repurchase option price at the end of the lease term to $80.3 million from $40 million, and to change the lease term to expire on January 1, 2006 instead of December 31, 2011. We filed an answer to the complaint and amended complaint denying the allegations, and we asserted claims against HRPT and counterclaims against SNH and HRES1 for breach of contract, reformation, and fraud based on the failure to convey title to the property in North Andover. We also seek damages incurred as a result of that failure to convey. The two actions in the Land Court have been consolidated for all purposes.
On May 13, 2005, the Land Court ruled that we are entitled to a jury trial in the consolidated cases. SNH, HRES1, and HRPT have taken an interlocutory appeal from this order, and argument before the Massachusetts Supreme Judicial Court was held on March 7, 2006. The Supreme Judicial Court has not issued its order as of the date of this report. The consolidated Land Court cases have been stayed pending disposition of the appeal. The parties were still in the discovery phase of the proceedings at the time the stay came into effect.
In a related action, on November 2, 2004, we filed a lawsuit in the Commonwealth of Massachusetts, Middlesex County Superior Court, captioned HealthSouth Corporation v. HRES1 Properties Trust, Case No 04-4345, in response to our receipt of a notice from HRES1 purporting to terminate our lease governing the Braintree Rehabilitation Hospital in Braintree, Massachusetts and the New England Rehabilitation Hospital in
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Woburn, Massachusetts due to our alleged failure to furnish quarterly and annual financial information pursuant to the terms of the lease. In the lawsuit, we seek a declaration that we are not in default of our obligations under the lease, as well as an injunction preventing HRES1 from terminating the lease, taking possession of the property on which the hospitals and facilities are located, and assuming or acquiring the hospital businesses and any licenses related thereto. We filed an amended complaint asserting violations of the Massachusetts unfair and deceptive business practices statute and adding HRPT as a party. On November 8, 2004, HRES1 and SNH, its parent, filed a counterclaim seeking a declaration that it lawfully terminated the lease and an order requiring us to use our best efforts to transfer the licenses for the hospitals and to continue to manage the hospitals during the time necessary to effect such transfer.
On September 25, 2005, the Superior Court granted SNH and HRES1’s motion for summary judgment on our requests for declaratory and injunctive relief, ruling that their termination of the lease was valid, and the Court granted HRPT’s motion to dismiss. On September 29, 2005, the Court, at SNH and HRES1’s request, appointed a receiver to hold the “net cash proceeds of operations” of the facilities during the pendency of the litigation.
On November 30 and December 9, 2005, the Court conducted a bench trial on the issues relating to the parties’ relationship post-termination. On January 12, 2006, the Court issued an order accepting HRES1’s construction that: (1) the lease requires us to use our best efforts to accomplish the license transfer while managing the facilities for HRES1’s account; and (2) since October 26, 2004 and until a successor operator assumes control over the facilities, HRES1 is entitled to the net cash proceeds of the hospitals after deducting direct operating expenses and a management fee equal to 5% of net patient revenues. A judgment reflecting this order was entered on January 18, 2006. The judgment required us to pay these amounts for the period from October 26, 2004 through January 18, 2006, within 15 days of the entry of judgment, or February 2, 2006. For future monthly periods, HealthSouth is obligated to pay the net cash proceeds to HRES1 within 15 days of the end of each month. We do not anticipate that these payments will be material to our results of operations or financial condition.
On January 24, 2006, we filed a Notice of Appeal from the judgment and all orders encompassed therein, including the order granting SNH and HRES1’s motion for summary judgment on the lease termination issue and their request for the appointment of a receiver. A hearing on the appeal has not yet been scheduled.
On January 31, 2006, the Superior Court denied our request to stay the judgment during the appeal, and, on February 2, 2006, a Single Justice of the Appeals Court also denied our request for a stay. Accordingly, we are cooperating with HRES1 regarding transfer of the licenses. In addition, through December 31, 2005, we have paid HRES1 a total of approximately $4.6 million for the net cash proceeds of the hospitals for the period between October 26, 2004 and December 31, 2005.
SNH, HRES1, and HRPT have recently filed motions seeking to require HealthSouth to pay their attorneys’ fees incurred in the Superior Court litigation. We have opposed these requests. A hearing on these motions is currently scheduled for April 11, 2006.
Other Litigation
On September 17, 1998, John Darling, who was one of the federal False Claims Act relators in the now-settled Devage case (see discussion in Item 1), filed a lawsuit captioned Darling v. HealthSouth Sports Medicine & Rehabilitation, et al ., 98-6110-CI-20, in the Circuit Court for Pinellas County, Florida. The complaint alleges that Mr. Darling was injured while receiving physical therapy during a 1996 visit to a HealthSouth outpatient rehabilitation facility in Clearwater, Florida. The complaint was amended in December 2004 to add a punitive damages claim. This amended complaint alleges that fraudulent misrepresentations and omissions by us resulted in the injury to Mr. Darling. The court recently ordered the parties to participate in non-binding arbitration.
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We have been named as a defendant in two lawsuits brought by individuals in the Circuit Court of Jefferson County, Alabama, Nichols v. HealthSouth Corp. , CV-03-2023, filed March 28, 2003, and Hilsman v. Ernst & Young, HealthSouth Corp., et al. , CV-03-7790, filed December 12, 2003. The plaintiffs allege that we, some of our former officers, and our former auditor engaged in a scheme to overstate and misrepresent our earnings and financial condition. The plaintiffs seek compensatory and punitive damages. On March 24, 2003, a lawsuit captioned Warren v. HealthSouth Corp., et al. , CV-03-5967, was filed in the Circuit Court of Montgomery County, Alabama. The lawsuit, which claims damages for the defendants’ alleged negligence, wantonness, fraud and breach of fiduciary duty, was transferred to the Circuit Court of Jefferson County, Alabama. Each of the lawsuits described in this paragraph has been consolidated with the Tucker case for discovery and other pretrial purposes.
On June 30, 2004, two physical therapy providers in New Jersey filed a class action lawsuit captioned William Weiss Physical Therapy, et al., v. HealthSouth Corporation, et al. , Docket No. BER-L-10218-04 (N.J. Super.) in the Superior Court of New Jersey. The nine count complaint alleges certain unfair trade practices in offering physical therapy services in violation of the New Jersey Physical Therapy Licensing Act of 1983. This case has been dismissed with prejudice.
On May 13, 2003, Plano Hospital Investors, Inc. (“Plano”) filed a complaint captioned Plano Hospital Investors, Inc., et al., v. HealthSouth Corp., et al. , Cause No. 219-1416-03, in the 219th Judicial District Court of Collin County, Texas. Plano was a limited partner in Collin County Rehab Associates Limited Partnership, a partnership in which we, through wholly owned subsidiaries, are the general partner and hold limited partner interests. Plano alleged that we conducted unauthorized and improper sweeps of partnership funds into a HealthSouth centralized cash management account instead of a partnership account, that we improperly received late partnership distributions, and that the predecessor general partner took a negative capital contribution improperly increasing its interest, and upon the sale of that interest to us, our interest, in the partnership. Effective on or about May 31, 2005, we settled this case and obtained a full and final release of all claims.
On December 28, 2004, we commenced a collection action in the Circuit Court of Jefferson County, Alabama, captioned HealthSouth Medical Center, Inc. v. Neurological Surgery Associates, P.C., CV-04-7700, to collect unpaid loans in the original principal amount of $275,000 made to Neurological Surgery Associates, P.C. (“NSA”), pursuant to a written Practice Guaranty Agreement. The purpose of the loans was to enable NSA to employ a physician who would bring necessary specialty skills to patients served by both NSA and our acute-care hospital in Birmingham, Alabama. NSA has asserted counterclaims that we breached verbal promises to lease space and employees from NSA, to pay NSA for billing and coding services performed by NSA on behalf of the subject physician-employee, and to pay NSA to manage the subject physician-employee. This case is currently in the discovery phase.
On April 15, 2004, Klemett L. Belt, Jr. filed a complaint captioned Belt v. HealthSouth Corp ., CV-2004-02517, in the Second Judicial District Court of Bernalillo County, New Mexico. Mr. Belt, a former executive officer and director of Horizon/CMS Healthcare Corporation, entered into a Non-Competition and Retirement Agreement with Horizon/CMS that we subsequently assumed in our acquisition of Horizon/CMS pursuant. Mr. Belt alleged in his complaint that he was entitled to retirement benefits, life insurance and, in the event of certain events of default, liquidated damages pursuant to a contractual provision requiring that the life insurance policies be fully paid and permitting Mr. Belt to receive a lump sum cash payment in lieu of certain unpaid retirement benefits. Mr. Belt alleges that we defaulted under the terms of the agreement due to our nonpayment of insurance policy premium payments beginning on December 31, 2003. As a result of our alleged default under the agreement, Mr. Belt sought liquidated damages in lieu of retirement benefits, payment of insurance policy premiums, amounts sufficient to compensate Mr. Belt for excess income taxes, interest, expenses, attorneys’ fees, and such other relief as may be determined by the court. We entered into a settlement agreement with Mr. Belt pursuant to which we must pay certain damages and relinquish our right to receive returned insurance premiums, if any, under a split dollar arrangement.
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On June 2, 2003, Vanderbilt Health Services, Inc. and Vanderbilt University filed a lawsuit captioned Vanderbilt Health Services, Inc. and Vanderbilt University v. HealthSouth Corporation , Case No. 03-1544-III, in the Chancery Court for Davidson County, Tennessee. We are partners with the plaintiffs in a partnership that operates a rehabilitation hospital in Nashville, Tennessee. In the complaint, the plaintiffs allege that we violated the terms of a non-competition provision in the partnership agreement in connection with our purchase of a number of rehabilitation clinics in the Nashville area. Effective as of January 20, 2006, we settled this case and obtained a full and final release of all claims.
On July 19, 2005, Gary Bellinger filed a pro se complaint captioned Gary Bellinger v. Eric Hanson, d/b/a U.S. Strategies, Inc., Medika Group, Ltd., Laserlife, Inc., & Relife, Inc.; and Richard Scrushy, d/b/a HealthSouth , Case No. 05-06898-B, In the District Court, Dallas County, Texas, 44th Judicial District. Mr. Bellinger claims the defendants violated the terms of a distribution agreement with his company, Laser Bio Therapy, Inc., resulting in that company’s bankruptcy. He has sued for breach of contract, breach of fiduciary duty, and fraud, and claims compensatory damages of $270 million and punitive damages of $10 million. We filed a Motion to Quash Service of Process because we were not properly named or served. That motion is currently pending before the court.
We held our first Annual Meeting of Stockholders since 2002 on December 29, 2005. At the annual meeting, the stockholders voted on the election of all ten directors and on a stockholder submitted proposal recommending the amendment of our bylaws to require the chairman of our board of directors to be an independent director, as defined in the proposal. The voting results at the annual meeting were as follows:
Proposal One, election of directors, which passed:
Proposal Two, stockholder proposal, which did not pass:
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Item 4. Submission of Matters to a Vote of Security Holders
Name of Nominee Votes For Votes Withheld
Steven R. Berrard 347,667,377 11,072,428 Edward A. Blechschmidt 353,190,740 5,549,065 Donald L. Correll 353,070,714 5,669,091 Yvonne M. Curl 346,349,152 12,390,653 Charles M. Elson 354,027,434 4,712,371 Jay Grinney 353,397,813 5,341,992 Jon F. Hanson 347,389,459 11,350,346 Leo I. Higdon, Jr. 347,574,800 11,165,005 John E. Maupin, Jr. 353,374,009 5,365,796 L. Edward Shaw, Jr. 347,935,809 10,803,996
Votes For Votes Against Abstain Broker Non-Votes
140,021,612 27,665,012 12,774,407 178,278,774
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PART II
Market Information
On March 19, 2003, after the Securities and Exchange Commission issued an Order of Suspension of Trading, the New York Stock Exchange (“NYSE”) suspended trading in our common stock, which was then listed under the symbol HRC. That same day, Standard & Poor’s announced that it removed our common stock from the S&P 500 Index. The NYSE continued the trading halt and eventually delisted our common stock. On March 25, 2003, immediately following the delisting from the NYSE, our stock began trading in the over-the-counter “Pink Sheets” market under the symbol HLSH.
The following table sets forth the high and low bid quotations per share of HealthSouth common stock as reported on the over-the-counter market from January 1, 2004 through December 31, 2005. The stock price information is based on published financial sources. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.
Holders
As of February 28, 2006, there were 398,229,960 shares of HealthSouth common stock issued and outstanding, net of treasury shares, held by approximately 8,581 holders of record.
Dividends
We have never paid cash dividends on our common stock, and we do not anticipate paying cash dividends on our common stock in the foreseeable future. In addition, the terms of our new credit agreement and interim loan agreement restrict us from declaring or paying cash dividends on our common stock unless: (1) all term loans made to us under our interim loan agreement have been repaid or such dividend occurs after the first anniversary of the effective date of our credit agreement and interim loan agreement, (2) we are not in default under our credit agreement or interim loan agreement, and (3) the amount of the dividend, when added to the aggregate amount of certain other defined payments made during the same fiscal year, does not exceed certain maximum thresholds. We currently anticipate that any future earnings will be retained to finance our operations and reduce debt. However, as described below, our recently issued 6.50% Series A Convertible Perpetual Preferred Stock generally provides for the payment of cash dividends subject to certain limitations.
Recent Sales of Unregistered Securities
In 2005, we sold an aggregate of 50,000 shares of common stock to Joel C. Gordon, a former director, pursuant to the exercise of outstanding stock options in reliance on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The aggregate consideration for this sale was $247,000. In 2005 we issued 1,232,827 shares of restricted stock to various directors and executive officers in reliance on Section 4(2) of the Securities Act. There was no monetary consideration for the issuances of restricted stock.
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Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market High Low
2004
First Quarter OTC $ 6.18 $ 3.76 Second Quarter OTC 6.07 4.10 Third Quarter OTC 6.41 5.02 Fourth Quarter OTC 6.46 4.88 2005
First Quarter OTC $ 6.16 $ 5.18 Second Quarter OTC 6.03 4.82 Third Quarter OTC 5.69 4.02 Fourth Quarter OTC 4.85 3.65
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In addition, on February 28, 2006, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with several investors, pursuant to which we sold 400,000 shares of 6.50% Series A Convertible Perpetual Preferred Stock (the “Series A Preferred Stock”) at a price per share of $1,000, for an aggregate purchase price of $400 million. We received approximately $388 million in net proceeds from this offering (after deducting the placement agents’ fees of $12 million paid to Citigroup Global Markets Inc., J.P. Morgan Securities Inc., Merrill Lynch, Pierce, Fenner and Smith Incorporated, Deutsche Bank Securities Inc., Goldman Sachs & Co., and Wachovia Capital Markets, LLC and before deducting our estimated offering expenses). The offers and sales of the Series A Preferred Stock were made only to Qualified Institutional Buyers as such term is defined under Rule 144A promulgated by the SEC under the Securities Act and were deemed exempt from registration under the Securities Act, in reliance on Section 4(2) of the Securities Act and Rule 506 promulgated by the SEC under the Securities Act, as transactions not involving a public offering. As of February 28, 2006 there were 47 holders of record of the Series A Preferred Stock.
The Series A Preferred Stock is convertible, at the option of the holder, at any time into shares of our common stock at an initial conversion price of $6.10 per share, which is equal to an approximate conversion rate of 163.9344 shares of common stock per share of Series A Preferred Stock, subject to specified adjustments. On or after July 20, 2011, we may cause the shares of Series A Preferred Stock to be automatically converted into shares of our common stock at the conversion rate then in effect if the closing sale price of our common stock for 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date we give the notice of forced conversion exceeds 150% of the conversion price of the Series A Preferred Stock.
Holders of Series A Preferred Stock are entitled to receive, when and if declared by our board of directors, cash dividends at the rate of 6.50% per annum on the accreted liquidation preference per share, payable quarterly in arrears on January 15, April 15, July 15 and October 15 of each year, commencing on July 15, 2006. If we are prohibited by the terms of our credit facilities, debt indentures or other debt instruments from paying cash dividends on the Series A Preferred Stock, we may pay dividends in shares of our common stock, or a combination of cash and shares of our common stock, if the shares of our common stock delivered as payment are freely transferable by the recipient thereof (other than by reason of the fact that the recipient is a HealthSouth affiliate) or if a shelf registration statement relating to that common stock is effective to permit the resale thereof. Shares of our common stock delivered as dividends will be valued at 95% of their market value. Unpaid dividends will accrete at an annual rate of 8.0% per year for the relevant dividend period and will be reflected as an accretion to the liquidation preference of the Series A Preferred Stock.
We applied the net proceeds from the issuance of the Series A Preferred Stock to prepay certain existing indebtedness and to pay associated transaction costs in connection with our recapitalization transactions.
The foregoing descriptions of the Series A Preferred Stock is qualified in its entirety by the complete text of the Certificate of Designation of 6.50% Series A Convertible Perpetual Preferred Stock, which is referenced in Item 15, Exhibits and Financial Statement Schedules, and is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by Item 201(d) of Regulation S-K is provided under Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, “Securities Authorized for Issuance Under Equity Compensation Plans,” which is incorporated herein by reference.
Purchases of Equity Securities
None.
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We derived the selected historical consolidated financial data presented below for the years ended December 31, 2005, 2004, and 2003 from our audited consolidated financial statements and related notes included elsewhere in this filing. We derived the selected historical consolidated financial data presented below for the years ended December 31, 2002 and 2001 from our audited consolidated financial statements and related notes included in our Form 10-K for the year ended December 31, 2003. You should refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the notes to our accompanying consolidated financial statements for additional information regarding the financial data presented below, including matters that might cause this data not to be indicative of our future financial condition or results of operations. In addition, you should note the following information regarding the selected historical consolidated financial data presented below.
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Item 6. Selected Financial Data
• Certain previously reported financial results have been reclassified to conform to the current year presentation. Such reclassifications primarily relate to facilities closed in 2005 that qualify under Financial Accounting Standards Board (“FASB”) Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , to be reported as discontinued operations. We reclassified our consolidated financial statements for the years ended December 31, 2004, 2003, 2002, and 2001 to show the results of those qualifying facilities in 2005 as discontinued operations.
• As discussed in more detail in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , a judgment was entered against us in 2005 that upheld the landlord’s termination of the lease at two of our inpatient rehabilitation facilities and placed us as the manager, rather than the owner, of these two facilities. Accordingly, our 2005 results of operations include only the $5.4 million management fee we earned for operating these facilities on behalf of the landlord during the year. In 2004 and 2003, the results of operations of these two facilities were included in our consolidated statements of operations on a gross basis. Our consolidated net operating revenues and consolidated operating earnings were negatively impacted by approximately $106.3 million and $3.6 million, respectively, in 2005 as a result of the change in classification of these two facilities.
• In 2001 and 2002, we reserved approximately $38.0 million related to amounts due from Meadowbrook Healthcare, Inc. (“Meadowbrook”), an entity formed by one of our former chief financial officers, Michael D. Martin, related to net working capital advances made to Meadowbrook in 2001 and 2002. In August 2005, we received a payment of $37.9 million from Meadowbrook. This cash payment is included as Amounts due from Meadowbrook in our 2005 income statement data. For more information regarding Meadowbrook, see Note 20, Related Party Transactions , to our accompanying consolidated financial statements.
• Included in our net loss for 2005, 2004, 2003, 2002, and 2001 are property and equipment and goodwill and other intangible assets impairment charges of $45.2 million, $37.3 million, $468.3 million, $83.3 million, and $0.1 million, respectively. These charges were recorded as a result of experiencing continued significant decreases in projected revenue and operating profit at numerous facilities and significant changes in the business climate over this five-year period. We performed impairment analyses and calculated the fair value of our long-lived assets with the assistance of a third-party valuation specialist using a combination of discounted cash flows and market valuation models based on competitors’ multiples of revenue, gross profit, and other financial ratios. These impairment charges are shown separately as a component of operating loss within the consolidated statements of operations, excluding $6.8 million, $19.3 million, $38.4 million, and $1.7 million of impairment charges in 2005, 2004, 2002, and 2001, respectively, related to certain closed facilities which are included in discontinued operations.
• In 2005, our net loss includes a $215.0 million charge as Government, class action, and related settlements expense under a proposed
settlement with the lead plaintiffs in the Stockholder Securities Action and the Bondholder Securities Action. In 2003, our net loss includes the cost related to our settlement with the United States Securities and Exchange Commission (the “SEC”) and certain
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additional settlements, as well as legal fees related to this litigation and certain other actions brought against us. Also, as a result of the Medicare Program Settlement, our 2002 net loss includes a $347.7 million charge as Government, class action, and related settlements expense. For additional information, see Note 21, Medicare Program Settlement, Note 22, SEC Settlement, Note 23, Securities Litigation Settlement , and Note 24, Contingencies and Other Commitments , to our accompanying consolidated financial statements.
• As noted throughout this filing, significant changes have occurred at HealthSouth since the events leading up to March 19, 2003. The steps taken to stabilize our business and operations, provide vital management assistance, and coordinate our legal strategy came at significant financial cost. Our net loss includes professional fees associated with the reconstruction and restatement of our previously issued consolidated financial statements of approximately $169.8 million in 2005, $206.2 million in 2004, and $70.6 million in 2003.
• We recorded the cumulative effect of an accounting change in both 2003 and 2002. Effective January 1, 2003, we adopted the provisions of FASB Statement No. 143, Accounting for Asset Retirement Obligations , and recorded a related charge of approximately $2.5 million. On January 1, 2002, we recorded a charge of approximately $48.2 million as a result of the adoption of FASB Statement No. 142, Goodwill and Other Intangible Assets , related to an impairment of goodwill of our diagnostic segment.
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Year ended December 31, 2005 2004 2003 2002 2001 (In Thousands, Except Per Share Data)
Salaries and benefits 1,429,867 1,619,834 1,595,534 1,630,565 1,510,590 Professional and medical director fees 76,373 78,118 87,673 95,271 78,523 Supplies 305,585 331,339 317,220 312,983 286,930 Other operating expenses 679,626 611,401 750,001 823,056 739,118 Provision for doubtful accounts 98,417 113,783 128,296 83,235 84,427 Depreciation and amortization 167,112 176,959 185,552 216,450 328,783 Amounts due from Meadowbrook (37,902 ) — — 36,902 1,000 Loss (gain) on disposal of assets 14,776 9,539 (14,967 ) 84,510 34,438 Impairment of goodwill — — 335,623 — — Impairment of intangible assets — 1,030 — 16,388 — Impairment of long-lived assets 45,203 36,260 132,722 66,901 58 Government, class action, and related settlements expense 215,000 — 170,949 347,716 — Professional fees—reconstruction and restatement 169,804 206,244 70,558 — — Loss (gain) on early extinguishment of debt 33 (45 ) (2,259 ) (9,644 ) 5,136 Interest expense and amortization of debt discounts and fees 338,701 302,635 265,327 251,776 308,199 Interest income (17,141 ) (13,090 ) (7,273 ) (6,709 ) (7,380 ) (Gain) loss on sale of investments (229 ) (3,601 ) 15,811 (12,464 ) (140 ) Equity in net income of nonconsolidated affiliates (29,432 ) (9,949 ) (15,769 ) (15,320 ) (16,909 ) Minority interests in earnings of consolidated entities 96,728 94,389 98,196 90,978 59,537
3,552,521 3,554,846 4,113,194 4,012,594 3,412,310
Loss from continuing operations (344,793 ) (42,214 ) (455,302 ) (370,778 ) (164,561 ) Provision for income tax expense (benefit) 39,792 11,914 (28,382 ) 20,338 (44,911 ) Loss from discontinued operations, net of income tax expense (61,409 ) (120,342 ) (5,181 ) (27,519 ) (71,575 ) Cumulative effect of accounting change, net of income tax expense — — (2,456 ) (48,189 ) —
Net loss $ (445,994 ) $ (174,470 ) $ (434,557 ) $ (466,824 ) $ (191,225 )
Weighted average common shares outstanding:
Basic 396,563 396,423 396,132 395,520 390,485
Diluted* 398,021 397,625 405,831 408,321 415,163
Basic and diluted loss per share:
Loss from continuing operations, net of tax $ (0.97 ) $ (0.14 ) $ (1.08 ) $ (0.99 ) $ (0.31 ) Discontinued operations, net of tax (0.15 ) (0.30 ) (0.01 ) (0.07 ) (0.18 ) Cumulative effect of accounting change, net of tax — — (0.01 ) (0.12 ) —
Net loss per common share $ (1.12 ) $ (0.44 ) $ (1.10 ) $ (1.18 ) $ (0.49 )
* Per share diluted amounts are treated the same as basic per share amounts, because the effect of including potentially dilutive shares is antidilutive.
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December 31, 2005 2004 2003 2002 2001 (In Thousands)
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of HealthSouth as a whole.
Forward Looking Information
This MD&A should be read in conjunction with our accompanying consolidated financial statements and related notes. See “Cautionary Statement Regarding Forward-Looking Statements” on page ii of this report for a description of important factors that could cause actual results to differ from expected results. See also Item 1A, Risk Factors .
Executive Overview
As described in detail in Item 1, Business , the past several years have been marked by profound turmoil and change. During this period, a significant portion of our time and attention has been devoted to matters primarily outside the ordinary course of business such as replacing our senior management team, cooperating with federal investigators, restructuring our finances, and reconstructing our accounting records. We have also devoted substantial resources to improving fundamental business systems including our corporate governance functions, financial controls, and operational infrastructure.
Despite these difficulties, our board of directors, senior management team, and employees worked diligently throughout 2005 and into 2006 and have made significant progress in addressing many of the more significant obstacles created by the March 2003 crisis, including the following:
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
• We have replaced our board of directors and senior management team and improved our corporate governance policies and practices.
See Item 1, Business , “Our New Board of Directors and Senior Management Team.”
• We have completed a substantive reconstruction of our accounting records and filed annual reports on Form 10-K for the fiscal years (including this filing) ended December 31, 2005, 2004, 2003, and 2002 (including a restatement of previously issued consolidated financial statements for the fiscal years ended December 31, 2001 and 2000). In December 2005, we held our first Annual Meeting of Stockholders since 2002.
• We have prepaid substantially all of our existing indebtedness with proceeds from a series of recapitalization transactions and replaced it with approximately $3 billion of new long-term debt, which we believe will produce enhanced operational flexibility, reduced refinancing risk, and an improved credit profile. See Item 1, Business , “Recapitalization Transactions” and Note 8, Long-term Debt , to our accompanying consolidated financial statements.
• We have reached a global, preliminary agreement in principle with the lead plaintiffs in the federal securities class actions and the
derivative litigation, as well as with our insurance carriers, to settle claims filed against us, certain of our former directors and officers, and certain other parties. See Item 1, Business , “Securities Litigation Settlement.”
• We have settled with the Department of Justice’s (the “DOJ”) civil division and other parties regarding their allegations that we submitted various fraudulent Medicare cost reports and committed certain other violations of federal health care program requirements. Although this settlement does not cover all similar claims that have been or could be brought against us, it settles the primary known claims that
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We have also made significant progress implementing our multi-year operational agenda, which strives to improve our business in five key areas: revenue, cost, quality, people, and infrastructure. In 2005, we made improvements in each of the five key areas listed in that agenda:
Our business, and the health care market in general, continued to evolve throughout 2005. On the positive side, health care sector growth continues to outpace the economy in response to an aging U.S. population and other factors. In addition, the delivery of health care services is migrating to outpatient and post-acute care
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have been pending against us relating to our participation in federal health care programs. The DOJ and the Office of Inspector General (the “HHS-OIG”) of the United States Department of Health and Human Services (“HHS”) continue to review certain other matters, including self-disclosures made by us to the HHS-OIG. See Item 1, Business , “Medicare Program Settlement.”
• We have settled with the United States Securities and Exchange Commission (the “SEC”) regarding its allegations that we violated
and/or aided and abetted violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. See Item 1, Business , “SEC Settlement.”
• We continue to cooperate with federal law enforcement officials and other federal investigators, including the DOJ and the SEC, as
they work to conclude their investigations, which are still ongoing.
• Revenue—We helped advocate a slower phase-in of the 75% Rule and, we believe, outperformed the industry in mitigating the impact of the 75% Rule. We consolidated outpatient revenue centers and overhauled our outpatient sales and marketing function. We also piloted various new programs to enhance our marketing and have hired a new senior vice president to improve our managed care contracting function.
• Cost—We substantially reduced unnecessary overhead expense and closed or sold under-performing facilities. We have also hired a new senior vice president to manage and streamline our supply chain. We will continue to work to reduce costs by reorganizing and flattening each operating division and implementing standardized labor management metrics and performance expectations. In addition, we are closely monitoring our business and will, when necessary, close or sell additional under-performing facilities.
• Quality—We began an inpatient clinical information assessment, increased production of our AutoAmbulator, and participated in various clinical research projects. We are also working to enhance strong quality assurance programs within our facilities and divisions. We plan to supplement these programs by improving our company-wide quality agenda that will include standardized division-specific quality metrics and improved clinical information through the use of technology.
• People—We completed our senior management team and hired a number of other management personnel. We also completed a
human resources strategic plan and increased 401(k) contributions for our employees. Our goal is to build a culture of integrity, transparency, diversity, and excellence, while simplifying and flattening our organizational structure.
• Infrastructure—We invested significant resources to evaluate and improve our financial, reporting, and compliance infrastructure, and will continue to invest heavily in our infrastructure throughout this turnaround period. Although our infrastructure needs further improvement in many areas, we are specifically focused on implementing required internal controls (e.g., compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”)), enhancing our financial infrastructure (e.g., improving financial and operational reporting and establishing a formal capital expenditure process and formal budget process), enhancing our management reporting capabilities (e.g., standardizing our monthly reporting and analysis, standardizing our financial projections, and implementing a faster month-end close), developing regulatory compliance programs, enhancing our information systems (e.g. upgrading our patient accounting systems), and implementing an information technology strategic plan.
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environments, which suits our business model. On the other hand, we anticipate pricing pressure in the markets we serve, as well as increased competition. Most importantly, recent changes to the 75% Rule and the prospective payment system applicable to our inpatient rehabilitation facilities (“IRF-PPS”) have combined to create a very challenging operating environment for us.
On the whole, our core businesses remain sound. We continue to be the largest provider of ambulatory surgery and rehabilitative health care services in the United States, with (as of December 31, 2005) 1,070 facilities and approximately 37,000 full- and part-time employees. We believe that we are responding to challenges in the inpatient market as well as or better than our competitors, which may lead to potential consolidation opportunities in the future.
We continue to face operational challenges, but we believe our accomplishments in 2005 and the 2006 recapitalization transactions have positioned us to capitalize on our competencies and move forward with implementing our strategic growth plan.
Our Business
Our business is currently divided into four primary operating divisions—inpatient, surgery centers, outpatient, and diagnostic—and a fifth division that manages certain other revenue producing activities and corporate functions. These five divisions correspond to our five reporting segments discussed later in this Item and throughout this annual report.
Inpatient . Our inpatient division, which comprises the majority of our net operating revenues, provides treatment at (as of December 31, 2005) 93 freestanding inpatient rehabilitation facilities (“IRFs”), 10 long-term acute care hospitals (“LTCHs”), and 101 satellites of inpatient facilities providing primarily outpatient care. In addition to the facilities in which we have an ownership interest, our inpatient division operated 14 inpatient rehabilitation units, 11 outpatient facilities, and 2 gamma knife radiosurgery centers through management contracts as of December 31, 2005. This division continues to be the market leader in inpatient rehabilitation services in terms of revenues, number of IRFs, and patients served. In 2004, operating earnings of this division remained stable due largely to treating higher acuity patients and stricter expense controls. In 2005, net operating revenues decreased due to the continued phase-in of the 75% Rule, but operating earnings increased slightly because of the division’s efforts to manage expenses in relation to declining patient volume. We expect this division to continue to show positive results; however, as discussed below, the 75% Rule and recent IRF-PPS changes are likely to have a materially negative impact on future results of operations.
Surgery Centers . Our surgery centers division, which is our second largest division in terms of net operating revenues, operates (as of December 31, 2005) 158 freestanding ambulatory surgery centers (“ASCs”) and 3 surgical hospitals. Our surgery centers segment’s net operating revenues declined from 2003 to 2005. Since March 2003, the division has struggled due in large part to an inability to efficiently resyndicate (i.e., sell ownership interests in) its partnership portfolio and its inability to control supply costs. During 2005, resyndication activity improved, and we enhanced our portfolio of ASCs through the closure of under-performing facilities. We expect this division to benefit as outpatient procedures continue to migrate to the more efficient ASC environment. However, potential benefits from industry growth may be offset by physician partners who are demanding a higher ownership interest in our partnerships, thereby lowering our share of partnership earnings.
Outpatient . Our outpatient division currently provides outpatient therapy services (as of December 31, 2005) at 620 facilities. This division’s performance declined between 2003 and 2005 due primarily to poor operational processes and increased competition from physician-owned physical therapy sites. During 2005, we continued the rationalization of our outpatient facilities and formulated a sales and marketing team with the primary purpose to diversify our referral sources and minimize our exposure to physician-owned physical therapy sites. We believe these initiatives will begin to produce positive results for this division in 2006.
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Diagnostic . Our diagnostic division operates (as of December 31, 2005) 85 diagnostic imaging centers. This division’s performance suffered from 2003 to 2005 due to poor margins for the diagnostic market in general and strong competition from physician-owned diagnostic service centers. We are beginning to see stabilization of both net operating revenues and operating earnings, which we believe is due in part to payor pressures to decrease perceived over-utilization of diagnostic services by physician-owned diagnostic service centers. We continue to focus on operational improvements to increase our margins. In 2006, we hired R. Gregory Brophy to serve as president of the diagnostic division. In addition, we have received inquiries from parties interested in acquiring our diagnostic division and have hired an investment bank to assist us in evaluating those opportunities. However, no final decision has been made with respect to the divestiture of our diagnostic division at this time.
As shown by the following charts, our inpatient and surgery centers divisions made up more than 80% of 2005 net operating revenues and over 85% of 2005 Consolidated Adjusted EBITDA (as defined in this Item, “Consolidated Results of Operations,”) from our four primary operating divisions. For a reconciliation of loss from continuing operations to Consolidated Adjusted EBITDA, see this Item, “Consolidated Results of Operations—Consolidated Adjusted EBITDA.”
We believe that the aging of the U.S. population, changes in technology, and the continuing growth in health care spending will increase demand for the types of services we provide. First, many of the health conditions associated with aging—like stroke and heart attacks, neurological disorders, and diseases and injuries to the muscles, bones, and joints—will increase the demand for ambulatory surgery and rehabilitative services. Second, pressure from payors to provide efficient, high-quality health care services is forcing many procedures traditionally performed in acute care hospitals out of the acute care environment. We believe these market factors align with our strengths. We plan to prioritize investment of time and capital based on where realistic growth prospects are strongest, which we currently believe are our inpatient and surgery centers divisions.
Key Challenges
Although our business is continuing to generate substantial revenues, and market factors appear to favor our outpatient and post-acute care business model, we still have several immediate internal and external challenges to overcome before we can realize significant improvements in our business, including:
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• Operational Improvements . We need to improve our operational efficiency, particularly in our surgery centers, outpatient, and diagnostic divisions. This includes streamlining our division management structure, continuing to consolidate or divest under-performing facilities, implementing standardized performance metrics and practices, and ensuring high quality care. We also will strive to reduce operational variation within each division.
• Price Pressure . We are seeing downward pressure on prices in our markets, from both commercial and government payors. We anticipate continuing price pressure in all our divisions. For example, recent IRF-PPS changes are likely to have a materially negative impact on inpatient revenues. In addition, Medicare has frozen ASC pricing through 2009, and beginning in 2007, the Deficit Reduction Act of 2005 will cap ASC and imaging service payments at hospital outpatient department reimbursement levels. Other pricing changes may have a negative impact on our operating results.
• Single-Payor Exposure . Medicare comprises approximately 48% of our consolidated net operating revenues and approximately 71% of our largest division’s revenues. Consequently, single-payor exposure presents a serious risk. In particular, as discussed in Item 1, Business , “Sources of Revenues,” changes to the 75% Rule and IRF-PPS have combined to create a very challenging operating environment for our inpatient division. The volume volatility created by the 75% Rule has had a
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significantly negative impact on our inpatient division’s net operating revenues in 2005. Thus far, we have been able to partially mitigate the impact of the 75% Rule on our inpatient division’s operating earnings by implementing the mitigation strategies discussed in Item 1, Business , “Our Business—Operating Divisions.” However, the combination of volume volatility created by the 75% Rule and lower unit pricing resulting from IRF-PPS changes reduced our operating earnings in 2005 and will have a continuing negative impact on our operating earnings in 2006. In addition, because we receive a significant percentage of our revenues from our inpatient division, and because our inpatient division receives a significant percentage of its revenues from Medicare, our inability to achieve continued compliance with or continue to mitigate the negative effects of the 75% Rule could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
• Competition . Competition is increasing as physicians look for new revenue sources to offset declining incomes. In our outpatient and diagnostic divisions, physician practices are the natural owners of most patient volume. Any physician group that generates a substantial portion of facility volume for us may have reached sufficient critical mass to insource their referrals, and is therefore a potential competitor. In addition, the low barriers to entry in the outpatient physical therapy sector, and decreasing barriers to entry in the diagnostic sector, make competition from physician practices a particular problem in those markets.
• Declining Ownership Share of Surgery Centers . Like most other ASCs, the majority of our centers are owned in partnership with surgeons and other physicians who perform procedures at the centers. As a result of increased competition in the ASC market and other factors, physicians are demanding increased equity participation in ASCs. Consequently, we expect to see our percentage ownership of centers within our ASC portfolio decline over time, thereby reducing our share of partnership earnings from our ASCs.
• Leverage . Although we have completed a series of recapitalization transactions that have eliminated significant uncertainty
regarding our capital structure and have improved our financial condition, we remain highly leveraged. Our high leverage increases our cost of capital, decreases our net income, and may prevent us from taking advantage of potential growth opportunities.
• Settlement Costs . We have significant cash obligations we must meet in the near future as a result of recent settlements with various federal agencies. Specifically, we are required to pay the remaining balance of our $325 million settlement to the United States in quarterly installments ending in the fourth quarter of 2007 to satisfy our obligations under a settlement described in Item 1, Business , “Medicare Program Settlement.” Furthermore, we are required to pay the remaining balance of our $100 million settlement to the SEC in four installments ending in the fourth quarter of 2007, as described in Item 1, Business , “SEC Settlement.” Payments due under these settlement agreements are as follows as of December 31, 2005:
Medicare Program
Settlement SEC
Settlement Total (In Thousands) 2006 $ 83,300 $ 37,500 $ 120,800 2007 86,666 50,000 136,666
$ 169,966 $ 87,500 $ 257,466
• Continuing Investigations and Litigation . We face continuing government investigations, as well as numerous class action and individual lawsuits, all of which will consume considerable management attention and company resources and could result in substantial additional payments and fines. Although we have reached a global, preliminary agreement in principle with the lead plaintiffs in the federal securities class actions and the derivative litigation, as well as with our insurance carriers, to settle claims filed against us, certain of our former directors and officers, and certain other parties, there can be no assurance that a final settlement can be reached or that the proposed settlement will receive the required court approval. For additional information, see Item 1, Business , “Securities Litigation Settlement.”
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Strategic Plan
Although management’s attention recently has been focused on a range of tactical issues critical to HealthSouth’s survival, our new senior management team has spent considerable time developing a comprehensive strategic plan for the next three to five years that is focused on HealthSouth’s future, not its past. The plan, which has been approved by our board of directors, is divided into the following three phases:
We are into the first phase of our strategic plan, and we are already making significant strides. For example, as described in Item 1, Business , “Recapitalization Transactions,” we have recently completed several recapitalization transactions resulting in reduced refinancing risk, enhanced operational flexibility, and increased liquidity. We have also entered into key settlements with the government and various private parties, reconstructed our accounting records, filed annual reports on Form 10-K for 2002 – 2005, and held our first Annual Meeting of Stockholders since 2002. Operationally, we have replaced the presidents of each of our primary operating divisions, reorganized these divisions by eliminating unnecessary management layers, increased productivity, divested under-performing facilities, and worked to improve operational systems. We are also continuing to implement mitigation strategies for the 75% Rule in our inpatient facilities, enhance the resyndication process for our ASCs, and implement new information systems to improve cash collections in our diagnostic division.
We believe our strategic plan capitalizes on our strengths, market direction, and legitimate growth opportunities. We are implementing a realistic operational plan and creating the appropriate infrastructure—organization, policies, protocols, systems, and reports—to support it. Finally, we are setting priorities based on resources and with our long-range goals of quality, profitability, and shareholder value at the forefront of our minds.
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• Reconstruction, Restatement, and Sarbanes-Oxley Related Costs . We paid approximately $208 million in 2005 in connection with the restructuring of our financial reporting processes, internal control over financial reporting, and managerial operations, and the reconstruction and/or restatement of our consolidated financial statements for the years ended December 31, 2004, 2003, 2002, 2001, and 2000. We anticipate incurring additional related costs in the future, although we expect these costs to decline over time.
• Phase 1—Operational Focus . Because of our highly leveraged balance sheet, we must generate additional cash flow from operating activities by improving operational performance in all our operating divisions. In the first phase, we plan to focus on key operational initiatives such as mitigating the impact of the 75% Rule, realizing significant operating performance improvements in each division through standardization of labor and supply chain practices and reduction of fixed costs, completing additional surgery center resyndications, and improving our company-wide quality agenda. In addition, we plan to establish an appropriate internal control environment, strengthen regulatory compliance programs, pilot new post-acute care services, and establish our business development capabilities. Phase 1 has already begun.
• Phase 2—Operational/Growth Focus . In this phase, we will continue establishing an appropriate internal control environment. We will also continue making operational improvements by developing ways to use our size to create supply chain efficiencies and to identify and disseminate operational best practices in patient care, sales, and payor contracting. Assuming we are successful in achieving our targeted operational improvements in Phase 1 and mitigating the impact of the 75% Rule, we anticipate we will generate sufficient additional cash flow from operating activities to enable us to take advantage of selected development opportunities in the post-acute and surgery markets. Specifically, we plan to explore consolidation opportunities as they arise and build new IRFs and surgery centers in target markets. During this phase, we also plan to grow promising new post-acute services that are complementary to our existing services.
• Phase 3—Growth Focus . The third phase will be more outward looking. We plan to continue to acquire or build IRFs in target
markets, develop new ASCs, grow new post-acute care businesses, and evaluate potential consolidation opportunities.
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Consolidated Results of Operations
HealthSouth is the largest provider of ambulatory surgery and rehabilitative health care services in the United States, with 1,070 facilities and approximately 37,000 full- and part-time employees. We provide these services through a national network of inpatient and outpatient rehabilitation facilities, outpatient surgery centers, diagnostic centers, and other health care facilities.
During 2005, 2004, and 2003, we derived consolidated net operating revenues from the following payor sources:
We provide our patient care services through four primary operating divisions and certain other services through a fifth division. These five divisions correspond to our five reporting segments discussed in this Item, “Segment Results of Operations,” and throughout this annual report.
When reading our consolidated statements of operations, it is important to recognize the following items included within our results of operations:
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For the year ended
December 31, 2005 2004 2003 Medicare 47.5 % 47.4 % 44.6 % Medicaid 2.3 % 2.4 % 2.6 % Workers’ compensation 7.4 % 8.1 % 9.5 % Managed care and other discount plans 33.1 % 31.8 % 31.8 % Other third-party payors 5.4 % 5.1 % 6.5 % Patients 1.8 % 3.0 % 2.6 % Other income 2.5 % 2.2 % 2.4 %
Total 100.0 % 100.0 % 100.0 %
• Restructuring charges . In our continuing efforts to streamline operations, we closed numerous under-performing facilities or consolidated similar facilities within the same market in 2005, 2004, and 2003. As a result of these facility closures or consolidations, we recorded certain restructuring charges approximating $8.2 million, $4.0 million, and $2.6 million in 2005, 2004, and 2003, respectively, for one-time termination benefits and contract termination costs under the guidance in Financial Accounting Standards Board (“FASB”) Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities . See Note 10, Restructuring Charges , to our accompanying consolidated financial statements for additional information.
• Change in ownership of certain inpatient rehabilitation facilities . As discussed in more detail in this Item, “Segment Results of Operations—Inpatient,” a judgment was entered against us in 2005 that upheld the landlord’s termination of the lease at two of our inpatient rehabilitation facilities and placed us as the manager, rather than the owner, of these two facilities. Accordingly, our 2005 results of operations include only the $5.4 million management fee we earned for operating these facilities on behalf of the landlord during the year. In 2004 and 2003, the results of operations of these two facilities were included in our consolidated statements of operations on a gross basis. Our consolidated net operating revenues and consolidated operating earnings were negatively impacted by approximately $106.3 million and $3.6 million, respectively, in 2005 as a result of the change in classification of these two facilities.
• Recovery of amounts due from Meadowbrook . In 2001, we sold four inpatient rehabilitation facilities to Meadowbrook Healthcare, Inc. (“Meadowbrook”), an entity formed by one of our former chief financial officers, Michael D. Martin, for a $9.7 million note receivable. Meadowbrook paid no cash in connection with the sale of these facilities. The transaction was closed effective January 1, 2002, but remained in escrow until July 2002. We recognized a loss on this sale of approximately $37.4 million
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In March 2005, we obtained a security interest in the real properties previously sold to Meadowbrook, evidenced by a mortgage that was recorded in June 2005. In July 2005, we received a payoff letter from Meadowbrook’s attorneys informing us that a payment of $37.9 million would be made by Meadowbrook to us. This repayment was effected by the purchase of Meadowbrook by Rehabcare Group, Inc. in August 2005. We received a cash payment of $37.9 million in August 2005 and recorded this bad debt recovery at that time.
See Note 20, Related Party Transactions , and Note 24, Contingencies and Other Commitments , to our accompanying consolidated financial statements for additional information regarding Meadowbrook.
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during 2001. In addition, during 2001, we advanced approximately $1.0 million in working capital loans to Meadowbrook. During 2002, we made a net advance of approximately $37.0 million to Meadowbrook. We reserved these amounts in 2001 and 2002, respectively.
• Impairments . During 2005, we recorded an impairment charge of approximately $45.2 million to reduce the carrying value of long-lived assets to their estimated fair market value. During 2004, we recorded an impairment charge of approximately $36.3 million to reduce the carrying value of property and equipment and an impairment charge of $1.0 million to reduce the carrying value of amortizable intangibles of certain operating facilities to their estimated fair market value. During 2003, we recorded a charge of approximately $335.6 million for the impairment of goodwill and an additional charge of approximately $132.7 million for the impairment of certain long-lived assets. These charges are discussed in more detail in this Item, “Segment Results of Operations,” Note 5, Property and Equipment , and Note 6, Goodwill and Other Intangible Assets , to our accompanying consolidated financial statements.
• Government, class action, and related settlements expense . In 2005, our net loss includes a $215.0 million charge as Government, class action, and related settlements expense under a proposed settlement with the lead plaintiffs in the Stockholder Securities Action and the Bondholder Securities Action. In 2003, our net loss includes the cost related to our settlement with the SEC and certain additional settlements, as well as legal fees related to this litigation and certain other actions brought against us. For additional information, see Note 22, SEC Settlement , Note 23, Securities Litigation Settlement , and Note 24, Contingencies and Other Commitments , to our accompanying consolidated financial statements.
• Professional fees—reconstruction and restatement . As noted throughout this annual report, significant changes have occurred at HealthSouth since the events leading up to March 19, 2003. The steps taken to stabilize our business and operations, provide vital management assistance, and coordinate our legal strategy came at significant financial cost. During 2005, 2004, and 2003, professional fees associated with the reconstruction of our financial records and restatement of our previously issued 2001 and 2000 consolidated financial statements approximated $169.8 million, $206.2 million, and $70.6 million, respectively.
• Loss (gain) on early extinguishment of debt . In each year, we recorded a loss or gain on early extinguishment of debt due to our
termination of certain capital leases or various credit agreements, or the repurchase of various bonds. For more information regarding these transactions, please see Note 8, Long-term Debt , to our accompanying consolidated financial statements.
• Cumulative effect of an accounting change , net of ta x. We recorded the cumulative effect of an accounting change in 2003.
Effective January, 1, 2003, we adopted the provisions of FASB Statement No. 143, Accounting for Asset Retirement Obligations , and recorded a related charge of approximately $2.5 million.
• Reclassifications . Certain previously reported financial results have been reclassified to conform to the current year presentation.
Such reclassifications primarily relate to facilities we closed or sold in 2005 that qualify under FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , to be reported as discontinued operations.
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From 2003 through 2005, our consolidated results of operations were as follows:
Salaries and benefits 1,429,867 1,619,834 1,595,534 (11.7 )% 1.5 % Professional and medical director fees 76,373 78,118 87,673 (2.2 )% (10.9 )% Supplies 305,585 331,339 317,220 (7.8 )% 4.5 % Other operating expenses 679,626 611,401 750,001 11.2 % (18.5 )% Provision for doubtful accounts 98,417 113,783 128,296 (13.5 )% (11.3 )% Depreciation and amortization 167,112 176,959 185,552 (5.6 )% (4.6 )% Recovery of amounts due from Meadowbrook (37,902 ) — — N/A N/A Loss (gain) on disposal of assets 14,776 9,539 (14,967 ) 54.9 % (163.7 )% Impairment of goodwill, intangible assets, and long-
lived assets 45,203 37,290 468,345 21.2 % (92.0 )% Government, class action, and related settlements
expense 215,000 — 170,949 N/A (100.0 )% Professional fees—reconstruction and restatement 169,804 206,244 70,558 (17.7 )% 192.3 %
Total operating expenses 3,163,861 3,184,507 3,759,161 (0.6 )% (15.3 )%
Loss (gain) on early extinguishment of debt 33 (45 ) (2,259 ) (173.3 )% (98.0 )% Interest expense and amortization of debt discounts and fees 338,701 302,635 265,327 11.9 % 14.1 % Interest income (17,141 ) (13,090 ) (7,273 ) 30.9 % 80.0 % (Gain) loss on sale of investments (229 ) (3,601 ) 15,811 (93.6 )% (122.8 )% Equity in net income of nonconsolidated affiliates (29,432 ) (9,949 ) (15,769 ) 195.8 % (36.9 )% Minority interests in earnings of consolidated affiliates 96,728 94,389 98,196 2.5 % (3.9 )%
Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change (344,793 ) (42,214 ) (455,302 ) 716.8 % (90.7 )%
Provision for income tax expense (benefit) 39,792 11,914 (28,382 ) 234.0 % (142.0 )%
Loss from continuing operations before cumulative effect of accounting change (384,585 ) (54,128 ) (426,920 ) 610.5 % (87.3 )%
Loss from discontinued operations, net of income tax expense (61,409 ) (120,342 ) (5,181 ) (49.0 )% 2222.8 %
Loss before cumulative effect of accounting change (445,994 ) (174,470 ) (432,101 ) 155.6 % (59.6 )% Cumulative effect of accounting change, net of income tax
expense — — (2,456 ) N/A (100.0 )%
Net loss $ (445,994 ) $ (174,470 ) $ (434,557 ) 155.6 % (59.9 )%
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Operating Expenses as a % of Net Operating Revenues
Net Operating Revenues
Our consolidated net operating revenues primarily include revenues derived from patient care services provided by one of our four primary operating segments. It also includes other revenues generated from management and administrative fees, trainer income, operation of the conference center located on our corporate campus, and other non-patient care services.
Volume decreases in each of our operating segments and the change in ownership of certain facilities within our inpatient segment were the primary factors that contributed to the declining net operating revenues in 2005. Our inpatient segment experienced volume decreases due to the continued phase-in of the 75% Rule. Although resyndication activity increased in 2005, volumes in our surgery centers segment continued to decline based on the timing of these resyndications. Competition from physician-owned similar sites continued to negatively impact volumes in our outpatient and diagnostic segments. The change in ownership of these two inpatient facilities contributed approximately $106.3 million to the decline in net operating revenues. See this Item, “Segment Results of Operations—Inpatient.”
The decrease in our consolidated net operating revenues from 2003 to 2004 was due primarily to volume decreases within our surgery centers, outpatient, and diagnostic segments. The volume decline within our surgery centers segment was due to the limited resyndication activity which occurred in 2004. Volume decreases within both our outpatient and diagnostic segments were due to competition from physician-owned similar sites.
Salaries and Benefits
Salaries and benefits represents the most significant cost to us and includes all amounts paid to full- and part-time employees, including all related costs of benefits provided to employees. It also includes amounts paid for contract labor.
In 2005, our segments demonstrated their ability to manage employee-related costs during periods of declining volumes, with salaries and benefits decreasing from 46.1% of net operating revenues in 2004 to 44.6% of net operating revenues in 2005. From 2004 to 2005, salaries and benefits decreased by 11.7%, primarily in our inpatient, surgery centers, and outpatient segments. Approximately $66.1 million of the decrease is due to the change in classification of two inpatient facilities, as discussed later in this Item. In addition, our inpatient and surgery centers segments reduced their full-time equivalents as their volumes declined throughout the year, and our outpatient segment reduced its full-time equivalents through the closure of under-performing facilities that did not qualify for discontinued operations treatment.
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For the year ended
December 31, 2005 2004 2003 Salaries and benefits 44.6 % 46.1 % 43.6 % Professional and medical director fees 2.4 % 2.2 % 2.4 % Supplies 9.5 % 9.4 % 8.7 % Other operating expenses 21.2 % 17.4 % 20.5 % Provision for doubtful accounts 3.1 % 3.2 % 3.5 % Depreciation and amortization 5.2 % 5.0 % 5.1 % Recovery of amounts due from Meadowbrook (1.2 )% 0.0 % 0.0 % Loss (gain) on disposal of assets 0.5 % 0.3 % (0.4 )% Impairment of goodwill, intangible assets, and long-lived assets 1.4 % 1.1 % 12.8 % Government, class action, and related settlements expense 6.7 % 0.0 % 4.7 % Professional fees—reconstruction and restatement 5.3 % 5.9 % 1.9 %
Total operating expenses as a % of net operating revenues 98.6 % 90.7 % 102.8 %
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Salaries and benefits grew as a percent of net operating revenues during 2004. This was due to rising costs associated with group medical and workers’ compensation across all of our segments, increased use of contract labor within our inpatient segment, and an inability to further adjust minimum staffing levels within our diagnostic segment. Due to staffing shortages for therapists and nurses, our inpatient segment was forced to increase its use of higher-priced contract labor to properly care for its patients during 2004. As discussed further in this Item, “Segment Results of Operations—Diagnostic,” our diagnostic segment reached minimum staffing levels and could not further adjust its staffing levels with the declining volumes experienced in 2004. All of the above contributed to the increase in salaries and benefits as a percent of net operating revenues during the year.
Professional and Medical Director Fees
Professional and medical director fees include fees paid under contracts with radiologists, medical directors, and other clinical professionals at our centers for services provided. It also includes professional consulting fees associated with operational initiatives, such as strategic planning and revenue enhancement projects.
The change in professional and medical director fees from 2004 to 2005 was not material in the aggregate. However, it is important to note that these fees decreased in our diagnostic segment due to declining volumes, but increased in our corporate and other segment due to fees paid to consulting firms for corporate strategy and other projects. From 2003 to 2004, these fees decreased primarily in our diagnostic division due to declining volumes. For more information regarding these fees and their relation to volumes in our diagnostic segment, see this Item, “Segment Results of Operations—Diagnostic.”
Supplies
Supplies include costs associated with supplies used while providing patient care at our facilities. Examples include pharmaceuticals, implants, bandages, food, and other similar items. In each year, our inpatient and surgery centers segments comprise over 94% of our supplies expense.
From 2004 to 2005, supplies expense decreased by 7.8% due primarily to the decline in volumes in our inpatient and surgery centers segments combined with the change in classification of two of our inpatient facilities, as discussed below. Supplies expense as a percent of net operating revenues remained relatively flat year-over-year.
The increase in supplies expense from 2003 to 2004 was due to an increase in supplies expense in our inpatient segment due to increasing costs associated with supplies and the higher acuity of our patients in 2004. Higher acuity results in increased costs associated with supplies, especially in drug costs.
Other Operating Expenses
Other operating expenses include costs associated with managing and maintaining our operating facilities as well as the general and administrative costs related to the operation of our corporate office. These expenses include such items as repairs and maintenance, utilities, contract services, rent, professional fees, and insurance.
The increase in other operating expenses from 2004 to 2005 primarily related to increased professional fees associated with projects related to our compliance with Sarbanes-Oxley, strategic consulting, and other similar services from accounting and consulting firms offset by an approximate $17.2 million decrease in other operating expenses due to the change in classification of certain facilities discussed below within our inpatient segment.
The decrease in other operating expenses from 2003 to 2004 primarily related to decreased operating expenses within our inpatient segment. Continuing a trend seen in 2003, our inpatient segment’s operating expenses decreased in 2004 as the segment continued to digest the change to the Prospective Payment System (“PPS”) and faced the challenge of mitigating the 75% Rule impact on its net operating revenues.
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Provision for Doubtful Accounts
In 2005, our provision for doubtful accounts decreased by $15.4 million due to the decrease in net operating revenues year-over-year in each of our operating segments and the continued implementation of new information systems to improve cash collections in our diagnostic segment.
Our provision for doubtful accounts decreased from 3.5% of net operating revenues in 2003 to 3.2% of net operating revenues in 2004 as we made progress collecting aged receivables and implementing improved cash collections procedures within our diagnostic and surgery centers segments.
For more information, please see this Item, “Segment Results of Operations.”
Depreciation and Amortization
The decrease in depreciation and amortization expense in each year is due to impairment charges and an increase in fully depreciated assets within our operating segments.
Loss (gain) on Disposal of Assets
The net loss on disposal of assets in 2005 resulted from numerous individually immaterial asset sales and disposals in our inpatient and outpatient segments. The net loss on disposal of assets in 2004 primarily resulted from facility closures in our outpatient and diagnostic segments. Continuing volume declines and competition in these segments forced us to close additional under-performing facilities in 2004. The net gain on disposal of assets in 2003 primarily resulted from the sale of our inpatient facility in Reno, Nevada.
Interest Expense and Amortization of Debt Discounts and Fees
Interest expense and amortization of debt discounts and fees increased by $36.1 million, or 11.9%, from 2004 to 2005 primarily due to the amortization of consent fees and bond issue costs associated with the 2004 consent solicitation and 2005 refinancings. During 2004, consent fees paid for all of our debt issues approximated $80.2 million, and we paid approximately $11.1 million in debt issuance costs. We amortize these fees to interest expense over the remaining term of the debt. In 2004, we amortized these costs for approximately six months, as compared to a full year of amortization in 2005. We also paid approximately $17.9 million in debt issuance costs in 2005. These costs are also amortized to interest expense over the life of the related debt. As a result of the above amortization charges, interest expense increased by approximately $17.2 million in 2005. An additional $11.2 million of interest expense was recorded in 2005 related to payments under our Medicare Program Settlement (see Note 21, Medicare Program Settlement , to our accompanying consolidated financial statements). The remaining $7.7 million of the increase in interest expense is primarily the result of higher average borrowing rates in 2005. In 2005, our average borrowing rate was 9.4% compared to an average rate of 8.5% in 2004.
The increase in interest expense from 2003 to 2004 was the result of higher average borrowing rates in 2004. In 2003, our average borrowing rate was 7.5% compared to an average rate of 8.5% in 2004. The average borrowing rate increased due to the repayment of our 3.25% convertible debentures with proceeds from a 10.375% senior subordinated term loan.
For more information regarding the above changes in debt, see Note 8, Long-term Debt , to our accompanying consolidated financial statements.
(Gain) loss on Sale of Investments
In each year presented in our consolidated statements of operations, the net gain or loss on sale of investments was primarily comprised of numerous individually insignificant transactions related to less than
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100% owned entities, including investments in nonconsolidated affiliates. In 2004, the net gain on sale of investments was solely comprised of these types of transactions. In 2005 and 2003, the net gain or loss on sale of investments also includes the realized gains and losses recorded on the sale of marketable securities. For additional information regarding our marketable securities, please see Note 4, Cash and Marketable Securities , to our accompanying consolidated financial statements.
Equity in Net Income of Nonconsolidated Affiliates
The increase in Equity in Net Income of Nonconsolidated Affiliates from 2004 to 2005 is primarily due to the reclassification of five surgery centers that became equity method investments rather than consolidated entities in 2005 as a result of changes in control of these entities. The decrease in Equity in Net Income of Nonconsolidated Affiliates from 2003 to 2004 is primarily due to higher year-over-year operating expenses at three of our nonconsolidated surgery centers.
Minority Interests in Earnings of Consolidated Affiliates
Minority interests in earnings of consolidated affiliates represent the share of net income or loss allocated to members or partners in our consolidated entities. For 2003 through 2005, the number and average external ownership interest in these consolidated entities were as follows:
Of our active consolidated affiliates at December 31, 2005, approximately 79% of them are in our inpatient and surgery centers segments. Fluctuations in Minority interests in earnings of consolidated affiliates generally follow the same trends as our inpatient and surgery centers segments. However, resyndication activities in 2005 and the absorption of losses for certain partnerships in 2005 combined to increase these expenses from 2004 to 2005.
Loss from Continuing Operations Before Income Tax Expense (Benefit) and Cumulative Effect of Accounting Change
Our Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change (“loss from continuing operations”) in 2005 includes $215.0 million associated with the settlement of our securities litigation and a $37.9 million recovery of bad debt associated with Meadowbrook. If these two items are excluded, our loss from continuing operations becomes $167.7 million, which represents a $125.5 million increase over our 2004 net loss from continuing operations. This increase is primarily due to a decrease in net operating revenues as a result of declining volumes, higher other operating expenses associated with professional service fees, and increased interest expense, as discussed above.
The decrease in our loss from continuing operations from 2003 to 2004 is primarily due to the 15.3% decrease in operating expenses year over year. Operating expenses decreased as a result of the $431.1 million decrease in impairment charges and a $170.9 million decrease in Government, class action, and related settlements expense offset by a $135.7 million increase in Professional fees—reconstruction and restatement . Increased interest expense during 2004 (as a result of higher average borrowing rates), as discussed above, also offset the decrease in operating expenses.
Provision for Income Tax Expense (Benefit)
We realized a $39.8 million income tax expense from continuing operations in 2005 as compared to an $11.9 million income tax expense from continuing operations in 2004. Deferred tax expense increased by
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As of and for the year ended
December 31, 2005 2004 2003 Active consolidated affiliates 272 276 322 Average external ownership interest 34.0 % 32.1 % 32.5 %
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approximately $23 million to reflect the change in the noncurrent deferred taxes associated with certain indefinite lived assets. Additionally, HealthSouth Corporation and its subsidiaries file separate income tax returns in a number of states, some of which result in current state tax liabilities. A current federal tax expense was also charged in 2005 and 2004 associated with ownership in corporate joint ventures.
We realized an $11.9 million income tax expense from continuing operations in 2004 compared to a $28.4 million income tax benefit from continuing operations in 2003. Deferred tax expense increased by approximately $20 million to reflect the change in the noncurrent deferred taxes associated with certain indefinite lived assets. Additionally, HealthSouth Corporation and its subsidiaries file separate income tax returns in a number of states, some of which result in current state income tax liabilities. A current federal tax expense was also charged in 2004 associated with ownership in corporate joint ventures.
Consolidated Adjusted EBITDA
Management continues to believe that an understanding of Consolidated Adjusted EBITDA is an important measure of operating performance, leverage capacity, our ability to service our debt, and our ability to make capital expenditures for our stakeholders.
We use Consolidated Adjusted EBITDA to assess our operating performance. We believe it is meaningful because it provides investors with a measure used by our internal decision makers for evaluating our business. Our internal decision makers believe Consolidated Adjusted EBITDA is a meaningful measure, because it represents a transparent view of our recurring operating performance and allows management to readily view operating trends, perform analytical comparisons, and perform benchmarking between segments. Additionally, our management believes the inclusion of professional fees associated with litigation, financial restructuring, government investigations, forensic accounting, creditor advisors, accounting reconstruction, audit and tax work associated with the reconstruction process, the implementation of Sarbanes-Oxley Section 404, and non-ordinary course charges incurred after March 19, 2003 and related to our overall corporate restructuring distort within EBITDA their ability to efficiently assess and view the core operating trends on a consolidated basis and within segments. Additionally, we use Consolidated Adjusted EBITDA as a significant criterion in our determination of performance-based cash bonuses and stock awards. We reconcile consolidated Adjusted EBITDA to loss from continuing operations.
We also use Consolidated Adjusted EBITDA on a consolidated basis as a liquidity measure. We believe this financial measure on a consolidated basis is important in analyzing our liquidity because it is also a component of certain material covenants contained within the documents governing our long-term indebtedness, as discussed in more detail in Note 8, Long-term Debt , to our accompanying consolidated financial statements. These covenants are material terms of these agreements because they govern several of our credit agreements, which in turn represent a substantial portion of our capitalization. Non-compliance with these financial covenants under our credit facilities—our interest coverage ratio and our leverage ratio—could result in the lenders requiring us to immediately repay all amounts borrowed. In addition, if we cannot satisfy these financial covenants, we would be prohibited under the documents governing our long-term indebtedness from engaging in certain activities, such as incurring additional indebtedness, making certain payments, and acquiring and disposing of assets. Consequently, Consolidated Adjusted EBITDA is critical to our assessment of our liquidity.
In general terms, the definition of Consolidated Adjusted EBITDA, per the documents governing our long-term indebtedness, allow us to add back to Consolidated Adjusted EBITDA charges classified as “Restructuring Charges.” Costs which we classify as “Restructuring Charges” include professional fees associated with certain litigation, financial restructuring, government investigations, forensic accounting, creditor advisors, accounting reconstruction, audit and tax work associated with the reconstruction process, compliance with Sarbanes-Oxley Section 404, and non-ordinary course charges incurred after March 19, 2003 related to our overall corporate restructuring.
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However, Consolidated Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles in the United States of America, and the items excluded from Consolidated Adjusted EBITDA are significant components in understanding and assessing financial performance. Therefore, Consolidated Adjusted EBITDA should not be considered a substitute for net loss from continuing operations or cash flows from operating, investing, or financing activities. Because Consolidated Adjusted EBITDA is not a measurement determined in accordance with generally accepted accounting principles in the United States of America and is thus susceptible to varying calculations, Consolidated Adjusted EBITDA, as presented, may not be comparable to other similarly titled measures of other companies. Revenue and expenses are measured in accordance with the policies and procedures described in Note 1, Summary of Significant Accounting Policies, to our accompanying consolidated financial statements.
As noted earlier in this Item, certain previously reported financial results have been reclassified to conform to the current year presentation. Such reclassifications primarily relate to facilities we closed or sold in 2005 that qualify under FASB Statement No. 144 to be reported as discontinued operations. These reclassifications may also impact previously reported Consolidated Adjusted EBITDA amounts. The facilities that were classified as discontinued operations in 2005 had a positive impact of approximately $56 million and $21 million, respectively, on 2004 and 2003 Consolidated Adjusted EBITDA reported in our 2004 annual report.
From 2003 through 2005, our Consolidated Adjusted EBITDA was as follows:
Reconciliation of Loss from Continuing Operations to Consolidated Adjusted EBITDA
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For the year ended December 31, 2005 2004 2003 (In Thousands)
Loss from continuing operations $ (384,585 ) $ (54,128 ) $ (429,376 ) Provision for income tax expense (benefit) 39,792 11,914 (28,382 ) Cumulative effect of accounting change, net of income tax expense — — 2,456 Depreciation and amortization 167,112 176,959 185,552 Loss (gain) on disposal of assets 14,776 9,539 (14,967 ) Impairment charges 45,203 37,290 468,345 Loss (gain) on early extinguishment of debt 33 (45 ) (2,259 ) Interest expense and amortization of debt discounts and fees 338,701 302,635 265,327 Interest income (17,141 ) (13,090 ) (7,273 ) Gain on sale of marketable securities (8 ) — (698 )
Consolidated Adjusted EBITDA before government, class action and related settlements expense, professional fees—reconstruction and restatement, and other restructuring charges 203,883 471,074 438,725
Government, class action, and related settlements expense 215,000 — 170,949 Professional fees—reconstruction and restatement 169,804 206,244 70,558 Sarbanes-Oxley related costs 32,204 17,534 — Restructuring activities under FASB Statement No. 146 8,190 3,973 2,571
Reconciliation of Consolidated Adjusted EBITDA to Net Cash Provided by Operating Activities
Our Consolidated Adjusted EBITDA approximated 19.6%, 19.9%, and 18.7% of net operating revenues in 2005, 2004, and 2003, respectively. Consolidated Adjusted EBITDA decreased from 2004 to 2005 due to the declining volumes experienced by each of our operating segments and increased operating expenses associated with professional service fees, as discussed above. Consolidated Adjusted EBITDA increased by 2.3% from 2003 to 2004. This increase was due primarily to our ability to control operating expenses as our segments experienced declining volumes. In 2004, net operating revenues decreased by 4.0%, while operating expenses decreased by 15.3%.
Impact of Inflation
The health care industry is labor intensive. Wages and other expenses increase during periods of inflation and when labor shortages occur in the marketplace. In addition, suppliers pass along rising costs to us in the form of higher prices. Although we cannot predict our ability to cover future cost increases, we believe that through adherence to cost containment policies and labor and supply management, the effects of inflation on future operating results should be manageable.
However, we have little or no ability to pass on these increased costs associated with providing services to Medicare and Medicaid patients due to federal and state laws that establish fixed reimbursement rates. In addition, as a result of increasing regulatory and competitive pressures and a continuing industry-wide shift of patients to managed care plans, our ability to maintain margins through price increases to non-Medicare patients is limited.
Relationships and Transactions with Related Parties
HealthSouth and its prior management and board of directors engaged in numerous relationships and transactions with related parties. These transactions involved certain venture capital firms, investments, real
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For the year ended December 31, 2005 2004 2003 (In Thousands)
Consolidated Adjusted EBITDA $ 629,081 $ 698,825 $ 682,803 Professional fees—reconstruction and restatement (169,804 ) (206,244 ) (70,558 ) Sarbanes-Oxley related costs (32,204 ) (17,534 ) — Interest expense and amortization of debt discounts and fees (338,701 ) (302,635 ) (265,327 ) Interest income 17,141 13,090 7,273 Provision for doubtful accounts 98,417 113,783 128,296 Amortization of debt issue costs, debt discounts, and fees 39,023 21,838 7,831 Amortization of restricted stock 1,998 614 (2,932 ) Accretion of debt securities (410 ) — — (Gain) loss on sale of investments, excluding marketable securities (221 ) (3,601 ) 16,509 Equity in net income of nonconsolidated affiliates (29,432 ) (9,949 ) (15,769 ) Distributions from nonconsolidated affiliates 22,457 17,029 8,561 Minority interest in earnings of consolidated affiliates 96,728 94,389 98,196 Stock-based compensation — (460 ) — Current portion of income tax provision (22,295 ) (17,253 ) 2,826 Restructuring charges under FASB Statement No. 146 (8,190 ) (3,973 ) (2,571 ) Other operating cash used in discontinued operations (47,823 ) (33,473 ) (35,813 ) Cash payments related to government, class action, and related settlements (165,434 ) (6,997 ) — Change in assets and liabilities, net of acquisitions (88,770 ) 34,147 14,868
Net Cash Provided by Operating Activities $ 1,561 $ 391,596 $ (574,193 )
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property, and indebtedness of management. For more information on our historic relationships and transactions with related parties, please see Note 7, Investment in and Advances to Nonconsolidated Affiliates , Note 11, Shareholders’ Deficit , and Note 20, Related Party Transactions , to our accompanying consolidated financial statements.
As part of our restructuring process, we have eliminated our interests in and relationships with related parties. These types of transactions are not material to our ongoing operations, and therefore, will not be presented as a separate discussion within this Item. When these relationships or transactions were significant to our results of operations during the years ended December 31, 2005, 2004, or 2003, information regarding the relationship or transaction(s) have been included within this Item.
Segment Results of Operations
Our internal financial reporting and management structure is focused on the major types of services provided by HealthSouth. We currently provide various patient care services through four operating divisions and certain other services through a fifth division, which correspond to our five reporting business segments: (1) inpatient, (2) surgery centers, (3) outpatient, (4) diagnostic, and (5) corporate and other. For additional information regarding our business segments, including a detailed description of the services we provide and financial data for each segment, please see Item 1, Business , and Note 25, Segment Reporting, to our accompanying consolidated financial statements. Future changes to this organizational structure may result in changes to the reportable segments disclosed.
Inpatient
We are the nation’s largest provider of inpatient rehabilitation services. Our inpatient rehabilitation facilities provide comprehensive services to patients who require intensive institutional rehabilitation care. Patient care is provided by nursing and therapy staff as directed by a physician order. Internal case managers monitor each patient’s progress and provide documentation of patient status, achievement of goals, functional outcomes and efficiency.
Our inpatient segment operates IRFs, LTCHs, home health, and skilled nursing units and provides treatment on both an inpatient and outpatient basis. As of December 31, 2005, our inpatient segment operated 93 freestanding IRFs, 10 LTCHs, and 101 outpatient facilities near our IRFs or LTCHs. In addition to HealthSouth facilities, our inpatient segment manages 14 inpatient rehabilitation units, 11 outpatient facilities, and 2 gamma knife radiosurgery centers through management contracts. Our inpatient facilities are located in 28 states, with a concentration of facilities in Texas, Pennsylvania, Florida, Tennessee, and Alabama. We also have facilities in Puerto Rico and Australia.
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For the years ended December 31, 2005, 2004, and 2003, our inpatient segment comprised approximately 56.4%, 57.5%, and 54.6%, respectively, of consolidated net operating revenues. For 2003 through 2005, this segment’s operating results were as follows:
During 2005, 2004, and 2003, inpatient’s net operating revenues were derived from the following payor sources:
Our inpatient segment’s payor mix is weighted heavily towards Medicare. Our IRFs receive Medicare reimbursements under PPS. Under IRF-PPS, our IRFs receive fixed payment amounts per discharge based on certain rehabilitation impairment categories established by the Department of Health and Human Services. With PPS, our facilities retain the difference, if any, between the fixed payment from Medicare and their operating costs. Thus, our facilities are rewarded for being high quality, low cost providers. For additional information regarding Medicare reimbursement, please see the “Sources of Revenue” section of Item 1, Business , of this annual report.
Due to the significance of Medicare payments to our inpatient facilities, the number of patient discharges is a key metric utilized by the segment to monitor and evaluate its performance. The number of outpatient visits is also tracked in order to measure the volume of outpatient activity within the segment. The segment’s primary operating expenses include salaries and benefits and supplies. Salaries and benefits represents the most significant cost to the segment and includes all amounts paid to full- and part-time employees, including all related costs of benefits provided to employees. It also includes amounts paid for contract labor. Supply costs include all expenses associated with supplies used while providing patient care. These costs include pharmaceuticals, needles, bandages, food, and other similar items.
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For the year ended December 31, 2005 2004 2003 (In Thousands) Inpatient
(Not In Thousands) Full time equivalents 16,795 19,859 19,430 Average length of stay 15.9 days 16.0 days 16.3 days
* Includes divisional overhead, but excludes corporate overhead allocation. See Note 25, Segment Reporting , to our accompanying consolidated financial statements. Includes the effect of minority interests in earnings of consolidated affiliates and equity in the net income of nonconsolidated affiliates.
For the year ended December 31, 2005 2004 2003
Medicare 71.2 % 70.6 % 71.1 % Medicaid 2.3 % 2.6 % 2.3 % Workers’ compensation 2.8 % 3.3 % 3.8 % Managed care and other discount plans 15.9 % 15.0 % 14.4 % Other third-party payors 5.2 % 6.6 % 6.3 % Patients 0.5 % 0.1 % 0.1 % Other income 2.1 % 1.8 % 2.0 %
Total 100.0 % 100.0 % 100.0 %
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Significant Changes in Regulations Governing IRF Reimbursement
As discussed in Item 1, Business , “Sources of Revenues,” two recent changes in regulations governing IRF reimbursement have combined to create a very challenging operating environment for our inpatient division. The first change occurred on May 7, 2004, when CMS issued a final rule stipulating revised criteria for qualifying as an IRF under Medicare. This rule, known as the “75% Rule,” has created significant volume volatility in our inpatient division. The second change, which became effective on October 1, 2005, relates to reduced unit pricing applicable to IRFs.
The 75% Rule, as revised, generally provides that to be considered an IRF, and to receive reimbursement for services under the IRF-PPS methodology, 75% of a facility’s total patient population must require treatment for at least one of 13 designated medical conditions. As a practical matter, this means that to maintain our current level of revenue from our IRFs we will need to reduce the number of nonqualifying patients treated at our IRFs and replace them with qualifying patients, establish other sources of revenues at our IRFs, or both. The Deficit Reduction Act of 2005, signed by President Bush on February 8, 2006 as Public Law 109-171, extended the phase-in schedule for the 75% Rule by one year and delayed implementation of the 65% compliance threshold until July 1, 2007.
On August 15, 2005, CMS published a final rule, as amended by the subsequent correction notice published on September 30, 2005, that updates the IRF-PPS for the federal fiscal year 2006 (which covers discharges occurring on or after October 1, 2005 and on or before September 30, 2006). Although the final rule includes an overall market basket update of 3.6%, it makes several other adjustments that we estimate will result in a net reduction in reimbursement to us. For example, the final rule (1) reduces the standard payment rates by 1.9%, (2) implements changes to Case-Mix Groups, comorbidity tiers, and relative weights, (3) updates the formula for the low income patient payment adjustment, (4) adopts the new geographic labor market area definitions based on the definitions created by the Office of Management and Budget known as Core-Based Statistical Areas, (5) implements new and revised payment adjustments on a budget-neutral basis, (6) implements a new indirect medical education teaching adjustment, (7) increases the rural add-on to 21.3%, and (8) incorporates several other modifications to Medicare reimbursement for IRFs. Although CMS predicted that overall payments to IRFs nationwide would increase by 3.4%, we estimate that the revised IRF-PPS will reduce Medicare reimbursement to our IRFs by 3.5% to 4%, primarily owing to the changes to Case-Mix Groups, comorbidity tiers, and relative weights. We estimate this net impact on reimbursement will reduce our inpatient division’s net operating revenues by approximately $10 million per quarter for the first three quarters of 2006 as compared to 2005. These estimates do not take into account potential changes in our case-mix resulting from our compliance with the 75% Rule, which could have the effect of increasing the acuity of our case-mix and therefore reducing the overall net impact of the IRF-PPS changes.
The volume volatility created by the 75% Rule had a significantly negative impact on our inpatient division’s net operating revenues in 2005. Thus far, we have been able to partially mitigate the impact of the 75% Rule on our inpatient division’s operating earnings by implementing the mitigation strategies discussed in Item 1, Business , “Our Business—Operating Divisions.” However, the combination of volume volatility created by the 75% Rule and lower unit pricing resulting from IRF-PPS changes reduced our operating earnings in 2005 and will have a continuing negative impact on our operating earnings in 2006. In addition, because we receive a significant percentage of our revenues from our inpatient division, and because our inpatient division receives a significant percentage of its revenues from Medicare, our inability to achieve continued compliance with or continue to mitigate the negative effects of the 75% Rule could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
On February 6, 2006, President Bush proposed a federal budget for fiscal year 2007. Among other things, the budget would eliminate Medicare payment increases for IRFs for the 2007 fiscal year. In 2008 and 2009, the budget proposes that IRFs and certain other providers receive a Medicare payment update of market basket minus 0.4%. These provisions are expected to reduce Medicare IRF spending by $1.59 billion in fiscal years
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2007 through 2011. The President’s budget also calls for reductions in Medicare payments to IRFs for hip and knee replacements to decrease variances in payments based on site of care. Specifically, for services provided to hip and knee replacement patients, the proposal would pay IRFs the average amount paid to skilled nursing facilities (“SNFs”), plus one third of the difference between the average IRF payment amount and the average SNF payment rate. The President’s budget would reduce Medicare spending by more than $2.4 billion by adjusting payment for hip and knee replacements in post-acute care settings. If the budget proposal is enacted by Congress, it could have a material adverse effect on our business, financial condition, results of operations, and cash flows. Moreover, the proposed budget would phase out all Medicare bad debt reimbursement to providers between 2007 and 2011. To enhance the long-term financing of the Medicare program, the budget also proposes automatic reductions in provider updates if general revenues are projected to exceed 45% of total Medicare financing. While legislation is necessary to enact these changes, Congress could consider this and other legislation in the future that would reduce Medicare reimbursement for IRF services. The potential effect of the President’s budget on our inpatient division is not known at this time.
Change in Ownership of Certain Facilities
Since 2003, we have been involved in a legal dispute regarding the lease of Braintree Rehabilitation Hospital in Braintree, Massachusetts and New England Rehabilitation Hospital in Woburn, Massachusetts. In 2005, a judgment was entered against us that upheld the landlord’s termination of our lease of these two facilities and placed us as the manager, rather than the owner, of these two facilities. We have appealed this decision, but a hearing on our appeal has not yet been scheduled.
During the appeals process, we have been cooperating with the landlord and have retroactively paid the net cash proceeds of the facilities to the landlord since the date the lease was deemed to have been terminated. Our 2005 results of operations include only the $5.4 million management fee we earned for operating the facilities on behalf of the landlord during the year. In 2004 and 2003, the results of operations of these two facilities were included in our consolidated statements of operations on a gross basis. As a result, our net operating revenues and operating earnings were negatively impacted by approximately $106.3 million and $3.6 million, respectively, in 2005.
For additional information, see Note 24, Contingencies and Other Commitments , to our accompanying consolidated financial statements.
Net Operating Revenues
Our inpatient segment’s net operating revenues declined by 10.4% from 2004 to 2005. The change in classification of our Braintree and Woburn facilities contributed to approximately $106.3 million, or 50.6%, of the decline. The remainder of the decrease in net operating revenues is due to declining volumes. Excluding the impact of the change in classification, discharges were approximately 7.6% lower than 2004 due to the continued phase-in of the 75% Rule and the majority of our facilities moving to the 50% phase. Our inpatient segment also experienced a 10.7% decrease in outpatient volumes due to continued competition from physicians offering physical therapy within their own offices, as well as the decrease in our inpatient volumes. Due to this continued competition from physicians and resulting decrease in outpatient visits, we evaluated our outpatient satellite sites and closed 22 sites during 2005. Declining volumes were offset slightly by favorable pricing from Medicare during the first nine months of 2005 due to the Medicare market basket adjustment discussed below. However, the PPS Final Rule, as discussed above, negatively impacted our fourth quarter earnings by approximately $10.0 million. Human capital constraints in key clinical positions (therapists and nurses) at some of our hospitals also negatively impacted volumes as facilities managed volumes within these constraints.
Net operating revenues of our inpatient segment increased by 1.1% from 2003 to 2004. This increase is primarily due to the higher net revenue per discharge, or improvement in our reimbursement per case, as well as a 2.3% increase in discharges. The increase in net operating revenues per discharge is due primarily to the 1.4%
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increase in the segment’s Case Mix Index (“CMI”). An increase in CMI indicates that our patients have a higher acuity. For Medicare, which was over 70% of inpatient’s 2004 net operating revenues, the result of an increase in CMI is an increased payment to the segment. In addition, a market basket adjustment of 3.1% was received from Medicare in October 2004. A market basket adjustment is made to Medicare rates by the Department of Health and Human Services to account for inflationary impacts on provider costs. The increased reimbursements were offset by a 6.5% decrease in outpatient visits due primarily to increased competition from physicians offering physical therapy within their own offices. Due to this increased competition and resulting decrease in outpatient visits, we evaluated our outpatient satellite sites and closed 23 sites during 2004.
Operating Expenses
Salaries and Benefits
Salaries and benefits comprised over 58% of inpatient’s operating expenses in each year.
Salaries and benefits decreased by $116.8 million, or 12.1%, from 2004 to 2005 primarily as a result of the change in facility classification discussed above and fewer full-time equivalents due to the decline in volumes. The change in classification of our Braintree and Woburn facilities contributed approximately $66.1 million, or 56.6%, to the decrease. Full-time equivalents, excluding the employees of the Braintree and Woburn facilities, declined by 9.6% from 2004 to 2005 which more than offset the 4.8% increase in average salaries and benefits per full-time equivalent due to merit and market rate adjustments. In addition, costs associated with contract labor decreased by approximately 50% year over year. However, excluding the impact of the change in facility classification discussed above, salaries and benefits as a percent of net operating revenues remained consistent from 2004 to 2005 approximating 47.8% and 47.7%, respectively. The segment’s ability to maintain this ratio while experiencing a 5.0% decline in net operating revenues (excluding the impact of the change in facility classification) is evidence of our facilities’ ability to adjust staffing levels to accommodate changing volumes.
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From 2003 to 2004, salaries and benefits increased by $57.9 million, or 6.4%. Approximately 65% of the increase is due to costs associated with annual merit increases and increases in group medical expenses and workers’ compensation costs. The remainder of the increase in salaries and benefits is due to an increase of 429 full-time equivalents due to the increased acuity of our patients, as discussed above. In addition, staffing shortages for both therapists and nurses resulted in the increased use of higher priced contract labor in order to provide appropriate care for our patients.
Supplies
From 2004 to 2005, supplies expense decreased by $13.5 million, or 11.1%. Approximately $6.2 million of the decrease is due to the change in classification of our Braintree and Woburn facilities. The remainder is due to the decline in volumes during 2005. Supplies expense as a percent of net operating revenues remained flat at approximately 6.0% each year.
Supplies expense increased by $13.7 million, or 12.7% from 2003 to 2004. This increase is primarily due to increased costs of supplies and the higher acuity of our patients in 2004. Higher acuity correlates to a higher cost patient, especially in drug expenses.
Provision for Doubtful Accounts
Our inpatient segment’s provision for doubtful accounts fluctuated between 1.5% of net operating revenues and 2.5% of net operating revenues from 2003 through 2005. During 2005, the segment’s provision for doubtful accounts decreased by $4.1 million, or 9.0%, due to the decrease in net operating revenues year over year. However, the provision for doubtful accounts as a percent of net operating revenues remained relatively flat, approximating 2.3% and 2.2% in 2005 and 2004, respectively.
From 2003 to 2004, the provision for doubtful accounts increased from 1.6% to 2.2% of net operating revenues due to a focus more on other operational projects and less on collection activities.
All Other Operating Expenses
From 2004 to 2005, all other operating expenses decreased by 7.0% due to the change in facility classification and the reduction in volumes discussed above. The inpatient segment’s all other operating expenses in 2005 also include an approximate $1.8 million impairment charge related to long-lived assets. Approximately $0.5 million of this charge relates to assets at our Pendleton facility in New Orleans, Louisiana. This facility was abandoned due to the damage caused by Hurricane Katrina. The remainder of the impairment charge is the result of continued negative cash flows experienced by one of our facilities in Texas.
All other operating expenses decreased by 12.1% from 2003 to 2004. As the inpatient segment digested the change to PPS, faced the challenge of mitigating the 75% Rule impact on net operating revenues, and realigned expenses going forward, a broad range of expenses were eliminated by the segment in this category during 2004.
Operating Earnings
Net operating earnings of our inpatient segment decreased by $43.9 million, or 10.0%, from 2004 to 2005. Approximately $3.6 million of this decrease is due to the change in classification of our Braintree and Woburn facilities. The remainder is due to the declining volumes experienced by the segment and the reimbursement challenges presented by the 75% Rule. Operating earnings increased by less than 1% from 2003 to 2004.
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Surgery Centers
We operate one of the largest networks of ambulatory surgery centers (“ASCs”) in the United States. As of December 31, 2005, we provided these services through the operation of our network of 158 freestanding ASCs and 3 surgical hospitals in 35 states, with a concentration of centers in California, Texas, Florida, and North Carolina.
Our surgery centers provide the facilities and medical support staff necessary for physicians to perform non emergency surgical procedures in more than a dozen specialties, such as orthopedic, GI, ophthalmology, plastic, and general surgery. For 2003 through 2005, this segment’s operating results were as follows:
During the years ended December 31, 2005, 2004, and 2003, our surgery centers segment derived its net operating revenues from the following payor sources:
Our commercial revenues, which are included in “Other third-party payors” in the above chart, increased by approximately $25 million from 2004 to 2005. This increase is the result of an increase in out-of-network cases that yield higher net revenue per case. The number of plastic surgery cases performed by our centers decreased by approximately 7% from 2004 to 2005. As a result, net operating revenues from cases where the patient has primary financial responsibility decreased from the prior year.
The number of cases performed by our centers is a key metric utilized by the segment to regularly evaluate its performance. The segment’s primary operating expenses include salaries and benefits and supplies. Salaries and benefits represents the most significant cost to the segment and includes all amounts paid to full- and part-time employees, as well as all related costs of benefits provided to employees. Supply costs include all expenses associated with medical supplies used while providing patient care at our centers. Such costs include sterile disposables, pharmaceuticals, implants, and other similar items.
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For the year ended December 31, 2005 2004 2003 (In Thousands)
* Includes divisional overhead, but excludes corporate overhead allocation. See Note 25, Segment Reporting , to our accompanying consolidated financial statements. Includes the effect of minority interests in earnings of consolidated affiliates and equity in the net income of nonconsolidated affiliates.
For the year ended December 31, 2005 2004 2003
Medicare 17.8 % 18.1 % 14.3 % Medicaid 2.7 % 2.7 % 2.3 % Workers’ compensation 10.5 % 10.7 % 12.5 % Managed care and other discount plans 59.2 % 55.5 % 55.1 % Other third-party payors 3.7 % 0.4 % 4.9 % Patients 4.8 % 11.0 % 9.3 % Other income 1.3 % 1.6 % 1.6 %
Total 100.0 % 100.0 % 100.0 %
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Like most other ASCs, the majority of our centers are owned in partnership with surgeons and other physicians who perform procedures at the centers. As existing physician partners retire or change geographic location, it is important that the surgery centers segment periodically provide other physicians with opportunities to purchase ownership interests in our ASCs in order to maintain or increase case volumes and net operating revenues. Our ability to resyndicate our partnerships is a key success factor for our surgery centers segment.
Net Operating Revenues
As noted above, our ability to efficiently resyndicate our partnership portfolio is critical to the success of our surgery centers segment. Since 2003, our surgery centers segment has experienced a decline in the number of cases performed at our centers. Management attributes the majority of the decline in each year to our inability to resyndicate partnership interests in each center and the negative publicity HealthSouth received as a result of the events leading up to March 19, 2003. Because of our inability to report financial information during 2003 and 2004, there was no resyndication activity during 2003 and minimal activity during the latter half of 2004. Resyndication activity increased in 2005, but the majority of this activity also took place in the latter half of the year. We expect to begin seeing the results of this resyndication activity in 2006.
From 2004 to 2005, net operating revenues decreased by $44.3 million, or 5.4%. Declining volumes contributed to an approximate $67.8 million decrease in net operating revenues. Although the majority of this decrease is due to the limited resyndication activities discussed above, approximately $25.6 million of the decrease is due to the reclassification of five surgery centers that became equity method investments rather than consolidated entities in 2005 as a result of changes in control of these entities. The net operating revenues lost through volume declines were offset by a shift in case mix to ophthalmology cases which generate higher average net revenue per case. This shift in case mix increased net operating revenues by approximately $28.7 million. The remainder of the 2005 decrease in net operating revenues of $5.2 million is primarily attributable to a decrease in rental income associated with subleases that were terminated during the year.
From 2003 to 2004, our surgery centers segment experienced a $53.6 million, or 6.2%, decrease in net operating revenues. Approximately 85% of this decrease was due to declining volumes, as discussed above. The remainder of the decrease is due to a shift in case mix to procedures that carry lower average net revenue per case.
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Operating Expenses
Salaries and Benefits
In each year, salaries and benefits represents over 29% of our surgery centers segment’s operating expenses.
Salaries and benefits decreased by approximately $9.1 million, or 3.4%, from 2004 to 2005. This decrease is primarily attributable to a reduction of 179 full-time equivalents year over year due to the decline in the number of cases performed by our surgery centers and the segment’s focus to improve operational performance and productivity. Salaries and benefits as a percent of net operating revenues remained flat at approximately 33% from 2004 to 2005.
During 2004, salaries and benefits decreased by $4.8 million, or 1.8%. Although full-time equivalents decreased by 168 year over year, increased costs associated with group medical insurance and workers’ compensation coverage offset these reductions.
Supplies
Supplies represents over 20% of our surgery centers segment’s operating expenses in each year, making it important for our ASCs to appropriately manage and monitor these costs.
Although total supplies cost decreased by $9.8 million, or 5.1%, from 2004 to 2005, supplies as a percent of net operating revenue remained flat at approximately 24%. The volume declines experienced by the segment in 2005 resulted in decreased supplies cost of approximately $16.3 million. However, this was offset by increased pricing associated with implants and prosthetics. The shift in case mix to more ophthalmology cases also contributed to an increase in the average supply cost per case in 2005.
From 2003 to 2004, supplies expense remained relatively flat. Although the average supply cost per case increased by approximately 6.6% year over year, there was a decrease in supplies used during the year due to the decline in the number of cases in 2004.
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Provision for Doubtful Accounts
From 2004 to 2005, our surgery centers segment’s provision for doubtful accounts remained relatively flat at approximately 1.8% of net operating revenues and 1.9% of net operating revenues, respectively. From 2003 to 2004, this segment was able to decrease its provision for doubtful accounts from 3.6% of net operating revenues to 1.8% of net operating revenues. This decrease is due to the positive impact of segment-wide business office manager training, outsourced billing statements (which provided consistent delivery and appearance of statements), and utilization of an outside collection agency during 2004.
All Other Operating Expenses
From 2004 to 2005, all other operating expenses decreased by approximately 5.3%. As discussed earlier in this Item, we reclassified five facilities from consolidated entities to equity method investments due to changes in control of these entities. This reclassification favorably impacted both Minority interest in earnings of consolidated affiliates and Equity in net income of nonconsolidated affiliates . In addition, all other operating expenses decreased due to the closure and/or sale of under-performing facilities in 2005 that did not qualify as discontinued operations.
All other operating expenses decreased by approximately 40.4% from 2003 to 2004 due primarily to a $173.6 million reduction in impairment charges year over year. Although impairment charges decreased significantly year over year, our surgery centers segment’s 2004 operating expenses include a $2.7 million charge for the impairment of long-lived assets. Due to facility closings and facilities experiencing negative cash flow from operations, we examined all of our facilities for impairment. The above impairment charge is the result of that review.
Our surgery centers segment’s operating expenses in 2003 include a $176.2 million goodwill impairment charge. We performed an impairment review as required by FASB Statement No. 142 as of October 1, 2003 and concluded that a potential goodwill impairment existed in our surgery centers segment. The amount of the impairment, which was determined by calculating the implied fair value of goodwill, primarily recognizes the decline in the expected future operating performance of our surgery centers.
Operating Earnings (Loss)
The decrease in this segment’s operating earnings from 2004 to 2005 was due to the volume declines discussed above. Operating earnings of our surgery centers segment increased by approximately $136.2 million from 2003 to 2004. Although the segment experienced a decline in net operating revenues, the segment decreased its provision for doubtful accounts (as discussed above) and did not record a goodwill impairment charge in 2004, thus improving its operating results.
Outpatient
We are one of the largest operators of free standing outpatient rehabilitation facilities in the United States. As of December 31, 2005, we provided outpatient rehabilitative health care services through 620 facilities. We have locations in 40 states, with a concentration of centers in Florida, Texas, New Jersey, Missouri, and Connecticut.
Our outpatient rehabilitation facilities are staffed by physical therapists, occupational therapists, and other clinicians and support personnel, depending on the services provided at a particular location, and we are open at hours designed to accommodate the needs of the patient population being served and the local demand for services. Our outpatient centers offer a range of rehabilitative health care services, including physical therapy and occupational therapy, with a particular focus on orthopedic, sports-related, work-related, hand and spine injuries, and various neurological/neuromuscular conditions.
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For 2003 through 2005, this segment’s operating results were as follows:
For the years ended December 31, 2005, 2004, and 2003, outpatient’s net operating revenues were derived from the following payor sources:
The number of visits patients make to our centers is a key metric utilized by the segment to regularly evaluate its performance. Outpatient’s net operating revenues include revenues from patient visits, as well as revenues generated from trainers and management contracts. Outpatient has contracts with schools, municipalities, and other parties around the country to provide physical therapists and/or athletic trainers for various events. Outpatient also receives management and administrative fees for facilities it manages, but does not own. Trainer income, management fees, and administrative fees comprise the majority of the segment’s other income.
The segment’s most significant operating expense is salaries and benefits, which includes all amounts paid to full- and part-time employees at our centers, as well as all related costs of benefits provided to employees. Due to the nature of the services provided by our outpatient centers, supplies expense does not represent a significant portion of the segment’s operating expenses, unlike our other business segments.
Our outpatient segment participates in a slower growing, lower margin business than our other operating segments. Due to regulatory changes, physicians that once referred business to us are now treating patients at their own facilities. Due to the relatively low barriers to entry associated with an outpatient facility, our outpatient segment continues to face increased competition from physician-owned physical therapy sites. The segment is also facing an industry-wide shortage of physical therapists. To combat the shortage, our outpatient segment implemented key incentive plans to help recruit and retain therapists. These incentive plans have begun to reduce therapist turnover rates and have increased the segment’s overall clinical productivity.
90
For the year ended December 31, 2005 2004 2003 (In Thousands)
* Includes divisional overhead, but excludes corporate overhead allocation. See Note 25, Segment Reporting , to our accompanying consolidated financial statements. Includes the effect of minority interests in earnings of consolidated affiliates and equity in the net income of nonconsolidated affiliates.
For the year ended December 31, 2005 2004 2003
Medicare 13.6 % 12.6 % 9.9 % Medicaid 0.7 % 0.6 % 4.1 % Workers’ compensation 22.0 % 24.7 % 27.3 % Managed care and other discount plans 47.2 % 49.6 % 44.6 % Other third-party payors 10.5 % 6.6 % 8.5 % Patients 1.3 % 1.2 % 1.2 % Other income 4.7 % 4.7 % 4.4 %
Total 100.0 % 100.0 % 100.0 %
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Net Operating Revenues
From 2003 to 2005, patient visits to our outpatient facilities decreased by over 1.5 million visits. This decreased volume negatively impacted net operating revenues by approximately $60.6 million in 2005 and approximately $86.9 million in 2004. Management attributes the volume decline in each year to increased competition from physician-owned physical therapy sites, expiration of noncompete agreements from prior acquisitions, and the nationwide physical therapist shortage. The volume impact of these factors resulted in the net closure of 108 facilities in 2005 and 70 facilities during 2004 that did not qualify for discontinued operations. These closures accounted for approximately $30.2 million and $16.3 million, respectively, of the total volume decrease in 2005 and 2004, respectively. The remainder of the decrease in each year represents the impact of the above factors on our facilities that remained open.
In 2004, our outpatient segment was able to achieve higher net patient revenue per visit, increasing this metric by approximately $2 per visit. The increased net patient revenue per visit yielded approximately $11.0 million in additional net operating revenues during 2004. The increase per visit was due to the segment’s examination and elimination of managed care contracts with low reimbursement rates, a price increase on some services, and an increase in manual therapy services. There was no significant impact to net operating revenues as a result of pricing in 2005.
During 2005 and 2004, non-patient revenues decreased by $3.0 million, or 14.5%, and $2.2 million, or 9.5%, respectively, due to facility closures and contract terminations during the year.
Operating Expenses
Salaries and Benefits
Salaries and benefits represent over 48% of outpatient’s operating expenses in each year.
In 2005 and 2004, salaries and benefits decreased by $29.4 million, or 11.9%, and $28.1 million, or 10.2%, respectively. The majority of this decrease is due to the closure of facilities in 2005 and 2004, as described
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above, which resulted in a 777 and an 802 decrease in full-time equivalents, respectively. This decrease in full- time equivalents in each year decreased salaries and benefits by approximately $41.1 million and $40.3 million in 2005 and 2004, respectively. Decreased costs associated with fewer full-time equivalents were offset by increasing costs associated with employee benefits in both years.
Provision for Doubtful Accounts
The provision for doubtful accounts of our outpatient segment increased from 2.8% to 4.2% of net operating revenues from 2003 to 2004, respectively. In 2005, the provision for doubtful accounts decreased to 1.9% of net operating revenues. These changes resulted from the segment’s reorganization of its billing and collecting function during 2004 and 2005.
All Other Operating Expenses
From 2004 to 2005, all other operating expenses decreased by approximately 10.7% due primarily to the closure of under-performing facilities and a $2.7 million decrease in impairment charges year over year. Triggering events related to facility closings and facilities experiencing negative cash flow from operations resulted in the segment recognizing a $0.8 million impairment charge to long-lived assets in 2005. We determined the fair value of the impaired long-lived assets at a facility primarily based on the assets’ estimated fair value using valuation techniques that included discounted future cash flows and third-party appraisals.
All other operating expenses decreased by approximately 51.8% from 2003 to 2004. This decrease primarily resulted from a $136.5 million decrease in impairment charges year over year. Triggering events related to facility closings and facilities experiencing negative cash flow from operations resulted in the segment recognizing an impairment charge of $2.4 million related to long-lived assets and $1.0 million related to intangible assets in 2004. We wrote these assets down to zero, or their estimated fair value, based on expected negative operating cash flows of these facilities in future years.
The segment’s 2003 operating expenses include approximately $140.0 million of impairment charges. As a result of the events leading up to March 19, 2003, we performed an impairment review, as required by FASB Statement No. 142, and concluded that a potential goodwill impairment existed in the outpatient segment. We calculated the implied fair value of the outpatient segment’s goodwill and determined that the outpatient segment’s goodwill was impaired by $135.9 million. Our outpatient segment also recorded a $4.1 million impairment charge related to long-lived assets in 2003.
Operating Earnings (Loss)
Operating earnings decreased from 2004 to 2005 due primarily to the declining volumes, as discussed above. In 2004, operating earnings increased by $93.4 million due primarily to a reduction in impairment charges. Our outpatient segment experienced an operating loss in 2003 due primarily to the $135.9 million goodwill impairment charge recorded by the segment.
Diagnostic
We are one of the largest operators of freestanding diagnostic imaging centers in the United States. As of December 31, 2005, we performed diagnostic services through the operation of our network of approximately 85 diagnostic centers in 27 states and the District of Columbia, with a concentration of centers in Texas, Georgia, Alabama, Florida, and the Washington D.C. area. In addition, the division operates five electro-shock wave lithotripter units.
Our diagnostic centers provide outpatient diagnostic imaging services, including MRI services, CT services, X-ray services, ultrasound services, mammography services, nuclear medicine services, and fluoroscopy. We do not provide all services at all sites, although approximately 71% of our diagnostic centers are multi-modality centers offering multiple types of service. Our outpatient diagnostic procedures are performed by experienced
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radiological technologists. After the diagnostic procedure is completed, the images are reviewed by radiologists who have contracted with us. These radiologists prepare an interpretation which is then delivered to the referring physician.
Due to the equipment utilized when performing diagnostic services for our patients, our diagnostic segment generally has high capital costs, including costs for maintaining its equipment.
For 2003 to 2005, our diagnostic segment’s operating results were as follows:
For the years ended December 31, 2005, 2004, and 2003, diagnostic derived its net operating revenues from the following payor sources:
The number of scans performed is a key metric utilized by the segment to regularly evaluate its performance. The segment’s primary operating expenses include salaries and benefits, professional and medical director fees, and supplies. Salaries and benefits expense represents the most significant cost to the segment and includes all amounts paid to full- and part-time employees at our centers, as well as all related costs of benefits provided to employees. Professional and medical director fees primarily include fees paid under contracts with radiologists and other clinical professionals to read and interpret the scans performed at our centers. Payments under these contracts are normally tied to the number of scans read by each independent contractor, associated revenues with each scan, or cash collections. Supply costs include all expenses associated with supplies used while performing diagnostic services for our patients. These costs primarily consist of the film costs associated with each scan.
Our diagnostic segment has struggled over the past several years due to poor margins for the diagnostic market in general, strong competition from physician-owned diagnostic service centers, increased pricing
93
For the year ended December 31, 2005 2004 2003 (In Thousands)
* Includes divisional overhead, but excludes corporate overhead allocation. See Note 25, Segment Reporting , to our accompanying consolidated financial statements. Includes the effect of minority interests in earnings of consolidated affiliates and equity in the net income of nonconsolidated affiliates.
For the year ended December 31, 2005 2004 2003
Medicare 19.5 % 17.3 % 16.5 % Medicaid 3.4 % 3.3 % 2.7 % Workers’ compensation 9.6 % 9.2 % 7.8 % Managed care and other discount plans 60.1 % 61.0 % 63.5 % Other third-party payors 4.4 % 6.1 % 7.2 % Patients 2.2 % 2.2 % 1.4 % Other income 0.8 % 0.9 % 0.9 %
Total 100.0 % 100.0 % 100.0 %
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pressure from payors, and the age of equipment in our installed base. We see competition only increasing as diagnostic equipment manufacturers continue to lower prices and offer special financing to encourage physicians to purchase equipment through their own practices, resulting in a decline in the number of procedures performed at our diagnostic centers.
Net Operating Revenues
The decrease in net operating revenues in each year is due to volume decreases caused primarily by competition from physician-owned diagnostic centers and the closure of under-performing facilities that did not qualify for discontinued operations.
Operating Expenses
Salaries and Benefits
The declining volumes of our diagnostic segment over the past several years has led management to take an active role in increasing efficiencies by reducing the number of full-time equivalents. However, our diagnostic centers have relatively few full-time equivalents on a per facility basis, and there are certain staffing requirements that are mandated for any volume level given the nature of services we provide.
Salaries and benefits decreased by $2.1 million, or 3.4%, from 2004 to 2005. This decrease was primarily the result of eliminating full-time positions at certain business offices by outsourcing the segment’s collections processes to a third-party and the closure of under-performing facilities that did not qualify for discontinued operations in 2005. Due to these headcount reductions at the segment’s business offices and the closure of under-performing facilities, salaries and benefits remained at approximately 26.0% of net operating revenues in 2005 in spite of the decline in revenues.
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Salaries and benefits grew from 22.8% of net operating revenues in 2003 to 26.0% of net operating revenues in 2004. Although volumes declined in 2004, our diagnostic centers did not further adjust their staffing levels due to management’s conclusion that minimum staffing levels had been achieved for the operation of our centers. Therefore, salaries and benefits grew as a percent of net operating revenues due to the decline in net operating revenues in 2004 without a commensurate reduction in personnel costs.
Supplies
In 2005 and 2004, supplies expense decreased by approximately 12.2% and 11.0%, respectively, due to the decrease in volumes during each year, more favorable supply pricing, and improved efficiency.
Professional and Medical Director Fees
From 2003 through 2005, professional and medical director fees generally followed the same trend as our net operating revenues and cash collections.
Provision for Doubtful Accounts
In 2003, our diagnostic segment’s provision for doubtful accounts was 16.7% of net operating revenues. This high percentage was primarily the result of a decline in operational efficiency within the segment as a result of (1) outsourcing the diagnostic segment’s collection activities to a third-party vendor (beginning March 2002), and (2) the conversion of 44 of the segment’s clinics to a new patient accounting system which failed to meet expectations. The contract with the third-party vendor was terminated in April 2003, and the 44 clinics were taken off the new patient accounting system during the summer of 2003.
During 2004, we made progress collecting aged receivables, which is reflected in the decrease in the provision for doubtful accounts to 16.1% of net operating revenues. In 2005, we continued to implement new information systems to improve cash collections in our diagnostic segment, and we outsourced collection activities to a third-party. These new systems along with management’s focus on collections decreased the segment’s provision for doubtful accounts to 15.5% of net operating revenues in 2005.
All Other Operating Expenses
From 2004 to 2005, all other operating expenses decreased by 1.3%. This decrease is primarily the result of the closure of under-performing facilities that did not qualify for discontinued operations treatment in 2005 offset by a $5.0 million impairment charge related to long-lived assets. Triggering events related to facility closings and facilities experiencing negative cash flow from operations resulted in the segment recognizing a $5.0 million impairment charge to long-lived assets in 2005. We determined the fair value of the impaired long-lived assets at a facility primarily based on the assets’ estimated fair value using valuation techniques that included discounted future cash flows and third-party appraisals.
During 2004, all other operating expenses decreased by 33.8% due primarily to a year over year reduction in impairment charges and the closure of under-performing facilities that did not qualify for discontinued operations treatment. In 2004, triggering events related to facility closings and facilities experiencing negative cash flow from operations resulted in the segment recognizing an impairment charge of $0.9 million related to long-lived assets. We wrote these assets down to zero, or their estimated fair value, based on expected negative operating cash flows of these facilities in future years.
During 2003, we performed an impairment review as required by FASB Statement No. 142 and concluded a potential goodwill impairment existed in our diagnostic segment. We calculated the implied fair value of the diagnostic segment’s goodwill and determined that an impairment charge of $23.5 million was appropriate. After this impairment charge, there is no goodwill remaining on our diagnostic segment. Our diagnostic segment also recorded a $0.5 million impairment charge related to long-lived assets in 2003.
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Operating Loss
In 2005, our diagnostic segment decreased its operating loss by closing additional under-performing facilities and decreasing its provision for doubtful accounts, as discussed above.
In 2004, the segment’s operating loss decreased by approximately 81.4%. Although our diagnostic segment experienced a decline in net operating revenues year over year, the segment decreased its total operating expenses due primarily to a year over year reduction in the provision for doubtful accounts and impairment charges, as discussed above.
We continue to focus on operational improvements to increase our margins and respond to the increased competition in this industry.
Corporate and Other
Corporate and other includes revenue-producing functions that are managed directly from our corporate office and that do not fall within one of the four operating segments discussed above, including other patient care services and certain non-patient care services.
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• Medical Centers . This category formerly included our acute care business which, for all practical purposes, we have now exited. Specifically, as described later in this Item under the heading “Results of Discontinued Operations,” we have signed an agreement to sell our acute care hospital located in Birmingham, Alabama. In addition, on January 4, 2006, we executed a letter of intent with an undisclosed party regarding the sale of the property and equipment which were to have comprised our Digital Hospital in Birmingham, Alabama. Any sale of the Digital Hospital will not involve conveyance of our interest in any certificate of need from our acute care hospital. The letter of intent expires, subject to certain conditions, on March 31, 2006 unless otherwise extended in accordance with the terms of the letter of intent. As of December 31, 2005, we had invested approximately $210 million in the Digital Hospital project. We have not signed a definitive agreement with respect to the Digital Hospital, and there can be no assurance any sale will take place. See Note 5, Property and Equipment , to our accompanying consolidated financial statements, for a discussion of the impairment charge we recognized in 2005 relating to the Digital Hospital. As of December 31, 2005, this category continues to include a physician practice located at the University of Miami Sports Center. During 2005, 2004, and 2003, net operating revenues from this category comprised 5.8%, 2.8%, and 7.8%, respectively, of corporate and other’s net operating revenues.
• Other Patient Care Services . In some markets, we provide other limited patient care services. We evaluate market opportunities on a case-by-case basis in determining whether to provide additional services of these types. We may provide these services as a complement to our facility-based businesses or as stand-alone businesses. During 2005, 2004, and 2003, net operating revenues from other patient care services comprised 3.1%, 3.2%, and 4.9%, respectively, of corporate and other’s net operating revenues.
• Non-Patient Care Services . We also provide certain services that do not involve the provision of patient care, including the operation of the conference center located at our corporate campus, operation of medical office buildings, various corporate marketing activities, our clinical research activities, and other services that are generally intended to complement our patient care activities. During 2005, 2004, and 2003, net operating revenues from non-patient care services comprised 91.1%, 94.0%, and 87.3% of corporate and other’s net operating revenues. This category’s net operating revenues include earned premiums of HCS, Ltd. (“HCS”). HCS handles medical malpractice, workers’ compensation, and other claims for us. HCS is a wholly owned subsidiary of HealthSouth Corporation, and, as such, these earned premiums eliminate in consolidation.
• Corporate Functions . All our corporate departments and related overhead are contained within this segment. These departments,
which include among others accounting, communications, compliance, human resources, information technology, internal audit, legal, payor strategies, reimbursement, tax, and treasury, provide support functions to our operating divisions.
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For 2003 through 2005, this segment’s operating results were as follows:
Corporate and other’s primary operating expense is salaries and benefits. Salaries and benefits represents the most significant cost to the segment and includes all amounts paid to full- and part-time employees at our corporate headquarters (excluding any divisional management allocated to each operating segment) in Birmingham, Alabama, as well as all related costs of benefits provided to these employees. All general and administrative costs related to the operation of our corporate office are included in other operating expenses. The most significant general and administrative expenses relate to insurance including property and casualty, general liability, and directors and officers’ coverage.
Net Operating Revenues
Changes in net operating revenues from year to year relate to changes in earned premiums of HCS, which eliminate in consolidation.
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For the year ended December 31, 2005 2004 2003 (In Thousands)
* Includes all corporate overhead. See Note 25, Segment Reporting , to our accompanying consolidated financial statements. Includes the effect of minority interests in earnings of consolidated affiliates and equity in net income of nonconsolidated affiliates. This line item also includes approximately $215 million and $171 million, respectively, in 2005 and 2003 related to Government, class action, and related settlements expense .
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Operating Expenses
Salaries and Benefits
From 2004 to 2005, salaries and benefits decreased by $10.6 million, or 13.2%, primarily due to lower claims and premiums expense associated with workers’ compensation. Salaries and benefits did not change materially from 2003 to 2004.
All Other Operating Expenses
All other operating expenses of the corporate and other segment include $24.4 million, $30.2 million, and $127.9 million of impairment charges related to the Digital Hospital in 2005, 2004, and 2003, respectively. In each year, the impairment charge represents the excess of costs incurred during the construction of the Digital Hospital over the estimated fair market value of the property, including the River Point facility, a 60,000 square foot office building, which shares the construction site and would be included with any sale of the Digital Hospital. The impairment of the Digital Hospital in 2003 was based on an appraisal that considered alternative uses for the property. The impairment of the Digital Hospital in 2004 and 2005 was determined using a weighted average fair value approach that considered the 2003 appraisal and other potential scenarios.
In addition to the $24.4 million impairment charge related to the Digital Hospital in 2005, the corporate and other segment recorded $9.0 million in other long-lived asset impairment charges. We determined the fair value of the impaired long-lived assets based on the assets’ estimated fair value using valuation techniques that included discounted future cash flows and third-party appraisals.
All other operating expenses increased by 65.8% from 2004 to 2005. The primary contributor to this increase is the $215.0 million settlement associated with our securities litigation, as discussed above in this Item, “Consolidated Results of Operations.” Excluding the amount recorded for the securities litigation settlement, all other operating expenses in the corporate and other segment would have decreased by less than 1.0% in 2005 due to the following:
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• Meadowbrook recovery . As discussed earlier in this Item, we recorded a $37.9 million recovery related to Meadowbrook in 2005.
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These decreases were offset by increased expenses associated with accounting, legal, and consulting professional fees. We incurred these fees in 2005 as a result of Sarbanes-Oxley costs and strategic agenda consulting.
From 2003 to 2004, all other operating expenses had a net decrease of approximately 33.2%. This decrease was primarily the result of the following:
The above decreases in 2004 were offset by a $135.7 million increase in Professional fees—reconstruction and restatement . As noted throughout this filing, significant changes have occurred at HealthSouth since the events leading up to March 19, 2003. The steps taken to stabilize our business and operations, provide vital management assistance, and coordinate our legal strategy came at significant financial cost. Much of the audit and reconstruction efforts occurred in 2004 causing these fees to increase from 2003.
Operating Loss
Our operating loss for the corporate and other segment increased from 2004 to 2005 due primarily to the securities litigation settlement. Our operating loss for the corporate and other segment decreased from 2003 to 2004 due to the decrease in all other operating expenses discussed above.
Results of Discontinued Operations
In our continuing effort to streamline operations, we identified 19 entities in our inpatient segment, 328 outpatient rehabilitation facilities, 25 surgery centers, 27 diagnostic centers, and 46 other facilities during 2005, 2004, and 2003 that met the requirements of FASB Statement No. 144 to report as discontinued operations. For the facilities identified during these years that met the requirements of FASB Statement No. 144 to report as discontinued operations, we reclassified our consolidated balance sheet for the year ended December 31, 2004 and our consolidated statements of operations and consolidated statements of cash flows for the years ended December 31, 2004 and 2003 to show the results of those facilities as discontinued operations.
When determining if a closed facility qualifies for discontinued operations under FASB Statement No. 144, we consider the proximity of the facility to other HealthSouth facilities offering similar services as well as other facilities within the same regional cost center that remain open. If we believe HealthSouth will retain patients by transferring the services to another HealthSouth facility, we will not treat the closed facility as a discontinued operation. We do not account for facilities that were closed or sold as discontinued operations until we have exited the specific market.
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• Professional fees—reconstruction and restatement . These fees decreased by $36.4 million from 2004 to 2005, showing the
decreased use of consultants as our new management team was in place.
• Software development costs . We began funding Source Medical for the HCAP software development in 2001. In 2004, we gave
approximately $6.5 million less to Source Medical for software development. For additional information regarding Source Medical, see Note 7, Investment in and Advances to Nonconsolidated Affiliates , to our accompanying consolidated financial statements.
• Impairment of Long-Lived Assets . During 2003, the corporate and other segment recorded long-lived asset impairments of $128.0
million, while in 2004, long-lived asset impairments approximated $30.2 million. Both charges related primarily to the Digital Hospital, as discussed above.
• Government, Class Action, and Related Settlements . There were no government, class action, or related settlements recorded in
2004.
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The operating results of discontinued operations, by operating segment and in total, are as follows:
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For the year ended December 31, 2005 2004 2003 (In Thousands)
Inpatient:
Net operating revenues $ — $ 4,699 $ 26,114 Costs and expenses 637 6,544 18,148
(Loss) income from discontinued operations (637 ) (1,845 ) 7,966 Gain (loss) on disposal of assets of discontinued operations 362 (642 ) (464 ) Income tax expense — — —
(Loss) income from discontinued operations $ (275 ) $ (2,487 ) $ 7,502
Surgery Centers:
Net operating revenues $ 18,854 $ 44,181 $ 57,608 Costs and expenses 30,967 56,846 99,628 Impairments 112 1,750 —
Loss from discontinued operations (12,225 ) (14,415 ) (42,020 ) Gain on disposal of assets of discontinued operations 6,181 1,134 11,299 Income tax expense — — —
Loss from discontinued operations $ (6,044 ) $ (13,281 ) $ (30,721 )
Outpatient:
Net operating revenues $ 11,815 $ 48,007 $ 78,742 Costs and expenses 16,852 52,102 74,316 Impairments — 822 —
(Loss) income from discontinued operations (5,037 ) (4,917 ) 4,426 Gain (loss) on disposal of assets of discontinued operations 165 (1,203 ) (1,758 ) Income tax expense — — —
(Loss) income from discontinued operations $ (4,872 ) $ (6,120 ) $ 2,668
Diagnostic:
Net operating revenues $ 2,191 $ 11,410 $ 21,009 Costs and expenses 4,733 17,702 25,435 Impairments — 133 —
Loss from discontinued operations (2,542 ) (6,425 ) (4,426 ) Gain on disposal of assets of discontinued operations 289 3,077 1,289 Income tax expense — — —
Loss from discontinued operations $ (2,253 ) $ (3,348 ) $ (3,137 )
Corporate and Other:
Net operating revenues $ 76,802 $ 153,609 $ 228,218 Costs and expenses 118,331 232,457 238,150 Impairments 6,693 16,577 —
Loss from discontinued operations (48,222 ) (95,425 ) (9,932 ) Gain on disposal of assets of discontinued operations 257 319 28,439 Income tax expense — — —
(Loss) income from discontinued operations $ (47,965 ) $ (95,106 ) $ 18,507
Total:
Net operating revenues $ 109,662 $ 261,906 $ 411,691 Costs and expenses 171,520 365,651 455,677 Impairments 6,805 19,282 —
Loss from discontinued operations (68,663 ) (123,027 ) (43,986 ) Gain on disposal of assets of discontinued operations 7,254 2,685 38,805 Income tax expense — — —
Loss from discontinued operations $ (61,409 ) $ (120,342 ) $ (5,181 )
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Inpatient . Our inpatient segment identified 19 facilities as discontinued operations. The decrease in net operating revenues and costs and expenses in each year is due to the timing of the closure of these facilities.
Surgery Centers . Twenty-five surgery centers were identified as discontinued operations. Both the decline in net operating revenues and the decline in costs and expenses in each year are due to the timing of the sale or closure of these facilities. As of December 31, 2005, we had three open surgery centers that qualified as discontinued operations. These three facilities were sold in February 2006.
The $11.3 million net gain on disposal of assets in 2003 is due primarily to a gain on disposal of the assets related to our former surgical hospital in Oklahoma.
Outpatient. Our outpatient segment identified 328 facilities as discontinued operations. The timing of the closure of these facilities drove the change in net operating revenues and costs and expenses in each year.
Diagnostic . Our diagnostic segment identified 27 facilities as discontinued operations. The timing of the closure of these facilities drove the change in net operating revenues and costs and expenses in each year.
Corporate and Other . Our corporate and other segment identified 46 facilities as discontinued operations.
On July 20, 2005, we executed an asset purchase agreement with The Board of Trustees of the University of Alabama (the “University of Alabama”) for the sale of the real property, furniture, fixtures, equipment and certain related assets associated with our only remaining operating acute care hospital, which has 219 licensed beds and is located in Birmingham, Alabama. Simultaneously with the execution of this purchase agreement with the University of Alabama, we executed an agreement with an affiliate of the University of Alabama whereby this entity currently provides certain management services to our acute care hospital in Birmingham. On December 31, 2005, we executed an amended and restated asset purchase agreement with the University of Alabama. This amended and restated agreement provides that the University of Alabama will purchase our Birmingham acute care hospital and associated real and personal property as well as our interest in the gamma knife partnership associated with this hospital. We anticipate closing this transaction by the end of the first quarter of 2006. We will transfer the hospital and associated real and personal property at that time, but will transfer our interest in the gamma knife partnership at a later date. The proposed transaction also requires that we acquire and convey title to the University of Alabama for certain professional office buildings that we are currently leasing. Both the certificate of need under which the hospital currently operates, and the licensed beds operated by us at the hospital, will be transferred as part of the sale of the hospital under the amended and restated agreement.
From 2003 to 2004, net operating revenues associated with discontinued operations within our corporate and other segment decreased by $74.6 million. Approximately $72.0 million of this decrease relates to Doctor’s Hospital in Miami, Florida, which was sold in late 2003. From 2004 to 2005, net operating revenues associated with discontinued operations within this segment decreased by $76.8 million. Approximately $20.0 million of this decrease was due to the closure of Metro West hospital in September 2004. An additional $35.0 million was due to the continued poor operating performance of the Birmingham Medical Center in 2005. The change in costs and expenses in each year follow these same trends.
The $16.6 million impairment charge in 2004 primarily relates to a $14.8 million impairment charge associated with the Birmingham Medical Center. Due to continuing negative cash flows from operations of this facility, we had the Birmingham Medical Center appraised as of December 31, 2004. The impairment charge represents the difference between the appraised value and the net book value of the long-lived assets associated with the Birmingham Medical Center.
The net gain on asset disposals in 2003 was primarily the result of our sale of Doctor’s Hospital in that year.
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Liquidity and Capital Resources
Our principal sources of liquidity are cash on hand, cash from operations, and our revolving credit agreement.
Historic Sources and Uses of Cash
Historically, our primary sources of funding have been cash flows from operations, borrowings under long-term debt agreements, and sales of limited partnership interests. Funds were used to fund working capital requirements, capital expenditures, and business acquisitions. The following chart shows the cash flows provided by or used in operating, investing, and financing activities for 2005, 2004, and 2003, as well as the effect of exchange rates for those same years:
2005 Compared to 2004
Operating activities . Net cash provided by operating activities decreased from 2004 to 2005 as a result of lower net operating revenues in 2005, cash payments for government, class action, and related settlements, and a return to normal payment terms with many of our vendors. As discussed earlier in this Item, our net operating revenues decreased in 2005 due to declining volumes experienced by our operating segments. In addition, we paid approximately $155.0 million, excluding interest, to the United States related to our Medicare program settlement, and we paid $12.5 million to the SEC under a settlement agreement. These settlements are discussed in Item 1, Business , and Note 21, Medicare Program Settlement , and Note 22, SEC Settlement , to our accompanying consolidated financial statements. With our revolving line of credit frozen throughout 2004, we added approximately two weeks to most payment terms of our vendors as part of our cash management and conservation process. After we amended and restated our credit agreement in March 2005 (see below), we were able to return to more normal payment terms with our vendors. This decreased our net cash provided by operating activities year over year.
Investing activities . Net cash used in investing activities decreased from 2004 to 2005 primarily due to a reduction in capital expenditures. During 2005, we decreased capital expenditure budgets and postponed development projects to conserve cash and restructure our business.
Financing activities . Net cash used in financing activities decreased from 2004 to 2005 due primarily to $73.5 million less in debt issuance costs and consent fees paid in 2005 offset by $21.7 million more in net debt payments, including capital lease obligations. See Item 1, Business , and Note 8, Long-term Debt , to our accompanying consolidated financial statements.
2004 Compared to 2003
Operating activities . Net cash provided by operating activities decreased from 2003 to 2004 as a result of lower net operating revenues in 2004 and a reduction in income tax refunds received year over year. In 2004, we received net income tax refunds of approximately $8.1 million, as compared to 2003 when we received $110.3 million in net income tax refunds.
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For the year ended December 31, 2005 2004 2003 (In Thousands)
Net cash provided by operating activities* $ 1,561 $ 391,596 $ 574,193 Net cash used in investing activities (104,298 ) (186,869 ) (76,873 ) Net cash used in financing activities (173,832 ) (224,469 ) (115,885 ) Effect of exchange rate changes on cash and cash equivalents (1,248 ) 1,251 (31 )
(Decrease) increase in cash and cash equivalents $ (277,817 ) $ (18,491 ) $ 381,404
* Includes approximately $165.4 million and $7.0 million of cash payments, excluding interest, related to government, class action, and related settlements in 2005 and 2004, respectively.
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Investing activities . Net cash used in investing activities increased from 2003 to 2004 primarily due to a reduction in proceeds from asset disposals year over year, including those of facilities designated as discontinued operations.
Financing activities . Net cash used in financing activities increased from 2003 to 2004 primarily due to consent fees paid in connection with all of our debt issues covered by the consent solicitations discussed in Item 1, Business , and Note 8, Long-term Debt , to our accompanying consolidated financial statements.
Current Liquidity and Capital Resources
As of December 31, 2005, we had approximately $175.5 million in cash and cash equivalents. This amount excludes approximately $242.5 million in restricted cash, which is cash we cannot use because of various obligations we have under lending agreements, partnership agreements, and other arrangements, primarily related to our captive insurance company. We also had approximately $23.8 million of marketable securities classified as available-for-sale.
On March 10, 2006, we completed the last of a series of recapitalization transactions (the “Recapitalization Transactions”) enabling us to prepay substantially all of our prior indebtedness and replace it with approximately $3 billion of new long-term debt. Although we remain highly leveraged, we believe these Recapitalization Transactions have eliminated significant uncertainty regarding our capital structure and have improved our financial condition in several important ways:
The Recapitalization Transactions included (1) entering into credit facilities that provide for extensions of credit of up to $2.55 billion of senior secured financing, (2) entering into an interim loan agreement that provides
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• Reduced refinancing risk—The terms governing our prior indebtedness would have required us to refinance approximately $2.7 billion between 2006 and 2009, assuming all noteholders holding options to require us to repurchase their notes in 2007 and 2009 were to exercise those options. Under the terms governing our new indebtedness, we have minimal maturities until 2013 when our new term loans come due. The extension of our debt maturities has substantially reduced the risk and uncertainty associated with our near-term refinancing obligations under our prior debt.
• Improved operational flexibility—We have negotiated new loan covenants with higher leverage ratios and lower interest coverage
ratios. In addition, our new loan agreements increase our ability to enter into certain transactions (e.g. acquisitions and sale-leaseback transactions).
• Increased liquidity—As a result of the Recapitalization Transactions, our revolving line of credit has increased by approximately
$150 million. In addition, the increased flexibility provided by the covenants governing our new indebtedness will allow us greater access to our revolving credit facility than we had under our prior indebtedness.
• Improved credit profile—By issuing $400 million in convertible perpetual preferred stock and using the net proceeds from that offering to repay a portion of our outstanding indebtedness and to pay fees and expenses related to such prepayment, we were able to reduce the amount we ultimately borrowed under the interim loan agreement. Accordingly, we have improved our capital structure. In addition, by increasing the ratio of our secured debt to unsecured debt, our capital structure is now closer to industry norms. Further, a substantial amount of our new indebtedness is prepayable without penalty, which will enable us to reduce debt and interest expense as operating and non-operating cash flows allow without the substantial cost associated with the prepayment of our prior public indebtedness.
• Reduced interest rate exposure—By completing the Recapitalization Transactions we have taken advantage of current interest rates, which are relatively low compared to historical rates, and eliminated the need to refinance our debt over the next four years in what we perceive to be a rising interest-rate environment. In addition, we have entered into an interest rate swap to reduce our variable rate debt exposure.
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us with $1.0 billion of senior unsecured financing, (3) completing a $400 million offering of convertible perpetual preferred stock, (4) completing cash tender offers to purchase $2.03 billion of our previously outstanding senior notes and $319 million of our previously outstanding senior subordinated notes and consent solicitations with respect to proposed amendments to the indentures governing each outstanding series of notes, and (5) prepaying and terminating our Senior Subordinated Credit Agreement, our Amended and Restated Credit Agreement, and our Term Loan Agreement. In order to complete the Recapitalization Transactions, we also entered into amendments, waivers, and consents to our prior senior secured credit facility, $200 million senior unsecured term loan agreement, and $355 million senior subordinated credit agreement. Detailed descriptions of each of the above transactions are contained in Item 1, Business , “Recapitalization Transactions,” and Note 8, Long-term Debt , to our accompanying consolidated financial statements.
As a result of the Recapitalization Transactions, we expect to record an approximate $350 million to $375 million net loss on early extinguishment of debt in the first quarter of 2006.
We used a portion of the proceeds of the loans under the new senior secured credit facilities, the proceeds of the interim loans, and the proceeds of the $400 million offering of convertible perpetual preferred stock, along with cash on hand, to prepay substantially all of our prior indebtedness and to pay fees and expenses related to such prepayment and the Recapitalization Transactions. The remainder of the proceeds and availability under the senior secured credit facilities are expected to be used for general corporate purposes. In addition, the letters of credit issued under the revolving letter of credit subfacility and the synthetic letter of credit facility will be used in the ordinary course of business to secure workers’ compensation and other insurance coverages and for general corporate purposes. We anticipate refinancing the $1 billion interim loans in the second quarter or third quarter of 2006 through an issuance of high-yield debt securities.
The face value of our long-term debt (excluding notes payable to banks and others, noncompete agreements, and capital lease obligations) before and after the Recapitalization Transactions is summarized in the following table:
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As of
December 31, 2005 As of
March 10, 2006 (In Thousands) Revolving credit facility $ — $ 50,000 Term loans 513,425 3,050,000 Bonds payable 2,720,907 80,101
$ 3,234,332 $ 3,180,101
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The following charts show our scheduled payments on long-term debt (excluding notes payable to banks and others, noncompete agreements, and capital lease obligations) for the next five years and thereafter before and after the Recapitalization Transactions. The charts also exclude the convertible perpetual preferred stock.
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* Interim Loan Agreement maturity, which is subject to automatic extension
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As noted above, we have negotiated new debt covenants as part of the Recapitalization Transactions. These covenants include higher leverage ratios and lower interest coverage ratios. The following chart shows a comparison of these two restrictive covenants as of March 31, 2006 under our former Amended and Restated Credit Agreement and our new Credit Agreement:
2005 Financial Restructuring
On March 21, 2005, we amended and restated our 2002 Credit Agreement as follows:
Until we filed our 2004 audited consolidated financial statements with the SEC, we were subject to commitment fees of 0.75% per annum on the daily amount of the unutilized commitments under the Revolving Facility and the LC Facility. After that filing, the commitment fees ranged between 0.50% and 0.75%, depending on the Net Leverage Ratio.
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Required Ratios at March 31, 2006
New Credit Agreement
Former Amended and
Restated Credit Agreement
Minimum interest coverage ratio 1.65 to 1.00 2.00 to 1.00 Maximum leverage ratio 7.25 to 1.00 5.50 to 1.00
• The balance of $315 million outstanding under the 2002 Credit Agreement when it was frozen in March 2003 was converted to a
term loan. The Term Loan bore interest, at our option, at a rate of (1) LIBOR, adjusted for statutory reserve requirements (“Adjusted LIBOR”), plus 2.50% or (2) 1.50% plus the higher of (a) the Federal Funds Rate plus 0.50% or (b) JPMorgan’s prime rate.
• We obtained a $250 million revolving credit facility (the “Revolving Facility”). As of December 31, 2005, no money was drawn on the Revolving Facility. Until we filed our 2004 audited consolidated financial statements with the SEC, the Revolving Facility accrued interest at our option, at a rate of (1) Adjusted LIBOR plus 2.75% or (2) 1.75% plus the higher of (a) the Federal Funds Rate plus 0.50% or (b) JPMorgan’s prime rate. After we filed our audited consolidated financial statements with the SEC for the fiscal year ended December 31, 2004, the interest rates and commitment fees on the Revolving Facility were determined based upon our ratio of (1) consolidated total indebtedness minus the amount by which the unrestricted cash and cash equivalents on such date exceed $50 million to (2) our adjusted consolidated EBITDA for the period of four consecutive fiscal quarters ending on or most recently prior to such date (the “Net Leverage Ratio”). During such period, the Revolving Facility bore interest, at our option, (1) at a rate of Adjusted LIBOR plus a spread ranging from 1.75% to 2.75%, depending on the Net Leverage Ratio or (2) at a rate of a spread ranging from 0.75% to 1.75%, depending on the Net Leverage Ratio, plus the higher of (a) the Federal Funds Rate plus 0.50% or (b) JPMorgan’s prime rate.
• We obtained a $150 million letter of credit facility (the “LC Facility”). As of December 31, 2005, approximately $123.8 million of this facility was utilized. A letter of credit participation fee was payable to the Lenders under the LC Facility with respect to a particular commitment under the LC Facility on the aggregate face amount of the commitment outstanding there under upon the later of the termination of the particular commitment under the LC Facility and the date on which the Lenders letters of credit exposure for such commitment cease, in an amount at any time equal to the LIBOR interest rate spread applicable at such time to loans outstanding under the Revolving Facility. In addition, we paid, for our own account, (1) a fronting fee of 0.25% per annum on the aggregate face amount of the letters of credit outstanding under the LC Facility upon the later of the termination of the commitments under the LC Facility and the date on which the Lenders’ letters of credit exposure for such commitment cease, and (2) customary issuance and administration fees relating to the letters of credit.
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The Amended and Restated Credit Facility cured all defaults under our 2002 Credit Agreement. Beginning June 30, 2005, it contained affirmative and negative covenants, including a minimum interest expense coverage ratio of 1.75 to 1.00 and a maximum leverage ratio of 5.75 to 1.00 as of December 31, 2005. The required ratios changed over time. The Amended and Restated Credit Facility also contained restrictive covenants related to our use of proceeds from asset sales and ability to pay dividends. For more information regarding the Amended and Restated Credit Facility, see Note 8, Long-term Debt , to our accompanying consolidated financial statements.
On June 15, 2005, we closed a $200 million senior unsecured term loan facility, the net proceeds of which, together with available cash, were used to repay our $245 million 6.875% senior notes due June 15, 2005, and to pay fees and expenses related to the term loan facility. This transaction allowed us to reduce our overall level of outstanding indebtedness.
The facility, which was launched in late May 2005, was increased from $150 million to $200 million based on strong investor demand.
The term loan facility bore interest, at our option, at a rate of (1) Adjusted LIBOR plus 5.0% or (2) 4.0% per year plus the higher of (a) JPMorgan’s prime rate and (b) the Federal Funds Rate plus 0.5%. The term loan facility would have matured on June 15, 2010.
The term loan facility contained affirmative and negative covenants and default and acceleration provisions. In addition, we were responsible for customary fees and expenses associated with the term loan facility.
Funding Commitments
After the above recapitalization transactions, we have scheduled payments of $34.3 million and $20.6 million in 2006 and 2007, respectively, related to long-term debt obligations (including notes payable to banks and others, noncompete agreements, and capital lease obligations; excluding the $1.0 billion interim loan agreement). For additional information about our long-term debt obligations, see Note 8, Long-term Debt , to our accompanying consolidated financial statements.
We also have funding commitments related to legal settlements. As a result of the Medicare Program Settlement discussed in Item 1, Business , we made principal payments of approximately $155 million to the United States during 2005. The remaining principal balance of $170 million will be paid in quarterly installments in 2006 and 2007. These amounts are exclusive of interest from November 4, 2004 at an annual rate of 4.125%. In addition to the Medicare Program Settlement, we reached an agreement with the SEC to resolve claims brought by the SEC against us in March 2003. As a result of the SEC Settlement, we made a $12.5 million payment to the SEC in October 2005. We will make payments of $37.5 million and $50.0 million in 2006 and 2007, respectively.
During 2005, we made capital expenditures of approximately $94 million, of which approximately $14 million related to the Digital Hospital. Total amounts budgeted for capital expenditures for 2006 approximate $147 million. These expenditures include IT initiatives, new business opportunities, and equipment upgrades and purchases. Approximately 50% of this budgeted amount is discretionary and could be revised, if necessary.
For a discussion of risk factors related to our business and our industry, please see Item 1A, Risk Factors .
Off-Balance Sheet Arrangements
In accordance with the definition under SEC rules, the following qualify as off–balance sheet arrangements:
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• any obligation under certain guarantees or contracts;
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The following discussion addresses each of the above items for our company.
On December 31, 2005, we were liable for guarantees of indebtedness owed by third parties in the amount of $30.8 million. We have recognized that amount as a liability as of December 31, 2005 because of existing defaults by the third parties under those guarantees.
We are also secondarily liable for certain lease obligations associated with sold facilities. As of December 31, 2005, we had entered into four sublease guarantee arrangements. The remaining terms of these subleases range from one year to nine years. If we were required to perform under all such guarantees, our maximum exposure approximates $11.6 million. We have not recorded a contingent liability for these guarantees, as we do not believe it is probable that we will be required to perform under these guarantees. In the event we are required to perform under these guarantees, we could potentially have recourse against the sublessee for recovery of any amounts paid. For additional information regarding these guarantees, see Note 5, Property and Equipment , to our accompanying consolidated financial statements.
As of December 31, 2005, we were not directly liable for the debt of any unconsolidated entity, and we do not have any retained or contingent interest in assets as defined above.
As of December 31, 2005, we do not hold any derivative financial instruments, as defined by FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. In March 2006, we entered into an interest rate swap related to our new Credit Agreement, as discussed in Note 8, Long-term Debt , to our accompanying consolidated financial statements.
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2005 and 2004, we are not involved in any unconsolidated SPE transactions.
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• a retained or contingent interest in assets transferred to an unconsolidated entity or similar entity or similar arrangement that serves as
credit, liquidity or market risk support to that entity for such assets;
• any obligation under certain derivative instruments; and
• any obligation under a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity,
market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant.
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Contractual Obligations
Achieving optimal returns on cash often involves making long-term commitments. SEC regulations require that we present our contractual obligations, and we have done so in the table that follows. However, our future cash flow prospects cannot reasonably be assessed based on such obligations, as the most significant factor affecting our future cash flows is our ability to earn and collect cash from our patients and third-party payors. Future cash outflows, whether they are contractual obligations or not, will vary based on our future needs. While some such outflows are completely fixed (for example, commitments to repay principal and interest on fixed-rate borrowings), most will depend on future events (for example, a facility has a lease for property that includes a base rent amount and an additional amount as a percentage of net operating revenues). Further, normal operations involve significant expenditures that are not based on “commitments.” Examples of such expenditures include amounts paid for income taxes or for salaries and benefits.
Our consolidated contractual obligations as of December 31, 2005, are as follows:
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Total 2006 2007 – 2008 2009 –2010 2011 and
Thereafter (In Thousands) Long-term debt obligations:
Government settlements, including interest when applicable 265,548 126,524 139,024 — — Other liabilities(i) 5,435 1,927 444 444 2,620
(a) Included in long-term debt are amounts owed on our bonds payable, notes payable to banks and others, and noncompete agreements. These borrowings are further explained in Note 8, Long-term Debt, of the notes to our accompanying consolidated financial statements. In 2009 and 2010, amortization of debt discounts exceed long-term debt obligations.
(b) Amounts included in this chart are based on our long-term indebtedness as of December 31, 2005. On March 10, 2006, we prepaid substantially all of our previously existing debt with proceeds from a series of recapitalization transactions and replaced it with approximately $3 billion of new long-term debt. Accordingly, these amounts have been adjusted to reflect the effect of the recapitalization transactions. See Note 8, Long-term Debt , of the notes to our accompanying consolidated financial statements.
(c) Interest on our fixed rate debt is presented using the stated interest rate. Interest expense on our variable rate debt is estimated using the rate in effect as of December 31, 2005. Interest related to capital lease obligations is excluded from this line. Amounts exclude amortization of debt discount, amortization of loans fees, or fees for lines of credit that would be included in interest expense in our consolidated statements of operations.
(d) Amounts include interest portion of future minimum capital lease payments. (e) We lease many of our facilities as well as other property and equipment under operating leases in the normal course of business. Some of
our facility leases require percentage rentals on patient revenues above specified minimums and contain escalation clauses. The minimum lease payments do not include contingent rental expense. Some lease agreements provide us with the option to renew the lease or purchase the leased property. Our future operating lease obligations would change if we exercised these renewal options and if we entered into additional operating lease agreements. For more information, see Note 5, Property and Equipment, of the notes to our accompanying consolidated financial statements.
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Indemnifications
In the ordinary course of business, HealthSouth enters into contractual arrangements under which HealthSouth may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of HealthSouth or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have not been material.
Critical Accounting Policies
Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgment that affects the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors we believe to be relevant at the time we prepared our consolidated financial statements. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
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(f) Lease obligations for facility closures are included in operating leases. (g) Future operating lease obligations and purchase obligations are not recognized in our consolidated balance sheet. (h) Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on HealthSouth and that
specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty. Approximately $36.1 million of the amounts included in this line represent commitments on the Digital Hospital. Commitments related to the Digital Hospital are currently under negotiation with various parties and may be less than the amounts reflected in the chart above.
(i) Because their future cash outflows are uncertain, the following non-current liabilities are excluded from the table above: medical malpractice and workers’ compensation risks, deferred income taxes, and our estimated liability for unsettled litigation. For more information, see Note 1, Summary of Significant Accounting Policies, “Self-Insured Risk , ” Note 18, Income Taxes, and Note 24, Contingencies and Other Commitments, of the notes to our accompanying consolidated financial statements.
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Our significant accounting policies are discussed in Note 1, Summary of Significant Accounting Policies , to our accompanying consolidated financial statements. We believe the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results, as they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting policies and related disclosures with the Audit Committee of our board of directors.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Revenue recognition
We recognize net patient service revenues in the reporting period in which we perform the service based on our current billing rates (i.e., gross charges), less actual adjustments and estimated discounts for contractual allowances (principally for patients covered by Medicare, Medicaid and managed care and other health plans).
We record gross service charges in our accounting records on an accrual basis using our established rates for the type of service provided to the patient. We recognize an estimated contractual allowance to reduce gross patient charges receivable to an amount we estimate we will actually realize for the service rendered based upon previously agreed to rates with a payor. Payors include federal and state agencies, including Medicare and Medicaid, managed care health plans, commercial insurance companies, employers, and patients.
Management does not expect our contractual allowance, as a percentage of revenues, to decline from 2005 levels during 2006, based upon the revenues and trends at December 31, 2005.
Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. Management continually reviews the contractual estimation process to consider and incorporate updates to laws and regulations and the frequent changes in managed care contractual terms that result from contract renegotiations and renewals.
If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material.
Due to complexities involved in determining amounts ultimately due under reimbursement arrangements with third-party payors, which are often subject to interpretation, we may receive reimbursement for health care services authorized and provided that is different from our estimates, and such difference could be material.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Allowance for doubtful accounts
We provide for an allowance against accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value.
The collection of outstanding receivables from Medicare, managed care payors, other third-party payors and patients is our primary source of cash and is critical to our operating performance. The primary collection risks relate to patient accounts for which the primary insurance carrier has paid the amounts covered by the applicable agreement, but patient responsibility amounts (deductibles and copayments) remain outstanding. The provision for doubtful accounts and the allowance for doubtful accounts relate primarily to amounts due directly from patients.
We estimate this allowance based on the aging of our accounts receivable, our historical collection experience by facility and type of payor, and other relevant factors. Our practice is to write-down self-pay accounts receivable, including accounts related to the co-payments and deductibles due from patients with insurance, to their estimated net realizable value.
Management does not expect the provision for doubtful accounts, as a percentage of revenues, to decline from 2005 levels during 2006, based upon the revenues and trends at December 31, 2005.
If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material.
Adverse changes in general economic conditions, business office operations, payor mix, or trends in federal or state governmental and private employer health care coverage could affect our collection of accounts receivable, cash flows and results of operations.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Consolidation
As of December 31, 2005, we had investments in approximately 317 partially owned subsidiaries, of which approximately 306 are general or limited partnerships, limited liability companies, or joint ventures in which HealthSouth or one of our subsidiaries is a general or limited partner, managing member, or venturer, as applicable.
We generally have a leadership role in these facilities through a significant voting and economic interest and a contract to manage each facility’s operations, but the degree of control we have varies from facility to facility.
We evaluate partially owned subsidiaries and joint-ventures held in partnership form in accordance with the provisions of American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 78-9: Accounting for Investments in Real Estate Ventures , and Emerging Issues Task Force (“EITF”) Issue No. 98-6, “Investor’s Accounting for an Investment in a Limited Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain Approval or Veto Rights,” to determine whether the rights held by other investors constitute “important rights” as defined therein.
For general partners of all new limited partnerships formed and for existing limited partnerships for which the partnership agreements were modified on or subsequent to June 29, 2005, we evaluate partially owned subsidiaries and joint ventures held in partnership form using the guidance in EITF Issue No. 04-5, “Investor’s Accounting for an Investment in a Limited Partnership
Our determination of the appropriate consolidation method to follow with respect to our investments in subsidiaries and affiliates is based on the amount of control we have, combined with our ownership level, in the underlying entity. Judgment is often required when determining the level of control or amount of influence we have over these entities.
Our consolidated financial statements include our accounts, the accounts of our wholly owned subsidiaries, and other subsidiaries over which we have control. Our investments in subsidiaries in which we have the ability to exercise significant influence over operating and financial policies, but do not control (including subsidiaries where we have less than 20% ownership) are accounted for on the equity method. All of our other investments are accounted for on the cost method.
Accounting for an investment as consolidated versus equity method generally has no impact on our net loss or shareholders’ deficit in any accounting period, but does impact individual statement of operations and balance sheet balances, as consolidation effectively grosses up our statement of operations and balance sheet. However, if control or influence aspects of an equity method investment were different, it could result in us being required to account for an investment by consolidation or using the cost method. Under the cost method, the investor does not record its share of income or losses of the investee until it receives dividends or distributions from the investee. Conversely, under either consolidation or equity method accounting, the investor effectively records its share of the underlying entity’s net income or loss based on its ownership percentage. At December 31, 2005, $1.9 million of our total investment in unconsolidated affiliates of $46.4 million relates to investments that are accounted for using the cost method and the remaining $44.5 million represents investments in unconsolidated affiliates accounted for using the equity method.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions When the Investor Is the Sole General Partner and the Limited Partners Have Certain Rights,” which includes a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate it. The framework includes the presumption that general-partner control would be overcome only when the limited partners have certain rights. Such rights include kick-out rights and participating rights.
For partially owned subsidiaries or joint ventures held in corporate form, we consider the guidance of FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries , and EITF Issue No. 96-16: “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights,” and, in particular, whether rights held by other investors would be viewed as “participating rights” as defined therein. To the extent that any minority investor has important rights in a partnership or participating rights in a corporation that inhibit our ability to control, including substantive veto rights, we generally will not consolidate the entity.
We also consider the guidance in FASB Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities . As of December 31, 2005, we do not have any arrangements or relationships where FASB Interpretation No. 46(R) is applicable.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Self-Insured Risk
We are self-insured for certain losses related to professional and comprehensive general liability risks, workers’ compensation, and certain construction risks. Although we obtain third-party insurance coverage to limit our exposure to these claims, a substantial portion of our professional liability and workers’ compensation risks are insured through a wholly owned insurance subsidiary. Obligations covered by reinsurance contracts remain on the balance sheet as the subsidiary remains liable to the extent that reinsurers do not meet their obligations. Our reserves and provisions for professional liability and workers’ compensation risks are based upon actuarially determined estimates calculated by third-party actuaries. The actuaries consider a number of factors, including historical claims experience, exposure data, loss development, and geography.
Periodically, management reviews its assumptions and the valuations provided by third-party actuaries to determine the adequacy of our self-insured liabilities.
Changes to the estimated reserve amounts are included in current operating results. All reserves are undiscounted.
Our self-insured liabilities contain uncertainties because management must make assumptions and apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date. The reserves for professional liability risks cover approximately 2,000 individual claims as of December 31, 2005 and estimates for potential unreported claims.
The time period required to resolve these claims can vary depending upon the jurisdiction and whether the claim is settled or litigated. The estimation of the timing of payments beyond a year can vary significantly.
Due to the considerable variability that is inherent in such estimates, there can be no assurance that the ultimate liability will not exceed management’s estimates. If actual results are not consistent with our assumptions and judgments, we may be exposed to gains or losses that could be material.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Long-lived assets
Long-lived assets, such as property and equipment, are reviewed for impairment when events or changes in circumstances indicate that the carrying value of the assets contained in our financial statements may not be recoverable.
When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset to the asset’s estimated future cash flows (undiscounted and without interest charges). If the estimated future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on estimated future cash flows (discounted and with interest charges). We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset will be its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated over the remaining useful life of that asset. Restoration of a previously recognized impairment loss is prohibited.
Our impairment loss calculations require management to apply judgment in estimating future cash flows and asset fair values, including forecasting useful lives of the assets and selecting the discount rate that represents the risk inherent in future cash flows.
Using the impairment review methodology described herein, we recorded long-lived asset impairment charges of $45.2 million during the year ended December 31, 2005. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to additional impairment losses that could be material to our results of operations.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies. We follow the guidance in FASB Statement No. 142, Goodwill and Intangible Assets , and test goodwill for impairment using a fair value approach, at the reporting unit level. We are required to test for impairment at least annually, absent some triggering event that would accelerate an impairment assessment. On an ongoing basis, absent any impairment indicators, we perform our goodwill impairment testing as of October 1st of each year. Our intangible assets consist of acquired certificates of need, licenses, noncompete agreements, and management agreements. We amortize these assets ranging from 5 to 30 years. As of December 31, 2005, we do not have any intangible assets with indefinite useful lives.
We continue to review the carrying values of amortizable intangible assets whenever facts and circumstances change in a manner that indicates their carrying values may not be recoverable.
We determine the fair value of our reporting units using valuation techniques that include discounted cash flow and market multiple analyses. These types of analyses require us to make assumptions and estimates regarding industry economic factors and the profitability of future business strategies.
We performed our annual testing for goodwill impairment as of October 1, 2005, using the methodology described herein, and determined that no goodwill impairment existed in any of our segments.
If actual results are not consistent with our assumptions and estimates, we may be exposed to additional goodwill impairment charges. The carrying value of goodwill as of December 31, 2005 was approximately $911.4 million.
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions Income Taxes
We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In addition, deferred tax assets are also recorded with respect to net operating losses and other tax attribute carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when realization of the benefit of deferred tax assets is not deemed to be more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Contingent tax liabilities must be accounted for separately from deferred tax assets and liabilities. FASB Statement No. 5, Accounting for Contingencies , is the governing standard for contingent liabilities. It must be probable that a contingent tax benefit will be sustained before the contingent benefit is recognized for financial reporting purposes.
The ultimate recovery of certain of our deferred tax assets is dependent on the amount and timing of taxable income that we will ultimately generate in the future and other factors. A high degree of judgment is required to determine the extent that valuation allowances should be provided against deferred tax assets. We have provided valuation allowances at December 31, 2005 aggregating $879 million against such assets based on our current assessment of future operating results and other factors.
We believe that we have previously overpaid federal and state income taxes during the reconstruction period. The estimate of this overpayment amount is included in Income tax refund receivable . In determining taxes receivable, we evaluated the potential exposures associated with various filing positions and our documentation requirements. We computed reserves for probable exposures. Such positions and substantiation matters may come under review during the audit and/or amended return process. We are currently under audit of our federal consolidated income tax returns for the years 1996 through 1998 and fully expect to have all open years included within this audit in the near future.
We will prepare amended federal and state income tax returns for the years 1996 through 2004, making all appropriate restatement and other adjustments, in order to obtain refunds for overpaid income taxes. Upon filing amended federal and state income tax returns, the tax authorities will conduct a detailed review of the adjustments. The actual amount of the refunds will not be finally determined until all of the applicable taxing authorities have completed their review.
Although management believes that the estimates and judgments discussed herein are reasonable, actual results could differ, and we may be exposed to gains or losses that could be material.
As of December 31, 2005, the Income tax refund receivable was approximately $241 million. This receivable is net of approximately $93 million in tentative refunds previously received by us through 2005 and includes our estimate of applicable interest and penalties. To the extent that either the federal or state taxing authorities disagree with our presentation of amended taxable income during the reconstruction period, this receivable may be overstated resulting in additional current tax expense and/or the requirement that some or all of the previous refunds be repaid.
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Recent Accounting Pronouncements
In December 2004, the FASB issued FASB Statement No. 123(Revised 2004), Share-Based Payment , which revises FASB Statement No. 123 and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees , and its related implementation guidance. The revised Statement focuses primarily on accounting for transactions in which a company obtains employee services in share-based payment transactions. FASB Statement No. 123(R) eliminates the alternative of applying the intrinsic value measurement provisions of APB Opinion No. 25 to stock compensation awards issued to employees. Rather, the new standard requires a company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. A company will recognize the cost over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
In March 2005, the Staff of the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment. SAB No. 107 expresses the view of the SEC staff regarding the interaction between FASB Statement No. 123(R) and certain SEC rules and regulations and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. The SEC staff believes the guidance in SAB No. 107 will assist public companies in their initial implementation of FASB Statement No. 123(R) and enhance the information received by investors and other users of financial statements, thereby assisting them in making investment and other decisions. SAB No. 107 also includes interpretive guidance related to share-based payment transactions with nonemployees, the transition from nonpublic to public entity status, valuation methods (including the determination of assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of FASB Statement No. 123(R) in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of FASB Statement No. 123(R), the modification of employee share options prior to adoption of FASB Statement No. 123(R), and disclosures in Management’s Discussion and Analysis subsequent to adoption of FASB Statement No. 123(R). FASB Statement No. 123(R) is effective for annual periods beginning after June 15, 2005. Its expected impact on our results of operations is discussed below.
FASB Statement No. 123(R) requires the use of the Modified Prospective Application Method at the required effective date. Under this method, FASB Statement No. 123(R) is applied to new awards and to awards
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Description Judgments and Uncertainties Effect if Actual Results Differ
from Assumptions
Assessment of Loss Contingencies
We have legal and other contingencies that could result in significant losses upon the ultimate resolution of such contingencies.
We have provided for losses in situations where we have concluded that it is probable that a loss has been or will be incurred and the amount of the loss is reasonably estimable. A significant amount of judgment is involved in determining whether a loss is probable and reasonably estimable due to the uncertainty involved in determining the likelihood of future events and estimating the financial statement impact of such events.
If further developments or resolution of a contingent matter are not consistent with our assumptions and judgments, we may need to recognize a significant charge in a future period related to an existing contingent matter.
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modified, repurchased, or cancelled after the effective date. Additionally, we will recognize compensation cost for the portion of awards for which the requisite service date has not been rendered (such as unvested options) that are outstanding as of the date of adoption as the remaining requisite services are rendered. We will base the compensation cost relating to unvested awards at the date of adoption on the grant-date fair value of those awards as calculated for pro forma disclosures under the original FASB Statement No. 123. In addition, a company may use the Modified Retrospective Application Method prior to the required effective date. A company may apply this method to all prior years for which the original FASB Statement No. 123 was effective or only to prior interim periods in the year of initial adoption. If a company uses the Modified Retrospective Application Method, it will adjust the financial statements for prior periods to give effect to the fair-value-based method of accounting for awards on a consistent basis with the pro forma disclosures required for those periods under the original FASB Statement No. 123.
We will adopt FASB Statement No. 123(R) on January 1, 2006 on a modified prospective basis, which will require recognition of compensation expense for all stock option or other equity-based awards that vest or become exercisable after the effective date. At December 31, 2005, unamortized compensation expense related to outstanding unvested options, as determined in accordance with FASB Statement No. 123(R), that we expect to record during 2006, 2007, and 2008 was approximately $9.1 million, $5.7 million, and $1.2 million, respectively, before provisions for income taxes and forfeitures. We will incur additional expense during fiscal 2006 related to new awards granted during 2006 that cannot yet be quantified. We are in the process of determining how the guidance regarding valuing share-based compensation as prescribed in FASB Statement No. 123(R) will be applied to valuing share-based awards granted after the effective date and the impact that the recognition of compensation expense related to such awards will have on our financial statements.
We do not believe any other recently issued, but not yet effective, accounting standards will have a material effect on HealthSouth’s consolidated financial position, results of operations, or cash flows.
For additional information regarding recent accounting pronouncements, please see Note 1, Summary of Significant Accounting Policies , to our accompanying consolidated financial statements.
Business Outlook
We were forced to devote a significant portion of our time and attention in 2005 to matters primarily outside the ordinary course of business, and those efforts have continued in 2006, although to a much lesser extent. At the same time, we expect to continue to experience volume volatility, payor pressure, and increased competition in our markets. Accordingly, we anticipate that our operating results will show a decline between 2005 and 2006 based on various factors.
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• Inpatient . In 2006, our inpatient division will continue to experience declining volumes as we move all of our facilities to the 60% minimum qualifying patient mix threshold under the 75% Rule. The division will also be negatively impacted by unit price reductions resulting from IRF-PPS changes that became effective October 1, 2005. To combat these issues, we will continue to aggressively attempt to mitigate the impact of the 75% Rule by managing our expenses, focusing our marketing efforts on compliant cases, and developing new post-acute services and other services that are complementary to our IRFs. In addition, we will strive to standardize our labor and supply practices. Within the post-acute care environment, we believe the continued implementation of the 75% Rule will pose a challenge for our competitors. As a result, we believe some of our competitors may choose to exit this industry. We will monitor this situation and look for consolidation opportunities that we believe fit our long-range strategic plan.
• Surgery Centers . In 2006, our focus within the surgery centers division will be on increasing volume growth and continuing the resyndication activity we began in 2005. We expect to see margin expansion through labor and supply cost management initiatives, including the standardization of non-physician preference items. We will also begin to explore growth opportunities through acquisition of existing centers and development of new centers, although we do not expect such growth opportunities to be a significant part of our 2006 results of operations for this division.
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Although we will be unable to offset inflationary costs with price increases, we do expect to be able to partially offset such costs through operational improvements. As we have previously disclosed, however, we expect our 2006 Consolidated Adjusted EBITDA to decline substantially from 2005 for two primary reasons. First, our 2005 Consolidated Adjusted EBITDA includes a one-time payment of $37.9 million from Meadowbrook (included as Amounts due from Meadowbrook in our 2005 income statement data contained in Item 6, Selected Financial Data ). Second, our 2005 Consolidated Adjusted EBITDA includes the impact of reduced unit pricing at our IRFs for one quarter only, since the recent IRF-PPS changes did not take effect until October 1, 2005, and our 2006 results will reflect the negative impact of IRF-PPS on our unit pricing for all quarters. As discussed in Item 1, Business , “Sources of Revenues,” we estimate that this pricing change will reduce our inpatient division’s net operating revenues by approximately $30 million in 2006 as compared to 2005.
In addition to lower unit pricing in our inpatient division, the 75% Rule continues to create operational challenges for us. Based on recent industry data, we believe the impact of the 75% Rule on the inpatient rehabilitation industry will be significantly greater than CMS estimated when the rule was promulgated. However, Congress has approved a one-year extension of the phase-in period for the 75% Rule and delayed implementation of the 65% compliance threshold until July 1, 2007. In addition, we believe that we are doing better than the industry as a whole in mitigating the effects of the 75% Rule. We anticipate year-over-year growth in our inpatient division from 2006 to 2007 largely because of the suspension of the 75% Rule at the 60% threshold, and again once the 75% Rule is fully implemented and the division is re-based to maximize admission of higher acuity compliant cases. In addition, we believe continued phase-in of the 75% Rule will cause certain competitors to exit the market which will create consolidation opportunities for us.
While we expect our 2006 operating results will be consistent with the fact that HealthSouth is still in a turnaround period, we are optimistic about the long-term positioning of HealthSouth. We continue to offer high quality services in growing segments of the health care industry which should provide long-term growth opportunities. In addition, we are stabilizing operations in our three ambulatory divisions (surgery centers, outpatient, and diagnostic) by focusing on volume growth, expense control through benchmarking and supply chain management, and various revenue enhancement activities. We are also looking to grow in targeted areas as development and consolidation opportunities arise. We believe we will see the results of these initiatives in late 2006 and into subsequent years.
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• Outpatient . We expect our facility rationalization and marketing initiatives within our outpatient division will begin to improve results in 2006. However, as discussed in Item 1, Business , “Sources of Revenues,” we anticipate the annual per-beneficiary limitations on outpatient therapy services will have a negative impact on net operating revenues in this division. The extent of that impact will depend on both the administration of the medical necessity exception process by CMS and the response of possible deferral of therapy treatment by patients subject to the therapy caps.
• Diagnostic . We expect new reimbursement rates for imaging services to negatively impact the financial performance of our diagnostic division in 2006. To mitigate the impact of these lower rates on our margins, we will focus our attention on the standardization of labor and supply costs across our facilities. We will also attempt to increase scan volumes by expanding our relationships with new referral sources and installing new equipment at select facilities. In addition, we will seek to improve operating efficiencies through the implementation of new claims software in 2006; however, given our anticipated implementation schedule, we do not expect to see the full benefit of this software conversion until 2007.
• Corporate and Other . In 2006, we will strive to control costs associated with our corporate and other division, but this may prove difficult due to our continued investment in our infrastructure (both people and technology). We will continue to focus on the remediation of internal controls, including the implementation of our information technology strategic plan. We will continue to replace the work performed by external consultants during the reconstruction period with HealthSouth employees, and we will continue to add resources to provide the necessary level of support to our facilities and meet our operational needs. In addition, our recapitalization transactions completed in March 2006 will result in significant amounts being expensed in 2006 for consent fees and tender costs incurred in connection therewith and the write-off of financing fees attributable to prior financing transactions. See this Item, “Liquidity and Capital Resources,” for additional information.
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Whatever market conditions we face, we will continue to seek opportunities to improve operations, stabilize our finances, and develop new facilities and post-acute services, with the ultimate goal of providing sustainable growth and return for our stockholders.
Our primary exposure to market risk is to changes in interest rates on our long-term debt. We use sensitivity analysis models to evaluate the impact of interest rate changes on these items.
Changes in interest rates have different impacts on the fixed and variable rate portions of our debt portfolio. A change in interest rates impacts the net market value of our fixed rate debt but has no impact on interest expense or cash flows. Interest rate changes on variable rate debt impacts the interest expense and cash flows, but does not impact the net market value of the underlying debt instruments. Our fixed and variable rate debt as of December 31, 2005 is shown in the following table:
Based on the variable rate of our debt as of December 31, 2005, a 1% increase in interest rates would result in an additional $5.1 million in interest expense per year, while a 1% decrease in interest rates would reduce interest expense per year by $5.1 million. A 1% increase in interest rates would result in an approximate $79.4 million decrease in the estimated fair value of our fixed rate debt, and a 1% decrease in interest rates would result in an approximate $82.0 million increase in its estimated fair value. During 2005, we did not utilize any type of derivative instruments to manage interest rate risk.
Foreign operations, and the related market risks associated with foreign currencies, are currently, and have been, insignificant to our financial position, results of operations, and cash flows.
On March 10, 2006, we prepaid substantially all of our previously existing debt with proceeds from a series of recapitalization transactions and replaced it with approximately $3 billion of new long-term debt. Also, in March 2006, we entered into an interest rate swap related to our new Credit Agreement. See Note 8, Long-term Debt, to our accompanying consolidated financial statements.
Our consolidated financial statements and related notes are filed together with this report. See the index to financial statements on page F-1 for a list of financial statements filed with this report. We have not presented the selected quarterly financial data required by Item 302(a) of Regulation S-K as supplementary information to the basic financial statements.
None.
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
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Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, an evaluation was carried out by our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our disclosure controls and procedures are designed to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosures. Based on our evaluation and the identification of the material weaknesses in internal control over financial reporting described below, our chief executive officer and chief financial officer concluded that, as of December 31, 2005, our disclosure controls and procedures were ineffective.
The company has undertaken a number of procedures and instituted controls to help ensure the proper collection, evaluation, and disclosure of the information included in the company’s financial statements. We engaged Callaway Partners, LLC; KPMG LLP; and Tatum CFO Partners LLP to assist us in these efforts. We also engaged Deloitte Consulting LLP to assist us with various aspects of project management. We have implemented additional analytical tools and verification procedures to address these weaknesses. As a result, we believe that the consolidated financial statements for the periods covered by and included in this Annual Report on Form 10-K are fairly stated in all material respects.
Management’s Report on Internal Control Over Financial Reporting
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”). Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on its financial statements. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”) .
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with management’s assessment of the company’s internal control over
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Item 9A. Controls and Procedures
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financial reporting described above, management has identified the following material weaknesses in the company’s internal control over financial reporting as of December 31, 2005:
1. We did not maintain effective controls, including monitoring, over our financial close and reporting process. Specifically, the following material weaknesses were identified in the financial close and reporting process:
These material weaknesses contributed to the matters described in 2 to 8 below and resulted in audit adjustments to the 2005 consolidated financial statements. Additionally, these material weaknesses could result in misstatements of any of our financial statement accounts that would result in a material misstatement to the annual or interim consolidated financial statements as noted in 2 to 8 below that would not be prevented or detected.
2. We did not maintain effective controls over access to financial application programs and data throughout our company. Specifically, we did not comply with our security access procedures related to the identification and monitoring of conflicting user roles (i.e., segregation of duties) and monitoring of access of employees and third parties to various application systems and data. This control deficiency could result in a misstatement in any of our financial statement accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
3. We did not maintain effective controls to ensure that information technology program changes were authorized and that such program changes were adequately tested for accuracy and performance. Specifically, information technology program change management controls were not operating effectively relative to the patient accounting systems used by our inpatient and diagnostic segments, the computer system used in accounting for income taxes and the computer system used in accounting for minority interest in equity of and interests in earnings of consolidated affiliates. This control deficiency contributed to the material weaknesses described in 5, 7, and 8 below. This control deficiency could result in a misstatement of our accounts receivable, net operating revenue, income taxes receivable and payable, deferred income tax assets and liabilities, income tax provision, minority interest in equity of and interests in earnings of consolidated affiliates that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
4. We did not maintain effective controls over the existence, completeness, and disclosure of our cash and cash equivalents and restricted cash accounts. Specifically, we did not maintain effective controls over the resolution of reconciling items on our bank account reconciliations, and we did not adequately maintain segregation between cash custody and accounting duties in our surgery centers division and at our corporate headquarters. Also, we did not maintain effective controls over the identification of restricted cash balances. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
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• We did not maintain effective controls over the recording of journal entries. Specifically, controls were not designed and in
place to ensure that journal entries were prepared with sufficient support or documentation or that journal entries were reviewed and approved to ensure the accuracy and completeness of the entries recorded.
• We did not maintain effective controls over the accuracy and completeness of spreadsheets used in the period-end closing
process and other spreadsheets supporting the company’s financial reporting.
• We did not maintain effective controls over the complete and accurate recording and monitoring of intercompany accounts. Effective controls were not designed and in place to ensure that intercompany balances were accurately classified and reported in the company’s underlying accounting records and to ensure proper elimination as part of the consolidation process in conformity with GAAP.
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5. We did not maintain effective controls over the accuracy, completeness, valuation and disclosure of our accounts receivable and the related net operating revenue accounts. Specifically, effective controls were not designed and in place to ensure that the most up-to-date information is incorporated into our calculation of contractual allowances and that contractual adjustments and cash receipts posted to patient accounts were valid and recorded completely and accurately. In addition, sustainable controls over the calculation and evaluation of contractual allowances and bad debt reserves applicable to patient accounts receivable for the diagnostic segment have not been developed. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
6. We did not maintain effective controls over the existence, valuation, and disclosure of our property and equipment, the related depreciation expense, and leased property and equipment. Specifically, policies and procedures for periodically performing property and equipment inventory counts were not in place and we did not have effective controls to ensure that all assets taken out of service were reported and appropriately accounted for. Additionally, controls were not in place to verify the completeness and accuracy of leased property and equipment and that future obligations related to such leases were properly disclosed. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
7. We did not maintain effective controls over the accounting for income taxes, including the accurate determination and reporting of income taxes receivable and payable, deferred income tax assets and liabilities, and the related income tax provision. Specifically, the company did not maintain effective controls to review and monitor the accuracy of the components of the income tax provision calculations and related deferred income taxes and income taxes receivable and payable, and to monitor the differences between the income tax basis and the financial reporting basis of assets and liabilities to effectively reconcile the deferred income tax balances. Also, the company did not have adequate personnel to enable the company to properly consider and apply GAAP for income taxes, ensure that the rationale for positions taken on certain tax matters was adequately documented and appropriately communicated, and ensure that the income tax accounts were appropriately adjusted based on the preparation and filing of income tax returns. This control deficiency could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
8. We did not maintain effective controls over the completeness, accuracy, and disclosure of our investment in and advances to and equity in net income of non-consolidated affiliates and the minority interest in equity of and interests in earnings of consolidated affiliates. Specifically, effective controls were not designed and in place to ensure that agreements with affiliates were properly accounted for and disclosed in accordance with GAAP. Controls over the accounting for partnership activity, including the accuracy and completeness of data input into the computer system in use for accounting for minority interest in equity of and interests in earnings of consolidated affiliates at December 31, 2005 were not adequate. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in misstatements in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
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Because of these material weaknesses, management has concluded that the company did not maintain effective internal control over financial reporting as of December 31, 2005, based on the criteria in the COSO framework.
Management’s assessment of the effectiveness of the company’s internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Plan for Remediation of Material Weaknesses
As discussed below, we significantly improved our internal control over financial reporting during 2005. However, as of December 31, 2005, we identified numerous material weaknesses and our remediation efforts with respect to those weaknesses are continuing. These remediation efforts are expected to continue throughout 2006 and beyond. During 2005, we have concentrated our remediation efforts on those areas that are transaction intensive, such as the recording of net operating revenues, accounts receivable and the related contractual and bad debt reserves, accounting for cash and expenditures, and the accrual of liabilities. These areas required the implementation of primarily manual controls at most of the company’s operating facilities and we devoted significant resources to documenting and training facility personnel in the use of those controls. We have also begun remediation efforts in many of the other areas that we identified as having material weaknesses in internal control over financial reporting as of December 31, 2005. Our Audit Committee has provided and will continue to provide oversight and review of the company’s completed, current, and planned initiatives to remediate material weaknesses in the company’s internal control over financial reporting. While these efforts are underway, we are relying on extensive manual procedures and the utilization of outside accounting professionals (under our direction) to assist us with meeting the objectives otherwise fulfilled by effective internal controls over financial reporting and to help ensure the proper collection, evaluation, and disclosure of the information included in the company’s financial statements. However, there remains a risk that the transitional procedures on which we currently rely will fail to prevent or detect a material misstatement of the annual or interim financial statements.
Changes in Internal Control Over Financial Reporting
We have engaged in, and are continuing to engage in, substantial efforts to improve our internal control over financial reporting and disclosure controls and procedures related to substantially all areas of our financial statements and disclosures. The following changes in our internal control over financial reporting were instituted during the year ended December 31, 2005:
1. We significantly improved our internal control environment based on criteria established in the COSO framework, as follows:
126
• We instituted an anti-fraud program, including the completion of a comprehensive fraud risk assessment, fraud awareness
training for key managers, and the establishment of a formalized investigation and reporting process for reported or suspected fraud incidents.
• We have made substantial changes to our corporate governance process, including the specification of issues that must be reviewed by our board of directors and its committees and comprehensive board of directors and committee charters. In 2004, we established a strong Code of Business Conduct as well as a set of implementing measures to ensure that the standards are accepted and practiced by our employees. Our directors maintain regular contact with our chief executive officer and our chief financial officer, as well as other executive officers. We believe that we have established a governance culture that places a premium on informed director oversight of our executive management and company behavior.
• We continued the process of identifying required competencies and staffed the key positions in the accounting and tax
departments in accordance with those required competencies.
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2. We designed and implemented improved company-wide policies and procedures over the financial close and reporting process, including communication, training and monitoring of our account coding process. We implemented a computer system to maintain the documentation supporting account balances and to require the approval for all of our balance sheet account reconciliations. In addition, we designed and implemented controls over our consolidations process as they relate to the accuracy and completeness of legal entity financial results and the reconciliation of such results to the consolidated financial statements.
3. We established controls relating to compliance with established approval authority policies, including authorization for purchases and the execution of contracts and to require adequate review of invoices prior to payment by facility and corporate/divisional personnel.
4. We designed security access and information technology program change policies and procedures.
5. We designed and implemented controls to support the existence of our accounts receivable accounts and the related net operating revenue accounts. We established a centralized repository for patient account information relating to our three largest primary operating divisions to support the reconciliation of accounts receivable subsidiary ledgers to the general ledger and to support the appropriate estimation of bad debt reserves. We also implemented controls with regard to the validity and accurate recording of bad debt adjustments and other non-contractual adjustments to patient accounts; and the validity and accurate recording of properly authorized patient charges in the applicable patient accounting system. In addition, we designed and implemented controls used to estimate contractual allowances based on historical payment patterns for each of our facilities.
6. We designed and implemented controls to require that prepaid expenses and other current asset accounts were reconciled to the general ledger and that operating expenses were appropriately recognized.
7. We designed and implemented controls to require that the cost and accumulated depreciation balances for property and equipment sub-ledgers were adequately reconciled to the general ledger, that leases were properly accounted for as either capital or operating leases, and that appropriate impairment analyses with respect to long-lived assets were performed.
8. We designed and implemented controls to require that an adequate periodic impairment analysis was conducted, reviewed, and approved in order to identify instances of impairment as required under GAAP for our goodwill and intangible assets accounts.
9. We designed and implemented controls to require that other long-term asset accounts were completely recorded and reconciled to the general ledger.
10. We designed and implemented controls relating to the completeness and accuracy of the accrual of liabilities at period end and to require that related expenses were accurately, completely, and properly reported. We installed a computer system in our facilities that requires three-way matching of order to receiving documentation and invoices prior to disbursement.
127
• We improved the lines of communication between operations and accounting/finance staff and personnel and hired chief financial officers for each of our four primary operating divisions who have reporting responsibilities both divisionally and to the finance organization. Division presidents and division chief financial officers certify as to the accuracy of the divisional financial statements and related disclosures.
• We updated and enhanced our policies and procedures with respect to the review, supervision, and monitoring of our accounting operations at the facility level. We trained over 8,000 employees throughout our company regarding their roles and responsibilities in our system of internal controls. The employees were required to satisfactorily complete testing regarding their job responsibilities, and the testing has continued for new employees.
• We established the relevant policies and procedures and began our monitoring of outsourced vendors.
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11. We designed and implemented controls relating to the timely communication to the accounting department regarding facility closings and facility/asset sales, and to require proper review and approval of the accounting for such transactions, including the valuation of assets, completeness of liabilities, presentation, and disclosure of discontinued operations.
12. We designed and implemented controls to require that the estimation of liabilities and expenses related to our self-insured worker’s compensation and professional liability risks were reviewed and approved and to require proper oversight over the processing of claims by third parties involved in the claims administration process.
13. We designed and implemented controls to require that sub-ledgers supporting debt balances and the related unamortized premium and discount amounts were maintained, that such sub-ledgers were reconciled to the general ledger, and that there was appropriate management review of recorded interest expense.
14. We designed and implemented controls relating to effective oversight of the work performed by our outside tax advisors.
None.
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Item 9B. Other Information
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PART III
We expect to file a definitive proxy statement relating to our 2006 Annual Meeting of Stockholders (the “2006 Proxy Statement”) with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of our most recent fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of the 2006 Proxy Statement that specifically address disclosure requirements of Items 10-14 below are incorporated by reference.
The information required by Item 10 is hereby incorporated by reference from our 2006 Proxy Statement under the captions “Election of Directors,” “Certain Additional Information about our Management,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Code of Ethics.”
The information required by Item 11 is hereby incorporated by reference from our 2006 Proxy Statement under the caption “Compensation of Directors and Executive Officers.”
The information required by Item 12 is hereby incorporated by reference from our 2006 Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management.”
The information required by Item 13 is hereby incorporated by reference from our 2006 Proxy Statement under the caption “Certain Relationships and Related Transactions.”
The information required by Item 14 is hereby incorporated by reference from our 2006 Proxy Statement under the caption “Independent Registered Public Accounting Firm Fees.”
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Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
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PART IV
Financial Statements
See the accompanying index on page F-1 for a list of financial statements filed as part of this report.
Financial Statement Schedules
None.
Exhibits
The exhibits required by Regulation S-K are set forth in the following list and are filed by attachment to this annual report unless otherwise noted.
130
Item 15. Exhibits and Financial Statement Schedules
No. Description 3.1
Restated Certificate of Incorporation of HealthSouth Corporation, as filed in the Office of the Secretary of State of the State of Delaware on May 21, 1998.*
3.2 By-Laws of HealthSouth Corporation, as amended through May 17, 2001.*
3.3
Certificate of Designation of 6.50% Series A Convertible Perpetual Preferred Stock, as filed with the Secretary of State of the State of Delaware on March 7, 2006 (incorporated by reference to Exhibit 3.1 to HealthSouth’s Current Report on Form 8-K dated March 9, 2006).
4.1.1
Indenture, dated as of June 22, 1998, between HealthSouth Corporation and PNC Bank, National Association, as trustee, relating to HealthSouth’s 6.875% Senior Notes due 2005 and 7.0% Senior Notes due 2008.*
4.1.2
Officer’s Certificate pursuant to Sections 2.3 and 11.5 of the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and PNC Bank, National Association, as trustee, relating to HealthSouth’s 6.875% Senior Notes due 2005 and 7.0% Senior Notes due 2008.*
4.1.3
Instrument of Resignation, Appointment and Acceptance, dated as of April 9, 2003, among HealthSouth Corporation, J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), as resigning trustee, and Wilmington Trust Company, as successor trustee, relating to HealthSouth’s 6.875% Senior Notes due 2005 and 7.0% Senior Notes due 2008.*
4.1.4
First Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), relating to HealthSouth’s 6.875% Senior Notes due 2005 (incorporated by reference to Exhibit 99.1 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.1.5
First Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), relating to HealthSouth’s 7.0% Senior Notes due 2008 (incorporated by reference to Exhibit 99.3 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.1.6
Second Supplemental Indenture, dated as of February 15, 2006, to the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), relating to HealthSouth’s 7.0% Senior Notes due 2008 (incorporated by reference to Exhibit 4.3 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
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No. Description 4.2.1
Indenture, dated as of September 25, 2000, between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008.*
4.2.2
Instrument of Resignation, Appointment and Acceptance, dated as of May 8, 2003, among HealthSouth Corporation, The Bank of New York, as resigning trustee, and HSBC Bank USA, as successor trustee, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008.*
4.2.3
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of September 25, 2000 between HealthSouth Corporation and HSBC Bank USA, as successor trustee to The Bank of New York, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008.*
4.2.4
Second Supplemental Indenture, dated as of May 14, 2004, to the Indenture dated as of September 25, 2000 between HealthSouth Corporation and HSBC Bank USA, as successor trustee to The Bank of New York, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008 (incorporated by reference to Exhibit 99.2 to HealthSouth’s Current Report on Form 8-K dated May 14, 2004).
4.2.5
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture dated as of September 25, 2000 between HealthSouth Corporation and HSBC Bank USA, as successor trustee to The Bank of New York, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008 (incorporated by reference to Exhibit 4.4 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.3.1
Indenture, dated as of February 1, 2001, between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008.*
4.3.2
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of February 1, 2001 between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008.*
4.3.3
Second Supplemental Indenture, dated as of May 14, 2004, to the Indenture dated as of February 1, 2001 between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008 (incorporated by reference to Exhibit 99.1 to HealthSouth’s Current Report on Form 8-K dated May 14, 2004).
4.3.4
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture dated as of February 1, 2001 between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008 (incorporated by reference to Exhibit 4.1 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.4.1
Indenture, dated as of September 28, 2001, between HealthSouth Corporation and National City Bank, as trustee, relating to HealthSouth’s 7.375% Senior Notes due 2006 and 8.375% Senior Notes due 2011.*
4.4.2
Instrument of Resignation, Appointment and Acceptance, dated as of April 9, 2003, among HealthSouth Corporation, National City Bank, as resigning trustee, and Wilmington Trust Company, as successor trustee, relating to HealthSouth’s 7.375% Senior Notes due 2006 and 8.375% Senior Notes due 2011.*
4.4.3
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of September 28, 2001 between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 7.375% Senior Notes due 2006 and 8.375% Senior Notes due 2011.*
4.4.4
Second Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 7.375% Senior Notes due 2006 (incorporated by reference to Exhibit 99.2 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
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No. Description 4.4.5
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 7.375% Senior Notes due 2006 (incorporated by reference to Exhibit 4.2 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.4.6
Second Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 8.375% Senior Notes due 2011 (incorporated by reference to Exhibit 99.4 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.4.7
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 8.375% Senior Notes due 2011 (incorporated by reference to Exhibit 4.6 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.5.1
Indenture, dated as of May 22, 2002, between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012.*
4.5.2
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of May 22, 2002 between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012.*
4.5.3
First Supplemental Indenture, dated as of June 24, 2004, to the Indenture dated as of May 22, 2002 between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012 (incorporated by reference to Exhibit 99.5 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.5.4
Second Supplemental Indenture, dated as of February 15, 2006, to the Indenture dated as of May 22, 2002 between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012 (incorporated by reference to Exhibit 4.5 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.6
Indenture, dated as of June 16, 1986, between Greenery Rehabilitation Group, Inc. and Shawmut Bank of Boston, N.A., as trustee, relating to the 6.500% Convertible Subordinated Debentures due 2011.*
4.7
Indenture, dated as of April 1, 1990, between Greenery Rehabilitation Group, Inc. and The Connecticut National Bank, as trustee, relating to the 8.750% Convertible Senior Subordinated Notes due 2015.*
4.8
Registration Rights Agreement, dated February 28, 2006, between HealthSouth and the purchasers party to the Securities Purchase Agreement, dated February 28, 2006, re: HealthSouth’s sale of 400,000 shares of 6.50% Series A Convertible Perpetual Preferred Stock.
10.1.1
Senior Subordinated Credit Agreement, dated as of January 16, 2004, among HealthSouth Corporation, the lenders party thereto, and Credit Suisse First Boston, as Administrative Agent and Syndication Agent (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated January 16, 2004).
10.1.2
Warrant Agreement, dated as of January 16, 2004, between HealthSouth Corporation and Wells Fargo Bank Northwest, N.A., as Warrant Agent (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated January 16, 2004).
10.1.3
Registration Rights Agreement, dated as of January 16, 2004, among HealthSouth Corporation and the entities listed on the signature pages thereto as Holders of Warrants and Transfer Restricted Securities (incorporated by reference to Exhibit 10.3 to HealthSouth’s Current Report on Form 8-K dated January 16, 2004).
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No. Description 10.1.4
Consent and Waiver No. 1, dated February 15, 2006, to the Senior Subordinated Credit Agreement, dated as of January 16, 2004, among HealthSouth Corporation, the lenders party thereto and Credit Suisse (formerly known as Credit Suisse First Boston), as Administrative Agent and Syndication Agent.
10.2.1
Amended and Restated Credit Agreement, dated as of March 21, 2005, among HealthSouth Corporation, the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, Wachovia Bank, National Association, as Syndication Agent, and Deutsche Bank Trust Company Americas, as Documentation Agent (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated March 22, 2005).
10.2.2
Collateral and Guarantee Agreement dated as of March 21, 2005, between HealthSouth Corporation and JPMorgan Chase Bank, N.A., as Collateral Agent (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated March 22, 2005).
10.2.3
Waiver, dated as of February 16, 2006 and effective as of February 22, 2006, to the Amended and Restated Credit Agreement dated as of March 21, 2005, among HealthSouth Corporation, the lenders party thereto and JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent.
10.3.1
Term Loan Agreement, dated as of June 15, 2005, among HealthSouth Corporation, the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, Citicorp North America, Inc., as Syndication Agent, and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc. as Co-Lead Arrangers and Joint Bookrunners (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K dated June 15, 2005).
10.3.2
Amendment and Waiver No. 1, dated February 15, 2006, to the Term Loan Agreement, dated as of June 15, 2005, among HealthSouth Corporation, the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, Citicorp North America, Inc., as Syndication Agent, and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc. as Co-Lead Arrangers and Joint Bookrunners.
10.4.1
Lease Agreement, dated as of December 27, 2001, between State Street Bank and Trust Company of Connecticut, National Association, as Owner Trustee for Digital Hospital Trust 2001-1, and HealthSouth Medical Center, Inc.*
10.4.2
Participation Agreement, dated as of December 27, 2001, among HealthSouth Medical Center, Inc., HealthSouth Corporation, State Street Bank and Trust Company of Connecticut, National Association, as Owner Trustee for Digital Hospital Trust 2001-1, the various banks and other lending institutions which are parties thereto from time to time as Holders and Lenders, and First Union National Bank.*
10.5
HealthSouth Corporation Change in Control Benefits Plan (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K filed November 14, 2005).+
10.14 HealthSouth Corporation Employee Stock Benefit Plan, as amended.* +
10.15 Employment Agreement, dated as of May 3, 2004, between HealthSouth Corporation and Jay F. Grinney.* +
10.16 Employment Agreement, dated as of June 30, 2004, between HealthSouth Corporation and Michael D. Snow.* +
10.17
Employment Agreement, dated as of September 3, 2004, between HealthSouth Corporation and John L. Workman (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated September 3, 2004).+
10.18.1 Employment Agreement, dated as of February 1, 2004, between HealthSouth Corporation and John Markus.* +
10.18.2
Amendment 1, dated as of April 14, 2004, to Employment Agreement, dated as of February 1, 2004, between HealthSouth Corporation and John Markus.* +
10.19 Employment Agreement, dated as of March 15, 2004, between HealthSouth Corporation and Gregory L. Doody.* +
10.20
Employment Agreement, dated as of July 1, 2004, between HealthSouth Corporation and Karen G. Davis (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated October 11, 2004).+
10.21.1 Employment Agreement, dated as of March 15, 2004, between HealthSouth Corporation and Diane L. Munson.* +
10.21.2
Amendment 1, dated as of April 12, 2004, to Employment Agreement, dated as of March 15, 2004, between HealthSouth Corporation and Diane Munson.* +
10.22
Employment Agreement, dated as of September 27, 2004, between HealthSouth Corporation and Mark J. Tarr (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated October 11, 2004).+
10.23
Employment Agreement, dated as of March 1, 2005, between HealthSouth Corporation and Joseph T. Clark (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated February 3, 2005).+
10.24
Employment Agreement, dated as of March 1, 2005, between HealthSouth Corporation and James C. Foxworthy (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated February 3, 2005).+
10.25
Form of Restricted Stock Agreement, dated as of March 1, 2005, between HealthSouth Corporation and each of Joel C. Gordon and Robert P. May (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K dated March 1, 2005)+.
10.26
Letter Agreement, dated as of May 10, 2005, between HealthSouth Corporation and Joel C. Gordon (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K dated May 10, 2005).+
10.27
Settlement Agreement, dated as of December 30, 2004, by and among HealthSouth Corporation, the United States of America, acting through the entities named therein and certain other parties named therein (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated December 30, 2004).
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No. Description 10.28
Administrative Settlement Agreement, dated as of December 30, 2004, by and among the United States Department of Health and Human Services acting through the Centers for Medicare & Medicaid Services and its officers and agents, including, but not limited to, its fiscal intermediaries, and HealthSouth Corporation (incorporated by reference to Exhibit 10.3 to HealthSouth’s Current Report on Form 8-K dated December 30, 2004).
10.29
Corporate Integrity Agreement, dated as of December 30, 2004, by and among the Office of Inspector General of the Department of Health and Human Services and HealthSouth Corporation (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated December 30, 2004).
10.30.1
Consent of Defendant HealthSouth Corporation, dated June 1, 2005, in the lawsuit captioned Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy , CV-03-J-0615-S (incorporated by reference to Exhibit 99.2 to HealthSouth’s Current Report on Form 8-K dated June 8, 2005).
10.30.2
Form of Final Judgment as to Defendant HealthSouth Corporation in the lawsuit captioned Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy , CV-03-J-0615-S (incorporated by reference to Exhibit 99.3 to HealthSouth’s Current Report on Form 8-K dated June 8, 2005).
10.31 Form of Indemnity Agreement entered into between HealthSouth Corporation and the directors of HealthSouth.* +
10.32 Form of letter agreement with former directors.* +
10.33
Written description of Senior Management Bonus Program (incorporated by reference to Item 1.01 to HealthSouth’s Current Report on Form 8-K dated March 1, 2005).+
10.34
Amended Class Action Settlement Agreement, dated July 25, 2005, with representatives of the plaintiff class relating to the action consolidated on July 2, 2003, captioned IN RE HEALTHSOUTH CORP. ERISA LITIGATION, No. CV-03-BE-1700 (N.D. Ala.).
10.35.1
Written description of HealthSouth Corporation Key Executive Incentive Program (incorporated by reference to Item 1.01 to HealthSouth’s Current Report on Form 8-K dated November 21, 2005).+
10.35.2 Form of Key Executive Incentive Award Agreement (Key Executive Incentive Program).+
10.36.1
HealthSouth Corporation 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K, dated November 21, 2005).+
10.36.2 Form of Non-Qualified Stock Option Agreement (2005 Equity Incentive Plan).+
10.37.1
Asset Purchase Agreement, dated as of July 20, 2005, by and among HealthSouth Corporation, HealthSouth Medical Center, Inc., and The Board of Trustees of The University of Alabama.
10.37.2
Amended and Restated Asset Purchase Agreement, dated as of December 31, 2005, by and among HealthSouth Corporation, HealthSouth Medical Center, Inc., and The Board of Trustees of The University of Alabama.
10.38
Commitment Letter, dated February 2, 2006, from JPMorgan Chase Bank, N.A., J.P. Morgan Securities Inc., Citicorp North America, Inc., Citigroup Global Markets Inc., Merrill Lynch Capital Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K, dated February 3, 2006).
10.39.1
Credit Agreement, dated March 10, 2006, by and among HealthSouth, the lenders party thereto, JPMorgan Chase Bank, N.A., as the administrative agent and the collateral agent, Citicorp North America, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as co-syndication agents; and Deutsche Bank Securities Inc., Goldman Sachs Credit Partners L.P. and Wachovia Bank, National Association, as co-documentation agents (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K, dated March 16, 2006).
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No. Description 10.39.2
Collateral and Guarantee Agreement, dated as of March 10, 2006, by and among HealthSouth, certain of the Company’s subsidiaries and JPMorgan Chase Bank, N.A., as collateral agent (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K, dated March 16, 2006).
10.40
Interim Loan Agreement, dated March 10, 2006, by and among HealthSouth and certain of the Company’s subsidiaries, the lenders party thereto, Merrill Lynch Capital Corporation, as
administrative agent, Citicorp North America, Inc. and JPMorgan Chase Bank, N.A., as co-syndication agents; and Deutsche Bank AG Cayman Islands Branch, Goldman Sachs Credit Partners L.P. and Wachovia Bank, National Association, as co-documentation agents (incorporated by reference to Exhibit 10.3 to HealthSouth’s Current Report on Form 8-K, dated March 16, 2006).
10.41
Securities Purchase Agreement, dated February 28, 2006, between HealthSouth and the purchasers party thereto re: the sale of 400,000 shares of 6.50% Series A Convertible Perpetual Preferred Stock.
11 Computation of Per Share Earnings.
12 Computation of Ratios.
14 HealthSouth Corporation Standards of Business Conduct.
21 Subsidiaries of HealthSouth Corporation.*
24 Power of Attorney.
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Incorporated by reference to HealthSouth’s Annual Report on Form 10-K filed with the SEC on June 27, 2005. + Management contract or compensatory plan or arrangement.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated
137
H EALTH S OUTH C ORPORATION
By: /s/ J AY G RINNEY Jay Grinney President and Chief Executive Officer
Date: March 28, 2006
Signature Capacity Date
/s/ J AY G RINNEY Jay Grinney
President and Chief Executive Officer and Director
March 28, 2006
/s/ J OHN L. W ORKMAN John L. Workman
Executive Vice President, Chief Financial Officer and Principal Accounting Officer
March 28, 2006
J ON F. H ANSON * Jon F. Hanson
Chairman of the Board of Directors
March 28, 2006
S TEVEN R. B ERRARD * Steven R. Berrard
Director
March 28, 2006
E DWARD L. B LECHSCHMIDT * Edward A. Blechschmidt
Director
March 28, 2006
D ONALD L. C ORRELL * Donald L. Correll
Director
March 28, 2006
Y VONNE M. C URL * Yvonne M. Curl
Director
March 28, 2006
C HARLES M. E LSON * Charles M. Elson
Director
March 28, 2006
L EO I. H IGDON , J R .* Leo I. Higdon, Jr.
Director
March 28, 2006
J OHN E. M AUPIN , J R .* John E. Maupin, Jr.
Director
March 28, 2006
L. E DWARD S HAW , J R .* L. Edward Shaw, Jr.
Director
March 28, 2006
*By: / S / G REGORY L. D OODY Gregory L. Doody Attorney-in-Fact
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Index to Financial Statements
F-1
Item 15. Financial Statements
Report of Independent Registered Public Accounting Firm F-2 Consolidated balance sheets as of December 31, 2005 and 2004 F-6 Consolidated statements of operations for each of the years in the three year period ended December 31, 2005 F-8 Consolidated statements of shareholders’ deficit and comprehensive loss for each of the years in the three year period ended
December 31, 2005 F-10 Consolidated statements of cash flows for each of the years in the three year period ended December 31, 2005 F-11 Notes to consolidated financial statements F-13
Table of Contents
Index to Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of HealthSouth Corporation:
We have completed an integrated audit of HealthSouth Corporation’s 2005 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005 and audits of its 2004 and 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of HealthSouth Corporation and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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 our opinion.
As discussed in Note 1, the Company has not presented the selected quarterly financial data as required by Item 302(a) of Regulation S-K that the Securities and Exchange Commission requires as supplementary information to the basic financial statements.
Internal control over financial reporting
Also, we have audited management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effects of material weaknesses relating to the Company not maintaining effective controls over the i) financial close and reporting process, ii) recording of journal entries, iii) accuracy and completeness of spreadsheets, iv) recording and monitoring of intercompany accounts, v) access to financial applications programs and data, vi) authorization and testing of information technology program changes, vii) existence, completeness, and disclosure of its cash and cash equivalents and restricted cash accounts, viii) accuracy, completeness, valuation, and disclosure of its accounts receivable and related net operating revenue accounts, ix) existence, valuation and disclosure of its property and equipment, the related depreciation expense, and leased property and equipment accounts, x) accounting for income taxes, and xi) completeness, accuracy and disclosure of its investment in and advances to and equity in net income of non-consolidated affiliates and the minority interest in equity of and interests in earnings of consolidated affiliates, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an
F-2
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Index to Financial Statements
understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment.
1. The Company did not maintain effective controls, including monitoring, over its financial close and reporting process. Specifically, the following material weaknesses were identified in the financial close and reporting process:
These material weaknesses contributed to the matters described in 2 to 8 below and resulted in audit adjustments to the 2005 consolidated financial statements. Additionally, these material weaknesses could result in misstatements of any of the Company’s financial statement accounts that would result in a material misstatement to the annual or interim consolidated financial statements as noted in 2 to 8 below that would not be prevented or detected.
2. The Company did not maintain effective controls over access to financial application programs and data throughout the Company. Specifically, the Company did not comply with security access procedures related to the identification and monitoring of conflicting user roles (i.e., segregation of duties) and monitoring of access of employees and third parties to various application systems and data. This control
F-3
• The Company did not maintain effective controls over the recording of journal entries. Specifically, controls were not
designed and in place to ensure that journal entries were prepared with sufficient support or documentation or that journal entries were reviewed and approved to ensure the accuracy and completeness of the entries recorded.
• The Company did not maintain effective controls over the accuracy and completeness of spreadsheets used in the period-
end closing process and other spreadsheets supporting the Company’s financial reporting.
• The Company did not maintain effective controls over the complete and accurate recording and monitoring of intercompany accounts. Effective controls were not designed and in place to ensure that intercompany balances were accurately classified and reported in the Company’s underlying accounting records and to ensure proper elimination as part of the consolidation process in conformity with GAAP.
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Index to Financial Statements
deficiency could result in a misstatement in any of the Company’s financial statement accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
3. The Company did not maintain effective controls to ensure that information technology program changes were authorized and that such program changes were adequately tested for accuracy and performance. Specifically, information technology program change management controls were not operating effectively relative to the patient accounting systems used by the Inpatient and Diagnostics segments, the computer system used in accounting for income taxes and the computer system used in accounting for minority interest in equity of and interests in earnings of consolidated affiliates. This control deficiency contributed to the material weaknesses described in 5, 7, and 8 below. This control deficiency could result in a misstatement of the Company’s accounts receivable, net operating revenue, income taxes receivable and payable, deferred income tax assets and liabilities, income tax provision, minority interest in equity of and interests in earnings of consolidated affiliates that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
4. The Company did not maintain effective controls over the existence, completeness, and disclosure of the cash and cash equivalents and restricted cash accounts. Specifically, the Company did not maintain effective controls over the resolution of reconciling items on bank account reconciliations, and the Company did not adequately maintain segregation between cash custody and accounting duties in the Surgery Centers division and at corporate headquarters. Also, the Company did not maintain effective controls over the identification of restricted cash balances. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
5. The Company did not maintain effective controls over the accuracy, completeness, valuation and disclosure of the accounts receivable and related net operating revenue accounts. Specifically, effective controls were not designed and in place to ensure that the most up-to-date information is incorporated into the calculation of contractual allowances, that contractual adjustments and cash receipts posted to patient accounts were valid and recorded completely and accurately. In addition, sustainable controls over the calculation and evaluation of contractual allowances and bad debt reserves applicable to patient accounts receivable for the Diagnostics segment have not been developed. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
6. The Company did not maintain effective controls over the existence, valuation and disclosure of the Company’s property and equipment, the related depreciation expense and leased property and equipment. Specifically, policies and procedures for periodically performing property and equipment inventory counts were not in place and the Company did not have effective controls to ensure that all assets taken out of service were reported and appropriately accounted for. Additionally, controls were not in place to verify the completeness and accuracy of leased property and equipment and that future obligations related to such leases were properly disclosed. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
7. The Company did not maintain effective controls over the accounting for income taxes, including the accurate determination and reporting of income taxes receivable and payable, deferred income tax assets and liabilities and the related income tax provision. Specifically, the company did not maintain effective controls to review and monitor the accuracy of the components of the income tax provision calculations and
F-4
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Index to Financial Statements
related deferred income taxes and income taxes receivable and payable, and to monitor the differences between the income tax basis and the financial reporting basis of assets and liabilities to effectively reconcile the deferred income tax balances. Also, the company did not have adequate personnel to enable the company to properly consider and apply GAAP for income taxes, ensure that the rationale for positions taken on certain tax matters was adequately documented and appropriately communicated and ensure that the income tax accounts were appropriately adjusted based on the preparation and filing of income tax returns. This control deficiency could result in a misstatement in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
8. The Company did not maintain effective controls over the completeness, accuracy and disclosure of the investment in and advances to and equity in net income of non-consolidated affiliates and the minority interest in equity of and interests in earnings of consolidated affiliates. Specifically, effective controls were not designed and in place to ensure that agreements with affiliates were properly accounted for and disclosed in accordance with GAAP. Controls over the accounting for partnership activity, including the accuracy and completeness of data input into the computer system in use for accounting for minority interest in equity of and interests in earnings of consolidated affiliates at December 31, 2005 were not adequate. This control deficiency resulted in audit adjustments to the 2005 consolidated financial statements and could result in misstatements in the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
In our opinion, management’s assessment that HealthSouth Corporation did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the COSO. Also, in our opinion, because of the effects of the material weaknesses described above on the achievement of the objectives of the control criteria, HealthSouth Corporation has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the COSO .
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP Birmingham, Alabama March 28, 2006
F-5
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Balance Sheets
(Continued)
F-6
As of December 31, 2005 2004 (In Thousands)
Assets
Current Assets:
Cash and cash equivalents $ 175,497 $ 449,125 Current portion of restricted cash 156,412 183,330 Marketable securities 23,839 — Accounts receivable, net of allowance for doubtful accounts of $124,542 in 2005 and $151,453 in 2004 405,173 430,816 Prepaid expenses 37,254 43,962 Other current assets 62,797 55,846 Deferred income tax assets 1,222 — Current assets of discontinued operations 12,061 31,966
Total current assets 874,255 1,195,045 Property and equipment, net 1,206,506 1,339,155 Goodwill 911,403 911,086 Intangible assets, net 54,247 63,257 Investment in and advances to nonconsolidated affiliates 46,388 41,045 Assets of discontinued operations 39,691 73,090 Income tax refund receivable 240,755 263,518 Other long-term assets 218,968 196,797
Total assets $ 3,592,213 $ 4,082,993
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Balance Sheets (Continued)
The accompanying notes to consolidated financial statements are an integral part of these balance sheets.
F-7
As of December 31, 2005 2004
(In Thousands, Except
Share Data)
Liabilities and Shareholders’ Deficit
Current liabilities:
Current portion of long-term debt $ 34,298 $ 277,533 Checks issued in excess of bank balance 29,975 22,303 Accounts payable 124,163 140,956 Accrued payroll 118,075 117,860 Accrued interest payable 45,641 45,404 Refunds due patients and other third-party payors 142,280 153,029 Other current liabilities 280,380 233,442 Current portion of government, class action, and related settlements 333,124 166,930 Current liabilities of discontinued operations 1,888 41,340
Total current liabilities 1,109,824 1,198,797 Long-term debt, net of current portion 3,369,745 3,219,658 Professional liability risks 165,649 181,257 Deferred income tax liabilities 47,471 28,752 Liabilities of discontinued operations 5,736 12,514 Government, class action, and related settlements, net of current portion 135,245 251,873 Other long-term liabilities 25,522 55,578
4,859,192 4,948,429
Commitments and contingencies
Minority interest in equity of consolidated affiliates 273,742 243,984
Shareholders’ deficit:
Preferred stock, $.10 par value; 1,500,000 shares authorized; none issued and outstanding — — Common stock, $.01 par value; 600,000,000 shares authorized; issued: 440,504,976 in 2005 and
439,360,620 in 2004 4,405 4,394 Capital in excess of par value 2,851,993 2,850,593 Accumulated deficit (4,088,827 ) (3,642,833 ) Accumulated other comprehensive (loss) income (937 ) 308 Treasury stock, at cost (42,796,508 shares in 2005 and 42,839,066 in 2004) (307,120 ) (307,910 ) Notes receivable from shareholders, officers, and management employees (235 ) (13,972 )
Total shareholders’ deficit (1,540,721 ) (1,109,420 )
Total liabilities and shareholders’ deficit $ 3,592,213 $ 4,082,993
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Statements of Operations
(Continued)
F-8
For the year ended December 31, 2005 2004 2003 (In Thousands)
Net operating revenues $ 3,207,728 $ 3,512,632 $ 3,657,892
Operating expenses:
Salaries and benefits 1,429,867 1,619,834 1,595,534 Professional and medical director fees 76,373 78,118 87,673 Supplies 305,585 331,339 317,220 Other operating expenses 679,626 611,401 750,001 Provision for doubtful accounts 98,417 113,783 128,296 Depreciation and amortization 167,112 176,959 185,552 Recovery of amounts due from Meadowbrook (37,902 ) — — Loss (gain) on disposal of assets 14,776 9,539 (14,967 ) Impairment of goodwill — — 335,623 Impairment of intangible assets — 1,030 — Impairment of long-lived assets 45,203 36,260 132,722 Government, class action, and related settlements expense 215,000 — 170,949 Professional fees—reconstruction and restatement 169,804 206,244 70,558
Total operating expenses 3,163,861 3,184,507 3,759,161 Loss (gain) on early extinguishment of debt 33 (45 ) (2,259 ) Interest expense and amortization of debt discounts and fees 338,701 302,635 265,327 Interest income (17,141 ) (13,090 ) (7,273 ) (Gain) loss on sale of investments (229 ) (3,601 ) 15,811 Equity in net income of nonconsolidated affiliates (29,432 ) (9,949 ) (15,769 ) Minority interests in earnings of consolidated affiliates 96,728 94,389 98,196
Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change (344,793 ) (42,214 ) (455,302 )
Provision for income tax expense (benefit) 39,792 11,914 (28,382 )
Loss from continuing operations before cumulative effect of accounting change (384,585 ) (54,128 ) (426,920 ) Loss from discontinued operations, net of income tax expense (61,409 ) (120,342 ) (5,181 )
Loss before cumulative effect of accounting change (445,994 ) (174,470 ) (432,101 ) Cumulative effect of accounting change, net of income tax expense — — (2,456 )
Net loss $ (445,994 ) $ (174,470 ) $ (434,557 )
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Statements of Operations (Continued)
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-9
For the year ended December 31, 2005 2004 2003 (In Thousands, Except Per Share Data)
Weighted average common shares outstanding:
Basic 396,563 396,423 396,132
Diluted 398,021 397,625 405,831
Basic and diluted loss per share:
Loss from continuing operations before cumulative effect of accounting change $ (0.97 ) $ (0.14 ) $ (1.08 ) Discontinued operations, net of tax (0.15 ) (0.30 ) (0.01 )
Loss before cumulative effect of accounting change (1.12 ) (0.44 ) (1.09 ) Cumulative effect of accounting change — — (0.01 )
Net loss per share $ (1.12 ) $ (0.44 ) $ (1.10 )
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Statements of Shareholders’ Deficit and Comprehensive Loss
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-10
For the year ended December 31, 2005 2004 2003 (In Thousands) NUMBER OF COMMON SHARES OUTSTANDING Balance at beginning of year 396,522 396,184 396,149
Stock issued to employees exercising stock options 50 31 359 Issuance of vested shares under 2004 Directors’ Plan 6 23 — Purchase or receipt of treasury stock (10 ) (31 ) — Issuance of restricted stock 1,087 315 — Cancellation of restricted stock — — (325 ) Reissuance of treasury stock 53 — 1
Balance at end of year 397,708 396,522 396,184
COMMON STOCK Balance at beginning of year $ 4,394 $ 4,390 $ 4,390
Stock issued to employees exercising stock options 1 1 3 Restricted stock and other stock plans, less cancellations 10 3 (3 )
Balance at end of year $ 4,405 $ 4,394 $ 4,390
CAPITAL IN EXCESS OF PAR VALUE Balance at beginning of year $ 2,850,593 $ 2,822,802 $ 2,824,479
Stock issued to employees exercising stock options 246 148 1,259 Stock warrants issued — 27,492 — Stock-based compensation — (460 ) — Reissuance of treasury stock (834 ) — (7 ) Restricted stock and other plans, less cancellations (10 ) (3 ) 3 Amortization of restricted stock 1,998 614 (2,932 )
Balance at end of year $ 2,851,993 $ 2,850,593 $ 2,822,802
ACCUMULATED DEFICIT Balance at beginning of year $ (3,642,833 ) $ (3,468,363 ) $ (3,033,806 )
Net loss (445,994 ) (174,470 ) (434,557 )
Balance at end of year $ (4,088,827 ) $ (3,642,833 ) $ (3,468,363 )
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME Balance at beginning of year $ 308 $ (943 ) $ (703 )
Net foreign currency translation adjustment, net of income tax expense (1,248 ) 1,251 (31 ) Net change in unrealized loss on available-for-sale securities, net of income tax expense 3 — (209 )
Net other comprehensive (loss) income adjustment (1,245 ) 1,251 (240 )
Balance at end of year $ (937 ) $ 308 $ (943 )
TREASURY STOCK Balance at beginning of year $ (307,910 ) $ (307,751 ) $ (307,758 )
Purchase or receipt of treasury stock (44 ) (159 ) — Reissuance of treasury stock 834 — 7
Balance at end of year $ (307,120 ) $ (307,910 ) $ (307,751 )
DUE FROM EMPLOYEE STOCK OWNERSHIP PLAN Balance at beginning of year $ — $ — $ (1,389 )
Reduction in receivable from ESOP — — 1,389
Balance at end of year $ — $ — $ —
NOTES RECEIVABLE FROM SHAREHOLDERS, OFFICERS, AND M ANAGEMENT EMPLOYEES Balance at beginning of year $ (13,972 ) $ (13,972 ) $ (13,972 )
Repayments 13,737 — —
Balance at end of year $ (235 ) $ (13,972 ) $ (13,972 )
COMPREHENSIVE LOSS Net loss $ (445,994 ) $ (174,470 ) $ (434,557 ) Net other comprehensive loss adjustments (1,245 ) 1,251 (240 )
TOTAL COMPREHENSIVE LOSS $ (447,239 ) $ (173,219 ) $ (434,797 )
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Continued)
F-11
For the year ended December 31, 2005 2004 2003 (In Thousands) Cash flows from operating activities:
Net loss $ (445,994 ) $ (174,470 ) $ (434,557 )
Loss from discontinued operations 61,409 120,342 5,181
Adjustments to reconcile net loss to net cash provided by operating activities— Cumulative effect of accounting change, net of income tax expense — — 2,456 Provision for doubtful accounts 98,417 113,783 128,296 Provision for government, class action, and related settlements expense 215,000 — 170,949 Depreciation and amortization 167,112 176,959 185,552 Amortization of debt issue costs, debt discounts, and fees 39,023 21,838 7,831 Amortization of restricted stock 1,998 614 (2,932 ) Accretion of debt securities (410 ) — — Impairment of long-lived assets, goodwill, and intangible assets 45,203 37,290 468,345 Realized loss on sale of investments 334 78 3,382 Loss (gain) on disposal of assets 14,776 9,539 (14,967 ) Loss (gain) on early extinguishment of debt 33 (45 ) (2,259 ) (Gain) loss on syndication of limited partnership interests (563 ) (3,679 ) 12,429 Equity in net income of nonconsolidated affiliates (29,432 ) (9,949 ) (15,769 ) Minority interests in earnings of consolidated affiliates 96,728 94,389 98,196 Distributions from nonconsolidated affiliates 22,457 17,029 8,561 Stock-based compensation — (460 ) — Deferred tax provision (benefit) 17,497 (5,339 ) (25,556 ) (Increase) decrease in assets, net of acquisitions—
(Decrease) increase in liabilities, net of acquisitions— Accounts payable (28,559 ) 19,311 2,149 Accrued payroll 638 14,686 1,662 Accrued interest payable 268 2,757 (931 ) Other liabilities 26,801 (29,075 ) (41,277 ) Refunds due patients and other third-party payors (10,749 ) 11,476 5,465 Professional liability risks (15,608 ) 15,838 33,181 Government, class action, and related settlements (165,434 ) (6,997 ) —
Net cash used in operating activities of discontinued operations (47,823 ) (33,473 ) (35,813 )
Total adjustments 386,146 445,724 1,003,569
Net cash provided by operating activities $ 1,561 $ 391,596 $ 574,193
Cash flows from investing activities Capital expenditures (94,045 ) (161,712 ) (133,394 ) Acquisition of businesses, net of cash acquired — (744 ) — Proceeds from disposal of assets 11,067 20,536 59,617 Proceeds from sale and maturities of marketable securities 47,191 — 3,698 Purchase of investments, net of cash equivalents (70,609 ) — — Proceeds from sale of equity interests of nonconsolidated affiliates 2,930 3,140 37,788 Repurchase of equity interests of nonconsolidated affiliates (287 ) (18 ) (750 ) Advances to nonconsolidated affiliates, net of cash received (800 ) 58 157 Proceeds from sale of equity interests of consolidated affiliates 18,795 4,454 14,659 Repurchase of equity interests of consolidated affiliates (11,547 ) (4,939 ) (5,434 ) Decrease in cash related to conversion of consolidated entities to equity method affiliates (8,797 ) — — Increase in cash related to conversion of equity method facilities to consolidated entities 1,386 — — Net change in restricted cash (1,075 ) (67,639 ) (149,706 ) Net cash provided by investing activities of discontinued operations 1,493 19,995 96,492
Net cash used in investing activities (104,298 ) (186,869 ) (76,873 )
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-12
For the year ended December 31, 2005 2004 2003 (In Thousands) Cash flows from financing activities
Checks in excess of bank balance 7,672 (9,094 ) (64,035 ) Principal borrowings on notes 200,065 — 5,880 Proceeds from bond issuance — 327,608 — Principal payments on debt (252,127 ) (359,475 ) (86,676 ) Net change in revolving credit facility — — 160,000 Principal payments under capital lease obligations (27,968 ) (26,462 ) (27,850 ) Proceeds from exercising stock options 247 149 1,262 Purchase of treasury stock (44 ) (159 ) — Debt issuance costs (17,852 ) (11,095 ) — Consent fees paid — (80,221 ) — Stock warrants issued — 27,492 — Reduction in receivable from ESOP — — 1,389 Proceeds from repayment of notes receivable from shareholders, officers, and management employees 13,737 — — Distributions to minority interests of consolidated affiliates (90,046 ) (88,254 ) (97,663 ) Net cash used in financing activities of discontinued operations (7,516 ) (4,958 ) (8,192 )
Net cash used in financing activities (173,832 ) (224,469 ) (115,885 )
Effect of exchange rate changes on cash and cash equivalents (1,248 ) 1,251 (31 )
(Decrease) increase in cash and cash equivalents (277,817 ) (18,491 ) 381,404 Cash and cash equivalents at beginning of year 449,125 463,952 85,312 Cash and cash equivalents of discontinued operations at beginning of year 6,286 9,950 7,186 Less: Cash and cash equivalents of discontinued operations at end of year (2,097 ) (6,286 ) (9,950 )
Cash and cash equivalents at end of year $ 175,497 $ 449,125 $ 463,952
Supplemental cash flow information: Cash paid (received) during the year for—
Interest, net of amounts capitalized $ 299,441 $ 278,040 $ 258,427 Income tax refunds, net (4,800 ) (8,100 ) (110,300 )
Supplemental schedule of noncash investing and financing activities Acquisition of businesses—
Fair value of assets acquired — 163 — Goodwill — 581 —
Net cash paid for acquisitions — 744 — Reissuance of treasury stock 834 — 7 Restricted stock cancellation (10 ) (3 ) 3 Unrealized gain (loss) on available-for-sale securities 3 — (330 ) Property and equipment acquired through capital leases 17,995 50,856 994 Termination of capital leases 27,793 — 37,061 Deferred gains on sale leaseback transactions — 1,020 — Goodwill from repurchase of equity interests of joint venture entities 3,638 7,121 5,702 Net investment in consolidated facilities that became equity method facilities 4,010 1,761 — Net investment in equity method facilities that became consolidated facilities 393 — — Note receivable from sale of assets 647 — — Sales proceeds in escrow 262 — —
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Organization and Description of Business—
HealthSouth Corporation, incorporated in Delaware in 1984, and its subsidiaries, is one of the largest providers of ambulatory surgery, outpatient, diagnostic, and rehabilitative health care services in the United States. References herein to “HealthSouth,” the “Company,” “we,” “our,” or “us” refer to HealthSouth Corporation and its subsidiaries unless the context specifically requires otherwise. We provide these services through a national network of inpatient and outpatient rehabilitation facilities, long-term acute care hospitals, ambulatory surgery centers, diagnostic centers, and other health care facilities.
As of December 31, 2005, we operate 93 freestanding inpatient rehabilitation facilities (“IRFs”) with approximately 6,450 licensed beds. We are the sole owner of 65 of these IRFs. We retain 50% to 97.5% ownership in the remaining 28 jointly owned IRFs. Our IRFs are located in 28 states, with a concentration of facilities in Texas, Pennsylvania, Florida, Alabama, and Tennessee, as well as a 70-bed rehabilitation hospital in Australia and a 60-bed rehabilitation facility in Puerto Rico. In addition to facilities in which we have an ownership interest, we operate 14 inpatient rehabilitation units and 2 gamma knife radiosurgery centers through management contracts.
We operate 10 long-term acute care hospitals (“LTCHs”) (7 freestanding and 3 hospital-within-hospital facilities), 9 of which we own and the other is a joint venture in which we have retained an 80% ownership interest.
We provide outpatient rehabilitative health care services through approximately 620 locations in 40 states, with a concentration of centers in Florida, Texas, New Jersey, Missouri, and Connecticut. These facilities are freestanding outpatient centers. In addition, our inpatient segment provides outpatient services through 101 facilities located within IRFs or in satellite offices near IRFs. Our inpatient segment also operates 11 outpatient facilities under management agreements.
We provide ambulatory (i.e., outpatient) surgery services through 158 freestanding surgery centers and three surgical hospitals in 35 states, with a concentration of centers in California, Texas, Florida, and North Carolina. We operate our surgery centers as general or limited partnerships or limited liability companies in which HealthSouth or one of our subsidiaries serves as the general partner, limited partner, member, or managing member. Our partners in these entities are generally licensed physicians, oral surgeons, and/or podiatrists.
We operate 85 diagnostic centers in 27 states and the District of Columbia, with a concentration of centers in Texas, Georgia, Alabama, Florida, and the Washington, D.C. area. In addition, we operate five electro-shock wave lithotripter units.
We also offer employer services, which are solutions that aim to help improve workplace performance and productivity, create a health-enhancing culture, and meet the medical care needs of employers. We also provide management services, including physician services, for other health care providers.
Reconstruction and Restatement of our Consolidated Financial Statements—
On March 18, 2003, a federal law enforcement task force executed a search warrant at our corporate offices in Birmingham, Alabama. The following day, the United States Securities and Exchange Commission (the “SEC”) filed suit against HealthSouth and our then-chairman and chief executive officer. On March 24, 2003, we announced that, in light of the SEC and the United States Department of Justice (the “DOJ”) investigations into our financial reporting and related activity, our previously filed consolidated financial statements should not be
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1. Summary of Significant Accounting Policies:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements relied upon. Since March 2003, as a result of the above circumstances, we have restated our previously filed consolidated financial statements for the years ended December 31, 2001 and 2000, and we have filed our consolidated financial statements for the years ended December 31, 2005, 2004, 2003, and 2002 (including these consolidated financial statements).
2004 Out-of-Period Adjustments—
During the preparation of our financial statements for the year ended December 31, 2004, we identified errors in our financial statements for the year ended December 31, 2003 and for prior periods. These errors primarily related to (1) the overstatement of approximately $10.0 million of property and equipment from a 1993 acquisition; (2) the improper recording of a prepaid expense of approximately $5.4 million relating to a lease entered into in 1999; (3) bookkeeping errors relating to our accounting for partnership interests and the initial formation of two partnerships of approximately $4.4 million; (4) certain tax errors discussed below; and (5) certain other miscellaneous items amounting to approximately $0.7 million. We corrected these errors in our financial statements for the year ended December 31, 2004, which resulted in an overstatement of our Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change of approximately $20.5 million. In 2005, as discussed below, certain facilities were classified as discontinued operations pursuant to Financial Accounting Standards Board (“FASB”) Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets . Consequently, our 2004 Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change was reduced by approximately $99.8 million, and our Loss from discontinued operations, net of income tax expense was increased by the same amount. None of the errors discussed above related to discontinued operations. In addition, we corrected in 2004 certain prior year tax errors relating primarily to the improper calculation of the deferred tax liability attributable to the book and tax basis differences in certain partnerships. The correction of these errors reduced our 2004 Provision for income tax expense (benefit) by approximately $18.5 million. The net impact of these corrections increased our 2004 Net loss by approximately $2.0 million for the year ended December 31, 2004. We do not believe these adjustments are material to the consolidated financial statements for the year ended December 31, 2004 or to any prior years’ consolidated financial statements. As a result, we have not restated any prior period amounts.
Reclassifications—
Certain previously reported financial results have been reclassified to conform to the current year presentation. Such reclassifications primarily relate to facilities we closed or sold in 2005 that qualify under FASB Statement No. 144 to be reported as discontinued operations. We reclassified our consolidated balance sheet for the year ended December 31, 2004 and our consolidated statements of operations and statements of cash flows for the years ended December 31, 2004 and 2003 to show the results of those qualifying facilities in 2005 as discontinued operations.
Basis of Presentation and Consolidation—
The accompanying consolidated financial statements of HealthSouth and its subsidiaries were prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and include the assets, liabilities, revenues, and expenses of all wholly owned subsidiaries, majority-owned subsidiaries over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest.
As of December 31, 2005, we had investments in approximately 317 partially owned subsidiaries, of which approximately 306 are general or limited partnerships, limited liability companies, or joint ventures in which HealthSouth or one of our subsidiaries is a general or limited partner, managing member, or joint venturer, as applicable. We evaluate partially owned subsidiaries and joint ventures held in partnership form in accordance
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements with the provisions of American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 78-9, Accounting for Investments in Real Estate Ventures , and Emerging Issues Task Force (“EITF”) Issue No. 98-6, “Investor’s Accounting for an Investment in a Limited Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain Approval or Veto Rights,” to determine whether the rights held by other investors constitute “important rights” as defined therein.
For general partners of all new limited partnerships formed and for existing limited partnerships for which the partnership agreements were modified on or subsequent to June 29, 2005, we evaluate partially owned subsidiaries and joint ventures held in partnership form using the guidance in EITF Issue No. 04-5, “Investor’s Accounting for an Investment in a Limited Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain Rights,” which includes a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate it. The framework includes the presumption that general-partner control would be overcome only when the limited partners have certain rights. Such rights include kick-out rights, the right to dissolve or liquidate the partnership or otherwise remove the general partner “without cause,” or participating rights, the right to effectively participate in significant decisions made in the ordinary course of the partnership’s business.
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities. This Interpretation was revised in December 2003 as FASB Interpretation No. 46 (Revised). The Interpretation clarifies the application of Accounting Research Bulletin (“ARB”) No. 51, Consolidated Financial Statements, to certain entities in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Interpretation, as revised, requires an entity to apply the interpretation to all interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ended after December 15, 2003. We have determined that we do not have any arrangements or relationships with special-purpose entities. Application for all other types of entities is required in financial statements for periods ending after March 15, 2004.
FASB Interpretation No. 46 specifically addresses the consolidation of business enterprises to which the usual condition (ownership of a majority voting interest) of consolidation does not apply. The Interpretation focuses on controlling financial interests that may be achieved through arrangements that do not involve voting interests. It concludes that in the absence of clear control through voting interests, a company’s exposure (variable interest) to the economic risks and potential rewards from the variable interest entity’s assets and activities are the best evidence of control. If a company holds a majority of the variable interests of an entity, it would be considered the primary beneficiary. The primary beneficiary is required to include assets, liabilities, and the results of operations of the variable interest entity in its financial statements. The adoption of FASB Interpretation No. 46(R) did not have a material impact on our financial position, results of operations, or cash flows.
For partially owned subsidiaries or joint ventures held in corporate form, we consider the guidance of FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries , and EITF Issue No. 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights,” and, in particular, whether rights held by other investors would be viewed as “participating rights” as defined therein. To the extent that any minority investor has important rights in a partnership or participating rights in a corporation that inhibit our ability to control the corporation, including substantive veto rights, we generally will not consolidate the entity.
We use the equity method to account for our investments in entities that we do not control, but where we have the ability to exercise significant influence over operating and financial policies. Consolidated net income includes our share of the net earnings of these entities. The difference between consolidation and the equity
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements method impacts certain financial ratios of the Company because of the presentation of the detailed line items reported in the consolidated financial statements for consolidated entities compared to a one line presentation of equity method investments.
We use the cost method to account for our investments in entities that we do not control and for which we do not have the ability to exercise significant influence over operating and financial policies. In accordance with the cost method, these investments are recorded at the lower of cost or fair value, as appropriate.
We eliminate from our financial results all significant intercompany accounts and transactions.
Use of Estimates and Assumptions—
The preparation of our consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions are used for, but not limited to: (1) allowance for contractual revenue adjustments; (2) allowance for doubtful accounts; (3) asset impairments, including goodwill; (4) depreciable lives of assets; (5) useful lives of intangible assets; (6) economic lives and fair value of leased assets; (7) income tax valuation allowances; (8) fair value of stock options; (9) reserves for professional, workers’ compensation, and comprehensive general insurance liability risks; and (10) contingency and litigation reserves. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. We evaluate and update our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluation, as considered necessary. Actual results could differ from those estimates.
Risks and Uncertainties—
HealthSouth operates in a highly regulated industry and is required to comply with extensive and complex laws and regulations at the federal, state, and local government levels. These laws and regulations relate to, among other things:
Many of these laws and regulations are expansive, and we do not have the benefit of significant regulatory or judicial interpretation of them. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our investment structure, facilities, equipment, personnel, services, capital expenditure programs, operating procedures, and contractual arrangements.
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• licensure, certification, and accreditation,
• coding and billing for services,
• relationships with physicians and other referral sources, including physician self-referral and anti-kickback laws,
• quality of medical care,
• use and maintenance of medical supplies and equipment,
• maintenance and security of medical records,
• accuracy of billing operations, and
• disposal of medical and hazardous waste.
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
If we fail to comply with applicable laws and regulations, we could be subjected to liabilities, including (1) criminal penalties, (2) civil penalties, including monetary penalties and the loss of our licenses to operate one or more of our facilities, and (3) exclusion or suspension of one or more of our facilities from participation in the Medicare, Medicaid, and other federal and state health care programs.
Two recent changes in regulations governing IRF reimbursement have combined to create a very challenging operating environment for our inpatient division. The first change occurred on May 7, 2004, when the United States Centers for Medicare and Medicaid Services (“CMS”) issued a final rule stipulating revised criteria for qualifying as an IRF under Medicare. This rule, known as the “75% Rule,” has created significant volume volatility in our inpatient division. The second change, which became effective on October 1, 2005, relates to reduced unit pricing applicable to IRFs (“IRF-PPS”).
The 75% Rule, as revised, generally provides that to be considered an IRF, and to receive reimbursement for services under the IRF-PPS methodology, 75% of a facility’s total patient population must require treatment for at least one of 13 designated medical conditions. As a practical matter, this means that to maintain our current level of revenue from our IRFs we will need to reduce the number of nonqualifying patients treated at our IRFs and replace them with qualifying patients, establish other sources of revenues at our IRFs, or both. The Deficit Reduction Act of 2005, signed by President Bush on February 8, 2006 as Public Law 109-171, extended the phase-in schedule for the 75% Rule by one year and delayed implementation of the 65% compliance threshold until July 1, 2007.
On August 15, 2005, CMS published a final rule, as amended by the subsequent correction notice published on September 30, 2005, that updates the IRF-PPS for the federal fiscal year 2006 (which covers discharges occurring on or after October 1, 2005 and on or before September 30, 2006). Although the final rule includes an overall market basket update of 3.6%, it makes several other adjustments that we estimate will result in a net reduction in reimbursement to us. For example, the final rule (1) reduces the standard payment rates by 1.9%, (2) implements changes to Case-Mix Groups, comorbidity tiers, and relative weights, (3) updates the formula for the low income patient payment adjustment, (4) adopts the new geographic labor market area definitions based on the definitions created by the Office of Management and Budget known as Core-Based Statistical Areas, (5) implements new and revised payment adjustments on a budget-neutral basis, (6) implements a new indirect medical education teaching adjustment, (7) increases the rural add-on to 21.3%, and (8) incorporates several other modifications to Medicare reimbursement for IRFs. Although CMS predicted that overall payments to IRFs nationwide would increase by 3.4%, we estimate that the revised IRF-PPS will reduce Medicare reimbursement to our IRFs by 3.5% to 4%, primarily owing to the changes to Case-Mix Groups, comorbidity tiers, and relative weights. We estimate this net impact on reimbursement will reduce our inpatient division’s net operating revenues by approximately $10 million per quarter for the first three quarters of 2006 as compared to 2005. These estimates do not take into account potential changes in our case-mix resulting from our compliance with the 75% Rule, which could have the effect of increasing the acuity of our case-mix and therefore reducing the overall net impact of the IRF-PPS changes.
The volume volatility created by the 75% Rule had a significantly negative impact on our inpatient division’s net operating revenues in 2005. Thus far, we have been able to partially mitigate the impact of the 75% Rule on our inpatient division’s operating earnings by implementing various mitigation strategies such as reducing costs and increasing admission of compliant cases. However, the combination of volume volatility created by the 75% Rule and lower unit pricing resulting from IRF-PPS changes reduced our operating earnings in 2005 and will have a continuing negative impact on our operating earnings in 2006. In addition, because we receive a significant percentage of our revenues from our inpatient division, and because our inpatient division receives a significant percentage of its revenues from Medicare, our inability to achieve continued compliance with or continue to mitigate the negative effects of the 75% Rule could have a material adverse effect on our business, financial position, results of operations, and cash flows.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
As described more fully below (see Note 22, SEC Settlement ), we settled a lawsuit brought by the SEC relating to our financial reporting practices prior to March 2003. However, investigations by the DOJ, the United States’ Attorney’s Office for the Northern District of Alabama, and other agencies are ongoing. While we are fully cooperating with the SEC, the DOJ, and other governmental authorities, we cannot predict the outcome of those investigations. Such investigations could have a material adverse effect on us, the trading prices of our securities, and our ability to access the capital markets. If we were convicted of a crime, certain contracts and licenses that are material to our operations may be revoked which would severely affect our business.
A number of lawsuits have been brought against us involving our accounting practices, coverage under our director and officer liability policies, and various other outstanding securities, derivative, regulatory, and qui tam (i.e., whistleblower) litigation (see Note 24, Contingencies and Other Commitments ). Although we have reached a global, preliminary agreement in principle with the lead plaintiffs in the federal securities class actions and the derivative actions, as well as with our insurance carriers, to settle litigation filed against us, certain of our former directors and officers, and certain other parties, there can be no assurances that a final settlement agreement can be reached or that the proposed settlement will receive the required court approval. We cannot predict the outcome of litigation filed against us. Substantial damages or other monetary remedies assessed against us could have a material adverse effect on our business, financial position, results of operations, and cash flows. In addition, given the size and nature of our business, we are subject from time to time to various other lawsuits which, depending on their outcome, may have a negative effect on us.
Self-Insured Risk—
We insure a substantial portion of our professional liability, general liability, and workers’ compensation risks through a self-insured retention program (“SIR”) written by our consolidated wholly owned offshore captive insurance subsidiary, HCS, Ltd., which we fund annually. HCS, Ltd., established in the fourth quarter of 2000, is located in the Cayman Islands and is an independent insurance company licensed by the Cayman Island Monetary Authority. We use HCS, Ltd. to fund part of our first layer of insurance coverage up to $60 million. Risks in excess of specified limits per claim and in excess of our aggregate SIR amount are covered by unrelated commercial carriers.
We primarily insure each of our facilities for professional and general liability losses through Columbia Casualty, a CNA company, for $1 million per claim/$3 million aggregate. These limits are applied towards a maximum limit of $6 million per claim under our SIR. In addition, ACE provides primary workers’ compensation insurance for each of our facilities under either a policy with a high deductible or as a third-party administrator for self-insured claims. In both cases, our retained risk ranges from $250,000 to $1,000,000 per claim. Pursuant to indemnification agreements between us, HCS, Ltd., CNA, and ACE, CNA and ACE are entitled to be indemnified by HCS, Ltd. for the primary coverage provided.
Reserves for professional liability, general liability, and workers’ compensation risks were $214.9 million and $221.5 million, at December 31, 2005 and 2004, respectively. The current portion of this reserve, $49.3 million and $40.2 million, at December 31, 2005 and 2004, respectively, is included in Other current liabilities in our consolidated balance sheets. Provisions for losses related to liability risks were $33.3 million, $52.8 million, and $65.4 million for the years ended December 31, 2005, 2004, and 2003, respectively, and are classified in Other operating expenses in our consolidated statements of operations.
Provisions for these self-insured risks are based upon actuarially determined estimates. Loss and loss expense reserves represent the estimated ultimate net cost of all reported and unreported losses incurred through the respective consolidated balance sheet dates. The reserves for unpaid losses and loss expenses are estimated using individual case-basis valuations and actuarial analyses. Those estimates are subject to the effects of trends
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements in loss severity and frequency. The estimates are continually reviewed and adjustments are recorded as experience develops or new information becomes known. The changes to the estimated reserve amounts are included in current operating results. The reserves for these self-insured risks cover approximately 2,000 individual claims at December 31, 2005 and 2004 and estimates for potential unreported claims. The time period required to resolve these claims can vary depending upon the jurisdiction and whether the claim is settled or litigated. During 2005, 2004, and 2003, $33.8 million, $34.4 million and $40.5 million, respectively, of payments (net of reinsurance recoveries of $6.0 million, $5.4 million and $8.2 million, respectively) were made for liability claims. The estimation of the timing of payments beyond a year can vary significantly. Although considerable variability is inherent in reserve estimates, management believes the reserves for losses and loss expenses are adequate; however, there can be no assurance that the ultimate liability will not exceed management’s estimates.
The obligations covered by excess contracts remain on the balance sheet, as the subsidiary or parent remains liable to the extent that the excess carriers do not meet their obligations under the insurance contracts. Amounts receivable under the excess contracts approximated $25.7 million and $23.4 million at December 31, 2005 and 2004, respectively. Approximately $7.1 million and $6.0 million are included in Other current assets in our consolidated balance sheets as of December 31, 2005 and 2004, respectively, with the remainder included in Other long-term assets .
Revenue Recognition—
Revenues consist primarily of net patient service revenues that are recorded based upon established billing rates less allowances for contractual adjustments. Revenues are recorded during the period the health care services are provided, based upon the estimated amounts due from the patients and third-party payors, including federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, and employers. Estimates of contractual allowances under third-party payor arrangements are based upon the payment terms specified in the related contractual agreements. Third-party payor contractual payment terms are generally based upon predetermined rates per diagnosis, per diem rates, or discounted fee-for-service rates. Settlements under reimbursement agreements with third-party payors are estimated and recorded in the period the related services are rendered and are adjusted in future periods as adjustments become estimable or as the service years are no longer subject to audit, review, or investigation. Other operating revenues, which include revenue from cafeteria, gift shop, rental income, conference center, and management and administrative fees, approximated 2.5%, 2.2%, and 2.4% of net operating revenues for the years ended December 31, 2005, 2004, and 2003, respectively.
Laws and regulations governing the Medicare and Medicaid programs are complex, subject to interpretation, and are routinely modified for provider reimbursement. All health care providers participating in the Medicare and Medicaid programs are required to meet certain financial reporting requirements. Federal regulations require submission of annual cost reports covering medical costs and expenses associated with the services provided by each facility to program beneficiaries. Annual cost reports required under the Medicare and Medicaid programs are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to HealthSouth under these reimbursement programs. These audits often require several years to reach the final determination of amounts earned under the programs. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. The estimated third-party settlements receivables or (liabilities) as of December 31, 2005 and 2004 were approximately $2.1 million and ($0.3) million, respectively. The $2.1 million third-party settlements receivable is included in Accounts receivable as of December 31, 2005, while the ($0.3) million third-party settlements liability is included in Refunds due patients and other third-party payors as of December 31, 2004 in the accompanying consolidated balance sheets (see Note 21, Medicare Program Settlement ).
CMS has been granted authority to suspend payments, in whole or in part, to Medicare providers if CMS possesses reliable information that an overpayment, fraud, or willful misrepresentation exists. If CMS suspects
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements that payments are being made as the result of fraud or misrepresentation, CMS may suspend payment at any time without providing us with prior notice. The initial suspension period is limited to 180 days. However, the payment suspension period can be extended almost indefinitely if the matter is under investigation by the United States Department of Health and Human Services Office of Inspector General or the DOJ. Therefore, we are unable to predict if or when we may be subject to a suspension of payments by the Medicare and/or Medicaid programs, the possible length of the suspension period, or the potential cash flow impact of a payment suspension. Any such suspension would adversely impact our financial position.
We provide care to patients who are financially unable to pay for the health care services they receive, and because we do not pursue collection of amounts determined to qualify as charity care, such amounts are not recorded as revenues.
Cash and Cash Equivalents—
Cash and cash equivalents include highly liquid investments with maturities of three months or less when purchased. Carrying values of cash and cash equivalents approximate fair value due to the short-term nature of these instruments. Certificates of deposit included in Cash and cash equivalents at December 31, 2005 approximated $1.5 million.
We maintain amounts on deposit with various financial institutions, which may, at times, exceed federally insured limits. However, management periodically evaluates the credit-worthiness of those institutions, and we have not experienced any losses on such deposits.
Restricted Cash—
As of December 31, 2005 and 2004, restricted cash consists of the following (in thousands):
Affiliate cash accounts represent cash accounts maintained by partnerships in which we participate where one or more external partners requested, and we agreed, that the partnership’s cash not be commingled with other corporate cash accounts and be used only to fund the operations of those partnerships. Self-insured captive funds represent cash held at our wholly owned insurance captive, HCS Ltd., in the Cayman Islands. HCS handles professional liability, workers’ compensation, and other insurance claims on behalf of HealthSouth. These funds are committed to third-party administrators for claims incurred. Paid loss deposit funds represent cash held by third-party administrators to fund expenses and other payments related to claims. Collateral deposits represent cash collateralized deposits for surety bonds related to HealthSouth’s workers’ compensation plans and were a requirement of the applicable states and insurance companies. During 2005, these deposits were returned to HealthSouth and replaced by letters of credit under our Amended and Restated Credit Agreement (see Note 8, Long-term Debt ). Non-U.S. based operations represents cash maintained by our inpatient rehabilitation facility in Australia.
Total restricted cash 242,450 241,375 Less current portion (156,412 ) (183,330 )
$ 86,038 $ 58,045
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Restricted cash includes certificates of deposit of approximately $45.0 million at December 31, 2004. The noncurrent portion of restricted cash is included in Other long-term assets in the accompanying consolidated balance sheets.
Accounts Receivable—
HealthSouth reports accounts receivable at estimated net realizable amounts from services rendered from federal and state agencies (under the Medicare and Medicaid programs), managed care health plans, commercial insurance companies, workers’ compensation, employers, and patients. Our accounts receivable are geographically dispersed, but a significant portion of our revenues are concentrated by type of payors. The concentration of net patient service accounts receivable by payor class, as a percentage of total net patient service accounts receivable as of the end of each of the reporting periods, is as follows:
During the years ended December 31, 2005, 2004, and 2003, approximately 47.5%, 47.4%, and 44.6%, respectively, of our revenues related to patients participating in the Medicare program. While revenues and accounts receivable from government agencies are significant to our operations, we do not believe there are significant credit risks associated with these government agencies. Because Medicare traditionally pays claims faster than our other third-party payors, the percentage of our Medicare charges in accounts receivable is less than the percentage of our Medicare revenues. HealthSouth does not believe there are any other significant concentrations of revenues from any particular payor that would subject it to any significant credit risks in the collection of its accounts receivable.
Additions to the allowance for doubtful accounts are made by means of the provision for doubtful accounts. We write off uncollectible accounts against the allowance for doubtful accounts after exhausting collection efforts and adding subsequent recoveries. Net accounts receivable include only those amounts we estimate we will collect.
For each of the three years ended December 31, 2005, we performed an analysis of our historical cash collection patterns and considered the impact of any known material events in determining the allowance for doubtful accounts. In performing our analysis, we considered the impact of any adverse changes in general economic conditions, business office operations, payor mix, or trends in federal or state governmental health care coverage. At December 31, 2005 and 2004, our allowance for doubtful accounts represented approximately 23.7% and 26.1%, respectively, of the $525.2 million and $581.1 million, respectively, total patient due accounts receivable balance.
In 2005, we reassessed our Refunds due patients and other third-party payors liability to update for allocations to various state jurisdictions and other payors. This change in estimate reduced our Refunds due
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As of December 31, 2005 2004
Medicare 38.2 % 39.6 % Medicaid 3.7 % 3.0 % Workers’ compensation 11.7 % 11.2 % Managed care and other discount plans 37.7 % 38.1 % Other third-party payors 7.5 % 7.5 % Patients 1.2 % 0.6 %
100.0 % 100.0 %
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements patients and other third-party payors liability at December 31, 2005 by approximately $14.5 million.
Marketable Securities—
In accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities , we record all debt investments and equity securities with readily determinable fair values and for which we do not exercise significant influence as available-for-sale securities. We carry the available-for-sale securities at fair value and report unrealized holding gains or losses, net of income taxes, in Accumulated other comprehensive (loss) income , which is a separate component of shareholders’ deficit. We recognize realized gains and losses in our consolidated statements of operations using the specific identification method.
Property and Equipment—
We report land, buildings, improvements, and equipment at cost, net of asset impairment, and assets under capital lease obligations at the lower of fair value or the present value of the aggregate future minimum lease payments at the beginning of the lease term. We depreciate our assets using the straight-line method over the shorter of the estimated useful life of the assets or life of the lease term, excluding any lease renewals, unless the lease renewals are reasonably assured. Useful lives are as follows:
Maintenance and repairs of property and equipment are expensed as incurred. We capitalize replacements and betterments that increase the estimated useful life of an asset. We capitalize interest expense on major construction and development projects while in progress.
We retain fully depreciated assets in property and accumulated depreciation accounts until we remove them from service. In the case of sale, retirement, or disposal, the asset cost and related accumulated depreciation balance is removed from the respective account, and the resulting net amount, less any proceeds, is included as a component of income from continuing operations in the consolidated statements of operations. However, if the sale, retirement, or disposal involves a discontinued operation, the resulting net amount, less any proceeds, is included in the results of discontinued operations.
We account for operating leases under the provisions of FASB Statement No. 13, Accounting for Leases, and FASB Technical Bulletin No. 85-3, Accounting for Operating Leases with Scheduled Rent Increases. These pronouncements require us to recognize escalated rents, including any rent holidays, on a straight-line basis over the term of the lease for those lease agreements where we receive the right to control the use of the entire leased property at the beginning of the lease term.
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Years Buildings 15 to 30 Leasehold improvements 5 to 30 Furniture, fixtures, and equipment 3 to 10 Assets under capital lease obligation:
Real estate 6 to 30 Equipment 2 to 5
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Goodwill and Other Intangible Assets—
We account for goodwill and other intangibles under the guidance in FASB Statement No. 141, Business Combinations , FASB Statement No. 142, Goodwill and Other Intangible Assets , and FASB Statement No. 144.
Under FASB Statement No. 142, we test goodwill for impairment using a fair value approach, at the reporting unit level. A reporting unit is the operating segment, or a business one level below that operating segment (the component level) if discrete financial information is prepared and regularly reviewed by management at the component level. At HealthSouth, our reporting units are equal to our operating segments. We are required to test for impairment at least annually, absent some triggering event that would require an impairment assessment. Absent any impairment indicators, we perform our goodwill impairment testing as of October 1st of each year. We also tested for goodwill impairment as of March 19, 2003, due to the significant events which occurred at HealthSouth on that date.
We recognize an impairment charge for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its implied fair value . We present a goodwill impairment charge as a separate line item within income from continuing operations in the consolidated statements of operations, unless the goodwill impairment is associated with a discontinued operation. In that case, we include the goodwill impairment charge, on a net-of-tax basis, within the results of discontinued operations.
We use discounted cash flows to establish the fair value of our reporting units as of the testing dates. The discounted cash flow approach includes many assumptions related to future growth rates, discount factors, future tax rates, etc. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairment in future periods. When available and as appropriate, we use comparative market multiples to corroborate discounted cash flow results. When a business within a reporting unit is disposed of, goodwill is allocated to the gain or loss on disposition using the relative fair value methodology, as prescribed in FASB Statement No. 142.
In accordance with FASB Statement No. 142, we amortize the cost of intangible assets with definite useful lives over their respective estimated useful lives to their estimated residual value. As of December 31, 2005, our definite useful lived intangible assets do not have an estimated residual value. We also review those assets for impairment in accordance with FASB Statement No. 144 whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. As of December 31, 2005, we do not have any intangible assets with indefinite useful lives. The range of estimated useful lives of our other intangible assets is as follows:
Impairment of Long-Lived Assets and Other Intangible Assets—
Under the guidance in FASB Statement No. 144, we assess the recoverability of long-lived assets (excluding goodwill) and identifiable acquired intangible assets with finite useful lives, whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. We measure the recoverability of assets to be held and used by a comparison of the carrying amount of the asset to the expected net future cash flows to be generated by that asset, or, for identifiable intangibles with finite useful lives, by
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Years Certificates of need 10 to 30 Licenses 10 to 20 Noncompete agreements 5 to 10 Management agreements 10 to 20
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements determining whether the amortization of the intangible asset balance over its remaining life can be recovered through undiscounted future cash flows. The amount of impairment of identifiable intangible assets with finite useful lives, if any, to be recognized is measured based on projected discounted future cash flows. We measure the amount of impairment of other long-lived assets (excluding goodwill) as the amount by which the carrying value of the asset exceeds the fair market value of the asset, which is generally determined based on projected discounted future cash flows or appraised values. We present an impairment charge as a separate line item within income from continuing operations in our consolidated statements of operations, unless the impairment is associated with a discontinued operation. In that case, we include the impairment charge, on a net-of-tax basis, within the results of discontinued operations. We classify long-lived assets to be disposed of other than by sale as held and used until they are disposed. We report long-lived assets to be disposed of by sale as held for sale and recognize those assets in the balance sheet at the lower of carrying amount or fair value less cost to sell, and cease depreciation.
Investment in and Advances to Nonconsolidated Affiliates—
Investments in entities in which we have the ability to exercise significant influence over the operating and financial policies of the investee are accounted for under the equity method. Equity method investments are recorded at original cost and adjusted periodically to recognize our proportionate share of the investees’ net income or losses after the date of investment, additional contributions made and dividends or distributions received, and impairment losses resulting from adjustments to net realizable value. We record equity method losses in excess of the carrying amount of an investment when we guarantee obligations or we are otherwise committed to provide further financial support to the affiliate.
We use the cost method to account for equity investments for which the equity securities do not have readily determinable fair values and for which we do not have the ability to exercise significant influence. Under the cost method of accounting, private equity investments are carried at cost and are adjusted only for other-than-temporary declines in fair value and additional investments.
Management periodically assesses the recoverability of our equity method and cost method investments and equity method goodwill for impairment. We consider all available information, including the recoverability of the investment, the earnings and near-term prospects of the affiliate, factors related to the industry, conditions of the affiliate, and our ability, if any, to influence the management of the affiliate. We assess fair value based on valuation methodologies, as appropriate, including discounted cash flows, estimates of sales proceeds and external appraisals, as appropriate. If an investment or equity method goodwill is considered to be impaired and the decline in value is other than temporary, we record an appropriate write-down.
Guarantees—
We account for certain guarantees in accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others . FASB Interpretation No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FASB Interpretation No. 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of certain obligations undertaken.
As of December 31, 2005 and 2004, we were liable for guarantees of indebtedness owed by third parties in the amount of $30.8 million and $29.0 million, respectively. We have recognized these amounts as liabilities in our consolidated balance sheets because of existing defaults by the third parties under those agreements.
We are also secondarily liable for certain lease obligations associated with sold facilities. See Note 5, Property and Equipment , for additional information.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Financing Costs—
We amortize financing costs using the effective interest method over the life of the related debt. The related expense is included in Interest expense and amortization of debt discounts and fees in our consolidated statements of operations.
We accrete discounts and amortize premiums using the effective interest method over the life of the related debt, and we report discounts or premiums as a direct deduction from, or addition to, the face amount of the financing. The related income or expense is included in Interest expense and amortization of debt discounts and fees in our consolidated statements of operations.
Fair Value of Financial Instruments—
FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, requires certain disclosures regarding the fair value of financial instruments. Our financial instruments consist mainly of cash and cash equivalents, certificates of deposit, restricted cash, accounts receivable, notes receivable from shareholders, officers, and employees, accounts payable, related party notes receivable and payable, letters of credit, and long-term debt. The carrying amounts of cash and cash equivalents, certificates of deposit, restricted cash, accounts receivable, notes receivable from shareholders, officers, and employees, related party notes receivable and payable, and accounts payable approximate fair value because of the short-term maturity of these instruments. The fair value of our letters of credit is deemed to be the amount of payment guaranteed on our behalf by third-party financial institutions. We determine the fair value of our long-term debt based on various factors, including maturity schedules, call features, and current market rates. We also use quoted market prices, when available, or discounted cash flows to determine fair values of long-term debt.
Asset Retirement Obligation—
We record certain obligations associated with the retirement of tangible long-lived assets under the guidance in FASB Statement No. 143, Accounting for Asset Retirement Obligations. Under this standard, we recognize the fair value of a liability for an asset retirement obligation in the period in which the obligation is incurred if we can make a reasonable estimate of the liability’s fair value. The associated asset retirement cost is capitalized as part of the carrying amount of the long-lived asset and depreciated over the remaining life of the underlying asset, and the associated liability is accreted to the estimated fair value of the obligation at the settlement date through periodic accretion charges to the consolidated statement of operations. When the obligation is settled, any difference between the final cost and the recorded amount is recognized as income or loss on settlement.
Effective January 1, 2003, we adopted the initial recognition and measurement provisions of FASB Statement No. 143 and identified certain asset retirement obligations to restore leased premises for the removal of certain diagnostic equipment. Upon adoption of FASB Statement No. 143, we recorded a $3.6 million increase to property and equipment, a $1.9 million increase to accumulated depreciation and amortization, a $4.2 million increase to Other long-term liabilities , and a $2.5 million noncash charge (net of tax of $0), which we reported as a Cumulative effect of accounting change in our 2003 consolidated statement of operations.
Minority Interests in Consolidated Affiliates—
The consolidated financial statements include all assets, liabilities, revenues, and expenses of less-than-100%-owned affiliates that we control. Accordingly, we have recorded minority interests in the earnings and equity of such entities. We record adjustments to minority interest for the allocable portion of income or loss to which the minority interest holders are entitled based upon their portion of the subsidiaries they own. Distributions to holders of minority interests are adjusted to the respective minority interest holders’ balance.
F-25
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
We suspend allocation of losses to minority interest holders when the minority interest balance for a particular minority interest holder is reduced to zero and the minority interest holder does not have an obligation to fund such losses. Any excess loss above the minority interest holders’ balance is not charged to minority interest but rather is recognized by us until the affiliate begins earning income again. We resume adjusting minority interest for the subsequent profits earned by a subsidiary only after the cumulative income exceeds the previously unrecorded losses.
Litigation Reserve—
Pursuant to FASB Statement No. 5, Accounting for Contingencies, we accrue for loss contingencies associated with outstanding litigation for which management has determined it is probable that a loss contingency exists and the amount of loss can be reasonably estimated. If the accrued amount associated with a loss contingency is greater than $5.0 million, we also accrue estimated future legal fees associated with the loss contingency. This requires management to estimate the amount of legal fees that will be incurred in the defense of the litigation. These estimates are based heavily on our expectations of the scope, length to complete, and complexity of the claims. In the future, additional adjustments may be recorded as the scope, length or complexity of outstanding litigation changes.
Advertising Costs—
We expense costs of print, radio, television, and other advertisements as incurred. Advertising expenses, included in Other operating expenses within the accompanying consolidated statements of operations, approximated $8.6 million in 2005, $5.3 million in 2004, and $7.7 million in 2003.
Stock-Based Compensation—
HealthSouth has various shareholder- and non-shareholder-approved stock-based compensation plans that provide for the granting of stock-based compensation to certain employees and directors, which are described more fully in Note 14, Stock-Based Compensation . We account for those stock-based compensation plans using the recognition and measurement principles of the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations, and apply the disclosure-only provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation . Under the intrinsic value method, we recognize compensation expense on the date of grant only if the current market price of the underlying stock on the grant date exceeds the exercise price of the stock-based award.
F-26
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
FASB Statement No. 123 requires that we present certain pro forma information assuming that we recognize an expense for our stock-based compensation using the fair value based method of accounting for stock-based compensation. We estimated the fair value of our stock-based compensation at the date of grant using the Black-Scholes option-pricing model using the assumptions described in Note 14, Stock-Based Compensation . If we had recognized compensation expense using the fair value recognition provisions of FASB Statement No. 123, the pro forma amounts of our net loss for the years ended December 31, 2005, 2004, and 2003 would have been as follows (in thousands, except per share amounts):
Discontinued Operations—
We account for discontinued operations under FASB Statement No. 144, which requires that a component of an entity that has been disposed of or is classified as held for sale and has operations and cash flows that can be clearly distinguished from the rest of the entity be reported as discontinued operations. In the period that a component of an entity has been disposed of or classified as held for sale, we reclassify the results of operations for current and prior periods into a single caption titled Loss from discontinued operations, net of income tax expense . In addition, we classify the assets and liabilities of those components as current and noncurrent assets and liabilities of discontinued operations in our consolidated balance sheets. We also classify cash flows related to discontinued operations as one line item within each category of cash flows in our consolidated statements of cash flows.
Income Taxes—
We provide for income taxes using the asset and liability method as required by FASB Statement No. 109, Accounting for Income Taxes. This approach recognizes the amount of federal, state, and local taxes payable or refundable for the current year, as well as deferred tax assets and liabilities for the future tax consequence of events recognized in the consolidated financial statements and income tax returns. Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates.
Under FASB Statement No. 109, a valuation allowance is required when it is more likely than not that some portion of the deferred tax assets will not be realized. Realization is dependent on generating sufficient future taxable income.
HealthSouth and its corporate subsidiaries file a consolidated federal income tax return. State income tax returns are filed on a separate, combined, or consolidated basis in accordance with relevant state laws and regulations. Partnerships, limited liability partnerships, limited liability companies, and other pass-through
F-27
For the year ended December 31, 2005 2004 2003
Net loss, as reported $ (445,994 ) $ (174,470 ) $ (434,557 )
Add: Stock-based employee compensation expense (benefit) included in reported net loss 1,999 614 (2,932 ) Deduct: Total stock-based employee compensation expense determined under fair value
based method for all awards (10,645 ) (8,693 ) (7,874 )
Pro forma net loss $ (454,640 ) $ (182,549 ) $ (445,363 )
Basic and diluted—pro forma $ (1.15 ) $ (0.46 ) $ (1.12 )
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements entities that we consolidate or account for using the equity method of accounting file separate federal and state income tax returns. We include the allocable portion of each pass-through entity’s income or loss in our federal income tax return. We allocate the remaining income or loss of each pass-through entity to the other partners or members who are responsible for their portion of the taxes.
Comprehensive Loss—
Comprehensive loss is reported in accordance with the provisions of FASB Statement No. 130, Reporting Comprehensive Income. FASB Statement No. 130 establishes the standard for reporting comprehensive loss and its components in financial statements. Comprehensive loss is comprised of net loss, changes in unrealized gains or losses on available-for-sale securities, and foreign currency translation adjustments and is included in the consolidated statements of shareholders’ deficit and comprehensive loss.
Foreign Currency Translation—
The financial statements of foreign subsidiaries whose functional currency is not the U.S. dollar have been translated to U.S. dollars in accordance with FASB Statement No. 52, Foreign Currency Translation. Foreign currency assets and liabilities are remeasured into U.S. dollars at the end-of-period exchange rates. Revenues and expenses are translated at average exchange rates in effect during each period, except for those expenses related to balance sheet amounts, which are translated at historical exchange rates. Gains and losses from foreign currency translations are reported as a component of Accumulated other comprehensive (loss) income within shareholders’ deficit. Exchange gains and losses from foreign currency transactions are recognized in the consolidated statements of operations and historically have not been material.
Restructuring Activities—
We assess the need to record restructuring charges in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities . FASB Statement No. 146 addresses the financial accounting and reporting for costs associated with exit or disposal activities and requires a company to recognize costs associated with exit or disposal activities when they are incurred. Examples of costs covered by the statement include lease termination costs and certain employee severance costs that are associated with restructuring activities, discontinued operations, facility closings, or other exit or disposal activities.
We recognize liabilities that primarily include one-time termination benefits, or severance, and contract termination costs, primarily related to equipment and facility lease obligations. These amounts are based on the remaining amounts due under various contractual agreements, adjusted for any anticipated or unanticipated events or changes in circumstances that would reduce these obligations. The settlement of these liabilities could differ materially from recorded amounts.
Loss Per Share—
The calculation of loss per share is based on the weighted-average number of our common shares outstanding during the applicable period. The calculation for diluted loss per share recognizes the effect of all potential dilutive common shares that were outstanding during the respective periods, unless their impact would be antidilutive.
Selected Quarterly Financial Information—
We have not presented the selected quarterly financial data for 2005 and 2004 as required by Item 302(a) of Regulation S-K that the SEC requires as supplementary information to the basic financial statements.
F-28
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Recent Accounting Pronouncements—
In December 2004, the FASB issued FASB Statement No. 123 (Revised 2004), Share-Based Payment , which revises FASB Statement No. 123 and supersedes APB Opinion No. 25 and its related implementation guidance. The revised Statement focuses primarily on accounting for transactions in which a company obtains employee services in share-based payment transactions. FASB Statement No. 123(R) eliminates the alternative of applying the intrinsic value measurement provisions of APB Opinion No. 25 to stock compensation awards issued to employees. Rather, the new standard requires a company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. A company will recognize the cost over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
In March 2005, the Staff of the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment . SAB No. 107 expresses the view of the SEC staff regarding the interaction between FASB Statement No. 123(R) and certain SEC rules and regulations and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. The SEC staff believes the guidance in SAB No. 107 will assist public companies in their initial implementation of FASB Statement No. 123(R) and enhance the information received by investors and other users of financial statements, thereby assisting them in making investment and other decisions. SAB No. 107 also includes interpretive guidance related to share-based payment transactions with nonemployees, the transition from nonpublic to public entity status, valuation methods (including the determination of assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instruments issued under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of FASB Statement No. 123(R) in an interim period, capitalization of compensation cost related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of FASB Statement No. 123(R), the modification of employee share options prior to adoption of FASB Statement No. 123(R), and disclosures in Management’s Discussion and Analysis subsequent to adoption of FASB Statement No. 123(R). FASB Statement No. 123(R) is effective for annual periods beginning after June 15, 2005. Its expected impact on our results of operations is discussed below.
FASB Statement No. 123(R) requires the use of the Modified Prospective Application Method at the required effective date. Under this method, FASB Statement No. 123(R) is applied to new awards and to awards modified, repurchased, or cancelled after the effective date. Additionally, we will recognize compensation cost for the portion of awards for which the requisite service date has not been rendered (such as unvested options) that are outstanding as of the date of adoption as the remaining requisite services are rendered. We will base the compensation cost relating to unvested awards at the date of adoption on the grant-date fair value of those awards as calculated for pro forma disclosures under the original FASB Statement No. 123. In addition, a company may use the Modified Retrospective Application Method prior to the required effective date. A company may apply this method to all prior years for which the original FASB Statement No. 123 was effective or only to prior interim periods in the year of initial adoption. If a company uses the Modified Retrospective Application Method, it will adjust the financial statements for prior periods to give effect to the fair-value-based method of accounting for awards on a consistent basis with the pro forma disclosures required for those periods under the original FASB Statement No. 123.
We will adopt FASB Statement No. 123(R) on January 1, 2006 on a modified prospective basis, which will require recognition of compensation expense for all stock option or other equity-based awards that vest or become exercisable after the effective date. At December 31, 2005, unamortized compensation expense related to outstanding unvested options, as determined in accordance with FASB Statement No. 123(R), that we expect to record during 2006, 2007, and 2008 was approximately $9.1 million, $5.7 million, and $1.2 million, respectively,
F-29
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements before provisions for income taxes and forfeitures. We will incur additional expense during fiscal 2006 related to new awards granted during 2006 that cannot yet be quantified. We are in the process of determining how the guidance regarding valuing share-based compensation as prescribed in FASB Statement No. 123(R) will be applied to valuing share-based awards granted after the effective date and the impact that the recognition of compensation expense related to such awards will have on our financial statements.
We do not believe any other recently issued, but not yet effective, accounting standards will have a material effect on our consolidated financial position, results of operations, or cash flows.
We are highly leveraged. As of December 31, 2005, we had approximately $3.4 billion of long-term debt outstanding.
On March 10, 2006, we prepaid substantially all of our previously existing debt with proceeds from a series of recapitalization transactions (see Note 8, Long-term Debt ). Although we remain highly leveraged, we believe these recapitalization transactions have eliminated significant uncertainty regarding our capital structure and have improved our financial position by reducing our refinancing risk, improving our operational flexibility, improving our credit profile, and reducing our interest rate exposure.
We are required to use a substantial portion of our cash flow to service our debt and meet cash obligations relating to government settlements (see Note 21, Medicare Program Settlement , and Note 22, SEC Settlement ). However, we believe our projected liquidity is sufficient to meet our current operating cash flow requirements, service our debt, and satisfy the obligations owed to the government.
The biggest risk relating to our high leverage is the possibility that a substantial down-turn in earnings could jeopardize our ability to service our debt payment obligations. See Note 1, Summary of Significant Accounting Policies , for a discussion of risks and uncertainties facing us. Changes in our business or other factors may occur that might have a material adverse impact on our financial position, results of operations, and cash flows.
Accounts receivable consists of the following (in thousands):
Patient accounts receivable, net 400,662 429,607 Other accounts receivable 4,511 1,209
Accounts receivable, net $ 405,173 $ 430,816
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The following is the activity related to our allowance for doubtful accounts (in thousands):
As of December 31, 2005, our investments consist of cash and cash equivalents and marketable securities. As of December 31, 2004, our investments consisted of only cash and cash equivalents, as disclosed in Note 1, Summary of Significant Accounting Policies . Our investments in marketable securities are classified as available-for-sale. The components of our investments as of December 31, 2005 are as follows (in thousands):
Approximately $86.0 million of restricted cash in the above chart is noncurrent (See Note 1, Summary of Significant Accounting Policies ).
When the maturity of our debt marketable securities in commercial paper or U.S. Government and agency securities is three months or less when purchased, we classify these amounts to Cash and cash equivalents on our consolidated balance sheets (see Note 1, Summary of Significant Accounting Policies ). A summary of our marketable securities as of December 31, 2005 is as follows (in thousands):
F-31
For the year ended December 31,
Balance at beginning of
period
Additions and charges to expense
Deductions and accounts written-off
Balance at end of period
2005 $ 151,453 $ 98,417 $ (125,328 ) $ 124,542
2004 $ 214,521 $ 113,783 $ (176,851 ) $ 151,453
2003 $ 220,733 $ 128,296 $ (134,508 ) $ 214,521
4. Cash and Marketable Securities:
Cash and cash
equivalents Restricted
cash Marketable securities Total
Cash $ 161,787 $ 242,450 $ — $ 404,237 Commercial paper 7,970 — 1,998 9,968 Certificates of deposit 1,500 — — 1,500 U.S. Government and agency securities 4,240 — 21,297 25,537 Corporate bonds and notes — — 97 97 Equity securities — — 447 447
Total $ 175,497 $ 242,450 $ 23,839 $ 441,786
Amortized
Cost
Gross Unrealized
Gains
Gross Unrealized
Losses Fair Value
Commercial paper $ 9,969 $ 1 $ (2 ) $ 9,968 U.S. Government and agency securities 25,582 1 (46 ) 25,537 Corporate bonds and notes 98 — (1 ) 97 Equity securities 397 62 (12 ) 447
Total $ 36,046 $ 64 $ (61 ) $ 36,049
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Investing information related to our marketable securities is as follows (in thousands):
The maturities of debt securities at December 31, 2005 are as follows (in thousands):
HealthTronics—
HealthSouth owned 415,666 shares of HealthTronics’s common stock from 1999 through 2003. A former director and employee owned 83,334 shares. The original value of the investment was approximately $3.0 million, which we accounted for at fair value. In addition, certain directors and officers of HealthSouth also served on the board of directors of HealthTronics. We sold our investment in HealthTronics during 2003 for approximately $3.7 million and realized a gain of approximately $0.7 million. We purchased medical equipment and related supplies from HealthTronics amounting to approximately $0.8 million in 2003.
Property and equipment consists of the following (in thousands):
F-32
For the year ended December 31, 2005 2004 2003
Proceeds from sales of available-for-sale securities $ 47,191 $ — $ 3,698
Gross realized gains $ 15 $ — $ 698
Gross realized losses $ (7 ) $ — $ —
Amortized
Cost Fair Value
Due in one year or less $ 31,788 $ 31,758 Due after one year through five years 5,361 5,344
$ 37,149 $ 37,102
5. Property and Equipment:
As of December 31, 2005 2004
Land $ 106,007 $ 98,103 Buildings 1,199,090 1,229,806 Leasehold improvements 209,917 214,168 Furniture, fixtures, and equipment 812,890 847,096
1,161,967 1,293,927 Construction in progress 44,539 45,228
Property and equipment, net $ 1,206,506 $ 1,339,155
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The amount of fully depreciated assets, depreciation expense, amortization expense, and accumulated amortization relating to assets under capital lease obligations, interest capitalized on construction projects, and rent expense under operating leases is as follows (in thousands):
Leases—
We lease certain land, buildings, and equipment under non-cancelable operating leases expiring at various dates through 2027, and certain buildings and equipment under capital leases also expiring at various dates through 2027. Operating leases generally have five- to ten-year terms, with one or more renewal options, with terms to be negotiated at the time of renewal. Various facility leases include provisions for rent escalation to recognize increased operating costs or require the Company to pay certain maintenance and utility costs. Contingent rents are included in rent expense in the year incurred. Some facilities are subleased to other parties. Rental income from subleases approximated $12.7 million, $8.8 million, and $16.5 million for the years ended December 31, 2005, 2004, and 2003, respectively. Certain leases contain annual escalation clauses based on changes in the Consumer Price Index while others have fixed escalation terms. The excess of cumulative rent expense (recognized on the straight-line basis) over cumulative rent payments made on leases with fixed escalation terms is recognized as straight-line rental accrual and is included in Other long-term liabilities in the accompanying consolidated balance sheets, as follows (in thousands):
Assets under capital lease obligations, net $ 150,001 $ 194,800 $ 170,479
Amortization expense $ 21,832 $ 26,338 $ 26,090
Interest capitalized $ — $ 8,412 $ 5,132
Rent expense:
Minimum rent payments $ 114,082 $ 128,361 $ 109,946 Contingent and other rents 37,618 67,634 90,001
Total rent expense $ 151,700 $ 195,995 $ 199,947
As of December 31, 2005 2004
Straight-line rental accrual $ 19,156 $ 20,935
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Future minimum lease payments at December 31, 2005, for those leases having an initial or remaining non-cancelable lease term in excess of one year are as follows (in thousands):
Obligations Under Sublease Guarantees—
In conjunction with the sale of certain facilities in prior years, HealthSouth agreed to enter into subleases for certain properties with certain purchasers and, as a condition of the sublease, agreed to act as a guarantor of the purchaser’s performance on the sublease. Should the purchaser, or sublessee, fail to pay the rent due on these leases, the lessor would have contractual recourse against us.
As of December 31, 2005, we had entered into four such sublease guarantee arrangements. The remaining terms of these subleases range from one year to nine years. If we were required to perform under all such guarantees, the maximum amount we would be required to pay approximates $11.6 million.
We have not recorded a contingent liability for these guarantees, as we do not believe it is probable we will have to perform under these agreements. In the event we are required to perform under these guarantees, we could potentially have recourse against the sublessee for recovery of any amounts paid. These guarantees are not secured by any assets under the leases. As of December 31, 2005, we have not been required to perform under any such sublease guarantees.
Collateralized Assets—
Pursuant to a Collateral and Guarantee Agreement dated as of March 21, 2005, between the Company and JPMorgan Chase Bank (“JPMorgan”), our obligations under our Amended and Restated Credit Agreement are collateralized by substantially all of the assets of HealthSouth. See Note 8, Long-term Debt , for additional information regarding the Amended and Restated Credit Agreement. See Note 8 also for a discussion of our recapitalization transactions in March 2006 and the collateral and guarantee agreement governing our new indebtedness.
Construction in Progress—
In 2001, we began construction of a 219 bed state of the art general acute care hospital (the “Digital Hospital”) on property adjacent to our corporate campus in Birmingham, Alabama. In connection with the construction of the Digital Hospital, we incurred significant costs and included those capitalized costs in Construction in Progress (“CIP”). Amounts in CIP at December 31, 2005 and 2004 relate principally to the Digital Hospital. We have entered into construction contracts and other future commitments for the completion of this property totaling in years subsequent to 2005 of approximately $36.1 million.
Notes to Consolidated Financial Statements Asset Impairments—
For the years ended December 31, 2005, 2004, and 2003, we recognized an impairment charge of approximately $45.2 million, $36.3 million, and $132.7 million, respectively. Of these total amounts, approximately $24.4 million, $30.2 million and $127.9 million, respectively, relate to the Digital Hospital and represent the excess of costs incurred during the construction of the Digital Hospital over the estimated fair market value of the property, including the RiverPoint facility, a 60,000 square foot office building, which shares the construction site and would be included with any sale of the Digital Hospital. The impairment of the Digital Hospital in 2003 was based on an appraisal that considered alternative uses for the property. The impairment of the Digital Hospital in 2004 and 2005 was determined using a weighted average fair value approach that considered the 2003 appraisal and other potential scenarios.
The remainder of the 2005, 2004, and 2003 impairment charges relate to long-lived assets at various facilities that were examined for impairment due to facility closings and facilities experiencing negative cash flow from operations. In 2005, we determined the fair value of the impaired long-lived assets at a facility primarily based on the assets’ estimated fair value using valuation techniques that included discounted future cash flows and third-party appraisals. These 2005 charges primarily relate to our surgery centers, diagnostic, and corporate and other segments. In 2004, the remainder of the charge represents our write-down of long-lived assets, primarily in our surgery centers and outpatient segments, based on a valuation of future cash flows. We wrote these assets down to zero, or their estimated fair value, based on expected negative operating cash flows of these facilities in future years. In 2003, we determined the fair value of the impaired long-lived assets at a facility primarily based on the discounted future cash flows of these facilities using an average weighted average discount rate of 10.5%.
See Note 6, Goodwill and Other Intangible Assets, for a description of the impairment charges recognized for goodwill and other intangibles.
See Note 25, Segment Reporting, for the amount of impairment charges by operating segment.
Goodwill represents the unallocated excess of purchase price over the fair value of identifiable assets and liabilities acquired in business combinations. Other definite-lived intangibles consist primarily of certificates of need, licenses, noncompete agreements, and management agreements.
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6. Goodwill and Other Intangible Assets:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The following table shows changes in the carrying amount of goodwill for the years ended December 31, 2005, 2004, and 2003, by operating segment (in thousands):
We performed an impairment review as required by FASB Statement No. 142 as of March 19, 2003, and concluded that a potential goodwill impairment existed in our outpatient and diagnostic reporting units. We calculated the implied fair value of the outpatient reporting unit’s goodwill and determined that the outpatient reporting unit’s goodwill was impaired by $135.9 million. We calculated the implied fair value of the diagnostic reporting unit’s goodwill and determined that the remaining goodwill was impaired, which resulted in an impairment charge of $23.5 million.
We performed an impairment review as required by FASB Statement No. 142 as of October 1, 2003 and concluded that a potential goodwill impairment existed in our surgery centers reporting unit. This impairment was caused by a continuing decline in the operating results of our surgery centers reporting unit caused primarily by the inability to attract new physicians to our surgery centers in the wake of the events of March 19, 2003. We calculated the implied fair value of our surgery centers reporting unit’s goodwill as required by FASB Statement No. 142 and determined that our surgery centers reporting unit’s goodwill was impaired by $176.2 million.
We performed impairment reviews as required by FASB Statement No. 142 as of October 1, 2005 and 2004 and concluded that no goodwill impairment existed.
F-36
Inpatient Surgery Centers Outpatient Diagnostic
Corporate
and Other Total
Goodwill as of January 1, 2003 $ 402,255 $ 649,123 $ 160,538 $ 21,000 $ — $ 1,232,916 Impairment charge — (176,208 ) (135,888 ) (23,527 ) — (335,623 ) Acquisition of equity interests in joint venture entities 64 2,761 350 2,527 — 5,702
Goodwill as of December 31, 2003 $ 402,319 $ 475,676 $ 25,000 $ — $ — $ 902,995 Acquisitions — — 581 — — 581 Acquisition of equity interests in joint venture entities — 7,121 — — — 7,121 Other (381 ) 881 (111 ) — — 389
Goodwill as of December 31, 2004 $ 401,938 $ 483,678 $ 25,470 $ — $ — $ 911,086 Acquisition of equity interests in joint venture entities 1,239 2,399 — — — 3,638 Conversion of consolidated facilities to equity method
facilities — (3,303 ) (18 ) — — (3,321 )
Goodwill as of December 31, 2005 $ 403,177 $ 482,774 $ 25,452 $ — $ — $ 911,403
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The following table provides information regarding our other intangible assets (in thousands):
Amortization expense for other intangible assets is as follows (in thousands):
Total estimated amortization expense for our other intangible assets for the next five fiscal years is as follows (in thousands):
Asset Impairments—
In the fourth quarter of 2004, we examined certain facilities for impairment due to continuing negative cash flows from operations and/or projected negative cash flows from operations of these facilities. As a result of this analysis, we recognized an impairment charge to reduce other intangibles to fair value for certain operating facilities of approximately $1.0 million under the provisions of FASB Statement No. 144. We determined the fair value of the impaired assets at a facility primarily based on a valuation of future cash flows. We wrote these assets down to zero, or their estimated fair value, based on expected negative future operating cash flows of these facilities in future years.
Investment in and advances to nonconsolidated affiliates represents our investment in 57 partially owned subsidiaries, of which 52 are general or limited partnerships, limited liability companies, or joint ventures in which HealthSouth or one of our subsidiaries is a general or limited partner, managing member, member, or venturer, as applicable. We do not control these affiliates, but have the ability to exercise significant influence over the operating and financial policies of certain of these affiliates. Our ownership percentages in these affiliates generally range from 4% to 52%. HealthSouth’s investment in these affiliates is an integral part of our operations. We account for these investments using the cost and equity methods of accounting. Our investments consist of the following (in thousands):
The following summarizes the combined assets, liabilities, and equity and the combined results of operations of our equity method affiliates (on a 100% basis, in thousands):
Condensed statements of operations (in thousands):
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7. Investment in and Advances to Nonconsolidated Affiliates:
As of December 31, 2005 2004
Equity method investments:
Capital contributions $ 41,767 $ 34,116 Cumulative share of income 144,120 126,925 Cumulative share of distributions (141,415 ) (121,109 )
44,472 39,932 Cost method investments:
Capital contributions, net of partnership distributions and impairments 1,916 1,113
Total investments in and advances to nonconsolidated affiliates $ 46,388 $ 41,045
As of December 31, 2005 2004
Assets—
Current $ 32,808 $ 34,628 Noncurrent 87,355 112,154
Total assets $ 120,163 $ 146,782
Liabilities and equity—
Current liabilities $ 6,343 $ 19,202 Noncurrent 14,479 12,716 Partners’ capital and shareholders’ equity—
Net operating revenues $ 142,684 $ 119,672 $ 106,685 Operating expenses (88,411 ) (84,847 ) (63,155 ) Income from continuing operations 54,273 34,825 43,530 Net income $ 41,293 $ 34,156 $ 35,510
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
During 2005, five surgery centers became equity method investments rather than consolidated affiliates as a result of changes of control of these entities. This reclassification decreased 2005 consolidated net operating revenues by approximately $25.6 million.
Source Medical—
In April 2001, we established Source Medical Solutions, Inc. (“Source Medical”) to continue development and allow commercial marketing of a wireless clinical documentation system originally developed by HealthSouth. This proprietary software was referred to internally as “HCAP” and was later marketed by Source Medical under the name “TherapySource.” At the time of our initial investment, certain of our directors, executive officers, and employees also purchased shares of Source Medical’s common stock. Currently, we estimate we own approximately 7% of Source Medical.
In connection with one of Source Medical’s acquisitions during 2001, HealthSouth guaranteed certain contingent payment obligations of Source Medical to the sellers of $6.0 million. We recorded an impairment charge in 2002 related to this note receivable from Source Medical. We have established an agreement with Source Medical requiring quarterly interest payments on this note. The note is due in full in April 2008 but is callable in August 2007.
In addition, during 2002, Source Medical borrowed $5.0 million for working capital from an unrelated third-party financial institution. HealthSouth guaranteed the loan. In March 2003, the loan was called, and we were required to pay $5.1 million to repay the loan, including interest, on behalf of Source Medical. In our 2002 consolidated financial statements, we accrued $5.1 million as an uncollectible amount due from Source Medical. In the fourth quarter of 2005, we received a $5.0 million payment from Source Medical related to this note.
We received approximately $1.0 million in interest payments throughout 2005 related to the two notes discussed above. From May 2003 to December 2004, Source Medical did not make interest payments on these two notes. This unpaid interest totaling $1.9 million is considered a separate note receivable from Source Medical, accrues additional interest at 4.75%, and is due to be repaid to us in April 2008. This note is also callable in August 2007.
We continue to lease HCAP software from Source Medical for approximately $4.3 million annually, and we remain a major customer of Source Medical. We paid Source Medical an additional $1.9 million in 2005 for custom software development and other miscellaneous services. We believe that the licensing terms are as favorable as we could have received from an unaffiliated third party.
Through December 2005, we held two of five seats on Source Medical’s board of directors. In December 2005, we gave up these seats but retained certain observation rights into Source Medical’s operations.
MedCenterDirect.Com, Inc.—
In 1999, we acquired 6,390,583 shares of Series A Preferred Stock of MedCenterDirect.com, Inc. (“MCD”) for a total purchase price of approximately $2.2 million. At the time of our initial investment, certain of our directors, executive officers, and employees also purchased shares of MCD’s Series A Preferred Stock. Charles W. Newhall III, a former HealthSouth director, served on MCD’s board of directors.
Until November 2002, MCD purchased equipment and supplies from third-party vendors for resale, and we paid MCD 105% of its cost for the purchase of equipment and supplies purchased through MCD, with the 5% margin intended to compensate MCD for the use of its software and inventory management services. Beginning
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements in November 2002, we began paying MCD a flat annual fee (equal to $5.0 million for the first year of the arrangement, payable in equal monthly installments, and declining thereafter) for the use of its software and systems, and we resumed paying equipment and supply vendors directly. We were MCD’s primary customer.
Equipment and pharmaceutical supplies purchased from MCD approximated $2.1 million in 2003. No purchases were made from MCD in 2005 or 2004.
As of December 31, 2000, indicators were present that we would not recover our investment, and we reduced the carrying value of the investment to $0. We also provided a guarantee for $20.0 million of MCD’s debt to UBS Warburg in 2001. In 2002, we advanced approximately $9.2 million to MCD in the form of a loan, which was included in Due from related parties in our consolidated balance sheet as of December 31, 2002.
During 2003, UBS called its loan to MCD. We recognized a liability of approximately $20.0 million under the terms of the guarantee as of December 31, 2003, but have not paid the amounts due under the terms of the guarantee to UBS Warburg as of December 31, 2005. We also fully reserved the note receivable of approximately $9.2 million as of December 31, 2003.
CMS Capital Ventures, Inc.—
In 1998, we entered into a recapitalization agreement with CMS Capital Ventures, Inc. (a wholly owned subsidiary of HealthSouth) (“CMSCV”), CompHealth, Inc. (a wholly owned subsidiary of CMSCV), and certain other parties, whereby CMSCV purchased 85% of our interest in CMSCV. As a result of the recapitalization, we retained approximately 15% of the outstanding capital stock of CMSCV with a carrying value of $1.5 million and received net proceeds of approximately $34.1 million. In connection with this recapitalization, certain investors purchased capital stock of CMSCV, including affiliates of Acacia Venture Partners (“Acacia”) and New Enterprise Associates. C. Sage Givens, Michael D. Martin, and Charles W. Newhall III, former directors of the Company, were also CMSCV directors. In 2003, we sold our remaining interests in CMSCV for approximately $16.0 million and recognized a gain of approximately $14.5 million. During 2003, we purchased approximately $0.5 million of services from CompHealth, Inc.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Our long-term financing obligations outstanding consist of the following (in thousands):
The following chart shows scheduled payments due on long-term debt for the next five years and thereafter, adjusted to reflect the effect of the recapitalization transactions described later in this note (see Subsequent Event—Recapitalization Transactions ) (in thousands):
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8. Long-term Debt:
As of December 31, 2005 2004
Advances under $1.25 billion revolving credit facility $ — $ 315,000 Advances under $250 million revolving credit facility — — Senior Term Loans 313,425 — Term Loans 200,000 — Bonds payable—
6.875% Senior Notes due 2005 — 244,805 7.000% Senior Notes due 2008 249,162 248,383 10.750% Senior Subordinated Notes due 2008 318,312 318,034 8.500% Senior Notes dues 2008 343,000 343,000 8.375% Senior Notes due 2011 347,365 347,272 7.375% Senior Notes due 2006 180,300 180,300 7.625% Senior Notes due 2012 904,839 903,744 6.500% Convertible Subordinated Debentures due 2011 6,311 6,311 8.750% Convertible Subordinated Notes due 2015 10,136 11,573 10.375% Senior Subordinated Credit Agreement due 2011 332,356 329,189 Hospital revenue bond 500 1,500
Notes payable to banks and others at interest rates from 2.4% to 12.9% 6,881 12,793 Noncompete agreements 154 1,891 Capital lease obligations 191,302 233,396
3,404,043 3,497,191 Less current portion (34,298 ) (277,533 )
Long-term debt, less current portion $ 3,369,745 $ 3,219,658
The following table provides information regarding our Interest expense and amortization of debt discounts and fees presented in our consolidated statements of operations (in thousands):
Revolving Credit Facilities and Senior Term Loans—
On June 14, 2002, we entered into a five-year, $1.25 billion revolving credit facility, as amended on August 20, 2002 (the “2002 Credit Agreement”), with JPMorgan, which served as administrative agent, Wachovia Bank, N.A. (“Wachovia”), UBS Warburg LLC, Scotiabanc, Inc., Deutsche Bank AG, and Bank of America, N.A. (“Bank of America”). Interest on the 2002 Credit Agreement was paid based on LIBOR plus a predetermined margin or base rate. We were required to pay a fee based on the unused portion of the revolving credit facility ranging from .275% to .500% depending on our debt ratings. On May 1, 2003, we elected to reduce the commitment amount under the revolving credit facility to $385.6 million, or the amount outstanding of $315.0 million plus our letter of credit exposure on that date. As a result of this reduction, no fees accrued on the unused portion of this credit facility after this date. Fees accrued prior to May 1, 2003 were included in Interest expense and amortization of debt discounts and fees in the consolidated statements of operations. The principal amount was payable in full on June 14, 2007. The effective interest rate on the average outstanding balance under the 2002 Credit Agreement was 5.3% for the year ended December 31, 2004, compared to the average prime rate of 4.3% during the same period. Since March 2003, all borrowings under the 2002 Credit Agreement were priced at a default rate of prime plus 1.0%. As of December 31, 2004, we had drawn $315.0 million under the 2002 Credit Agreement.
In March 2003, our line of credit was frozen under the 2002 Credit Agreement. On March 27, 2003, we received notice that we were in default under the 2002 Credit Agreement. As a result, the lenders instituted a payment blockage which prohibited us from making the payments of principal and interest due to holders of our 3.25% Convertible Subordinated Debentures due on April 1, 2003.
On March 21, 2005, we entered into an amended and restated credit agreement (the “Amended and Restated Credit Agreement”) with a consortium of financial institutions (collectively, the “Lenders”), JPMorgan, as Administrative Agent and Collateral Agent, Wachovia, as Syndication Agent, and Deutsche Bank Trust Company Americas, as Documentation Agent. The Amended and Restated Credit Agreement amended and restated the 2002 Credit Agreement.
Pursuant to the Amended and Restated Credit Agreement, the Lenders converted $315 million in aggregate principal amount of the loans outstanding under the 2002 Credit Agreement into a senior secured term facility with a scheduled maturity date of June 14, 2007 (the “Senior Term Loans”). Such maturity date for the Senior Term Loans, however, will automatically be extended to March 21, 2010 in the event that (1) such extension
Notes to Consolidated Financial Statements becomes permitted under the Company’s Senior Subordinated Credit Agreement (as defined in the Amended and Restated Credit Agreement) or (2) such Senior Subordinated Credit Agreement ceases to be in effect. No portion of the Senior Term Loans that are repaid may be reborrowed. The Senior Term Loans amortize in quarterly installments, commencing with the quarter ending on September 30, 2005, equal to 0.25% of the original principal amount thereof, with the balance payable upon the final maturity. Until we obtain ratings from Moody’s and S&P, the Senior Term Loans bear interest, at our option, at a rate of (1) LIBOR, adjusted for statutory reserve requirements (“Adjusted LIBOR”), plus 2.5% or (2) 1.5% plus the higher of (a) the Federal Funds Rate plus 0.5% and (b) JPMorgan’s prime rate. After we obtain such ratings, the Senior Term Loans will bear interest, at our option, (1) at a rate of Adjusted LIBOR plus a spread ranging from 2.0% to 2.5%, depending on our ratings with such institutions or (2) at a rate of a spread ranging from 1.0% to 1.5%, depending on our ratings with such institutions, plus the higher of (a) the Federal Funds Rate plus 0.5% and (b) JPMorgan’s prime rate. The effective interest rate on the outstanding balance under the Amended and Restated Credit Agreement was 6.2% for the year ended December 31, 2005 compared to the average prime rate of 6.1% during the same period.
In addition, the Amended and Restated Credit Agreement makes available to us a new senior secured revolving credit facility in an aggregate principal amount of $250 million (the “Revolving Facility”) and a new senior secured revolving letter of credit facility in an aggregate principal amount of $150 million (the “LC Facility”). The commitments under the Revolving Facility and the LC Facility expire, and all borrowings under such facilities mature, on March 21, 2010. At December 31, 2005, no money was drawn on the Revolving Facility, and approximately $123.8 million of the LC Facility was utilized.
The Revolving Facility accrued interest at our option, at a rate of (1) Adjusted LIBOR plus 2.75% or (2) 1.75% plus the higher of (a) the Federal Funds Rate plus 0.5% and (b) JPMorgan’s prime rate to December 2, 2005, which is the date we filed audited consolidated financial statements with the SEC for the year ended December 31, 2004. After that filing, the interest rates and commitment fees on the Revolving Facility are determined based upon our ratio of (1) consolidated total indebtedness minus the amount by which the unrestricted cash and cash equivalents on such date exceed $50 million to (2) our adjusted consolidated EBITDA, as defined in the agreement, for the period of four consecutive fiscal quarters ending on or most recently prior to such date (the “Net Leverage Ratio”). During such period, the Revolving Facility will bear interest, at our option, (1) at a rate of Adjusted LIBOR plus a spread ranging from 1.75% to 2.75%, depending on the Net Leverage Ratio or (2) at a rate of a spread ranging from 0.75% to 1.75%, depending on the Net Leverage Ratio, plus the higher of (a) the Federal Funds Rate plus 0.5% and (b) JPMorgan’s prime rate.
We were subject to commitment fees of 0.75% per annum on the daily amount of the unutilized commitments under the Revolving Facility and the LC Facility to December 2, 2005. After our 2004 filing with the SEC on that date, the commitment fees ranged between 0.5% and 0.75%, depending on the Net Leverage Ratio. At December 31, 2005, the commitment fee rate was 0.75%.
A letter of credit participation fee is payable to the Lenders under the LC Facility with respect to a particular commitment under the LC Facility on the aggregate face amount of the commitment outstanding there under upon the later of the termination of the particular commitment under the LC Facility and the date on which the Lenders letters of credit exposure for such commitment cease, in an amount at any time equal to the LIBOR interest rate spread applicable at such time to loans outstanding under the Revolving Facility. In addition, we shall pay, for our own account, (1) a fronting fee of 0.25% per annum on the aggregate face amount of the letters of credit outstanding under the LC Facility upon the later of the termination of the commitments under the LC Facility and the date on which the Lenders’ letters of credit exposure for such commitment cease, and (2) customary issuance and administration fees relating to the letters of credit.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
We may use the proceeds of the loans under the Revolving Facility for general corporate purposes, and we may use the letters of credit under the LC Facility in the ordinary course of business to secure workers’ compensation and other insurance coverage and for general corporate purposes.
Pursuant to a Collateral and Guarantee Agreement (the “Collateral and Guarantee Agreement”), dated as of March 21, 2005, between the Company and JPMorgan, our obligations under the Amended and Restated Credit Agreement are secured (1) by substantially all of the assets of HealthSouth and (2) from and after the date on which the Restrictive Indentures (as defined in the Amended and Restated Credit Agreement) and the Senior Subordinated Credit Agreement permit the obligations (or an amount thereof) to be guaranteed by or secured by the assets of existing and subsequently acquired or organized subsidiaries of HealthSouth by substantially all of the assets of such subsidiaries.
The Amended and Restated Credit Agreement contains affirmative and negative covenants and default and acceleration provisions. The affirmative covenants include, but are not limited to, delivery of regular financial statements and reports, proper maintenance of properties, compliance with laws and regulations, and maintenance of insurance. As of December 31, 2005, negative covenants include a minimum interest expense coverage ratio of 1.75 to 1.00 and a maximum leverage ratio of 5.75 to 1.00. These ratios change over time in accordance with an established schedule included in the Amended and Restated Credit Agreement. The negative covenants also include restrictions on our ability to increase indebtedness, restrict the use of proceeds from asset sales, and limit the amount of capital expenditures that can be made in any year. As of December 31, 2005, we were in compliance with all covenants contained within the Amended and Restated Credit Agreement. See Subsequent Event—Recapitalization Transactions section of this disclosure below.
Term Loans—
On June 15, 2005, we obtained a new senior unsecured term facility consisting of term loans (the “Term Loans”) in an aggregate principal amount of $200 million under a term loan agreement (the “Term Loan Agreement”). The Term Loans bear interest, at our option, at a rate of (1) Adjusted LIBOR plus 5.0% or (2) 4.0% per year plus the higher of (a) JPMorgan’s prime rate and (b) the Federal Funds Rate plus 0.50%. At December 31, 2005, our interest rate was 9.4%. The Term Loans mature in full on June 15, 2010. The Term Loan Agreement contains affirmative and negative covenants and default and acceleration provisions. As of December 31, 2005, we were in compliance with all covenants contained within the Term Loan Agreement. In addition, we will be responsible for customary fees and expenses associated with the Term Loans. We used the proceeds of the Term Loans, together with cash on hand, to repay our $245 million 6.875% Senior Notes due June 15, 2005 and to pay fees and expenses related to the Term Loans. See Subsequent Event—Recapitalization Transactions section of this disclosure below.
Bonds Payable—
6.875% and 7.000% Senior Notes—
On June 22, 1998, we issued $250 million in 6.875% Senior Notes due 2005 and $250 million in 7.000% Senior Notes due 2008 (collectively, the “1998 Senior Notes”). Due to discounts and financing costs, the effective interest rate on the 6.875% Senior Notes is 7.1%, while the effective interest rate is 7.3% on the 7.000% Senior Notes. Interest is payable on June 15 and December 15. The 1998 Senior Notes are unsecured and unsubordinated. We used the net proceeds from the issuance of the 1998 Senior Notes to pay down indebtedness outstanding under our then-existing credit facilities. The 6.875% Senior Notes matured on June 15, 2005. We used the proceeds from the $200 million Term Loans, as discussed above, and available cash to repay the 6.875% Senior Notes. The 7.000% Senior Notes mature on June 15, 2008. We may redeem the 7.000% Senior Notes, in
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements whole or in part, at our option, and at any time at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued interest. The indenture contains affirmative and negative covenants including limits on incurring indebtedness. In June 2004, we received consent of a majority of the principal amount of the holders to waive all alleged and potential defaults of these covenants. Each holder of the 7.000% Senior Notes shall have the right to require us to purchase all outstanding notes held by such holder on January 15, 2007 for a purchase price equal to 100% of the principal amount of such notes, plus accrued interest. See 2004 Consent Solicitation section and Subsequent Event—Recapitalization Transactions section of this disclosure below.
10.750% Senior Subordinated Notes—
On September 25, 2000, we issued $350 million in 10.750% Senior Subordinated Notes due 2008 (the “10.750% Senior Notes”). Due to discounts and financing costs, the effective interest rate on the 10.750% Senior Notes is 11.4%. Interest is payable on April 1 and October 1. The 10.750% Senior Notes are senior subordinated obligations of HealthSouth and also are effectively subordinated to all existing and future liabilities of our subsidiaries and partnerships. We used the net proceeds from the issuance of the 10.750% Senior Notes to redeem our then-outstanding 9.500% Notes due 2001 and to pay down indebtedness outstanding under our then-existing credit facilities. The 10.750% Senior Notes mature on October 1, 2008.
We may redeem the 10.750% Senior Notes, in whole or in part, at our option, from time to time, on or after October 1, 2004 at the following redemption prices (expressed in rates), together with accrued and unpaid interest and additional interest, if any, thereon to the Redemption Date, if redeemed during the twelve-month period commencing on October 1 of the year set forth below:
The indenture contains affirmative and negative covenants including limits on incurring indebtedness and certain financial covenants. In May 2004, we received consent of a majority of the principal amount of the holders to waive all alleged and potential defaults of these covenants. See 2004 Consent Solicitation section and Subsequent Event—Recapitalization Transactions section of this disclosure below.
8.500% Senior Notes—
On February 1, 2001, we issued $375 million in 8.500% Senior Notes due 2008 (the “8.500% Senior Notes”). Due to discounts and financing costs, the effective interest rate on the 8.500% Senior Notes is 9.0%. Interest is payable on February 1 and August 1. The 8.500% Senior Notes are unsecured and unsubordinated. We used the net proceeds from the issuance of the 8.500% Senior Notes to pay down indebtedness outstanding under our then-existing credit facilities. The 8.500% Senior Notes mature on February 1, 2008. We may redeem the 8.500% Senior Notes, in whole or in part, at our option, and at any time, at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued interest. The indenture contains affirmative and negative covenants including limits on incurring indebtedness. In May 2004, we received consent of a majority of the principal amount of the holders to waive all alleged and potential defaults of these covenants. See 2004 Consent Solicitation section and Subsequent Event—Recapitalization Transactions section of this disclosure below.
Notes to Consolidated Financial Statements 8.375% Senior Notes—
On September 28, 2001, we issued $400 million in 8.375% Senior Notes due 2011 (the “8.375% Senior Notes”). Due to discounts and financing costs, the effective interest rate on the 8.375% Senior Notes is 8.7%. Interest is payable on April 1 and October 1. The 8.375% Senior Notes are unsecured and unsubordinated. We used the net proceeds from the issuance of the 8.375% Senior Notes to pay down indebtedness outstanding under our then-existing credit facilities. The 8.375% Senior Notes mature on October 1, 2011. We may redeem the 8.375% Senior Notes, in whole or in part, at our option, and at any time at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus any applicable premium plus accrued interest. The indenture contains affirmative and negative covenants including limits on incurring indebtedness. In June 2004, we received consent of a majority of the principal amount of the holders to waive all alleged and potential defaults of these covenants. Each holder of the 8.375% Senior Notes shall have the right to require us to purchase all outstanding notes held by such holder on January 2, 2009 for a purchase price equal to 100% of the principal amount of such notes, plus accrued interest. See 2004 Consent Solicitation section and Subsequent Event—Recapitalization Transactions section of this disclosure below.
7.375% Senior Notes—
On September 28, 2001, we issued $200 million in 7.375% Senior Notes due 2006 (the “7.375% Senior Notes”). Due to discounts and financing costs, the effective interest rate on the 7.375% Senior Notes is 7.7%. Interest is payable on April 1 and October 1. The 7.375% Senior Notes are unsecured and unsubordinated. We used the net proceeds from the issuance of the 7.375% Senior Notes to pay down indebtedness outstanding under our then-existing credit facilities. The 7.375% Senior Notes mature on October 1, 2006. We may redeem the 7.375% Senior Notes, in whole or in part, at our option, and at any time at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus any applicable premium plus accrued interest. The indenture contains affirmative and negative covenants including limits on incurring indebtedness. In June 2004, we received consent of a majority of the principal amount of the holders to waive all alleged and potential defaults of these covenants. See 2004 Consent Solicitation section and Subsequent Event—Recapitalization Transactions section of this disclosure below.
7.625% Senior Notes—
On May 17, 2002, we issued $1 billion in 7.625% Senior Notes due 2012 at 99.3% of par value (the “7.625% Senior Notes”). Due to discounts and financing costs, the effective interest rate on the 7.625% Senior Notes is 8.0%. Interest is payable on June 1 and December 1. The 7.625% Senior Notes are unsecured and unsubordinated. We used the net proceeds from the issuance of the 7.625% Senior Notes to pay down indebtedness outstanding under our credit facilities and for other corporate purposes. The 7.625% Senior Notes mature on June 1, 2012. We may redeem the 7.625% Senior Notes, in whole or in part, at our option, and at any time at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus any applicable premium plus accrued interest. The indenture contains affirmative and negative covenants including limits on incurring indebtedness. In June 2004, we received consent of a majority of the principal amount of the holders to waive all alleged and potential defaults of these covenants. Each holder of the 7.625% Senior Notes shall have the right to require us to purchase all outstanding notes held by such holder on January 2, 2009 for a purchase price equal to 100% of the principal amount of such notes, plus accrued interest. See 2004 Consent Solicitation section and Subsequent Event—Recapitalization Transactions section of this disclosure below.
6.500% Convertible Subordinated Debentures—
Effective October 29, 1997, the Company acquired the obligor of $30 million par value 6.500% Convertible Subordinated Debentures due 2011 (the “6.500% Convertible Subordinated Debentures”) as part of the Horizon/ CMS Healthcare Corporation acquisition. Due to financing costs, the effective interest rate on the 6.500%
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Convertible Subordinated Debentures is 6.7%. Interest is payable on June 15 and December 15. The 6.500% Convertible Subordinated Debentures are convertible into common stock of HealthSouth at the option of the holder at a conversion price of $82.19 per share. The conversion price is subject to adjustment upon the occurrence of (1) a subdivision, combination, or reclassification of outstanding shares of common stock, (2) the payment of a stock dividend or stock distribution on any shares of HealthSouth’s stock, (3) the issuance of rights or warrants to all holders of common stock entitling them to purchase shares of common stock at less than the current market price, or (4) the payment of certain other distributions with respect to HealthSouth’s common stock. We may redeem the 6.500% Convertible Subordinated Debentures, in whole or in part, at our option, and at any time at a redemption price equal to 100% of their principal amount to be redeemed plus any applicable interest. See 2004 Consent Solicitation section of this disclosure below.
8.750% Convertible Senior Subordinated Notes—
Effective October 29, 1997, the Company acquired the obligor of $25 million par value 8.750% Convertible Senior Subordinated Notes due 2015 (the “8.750% Convertible Subordinated Debentures”) as part of the Horizon/CMS Healthcare Corporation acquisition. Due to financing costs, the effective interest rate on the 8.750% Convertible Subordinated Debentures is 9.1%. Interest is payable on April 1 and October 1. The 8.750% Convertible Subordinated Debentures provide for an annual sinking fund payment equal to 5% of the aggregate principal amount originally issued. The sinking fund is paid annually, commencing April 1, 2000. The 8.750% Convertible Debentures are convertible into common stock of HealthSouth at the option of the holder at a conversion price of $64.03 per share. The conversion price is subject to adjustment upon the occurrence of (1) a subdivision, combination, or reclassification of outstanding shares of common stock, (2) the payment of a stock dividend or stock distribution on any shares of HealthSouth’s stock, (3) the issuance of rights or warrants to holders of common stock entitling them to purchase shares of common stock at less than the current market price, or (4) the payment of certain other distributions with respect to HealthSouth’s common stock. We may redeem the 8.750% Convertible Subordinated Debentures, in whole or in part, at our option, and at any time at a redemption price equal to 100% of their principal amount to be redeemed plus any applicable interest. See 2004 Consent Solicitation section of this disclosure below.
10.375% Senior Subordinated Credit Agreement—
On January 16, 2004, we issued $355 million in a senior subordinated term loan arranged by Credit Suisse First Boston (the “10.375% Senior Subordinated Credit Agreement”). This loan has an interest rate of 10.375% per annum, payable quarterly, with a seven-year maturity and is callable after the third year with a premium. If this bond is called after January 16, 2007 and on or prior to January 16, 2008 the prepayment premium is 110.375%. If called after January 16, 2008 and on or prior to January 16, 2009 the prepayment premium is 105.1875% If called after January 16, 2009 and on or before January 16, 2010 the prepayment premium is 102.59375%. If called after January 16, 2010 and before the maturity date there is no prepayment premium. Due to discounts and financing costs, the effective interest rate is 12.8%. We used the net proceeds from the issuance of the 10.375% Senior Subordinated Credit Agreement to redeem our then-outstanding 3.25% Convertible Subordinated Debentures due 2003. This agreement contains affirmative and negative covenants including limitations on additional indebtedness by HealthSouth and limitations on asset sales. We also issued warrants to the lender to purchase ten million shares of our common stock. Each warrant has a term of ten years from the date of issuance and an exercise price of $6.50 per share.
We accounted for these warrants under the guidance provided in APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants . APB Opinion No. 14 requires that separate amounts attributable to the debt and the purchase warrants be computed and accounting recognition be given to each component. We based our allocation to each component on the relative market value of the two components at the time of issuance. The portion allocable to the warrants was accounted for as additional paid in capital.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements 2004 Consent Solicitation—
On March 16, 2004, we announced that we were soliciting consents seeking approval of proposed amendments to, and waivers under, the indentures governing our 6.875% Senior Notes due 2005, 7.375% Senior Notes due 2006, 7.000% Senior Notes due 2008, 8.500% Senior Notes due 2008, 8.375% Senior Notes due 2011, 7.625% Senior Notes due 2012, and our 10.750% Senior Subordinated Notes due 2008 (collectively, the “Senior Notes”) on, among other things, issues relating to our inability to provide current financial statements, our ability to incur indebtedness under certain circumstances and to obtain waivers of all alleged and potential defaults under the respective indentures. The expiration periods for these solicitations were extended from time to time.
On May 7, 2004, we announced that we were amending the solicitation of consents from holders of our 10.750% Senior Subordinated Notes due 2008 to further conform the definition of “Refinancing Indebtedness” in the indenture governing our Senior Subordinated Notes to the definition in the indentures governing our Senior Notes.
On June 24, 2004, we announced that we had closed all of our consent solicitations for our outstanding public debt. The total consent fees paid for all of our debt issues, including the previously completed consent solicitations for our 10.750% Senior Subordinated Notes and our 8.500% Senior Notes due 2008, was approximately $80 million, which we are amortizing to interest expense over the remaining term of the debt.
Subsequent Event—Recapitalization Transactions—
On March 10, 2006, we completed the last of a series of recapitalization transactions (the “Recapitalization Transactions”) enabling us to prepay substantially all of our prior indebtedness and replace it with approximately $3 billion of new long-term debt. The Recapitalization Transactions included (1) entering into credit facilities that provide for credit of up to $2.55 billion of senior secured financing, (2) entering into an interim loan agreement that provides us with $1.0 billion of senior unsecured financing, (3) completing a $400 million offering of convertible perpetual preferred stock, (4) completing cash tender offers to purchase all $2.03 billion of our previously outstanding senior notes and $319 million of our previously outstanding senior subordinated notes and consent solicitations with respect to proposed amendments to the indentures governing each outstanding series of notes, and (5) prepaying and terminating our 10.375% Senior Subordinated Credit Agreement, our Amended and Restated Credit Agreement, and our Term Loan Agreement. In order to complete the Recapitalization Transactions, we also entered into consents, amendments, and waivers to our Amended and Restated Credit Agreement, $200 million Term Loan Agreement, and $355 million 10.375% Senior Subordinated Credit Agreement.
We used a portion of the proceeds of the loans under the new senior secured credit facilities, the proceeds of the interim loans, and the proceeds of the $400 million offering of convertible perpetual preferred stock, along with cash on hand, to prepay substantially all of our prior indebtedness and to pay fees and expenses related to such prepayment and the Recapitalization Transactions. The remainder of the proceeds and availability under the senior secured credit facilities are expected to be used for general corporate purposes. In addition, the letters of credit issued under the revolving letter of credit subfacility and the synthetic letter of credit facility will be used in the ordinary course of business to secure workers’ compensation and other insurance coverages and for general corporate purposes.
As a result of the Recapitalization Transactions, we expect to record an approximate $350 million to $375 million net loss on early extinguishment of debt in the first quarter of 2006. Below are more detailed descriptions of each of the transactions described above.
Offers to Purchase and Consent Solicitations—
On February 2, 2006, we announced that we were offering to purchase, and soliciting consents seeking approval of proposed amendments to the indentures governing, our 7.375% Senior Notes due 2006, 7.000%
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Senior Notes due 2008, 8.500% Senior Notes due 2008, 8.375% Senior Notes due 2011, 7.625% Senior Notes due 2012 and our 10.750% Senior Subordinated Notes due 2008 (collectively, the “Notes”). On February 15, 2006, we announced that a majority in principal amount of the holders of our Notes had delivered consents under the indentures governing these Notes, thereby approving proposed amendments to the indentures.
Consents, Amendments, and Waivers—
On February 15, 2006, we entered into a consent and waiver (the “Consent”) to our 10.375% Senior Subordinated Credit Agreement. Pursuant to the terms of the Consent, the lenders consented to the prepayment of all outstanding loans in full (together with all accrued and unpaid interest) on or prior to March 20, 2006 and waived certain provisions of the 10.375% Senior Subordinated Credit Agreement to the extent such provisions prohibited such prepayment. In connection with the Consent, we paid to each lender a prepayment premium equal to 15.0% of the principal amount of such lender’s loans.
Also on February 15, 2006, we entered into an amendment and waiver (the “Amendment”) to our Term Loan Agreement. Pursuant to the terms of the Amendment, the lenders amended certain provisions of the Term Loan Agreement to the extent such provisions prohibited a prepayment of the loans thereunder prior to June 15, 2006. In connection with the Amendment, we paid a consent fee equal to 1.0% of the principal amount of such lender’s loans. We also paid a prepayment fee equal to 2.0% of the aggregate principal amount of the prepayment.
On February 22, 2006, we entered into an amendment and waiver (the “Waiver”) to our Amended and Restated Credit Agreement. Pursuant to the terms of the Waiver, the lenders waived, in the event the recapitalization did not occur substantially simultaneously with the issuance of the convertible preferred stock, certain provisions of the Amended and Restated Credit Agreement to the extent required to permit us to apply 100% of the net proceeds of the issuance of the convertible perpetual preferred stock to the prepayment or repayment of other existing indebtedness. In connection with the Waiver, we paid to each lender executing the Waiver a waiver fee equal to 0.05% of the principal amount of such lender’s loans.
Senior Credit Facility—
On March 10, 2006, we entered into a credit agreement (the “Credit Agreement”) with a consortium of financial institutions (collectively, the “Lenders”), JPMorgan, as administrative agent and the collateral agent, Citicorp North America, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as co-syndication agents; and Deutsche Bank Securities Inc., Goldman Sachs Credit Partners L.P., and Wachovia, as co-documentation agents.
The Credit Agreement provides for credit of up to $2.55 billion of senior secured financing. The $2.55 billion available under the Credit Agreement includes (1) a six-year $400 million revolving credit facility (the “Revolving Loans”), with a revolving letter of credit subfacility and swingline loan subfacility, (2) a six-year $100 million synthetic letter of credit facility, and (3) a seven-year $2.05 billion term loan facility (the “Term Loan Facility”). The Term Loan Facility amortizes in quarterly installments, commencing with the quarter ending on September 30, 2006, equal to 0.25% of the original principal amount thereof, with the balance payable upon the final maturity. Loans under the Credit Agreement bear interest at a rate of, at our option, (1) Adjusted LIBOR or (2) the higher of (a) the federal funds rate plus 0.5% and (b) JPMorgan’s prime rate, in each case, plus an applicable margin that varies depending upon our leverage ratio and corporate credit rating.
As described above, a portion of the proceeds of the loans under the Credit Agreement were used to refinance a portion of our prior indebtedness and to pay fees and expenses related to such refinancing. The
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements remainder of the proceeds will be used for general corporate purposes. The letters of credit issued under the revolving letter of credit subfacility and the synthetic letter of credit facility will be used in the ordinary course of business to secure workers’ compensation and other insurance coverages and for general corporate purposes.
Pursuant to a Collateral and Guarantee Agreement (the “Collateral and Guarantee Agreement”), dated as of March 10, 2006, between us, our subsidiaries defined therein (collectively, the “Subsidiary Guarantors”) and JPMorgan, our obligations under the Credit Agreement are (1) secured by substantially all of our assets and the assets of the Subsidiary Guarantors and (2) guaranteed by the Subsidiary Guarantors. In addition to the Collateral and Guarantee Agreement, we and the Subsidiary Guarantors agreed to enter into mortgages with respect to certain of our material real property (excluding real property owned by the surgery centers segment or otherwise subject to preexisting liens and/or mortgages) in connection with the Credit Agreement. Our obligations under the Credit Agreement will be secured by the real property subject to such mortgages.
The Credit Agreement contains affirmative and negative covenants and default and acceleration provisions, including a minimum interest coverage ratio and a maximum leverage ratio that changes over time.
Interim Loan Agreement—
On March 10, 2006, we and the Subsidiary Guarantors also entered into the Interim Loan Agreement (the “Interim Loan Agreement”) with a consortium of financial institutions (collectively, the “ Interim Lenders”), Merrill Lynch Capital Corporation, as administrative agent (“Merrill”), Citicorp North America, Inc. and JPMorgan, as co-syndication agents; and Deutsche Bank AG Cayman Islands Branch, Goldman Sachs Credit Partners L.P. and Wachovia, as co-documentation agents. The Interim Loan Agreement provides us with $1 billion of senior unsecured interim financing. The loans under the Interim Loan Agreement will mature on March 10, 2007 (the “Initial Maturity Date”). Any Interim Lender who has not been repaid in full on or prior to the Initial Maturity Date will have the option to receive exchange notes (the “Exchange Notes”) issued under a certain indenture (the “Exchange Note Indenture”) in exchange for the outstanding loan. If any such Lender does not exchange its loans for Exchange Notes on the Initial Maturity Date, the maturity date of the loans will automatically extend to March 10, 2014, prior to which such Lender may exchange its loans for Exchange Notes at any time. The proceeds of the loans under the Interim Loan Agreement were used to refinance a portion of our prior indebtedness and to pay fees and expenses related to such refinancing. Our obligations under the Interim Loan Agreement are guaranteed by the Subsidiary Guarantors.
Prior to the Initial Maturity Date, subject to certain agreed upon minimum and maximum rates, the loans will bear interest at a rate per annum equal to: (1) Adjusted LIBOR plus 4.5% for the period following the closing date on March 10, 2006 and ending prior to September 10, 2006 and (2) Adjusted LIBOR plus 5.5% as of September 10, 2006 and an additional 0.50% at the end of each three-month period commencing on September 10, 2006 until but excluding the Initial Maturity Date. After the Initial Maturity Date, subject to certain agreed upon minimum and maximum rates, the loans that have not been repaid or exchanged for Exchange Notes will bear interest at the rate borne by the loans on the day immediately preceding the Initial Maturity Date plus 0.5% during the three-month period commencing on the Initial Maturity Date and an additional 0.5% at the beginning of each subsequent three-month period.
The proceeds of the Interim Loan Agreement were used to prepay a portion of our prior indebtedness and to pay associated transaction costs in connection with the recapitalization transactions.
The Interim Loan Agreement contains affirmative and negative covenants and default and acceleration provisions that are substantially similar to the Credit Agreement. However, following the Initial Maturity Date, most of the affirmative covenants will cease to apply to us and the Subsidiary Guarantors and the negative covenants and the default and acceleration provisions will be replaced by those contained in the Exchange Note Indenture.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Convertible Perpetual Preferred Stock Offering—
On March 7, 2006, we completed the sale of our 6.50% Series A Convertible Perpetual Preferred Stock (the “Series A Preferred Stock”). The Series A Preferred Stock has an initial liquidation preference of $1,000 per share of Series A Preferred Stock, which is subject to accretion. Holders of Series A Preferred Stock are entitled to receive, when and if declared by our Board of Directors, cash dividends at the rate of 6.50% per annum on the accreted liquidation preference per share, payable quarterly in arrears on January 15, April 15, July 15, and October 15 of each year, commencing on July 15, 2006. If we are prohibited by the terms of our credit facilities, debt indentures or other debt instruments from paying cash dividends on the Series A Preferred Stock, we may pay dividends in shares of our common stock, or a combination of cash and shares of our common stock, if the shares of our common stock delivered as payment are freely transferable by the recipient thereof (other than by reason of the fact that the recipient is our affiliate) or if a shelf registration statement relating to that common stock is effective to permit the resale thereof. Shares of our common stock delivered as dividends will be valued at 95% of their market value. Unpaid dividends will accrete at an annual rate of 8.0% per year for the relevant dividend period and will be reflected as an accretion to the liquidation preference of the Series A Preferred Stock. The Series A Preferred Stock is convertible, at the option of the holder, at any time into shares of our common stock at an initial conversion price of $6.10 per share, which is equal to an approximate conversion rate of approximately 163.9344 shares of common stock per share of Series A Preferred Stock, subject to specified adjustments. On or after July 20, 2011, we may cause the shares of Series A Preferred Stock to be automatically converted into shares of our common stock at the conversion rate then in effect if the closing sale price of our common stock for 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date we give the notice of forced conversion exceeds 150% of the conversion price of the Series A Preferred Stock. If we are subject to a fundamental change, as defined in the Certificate of Designation of the Series A Preferred Stock, each holder of shares of Series A Preferred Stock has the right, subject to certain limitations, to require us to purchase any or all of its shares of Series A Preferred Stock at a purchase price equal to 100% of the accreted liquidation preference, plus any accrued and unpaid dividends to the date of purchase. In addition, if holders of the Series A Preferred Stock elect to convert shares of Series A Preferred Stock in connection with certain fundamental changes, we will in certain circumstances increase the conversion rate for such shares of Series A Preferred Stock.
Each holder of Series A Preferred Stock has one vote for each share of Series A Preferred Stock held by the holder on all matters voted upon by the holders of our common stock, as well as voting rights specifically provided for in our restated certificate of incorporation or as otherwise from time to time required by law. In addition, if we fail to repurchase shares of Series A Preferred Stock following a fundamental change, then the holders of Series A Preferred Stock (voting separately as a class with all other series of preferred stock upon which like voting rights have been conferred and are exercisable) will be entitled to call a special meeting of our board of directors and, at the special meeting, vote for the election of two additional directors to our board of directors. The term of office of all directors so elected will terminate immediately upon our repurchase of those shares of Series A Preferred Stock.
The Series A Preferred Stock will be, with respect to dividend rights and rights upon liquidation, winding-up or dissolution: (1) senior to all classes of our common stock and each other class of capital stock or series of preferred stock established after the original issue date of the Series A Preferred Stock (which we will refer to as the “Issue Date”), the terms of which do not expressly provide that such class or series ranks senior to or on a parity with the Series A Preferred Stock as to dividend rights or rights upon our liquidation, winding-up or dissolution; (2) on a parity with any class of capital stock or series of preferred stock established after the Issue Date, the terms of which expressly provide that such class or series will rank on a parity with the Series A Preferred Stock as to dividend rights or rights upon our liquidation, winding-up or dissolution; (3) junior to each class of capital stock or series of preferred stock established after the Issue Date, the terms of which expressly
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements provide that such class or series will rank senior to the Series A Preferred Stock as to dividend rights or rights upon our liquidation, winding-up or dissolution; and (4) junior to all our existing and future debt obligations and other liabilities, including claims of trade creditors.
We are required to use our reasonable best efforts to file on or prior to the day that is 30 days after we are required under the Securities Exchange Act of 1934, as amended, to file our Report on Form 10-K with the SEC for the fiscal year ending December 31, 2006 (giving effect to any extensions under the Exchange Act) and have declared effective no later than 180 days after such date a shelf registration statement registering the Series A Preferred Stock and the common stock issuable upon the conversion of the Series A Preferred Stock, and to use our reasonable best efforts to cause such registration statement to remain effective until the earliest of two years following the date of issuance of the Series A Preferred Stock, the sale of all Series A Preferred Stock and common stock issuable upon the conversion of the Series A Preferred Stock under such registration statement and the date on which all Series A Preferred Stock and common stock issuable upon the conversion of the Series A Preferred Stock cease to be outstanding or have been resold pursuant to Rule 144 under the Securities Act. If we fail to comply with any of the foregoing requirements, then, in each case, we will pay additional dividends to all holders of Series A Preferred Stock equal to the applicable dividend rate or accretion rate for the relevant period plus (1) 0.25% per annum for the first 90 days after such registration default and (2) thereafter, 0.50% per annum.
The net proceeds of $388 million (after deducting the placement agents’ fees and before deducting our estimated offering expenses) were applied to prepay a portion of our prior indebtedness and to pay associated transaction costs in connection with the recapitalization transactions.
Hospital Revenue Bond—
We have one Hospital Revenue Bond that was issued in 1993 for $20 million maturing in December 2014. The purpose of the bond was to help finance the construction and improvements to the Vanderbilt Stallworth Rehabilitation Hospital. The bond has a variable interest rate (effective interest rate at December 31, 2005 was 4.3%) with required semiannual redemptions of $0.5 million. The outstanding balance for the Hospital Revenue Bond at December 31, 2005 and 2004 was $0.5 million and $1.5 million, respectively.
We may redeem the Hospital Revenue Bond, in whole or in part, at our option, and at any time at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus any applicable interest, provided that any such redemption in part shall be in a minimum principal amount of $0.1 million.
Notes Payable to Banks and Others—
We have numerous notes payable agreements outstanding. These agreements are used for various purposes such as equipment purchases, real estate purchases, and repurchases of limited partner interests. The terms on these notes vary by agreement, but range in length from 12 to 300 months. Most of the agreements have fixed interest rates ranging from 2.4% to 12.9%. In the case of equipment and real estate purchases, the notes are collateralized by the specific purchased equipment or real estate. The limited partner interests repurchased do not secure these notes.
Some of these agreements are subject to certain financial, positive, and negative covenants. For the periods covered by this filing, we were sometimes not in compliance with certain covenants. In all cases where we were not in compliance, we classified the debt as current.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Noncompete Agreements—
Noncompete agreements range in length from 24 to 144 months. The noncompete agreements have no stated interest rate and are recorded at a discounted rate. The discount rate applied is based on our revolving credit facility interest rate and ranges from 2.1% to 7.1%.
Capital Lease Obligations—
We engage in a significant number of leasing transactions including real estate, medical equipment, computer equipment, and other equipment utilized in operations. Certain leases that meet the lease capitalization criteria in accordance with FASB Statement No. 13 have been recorded as an asset and liability at the net present value of the minimum lease payments at the inception of the lease. Interest rates used in computing the net present value of the lease payments generally ranged from 4.0% to 14.2% based on our incremental borrowing rate at the inception of the lease. Our leasing transactions have included arrangements for equipment with major equipment finance companies and manufacturers who retain ownership in the equipment during the term of the lease and with a variety of both small and large real estate owners.
The following is an analysis of our asset retirement obligation for the years ended December 31, 2005, 2004, and 2003 (in thousands):
In our continuing efforts to streamline operations, we closed numerous under-performing facilities or consolidated similar facilities within the same market in 2005, 2004, and 2003. As a result of these facility closures and consolidations, we recorded certain restructuring charges for one-time termination benefits and contract termination costs under the guidance in FASB Statement No. 146. One-time termination benefits relate to severance costs provided to employees who were involuntarily terminated as a result of the facility closings. Contract termination costs primarily relate to costs to terminate operating leases or other contracts before the end of their term due to the closure of these facilities or costs that will continue to be incurred under these contracts for their remaining term without economic benefit to the entity.
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9. Asset Retirement Obligation:
Amount Asset retirement obligation as of January 1, 2003 $ 4,234
Liability accrued upon capital expenditures 110 Liability settled (430 ) Accretion of discount 165
Asset retirement obligation as of December 31, 2003 4,079 Liability accrued upon capital expenditures 136 Liability settled (289 ) Accretion of discount 160
Asset retirement obligation as of December 31, 2004 4,086 Liability accrued upon capital expenditures — Liability settled (137 ) Accretion of discount 160
Asset retirement obligation as of December 31, 2005 $ 4,109
10. Restructuring Charges:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The following chart presents the detail of our restructuring expenses and liabilities by segment (in thousands):
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Inpatient
Surgery
Centers Outpatient Diagnostic
Corporate
and Other Total
One-Time Termination Benefits:
Liability as of January 1, 2003 $ — $ — $ — $ — $ — $ — Costs incurred and charged to expense — 95 601 64 — 760 Costs paid or otherwise settled — (95 ) (601 ) (64 ) — (760 )
Liability as of December 31, 2003 $ — $ — $ — $ — $ — $ — Costs incurred and charged to expense — 66 847 1 — 914 Costs paid or otherwise settled — (66 ) (847 ) (1 ) — (914 )
Liability as of December 31, 2004 $ — $ — $ — $ — $ — $ — Costs incurred and charged to expense — 285 1,442 42 — 1,769 Costs paid or otherwise settled — (146 ) (1,442 ) (42 ) — (1,630 )
Liability as of December 31, 2005 $ — $ 139 $ — $ — $ — $ 139
Contract Termination Costs:
Liability as of January 1, 2003 $ — $ 134 $ 983 $ 132 $ — $ 1,249 Costs incurred and charged to expense — 175 1,383 253 — 1,811 Costs paid or otherwise settled — (134 ) (875 ) (262 ) — (1,271 )
Liability as of December 31, 2003 $ — $ 175 $ 1,491 $ 123 $ — $ 1,789 Costs incurred and charged to expense 59 242 2,747 11 — 3,059 Costs paid or otherwise settled (14 ) (313 ) (1,989 ) (62 ) — (2,378 )
Liability as of December 31, 2004 $ 45 $ 104 $ 2,249 $ 72 $ — $ 2,470 Costs incurred and charged to expense — 427 5,945 49 — 6,421 Costs paid or otherwise settled (45 ) (284 ) (6,614 ) (82 ) — (7,025 )
Liability as of December 31, 2005 $ — $ 247 $ 1,580 $ 39 $ — $ 1,866
Total Restructuring Costs:
Liability as of January 1, 2003 $ — $ 134 $ 983 $ 132 $ — $ 1,249 Costs incurred and charged to expense — 270 1,984 317 — 2,571 Costs paid or otherwise settled — (229 ) (1,476 ) (326 ) — (2,031 )
Liability as of December 31, 2003 $ — $ 175 $ 1,491 $ 123 $ — $ 1,789 Costs incurred and charged to expense 59 308 3,594 12 — 3,973 Costs paid or otherwise settled (14 ) (379 ) (2,836 ) (63 ) — (3,292 )
Liability as of December 31, 2004 $ 45 $ 104 $ 2,249 $ 72 $ — $ 2,470 Costs incurred and charged to expense — 712 7,387 91 — 8,190 Costs paid or otherwise settled (45 ) (430 ) (8,056 ) (124 ) — (8,655 )
Liability as of December 31, 2005 $ — $ 386 $ 1,580 $ 39 $ — $ 2,005
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Amounts included in the above chart represent the total amounts expected to be incurred in connection with these restructuring activities. For most of these facility closures or consolidations, the restructuring activities have been completed by December 31, 2005, but we have payments remaining under severance or lease agreements as of that date. Scheduled payments under these arrangements are as follows:
Expenses related to one-time termination benefits are included in Salaries and benefits in our consolidated statements of operations. Expenses related to contract termination costs are included in Other operating expenses in our consolidated statements of operations.
Common Stock Warrants—
In connection with the repayment of our 3.25% Convertible Debentures on January 16, 2004, we also issued warrants to the lender to purchase ten million shares of our common stock. Each warrant has a term of ten years from the date of issuance and an exercise price of $6.50 per share. See also Note 8, Long-term Debt .
Employee Stock Purchase Plan—
Effective January 1, 1994, we adopted an Employee Stock Purchase Plan. This plan was suspended indefinitely as of March 19, 2003. This plan, which was open to regular full-time or part-time employees who had been employed for six months and were at least 21 years old, allowed participating employees to contribute $10 to $200 per pay period toward the purchase of HealthSouth common stock in open-market transactions. In addition, after six months of participation in this plan, we provided a 20% matching contribution to be applied to purchases under the plan. We also paid all fees and brokerage commissions associated with the purchase of stock under the plan. We have not determined whether we will continue the plan.
1999 Executive Equity Loan Plan—
In May 1999, HealthSouth established the 1999 Executive Equity Loan Plan (the “Loan Plan”) for the Company’s executives and other key employees of the Company and its subsidiaries. Under this plan, the Audit and Compensation Committee of the Board of Directors may approve loans to executives and key employees of HealthSouth to purchase HealthSouth common stock. The proceeds of Loans may be used only for purchases of HealthSouth common stock in open-market transactions, block trades or negotiated transactions. Such purchases must be effected through a broker approved by the Company. The maximum aggregate principal amount of loans outstanding under the Loan Plan may not exceed $50 million. Plan Loans are secured by a pledge of all of the shares of HealthSouth common stock purchased with the proceeds thereof (“Loan Shares”), pursuant to which the participant shall grant the Company a first priority lien on and security interest in the Loan Shares. The proceeds from any such sale must be used to repay a percentage of the principal amount of the Loan equal to the percentage of Loan Shares sold, less any amounts withheld for taxes (the “Mandatory Prepayment Amount”). Any proceeds in excess of the Mandatory Prepayment Amount shall be retained by the participant.
Under the Loan Plan, HealthSouth executives purchased 6,771,761 shares of the Company’s common stock at a cost of approximately $39.3 million, including approximately $25.2 million which Richard M. Scrushy borrowed on September 10, 1999 (the “Scrushy Loan”), to purchase 4,362,297 share of common stock under this plan. On July 31, 2002, in lieu of a cash payment, Mr. Scrushy tendered 2,506,770 shares of HealthSouth common stock with a then current value of $25.2 million to repay his above-mentioned loan. We have discontinued the Executive Loan Program.
Subsequently, on December 22, 2003, as a result of a case filed in the Court of Chancery of the State of Delaware, In re HealthSouth Corp. Shareholders Litigation , a court ordered judgment stipulated that Mr. Scrushy repaid his loan with over-valued stock, which was improper and, as a result, the Scrushy Loan will be treated as reinstated as of July 31, 2002 and repayable with interest as of April 30, 2003.
The judgment ordered Mr. Scrushy to pay on January 2, 2004 by transfer of cash or cash equivalents the sum of (1) $25.9 million (the “Judgment Amount”), (2) $0.7 million (the “Pre-Judgment Interest”), and (3) post-judgment interest of $2.4 million on the Judgment Amount. Upon receipt of those amounts, HealthSouth was ordered to return to Mr. Scrushy the 2,506,770 shares of HealthSouth common stock that he originally tendered to the Company.
After appeals, Mr. Scrushy satisfied the full obligation of $29.0 million by paying $12.5 million cash in July 2005 and through his tender of common stock valued at $11.9 million to us in 2002, as discussed above. The remaining $4.6 million represents legal fees paid by HealthSouth to Mr. Scrushy’s counsel on his behalf.
As of December 31, 2004, we recognized the net amount due under the Scrushy Loan of approximately $13.7 million as a component of shareholders’ deficit. We recognized interest income of $3.0 million in 2004 related to this loan. Amounts due under the Executive Loan Program consisted of the following (in thousands):
Amounts due from Daniel J. Riviere approximate $2.5 million as of December 31, 2005, which we have fully reserved (see Note 24, Contingencies and Other Commitments ). We deem all other amounts collectible.
Accumulated other comprehensive (loss) income , net of income tax effect, consists of the following (in thousands):
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As of December 31, 2005 2004
Richard M. Scrushy $ — $ 13,737 David Fuller 119 119 Larry D. Taylor 116 116 Daniel J. Riviere — —
Total Notes receivable from shareholders, officers, and management employees $ 235 $ 13,972
12. Comprehensive Loss:
As of December 31, 2005 2004
Foreign currency translation adjustment $ (940 ) $ 308 Unrealized gain on available-for-sale securities 3 —
Total $ (937 ) $ 308
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
A summary of the components of other comprehensive loss is as follows (in thousands):
The following table presents the carrying amounts and estimated fair values of our financial instruments that are classified as long-term in our consolidated balance sheets (in thousands). The carrying value equals fair value for our financial instruments that are classified as current in our consolidated balance sheets. The Hospital Revenue Bond and noncompete agreements approximate fair value because of the short-term maturity of these instruments. The carrying amounts of our 6.5% Convertible Subordinated Debentures, 8.75% Convertible Subordinated Notes, revolving credit facility, and notes payable to banks and others also approximate fair value due to various characteristics of these issues including short-term maturities, call features, and rates that are reflective of current market rates. For the remainder of our long-term debt, we determined the fair market value by using quoted market prices, when available, or discounted cash flows to calculate these fair values.
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For the year ended December 31, 2005 2004 2003
Net change in foreign currency translation adjustment $ (1,248 ) $ 1,251 $ (31 ) Net change in unrealized loss on available-for-sale securities:
Unrealized net holding loss arising during the year 3 — — Reclassification adjustment for gains included in net loss — — (330 )
Net other comprehensive loss adjustments, before income tax benefit (1,245 ) 1,251 (361 ) Income tax benefit — — 121
Net other comprehensive loss adjustment $ (1,245 ) $ 1,251 $ (240 )
13. Fair Value of Financial Instruments:
As of December 31, 2005 As of December 31, 2004
Carrying Amount
Estimated Fair Value
Carrying Amount
Estimated Fair Value
Notes receivable from shareholders, officers, and management employees $ 235 $ 235 $ 13,972 $ 13,972 Long-term debt:
Advances under $1.25 billion revolving credit facility $ — $ — $ 315,000 $ 315,000 Advances under $250 million revolving credit facility — — — — Senior Term Loans due 2007 313,425 314,248 — — Term Loans due 2010 200,000 199,833 — — 10.375% Senior Subordinated Credit Agreement due 2011 332,356 349,529 329,189 361,696 6.875% Senior Notes due 2005 — — 244,805 246,029 7.000% Senior Notes due 2008 249,162 249,785 248,383 250,867 10.750% Senior Subordinated Notes due 2008 318,312 316,720 318,034 333,140 8.500% Senior Notes due 2008 343,000 345,573 343,000 353,290 8.375% Senior Notes due 2011 347,365 349,537 347,272 355,086 7.375% Senior Notes due 2006 180,300 181,202 180,300 183,455 7.625% Senior Notes due 2012 904,839 905,970 903,744 899,226 6.500% Convertible Subordinated Debentures due 2011 6,311 6,311 6,311 6,311 8.750% Convertible Subordinated Notes due 2015 10,136 10,136 11,573 11,573 Notes payable to banks and others 6,881 6,881 12,793 12,793 Hospital revenue bond 500 500 1,500 1,500 Noncompete agreements 154 154 1,891 1,891
Financial commitments:
Letters of credit $ — $ 123,750 $ — $ 105,634
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Employee Stock-Based Compensation Plans—
As of December 31, 2005, the Company had outstanding options from the 1993, 1995, 1997, 1999, and 2002 Stock Option Plans, the Key Executive Incentive Program, and several other stock option plans assumed from various acquisitions that occurred in prior years, (collectively, the “Option Plans”). As of December 31, 2005, the Company had no outstanding options from the 2005 Equity Incentive Plan. The Option Plans were designed to provide a performance incentive by issuing options to purchase shares of HealthSouth common stock to certain members of our board of directors, officers, and employees. The Option Plans provided for the granting of both incentive stock options and nonqualified stock options. The terms and conditions of the options, including exercise prices and the periods in which options are exercisable, generally were at the discretion of the Compensation and Stock Option Committee of the Board of Directors; however, no options were exercisable beyond approximately ten years from the date of grant and granted options generally vested in periods of up to five years depending on the type of award granted. As of December 31, 2005, the number of authorized shares available to grant under each of the above plans is as follows (in thousands):
Restricted Stock—
We can issue restricted common stock under the 1998 Restricted Stock Plan (the “Restricted Stock Plan”) to executives and key employees of HealthSouth. The terms of the Restricted Stock Plan call for up to 3,000,000 shares of common stock to be granted beginning in 1998 through 2008. Total grants under the Restricted Stock Plan through December 31, 2005 totaled 1,735,000 shares. There were no grants made in 2003, and we granted 510,000 shares and 375,000 shares in 2005 and 2004, respectively. The fair value of the shares granted in 2005 ranged from $5.37 to $5.71 per share and the shares cliff-vest after three years. The fair value of the shares granted in 2004 ranged from $3.95 to $6.00 per share and the shares cliff-vest after three years. Two of the employees who received awards in 2004 also left HealthSouth in 2004 and, accordingly, forfeited their 60,000 awards. In addition, 675,000 other awards were forfeited prior to vesting. As of December 31, 2005, 2,000,000 shares had not been awarded and were available for future grants. Deferred compensation related to unvested shares was $2.8 million and $1.3 million at December 31, 2005, and 2004, respectively.
Awards made under the 1998 plan are subject to a three year cliff vesting schedule. As of December 31, 2005, 175,000 shares had fully vested.
During 2005, we issued restricted common stock to our key executives under the Key Executive Incentive Program (the “Key Executive Program”). Total issued grants consisted of 577,735 shares of restricted stock. The fair value of the restricted shares was $3.87 and the shares are subject to a three year weighted-graded vesting
Notes to Consolidated Financial Statements period with 25% of the shares vesting on January 1, 2007, 25% of the shares vesting on January 1, 2008, and 50% of the shares vesting on January 1, 2009. Deferred compensation related to the unvested shares was $2.1 million at December 31, 2005.
We recognized compensation expense (benefit) under the Restricted Stock Plan, which is included in Salaries and benefits in the accompanying consolidated statements of operations, as follows (in thousands):
Stock Options—
Pro forma information regarding net loss and loss per share is required by FASB Statement No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of FASB Statement No. 123. The fair values of the options granted during the years ended December 31, 2005, 2004, and 2003 have been estimated at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Under the Black-Scholes option valuation model, the weighted average fair value per share of employee stock options granted during the years ended December 31, 2005, 2004, and 2003 were $2.47, $2.58, and $2.09, respectively.
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For the year ended
December 31, 2005 2004 2003
Compensation expense (benefit):
Restricted Stock Plan $ 1,247 $ 398 $ (2,932 ) Key Executive Incentive Program 135 — —
A summary of our stock option activity and related information is as follows (share information in thousands):
For various price ranges, weighted average characteristics of outstanding employee stock options at December 31, 2005 are as follows (in thousands, except per share amounts and years):
Notes to Consolidated Financial Statements Non-Employee Stock-Based Compensation Plans—
In 1993, we adopted the 1993 Consultants Stock Option Plan to provide incentives to non-employee consultants who provide significant services to us. On February 1, 2002, we amended and restated this plan to increase the total number of shares covered by the plan to 4,500,000. The plan expired on February 25, 2003. All options outstanding at that date remain valid and must be held and exercised in accordance with the terms of the plan. All of these options must be exercised within ten years after they were granted, although they may be exercised at any time during this ten-year period. All of these options terminate automatically within three months after termination of association with us, unless such termination is by reason of death. In addition, the options may not be transferred, except pursuant to the terms of a valid will or applicable laws of descent and distribution. As of December 31, 2005, there were 407,000 options outstanding. We recognized compensation expense under the 1993 Consultants Stock Option Plan, which is included in Salaries and benefits in the accompanying consolidated statements of operations as follows (in thousands):
In 2004, the Special Committee of our board of directors (“Special Committee”) adopted the 2004 Director Incentive Plan to provide incentives to our non-employee members of the Special Committee. Up to 2,000,000 shares may be granted pursuant to the 2004 Director Incentive Plan. All awards are subject to a three year graded vesting period. We awarded a total of 92,552 shares, with a fair value range from $5.80 to $6.28 per share, and 93,057 shares, with a fair value range from $5.03 to $5.93 per share, under the 2004 Director Incentive Plan during 2005 and 2004, respectively. Of the awarded shares 28,212 were vested and issued, 96,973 were unvested, and 60,424 were cancelled prior to vesting. As of December 31, 2005, 1,874,815 shares had not been awarded and were available for future grants. Deferred compensation related to unvested shares was $0.2 million at December 31, 2005 and 2004.
We recognized compensation expense under the 2004 Director Incentive Plan and other individual restricted stock agreements, which is included in Salaries and benefits in the accompanying consolidated statements of operations as follows (in thousands):
2005 Equity Incentive Plan—
On November 17, 2005, upon recommendation of the Compensation Committee, the Special Committee adopted the HealthSouth Corporation 2005 Equity Incentive Plan (the “Equity Plan”). The Equity Plan was adopted to replace the company’s 1995 Stock Option Plan, which recently expired. The Equity Plan provides for the grant of stock options, restricted stock, stock appreciation rights, deferred stock, and other stock-based awards (collectively, the “Awards”) to directors, executives, and other key employees of the company as
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For the year ended
December 31, 2005 2004 2003
Compensation benefit $
— $ (460 ) $
—
For the year ended
December 31, 2005 2004 2003
Compensation expense:
2004 Director Incentive Plan $ 316 $ 216 $
—
Other individual agreements 300 —
—
$ 616 $ 216 $ —
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements determined by the board of directors or the Compensation Committee in accordance with the terms of the Equity Plan and evidenced by an award agreement with each participant. As of December 31, 2005, the Company had no outstanding options from the Equity Plan.
The Equity Plan has a term of three years, unless terminated earlier by the board of directors. Any Awards outstanding under the Equity Plan at the time of its termination will remain in effect in accordance with their terms. The aggregate number of shares of common stock available for issuance under the Equity Plan is 22 million shares, subject to equitable adjustment upon a change in capitalization of the company or the occurrence of certain transactions affecting the common stock reserved for issuance under the Equity Plan. Any awards under the Equity Plan must have a purchase price or an exercise price not less than the fair market value of such shares of common stock on the date of grant. Unless otherwise determined by the Board or as provided in an award agreement, upon a Change in Control (as defined in the Equity Plan) of the company, the vesting of all outstanding awards will accelerate.
Notwithstanding the foregoing, no option may be exercised and no shares of stock may be issuable pursuant to other Awards under the Equity Plan until we comply with our reporting and registration obligations under the federal securities laws, unless an exemption from registration is available with respect to such shares.
Substantially all HealthSouth employees are eligible to enroll in HealthSouth sponsored health care plans, including coverage for medical and dental benefits. Our primary health care plans are national plans administered by third-party administrators. We are self-insured for these plans. We also sponsor certain regional plans inherited through various past acquisitions. These regional plans are fully insured. During 2005, 2004, and 2003, costs associated with these plans, net of amounts paid by employees, approximated $89.7 million, $98.0 million, and $103.4 million, respectively.
We also provide basic life insurance equal to one times each eligible employee’s annual base salary amount at no cost to each employee. In addition, HealthSouth provides long-term disability insurance to each full-time employee at no cost. During 2005, 2004, and 2003, costs for premiums related to these employee benefits approximated $4.2 million, $3.6 million, and $2.9 million, respectively. Additional life insurance is available to full-time employees, but the premiums associated with any additional coverage are the responsibility of each employee. Employees may also purchase short-term disability coverage and accidental death and dismemberment life insurance through HealthSouth, but all premiums are the responsibility of each applicable employee.
The HealthSouth Retirement Investment Plan is a qualified 401(k) savings plan. The plan allows eligible employees to contribute up to 100% of their pay on a pre-tax basis into their individual retirement account in the plan subject to the normal maximum limits set annually by the IRS. The company match is 15% of the first 4% of each participant’s elective deferrals. All contributions to the plan are in the form of cash. Employees who are at least 21 years of age and have completed 90 days of service with the company are eligible to participate in the plan. Employer contributions to each plan participant’s account vest gradually over a six-year service period. Participants are always fully vested in their own contributions.
Employer contributions to the HealthSouth Retirement Investment Plan approximated $2.7 million, $3.3 million, and $0.9 million in 2005, 2004, and 2003, respectively. In 2003, $2.3 million from the plan’s forfeiture account was used to fund matching contributions in accordance with the terms of the plan.
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15. Employee Benefit Plans:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Effective January 1, 2006, HealthSouth increased its employer matching contribution from 15% to 50% of the first 4% of each participant’s elective deferrals. In addition, as of January 1, 2006, participants are no longer required to complete 90 days of service prior to participating in this 401(k) savings plan.
Senior Management Bonus Program—
In 2005 and 2004, we adopted the 2005 Senior Management Bonus Program and the 2004 Senior Management Bonus Program, respectively, to reward senior management for performance based on a combination of corporate goals, divisional or regional goals, and individual goals. The corporate goals are dependent upon the company meeting a pre-determined financial goal. The divisional or regional goals are determined in accordance with the specific plans agreed upon between each division and our board of directors as part of our routine budgeting and financial planning process. The individual goals, which are weighted according to importance and include some objectives common to all eligible persons, are determined between each participant and his or her immediate supervisor. The program applies to persons who join the company in, or are promoted to, senior management positions. In March 2005, we paid approximately $6.2 million under the program for the year ended December 31, 2004. In February 2006, we paid approximately $7.1 million under the program for the year ended December 31, 2005.
Key Executive Incentive Program—
On November 17, 2005, the Special Committee approved, upon the recommendation of the Compensation Committee and our chief executive officer (who is not a participant), the HealthSouth Corporation Key Executive Incentive Program. The Key Executive Program is a supplement to the company’s overall compensation program for executives and is intended to incentivize key senior executives with equity awards that vest and cash bonuses that are payable, in each case through January 2009.
Eight executive officers (each a “Key Executive” and, collectively, the “Key Executives”) are entitled to receive incentive awards under the Key Executive Program. The Key Executives will receive approximately 50% – 60% of their awards in equity and 40% – 50% in cash. The equity component was comprised of approximately one-third stock options and two-thirds restricted stock.
The equity awards, which were made on November 17, 2005, were one-time special equity grants. These awards are separate from, and in addition to, the normal equity grants awarded in March and generally are equivalent to the Key Executive’s normal annual grant. The stock options have an exercise price equal to $3.87 per share, the fair market value on the date of grant. The stock options and restricted stock will vest according to the following schedule: twenty-five percent in January 2007, twenty-five percent in January 2008, and the remaining fifty percent in January 2009.
The cash component of the award will be a one-time cash incentive payment payable twenty-five percent in January 2007, twenty-five percent in January 2008, and the remaining fifty percent in January 2009. This cash bonus will be equivalent to between approximately 80% and 110% of the Key Executive’s base salary. In order for each Key Executive to receive each installment of the cash award, he or she must be employed in good standing on a full-time basis at the time of each payment, and the company must have attained certain performance goals based on liquidity.
Change in Control Benefits Plan—
On November 4, 2005, the Special Committee approved, upon the recommendation of the Compensation Committee, the HealthSouth Corporation Change in Control Benefits Plan (the “Change in Control Plan”).
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Amounts payable under the Change in Control Plan are in lieu of and not in addition to any other severance or termination payment under any other plan or agreement with HealthSouth. As a condition to receipt of any payment or benefits under the Change in Control Plan, participating employees, as designated by the Chief Executive Officer (each a “Participant” and, collectively, “Participants”) must enter into a Non-Solicitation, Non-Disclosure, Non-Disparagement and Release Agreement with HealthSouth.
Under the Change in Control Plan, Participants are divided into three different tiers as designated by the Compensation Committee. Tier 1 is comprised of certain executive officers of HealthSouth; Tier 2 is comprised of HealthSouth’s division presidents and certain other officers of HealthSouth; and Tier 3 will be comprised of officers of the company subsequently determined. Upon the occurrence of a Change in Control, each outstanding option to purchase common stock of HealthSouth held by Participants will become automatically vested and exercisable and (1) in the case of all options outstanding as of November 4, 2005, will remain exercisable until the later of the 15th day of the third month following the date at which, or December 31 of the calendar year in which, the option would have otherwise expired; and (2) in the case of all options granted after November 4, 2005, shall remain exercisable for a period of (a) three years in the case of a Tier 1 Participant, (b) two years in the case of a Tier 2 Participant or (c) one year in the case of a Tier 3 Participant, beyond the date at which the option would have otherwise expired. In addition, the vesting restrictions on all other awards relating to HealthSouth’s common stock held by a Participant will immediately lapse and will, in the case of restricted stock units and stock appreciation rights, become immediately payable.
In the event that a Participant’s employment is terminated either (1) by the Participant for Good Reason (as defined in the Change in Control Plan) or (2) by HealthSouth without Cause (as defined in the Change in Control Plan) within twenty-four months following a Change in Control or within three months of a Potential Change in Control (as defined in the Change in Control Plan), then such Participant shall receive a lump sum severance payment in an amount equal to, for Tier 1 Participants, the sum of (a) the Participant’s highest annual salary in the three years preceding the termination date plus (b) the Participant’s highest target bonus for the year of termination or for the year in which the Change in Control occurred, whichever is larger (together, the “CIC Payment”) multiplied by 2.99. Tier 2 Participants will be entitled to receive two times the CIC Payment, and Tier 3 Participants will be entitled to receive an amount equal to the CIC Payment. Participants also will be entitled to receive a lump sum payment equal to all unused vacation time accrued by such Participant as of the termination date under HealthSouth’s vacation policy, plus all accrued but unpaid compensation earned by such Participant as of the termination date.
Following a termination upon a Change in Control, each Participant will continue to be covered by those benefit plans (excluding disability) maintained by HealthSouth under which the Participant was covered immediately prior to termination (the “Continued Benefits”). The Change in Control Plan provides that Continued Benefits are to be provided to Tier 1 Participants for thirty-six months, to Tier 2 Participants for twenty-four months, and to Tier 3 Participants for twelve months. HealthSouth’s obligation to provide Continued Benefits will cease if and when a Participant becomes employed by a third party that provides the Participant with substantially comparable health and welfare benefits.
During 2005, 2004, and 2003, we identified 19 entities in our inpatient segment, 328 outpatient rehabilitation facilities, 25 surgery centers, 27 diagnostic centers, and 46 other facilities that met the requirements of FASB Statement No. 144 to be reported as discontinued operations.
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16. Discontinued Operations:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
For the facilities identified in 2005, 2004, and 2003 that met the requirements of FASB Statement No. 144, we reclassified our consolidated balance sheet for the year ended December 31, 2004 and our consolidated statements of operations and consolidated statements of cash flows for the years ended December 31, 2004 and 2003 to show the results of those facilities as discontinued operations. The operating results of discontinued operations, by operating segment and in total, are as follows (in thousands):
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For the year ended December 31, 2005 2004 2003 Inpatient:
Net operating revenues $ — $ 4,699 $ 26,114 Costs and expenses 637 6,544 18,148
(Loss) income from discontinued operations (637 ) (1,845 ) 7,966 Gain (loss) on disposal of assets of discontinued operations 362 (642 ) (464 ) Income tax expense — — —
(Loss) income from discontinued operations $ (275 ) $ (2,487 ) $ 7,502
Surgery Centers: Net operating revenues $ 18,854 $ 44,181 $ 57,608 Costs and expenses 30,967 56,846 99,628 Impairments 112 1,750 —
Loss from discontinued operations (12,225 ) (14,415 ) (42,020 ) Gain on disposal of assets of discontinued operations 6,181 1,134 11,299 Income tax expense — — —
Loss from discontinued operations $ (6,044 ) $ (13,281 ) $ (30,721 )
Outpatient: Net operating revenues $ 11,815 $ 48,007 $ 78,742 Costs and expenses 16,852 52,102 74,316 Impairments — 822 —
(Loss) income from discontinued operations (5,037 ) (4,917 ) 4,426 Gain (loss) on disposal of assets of discontinued operations 165 (1,203 ) (1,758 ) Income tax expense — — —
(Loss) income from discontinued operations $ (4,872 ) $ (6,120 ) $ 2,668
Diagnostic: Net operating revenues $ 2,191 $ 11,410 $ 21,009 Costs and expenses 4,733 17,702 25,435 Impairments — 133 —
Loss from discontinued operations (2,542 ) (6,425 ) (4,426 ) Gain on disposal of assets of discontinued operations 289 3,077 1,289 Income tax expense — — —
Loss from discontinued operations $ (2,253 ) $ (3,348 ) $ (3,137 )
Corporate and other: Net operating revenues $ 76,802 $ 153,609 $ 228,218 Costs and expenses 118,331 232,457 238,150 Impairments 6,693 16,577 —
Loss from discontinued operations (48,222 ) (95,425 ) (9,932 ) Gain on disposal of assets of discontinued operations 257 319 28,439 Income tax expense — — —
(Loss) income from discontinued operations $ (47,965 ) $ (95,106 ) $ 18,507
Total: Net operating revenues $ 109,662 $ 261,906 $ 411,691 Costs and expenses 171,520 365,651 455,677 Impairments 6,805 19,282 —
Loss from discontinued operations (68,663 ) (123,027 ) (43,986 ) Gain on disposal of assets of discontinued operations 7,254 2,685 38,805 Income tax expense — — —
Loss from discontinued operations $ (61,409 ) $ (120,342 ) $ (5,181 )
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The assets and liabilities of discontinued operations consist of the following (in thousands):
On July 20, 2005, we executed an asset purchase agreement with The Board of Trustees of the University of Alabama (the “University of Alabama”) for the sale of the real property, furniture, fixtures, equipment and certain related assets associated with our 219 licensed-bed acute care hospital located in Birmingham, Alabama for $33 million. Simultaneously with the execution of this purchase agreement with the University of Alabama, we executed an agreement with an affiliate of the University of Alabama whereby this entity currently provides certain management services to our acute care hospital in Birmingham. On December 31, 2005, we executed an amended and restated asset purchase agreement with the University of Alabama. This amended and restated agreement provides that the University of Alabama will purchase our Birmingham acute care hospital and associated real and personal property as well as our interest in the gamma knife partnership associated with this hospital. We anticipate closing this transaction by the end of the first quarter of 2006. We will transfer the hospital and associated real and personal property at that time, but will transfer our interest in the gamma knife partnership at a later date. The proposed transaction also requires that we acquire and convey title to the University of Alabama for certain professional office buildings that we are currently leasing. The cost to terminate the lease associated with the professional office buildings is estimated to be approximately $22 million. Both the certificate of need under which the hospital currently operates, and the licensed beds operated by us at the hospital, will be transferred as part of the sale of the hospital under the amended and restated agreement. Upon consummation of the agreement with the University of Alabama, we would no longer have the ability to operate or sell the Digital Hospital project as an acute care hospital without obtaining an additional certificate of need or specific exception.
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As of December 31, 2005 2004
Assets:
Cash and cash equivalents $ 2,097 $ 6,286 Accounts receivable, net 6,852 22,212 Prepaid expenses 367 1,511 Other current assets 2,745 1,957
Total current assets 12,061 31,966
Property and equipment, net 34,412 67,147 Intangible assets, net 744 1,467 Other long-term assets 4,535 4,476
Total long-term assets 39,691 73,090
Total assets $ 51,752 $ 105,056
Liabilities:
Current portion of long-term debt $ 1,697 $ 4,233 Accounts payable and other current liabilities 191 37,107
Total current liabilities 1,888 41,340
Long-term debt, net of current portion 4,752 9,731 Other long-term liabilities 984 2,783
Total long-term liabilities 5,736 12,514
Total liabilities $ 7,624 $ 53,854
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The assets and liabilities of this acute care hospital included in discontinued operations consist of the following (in thousands):
The operating results of this acute care hospital included in discontinued operations of our corporate and other segment are as follows (in thousands):
In addition to the acute care hospital, there were three surgery centers sold by the end of the first quarter of 2006. Substantially all other facilities classified as discontinued operations were sold or closed by December 31, 2005.
During 2005, Hurricanes Katrina, Rita, and Wilma made landfall and caused extensive flooding and destruction along portions of the southeastern United States. Operations of our facilities in these areas were disrupted by the evacuation of patients as well as the physical damage to our facilities.
We have filed insurance claims approximating $11.1 million, net of policy deductibles, related to both actual and contingent losses for property damage and business interruption losses. Through March 10, 2006, we had received cash advances of approximately $1.8 million from our insurance carriers related to these claims. However, to date, we have received no other insurance funds or any indication of the amount the insurance companies are willing to pay related to such claims. Therefore, we have recorded no insurance related receivables for these losses.
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As of December 31, 2005 2004
Assets:
Accounts receivable, net $ 5,301 $ 6,314 Other current assets 1,976 2,298
Total current assets 7,277 8,612
Property and equipment, net 26,068 44,708 Other long-term assets — 1,635
Total long-term assets 26,068 46,343
Total assets $ 33,345 $ 54,955
Liabilities:
Accounts payable and other current liabilities $ 3,731 $ 12,513 Other long-term liabilities 4,780 7,865
Total liabilities $ 8,511 $ 20,378
For the year ended December 31, 2005 2004 2003
Net operating revenues $ 70,678 $ 130,988 $ 139,040 Loss from discontinued operations, before provision for income tax expense (34,722 ) (49,689 ) (22,626 )
17. Losses Due to Natural Disasters:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
As a result of the 2005 hurricanes, we recorded a net loss related to property damage of approximately $1.9 million in 2005. Of this amount, approximately $0.9 million is recorded in Other operating expenses , $0.5 million is recorded in Loss (gain) on disposal of assets , and $0.5 million is recorded in Impairment of long-lived assets in our 2005 consolidated statement of operations. The $0.5 million impairment charge relates to abandoned equipment at our Pendleton LTCH in New Orleans, Louisiana. The following table summarizes the total net loss related to property damage recorded by segment (in thousands):
During 2004, Hurricanes Charley, Frances, Ivan, and Jeanne made landfall and caused damage to certain of our facilities located in Florida, Alabama, Georgia, and Pennsylvania. However, the damage caused by these hurricanes was not as extensive as that of the 2005 hurricanes and did not result in a material property damage net loss to our consolidated operations in 2004.
We have filed insurance claims approximating $7.4 million, net of policy deductibles, related to both actual and contingent losses for property damage and business interruption losses incurred in 2004. Through March 2006, we had received approximately $1.0 million in insurance proceeds related to these claims.
HealthSouth is subject to U.S. federal, state, local, and foreign income taxes. The Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change is as follows (in thousands):
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Division 2005
Inpatient $ 1,016 Surgery Centers 374 Outpatient — Diagnostic 485 Corporate and Other —
$ 1,875
18. Income Taxes:
For the year ended December 31, 2005 2004 2003
Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change $ (344,793 ) $ (42,214 ) $ (455,302 )
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The significant components of the provision for (benefit from) income taxes related to continuing operations are as follows (in thousands):
We received net income tax refunds of $4.8 million in 2005, $8.1 million in 2004, and $110.3 million in 2003. Net income tax refunds were attributable to payments for estimated income taxes offset by payments that exceeded the actual tax liabilities, net operating loss carryback claims received, and settlements of previous audits.
A reconciliation of differences between the federal income tax at statutory rates and our actual income tax expense (benefit) on loss from continuing operations, which include federal, state, and other income taxes, is as follows:
The income tax benefit at the statutory rate is the expected tax benefit resulting from the loss due to continuing operations. However, we have an income tax expense in 2005 due to state income taxes associated with certain subsidiaries that file separate state tax returns, corporate joint ventures that file separate federal tax returns, foreign taxes, and an increase in the valuation allowance. We have an income tax expense in 2004 primarily due to state income taxes associated with certain subsidiaries that file separate state income tax returns and an increase in the valuation allowance. Our income tax benefit in 2003 is less than the benefit at the statutory rate primarily due to state income taxes associated with certain subsidiaries that file separate state income tax returns, impairment charges, accrual of future government settlement payments, and an increase in the valuation allowance.
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For the year ended December 31, 2005 2004 2003
Current:
Federal $ 4,235 $ 2,688 $ (13,922 ) State and local 17,207 14,565 11,096 Foreign 353 — —
Total current expense (benefit) 21,795 17,253 (2,826 )
Deferred:
Federal 17,239 (5,080 ) (23,785 ) State and local (270 ) (259 ) (1,771 ) Foreign 1,028 — —
Total deferred expense (benefit) 17,997 (5,339 ) (25,556 )
Total income tax expense (benefit) related to continuing operations $ 39,792 $ 11,914 $ (28,382 )
For the year ended December 31, 2005 2004 2003
Tax benefit at statutory rate (35.0 )% (35.0 )% (35.0 )% Increase (decrease) in tax rate resulting from:
State income taxes, net of federal tax benefit 3.2 % 22.4 % 1.3 % Non-deductible goodwill 0.0 % 0.0 % 6.6 % Accrual for government, class action, and related settlements 0.0 % 0.0 % 7.7 % Interest, net 0.0 % 0.0 % (3.1 )% Indefinite-lived assets 6.0 % (12.6 )% (5.6 )% Other, net (0.2 )% 0.8 % (1.0 )% Increase in valuation allowance 37.5 % 52.6 % 22.9 %
Income tax expense (benefit) 11.5 % 28.2 % (6.2 )%
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Deferred income taxes recognize the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes and the impact of available net operating loss (“NOL”) carryforwards. The significant components of HealthSouth’s deferred tax assets and liabilities were as follows (in thousands):
FASB Statement No. 109 requires that we reduce our deferred income tax assets by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or a portion of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are deductible. We based our decision to establish a valuation allowance primarily on negative evidence of cumulative losses in recent years. After consideration of all evidence, both positive and negative, management concluded that it is more likely than not that we will not realize a portion of our deferred tax assets and that a valuation allowance of $879.4 million and $744.4 million is necessary for the years ended December 31, 2005 and 2004, respectively. For the years ended December 31, 2005, 2004, and 2003, the net increases in our valuation allowance were $135.1 million, $192.9 million, and $53.6 million, respectively. The valuation allowance for all years increased in part as a result of certain deferred tax liabilities that are indefinite-lived, which inherently means that the reversal period of these liabilities is unknown. Therefore, for scheduling the expected utilization of deferred tax assets as required by FASB Statement No. 109, these indefinite-lived liabilities cannot be looked upon as a source of future taxable income, and an additional valuation allowance must be established. An additional liability was established as a result of carrying value differences in partnerships resulting from accounting adjustments for past years in which we are precluded from filing amended partnership returns due to the statute of limitations being closed. The IRS is currently examining our originally filed 1996 – 1998 income tax returns.
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As of December 31, 2005 2004
Deferred income tax assets:
Net operating loss $ 405,548 $ 206,912 Allowance for doubtful accounts 27,635 63,001 Accrual for government, class action, and related settlements 139,483 117,458 Insurance reserve 42,843 44,498 Other accruals 9,095 43,903 Property, net 143,134 119,396 Intangibles 121,108 150,357 Capitalized costs 213 — Carrying value of partnerships — 1,154
Total deferred income tax assets 889,059 746,679 Less: Valuation reserve (879,440 ) (744,373 )
Net deferred income tax assets 9,619 2,306
Deferred income tax liabilities:
Capitalized costs — (1,534 ) Intangibles (49,283 ) (28,752 ) Carrying value of partnerships (5,817 ) — Other (768 ) (772 )
Total deferred income tax liabilities (55,868 ) (31,058 )
Net deferred income tax liabilities (46,249 ) (28,752 ) Less: Current deferred tax assets 1,222 —
At December 31, 2005, HealthSouth had unused federal net operating loss carryforwards of approximately $764.0 million. Such losses expire in various amounts at varying times through 2025. These NOL carryforwards result in a deferred tax asset of approximately $267.4 million at December 31, 2005. A valuation allowance is being taken against our net deferred tax assets, exclusive of indefinite-lived intangibles discussed above, including these loss carryforwards.
Based on the operating results for the years 2003 and 2004, we anticipate filing amended income tax returns which will result in significant tax net operating losses. Such losses may be carried back to reclaim any available U.S. federal income taxes paid in prior years or carried forward to mitigate future tax liabilities. Prior to the Job Creation and Worker Assistance Act of 2002 (the “Worker Assistance Act”), enacted by Congress on March 9, 2002, a company could carry back tax net operating losses to reclaim U.S. federal income taxes paid in the two years preceding the tax year in which the company generated and utilized the net operating losses. For alternative minimum tax (“AMT”) purposes, only 90% of alternative minimum taxable income could be offset by net operating loss carrybacks. For tax years ending in 2002 and 2001, the Worker Assistance Act extended the carryback period to the five years preceding the tax year in which the net operating loss was generated. With respect to AMT, the limit on net operating loss deductions from alternative minimum taxable income was increased from 90% to 100% for net operating losses generated or taken as carryforwards in tax years ending in 2002 and 2001.
Pursuant to FASB Statement No. 5, we evaluated the recovery of federal and state income taxes in anticipation of filing amended income tax returns for all open years where income has been adjusted or restated. Additionally, HealthSouth and its subsidiaries’ federal and state income tax returns are periodically examined by various regulatory taxing authorities. In connection with such examinations, taxing authorities, including the IRS and various state departments of revenue, have raised issues and proposed tax deficiencies. Amounts related to these tax deficiencies and other contingencies have been considered by management in its estimate of our potential net recovery of prior income taxes. This potential net recovery is included on the consolidated balance sheet as Income tax refund receivable and has a balance of $240.8 million as of December 31, 2005. This balance also includes a refund from the IRS of approximately $14 million, which represents the settlement of the Company’s 1992 through 1995 examinations and is net of approximately $93 million of tentative refunds already received as of the end of 2005 based upon carryback claims previously filed by the Company. The assumptions and computations used to determine this estimate have not yet been reviewed by federal or state examiners, and are subject to reduction and/or elimination. Resolution of the amount of taxes recoverable will not be made until a future date when HealthSouth and the taxing authorities agree to the appropriate adjustments. Management believes it has provided the best estimate of this probable recovery based upon the information available at this time and believes that the ultimate resolution of these amounts is not expected to materially affect our consolidated financial position, results of operations, or cash flows.
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Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The following table sets forth the computation of basic and diluted loss per share (in thousands, except per share amounts):
Diluted earnings per share report the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. These potential shares include dilutive stock options, unissued restricted stock awards, and convertible debentures. For the years ended December 31, 2005, 2004, and 2003, the number of potential shares approximated 1.5 million, 1.2 million, and 9.7 million, respectively. Including these potential common shares in the denominator resulted in an antidilutive per share amount due to our loss from continuing operations. Therefore, no separate computation of diluted earnings per share is presented.
Options to purchase approximately 9.9 million shares of common stock were outstanding during 2005, but were not included in the computation of diluted weighted average shares because these options’ exercise prices were greater than the average market price of the common shares.
As discussed within Note 8, Long-term Debt , we repaid our 3.25% Convertible Debentures which were due April 1, 2003, from the net proceeds of a loan arranged by Credit Suisse First Boston, on January 16, 2004. In connection with this transaction, HealthSouth issued warrants to the lender to purchase ten million shares of its common stock. Each warrant has a term of ten years from the date of issuance and an exercise price of $6.50 per share. The warrants were not assumed exercised for dilutive shares outstanding because they were antidilutive in the period. As also discussed in Note 8, we issued 400,000 shares of convertible perpetual preferred stock in March 2006.
As discussed in Note 23, Securities Litigation Settlement , in February 2006, we agreed to issue approximately 25.1 million common shares and approximately 40.8 million common stock warrants to settle our class action securities litigation.
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19. Loss Per Share:
For the year ended December 31, 2005 2004 2003
Numerator:
Loss from continuing operations $ (384,585 ) $ (54,128 ) $ (426,920 ) Loss from discontinued operations (61,409 ) (120,342 ) (5,181 ) Cumulative effect of accounting change — — (2,456 )
Net loss $ (445,994 ) $ (174,470 ) $ (434,557 )
Denominator:
Basic—weighted average common shares outstanding 396,563 396,423 396,132
Diluted—weighted average common shares outstanding 398,021 397,625 405,831
Basic and diluted loss per share:
Loss from continuing operations $ (0.97 ) $ (0.14 ) $ (1.08 ) Loss from discontinued operations (0.15 ) (0.30 ) (0.01 ) Cumulative effect of accounting change — — (0.01 )
Net loss $ (1.12 ) $ (0.44 ) $ (1.10 )
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The Company has entered into a significant number of transactions involving former directors, officers and employees. We have summarized material related party transactions, not disclosed elsewhere, (see Note 4, Cash and Marketable Securities and Note 7, Investment in and Advances to Nonconsolidated Affiliates) as follows:
Meadowbrook Healthcare, Inc.—
In 2001, we sold four inpatient rehabilitation facilities to Meadowbrook Healthcare, Inc. (“Meadowbrook”), an entity formed by one of our former chief financial officers. In addition, during 2001 and 2002, we advanced approximately $38.0 million in working capital loans to Meadowbrook. We reserved these amounts in 2001 and 2002.
In March 2005, we obtained a security interest in the real properties previously sold to Meadowbrook, evidenced by a mortgage that was recorded in June 2005. In July 2005, we received a payoff letter from Meadowbrook’s attorneys informing us that a payment of $37.9 million would be made by Meadowbrook to us. This repayment was effected by the purchase of Meadowbrook by Rehabcare Group, Inc. in August 2005. We received a cash payment of $37.9 million in August 2005 and recorded this bad debt recovery on that date. See Note 24, Contingencies and Other Commitments , for information regarding litigation between HealthSouth and Meadowbrook.
Nelson-Brantley Glass Contractors—
In connection with the construction of the Digital Hospital, the general contractor on that project, which is an unrelated third party, entered into a subcontract agreement with Nelson-Brantley Glass Contractors, Inc. for the provision of glass required for the project. Larry D. Striplin, Jr., a former HealthSouth director, is the Chairman and Chief Executive Officer of Nelson-Brantley, and is also the company’s sole owner. During 2004 and 2003, we paid the contractor a total of approximately $5.7 million for glass and glazing work performed on the Digital Hospital.
U.S. HealthWorks, Inc.—
In March 2001, we sold our occupational medicine business to U.S. HealthWorks, Inc. for approximately $43.1 million. The purchase price consisted of approximately $30.1 million in cash at closing and two notes ($7.0 million and $6.0 million) for the balance. As a result of this transaction, we recorded a gain on sale of assets of approximately $15.8 million. One of our former chief financial officers, William T. Owens, was appointed to the board of directors of U.S. HealthWorks, Inc. as a condition to the sale.
In April 2001, we loaned U.S. HealthWorks $2.9 million, which was repaid five days after the loan was advanced. In May 2001, we paid U.S. HealthWorks $2.0 million to settle a dispute related to the transaction. In October 2002, we loaned U.S. HealthWorks $2.3 million (which was repaid in December 2002), paid U.S. HealthWorks $1.2 million to settle another dispute related to the transaction, and forgave the remaining $4.0 million due on the $6.0 million note. In April 2003, there was another dispute regarding the transaction that was resolved by us forgiving the $7.0 million note in 2004.
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20. Related Party Transactions:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Due from related parties—
Amounts due from employees, officers, and other related parties are (in thousands):
The amount outstanding at December 31, 2004 of $24,000 from one current employee bore interest at the prime rate less 1.25% (effective rate at December 31, 2004 was 4.0%) and is included in Other long-term assets in our 2004 consolidated balance sheet. This amount was fully paid in 2005. We have reserved all amounts due from former employees that have become past due. As discussed in Note 7, Investment in and Advances to Nonconsolidated Affiliates, we fully reserved the note receivable of approximately $9.2 million due from MCD as of December 31, 2003.
The Civil DOJ Settlement—
On January 23, 2002, the United States intervened in four lawsuits filed against us under the federal civil False Claims Act. These so-called “ qui tam ” (i.e. whistleblower) lawsuits were transferred to the Western District of Texas and were consolidated under the caption United States ex rel. Devage v. HealthSouth Corp., et al. , No. 98-CA-0372 (DWS) (W.D. Tex. San Antonio). On April 10, 2003, the United States informed us that it was expanding its investigation to review whether fraudulent accounting practices affected our previously submitted Medicare cost reports.
On December 30, 2004, we entered into a global settlement agreement (the “Settlement Agreement”) with the United States. This settlement was comprised of (1) the claims consolidated in the Devage case, which related to claims for reimbursement for outpatient physical therapy services rendered to Medicare, the TRICARE Management Activity (“TRICARE”), or United States Department of Labor (the “DOL”) beneficiaries, (2) the submission of claims to Medicare for costs relating to our allegedly improper accounting practices, (3) the submission of other unallowable costs included in our Medicare Home Office Cost Statements and in our individual provider cost reports, and (4) certain other conduct (collectively, the “Covered Conduct”). The parties to this global settlement include us and the United States acting through the DOJ’s civil division, the Office of Inspector General (the “HHS-OIG”) of the Department of Health and Human Services (“HHS”), the DOL through the Employment Standards Administration’s Office of Workers’ Compensation Programs, Division of Federal Employees’ Compensation (“OWCP-DFEC”), TRICARE, and certain other individuals and entities which had filed civil suits against us and/or our affiliates (those other individuals and entities, the “Relators”).
Pursuant to the Settlement Agreement, we agreed to make cash payments to the United States in the aggregate amount of $325 million, plus accrued interest from November 4, 2004 at an annual rate of 4.125%. The United States agreed, in turn, to pay the Relators the portion of the settlement amount due to the Relators pursuant to the terms of the Settlement Agreement. Through December 31, 2005, we have made payments of
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As of December 31, 2005 2004
Notes receivable, employees and officers $ 3,092 $ 3,281 Due from MedCenter Direct 9,234 9,234
Less: Allowance for doubtful accounts (12,326 ) (12,491 )
— 24 Less: Current portion — —
Due from related parties $ — $ 24
21. Medicare Program Settlement:
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements approximately $155 million (excluding interest), with the remaining balance of $170 million (plus interest), to be paid in quarterly installments ending in the fourth quarter of 2007. As of December 31, 2005 and 2004, approximately $83.3 million and $155.0 million, respectively, of the cash settlement amount is included in Current portion of government, class action, and related settlements in our consolidated balance sheets.
The Settlement Agreement provides for our release by the United States from any civil or administrative monetary claim the United States had or may have had relating to Covered Conduct that occurred on or before December 31, 2002 (with the exception of Covered Conduct for certain outlier payments, for which the release date is extended to September 30, 2003). The Settlement Agreement also provides for our release by the Relators from all claims based upon any transaction or incident occurring prior to December 30, 2004, including all claims that have been or could have been asserted in each Relator’s civil action, and from any civil monetary claim the United States had or may have had for the Covered Conduct that is pled in each Relator’s civil action.
The Settlement Agreement also provides for the release of HealthSouth by the HHS-OIG and OWCP-DFEC, and the agreement by the HHS-OIG and OWCP-DFEC to refrain from instituting, directing, or maintaining any administrative action seeking exclusion from Medicare, Medicaid, the FECA Program, the TRICARE Program and other federal health care programs, as applicable, for the Covered Conduct. The DOJ continues to review certain other matters, including self-disclosures made by us to the HHS-OIG.
The Administrative Settlement Agreement—
In connection with the Settlement Agreement, we entered into a separate settlement agreement (the “Administrative Settlement Agreement”) with CMS acting on behalf of HHS, to resolve issues associated with various Medicare cost reporting practices.
Subject to certain exceptions and the terms and conditions of the Administrative Settlement Agreement, the Administrative Settlement Agreement provides for the release of HealthSouth by CMS from any obligations related to any cost statements or cost reports that had, or could have been submitted to CMS or its fiscal intermediaries by HealthSouth for cost reporting periods ended on or before December 31, 2003. The Administrative Settlement Agreement provides that all covered cost reports be closed and considered final and settled.
The December 2004 Corporate Integrity Agreement—
On December 30, 2004, we entered into a new corporate integrity agreement (the “CIA”) with the HHS-OIG. This new CIA has an effective date of January 1, 2005 and a term of five years from that effective date. It incorporates a number of compliance program changes already implemented by us and requires, among other things, that not later than 90 days after the effective date, we:
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• form an executive compliance committee (made up of our chief compliance officer and other executive management members),
which shall participate in the formulation and implementation of HealthSouth’s compliance program;
• require certain independent contractors to abide by our Standards of Business Conduct;
• provide general compliance training to all HealthSouth personnel as well as specialized training to personnel responsible for billing,
coding, and cost reporting relating to federal health care programs;
• report and return overpayments received from federal health care programs;
• notify the HHS-OIG of any new investigations or legal proceedings initiated by a governmental entity involving an allegation of
fraud or criminal conduct against HealthSouth;
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
On April 28, 2005, we submitted an implementation report to the HHS-OIG stating that we had, within the 90-day time frame, materially complied with the initial requirements of this new CIA.
Failure to meet our obligations under our CIA could result in stipulated financial penalties. Failure to comply with material terms, however, could lead to exclusion from further participation in federal health care programs, including Medicare and Medicaid, which currently account for a substantial portion of our revenues.
On June 6, 2005, the SEC approved a settlement (the “SEC Settlement”) with us relating to the action filed by the SEC on March 19, 2003 captioned SEC v. HealthSouth Corporation and Richard M. Scrushy , No. CV-03-J-0615-S (N.D. Ala.) (the “SEC Litigation”). That lawsuit alleges that HealthSouth and our former Chairman and Chief Executive Officer, Richard M. Scrushy, violated and/or aided and abetted violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. The civil claims against Mr. Scrushy are still pending.
Under the terms of the SEC Settlement, we have agreed, without admitting or denying the SEC’s allegations, to be enjoined from future violations of certain provisions of the securities laws. We have also agreed to:
We retained a qualified governance consultant to perform a review of the adequacy and effectiveness of our corporate governance systems, policies, plans, and practices, which review is now complete. The consultant’s
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• notify the HHS-OIG of the purchase, sale, closure, establishment, or relocation of any facility furnishing items or services that are
reimbursed under federal health care programs; and
• submit regular reports to the HHS-OIG regarding our compliance with the CIA.
22. SEC Settlement:
• pay a $100 million civil penalty and disgorgement of $100 to the SEC in the following installments: $12,500,100 by October 15,
2005, $12.5 million by April 15, 2006, $25.0 million by October 15, 2006; $25.0 million by April 15, 2007, and $25.0 million by October 15, 2007;
• retain a qualified governance consultant to perform a review of the adequacy and effectiveness of our corporate governance systems,
policies, plans, and practices;
• either (1) retain a qualified accounting consultant to perform a review of the effectiveness of our material internal accounting control structure and policies, as well as the effectiveness and propriety of our processes, practices, and policies for ensuring our financial data is accurately reported in our filed consolidated financial statements, or (2) within 60 days of filing with the SEC audited consolidated financial statements for the fiscal year ended December 31, 2005, including our independent auditor’s attestation on internal control over financial reporting, provide to the SEC all communications between our independent auditor and our management and/or Audit Committee from the date of the judgment until such report concerning our internal accounting controls;
• provide reasonable training and education to certain of our officers and employees to minimize the possibility of future violations of
the federal securities laws;
• continue to cooperate with the SEC and the DOJ in their respective ongoing investigations; and
• create, staff, and maintain the position of Inspector General within HealthSouth, which position shall have the responsibility of
reporting any indications of violations of law or of HealthSouth’s procedures, insofar as they are relevant to the duties of the Audit Committee, to the Audit Committee.
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements report of that review concludes, among other things, that “[t]he company’s current practices, created by the new directors and executives, meet contemporary standards of corporate governance.” In addition, we have chosen to provide the SEC all communications between our independent auditor and our management and/or Audit Committee rather than retaining an accounting consultant to review the effectiveness of our internal controls. Further, we hired Shirley Yoshida, formerly Vice President, Internal Audit at Safeway Inc., to serve as our Inspector General and to lead our internal audit department. We continue to comply with the other terms of the SEC Settlement.
The SEC Settlement also provides that we must treat the amounts ordered to be paid as civil penalties as penalties paid to the government for all purposes, including all tax purposes, and that we will not be able to be reimbursed or indemnified for such payments through insurance or any other source, or use such payments to set off or reduce any award of compensatory damages to plaintiffs in related securities litigation pending against us.
In connection with the SEC Settlement, we consented to the entry of a final judgment in the SEC Litigation (which judgment was entered by the United States District Court for the Northern District of Alabama, Southern Division) to implement the terms of the SEC Settlement. However, Mr. Scrushy remains a defendant in the SEC Litigation.
In accordance with FASB Statement No. 5 and EITF Abstract Topic No. D-86, we recognized the cost of the SEC Settlement as of December 31, 2003. The cost of the SEC Settlement is classified as Government, class action, and related settlements expense in the consolidated statement of operations for the year ended December 31, 2003 and is included in Government, class action, and related settlements in the consolidated balance sheets.
On June 24, 2003, the United States District Court for the Northern District of Alabama consolidated a number of separate securities lawsuits filed against us under the caption In re HealthSouth Corp. Securities Litigation , Master Consolidation File No. CV-03-BE-1500-S (the “Consolidated Securities Action”). The Consolidated Securities Action included two prior consolidated cases ( In re HealthSouth Corp. Securities Litigation , CV-98-J-2634-S and In re HealthSouth Corp. 2002 Securities Litigation , Consolidated File No. CV-02-BE-2105-S) as well as six lawsuits filed in 2003. Including the cases previously consolidated, the Consolidated Securities Action comprised over 40 separate lawsuits. The court divided the Consolidated Securities Action into two subclasses:
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23. Securities Litigation Settlement:
• Complaints based on purchases of our common stock were grouped under the caption In re HealthSouth Corp. Stockholder Litigation , Consolidated Case No. CV-03-BE-1501-S (the “Stockholder Securities Action”), which was further divided into complaints based on purchases of our common stock in the open market (grouped under the caption In re HealthSouth Corp. Stockholder Litigation, Consolidated Case No. CV-03-BE-1501-S) and claims based on the receipt of our common stock in mergers (grouped under the caption HealthSouth Merger Cases , Consolidated Case No. CV-98-2777-S). Although the plaintiffs in the HealthSouth Merger Cases have separate counsel and have filed separate claims, the HealthSouth Merger Cases are otherwise consolidated with the Stockholder Securities Action for all purposes.
• Complaints based on purchases of our debt securities were grouped under the caption In re HealthSouth Corp. Bondholder
Litigation , Consolidated Case No. CV-03-BE-1502-S (the “Bondholder Securities Action” ).
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
On February 22, 2006, we announced that we had reached a global, preliminary settlement with the lead plaintiffs in the Stockholder Securities Action, the Bondholder Securities Action, and the derivative litigation, as well as with our insurance carriers, to settle claims filed in those actions against us and many of our former directors and officers. Under the proposed settlement, claims brought against the settling defendants will be settled for consideration consisting of HealthSouth common stock and warrants valued at approximately $215 million and cash payments by our insurance carriers of $230 million. In addition, we have agreed to give the class 25% of our net recovery from any future judgments won by us or on our behalf against Richard M. Scrushy, our former Chairman and Chief Executive Officer, Ernst & Young LLP, our former auditor, and certain affiliates of UBS Group, our former lead investment banker, none of whom are included in the settlement. The proposed settlement is subject to a number of conditions, including the successful negotiation of definitive documentation and final court approval. The proposed settlement does not include Richard M. Scrushy or any director or officer who has agreed to plead guilty or otherwise been convicted in connection with our former financial reporting activities.
There can be no assurances that a final settlement agreement can be reached or that the proposed settlement will receive the required court approval. We recorded a charge of $215 million as Government, class action, and related settlements expense in our 2005 consolidated statement of operations. The corresponding liability is included in Current portion of government, class action, and related settlements in our consolidated balance sheet as of December 31, 2005. The charge for the settlement will be revised in future periods to reflect additional changes in the fair value of the common stock and warrants until they are issued.
Significant Legal Proceedings—
We operate in a highly regulated and litigious industry. As a result, various lawsuits, claims and legal and regulatory proceedings have been and can be expected to be instituted or asserted against us. The resolution of any such lawsuits, claims or legal and regulatory proceedings could materially and adversely affect our results of operations and financial position in a given period.
Investigations and Proceedings Commenced by the SEC, the Department of Justice, and Other Governmental Authorities—
In September 2002, the SEC notified us that it was conducting an investigation of trading in our securities that occurred prior to an August 27, 2002 press release concerning the impact of new Medicare billing guidance on our expected earnings. On February 5, 2003, the United States District Court for the Northern District of Alabama issued a subpoena requiring us to provide various documents in connection with a criminal investigation of us and certain of our directors, officers, and employees being conducted by the United States Attorney for the Northern District of Alabama. On March 18, 2003, agents from the Federal Bureau of Investigation (the “FBI”) executed a search warrant at our headquarters in connection with the United States Attorney’s investigation and were provided access to a number of financial records and other materials. The agents simultaneously served a grand jury subpoena on us on behalf of the criminal division of the DOJ. Some of our employees also received subpoenas.
On March 19, 2003, the SEC filed a lawsuit captioned Securities and Exchange Commission v. HealthSouth Corp., et al ., CV-03-J-0615-S, in the United States District Court for the Northern District of Alabama. The complaint alleges that we overstated earnings by at least $1.4 billion since 1999, and that this overstatement occurred because our then-Chairman and Chief Executive Officer, Richard M. Scrushy, insisted that we meet or exceed earnings expectations established by Wall Street analysts.
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24. Contingencies and Other Commitments:
Table of Contents
Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
The SEC states in its complaint that our actions and those of Mr. Scrushy violated and/or aided and abetted violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. Specifically, the SEC charged us with violations of Section 17(a) of the Securities Act of 1933 (the “Securities Act”) and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 (the “Exchange Act”), and Exchange Act Rules 10b-5, 12b-20, 13a-1, and 13a-13. The SEC sought a permanent injunction against us, civil money penalties, disgorgement of ill-gotten gains and losses avoided, as well as prejudgment interest. On March 19, 2003, we consented to the entry of an order by the court that (1) required us to place in escrow all extraordinary payments (whether compensation or otherwise) to our directors, officers, partners, controlling persons, agents, and employees, (2) prohibited us and our employees from destroying documents relating to our financial activities and/or the allegations in the SEC’s lawsuit against us and Mr. Scrushy, and (3) provided for expedited discovery in the lawsuit brought by the SEC.
As discussed in greater detail in Note 22, SEC Settlement, on June 6, 2005, the SEC approved the SEC Settlement with us relating to this lawsuit. Under the terms of the SEC Settlement, we have agreed, without admitting or denying the SEC’s allegations, to be enjoined from future violations of certain provisions of the securities laws. We have also agreed to pay a $100 million civil penalty and disgorgement of $100 to the SEC in installments over two years, beginning in the fourth quarter of 2005. We consented to the entry of a final judgment (which judgment was entered by the United States District Court for the Northern District of Alabama, Southern Division) to implement the terms of the SEC Settlement. Mr. Scrushy remains a defendant in the lawsuit.
On November 4, 2003, Mr. Scrushy was charged in federal court on 85 counts of wrongdoing in connection with his actions while employed by us. A superseding indictment of 58 counts, released on September 29, 2004, added charges of obstruction of justice and perjury while consolidating and eliminating some of the 85 counts of conspiracy, mail fraud, wire fraud, securities fraud, false statements, false certifications, and money laundering that were previously charged. The superseding indictment sought the forfeiture of $278 million in property from Mr. Scrushy allegedly derived from his offenses. Mr. Scrushy was acquitted on June 28, 2005.
On April 10, 2003, the DOJ’s civil division notified us that it was expanding its investigation (which began with the lawsuit United States ex rel. Devage v. HealthSouth Corp., et al ., C.A. No. SA-98-EA-0372-FV, filed in the United States District Court for the Western District of Texas) into allegations of fraud associated with Medicare cost reports submitted by us for fiscal years 1995 through 2002. We subsequently received subpoenas from the Office of Inspector General (the “HHS-OIG”) of the United States Department of Health and Human Services (“HHS”) and requests from the DOJ’s civil division for documents and other information regarding this investigation. As described in Note 21, Medicare Program Settlement , on December 30, 2004, we announced that we had entered into a global settlement agreement with the DOJ’s civil division and other parties to resolve the primary claims made in the Devage litigation, although the DOJ continues to review certain other matters, including self-disclosures made by us to the HHS-OIG. The total financial impact of the global settlement is approximately $347.7 million, which, in accordance with FASB Statement No. 5, we recognized as a settlement expense in 2002.
In the summer of 2003, we discovered certain irregular payments made to a foreign official under a consulting agreement entered into in connection with an October 2000 agreement between us and the Sultan Bin Abdul Aziz Foundation to manage an inpatient rehabilitation hospital in Riyadh, Saudi Arabia. We notified the DOJ immediately, and we cooperated fully with the investigation. One former executive pled guilty to charges of wire fraud in connection with the irregular payments, and another former executive pled guilty to charges of making a false statement to government investigators in connection with the investigation. Two additional former executives were acquitted by a jury of charges that they participated in the fraud. We terminated the October
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements 2000 agreement and entered into a new agreement, effective January 1, 2004, to manage the Riyadh facility. Effective October 2004, we terminated our relationship with the Sultan Bin Abdul Aziz Foundation and the Riyadh facility entirely.
Many of our former officers, including all five of our former chief financial officers, have pleaded guilty to federal criminal charges filed in connection with the investigations described above. These individuals pled guilty to a variety of charges, including securities fraud, accounting fraud, filing false tax returns, making a false statement to governmental authorities, falsifying books and accounts, wire fraud, conspiracy, and falsely certifying financial information to the SEC. One former executive was convicted on November 18, 2005 of criminal charges filed in connection with the accounting fraud investigation.
On October 26, 2005, a federal grand jury issued a superseding indictment against Richard M. Scrushy, former Alabama Governor Don Siegelman, and others, in which Mr. Scrushy is charged with three counts of bribery and mail fraud. We are cooperating with the Office of the United States Attorney on that matter.
Securities Litigation—
See Note 23, Securities Litigation Settlement , for discussion of a global, preliminary settlement with the lead plaintiffs in certain securities actions.
On March 17, 2004, an individual securities fraud action captioned Amalgamated Gadget, L.P. v. HealthSouth Corp. , 4-04CV-198-A, was filed in the United States District Court for the Northern District of Texas. The complaint made allegations similar to those in the Consolidated Securities Action and asserted claims under the federal securities laws and Texas state law based on the plaintiff’s purchase of $24 million in face amount of 3.25% convertible debentures. The court denied our motion to transfer the action to the United States District Court for the Northern District of Alabama, and also denied our motion to dismiss. This action has been settled by the agreement of the parties and dismissed with prejudice. The cost of the settlement is included in Other current liabilities in the consolidated balance sheet as of December 31, 2003 and Government, class action, and related settlements expense in the consolidated statement of operations for the year ended December 31, 2003. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
On November 24, 2004, an individual securities fraud action captioned Burke v. HealthSouth Corp., et al. , 04-B-2451 (OES), was filed in the United States District Court of Colorado against us, some of our former directors and officers, and our former auditor. The complaint makes allegations similar to those in the Consolidated Securities Action and asserts claims under the federal securities laws and Colorado state law based on plaintiff’s alleged receipt of unexercised options and his open-market purchases of our stock. By order dated May 3, 2005, the action was transferred to the United States District Court for the Northern District of Alabama, where it remains pending. We intend to vigorously defend ourselves in this case. At this time, based on the stage of litigation, and review of the current facts and circumstances, we are unable to determine an amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case or whether any resultant liability would have a material adverse effect on our financial position, results of operations, or cash flows.
Derivative Litigation—
Between 1998 and 2004, a number of lawsuits purporting to be derivative actions ( i.e. , lawsuits filed by shareholder plaintiffs on our behalf) were filed in several jurisdictions, including the Circuit Court for Jefferson
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Notes to Consolidated Financial Statements County, Alabama, the Delaware Court of Chancery, and the United States District Court for the Northern District of Alabama. Most of these lawsuits have been consolidated as described below:
When originally filed, the primary allegations in the Tucker case involved self-dealing by Richard M. Scrushy and other insiders through transactions with various entities allegedly controlled by Mr. Scrushy. The complaint was amended four times to add additional defendants and include claims of accounting fraud, improper Medicare billing practices, and additional self-dealing transactions. On September 7, 2005, the Alabama Circuit Court ordered the parties to participate in mediation.
On January 3, 2006, the Alabama Circuit Court in the Tucker case granted the plaintiff’s motion for summary judgment against Mr. Scrushy on a claim for the restitution of incentive bonuses Scrushy received for years 1996 through 2002. Including pre-judgment interest, the court’s total award was approximately $48 million. The judgment does not resolve other claims brought by the plaintiff against Scrushy, which remain pending. On February 8, 2006, the Alabama Supreme Court stayed execution on the judgment and ordered briefing on whether or not the Alabama Circuit Court’s order was appropriate for certification as a final appealable order pursuant to Rule 54(b).
The plaintiffs in the Tucker action have reached a preliminary agreement in principle to settle their claims against many of our former directors and officers for $100 million in cash. This settlement amount is to be paid by our insurance carriers, and will be included in the aggregate cash payment of $230 million that is part of the proposed settlement of the Consolidated Securities Action. We are continuing to negotiate the other terms of a settlement with the other parties to this agreement; however, there can be no assurance that a final settlement agreement will be reached or that the proposed settlement will receive the required court approval.
We intend to continue to vigorously defend ourselves in Tucker . Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to determine our likelihood of prevailing in Tucker , or any financial impact that may result from an adverse judgment in Tucker if the proposed settlement is not finalized or approved by the court.
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• All derivative complaints filed in the Circuit Court of Jefferson County, Alabama since 2002 have been consolidated and stayed in favor of the first-filed action captioned Tucker v. Scrushy , No. CV-02-5212, filed August 28, 2002. The Tucker complaint names as defendants a number of former HealthSouth officers and directors. Tucker also asserts claims on our behalf against Ernst & Young LLP, UBS Group, UBS Investment Bank, and UBS Securities, LLC, as well as against MedCenterDirect.com, Source Medical Solutions, Inc., Capstone Capital Corp., Healthcare Realty Trust, and G.G. Enterprises.
• Two derivative lawsuits filed in the United States District Court for the Northern District of Alabama were consolidated under the
caption In re HealthSouth Corp. Derivative Litigation , CV-02-BE-2565. The court stayed further action in this federal consolidated action in deference to litigation filed in state courts in Alabama and Delaware.
• Two derivative lawsuits filed in the Delaware Court of Chancery were consolidated under the caption In re HealthSouth Corp. Shareholders Litigation , Consolidated Case No. 19896. Plaintiffs’ counsel in this litigation and in Tucker agreed to litigate all claims asserted in those lawsuits in the Tucker litigation, except for claims relating to an agreement to retire a HealthSouth loan to Richard M. Scrushy with shares of our stock (the “Buyback Claim”). On November 24, 2003, the court granted the plaintiffs’ motion for summary judgment on the Buyback Claim and rescinded the retirement of Scrushy’s loan. The court’s judgment was affirmed on appeal. We have collected a judgment of $12.5 million, net of attorneys’ fees awarded by the court. The plaintiffs’ remaining claims are being litigated in Tucker .
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Notes to Consolidated Financial Statements
On September 8, 2003, a derivative lawsuit captioned Teachers Retirement Sys. of Louisiana v. Scrushy , C.A. No. 20529-NC, was filed in the Delaware Court of Chancery. The complaint contains allegations similar to those made in the Tucker case, class claims, as well as a request for relief seeking an order compelling us to hold an annual meeting of stockholders. On December 2, 2003, we announced a settlement of the plaintiff’s claims seeking an annual meeting of stockholders. The Court of Chancery has stayed the remaining claims in favor of earlier-filed litigation in Alabama. This case was not consolidated with In re HealthSouth Corp. Shareholders Litigation .
On November 19, 2004, a derivative lawsuit captioned Campbell v. HealthSouth Corp., Scrushy, et al ., CV-04-6985, was filed in Circuit Court of Jefferson County, Alabama, alleging that we wrongfully refused to file with the IRS refund requests for overpayment of taxes and seeking an order allowing the plaintiff to file claims for refund of excess tax paid by us. This suit was filed just prior to the voluntary dismissal of a similar suit brought by the same plaintiff in the United States District Court for the Northern District of Alabama. On August 23, 2005, the court granted our motion to dismiss without prejudice.
Litigation by and Against Former Independent Auditors—
On March 18, 2005, Ernst & Young LLP filed a lawsuit captioned Ernst & Young LLP v. HealthSouth Corp. , CV-05-1618, in the Circuit Court of Jefferson County, Alabama. The complaint asserts that the filing of the claims against us was for the purpose of suspending any statute of limitations applicable to those claims. The complaint alleges that we provided Ernst & Young LLP with fraudulent management representation letters, financial statements, invoices, bank reconciliations, and journal entries in an effort to conceal accounting fraud. Ernst & Young LLP claims that as a result of our actions, Ernst & Young LLP’s reputation has been injured and it has and will incur damages, expense, and legal fees. Ernst & Young LLP seeks recoupment and setoff of any recovery against Ernst & Young LLP in the Tucker case, as well as litigation fees and expenses, damages for loss of business and injury to reputation, and such other relief to which it may be entitled. On April 1, 2005, we answered Ernst & Young LLP’s claims and asserted counterclaims alleging, among other things, that from 1996 through 2002, when Ernst & Young LLP served as our independent auditor, Ernst & Young LLP acted recklessly and with gross negligence in performing its duties, and specifically that Ernst & Young LLP failed to perform reviews and audits of our financial statements with due professional care as required by law and by its contractual agreements with us. Our counterclaims further allege that Ernst & Young LLP either knew of or, in the exercise of due care, should have discovered and investigated the fraudulent and improper accounting practices being directed by Richard M. Scrushy and certain other officers and employees, and should have reported them to our board of directors and the Audit Committee. The counterclaims seek compensatory and punitive damages, disgorgement of fees received from us by Ernst & Young LLP, and attorneys’ fees and costs. We intend to vigorously defend ourselves in this case. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case.
ERISA Litigation—
In 2003, six lawsuits were filed in the United States District Court for the Northern District of Alabama against us and some of our current and former officers and directors alleging breaches of fiduciary duties in connection with the administration of our Employee Stock Benefit Plan (the “ESOP”). These lawsuits have been consolidated under the caption In re HealthSouth Corp. ERISA Litigation , Consolidated Case No. CV-03-BE-1700-S (the “ERISA Action”). The plaintiffs filed a consolidated complaint on December 19, 2003 that alleges, generally, that fiduciaries to the ESOP breached their duties to loyally and prudently manage and administer the ESOP and its assets in violation of sections 404 and 405 of Employee Retirement Income Security
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Notes to Consolidated Financial Statements Act of 1974 (“ERISA”), by failing to monitor the administration of the ESOP, failing to diversify the portfolio held by the ESOP, and failing to provide other fiduciaries with material information about the ESOP. The plaintiffs seek actual damages including losses suffered by the plan, imposition of a constructive trust, equitable and injunctive relief against further alleged violations of ERISA, costs pursuant to 29 U.S.C. § 1132(g), and attorneys’ fees. The plaintiffs also seek damages related to losses under the plan as a result of alleged imprudent investment of plan assets, restoration of any profits made by the defendants through use of plan assets, and restoration of profits that the plan would have made if the defendants had fulfilled their fiduciary obligations. Pursuant to an Amended Class Action Settlement Agreement entered into on March 6, 2006, all parties have agreed to a global settlement of the claims in the ERISA Action. Under the terms of this settlement, Michael Martin, a former chief financial officer of the company, will contribute $350,000 to resolve claims against him, Richard Scrushy, former chief executive officer of the company, and our insurance carriers will contribute $3.5 million to resolve claims against him, and HealthSouth and its insurance carriers will contribute $25 million to settle claims against all remaining defendants, including HealthSouth. In addition, if we recover any or all of the judgment against Mr. Scrushy for the restitution of incentive bonuses paid to him during 1996 through 2002, we will contribute the first $1 million recovered to the class in the ERISA Action. There can be no assurance that the settlement will be approved by an independent fiduciary appointed to review the settlement on behalf of the ESOP or that the settlement will receive the required court approval.
We intend to continue to vigorously defend ourselves in these cases. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to determine our likelihood of prevailing in these cases, or any financial impact that may result from an adverse judgment in these cases if the proposed settlement is not finalized or approved by the court.
Insurance Coverage Litigation—
In 2003, approximately 14 insurance companies filed complaints in state and federal courts in Alabama, Delaware, and Georgia alleging that the insurance policies issued by those companies to us and/or some of our directors and officers should be rescinded on grounds of fraudulent inducement. The complaints also seek a declaration that we and/or some of our current and former directors and officers are not covered under various insurance policies. These lawsuits challenge the majority of our director and officer liability policies, including our primary director and officer liability policy in effect for the claims at issue. Actions filed by insurance companies in the United States District Court for the Northern District of Alabama were consolidated for pretrial and discovery purposes under the caption In re HealthSouth Corp. Insurance Litigation , Consolidated Case No. CV-03-BE-1139-S. Four lawsuits filed by insurance companies in the Circuit Court of Jefferson County, Alabama have been consolidated with the Tucker case for discovery and other pretrial purposes. Cases related to insurance coverage that were filed in Georgia and Delaware have been dismissed. We have filed counterclaims against a number of the plaintiffs in these cases alleging, among other things, bad faith for wrongful failure to provide coverage.
On February 22, 2006, we announced that we had reached a preliminary agreement in principle with our insurance carriers to resolve our claims against each other. In the proposed settlement, the carriers will contribute $230 million in cash toward the settlement of both the Consolidated Securities Action and the Tucker derivative litigation. However, there can be no assurances that a final settlement agreement can be reached.
We intend to continue to vigorously defend ourselves in these cases. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to determine our likelihood of prevailing in these cases, or any financial impact that may result from an adverse judgment in these cases if the proposed settlement is not finalized or approved by the court.
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Notes to Consolidated Financial Statements Litigation by and Against Richard M. Scrushy—
Richard M. Scrushy filed two lawsuits against us in the Delaware Court of Chancery. One lawsuit, captioned Scrushy v. HealthSouth Corp ., C.A. No. 20357-NC, filed on June 10, 2003, sought indemnification and advancement of Mr. Scrushy’s legal fees. The other lawsuit, captioned Scrushy v. Gordon, et al. , C.A. No. 20375, filed June 16, 2003, named us and our then-current directors as defendants and petitioned the court to enjoin the defendants from excluding Mr. Scrushy from board meetings and from conducting the business of HealthSouth exclusively through the meetings of the Special Committee. The second lawsuit also sought access to certain information, including meetings of the Special Committee. Both lawsuits were voluntarily dismissed without prejudice.
On December 9, 2005, Richard M. Scrushy filed a new complaint in the Circuit Court of Jefferson County, Alabama, captioned Scrushy v. HealthSouth , CV-05-7364. The complaint alleges that, as a result of Mr. Scrushy’s removal from the position of CEO in March 2003, we owe him “in excess of $70 million” pursuant to an employment agreement dated as of September 17, 2002. We have answered the complaint and filed counterclaims against Mr. Scrushy.
In addition, on or about December 19, 2005, Mr. Scrushy filed a demand for arbitration with the American Arbitration Association, supposedly pursuant to an indemnity agreement with us. The arbitration demand seeks to require us to pay expenses which he estimates exceed $31 million incurred by Mr. Scrushy, including attorneys’ fees, in connection with the defense of criminal fraud claims against him and in connection with a preliminary hearing in the SEC litigation.
In our counterclaim filed in the Alabama Circuit Court action, we have asked the court to prohibit Mr. Scrushy from having his claims resolved in arbitration, as opposed to a jury trial. After hearings on January 4, 2006 and January 23, 2006, the Alabama Circuit Court denied our motion to stay and enjoin the arbitration. However, the court ordered Mr. Scrushy to terminate the arbitration and withdraw his demand for arbitration, but left him the option of beginning arbitration at a later date on further order of the court. The court also granted Scrushy the right to petition the court to lift the stay after pre-trial discovery had occurred in the court proceeding between us and Mr. Scrushy.
On or about February 6, 2006, Mr. Scrushy filed a motion with the Alabama Supreme Court asking it to direct the Alabama Circuit Court to vacate its order requiring Mr. Scrushy to withdraw his arbitration demand, and to direct the Alabama Circuit Court to dismiss our counterclaim for a declaratory judgment and end “any further exercise of jurisdiction over this arbitration matter.” Mr. Scrushy’s motion is still pending.
We intend to vigorously defend ourselves in this case. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case.
Litigation by Other Former Officers—
On August 22, 2003, Anthony Tanner, our former Secretary and Executive Vice President—Administration, filed a petition in the Circuit Court of Jefferson County, Alabama, captioned In re Tanner , CV-03-5378, seeking permission to obtain certain information through the discovery process prior to filing a lawsuit. That petition was voluntarily dismissed with prejudice on August 11, 2004. On December 29, 2004, Mr. Tanner filed a lawsuit in the Circuit Court of Jefferson County, Alabama, captioned Tanner v. HealthSouth Corp ., CV-04-7715, alleging that we breached his employment contract by failing to pay certain retirement benefits. The complaint requests damages, a declaratory judgment, and a preliminary injunction to require payment of past due amounts under the
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Notes to Consolidated Financial Statements contract and reinstatement of the claimed retirement benefits. The parties have agreed to settle this case. The settlement will not have a material effect on our financial position, results of operations, or cash flows.
On December 23, 2003, Jason Hervey, one of our former officers, filed a lawsuit captioned Hervey v. HealthSouth Corp., et al ., CV-03-8031, in the Circuit Court of Jefferson County, Alabama. The complaint sought compensatory and punitive damages in connection with our alleged breach of his employment contract. We settled this lawsuit in 2005. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
Litigation Against Former Officers—
On June 10, 2004, we filed a collection action in the Circuit Court of Jefferson County, Alabama, captioned HealthSouth Corp. v. James Goodreau , CV-04-3619, to collect unpaid loans in the original principal amount of $55,500 that we made to James A. Goodreau, our former Director of Corporate Security, while he was a HealthSouth employee. Mr. Goodreau has asserted counterclaims against us seeking monetary damages in an unspecified amount and equitable relief based upon his contention that he was promised lifetime employment with us by Mr. Scrushy. This case is still pending. We intend to vigorously defend ourselves against the counterclaims alleged by Mr. Goodreau. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount or range of possible gain or loss that might result from a judgment or a settlement of this case.
On August 30, 2004, we filed a collection action in the United States District Court for the Northern District of Alabama, captioned HealthSouth Corp. v. Daniel J. Riviere , CV-04-CO-2592-S, to collect unpaid loans in the original principal amount of $3,163,421 that we made to Daniel J. Riviere, our former President—Ambulatory Services Division, while he was a HealthSouth employee. Mr. Riviere filed a six-count counterclaim against us on April 5, 2005 seeking (1) severance benefits exceeding $2 million under a written employment agreement dated March 18, 2003, (2) a declaratory judgment that the noncompete clause in his employment agreement is void, (3) damages in an unspecified amount based on stock allegedly purchased and held by him in reliance on misrepresentations made by Richard M. Scrushy, (4) $500,000 in lost profits based allegedly on us forcing him to sell shares of our common stock after he was terminated, (5) damages in an unspecified amount based on our alleged conversion of the cash value of certain insurance policies after his termination, and (6) set off of any award from his counterclaim against unpaid loans we made to him. On April 5, 2005, Mr. Riviere commenced a Chapter 7 bankruptcy case in the U.S. Bankruptcy Court for the Northern District of Florida, Case No. 05-30718-LMK, and this lawsuit is stayed pending resolution of the bankruptcy proceedings. We entered into a settlement agreement with Mr. Riviere and his bankruptcy trustee settling the disputes made the subject of the lawsuit. Pursuant to the settlement agreement, Mr. Riviere has agreed to pay us $1.5 million, plus accrued interest at 6% per annum, within three years. The settlement was approved by the bankruptcy court on November 8, 2005.
On July 28, 2005, we filed a collection action in the Circuit Court of Jefferson County, Alabama captioned HealthSouth Corp. v. William T. Owens , CV-05-4420, to collect unpaid loans in the original principal amount of approximately $1.0 million that we made to William T. Owens, our former Chief Financial Officer, while he was a HealthSouth employee. On March 16, 2006, the trial court granted from the bench our motion for summary judgment against Mr. Owens for the balance of the outstanding company loans, plus attorneys’ fees, and a written order to that effect should be issued shortly.
Litigation by Former Medical Director—
On April 5, 2001, Helen M. Schilling, one of our former medical directors, filed a lawsuit captioned Helen M. Schilling, M.D. v. North Houston Rehabilitation Associates d/b/a HealthSouth Houston Rehabilitation
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Notes to Consolidated Financial Statements Institute, Romano Rehabilitation Hospital, Inc. and Anne Leon , Cause No. 01-04-02243-CV, in the 410 th Judicial District Court of Montgomery County, Texas. The plaintiff claimed, among other things, that we wrongfully terminated her medical director agreement. On November 5, 2003, after a jury trial, the court entered a final judgment awarding the plaintiff $465,000 in compensatory damages and $865,000 in exemplary damages. We appealed the judgment and settled the case while on appeal in 2005. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
Certain Regulatory Actions—
The False Claims Act, 18 U.S.C. § 287, allows private citizens, called “relators,” to institute civil proceedings alleging violations of the False Claims Act. These so-called qui tam , or “whistleblower,” cases are sealed by the court at the time of filing. The only parties privy to the information contained in the complaint are the relator, the federal government, and the presiding court. We recently settled one qui tam lawsuit, Devage , which is discussed in Note 21, Medicare Program Settlement . We are aware of one other qui tam lawsuit, Mathews , which is discussed below. It is possible that additional qui tam lawsuits have been filed against us and that we are unaware of such filings or have been ordered by the presiding court not to discuss or disclose the filing of such lawsuits. Thus, we may be subject to liability exposure under one or more undisclosed qui tam cases brought pursuant to the False Claims Act.
On April 1, 1999, a plaintiff relator filed a lawsuit captioned United States ex rel. Mathews v. Alexandria Rehabilitation Hospital , CV-99-0604, in the United States District Court for the Western District of Louisiana. On February 29, 2000, the United States elected not to intervene in the lawsuit. The complaint alleged, among other things, that we filed fraudulent reimbursement claims under the Medicare program on a nationwide basis. The district court dismissed the False Claims Act allegations of two successive amended complaints. However, the district court’s dismissal of the third amended complaint with prejudice was partially reversed by the United States Court of Appeals for the Fifth Circuit on October 22, 2002. The case was remanded to the district court, and our subsequent motion to dismiss was denied on February 21, 2004. The case is currently in the discovery stage on False Claims Act allegations concerning one HealthSouth facility during a specific timeframe. We intend to vigorously defend ourselves against the claims alleged by the plaintiff relator. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case.
Americans with Disabilities Act Litigation—
On April 19, 2001 a nationwide class action now captioned Michael Yelapi, et al. v. St. Petersburg Surgery Center, et al. , Case No: 8:01-CV-787-T-17EAJ, was filed in the United States District Court for the Middle District of Florida alleging violations of the Americans with Disabilities Act, 42 U.S.C. § 12181, et seq . (the “ADA”) and the Rehabilitation Act of 1973, 92 U.S.C. § 792 et seq . (the “Rehabilitation Act”) at our facilities. The complaint alleges violations of the ADA and Rehabilitation Act for the purported failure to remove barriers and provide accessibility to our facilities, including reception and admitting areas, signage, restrooms, phones, paths of access, elevators, treatment and changing rooms, parking, and door hardware. As a result of these alleged violations, the plaintiffs sought an injunction ordering that we make necessary modifications to achieve compliance with the ADA and the Rehabilitation Act, as well as attorneys’ fees. We have entered into a settlement agreement with the plaintiffs that provides for inspection of our facilities and requires us to correct any deficiencies under the ADA and the Rehabilitation Act. The settlement agreement was approved by the court on December 29, 2005. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
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Notes to Consolidated Financial Statements General Medicine, P.C. and Meadowbrook Actions—
Pursuant to a Plan and Agreement of Merger dated February 17, 1997, Horizon/CMS Healthcare Corporation (“Horizon/CMS”) became a wholly owned subsidiary of HealthSouth Corporation. At the time of the merger, there was pending against Horizon/CMS in the United States District Court for the Eastern District of Michigan a lawsuit captioned General Medicine, P.C. v. Horizon/CMS Healthcare Corporation , CV-96-72624 (the “Michigan Action”). The complaint in the Michigan Action alleged that Horizon/CMS wrongfully terminated a contract with General Medicine, P.C. (“General Medicine”) for the provision of medical directorship services to long-term care facilities owned and/or operated by Horizon/CMS. Effective December 31, 2001, while the Michigan Action was pending, we sold all of our stock in Horizon/CMS to Meadowbrook pursuant to a Stock Purchase Agreement dated November 2, 2001. Pursuant to the Stock Purchase Agreement, Meadowbrook agreed to indemnify us against losses arising out of the historic and ongoing operations of Horizon/CMS. The Michigan Action was disclosed to Meadowbrook in the Stock Purchase Agreement.
On April 21, 2004, Meadowbrook and Horizon/CMS entered into a settlement agreement with General Medicine in connection with the Michigan Action. Pursuant to the settlement agreement, Horizon/CMS consented to the entry of a final judgment in the amount of $376 million in favor of General Medicine in the Michigan Action on May 3, 2004 (the “Consent Judgment”). The settlement agreement between the parties provides that, with the exception of $0.3 million paid by Meadowbrook, the Consent Judgment may only be collected from us. At the time of the Consent Judgment, we had no ownership or other interest in Horizon/CMS.
On August 16, 2004, General Medicine filed a lawsuit captioned General Medicine, P.C. v. HealthSouth Corp. , CV-04-958, in the Circuit Court of Shelby County, Alabama, seeking to recover the unpaid amount of the Consent Judgment from us. The complaint alleges that while Horizon/CMS was a wholly-owned subsidiary of HealthSouth Corporation and General Medicine was an existing creditor of Horizon/CMS, we caused Horizon/CMS to transfer assets to us thereby rendering Horizon/CMS insolvent and unable to pay its creditors. The complaint asserts that these transfers were made for less than a reasonably equivalent value and/or with the actual intent to defraud creditors of Horizon/CMS, including General Medicine, in violation of the Alabama Uniform Fraudulent Transfer Act. General Medicine’s complaint requests relief including the avoidance of the subject transfers of assets, attachment of the assets transferred to us, appointment of a receiver over the transferred properties, and a monetary judgment for the value of properties transferred. We have filed an answer denying that we have any liability to General Medicine.
On October 6, 2004, Meadowbrook filed a declaratory judgment action against us in the Circuit Court of Shelby County, Alabama, captioned Meadowbrook Healthcare Corporation v. HealthSouth Corp ., CV-04-1131, seeking a declaration that it is not contractually obligated to indemnify us against General Medicine’s complaint.
On February 28, 2005, the General Medicine case was transferred to the Circuit Court of Jefferson County, Alabama, and assigned case number CV-05-1483. On May 9, 2005, the Meadowbrook case was transferred to the Circuit Court of Jefferson County, Alabama, and assigned case number CV-05-3042.
On July 26, 2005, we filed an Answer and Verified Counterclaim for Injunctive and Other Relief in the Meadowbrook case seeking a judgment requiring Meadowbrook to indemnify us against the claims asserted by General Medicine in its complaint and other relief based upon legal and equitable theories. In August of 2005, both sides filed motions for summary judgment in the Meadowbrook case based upon the express language of the
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Notes to Consolidated Financial Statements indemnification provision in the Stock Purchase Agreement. On November 15, 2005, the court entered a final order determining that Meadowbrook is not contractually obligated under the Stock Purchase Agreement to indemnify us against the claims asserted by General Medicine in its complaint. The final order did not adjudicate our equitable claims against Meadowbrook which, if successful, would require Meadowbrook to pay our liability, if any, to General Medicine. On December 21, 2005, we filed an appeal of the court’s ruling that Meadowbrook has no contractual obligation to indemnify us under the Stock Purchase Agreement, captioned HealthSouth Corporation vs. Meadowbrook Healthcare, Inc ., appeal no. 1050406 in the Supreme Court of Alabama.
On December 9, 2005, we filed a Motion to Consolidate the Meadowbrook case and the General Medicine case. On January 26, 2006, the court entered an order consolidating the two cases for purposes of discovery and pre-trial matters.
On December 9, 2005, we filed a First Amended Counterclaim asserting counterclaims against Meadowbrook, General Medicine and Horizon/CMS for fraud, injurious falsehood, tortious interference with business relations, bad faith, conspiracy, unjust enrichment, and other causes of action. The First Amended Counterclaim alleges that the Consent Judgment is the product of fraud, collusion and bad faith by Meadowbrook, General Medicine and Horizon/CMS and, further, that these parties are guilty of a conspiracy to manufacture a lawsuit against HealthSouth in favor of General Medicine and to divert the assets of Horizon/CMS to Meadowbrook and away from creditors, including HealthSouth.
We intend to vigorously defend ourselves against the claims alleged by the plaintiffs. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of this case.
For additional information about Meadowbrook, see Note 20, Related Party Transactions .
Massachusetts Real Estate Actions—
On February 3, 2003, HRPT Properties Trust (“HRPT”) filed a lawsuit against Senior Residential Care/North Andover, Limited Partnership (“SRC”) in the Land Court for the Commonwealth of Massachusetts captioned HRPT Properties Trust v. Senior Residential Care/North Andover, Limited Partnership , Misc. Case No. 287313, in which it claimed an ownership interest in certain parcels of real estate in North Andover, Massachusetts and alleged that SRC unlawfully occupied and made use of those properties. On March 17, 2003, we (and our subsidiary, Greenery Securities Corp.) moved to intervene in this case claiming ownership of the disputed property pursuant to an agreement that involved the conveyance of five nursing homes. We seek to effect a transfer of title to the disputed property by HRPT to us or our nominee.
On April 16, 2003, Senior Housing Properties Trust (“SNH”) and its wholly owned subsidiary, HRES1 Properties Trust (“HRES1”), filed a lawsuit against us in Land Court for the Commonwealth of Massachusetts captioned Senior Housing Properties Trust and HRES1 Properties Trust v. HealthSouth Corporation, Misc. Case No 289182, seeking reformation of a lease pursuant to which we, through subsidiaries, operate the Braintree Rehabilitation Hospital in Braintree, Massachusetts and the New England Rehabilitation Hospital in Woburn, Massachusetts. HRES1 and SNH allege that certain of our representatives made false statements regarding our financial position, thereby inducing HRES1 to enter into lease terms and other arrangements to which it would not have otherwise agreed. HRES1 and SNH have since amended their complaint to add claims for rescission and damages for fraud. HRES1 and SNH seek to reform the lease to increase the annual rent from $8.7 million to $10.3 million, to increase the repurchase option price at the end of the lease term to $80.3 million from $40
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Notes to Consolidated Financial Statements million, and to change the lease term to expire on January 1, 2006 instead of December 31, 2011. We filed an answer to the complaint and amended complaint denying the allegations, and we asserted claims against HRPT and counterclaims against SNH and HRES1 for breach of contract, reformation, and fraud based on the failure to convey title to the property in North Andover. We also seek damages incurred as a result of that failure to convey. The two actions in the Land Court have been consolidated for all purposes.
On May 13, 2005, the Land Court ruled that we are entitled to a jury trial in the consolidated cases. SNH, HRES1, and HRPT have taken an interlocutory appeal from this order, and argument before the Massachusetts Supreme Judicial Court was held on March 7, 2006. The Supreme Judicial Court has not issued its order as of the date of this report. The consolidated Land Court cases have been stayed pending disposition of the appeal. The parties were still in the discovery phase of the proceedings at the time the stay came into effect. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of the consolidated cases.
In a related action, on November 2, 2004, we filed a lawsuit in the Commonwealth of Massachusetts, Middlesex County Superior Court, captioned HealthSouth Corporation v. HRES1 Properties Trust , Case No 04-4345, in response to our receipt of a notice from HRES1 purporting to terminate our lease governing the Braintree Rehabilitation Hospital in Braintree, Massachusetts and the New England Rehabilitation Hospital in Woburn, Massachusetts due to our alleged failure to furnish quarterly and annual financial information pursuant to the terms of the lease. In the lawsuit, we seek a declaration that we are not in default of our obligations under the lease, as well as an injunction preventing HRES1 from terminating the lease, taking possession of the property on which the hospitals and facilities are located, and assuming or acquiring the hospital businesses and any licenses related thereto. We filed an amended complaint asserting violations of the Massachusetts unfair and deceptive business practices statute and adding HRPT as a party. On November 8, 2004, HRES1 and SNH, its parent, filed a counterclaim seeking a declaration that it lawfully terminated the lease and an order requiring us to use our best efforts to transfer the licenses for the hospitals and to continue to manage the hospitals during the time necessary to effect such transfer.
On September 25, 2005, the Superior Court granted SNH and HRES1’s motion for summary judgment on our requests for declaratory and injunctive relief, ruling that their termination of the lease was valid, and the Court granted HRPT’s motion to dismiss. On September 29, 2005, the Court, at SNH and HRES1’s request, appointed a receiver to hold the “net cash proceeds of operations” of the facilities during the pendency of the litigation.
On November 30 and December 9, 2005, the Court conducted a bench trial on the issues relating to the parties’ relationship post-termination. On January 12, 2006, the Court issued an order accepting HRES1’s construction that: (1) the lease requires us to use our best efforts to accomplish the license transfer while managing the facilities for HRES1’s account; and (2) since October 26, 2004 and until a successor operator assumes control over the facilities, HRES1 is entitled to the net cash proceeds of the hospitals after deducting direct operating expenses and a management fee equal to 5% of net patient revenues. A judgment reflecting this order was entered on January 18, 2006. The judgment required us to pay these amounts for the period from October 26, 2004 through January 18, 2006, within 15 days of the entry of judgment, or February 2, 2006. For future monthly periods, HealthSouth is obligated to pay the net cash proceeds to HRES1 within 15 days of the end of each month. We do not anticipate that these payments will be material to our financial position, results of operations, or cash flows.
On January 24, 2006, we filed a Notice of Appeal from the judgment and all orders encompassed therein, including the order granting SNH and HRES1’s motion for summary judgment on the lease termination issue and their request for the appointment of a receiver. A hearing on the appeal has not yet been scheduled.
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
On January 31, 2006, the Superior Court denied our request to stay the judgment during the appeal, and, on February 2, 2006, a Single Justice of the Appeals Court also denied our request for a stay. Accordingly, we are cooperating with HRES1 regarding transfer of the licenses. In addition, through December 31, 2005, we have paid HRES1 a total of approximately $4.6 million for the net cash proceeds of the hospitals for the period between October 26, 2004 and December 31, 2005.
Based on the judgment, our 2005 results of operations include only a management fee received from our management of the applicable facilities. We estimate that our net operating revenues and operating earnings were negatively impacted by approximately $111.7 million and $9.0 million, respectively, in 2005 as a result of this lease termination.
SNH, HRES1, and HRPT have recently filed motions seeking to require HealthSouth to pay their attorneys’ fees incurred in the Superior Court litigation. We have opposed these requests. A hearing on these motions is currently scheduled for April 11, 2006.
Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or a settlement of the consolidated cases.
Other Litigation—
On September 17, 1998, John Darling, who was one of the federal False Claims Act relators in the now-settled Devage case, filed a lawsuit captioned Darling v. HealthSouth Sports Medicine & Rehabilitation, et al ., 98-6110-CI-20, in the Circuit Court for Pinellas County, Florida. The complaint alleges that Mr. Darling was injured while receiving physical therapy during a 1996 visit to a HealthSouth outpatient rehabilitation facility in Clearwater, Florida. The complaint was amended in December 2004 to add a punitive damages claim. This amended complaint alleges that fraudulent misrepresentations and omissions by us resulted in the injury to Mr. Darling. The court recently ordered the parties to participate in non-binding arbitration. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or settlement of this case.
We have been named as a defendant in two lawsuits brought by individuals in the Circuit Court of Jefferson County, Alabama, Nichols v. HealthSouth Corp. , CV-03-2023, filed March 28, 2003, and Hilsman v. Ernst & Young, HealthSouth Corp., et al. , CV-03-7790, filed December 12, 2003. The plaintiffs allege that we, some of our former officers, and our former auditor engaged in a scheme to overstate and misrepresent our earnings and financial position. The plaintiffs seek compensatory and punitive damages. On March 24, 2003, a lawsuit captioned Warren v. HealthSouth Corp., et al. , CV-03-5967, was filed in the Circuit Court of Montgomery County, Alabama. The lawsuit, which claims damages for the defendants’ alleged negligence, wantonness, fraud and breach of fiduciary duty, was transferred to the Circuit Court of Jefferson County, Alabama. Each of the lawsuits described in this paragraph has been consolidated with the Tucker case for discovery and other pretrial purposes.
On June 30, 2004, two physical therapy providers in New Jersey filed a class action lawsuit captioned William Weiss Physical Therapy, et al., v. HealthSouth Corporation, et al. , Docket No. BER-L-10218-04 (N.J. Super.), in the Superior Court of New Jersey. The nine count complaint alleges certain unfair trade practices in offering physical therapy services in violation of the New Jersey Physical Therapy Licensing Act of 1983. This case has been dismissed with prejudice.
On May 13, 2003, Plano Hospital Investors, Inc. (“Plano”) filed a complaint captioned Plano Hospital Investors, Inc., et al., v. HealthSouth Corp., et al. , Cause No. 219-1416-03, in the 219 th Judicial District Court of
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HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Collin County, Texas. Plano was a limited partner in Collin County Rehab Associates Limited Partnership, a partnership in which we, through wholly owned subsidiaries, are the general partner and hold limited partner interests. Plano alleged that we conducted unauthorized and improper sweeps of partnership funds into a HealthSouth centralized cash management account instead of a partnership account, that we improperly received late partnership distributions, and that the predecessor general partner took a negative capital contribution improperly increasing its interest, and upon the sale of that interest to us, our interest, in the partnership. Effective on or about May 31, 2005, we settled this case and obtained a full and final release of all claims. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
On December 28, 2004, we commenced a collection action in the Circuit Court of Jefferson County, Alabama, captioned HealthSouth Medical Center, Inc. v. Neurological Surgery Associates, P.C., CV-04-7700, to collect unpaid loans in the original principal amount of $275,000 made to Neurological Surgery Associates, P.C. (“NSA”), pursuant to a written Practice Guaranty Agreement. The purpose of the loans was to enable NSA to employ a physician who would bring necessary specialty skills to patients served by both NSA and our acute-care hospital in Birmingham, Alabama. NSA has asserted counterclaims that we breached verbal promises to lease space and employees from NSA, to pay NSA for billing and coding services performed by NSA on behalf of the subject physician-employee, and to pay NSA to manage the subject physician-employee. This case is currently in the discovery phase. We intend to vigorously defend ourselves against these counterclaims. Based on the stage of litigation, and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result from an adverse judgment or settlement of this case.
On April 15, 2004, Klemett L. Belt, Jr. filed a complaint captioned Belt v. HealthSouth Corp ., CV-2004-02517, in the Second Judicial District Court of Bernalillo County, New Mexico. Mr. Belt, a former executive officer and director of Horizon/CMS Healthcare Corporation, entered into a Non-Competition and Retirement Agreement with Horizon/CMS Healthcare Corporation that we subsequently assumed in our acquisition of Horizon/CMS Healthcare Corporation pursuant. Mr. Belt alleged in his complaint that he was entitled to retirement benefits, life insurance and, in the event of certain events of default, liquidated damages pursuant to a contractual provision requiring that the life insurance policies be fully paid and permitting Mr. Belt to receive a lump sum cash payment in lieu of certain unpaid retirement benefits. Mr. Belt alleges that we defaulted under the terms of the agreement due to our nonpayment of insurance policy premium payments beginning on December 31, 2003. As a result of our alleged default under the agreement, Mr. Belt sought liquidated damages in lieu of retirement benefits, payment of insurance policy premiums, amounts sufficient to compensate Mr. Belt for excess income taxes, interest, expenses, attorneys’ fees, and such other relief as may be determined by the court. We entered into a settlement agreement with Mr. Belt pursuant to which we must pay certain damages and relinquish our right to receive returned insurance premiums, if any, under a split dollar arrangement. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
On June 2, 2003, Vanderbilt Health Services, Inc. and Vanderbilt University filed a lawsuit captioned Vanderbilt Health Services, Inc. and Vanderbilt University v. HealthSouth Corporation , Case No. 03-1544-III, in the Chancery Court for Davidson County, Tennessee. We are partners with the plaintiffs in a partnership that operates a rehabilitation hospital in Nashville, Tennessee. In the complaint, the plaintiffs allege that we violated the terms of a non-competition provision in the partnership agreement in connection with our purchase of a number of rehabilitation clinics in the Nashville area. Effective as of January 20, 2006, we settled this case and obtained a full and final release of all claims. The settlement did not have a material effect on our financial position, results of operations, or cash flows.
On July 19, 2005, Gary Bellinger filed a pro se complaint captioned Gary Bellinger v. Eric Hanson, d/b/a U.S. Strategies, Inc., Medika Group, Ltd., Laserlife, Inc., & Relife, Inc.; and Richard Scrushy, d/b/a HealthSouth ,
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HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements Case No. 05-06898-B, In the District Court, Dallas County, Texas, 44 th Judicial District. Mr. Bellinger claims the defendants violated the terms of a distribution agreement with his company, Laser Bio Therapy, Inc., resulting in that company’s bankruptcy. He has sued for breach of contract, breach of fiduciary duty, and fraud, and claims compensatory damages of $270.0 million and punitive damages of $10.0 million. We filed a Motion to Quash Service of Process because we were not properly named or served. That motion is currently pending before the court. Based on the stage of litigation and review of the current facts and circumstances, it is not possible to estimate the amount of loss or range of possible loss that might result, if any, from an adverse judgment or settlement of this case.
Litigation Reserves—
In connection with the SEC, securities, and ERISA litigation, we accrued approximately $31.0 million in legal fees as of December 31, 2003 that are included in Government, class action, and related settlements expense in our consolidated statement of operations for the year ended December 31, 2003.
Under our bylaws and certain indemnification agreements, we may have an obligation to indemnify our current and former officers and directors. Although we contest the validity of his claim, Richard M. Scrushy requested that we reimburse him for costs relating to his criminal defense, which he estimates exceed $31 million. We accrued an estimate of these legal fees as of December 31, 2005 and 2004, which is included in Professional fees—reconstruction and restatement in our consolidated statements of operations for the years ended December 31, 2005 and 2004 and Other current liabilities in our consolidated balance sheets as of December 31, 2005 and 2004 in connection with Mr. Scrushy’s claim.
Total accrued legal fees as of December 31, 2005 and 2004 included in Other current liabilities in our consolidated balance sheets approximated $47.6 million and $68.5 million, respectively.
Other Matters—
The reconstruction of our historical financial records has resulted in the restatement of not only our consolidated financial statements, but also the financial statements of certain of our subsidiary partnerships. While the process of communicating the effect of these restatements to the outside partners has begun, we anticipate the process of resolving the partnership issues arising from these restatements will continue through 2006 and beyond. The ultimate resolution of these matters may have a negative impact on our relationships with our partners, or could cause us to incur charges in future periods. As of December 31, 2005, we are unable to determine an amount of potential exposure or financial loss that might result from the ultimate resolution of these issues, or whether such resolution would have a material impact on our consolidated financial statements in future periods.
Other Commitments—
We are a party to service and other contracts in connection with conducting our business. Minimum amounts due under these agreements are $32.1 million in 2006, $24.7 million in 2007, $9.5 million in 2008, $1.9 million in 2009, $1.7 million in 2010, and $23.5 million thereafter. These contracts primarily relate to software licensing and support, telecommunications, equipment maintenance within our diagnostic segment, and medical supplies. The amount due after 2010 represents a 20-year Master License and Services Agreement with IDX Information Systems Corporation, a provider of health information software applications, for their Flowcast and Imagecast/PACS systems for out diagnostic segment. These amounts do not include commitments related to the Digital Hospital, as discussed in Note 5, Property and Equipment .
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
We also have commitments under severance agreements with former employees. Payments under these agreements for the next five years approximate $1.3 million in 2006, $0.2 million in 2007, $0.2 million in 2008, $0.2 million in 2009, $0.2 million in 2010, and $2.6 million thereafter. Additionally, we expect to pay approximately $0.6 million to Medicare in 2006 relating to certain overpayments received from Medicare in previous years.
Our reportable segments are consistent with how we currently manage the business and view the patients we serve. We have divided our business into operating segments, defined as components of an enterprise about which financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources to an individual segment and in assessing performance of the segment. HealthSouth’s chief operating decision maker is its chief executive officer.
We define segment operating earnings as income before (1) interest income; (2) interest expense and amortization of debt discounts and fees; (3) gain or loss on early extinguishment of debt; (4) gain or loss on sale of investments, and (5) income taxes. We also do not allocate corporate overhead to our operating segments. The chief operating decision maker of HealthSouth uses segment operating earnings as an analytical indicator for purposes of allocating resources to a particular segment and assessing segment performance. Revenues and expenses are measured in accordance with the policies and procedures described in Note 1, Summary of Significant Accounting Policies .
Our internal financial reporting and management structure is focused on the major types of services provided by HealthSouth. The following is a description of our operating segments:
Our IRFs provide comprehensive services to patients who require intensive institutional rehabilitation care. Inpatient rehabilitation patients typically experience significant physical disabilities due to various conditions, such as head injury, spinal cord injury, stroke, certain orthopedic problems, and neuromuscular disease. Our inpatient rehabilitation facilities provide the medical, nursing, therapy, and ancillary services required to comply with local, state, and federal regulations, as well as accreditation standards of the Joint Commission on Accreditation of Healthcare Organizations (the “JCAHO”). Some facilities are also accredited by the Commission on Accreditation of Rehabilitation Facilities. All of our inpatient rehabilitation facilities utilize an interdisciplinary team approach to the rehabilitation process and involve the patient and family, as well as the payor, in the determination of the goals for the patient. Internal case managers monitor each patient’s progress and provide documentation of patient status, achievement of goals, functional outcomes, and efficiency.
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25. Segment Reporting:
• Inpatient includes the operations of 93 freestanding IRFs, 10 LTCHs, and 101 outpatient facilities located in IRFs or in satellite facilities near our IRFs. In addition to HealthSouth facilities, our inpatient segment manages 14 inpatient rehabilitation units, 11 outpatient facilities, and 2 gamma knife radiosurgery centers through management contracts. We also provided management services to a rehabilitation hospital in Saudi Arabia until July 2004. However, the contract was not effectively terminated until October 2004.
• Surgery Centers includes the operations of our network of approximately 158 freestanding ambulatory surgery centers and 3 surgical hospitals. Our ambulatory surgery centers provide the facilities and medical support staff necessary for physicians to perform nonemergency surgical procedures in various specialties, such as orthopedic, GI, ophthalmology, plastic, and general surgery. Our typical ambulatory surgery center is a freestanding facility with two to six fully equipped operating and procedure rooms and ancillary areas for reception, preparation, recovery, and administration. To ensure consistent quality
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Substantially all revenues for our services are generated through external customers. During the years ended December 31, 2005, 2004, and 2003, approximately 47.5%, 47.4%, and 44.6%, respectively of our revenues related to patients participating in the Medicare program.
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of care, each of our surgery centers has a medical advisory committee that implements quality control procedures and reviews the professional credentials of physicians applying for medical staff privileges at the center. In addition, all but a few unique specialty centers are certified by the JCAHO.
• Outpatient includes the operations of our network of approximately 620 outpatient rehabilitation centers and outpatient facilities owned by other health care providers that we manage. Our outpatient rehabilitation centers offer a range of rehabilitative health care services, including physical therapy and occupational therapy that are tailored to the individual patient’s needs, focusing predominantly on orthopedic, sports-related, work-related, hand and spine injuries, and various neurological/neuromuscular conditions. Outpatient treatments include physical, occupational/hand, and aquatic therapies.
• Diagnostic includes the operations of our network of approximately 85 diagnostic centers. Our diagnostic centers provide outpatient diagnostic imaging services, including MRI services, CT services, X-ray services, ultrasound services, mammography services, nuclear medicine services, and fluoroscopy. Not all services are provided at all sites; however, most of our diagnostic centers are multi- modality centers offering multiple types of service. In addition, the segment operates five electro-shock wave lithotripter units.
• Corporate and Other includes revenue-producing functions that are managed directly from our corporate office and that do not fall within one of the four divisions discussed above, including other patient care services and certain non-patient care services, including the operations of the conference center located on our corporate campus, various corporate marketing activities, our clinical research activities, and other services that are generally intended to complement our patient care services activities and certain costs which have not been allocated to the other operating segments.
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Index to Financial Statements
HealthSouth Corporation and Subsidiaries
Notes to Consolidated Financial Statements
Selected financial information for our operating segments for each of the three years ended December 31, 2005, is as follows (in thousands):
Total consolidated interest expense $ 338,701 $ 302,635 $ 265,327
Loss from continuing operations:
Total segment operating earnings (loss) $ (23,429 ) $ 243,685 $ (183,696 ) Interest income 17,141 13,090 7,273 Interest expense and amortization of debt discounts and fees (338,701 ) (302,635 ) (265,327 ) (Loss) gain on early extinguishment of debt (33 ) 45 2,259 Gain (loss) on sale of investments 229 3,601 (15,811 )
Loss from continuing operations before income tax expense (benefit) and cumulative effect of accounting change $ (344,793 ) $ (42,214 ) $ (455,302 )
Total assets:
Total assets for reportable segments $ 3,595,213 $ 4,084,983 $ 4,321,439 Elimination of intersegment assets (3,000 ) (1,990 ) (111,736 )
Total assets $ 3,592,213 $ 4,082,993 $ 4,209,703
For the year ended December 31, 2005 2004 2003
Net operating revenues:
United States $ 3,184,622 $ 3,491,408 $ 3,637,974 International 23,106 21,224 19,918
Total consolidated net operating revenues $ 3,207,728 $ 3,512,632 $ 3,657,892
Property and equipment, net:
United States $ 1,196,592 $ 1,328,558 $ 1,333,681 International 9,914 10,597 9,407
Total property and equipment, net $ 1,206,506 $ 1,339,155 $ 1,343,088
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Index to Financial Statements
EXHIBIT INDEX
1
No. Description 3.1
Restated Certificate of Incorporation of HealthSouth Corporation, as filed in the Office of the Secretary of State of the State of Delaware on May 21, 1998.*
3.2 By-Laws of HealthSouth Corporation, as amended through May 17, 2001.*
3.3
Certificate of Designation of 6.50% Series A Convertible Perpetual Preferred Stock, as filed with the Secretary of State of the State of Delaware on March 7, 2006 (incorporated by reference to Exhibit 3.1 to HealthSouth’s Current Report on Form 8-K dated March 9, 2006).
4.1.1
Indenture, dated as of June 22, 1998, between HealthSouth Corporation and PNC Bank, National Association, as trustee, relating to HealthSouth’s 6.875% Senior Notes due 2005 and 7.0% Senior Notes due 2008.*
4.1.2
Officer’s Certificate pursuant to Sections 2.3 and 11.5 of the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and PNC Bank, National Association, as trustee, relating to HealthSouth’s 6.875% Senior Notes due 2005 and 7.0% Senior Notes due 2008.*
4.1.3
Instrument of Resignation, Appointment and Acceptance, dated as of April 9, 2003, among HealthSouth Corporation, J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), as resigning trustee, and Wilmington Trust Company, as successor trustee, relating to HealthSouth’s 6.875% Senior Notes due 2005 and 7.0% Senior Notes due 2008.*
4.1.4
First Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), relating to HealthSouth’s 6.875% Senior Notes due 2005 (incorporated by reference to Exhibit 99.1 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.1.5
First Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), relating to HealthSouth’s 7.0% Senior Notes due 2008 (incorporated by reference to Exhibit 99.3 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.1.6
Second Supplemental Indenture, dated as of February 15, 2006, to the Indenture, dated as of June 22, 1998, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to J.P. Morgan Trust Company, National Association (successor in interest to PNC Bank, National Association), relating to HealthSouth’s 7.0% Senior Notes due 2008 (incorporated by reference to Exhibit 4.3 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.2.1
Indenture, dated as of September 25, 2000, between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008.*
4.2.2
Instrument of Resignation, Appointment and Acceptance, dated as of May 8, 2003, among HealthSouth Corporation, The Bank of New York, as resigning trustee, and HSBC Bank USA, as successor trustee, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008.*
4.2.3
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of September 25, 2000 between HealthSouth Corporation and HSBC Bank USA, as successor trustee to The Bank of New York, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008.*
4.2.4
Second Supplemental Indenture, dated as of May 14, 2004, to the Indenture dated as of September 25, 2000 between HealthSouth Corporation and HSBC Bank USA, as successor trustee to The Bank of New York, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008 (incorporated by reference to Exhibit 99.2 to HealthSouth’s Current Report on Form 8-K dated May 14, 2004).
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Index to Financial Statements
2
No. Description 4.2.5
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture dated as of September 25, 2000 between HealthSouth Corporation and HSBC Bank USA, as successor trustee to The Bank of New York, relating to HealthSouth’s 10.750% Senior Subordinated Notes due 2008 (incorporated by reference to Exhibit 4.4 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.3.1
Indenture, dated as of February 1, 2001, between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008.*
4.3.2
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of February 1, 2001 between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008.*
4.3.3
Second Supplemental Indenture, dated as of May 14, 2004, to the Indenture dated as of February 1, 2001 between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008 (incorporated by reference to Exhibit 99.1 to HealthSouth’s Current Report on Form 8-K dated May 14, 2004).
4.3.4
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture dated as of February 1, 2001 between HealthSouth Corporation and The Bank of New York, as trustee, relating to HealthSouth’s 8.500% Senior Notes due 2008 (incorporated by reference to Exhibit 4.1 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.4.1
Indenture, dated as of September 28, 2001, between HealthSouth Corporation and National City Bank, as trustee, relating to HealthSouth’s 7.375% Senior Notes due 2006 and 8.375% Senior Notes due 2011.*
4.4.2
Instrument of Resignation, Appointment and Acceptance, dated as of April 9, 2003, among HealthSouth Corporation, National City Bank, as resigning trustee, and Wilmington Trust Company, as successor trustee, relating to HealthSouth’s 7.375% Senior Notes due 2006 and 8.375% Senior Notes due 2011.*
4.4.3
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of September 28, 2001 between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 7.375% Senior Notes due 2006 and 8.375% Senior Notes due 2011.*
4.4.4
Second Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 7.375% Senior Notes due 2006 (incorporated by reference to Exhibit 99.2 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.4.5
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 7.375% Senior Notes due 2006 (incorporated by reference to Exhibit 4.2 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.4.6
Second Supplemental Indenture, dated as of June 24, 2004, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 8.375% Senior Notes due 2011 (incorporated by reference to Exhibit 99.4 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.4.7
Third Supplemental Indenture, dated as of February 15, 2006, to the Indenture, dated as of September 28, 2001, between HealthSouth Corporation and Wilmington Trust Company, as successor trustee to National City Bank, relating to HealthSouth’s 8.375% Senior Notes due 2011 (incorporated by reference to Exhibit 4.6 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
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Index to Financial Statements
3
No. Description 4.5.1
Indenture, dated as of May 22, 2002, between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012.*
4.5.2
Amendment to Indenture, dated as of August 27, 2003, to the Indenture dated as of May 22, 2002 between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012.*
4.5.3
First Supplemental Indenture, dated as of June 24, 2004, to the Indenture dated as of May 22, 2002 between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012 (incorporated by reference to Exhibit 99.5 to HealthSouth’s Current Report on Form 8-K dated June 24, 2004).
4.5.4
Second Supplemental Indenture, dated as of February 15, 2006, to the Indenture dated as of May 22, 2002 between HealthSouth Corporation and The Bank of Nova Scotia Trust Company of New York, as trustee, relating to HealthSouth’s 7.625% Senior Notes due 2012 (incorporated by reference to Exhibit 4.5 to HealthSouth’s Current Report on Form 8-K filed February 17, 2006).
4.6
Indenture, dated as of June 16, 1986, between Greenery Rehabilitation Group, Inc. and Shawmut Bank of Boston, N.A., as trustee, relating to the 6.500% Convertible Subordinated Debentures due 2011.*
4.7
Indenture, dated as of April 1, 1990, between Greenery Rehabilitation Group, Inc. and The Connecticut National Bank, as trustee, relating to the 8.750% Convertible Senior Subordinated Notes due 2015.*
4.8
Registration Rights Agreement, dated February 28, 2006, between HealthSouth and the purchasers party to the Securities Purchase Agreement, dated February 28, 2006, re: HealthSouth’s sale of 400,000 shares of 6.50% Series A Convertible Perpetual Preferred Stock.
10.1.1
Senior Subordinated Credit Agreement, dated as of January 16, 2004, among HealthSouth Corporation, the lenders party thereto, and Credit Suisse First Boston, as Administrative Agent and Syndication Agent (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated January 16, 2004).
10.1.2
Warrant Agreement, dated as of January 16, 2004, between HealthSouth Corporation and Wells Fargo Bank Northwest, N.A., as Warrant Agent (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated January 16, 2004).
10.1.3
Registration Rights Agreement, dated as of January 16, 2004, among HealthSouth Corporation and the entities listed on the signature pages thereto as Holders of Warrants and Transfer Restricted Securities (incorporated by reference to Exhibit 10.3 to HealthSouth’s Current Report on Form 8-K dated January 16, 2004).
10.1.4
Consent and Waiver No. 1, dated February 15, 2006, to the Senior Subordinated Credit Agreement, dated as of January 16, 2004, among HealthSouth Corporation, the lenders party thereto and Credit Suisse (formerly known as Credit Suisse First Boston), as Administrative Agent and Syndication Agent.
10.2.1
Amended and Restated Credit Agreement, dated as of March 21, 2005, among HealthSouth Corporation, the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, Wachovia Bank, National Association, as Syndication Agent, and Deutsche Bank Trust Company Americas, as Documentation Agent (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated March 22, 2005).
10.2.2
Collateral and Guarantee Agreement dated as of March 21, 2005, between HealthSouth Corporation and JPMorgan Chase Bank, N.A., as Collateral Agent (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated March 22, 2005).
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No. Description 10.2.3
Waiver, dated as of February 16, 2006 and effective as of February 22, 2006, to the Amended and Restated Credit Agreement dated as of March 21, 2005, among HealthSouth Corporation, the lenders party thereto and JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent.
10.3.1
Term Loan Agreement, dated as of June 15, 2005, among HealthSouth Corporation, the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, Citicorp North America, Inc., as Syndication Agent, and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc. as Co-Lead Arrangers and Joint Bookrunners (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K dated June 15, 2005).
10.3.2
Amendment and Waiver No. 1, dated February 15, 2006, to the Term Loan Agreement, dated as of June 15, 2005, among HealthSouth Corporation, the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, Citicorp North America, Inc., as Syndication Agent, and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc. as Co-Lead Arrangers and Joint Bookrunners.
10.4.1
Lease Agreement, dated as of December 27, 2001, between State Street Bank and Trust Company of Connecticut, National Association, as Owner Trustee for Digital Hospital Trust 2001-1, and HealthSouth Medical Center, Inc.*
10.4.2
Participation Agreement, dated as of December 27, 2001, among HealthSouth Medical Center, Inc., HealthSouth Corporation, State Street Bank and Trust Company of Connecticut, National Association, as Owner Trustee for Digital Hospital Trust 2001-1, the various banks and other lending institutions which are parties thereto from time to time as Holders and Lenders, and First Union National Bank.*
10.5
HealthSouth Corporation Change in Control Benefits Plan (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K filed November 14, 2005).+
10.14 HealthSouth Corporation Employee Stock Benefit Plan, as amended.* +
10.15 Employment Agreement, dated as of May 3, 2004, between HealthSouth Corporation and Jay F. Grinney.* +
10.16 Employment Agreement, dated as of June 30, 2004, between HealthSouth Corporation and Michael D. Snow.* +
10.17
Employment Agreement, dated as of September 3, 2004, between HealthSouth Corporation and John L. Workman (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated September 3, 2004).+
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No. Description 10.18.1 Employment Agreement, dated as of February 1, 2004, between HealthSouth Corporation and John Markus.* +
10.18.2
Amendment 1, dated as of April 14, 2004, to Employment Agreement, dated as of February 1, 2004, between HealthSouth Corporation and John Markus.* +
10.19 Employment Agreement, dated as of March 15, 2004, between HealthSouth Corporation and Gregory L. Doody.* +
10.20
Employment Agreement, dated as of July 1, 2004, between HealthSouth Corporation and Karen G. Davis (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated October 11, 2004).+
10.21.1 Employment Agreement, dated as of March 15, 2004, between HealthSouth Corporation and Diane L. Munson.* +
10.21.2
Amendment 1, dated as of April 12, 2004, to Employment Agreement, dated as of March 15, 2004, between HealthSouth Corporation and Diane Munson.* +
10.22
Employment Agreement, dated as of September 27, 2004, between HealthSouth Corporation and Mark J. Tarr (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated October 11, 2004).+
10.23
Employment Agreement, dated as of March 1, 2005, between HealthSouth Corporation and Joseph T. Clark (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated February 3, 2005).+
10.24
Employment Agreement, dated as of March 1, 2005, between HealthSouth Corporation and James C. Foxworthy (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated February 3, 2005).+
10.25
Form of Restricted Stock Agreement, dated as of March 1, 2005, between HealthSouth Corporation and each of Joel C. Gordon and Robert P. May (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K dated March 1, 2005).+
10.26
Letter Agreement, dated as of May 10, 2005, between HealthSouth Corporation and Joel C. Gordon (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K dated May 10, 2005).+
10.27
Settlement Agreement, dated as of December 30, 2004, by and among HealthSouth Corporation, the United States of America, acting through the entities named therein and certain other parties named therein (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K dated December 30, 2004).
10.28
Administrative Settlement Agreement, dated as of December 30, 2004, by and among the United States Department of Health and Human Services acting through the Centers for Medicare & Medicaid Services and its officers and agents, including, but not limited to, its fiscal intermediaries, and HealthSouth Corporation (incorporated by reference to Exhibit 10.3 to HealthSouth’s Current Report on Form 8-K dated December 30, 2004).
10.29
Corporate Integrity Agreement, dated as of December 30, 2004, by and among the Office of Inspector General of the Department of Health and Human Services and HealthSouth Corporation (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K dated December 30, 2004).
10.30.1
Consent of Defendant HealthSouth Corporation, dated June 1, 2005, in the lawsuit captioned Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy , CV-03-J-0615-S (incorporated by reference to Exhibit 99.2 to HealthSouth’s Current Report on Form 8-K dated June 8, 2005).
10.30.2
Form of Final Judgment as to Defendant HealthSouth Corporation in the lawsuit captioned Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy , CV-03-J-0615-S (incorporated by reference to Exhibit 99.3 to HealthSouth’s Current Report on Form 8-K dated June 8, 2005).
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No. Description 10.31 Form of Indemnity Agreement entered into between HealthSouth Corporation and the directors of HealthSouth.* +
10.32 Form of letter agreement with former directors.* +
10.33
Written description of Senior Management Bonus Program (incorporated by reference to Item 1.01 to HealthSouth’s Current Report on Form 8-K dated March 1, 2005).+
10.34
Amended Class Action Settlement Agreement, dated July 25, 2005, with representatives of the plaintiff class relating to the action consolidated on July 2, 2003, captioned IN RE HEALTHSOUTH CORP. ERISA LITIGATION, No. CV-03-BE-1700 (N.D. Ala.).
10.35.1
Written description of HealthSouth Corporation Key Executive Incentive Program (incorporated by reference to Item 1.01 to HealthSouth’s Current Report on Form 8-K dated November 21, 2005).+
10.35.2 Form of Key Executive Incentive Award Agreement (Key Executive Incentive Program).+
10.36.1
HealthSouth Corporation 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10 to HealthSouth’s Current Report on Form 8-K, dated November 21, 2005).+
10.36.2 Form of Non-Qualified Stock Option Agreement (2005 Equity Incentive Plan).+
10.37.1
Asset Purchase Agreement, dated as of July 20, 2005, by and among HealthSouth Corporation, HealthSouth Medical Center, Inc., and The Board of Trustees of The University of Alabama.
10.37.2
Amended and Restated Asset Purchase Agreement, dated as of December 31, 2005, by and among HealthSouth Corporation, HealthSouth Medical Center, Inc., and The Board of Trustees of The University of Alabama.
10.38
Commitment Letter, dated February 2, 2006, from JPMorgan Chase Bank, N.A., J.P. Morgan Securities Inc., Citicorp North America, Inc., Citigroup Global Markets Inc., Merrill Lynch Capital Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K, dated February 3, 2006).
10.39.1
Credit Agreement, dated March 10, 2006, by and among HealthSouth, the lenders party thereto, JPMorgan Chase Bank, N.A., as the administrative agent and the collateral agent, Citicorp North America, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as co-syndication agents; and Deutsche Bank Securities Inc., Goldman Sachs Credit Partners L.P. and Wachovia Bank, National Association, as co-documentation agents (incorporated by reference to Exhibit 10.1 to HealthSouth’s Current Report on Form 8-K, dated March 16, 2006).
10.39.2
Collateral and Guarantee Agreement, dated as of March 10, 2006, by and among HealthSouth, certain of the Company’s subsidiaries and JPMorgan Chase Bank, N.A., as collateral agent (incorporated by reference to Exhibit 10.2 to HealthSouth’s Current Report on Form 8-K, dated March 16, 2006).
10.40
Interim Loan Agreement, dated March 10, 2006, by and among HealthSouth and certain of the Company’s subsidiaries, the lenders party thereto, Merrill Lynch Capital Corporation, as
administrative agent, Citicorp North America, Inc. and JPMorgan Chase Bank, N.A., as co-syndication agents; and Deutsche Bank AG Cayman Islands Branch, Goldman Sachs Credit Partners L.P. and Wachovia Bank, National Association, as co-documentation agents (incorporated by reference to Exhibit 10.3 to HealthSouth’s Current Report on Form 8-K, dated March 16, 2006).
10.41
Securities Purchase Agreement, dated February 28, 2006, between HealthSouth and the purchasers party thereto re: the sale of 400,000 shares of 6.50% Series A Convertible Perpetual Preferred Stock.
11 Computation of Per Share Earnings.
12 Computation of Ratios.
14 HealthSouth Corporation Standards of Business Conduct.
21 Subsidiaries of HealthSouth Corporation.*
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No. Description 24 Power of Attorney.
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities and Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Incorporated by reference to HealthSouth’s Annual Report on Form 10-K filed with the SEC on June 27, 2005. + Management contract or compensatory plan or arrangement.
Exhibit 4.8
HealthSouth Corporation
6.50% Series A Convertible Perpetual Preferred Stock
REGISTRATION RIGHTS AGREEMENT
This Registration Rights Agreement is made as of February 28, 2006, by and among HealthSouth Corporation, a Delaware corporation (the “ Company ”) and the purchasers listed in the signature pages of this Agreement (the “ Purchasers ”). The Company proposes to issue and sell (the “ Offering ”) to the Purchasers upon the terms set forth in the purchase agreement, dated February 28, 2006 (the “ Purchase Agreement ”), between the Purchasers and the Company, 400,000 shares (the “ Securities ”) of its 6.50% Convertible Perpetual Preferred Stock, par value $0.10 per share, which shall have the rights, powers and preferences set forth in the Certificate of Designations (the “ Certificate of Designations ”) of 6.50% Series A Convertible Perpetual Preferred Stock, each having an initial liquidation preference of $1,000 per Security, for the aggregate purchase price set forth in the Purchase Agreement. The Securities are convertible into common stock, par value of $0.01 per share (the “ Common Stock ”), of the Company. In satisfaction of a condition to the obligations of the Purchasers in the Purchase Agreement, the Company agrees with the Purchasers and the Holders (as defined herein) as follows:
1. Definitions. Capitalized terms used herein without definition shall have the meanings ascribed to them in the Purchase Agreement. As used in this Agreement, the following capitalized defined terms shall have the following meanings:
“ Act ” or “ Securities Act ” means the Securities Act of 1933, as amended, and the rules and regulations of the Commission promulgated thereunder.
“ Additional Dividends ” has the meaning given to such term in Section 7(a) hereof.
“ Affiliate ” of any specified person means any other person which, directly or indirectly, controls, is controlled by, or is under common control with, such specified person. For purposes of this definition, control of a person means the power, direct or indirect, to direct or cause the direction of the management and policies of such person whether by contract or otherwise; the terms “controlling” and “controlled” have meanings correlative to the foregoing.
“ Business Day ” means any day other than (i) a Saturday or Sunday or (ii) a day on which banking institutions in the City of New York are authorized or required by law to close.
“ Certificate of Designations ” has the meaning set forth in the first paragraph to this Agreement.
“ Commission ” means the United States Securities and Exchange Commission, or any other federal agency at the time administering the Exchange Act or the Securities Act, whichever is the relevant statute for the particular purpose.
“ Common Stock ” has the meaning set forth in the first paragraph of this Agreement.
“ Company ” has the meaning set forth in the first paragraph of this Agreement.
“ Effective Date ” means the date on which the Registration Statement filed pursuant to Section 2 is declared effective by the Commission.
“ Effectiveness Deadline ” means the 180 th day following the Filing Deadline.
“ Electing Holder ” has the meaning given to such term in Section 3(a)(ii) hereof.
“ Exchange Act ” means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder.
“ Filing Deadline ” means the 30 th day following the day the Company is required under the Exchange Act to file its Annual Report on Form 10-K with the Commission for the fiscal year ending December 31, 2006 (giving effect to any extensions under the Exchange Act).
“ Holder ” and “ Holders ” each mean any person that is the record owner of Registrable Securities (and includes any person that has a beneficial interest in any Registrable Security in book-entry form).
“ Notice of Registration ” means a Notice of Registration Statement in a form to be reasonably agreed to by the Company and the Holders.
“ Offering ” has the meaning set forth in the first paragraph to this Agreement.
“ Person ” means any individual, partnership, corporation, trust, or unincorporated organization, or a governmental agency or political subdivision thereof.
“ Prospectus ” means the prospectus included in any Shelf Registration Statement (including, without limitation, a prospectus that discloses information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A under the Act), with respect to the terms of the offering of any portion of the Securities covered by such Shelf Registration Statement, as amended or supplemented by all amendments (including post-effective amendments) and supplements to the Prospectus.
“ Purchase Agreement ” has the meaning set forth in the first paragraph to this Agreement.
“ Purchasers ” has the meaning set forth in the first paragraph to this Agreement.
“ Registrable Securities ” means (i) any Securities and (ii) any Common Stock issuable upon conversion of the Securities, in each case that has not been registered under the Act, unless such Security or Common Stock issuable upon conversion of such Security has been sold in compliance with Rule 144 or is eligible for sale pursuant to Rule 144(k).
“ Registration Default ” has the meaning given to such term in Section 7(a) hereof.
“ Securities ” has the meaning set forth in the first paragraph to this Agreement.
“ Selling Securityholder Questionnaire ” means the Selling Securityholder Notice and Questionnaire in the form attached as Exhibit B to the Private Placement Memorandum, dated February 28, 2006, relating to the Securities.
“ Shelf Registration ” means a registration effected pursuant to Section 2 hereof.
“ Shelf Registration Period ” has the meaning set forth in Section 2(b) hereof.
“ Shelf Registration Statement ” shall mean a “shelf” registration statement filed under the Securities Act on an appropriate form providing for the registration of, and the sale on a continuous or delayed basis by the Holders of, all of the Registrable Securities pursuant to Rule 415 under the Securities Act and/or any similar rule that may be adopted by the Commission, filed by the Company pursuant to the provisions of Section 2 of this Agreement, including the Prospectus contained therein, any amendments and supplements to such registration statement, including post-effective amendments, and all exhibits and all material incorporated by reference in such registration statement.
“ Transfer Agent ” means Mellon Investor Services, LLC, the transfer agent for the Securities, or any successor Transfer Agent pursuant to the terms of the Certificate of Designations.
“ Underwritten Registration ” or “ Underwritten Offering ” means a registration in which Registrable Securities are sold to an underwriter for reoffering to the public.
2. Shelf Registration. (a) The Company shall as promptly as practicable prepare and, not later than the Filing Deadline, shall file with the Commission a Shelf Registration Statement relating to the offer and sale of the Registrable Securities by the Holders from time to time in accordance with the methods of distribution elected by such Holders and set forth in such Shelf Registration Statement and, thereafter, shall
use all reasonable best efforts to cause such Shelf Registration Statement to be declared effective under the Act as soon as practicable, but in no event later than the Effectiveness Deadline; provided , however , that no Holder shall be entitled to have its Registrable Securities held by it covered by such Shelf Registration Statement unless such Holder is a party to this Agreement or otherwise agrees in writing to be bound by all the provisions of this Agreement that are applicable to such Holder.
The Company shall use all reasonable best efforts to keep the Shelf Registration Statement continuously effective in order to permit the Prospectus forming a part thereof to be lawfully delivered to the Holders until the earliest of (a) the sale of all Registrable Securities registered under the Shelf Registration Statement; (b) two years from the last date of original issuance of the Securities (or for such other period as shall be required by Rule 144(k) of the Act or any successor provision thereto); and (c) the date on which the Securities and any shares of Common Stock issued in conversion of the Securities (1) cease to be outstanding or (2) have been resold pursuant to Rule 144 under the Act (any such period described in this paragraph being referred to as the “ Shelf Registration Period ”).
(b) The Company may suspend the use of the Prospectus for a period not to exceed 30 days in any three-month period or an aggregate of 120 days in any 12-month period if the Board of Directors of the Company shall have determined in good faith that because of bona fide business reasons (not including the avoidance of the Company’s obligations hereunder), including the acquisition or divestiture of assets, pending corporate developments and similar events, it is in the best interests of the Company to suspend such use, and prior to suspending such use, the Company provides the Holders with written notice of such suspension, which notice need not specify the nature of the event giving rise to such suspension.
(c) Notwithstanding any provisions of this Agreement to the contrary, the Company shall cause the Shelf Registration Statement and the related Prospectus and any amendment or supplement thereto, as of the Effective Date of the Shelf Registration Statement, amendment or supplement, as applicable, (i) to comply in all material respects with the applicable requirements of the Securities Act and the rules and regulations of the Commission and (ii) not to contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading.
(d) The Company hereby agrees that it will not file any registration statement under the Securities Act (other than any registration on Form S-8 or any similar form) prior to the date on which it files the Shelf Registration Statement in accordance with Section 2(a) hereof.
3. Registration Procedures. (a) In connection with any Shelf Registration Statement, the following provisions shall apply:
(i) Not less than 30 Business Days prior to the Effective Date of the Shelf Registration Statement, the Company shall mail the Notice of Registration to the Holders of Registrable Securities. No Holder shall be entitled to be named as a selling securityholder in the Shelf Registration Statement or have its Registrable Securities included therein, and no Holder shall be entitled to use the Prospectus forming a part of the Shelf Registration Statement for resales of Registrable Securities at any time, unless such Holder is an Electing Holder; provided , however , that Holders of Registrable Securities shall have at least 15 Business Days from the date on which the Notice of Registration is first received by such Holders to return a completed and signed Selling Securityholder Questionnaire to the Company.
(ii) The term “Electing Holder” shall mean any Holder of Registrable Securities that has returned a completed and signed Selling Securityholder Questionnaire to the Company in accordance with Section 3(a)(i) or 3(a)(ii) hereof and is a party to this Agreement or has otherwise agreed to be bound by all the provisions of this Agreement applicable to such Holder.
(b) The Company shall furnish to any Holders who so request, and its counsel and accountants, a reasonable amount of time prior to the proposed filing thereof with the Commission, an electronic or paper copy, at the Company’s option, of any Shelf Registration Statement, and each amendment thereof and each amendment or supplement, if any, to the Prospectus included therein. All such documents proposed to be filed will be subject to review of one counsel, who shall be Debevoise & Plimpton LLP or another
nationally-recognized law firm with specialization in securities laws chosen by the Company, at the Company’s expense. The Company will not file any Shelf Registration Statement or amendment or post-effective amendment or supplement to such Shelf Registration Statement to which such counsel will have reasonably objected in writing on the grounds that such amendment or supplement does not comply in all material respects with the requirements of the Securities Act or of the rules or regulations thereunder. The Company shall use all reasonable best efforts to reflect in each such document, when so filed with the Commission, such comments as such Holders reasonably may propose.
(c) The Company shall give written notice to the Holders:
(i) when the Shelf Registration Statement and any amendment thereto has been filed with the Commission and when the Shelf Registration Statement or any post-effective amendment thereto has become effective;
(ii) of any written request by the Commission for amendments or supplements to the Shelf Registration Statement or the Prospectus included therein or for additional information;
(iii) of the issuance by the Commission of any stop order suspending the effectiveness of the Shelf Registration Statement or the initiation of any proceedings for that purpose;
(iv) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Securities included therein for sale in any state or the initiation or threatening of any proceeding for such purpose; and
(v) of the happening, during the Shelf Registration Period, of any event that requires the making of any changes in the Shelf Registration Statement or the Prospectus so that, as of such date, the Registration Statement and the Prospectus do not contain an untrue statement of a material fact and do not omit to state a material fact required to be stated therein or necessary to make the statements therein (in the case of the Prospectus, in light of the circumstances under which they were made) not misleading (which written notice shall be accompanied by an instruction to suspend the use of the Prospectus until the requisite changes have been made).
(d) The Company shall use all reasonable best efforts to prevent the issuance, and, if issued, to obtain the withdrawal, of any order suspending the effectiveness of any Shelf Registration Statement at the earliest possible time.
(e) The Company shall furnish, upon written request, to each requesting Holder included within the coverage of any Shelf Registration Statement, without charge, at least one electronic or paper copy, at the Company’s option, of such Shelf Registration Statement and any post-effective amendment thereto (including, to any such Holder who so requests, any reports or other documents incorporated therein by reference), including financial statements and schedules included therein, and, if such Holder so requests, all exhibits (including those incorporated by reference).
(f) The Company shall, during the Shelf Registration Period, deliver to each Holder included within the coverage of any Shelf Registration Statement, without charge, as many electronic or paper copies, at the Company’s option, of the Prospectus (including each preliminary Prospectus) included in such Shelf Registration Statement and any amendment or supplement thereto as such Holder may reasonably request; and the Company consents to the use (except during the periods specified in Section 2(c) above or during the continuance of any event of the existence of any state of facts described in Section 3(c)(v) above) of the Prospectus or any amendment or supplement thereto by each of the selling Holders of Registrable Securities in connection with the offering and sale of the Registrable Securities covered by the Prospectus or any amendment or supplement thereto during the Shelf Registration Period.
(g) Prior to any offering of Registrable Securities pursuant to any Shelf Registration Statement, the Company shall register or qualify, or shall cooperate with the Holders of Registrable Securities included therein and their respective counsel in connection with the registration or qualification of, such Registrable Securities for offer and sale under the securities or blue sky laws of such states as any such Holders reasonably request in writing and do any and all other acts or things necessary or advisable to enable the
offer and sale in such states of the Registrable Securities covered by such Shelf Registration Statement; provided , however , that the Company will not be required to qualify generally to do business in any jurisdiction where it is not then so qualified or to take any action which would subject it to general service of process or to taxation in any such jurisdiction where it is not then so subject.
(h) Unless any Registrable Securities shall be in book-entry only form, the Company shall cooperate with the Holders of Registrable Securities to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold pursuant to any Shelf Registration Statement free of any restrictive legends and in such permitted denominations and registered in such names as Holders may request in connection with the sale of Registrable Securities pursuant to such Shelf Registration Statement.
(i) Upon the occurrence of any event contemplated by paragraphs (ii) through (v) of Section 3(c) above (other than a request by the Commission solely for additional information as referred to in Section 3(c)(ii) and unless directed otherwise by the Commission), the Company shall promptly prepare and file a post-effective amendment to any Shelf Registration Statement or an amendment or supplement to the related Prospectus or file any other required document so that, as thereafter delivered to Holders or purchasers of the Registrable Securities included therein, the Prospectus will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. If the Company notifies the Holders of the Securities in accordance with paragraphs (ii) through (v) of Section 3(c) above to suspend the use of the Prospectus until the requisite changes to the Prospectus have been made, then the Holders of Registrable Securities shall suspend use of the Prospectus for such time.
(j) Not later than the Effective Date of any Shelf Registration Statement hereunder, the Company shall provide a CUSIP number for the Registrable Securities registered under such Shelf Registration Statement, and provide the Transfer Agent and the transfer agent for the Common Stock with printed certificates for the Registrable Securities that are in a form eligible for deposit with The Depository Trust Company.
(k) The Company shall comply, in all material respects, with all applicable rules and regulations of the Commission and shall make generally available to its security holders (or otherwise provide in accordance with Section 11(a) of the Securities Act) as soon as practicable after the Effective Date of the applicable Shelf Registration Statement an earnings statement satisfying the provisions of Section 11(a) of the Securities Act, but in no event later than 45 days after the end of a 12-month period (or 90 days, if such period is a fiscal year) beginning with the first month of the Company’s first fiscal quarter commencing after the Effective Date of the Registration Statement, which statement shall cover such 12-month period.
(l) The Company may require each Holder of Registrable Securities to be sold pursuant to any Shelf Registration Statement as a condition to the registration of such Holder’s Registrable Securities thereunder to furnish to the Company such information regarding the Holder and the distribution of such Registrable Securities as the Company may from time to time reasonably require for inclusion in such Shelf Registration Statement. Each Holder who offers and sells Registrable Securities by means of the Shelf Registration Statement shall do so in accordance with the terms thereof and the requirements of the Securities Act.
(m) The Company shall, if requested, promptly incorporate in a Prospectus supplement or post-effective amendment to a Shelf Registration Statement, such information as the Holders reasonably agree should be included therein and to which the Company does not reasonably object, and shall make all required filings of such Prospectus supplement or post-effective amendment as soon as practicable after the Company is notified of the matters to be incorporated in such Prospectus supplement or post-effective amendment.
(n) The Company shall (i) make reasonably available for inspection by the Holders of Registrable Securities to be registered thereunder and any attorney, accountant or other agent retained by such Holders, all relevant financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries as shall be requested in connection with the discharge of their due diligence obligations and (ii) cause the Company’s officers, directors, employees and independent public accountants and the Transfer Agent to supply at the Company’s expense all relevant information reasonably requested by such
Holders, attorney, accountant or agent in connection with any such Shelf Registration Statement as is customary for similar due diligence examinations; provided , however , with respect to clauses (i) and (ii) of this paragraph, the Company shall have no obligation to provide any such information prior to the execution by the party receiving such information of a confidentiality agreement in a form reasonably acceptable to the Company; provided , further that any information that is designated in writing by the Company in good faith as confidential at the time of delivery of such information shall not be disclosed by such Holders, attorney, accountant or agent, unless such disclosure is made in connection with a court proceeding or required by law, or such information becomes available to the public generally or through a third party without an accompanying obligation of confidentiality, provided , further that prior notice shall be provided as soon as possible to the Company of the potential disclosure of any information by such Holder, attorney, accountant or agent pursuant to court proceeding or legal requirement in order to permit the Company to obtain a protective order with respect to such potential disclosure. The foregoing inspection and information gathering shall be coordinated on behalf of the Holders and the other parties entitled thereto by one counsel, who shall be Debevoise & Plimpton LLP or another nationally-recognized law firm with specialization in securities laws chosen by the Company.
(o) The Company will use all reasonable best efforts to cause the Common Stock issuable upon conversion of the Securities to be listed on each securities exchange, over-the-counter market, or respective counterpart, if any, on which any shares of Common Stock are then listed.
(p) The Company shall use all reasonable best efforts to take all other steps necessary to effect the registration, offering and sale of Registrable Securities covered by the Shelf Registration Statement contemplated hereby.
4. Registration Expenses. (a) All expenses incident to the Company’s performance of and compliance with this Agreement will be borne by the Company, regardless of whether a Shelf Registration Statement is ever filed or becomes effective, including without limitation:
(i) all registration and filing fees and expenses;
(ii) all fees and expenses of compliance with federal securities and state “blue sky” or securities laws;
(iii) all expenses of printing (including printing certificates for the Securities without the restrictive legend to be issued and printing of Prospectuses), messenger and delivery services and telephone;
(iv) all fees and disbursements of counsel for the Company;
(v) all application and filing fees in connection with listing Common Stock issuable upon conversion of the Securities on a national securities exchange or automated quotation system pursuant to the requirements hereof; and
(vi) all fees and disbursements of independent certified public accountants of the Company (including the expenses of any special audit and comfort letters required by or incident to such performance).
The Company will bear its internal expenses (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties), the expenses of any annual audit and the fees and expenses of any person, including special experts, retained by the Company. Notwithstanding anything in this Agreement to the contrary, each Holder shall pay all brokerage commissions with respect to any Registrable Securities sold by it and, except as set forth in Section 4(b) below, the Company shall not be responsible for the fees and expenses of any counsel, accountant or advisor for the Holders.
(b) In connection with any Shelf Registration Statement required by this Agreement, the Company will reimburse the Holders who are selling or reselling Registrable Securities pursuant to the Shelf Registration Statement for the reasonable and documented fees and disbursements of not more than one counsel, who shall be Debevoise & Plimpton LLP or another nationally-recognized law firm with specialization in securities laws chosen by the Company.
5. Indemnification and Contribution. (a) In connection with any Shelf Registration Statement, the Company agrees to indemnify and hold harmless each Holder of Registrable Securities covered thereby, its partners, directors, officers, employees, advisors and agents and each person, if any, who controls any such Holder within the meaning of Section 15 of the Securities Act (such Holders, such partners, directors, officers, employees and advisors and such controlling persons are referred to collectively as the “ Indemnified Parties ”) against any losses, claims, damages or liabilities, joint or several, or any actions in respect thereof (including, but not limited to, any losses, claims, damages, liabilities or actions relating to purchases and sales of the Securities) to which each Indemnified Party may become subject under the Securities Act, the Exchange Act or other Federal or state statutory law or regulation, at common law or otherwise, regardless of whether such losses, claims, damages or liabilities result from actions by the Company, any of its partners, directors, officers, employees, advisors, agents or controlling persons or by any third party and regardless of whether any Indemnified Party is a party to such actions, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Shelf Registration Statement as originally filed or in any amendment or supplement thereof, or in any preliminary Prospectus or Prospectus, or in any amendment thereof or supplement thereto, or arise out of or are based upon the omission or alleged omission to state in any of the foregoing documents a material fact required to be stated therein or necessary to make the statements therein not misleading, in the light of the circumstances under which they were made, and shall reimburse each such Indemnified Party, as incurred, for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided , however , that the Company will not be liable to a Holder of Registrable Securities in any case to the extent that any such loss, claim, damage or liability arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished to the Company by or on behalf of any such Holder specifically for inclusion therein. This indemnity agreement will be in addition to any liability which the Company may otherwise have.
(b) Each Holder of Registrable Securities covered by a Shelf Registration Statement severally, and not jointly, agrees to indemnify and hold harmless (i) the Company, (ii) each of the directors of the Company, (iii) each of its officers who signs such Shelf Registration Statement and (iv) each person who controls the Company within the meaning of either the Securities Act or the Exchange Act to the same extent as the foregoing indemnity from the Company, but only in respect of written information relating to such Holder furnished to the Company by or on behalf of such Holder specifically for inclusion in the documents referred to in the foregoing indemnity. This indemnity agreement will be in addition to any liability which any such Holder may otherwise have.
(c) Promptly after receipt by an indemnified party under this Section 5 of notice of the commencement of any action or proceeding (including a governmental investigation), such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 5, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not relieve the indemnifying party from any liability it may have to any indemnified party (i) except to the extent that the indemnifying party has been materially prejudiced (through the forfeiture of substantive rights or defenses) by such failure and (ii) otherwise than under paragraph (a) or (b) above. In case any such action is brought against any indemnified party and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party (who shall not, except with the consent of such indemnified party, be counsel to the indemnifying party), and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section 5 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened action in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party unless such settlement includes an unconditional release of such indemnified party from all liability on any claims
that are the subject matter of such action and does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party.
(d) If at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel, such indemnifying party agrees that it shall be liable for any settlement of the nature contemplated by Section 5(a) effected without its written consent if (i) such settlement is entered into more than 45 days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall have received notice of the terms of such settlement at least 30 days prior to such settlement being entered into and (iii) such indemnifying party shall not have reimbursed such indemnified party in accordance with such request prior to the date of such settlement; provided that an indemnifying party shall not be liable for any such settlement if such indemnifying party (1) reimburses such indemnified party in accordance with such request for the amount of such fees and expenses of such counsel as the indemnifying party believes in good faith to be reasonable and (2) provides written notice to the indemnified party and the indemnifying party disputes in good faith the reasonableness of the unpaid balance of such fees and expenses.
(e) If the indemnification provided for in this Section 5 is unavailable or insufficient to hold harmless an indemnified party under paragraph (a) or (b) above, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to in paragraph (a) or (b) above (i) in such proportion as is appropriate to reflect the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party on the other from the Offering and the Shelf Registration Statement, or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof) as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and a Holder on the other hand with respect to such offering and such sale shall be deemed to be in the same proportion as the total net proceeds from the offering of the Registrable Securities purchased under the Purchase Agreement (before deducting expenses) received by the Company bear to the total net proceeds received by such Holder with respect to its sale of Registrable Securities on the other. The relative faults of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or such Holder or such other indemnified party, as the case may be, on the other, and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the first sentence of this subsection (e) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any action or claim which is the subject of this subsection (e). Notwithstanding any other provision of this Section 5(e), the Holders of Registrable Securities shall not be required to contribute any amount in excess of the amount by which the net proceeds received by such Holders from the sale of Registrable Securities pursuant to the Shelf Registration Statement exceeds the amount of damages which such Holders have otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this paragraph (e), each person, if any, who controls such indemnified party within the meaning of the Securities Act or the Exchange Act shall have the same rights to contribution as such indemnified party and each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act shall have the same rights to contribution as the Company.
(f) The agreements contained in this Section 5 shall survive the sale of Registrable Securities pursuant to a Registration Statement and shall remain in full force and effect, regardless of any termination or cancellation of this Agreement or any investigation made by or on behalf of any indemnified party.
6. Underwritten Offering.
No Holder of Registrable Securities may participate in any Underwritten Registration hereunder.
7. Additional Dividends Under Certain Circumstances. (a) Additional Dividends (as defined below) shall be payable as follows, if any of the following events occur (each such event in clauses (i) through (iii) below, a “ Registration Default ”):
(i) if a Shelf Registration Statement has not been filed with the Commission on or prior to the Filing Deadline;
(ii) if the Shelf Registration Statement has not been declared effective by the Commission on or prior to the Effectiveness Deadline;
(iii) if (A) after the Shelf Registration Statement is declared effective, such Shelf Registration Statement ceases to be effective prior to the end of the Shelf Registration Period or (B) such Shelf Registration Statement or the related Prospectus ceases to be usable (including if the use of the Prospectus is suspended by the Company for more than 30 days in any three-month period or an aggregate of 120 days in any 12-month period, as set forth in Section 2(c) hereof) in connection with resales of Registrable Securities covered by such Shelf Registration Statement prior to the end of the Shelf Registration Period.
Each of the foregoing will constitute a Registration Default whatever the reason for any such event and whether it is voluntary or involuntary or is beyond the control of the Company or pursuant to operation of law or as a result of any action or inaction by the Commission.
Additional Dividends shall accrue with respect to the Securities from and including the date on which any such Registration Default shall occur to and including the date on which all such Registration Defaults have been cured or have ceased at a rate of (i) for the first 90 days after such Registration Default, 0.25% per annum and (ii) thereafter, 0.50% per annum (the “ Additional Dividends ”). The Additional Dividends attributable to any Registration Default shall cease to accrue from the date on which such Registration Default is cured.
(b) A Registration Default referred to in Section 7(a)(iii) shall be deemed not to have occurred and be continuing in relation to the Shelf Registration Statement or the related Prospectus if (i) such Registration Default has occurred solely as a result of (x) the filing of a post-effective amendment to such Shelf Registration Statement to incorporate annual audited financial information with respect to the Company where such post-effective amendment is not yet effective and needs to be declared effective to permit Holders to use the related Prospectus or (y) the occurrence of other material events or developments with respect to the Company that would need to be described in such Registration Statement or the related Prospectus and (ii) in the case of clause (y) the Company is proceeding promptly and in good faith to amend or supplement such Registration Statement and related Prospectus to describe such events; provided , however , that in any case if such Registration Default occurs for a continuous period in excess of 30 days in any 90-day period or an aggregate of 120 days in any 12-month period, Additional Dividends shall be payable in accordance with the above paragraph from the day such Registration Default occurred until such Registration Default is cured.
(c) Any amounts of Additional Dividends due pursuant to Section 7(a) will be payable in cash on the regular dividend payment dates (or such other time as provided in the Certificate of Designations for the payment of dividends or distributions) with respect to the Securities. The amount of Additional Dividends will be determined by multiplying the applicable Additional Dividends by the aggregate liquidation preference of the Securities and further multiplied by a fraction, the numerator of which is the number of days such Additional Dividends were applicable during such period (determined on the basis of a 360-day year comprised of twelve 30-day months), and the denominator of which is 360.
8. Rules 144 and 144A. The Company shall use all reasonable best efforts to file the reports required to be filed by it under the Securities Act and the Exchange Act in a timely manner and, if at any time the Company is not required to file such reports, it will, upon the request of any Holder of Registrable Securities, make publicly available other information so long as necessary to permit sales of their securities
pursuant to Rules 144 and 144A of the Securities Act, or any successor regulation or statute thereto. The Company covenants that it will take such further action as any Holder may reasonably request, all to the extent required from time to time to enable such Holder to sell Securities without registration under the Securities Act within the limitation of the exemptions provided by Rules 144 and 144A (including the requirements of Rule 144A(d)(4)). The Company will provide a copy of this Agreement to prospective purchasers of Securities identified to the Company by the requesting Holder upon request. Upon the request of any Holder of Registrable Securities, the Company shall deliver to such Holder a written statement as to whether it has complied with such requirements. Notwithstanding the foregoing, nothing in this Section 8 shall be deemed to require the Company to register any of its securities pursuant to the Exchange Act.
9. Miscellaneous.
(a) Remedies . The Company acknowledges and agrees that any failure by it to comply with its obligations under Section 2 hereof may result in material irreparable injury to the Holders for which there is no adequate remedy at law, that it will not be possible to measure damages for such injuries precisely and that, in the event of any such failure, any Holder may obtain such relief as may be required to specifically enforce the Company’s obligations under Section 2 hereof.
(b) No Inconsistent Agreements . The Company has not, as of the date hereof, entered into, nor shall it on or after the date hereof, enter into, any agreement with respect to its securities or otherwise that is inconsistent with the rights granted to the Holders herein or otherwise conflicts with the provisions hereof.
(c) Amendments and Waivers . The provisions of this Agreement, including the provisions of this sentence, may not be amended, qualified, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given, unless the Company has obtained the written consent of a majority in principal amount of the Registrable Securities affected by such amendment, qualification, modification, supplement, waiver or consent.
(d) Notices . All notices and other communications provided for or permitted hereunder shall be made in writing and shall be mailed, delivered, telegraphed and confirmed or faxed and confirmed:
(1) if to a Holder, at the most current address given by such Holder to the Company in accordance with the provisions of this Section 9(d), which address initially is, with respect to each Holder, the address of such Holder maintained by the Registrar under the Certificate of Designations; and
(2) if to the Company, initially at its address set forth in the Purchase Agreement.
Any Holder or the Company by notice to the other may designate additional or different addresses for subsequent notices or communications.
(e) Successors and Assigns . This Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties hereto, including, without the need for an express assignment or any consent by the Company thereto, subsequent Holders of Registrable Securities. The Company hereby agrees to extend the benefits of this Agreement to any Holder of Registrable Securities and any such Holder may specifically enforce the provisions of this Agreement as if an original party hereto.
(f) Counterparts . This Agreement may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement.
(g) Headings . The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof.
(h) Governing Law . THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED I N ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.
(i) Securities Held by the Company . Whenever the consent or approval of Holders of a specified percentage of principal amount of Registrable Securities is required hereunder, Registrable Securities held
by the Company or its affiliates (other than subsequent Holders of Registrable Securities if such subsequent Holders are deemed to be affiliates solely by reason of their holdings of such Registrable Securities) shall not be considered to be outstanding and shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage.
(j) Severability . In the event that any one of more of the provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable in any respect for any reason, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions hereof shall not be in any way impaired or affected thereby, it being intended that all of the rights and privileges of the parties shall be enforceable to the fullest extent permitted by law.
(Signature page follows.)
Please confirm that the foregoing correctly sets forth the agreement between the Company and each Purchaser.
The foregoing Registration Rights Agreement is hereby confirmed and accepted as of the date first above written.
Name of Investor: Shepherd Investments International, Ltd.
Name of Investor: Stark Trading
Name of Investor: Advent Capital Management
Name of Investor: Amaranth LLC
By: Amaranth Advisors LLC, its Trading Advisor
Name of Investor: AG Offshore Convertibles Ltd.
By: Angelo Gordon & Co., L.P. Its: Investment Manager
Very truly yours,
HEALTHSOUTH CORPORATION
By: /s/ JOHN WORKMAN Name: John Workman Title:
Executive Vice President and Chief Financial Officer
By: /s/ MICHAEL A. ROTH Name: Michael A. Roth Title: Managing Member of its Investment Manager
By: /s/ MICHAEL A. ROTH Name: Michael A. Roth Title: Managing Member of its Managing General Partner
By: /s/ ROBERT J. WHITE Name: Robert J. White Title: Chief Financial Officer
Name of Investor: AM Investment Partners, LLC
By: /s/ MARK FRIEDMAN Name: Mark Friedman Title: Principal
By: /s/ KARL J. WACHTER Name: Karl J. Wachter Title: Authorized Signatory
By: /s/ JOHN M. ANGELO Name: John M. Angelo Title: Chief Executive Officer
Name of Investor: CNH CA Master Account, L.P.
Name of Investor: Argent Funds Group
Name of Investor: Aristeia
Name of Investor: Basso Capital Management, L.P. on behalf of 3-4 Basso Funds to be determined
Name of Investor: Camden Asset Management
Name of Investor: CQS Convertible and Quantitative Strategies Master Fund Limtied
Name of Investor: Credit Suisse
Name of Investor: D.E. Shaw Valence Portfolios, L.L.C.
Name of Investor: Deerfield Management Company, LP
By: /s/ BRADLEY ASNESS Name: Bradley Asness Title: Secretary, Principal
By: /s/ BOBBY RICHARDSON Name: Bobby Richardson Title: Managing Director
By: /s/ ANTHONY FRASCELLA Name: Anthony Frascella Title: Principal
By: /s/ JOHN LEPORE Name: John Lepore Title: Authorized Signatory
By: /s/ ALEXANDER A. LACH Name: Alexander A. Lach Title: Partner, Camden Asset Management
By: /s/ MICHAEL HINTZ Name: Michael Hintz Title: Director
By: /s/ ONU ODIM Name: Onu Odim Title: Managing Director
By: D.E. Shaw & Co., L.P., as managing member
By: /s/ JOE PRIOR Name: Joe Prior Title: Authorized Signatory
By: /s/ DARREN LEVINE Name: Darren Levine Title: CFO
Name of Investor: DRW Securities
Name of Investor: Empyrean Capital Partners, LP
Name of Investor: Forest Investment Management
Name of Investor: GLG Partners LP
Name of Investor: Harvard Management Co.
Name of Investor: HBK Master Fund L.P. By: HBK Investments L.P.
Name of Investor: Highbridge International LLC By: Highbridge Capital Management LLC
Name of Investor: Highfields Capital I LP, Highfields Capital II LP and Highfields Capital Ltd.
By: /s/ DONALD R. WILSON, JR. Name: Donald R. Wilson, Jr. Title: Manager
By: /s/ ANTHONY THIMES Name: Anthony Thimes Title: Chief Financial Officer
By: /s/ STEVE DEVOE Name: Steve Devoe Title: President
By: /s/ STEVE. ROTH Name: Steve Roth Title: Portfolio Manager
By: /s/ CRAIG A. SZEMAN Name: Craig A. Szeman Title: Vice President
By: /s/ J. BAKER GENTRY, JR. Name: J. Baker Gentry, Jr. Title: Authorized Signatory
By: /s/ RICHARD POTAPCHUK Name: Richard Potapchuk Title: Managing Director
By: /s/ JENNIFER L. STIER Name: Jennifer L. Stier Title:
Chief Operating Officer of Highfields Capital Management LP, Investment Manager On behalf of Highfields Capital I LP, Highfields Capital II LP and Highfields Capital Ltd.
Name of Investor: JD Capital
By: /s/ ANDREW BARNARD Name: Andrew Barnard Title: Portfolio Manager
Name of Investor: JMG Capital Partners LP
By: /s/ JONATHAN GLASS Name: Jonathan Glass Title: Member Manager of the GP
Name of Investor: Kamunting Street Master Fund, Ltd.
By: /s/ GREGOR T. DANNALHER Name: Gregor T. Dannalher Title: Senior Analyst
Name of Investor: KBC Financial Products
By: /s/ JASON CUEVAS Name: Jason Cuevas Title: Managing Director
Name of Investor: LibertyView Funds, L.P.
By: /s/ STEVEN S. ROGERS Name: Steven S. Rogers Title: Authorized Signatory
Name of Investor: Marathon Global Convertible Master Fund, Ltd.
By: /s/ CHRISTOPHE THOMAS Name: Christophe Thomas Title: Managing Director
Name of Investor: OZ Master Fund, Ltd.
By: /s/ JOEL FRANK Name: Joel Frank Title: Chief Financial Officer
Name of Investor: Parabolic Partners
By: /s/ A. PAUL BOWYER Name: A. Paul Bowyer Title: Managing Member
Name of Investor: Radcliffe SPC Ltd. For and on behalf of the Class A Convertible Crossover Segregated Portfolio, By: RG Capital Management, L.P., By: RGC Management Company LLC
Name of Investor: Polygon Investment Partners LP
By: /s/ WILLIAM W. HOBAN Name: William W. Hoban Title: Portfolio Manager
By: /s/ GERALD STAHLECKER Name: Gerald F. Stahlecker Title: Managing Director
Name of Investor: Ramius Capital
By: /s/ MORGAN STARK Name: Morgan Stark Title: Managing Partner
Name of Investor: Funds Managed by Rumson Capital LLC
By: /s/ JOHN BURKE Name: John Burke Title: Managing Partner
Name of Investor: Sandelman Partners
By: /s/ MICHAEL PASCUTTI Name: Michael Pascutti Title: Partner
Name of Investor: Satellite Convertible Arbitrage Master Fund, LLC By: Satellite Asset Management, L.P., its Investment Manager
By: /s/ SIMON RAYKHER Name: Simon Raykher Title: General Counsel
Name of Investor: Satellite Credit Opportunities Fund, Ltd. By: Satellite Asset Management, L.P., its Investment Manager
By: /s/ SIMON RAYKHER Name: Simon Raykher Title: General Counsel
Name of Investor: Susquehanna Capital Group
By: /s/ JACK GREENBERG Name: Jack Greenberg Title: Managing Director
Name of Investor: Suttonbrook Capital Portfolio LP
By: /s/ BRETT SPECTOR Name: Brett Spector Title: Authorized Person
Name of Investor: Zazove Associates, LLC, as registered investment advisor with discretionary authority
Name of Investor: TQA Investors LLC
By: /s/ DARREN J. LONGIS Name: Darren J. Longis Title: Principal
Name of Investor: UBS A.G. (London Branch)
By: /s/ RICHARD SIMPSON Name: Richard Simpson Title: Managing Director
Name of Investor: Whitebox Advisors, LLC
By: /s/ ANDREW REDLEAF Name: Andrew Redleaf Title: Managing Member of the General Partner
By: /s/ STEVE KLIEMAN Name: Steve Klieman Title: COO Member
Exhibit 10.1.4
CONSENT AND WAIVER NO. 1 TO
SENIOR SUBORDINATED CREDIT AGREEMENT
This CONSENT AND WAIVER NO. 1 TO SENIOR SUBORDINATED CREDIT AGREEMENT, dated as of February 15, 2006 (this “ Consent ”), among HealthSouth Corporation (the “ Borrower ”), and the Lenders party hereto, is being entered into in connection with that certain Senior Subordinated Credit Agreement, dated as of January 16, 2004 (the “ Credit Agreement ”), among the Borrower, the Lenders from time to time party thereto and Credit Suisse (formerly Credit Suisse First Boston), as administrative agent (the “ Administrative Agent ”), syndication agent and arranger. Capitalized terms used herein and not defined herein shall have the respective meanings assigned to such terms in the Credit Agreement.
WHEREAS, the Borrower is contemplating a series of transactions pursuant to which, among other things, the Borrower will (a) offer to repurchase and, to the extent tendered, repurchase substantially all of its outstanding senior notes and senior subordinated notes, (b) repay all outstanding Loans and pay all other amounts due under, and terminate, the Credit Agreement and (c) repay certain other outstanding indebtedness (the transactions referred to in clauses (a) through (c) above being called the “ Debt Refinancing ”);
WHEREAS, in connection with the Debt Refinancing the Borrower has requested that, notwithstanding the limitation contained in Section 2.12 of the Credit Agreement, the Lenders permit the Loans to be prepaid on or prior to March 20, 2006; and
WHEREAS, the Required Lenders have indicated their willingness to consent to such early prepayment on the terms and subject to the satisfaction of the conditions and compliance with the covenants set forth herein;
NOW, THEREFORE, in consideration of the mutual agreements contained in this Consent and other good and valuable consideration, the sufficiency and receipt of which are hereby acknowledged, the parties hereto agree as follows:
SECTION 1. Consent . Effective upon the Effective Date (as defined below), the Lenders party hereto, constituting the Required Lenders, hereby consent, notwithstanding the limitation contained in Section 2.12 of the Credit Agreement, to permit the Borrower to prepay the Loans in full at any time on or prior to March 20, 2006; provided , however , any such prepayment of the Loans shall include (i) the payment of all principal and accrued but unpaid interest on the Loans and the payment of all other Obligations owing under Credit Agreement, including the reasonable and documented fees, charges and disbursements of counsel to the Administrative Agent, through the date of such prepayment, and (ii) such prepayment shall be accompanied by a prepayment premium on the principal amount of each Loan prepaid of 15.00%. In the event the Loans are not prepaid as provided in clauses (i) and (ii) above on or prior to March 20, 2006,
and regardless of whether or not the Debt Refinancing has been consummated, this Consent shall be null and void and cease to be of any further force and effect.
SECTION 2. Waiver . Effective upon the Effective Date, the Required Lenders hereby waive Section 2.12(b) of the Credit Agreement in connection with the prepayment contemplated in Section 1 above to the extent such Section requires irrevocable notice three Business Days prior to a prepayment of Loans under the Credit Agreement.
SECTION 3. Conditions Precedent . This Consent and Waiver shall become effective on the date (the “ Effective Date ”) when each of the following shall have occurred; provided , however , in the event the Effective Date has not occurred prior to 5:00 p.m. (New York time) on February 22, 2006, then this Consent shall be null and void and cease to be of any further force and effect.
(a) The Administrative Agent shall have received counterparts of this Consent that, when taken together, bear the signatures of the Borrower and the Required Lenders (or, in the case of any party as to which an executed counterpart has not been received, the Administrative Agent shall have received written confirmation from such party of execution of a counterpart hereof by such party).
(b) The Borrower shall have paid the Administrative Agent the fee payable in connection with this Consent required by agreement between them.
(c) The Borrower shall have paid in full the invoice dated February 9, 2006 in the amount of $83,715.37 for legal fees incurred by the Administrative Agent and any reasonable and documented out-of-pocket expenses incurred by the Administrative Agent in connection with this Consent and invoiced to the Borrower prior to the Effective Date, including the reasonable and documented fees, charges and disbursements of counsel to the Administrative Agent.
SECTION 4. References to Credit Agreement .
(a) From and after the effectiveness of this Consent and the modifications to the Credit Agreement contemplated hereby, all references in the Credit Agreement to “this Agreement”, “hereof”, “herein”, and similar terms shall mean and refer to the Credit Agreement, as amended and modified by this Consent (to the extent applicable), and all references in other documents to the Credit Agreement shall mean such agreement as modified by this Consent (to the extent applicable).
(b) The execution, delivery and effectiveness of this Consent and the waiver contemplated hereby shall not operate as a waiver of any right, power or remedy of the Lenders under the Credit Agreement, nor constitute a waiver of any provision of the Credit Agreement, except to the extent expressly set forth herein.
SECTION 5. Ratification and Confirmation . The Credit Agreement is hereby ratified and confirmed and, except as herein agreed, remains in full force and effect.
SECTION 6. Execution and Counterparts . This Consent may be executed by the parties hereto individually or in combination, in one or more counterparts, each of which shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page by telecopier shall be effective as delivery of a manually executed counterpart.
SECTION 7. Governing Law . This Consent and the rights and obligations of the parties hereto under this Consent shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York.
[Signature Pages Follow]
IN WITNESS WHEREOF, the parties hereto have caused this Consent to be executed and delivered by their respective proper and duly authorized officers as of the date first written above.
HEALTHSOUTH CORPORATION, as Borrower
By: /s/ John Workman Name: John Workman Title:
Executive Vice President and Chief Financial Officer
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
Merrill Lynch Global Investment Series: Income Strategies Portfolio , as Lender
By: Merrill Lynch Investment Managers, L.P., as Investment Advisor
By: /s/ Kevin Booth Name: Kevin Booth Title: Authorized Signatory
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
Diversified Income Strategies Portfolio, Inc., as Lender
By: /s/ Kevin Booth Name: Kevin Booth Title: Authorized Signatory
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
Debt Strategies Fund, Inc., as Lender
By: /s/ Kevin Booth Name: Kevin Booth Title: Authorized Signatory
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
Master U.S. High Yield Trust, as Lender
By: /s/ Dan Evans Name: Dan Evans Title: Authorized Signatory
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
Managed Account Series:High Income Portfolio, as Lender
By: /s/ Dan Evans Name: Dan Evans Title: Authorized Signatory
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
Merrill Lynch World Income Fund, as Lender
By: /s/ Dan Evans Name: Dan Evans Title: Authorized Signatory
SIGNATURE PAGE TO CONSENT AND WAIVER NO. 1 TO THE HEALTHSOUTH SENIOR SUBORDINATED CREDIT AGREEMENT
ML Bond High Income, as Lender
By: /s/ Dan Evans Name: Dan Evans Title: Authorized Signatory
Exhibit 10.2.3
WAIVER dated as of February 16, 2006 (this “ Waiver ”) to the Amended and Restated Credit Agreement dated as of March 21, 2005 (the “ Credit Agreement ”), among HEALTHSOUTH CORPORATION (the “ Borrower ”), the Lenders party thereto and JPMORGAN CHASE BANK, N.A., as Administrative Agent and Collateral Agent.
WHEREAS, the Borrower has informed the Administrative Agent that it desires to issue Capital Stock of the Borrower generating Net Proceeds of up to $400,000,000, with such issuance to be completed no later than March 31, 2006 (such issuance, the “ Equity Issuance ”);
WHEREAS, Section 2.10(c) of the Credit Agreement requires that the Borrower apply 50% of the Net Proceeds from the issuance of any Capital Stock of the Borrower (other than any such issuance to any Subsidiary) to prepay Borrowings and/or cash collateralize Letters of Credit under the Credit Agreement in accordance with the terms of the Credit Agreement;
WHEREAS, the Borrower is contemplating a series of transactions pursuant to which, among other things, the Borrower will (a) offer to repurchase and, to the extent tendered, repurchase substantially all of its outstanding senior notes and senior subordinated notes, (b) repay all outstanding Loans and pay all other amounts due under, and terminate, the Credit Agreement and (c) repay certain other outstanding indebtedness (the transactions referred to in clauses (a) through (c) above being called the “ Debt Refinancing ”);
WHEREAS, Section 2.10(g) of the Credit Agreement requires that the Borrower notify the Administrative Agent of any prepayment of Loans under the Credit Agreement (in the case of a prepayment of Eurodollar Borrowings, three Business Days before the date of such prepayment);
WHEREAS, the Borrower has requested that compliance with (i) Section 2.10(c) of the Credit Agreement be waived to the extent necessary to permit the Borrower to use 100% of the Net Proceeds from the Equity Issuance to repay certain Existing Indebtedness of the Borrower and (ii) Section 2.10(g) of the Credit Agreement be waived to the extent such Section requires irrevocable notice three Business Days prior to a prepayment of Loans under the Credit Agreement in connection with the Debt Refinancing, and the undersigned Lenders, constituting the Required Lenders, are willing, on the terms and subject to the conditions set forth herein, to grant such a waiver;
NOW, THEREFORE, in consideration of the above premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows:
SECTION 1. Defined Terms. Capitalized terms used and not defined herein shall have meanings given to them in the Credit Agreement.
SECTION 2. Waiver. Effective as of the Effective Date (as defined in Section 5), the Lenders hereby waive compliance by the Borrower with the provisions of (i) Section
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2.10(c) of the Credit Agreement to the extent, and only to the extent, necessary to permit the Borrower to apply 100% of Net Proceeds in an aggregate amount of up to $400,000,000 from the Equity Issuance to repay Existing Indebtedness of the Borrower and (ii) Section 2.10(g) of the Credit Agreement to the extent such Section requires irrevocable notice three Business Days prior to a prepayment of Loans under the Credit Agreement in connection with the Debt Refinancing.
SECTION 3. No Amendments or Other Waivers; Confirmation. Except as expressly set forth herein, this Waiver shall not by implication or otherwise limit, impair, constitute a waiver of, or otherwise affect the rights and remedies of the Lenders or the Administrative Agent under the Credit Agreement or any other Loan Document, and shall not alter, modify, amend or in any way affect any of the terms, conditions, obligations, covenants or agreements contained in the Credit Agreement or any other Loan Document, all of which are ratified and affirmed in all respects and shall continue in full force and effect. Nothing herein shall be deemed to entitle any Loan Party to a consent to, or a waiver, amendment, modification or other change of, any of the terms, conditions, obligations, covenants or agreements contained in the Credit Agreement or any other Loan Document in similar or different circumstances. This Waiver shall apply and be effective only with respect to the provisions of the Credit Agreement specifically referred to in Section 2 herein, and only to the extent specified in Section 2 herein.
SECTION 4. Representations and Warranties. The Borrower hereby represents and warrants to the Administrative Agent and the Lenders that as of the date hereof:
(a) no Default or Event of Default has occurred and is continuing; and
(b) the representations and warranties of each Loan Party set forth in the Loan Documents are true and correct in all material respects on and as of the date hereof (and after giving effect to this Waiver) with the same effect as though made on and as of the date hereof (except to the extent such representations and warranties by their terms relate to an earlier date, in which case such representations and warranties were true and correct in all material respects on and as of such earlier date).
SECTION 5. Effectiveness. This Waiver shall become effective on the date (the “Effective Date”) on which the Administrative Agent shall have received counterparts hereof duly executed and delivered by the Borrower and the Required Lenders.
SECTION 6. Waiver Fee. In consideration of the agreements of the Lenders contained herein, the Borrower agrees to pay to the Administrative Agent, for the account of each Lender that delivers an executed counterpart of this Waiver by 5:00 p.m., New York City time, on February 22, 2006, a waiver fee (the “ Waiver Fee ”) in an amount equal to .05% of the aggregate amount of such Lender’s Commitments and Term Loans on such date, provided that such Waiver Fee shall not be payable unless and until this Waiver becomes effective as provided in Section 5 above, in which case such Waiver Fee shall become immediately payable by the Borrower.
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SECTION 7. Expenses. The Borrower agrees to reimburse the Administrative Agent for its reasonable and documented out-of-pocket expenses in connection with this Waiver, including the reasonable and documented fees, charges and disbursements of counsel for the Administrative Agent.
SECTION 8. Governing Law; Counterparts. (a) This Waiver and the rights and obligations of the parties hereto shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York.
(b) This Waiver may be executed by one or more of the parties to this Waiver on any number of separate counterparts, and all of said counterparts taken together shall be deemed to constitute one and the same instrument. This Waiver may be delivered by facsimile transmission electronic pdf of the relevant signature pages hereof.
SECTION 9. Headings. The headings of this Waiver are for purposes of reference only and shall not limit or otherwise affect the meaning hereof.
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IN WITNESS WHEREOF, the parties hereto have caused this Waiver to be duly executed and delivered by their duly authorized officers as of the day and year first above written.
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HEALTHSOUTH CORPORATION,
by /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
JPMORGAN CHASE BANK, N.A., individually and as Administrative Agent,
by /s/ DAWN LEE LUM Name: Dawn Lee Lum Title: Vice President
SIGNATURE PAGE FOR WAIVER DATED FEBRUARY 16, 2006
TO THE HEALTHSOUTH CORPORATION AMENDED AND RESTATED CREDIT AGREEMENT
DATED AS OF MARCH 21, 2005
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Institution: First Commercial Bank
by /s/ FRED R. ELLIOT Name: Fred R. Elliot Title: Sr. Vice President
Institution: Merrill Lynch Capital Corp.
by /s/ MICHAEL E. O’BRIEN Name: Michael E. O’Brien Title: Vice President
Institution: Credit Suisse, Cayman Islands Branch
by /s/ BARRY ZAMORE Name: Barry Zamore Title: Managing Director
by /s/ MICHAEL T. WOTANOWSKI Name: Michael T. Wotanowski Title: Vice President
Institution: Regiment Capital, LTD
by Regiment Capital Management LLC as its Investment Advisor
by Regiment Capital Advisors, LP its Manager and pursuant to delegated authority
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by /s/ TIMOTHY S. PETERSON Name: Timothy S. Peterson Title: President
Institution: The Foothill Group, Inc.
by /s/ MICHAEL R. BOHANNON Name: Michael R. Bohannon Title: SVP
Institution: Grand Central Asset Trust, BDC Series
by /s/ MIKUS N. KINS Name: Mikus N. Kins Title: Attorney-in-fact
Institution: The Hartford Mutual Funds, Inc., on behalf of the Hartford Floating Rate Fund by Hartford Investment Management Company, its sub-advisor
by /s/ ADRAYLL ASKEW Name: Adrayll Askew Title: AVP
Institution: WB Loan Funding 1, LLC
by /s/ DIANA M. HIMES Name: Diana M. Himes Title: Associate
Institution: WB Loan Funding 2, LLC
by /s/ DIANA M. HIMES Name: Diana M. Himes Title: Associate
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Institution: WB Loan Funding 3, LLC
by /s/ DIANA M. HIMES Name: Diana M. Himes Title: Associate
Institution: Spiret IV Loan Trust 2003-B
by Wilmington Trust Company not in its individual capacity but solely as trustee
by /s/ RACHEL L. SIMPSON Name: Rachel L. Simpson Title: Financial Services Officer
by /s/ DORRI E. WOLHAR Name: Dorri E. Wolhar Title: Financial Services Officer
Institution: Deutsche Bank Trust Company Americas
by /s/ DIANE F. ROLFE Name: Diane F. Rolfe Title: Vice President
by /s/ SCOTTYE LINDSEY Name: Scottye Lindsey Title: Director
Institution: SunAmerica Life Insurance Company
by AIG Global Investment Corp., Its Investment Advisor
by /s/ W. JEFFREY BAXTER Name: W. Jeffrey Baxter Title: Managing Director
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Institution: SunAmerica Senior Floating Rate Fund
by AIG Global Investment Corp., Its Investment Sub-Advisor
by /s/ W. JEFFREY BAXTER Name: W. Jeffrey Baxter Title: Managing Director
Institution: Galaxy CLO 1999-1, Ltd.
by AIG Global Investment Corp., Its Collateral Manager
by /s/ W. JEFFREY BAXTER Name: W. Jeffrey Baxter Title: Managing Director
Institution: Oppenheimer Senior Floating Rate Fund
by /s/ LISA CHAFFEE Name: Lisa Chaffee Title: AVP
Institution: Wells Fargo Bank
by /s/ PETA SWIDLER Name: Peta Swidler Title: Senior Vice President
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Institution: TRS Quogue LLC
by /s/ ALICE L. WAGNER Name: Alice L. Wagner Title: Vice President
Institution: Citibank, N.A.
by /s/ DAVID E. GRABER Name: David E. Graber Title: Attorney-In-Fact
Institution: Citicorp North America, Inc.
by /s/ HECTOR GUENTHER Name: Hector Guenther Title: Vice President
by /s/ MICHAEL B. BOTTHOF Name: Michael B. Botthof Title: Vice President
Institution: Eaton Vance Floating Rate Income Trust
by Eaton Vance Management as Investment Advisor
by /s/ MICHAEL B. BOTTHOF Name: Michael B. Botthof Title: Vice President
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Institution:
Eaton Vance Short Duration Diversified Income Fund
by Eaton Vance Management as Investment Advisor
by /s/ MICHAEL B. BOTTHOF Name: Michael B. Botthof Title: Vice President
Institution: Chatham Asset High Yield Master Fund, Ltd.
by
Chatham Asset Management, LLC, as Investment Advisor
by /s/ ANTHONY MELCHIORRE Name: Anthony Melchiorre Title: Managing Member
Institution: Wachovia Bank, National Association
by /s/ CHRIS McCOY Name: Chris McCoy Title: Vice President
Institution: Goldman Sachs Credit Partners
by /s/ COURTNEY MATHER Name: Courtney Mather Title: Vice President
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Institution: Putnam Floating Rate Income Fund
by /s/ BETH MAZOR Name: Beth Mazor Title: V.P.
Institution: Putnam Diversified Income Trust
by /s/ BETH MAZOR Name: Beth Mazor Title: V.P.
Institution: Putnam Premier Income Trust
by /s/ BETH MAZOR Name: Beth Mazor Title: V.P.
Institution: Special Situations Investing Group
by /s/ ALBERT DOMBROWSKI Name: Albert Dombrowski Title: Authorized Signatory
Institution: Eaton Vance CDO VIII, Ltd.
by Eaton Vance Management as Investment Advisor
by /s/ MICHAEL B. BOTTHOF Name: Michael B. Botthof Title: Vice President
Exhibit 10.3.2
AMENDMENT AND WAIVER NO. 1 TO
TERM LOAN AGREEMENT
This AMENDMENT AND WAIVER NO. 1 TO TERM LOAN AGREEMENT, dated as of February 15, 2006 (this “ Amendment ”), among HealthSouth Corporation (the “ Borrower ”), the Lenders party hereto and JPMorgan Chase Bank, N.A., as Administrative Agent (the “ Administrative Agent ”), amends and waives certain provisions of that certain Term Loan Agreement, dated as of June 15, 2005 (the “ Loan Agreement ”), among the Borrower, the Lenders from time to time party thereto and JPMorgan Chase Bank, N.A., as administrative agent, Citicorp North America, Inc., as syndication agent, and J.P. Morgan Securities Inc. and Citigroup Global Markets Inc., as co-lead arrangers and joint bookrunners. Capitalized terms used herein and not defined herein shall have the respective meanings assigned to such terms in the Loan Agreement.
WHEREAS, the Borrower is contemplating a series of transactions pursuant to which, among other things, the Borrower will (a) offer to repurchase and, to the extent tendered, repurchase substantially all of its outstanding senior notes and senior subordinated notes, (b) repay all outstanding Loans and pay all other amounts due under, and terminate, the Loan Agreement and (c) repay certain other outstanding indebtedness (the transactions referred to in clauses (a) through (c) above being called the “ Debt Refinancing ”);
WHEREAS, in connection with the Debt Refinancing, the Borrower has requested that the Lenders amend and waive certain provisions of the Loan Agreement as more specifically set forth herein; and
WHEREAS, the Required Lenders have indicated their willingness to agree to amend and waive such certain provisions of the Loan Agreement on the terms and subject to the satisfaction of the conditions set forth herein.
NOW, THEREFORE, in consideration of the mutual agreements contained in this Amendment and other good and valuable consideration, the sufficiency and receipt of which are hereby acknowledged, the parties hereto agree as follows:
SECTION 1. Amendment . Upon the fulfillment of the conditions precedent set forth in Sections 3 hereof, clauses (a) and (b) of Section 2.06 of the Loan Agreement shall be, and are hereby amended and restated in their entirety as follows:
SECTION 2.06. Prepayment of Loans . (a) The Borrower may any time and from time to time prepay any Borrowing in whole or in part, subject to the requirements of this Section and payment of any amounts required under Section 2.11; provided that each such partial repayment shall be in an integral multiple of $1,000,000 and not less than $10,000,000.
(b) All voluntary prepayments of Loans will be accompanied by a prepayment fee equal to (i) 2.00% of the aggregate principal amount of such prepayment, if made prior to the second anniversary of the Effective Date and (ii) 1.00% of the aggregate principal amount of such prepayment, if made on or after the second anniversary of the Effective Date and prior to the third anniversary of the Effective Date. Voluntary prepayments effected on or after the third anniversary of the Effective Date will not be subject to a prepayment fee. Such fee shall be paid by the Borrowers to the Administrative Agent, for the accounts of the Lenders, on the date of such prepayment.
SECTION 2. Waiver . Upon the fulfillment of the conditions precedent set forth in Section 3 hereof, the Required Lenders hereby waive Section 2.06(c) of the Loan Agreement to the extent such Section requires irrevocable notice three Business Days prior to a prepayment of Loans under the Loan Agreement.
SECTION 3. Conditions Precedent . (a) The Administrative Agent shall have received counterparts of this Amendment that, when taken together, bear the signatures of the Borrower and the Required Lenders (or, in the case of any party as to which an executed counterpart has not been received, the Administrative Agent shall have received written confirmation from such party of execution of a counterpart hereof by such party).
(b) The Borrower shall have paid to the Administrative Agent, for the ratable account of each Lender that delivers to the Administrative Agent its executed counterpart of this Amendment before 5:00 p.m. (New York time) on February 15, 2006, a fee of 1.00% of such Lender’s aggregate principal amount of outstanding Loans (the “ Consent Fee ”).
SECTION 4. Expenses . The Borrower agrees to reimburse the Administrative Agent for its reasonable and documented out-of-pocket expenses in connection with this Amendment, including the reasonable and documented fees, charges and disbursements of counsel to the Administrative Agent.
SECTION 5. References to Loan Agreement, Effect of Loan Documents . (a) From and after the effectiveness of this Amendment and the amendments contemplated hereby, all references in the Loan Agreement to “this Agreement”, “hereof”, “herein”, and similar terms shall mean and refer to the Loan Agreement, as amended and modified by this Amendment (to the extent applicable), and all references in other documents to the Loan Agreement shall mean such agreement as amended and modified by this Amendment (to the extent applicable).
(b) The execution, delivery and effectiveness of this Amendment and the waiver contemplated hereby shall not operate as a waiver of any right, power or remedy of the Lenders under the Loan Agreement, nor constitute a waiver of any provision of the Loan Agreement, except to the extent expressly set forth herein.
SECTION 6. Ratification and Confirmation . The Loan Agreement is hereby ratified and confirmed and, except as herein agreed, remains in full force and effect.
SECTION 7. Execution and Counterparts . This Amendment may be executed by the parties hereto individually or in combination, in one or more counterparts, each of which shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page by telecopier shall be effective as delivery of a manually executed counterpart.
SECTION 8. Governing Law . This Amendment and the rights and obligations of the parties hereto under this Amendment shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York.
[Signature Pages Follow]
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed and delivered by their respective proper and duly authorized officers as of the date first written above.
HEALTHSOUTH CORPORATION, as Borrower
By: /s/ John Workman Name: John Workman Title:
Executive Vice President and Chief Financial Officer
JPMORGAN CHASE BANK, N.A., as Administrative Agent
By: /s/ Dawn Lee Lum Name: Dawn Lee Lum Title: Vice President
SIGNATURE PAGE TO AMENDMENT AND WAIVER NO. 1 TO THE HEALTHSOUTH TERM LOAN AGREEMENT
JP Morgan Chase Bank, N.A., as Lender
By: /s/ Dawn Lee Lum Name: Dawn Lee Lum Title: Vice President
SIGNATURE PAGE TO AMENDMENT AND WAIVER NO. 1 TO THE HEALTHSOUTH TERM LOAN AGREEMENT
Appaloosa Investment L.P.I, as Lender
By: Appaloosa Management, L.P. Its: General Partner
By: Appaloosa Partners Inc. Its: General Partner
By: /s/ Kenneth Maiman Name: Kenneth Maiman Title: General Counsel
EXHIBIT 10.12.1
HEALTHSOUTH CORPORATION
2004 AMENDED AND RESTATED
DIRECTOR INCENTIVE PLAN
1. PURPOSE OF THE PLAN. The purpose of the 2004 Amended and Restated Director Incentive Plan (hereinafter called the “Plan”) of HEALTHSOUTH Corporation, a Delaware corporation (hereinafter called the “Corporation”), is to provide incentives for future endeavors and to advance the interests of the Corporation and its stockholders by encouraging ownership of the Common Stock, par value $.01 per share (hereinafter called the “Common Stock”), of the Corporation by its directors who are not employees of the Corporation (hereinafter called the “Outside Directors”) as designated by the Board of Directors of the Corporation (hereinafter called the “Board”) and upon whose judgment, interest and continuing special efforts the Corporation is largely dependent for the successful conduct of its operations, and to enable the Corporation to compete effectively with other enterprises for the services of such Outside Directors as may be needed for the continued improvement of the Corporation’s business, through the award of shares of unrestricted Common Stock, restricted shares of Common Stock (hereinafter called the “Restricted Stock”) and/or through the award of a right to receive shares of Common Stock (hereinafter called “RSUs” and collectively the “Awards”).
2. PARTICIPANTS. Awards shall be granted under the Plan to Outside Directors of the Corporation as set forth herein.
3. TERM OF THE PLAN. The Plan shall become effective as of January 1, 2005. No Award shall be granted under the Plan after the earliest of (a) March 31, 2008, (b) such time as all shares of Common Stock reserved for issuance under the Plan have been acquired through the issuance of Awards granted under the Plan or (c) such earlier time as the Board may determine. Awards granted under the Plan at the time of its termination shall continue in effect in accordance with its terms and conditions and those of the Plan.
4. STOCK SUBJECT TO THE PLAN. Subject to the provisions of Section 11, the aggregate number of shares of Common Stock for which Awards may be granted under the Plan shall not exceed 2,000,000. If an Award is cancelled or repurchased by the Corporation, the cancelled or repurchased shares shall again be available under the Plan.
The shares to be delivered under the Plan shall be made available, at the discretion of the Board, either from authorized but previously unissued shares as permitted by the Certificate of Incorporation of the Corporation or, from shares re-acquired by the Corporation, including shares of Common Stock purchased in the open market, or from shares held in the treasury of the Corporation.
5. ADMINISTRATION OF THE PLAN. The Plan shall be administered by the Board. The acts of a majority of the Board, at any meeting thereof at which a quorum is present, or acts reduced to or approved in writing by a majority of the members of the Board, shall be the valid acts of the Board. The expenses of administering the Plan shall be borne by the Corporation.
The interpretation and construction of any provision of the Plan or of any Award granted hereunder by the Board shall be final, conclusive and binding upon all parties, including the Corporation, its stockholders and directors, and the executives and employees of the Corporation and its subsidiaries. No member of the Board shall be liable to the Corporation, any stockholder, any Award holder or any employee of the Corporation or its subsidiaries for any action or determination made in good faith with respect to the Plan or any Award granted under it.
6. ANNUAL AWARDS. Each Outside Director shall be granted during the term of the Plan, on the date the Corporation grants awards to its management employees (or, in the case of an Outside Director first appointed or elected to the Board following such date, the date on which such Outsider Director is first appointed or elected to the Board), (i) Restricted Stock Units having a value on the date of grant equal to $95,000 or (ii) to the extent elected by the Outside Director prior to the beginning of the calendar year in which an Award would otherwise be made and in accordance with the election form prescribed by the Corporation, shares of unrestricted Common Stock having a value on the date of grant equal to $95,000, in each case, determined using the fair market value of the Common Stock pursuant to the provisions of Section 8 and rounding up to the nearest number of full shares.
7. AWARD AGREEMENT. Awards granted under the Plan shall be granted pursuant to and subject to the terms and conditions of an Award Agreement to be entered into between the Corporation and the director at the time of such grant. Each such agreement shall be in a form from time-to-time adopted for use under the Plan by the Board (such form being hereinafter called an “Agreement”). Any such Agreement shall incorporate by reference all of the terms and provisions of the Plan as in effect at the time of grant and may contain such other terms and provisions as shall be approved and adopted by the Board.
8. VALUE OF AWARD. If the Common Stock is not listed upon a national securities exchange or exchanges, the fair market value shall be as determined by the Board (which determination shall be conclusive and binding for all purposes) or, if applicable, shall be deemed to be the last reported sale price for the Common Stock as quoted by brokers and dealers trading in the Common Stock in the over-the-counter market (or if the Common Stock shall be quoted by the National Association of Securities Dealers Automated Quotation system, then such NASDAQ quote) on the date on which the Award is granted. If the Common Stock is listed upon a national securities exchange or exchanges, such fair market value shall be deemed to be the last reported sale price at which the shares of Common Stock were traded on such securities exchange or exchanges on the date on which the Award is granted, or if no sale of the Common Stock was made on any national securities exchange on such date, then the closing price per share of the Common Stock on such securities exchange or exchanges on the next preceding day on which there was a sale of the Common Stock.
9. TERMS OF RESTRICTED STOCK. (a) With respect to an award of Restricted Stock granted prior to the date of the adoption of this Amended and Restated Director Incentive Plan, the following terms and conditions shall apply:
(i) STOCKHOLDER RIGHTS. Holders of Restricted Stock shall have any rights to dividends, voting and/or other rights of a stockholder subject to the restrictions and terms of the Plan and the Agreement.
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(ii) CERTIFICATES. The Corporation shall, upon the date of the Restricted Stock grant, issue the shares of Common Stock by registering such shares in book entry form with the Corporation’s transfer agent in the name of the recipient. No certificate(s) representing all or a part of such shares shall be issued until the conclusion of the Restricted Period (as defined in subparagraph (vi)(1) below.
(iii) PRICE. Except as otherwise determined by the Board of Directors, all Restricted Stock issued hereunder shall be issued without the payment of any cash purchase price by the recipients (in which case the “price per share originally paid” for purposes of clause (2) of paragraph (vi) below shall be zero).
(iv) VESTING. Except as otherwise provided in the Plan, the forfeiture provisions of each grant of Restricted Stock shall lapse on January 1 of each year following the date of grant (beginning on January 1 of the year following the year in which the grant is made) with regard to one-third of the number of shares granted until all such restrictions have lapsed and such shares of Restricted Stock shall become fully vested in the recipient thereof. Notwithstanding the foregoing, the forfeiture provisions of the Restricted Stock granted under this Plan shall immediately lapse in the event (A) a Change in Control (as defined in Section 17) of the Corporation occurs, or (B) the recipient ceases to serve as a director of the Corporation due to his or her death, Director Disability or Director Retirement (both as defined in Section 18), provided that the recipient has held such Restricted Stock for a period of at least twelve months. Notwithstanding the foregoing, if any Outside Director ceases to serve as a director of the Corporation by reason of Director Misconduct (as defined in Section 18) during the course of such Outside Director’s term, the Outside Director’s rights to any shares of Restricted Stock for which the holding period set forth in subparagraph (v) below has not expired shall be forfeited as of the date of the occurrence of such Director Misconduct.
(v) HOLDING PERIOD. Except as set forth below, the restrictions on transfer of the Restricted Stock shall apply during the course of the Outside Director’s term and for a period of twelve months thereafter. Notwithstanding the foregoing, the restrictions on transfer of the Restricted Stock granted under this Plan shall immediately lapse in the event (A) a Change in Control of the Corporation occurs, or (B) the recipient ceases to serve as a director of the Corporation due to his or her death, Director Disability or Director Retirement.
(vi) RESTRICTIONS ON TRANSFER / FORFEITURE PROVI SIONS. In addition to such other terms, conditions and restrictions on Restricted Stock contained in the Plan or the applicable Restricted Stock Agreement, all Restricted Stock shall be subject to the following restrictions:
(1) No shares of Restricted Stock shall be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of until they become vested pursuant to paragraph (iv) above and the holding period set forth in subparagraph (v) above has expired. The period during which such restrictions are applicable is referred to as the “Restricted Period.”
(2) Except as set forth in the last two sentences of subparagraph (iv) above, if a recipient ceases to be a director of the Corporation within the
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Restricted Period for any reason, the shares of Restricted Stock that have not become fully vested shall be forfeited by the holder and cancelled by the Corporation.
(3) Notwithstanding subparagraphs (1) and (2) above, the Board may, in its discretion, either at the time that shares of Restricted Stock are awarded or at any time thereafter, waive the restrictions on transfer and forfeiture provisions of any Restricted Stock upon the occurrence of any of the events described in this paragraph (vi) or remove or modify any part or all of the restrictions. In addition, the Board may, in its discretion, impose upon the recipient of Restricted Stock at the time that such shares of Restricted Stock are granted such other restrictions on any Restricted Stock as the Board may deem advisable.
(vi) ADDITIONAL SHARES. Any shares received by a recipient of Restricted Stock as a stock dividend, or as a result of stock splits, combinations, exchanges of shares, reorganizations, mergers, consolidations or otherwise with respect to such Restricted Stock shall have the same status and shall bear the same restrictions, all on a proportionate basis, as the shares or Restricted Stock initially subject to such restrictions.
(vii) TRANSFERS IN BREACH OF RESTRICTED STOCK. If any transfer of Restricted Stock is made or attempted contrary to the terms of the Plan and of such Restricted Stock, the Board shall have the right to purchase for the account of the Corporation those shares from the owner thereof or his or her transferee at any time before or after the transfer at the price paid for such shares by the person to whom they were awarded under the Plan. In addition to any other legal or equitable remedies that it may have, the Corporation may enforce its rights by specific performance to the extent permitted by law. The Corporation may refuse for any purpose to recognize as a shareholder of the Corporation any transferee who receives any shares contrary to the provisions of the Plan and the applicable Restricted Stock or any recipient of Restricted Stock who breaches his or her obligation to resell shares as required by the provisions of the Plan and the applicable Restricted Stock, and the Corporation may retain and/or recover all dividends on such shares which were paid or payable subsequent to the date on which the prohibited transfer or breach was made or attempted.
(b) With respect to an award of Restricted Stock awarded following the date of the adoption of this Amended and Restated Director Incentive Plan, the terms and conditions relating to such Restricted Stock shall be set forth in the Award Agreement evidencing the grant of such award.
10. TERMS OF RSUS AND UNRESTRICTED COMMON STOCK. The terms and conditions relating to the RSUs, or if applicable, the shares of Common Stock, shall be set forth in the Award Agreement evidencing the grant of such Award.
11. ADJUSTMENT OF AND CHANGES IN CAPITALIZATION. In the event that the outstanding shares of Common Stock shall be changed in number or class by reason of split-ups, combinations, mergers, consolidations or recapitalizations, or by reason of stock dividends, the number of shares available for grant and Awards granted under the Plan, both in the aggregate and as to any individual, shall be adjusted so as to reflect such change, all as
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determined by the Board. In the event there shall be any other change in the number or kind of the outstanding shares of Common Stock, or of any stock or other securities into which such Common Stock shall have been changed, or for which it shall have been exchanged, then if the Board, in its sole discretion, determine that such change equitably requires an adjustment to Awards theretofore granted or which may be granted under the Plan, such adjustment shall be made in accordance with such determination.
Notice of any adjustment shall be given by the Corporation to each holder of an Award which shall have been so adjusted and such adjustment (whether or not such notice is given) shall be effective and binding for all purposes of the Plan. Fractional shares resulting from any adjustment to Awards pursuant to this Section 11 may be settled in cash or otherwise as the Board may determine.
12. SECURITIES ACTS RESTRICTIONS AND REQUIREMENT S. THE CORPORATION HAS NOT FILED FINANCIAL STATEMENTS FOR ANY PERIODS ENDED AFTER DECEMBER 31, 2004. THE CORPORATION DOES NOT EXPECT TO BECOME CURRENT WITH RESPECT TO ALL OF ITS PREVIOUSL Y UNFILED FINANCIAL STATEMENTS UNTIL AT LEAST THE FIRST QUARTER OF 2006. THE OUTSIDE DIRECT ORS ARE CAUTIONED NOT TO RELY UPON ANY OF THE CORPORATION’S FINANCIAL STATEMENTS FILED PRIOR TO T HE CORPORATION’S COMPREHENSIVE ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEARS ENDED DECE MBER 31, 2003 AND 2002 WHEN MAKING ANY INVESTMENT DECISION TO RETAIN OR TRANSFER ANY SHARE S OF COMMON STOCK AND/OR SHARES OF RESTRICTED STOCK.
The Corporation shall not be obligated to issue any shares of Common Stock in respect of an Award if such issuance would, in the opinion of counsel for the Corporation, violate the Securities Act of 1933 or other Federal or state statutes having similar requirements, as they may be in effect at that time. Each Award shall be subject to the further requirement that, at any time that the Board shall determine, in its discretion, that the listing, registration or qualification of the shares of Common Stock subject to such Award under any securities exchange requirements or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the issuance of shares underlying any Award, such shares shall not be issued in whole or in part unless such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Board.
As a condition to the issuance of shares underlying any Award under the Plan, the Board may require the holder to furnish a written representation that he is acquiring the shares for investment and not with a view to distribution of the shares to the public and a written agreement restricting the transferability of the shares solely to the Corporation, and may affix a restrictive legend or legends on the face of the certificate representing such shares. Such representation, agreement and/or legend shall be required only in cases where in the opinion of the Board and counsel for the Corporation, it is necessary to enable the Corporation to comply with the provisions of the Securities Act of 1933 or other Federal or state statutes having similar requirements, and any stockholder who gives such representation and agreement shall be released from it and the legend removed at such time as the shares to which they applied are
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registered or qualified pursuant to the Securities Act of 1933 or other Federal or state statutes having similar requirements, or at such other time as, in the opinion of the Board and counsel for the Corporation, the representation and agreement and legend cease to be necessary to enable the Corporation to comply with the provisions of the Securities Act of 1933 or other Federal or state statutes having similar requirements.
13. AMENDMENT OF THE PLAN. The Plan may, at any time or from time to time, be terminated, modified or amended by the Board; provided, however, that no such amendment (i) may allow for the grant of Restricted Stock hereunder to any person who is not an Outside Director of the Corporation at the time of the grant, unless such amendment and the Plan shall have been approved by the stockholders of the Corporation and (ii) shall be applicable to an Award previously granted.
14. CHANGES IN LAW. Subject to the provisions of Section 13, the Board shall have the power to amend the Plan and any outstanding Award granted thereunder in such respects as the Board shall, in its sole discretion, deem advisable in order to incorporate in the Plan or any such Award any new provision or change designed to comply with or take advantage of requirements or provisions of the Internal Revenue Code or any other statute, or Rules or Regulations of the Internal Revenue Service or any other Federal or state governmental agency enacted or promulgated after the adoption of the Plan.
15. APPLICABLE LAW. This Plan and all determinations made and actions taken pursuant hereto shall be governed by the law of Delaware, applied without giving effect to any conflicts-of-law principles, and construed accordingly.
16. WITHHOLDING.
(a) The Corporation shall have the right to deduct from payments of any kind otherwise due to the recipient of Award any federal, state or local taxes of any kind required by law to be withheld or paid with respect to any shares issued under the Plan or upon the expiration or termination of the Restricted Period relating to an Award. Subject to the prior approval of the Corporation, the holder of an Award may elect to satisfy such obligations, in whole or in part, (i) by causing the Corporation to withhold shares of Common Stock otherwise issuable pursuant to the expiration or termination of the Restricted Period relating to the Award or (ii) by delivering to the Corporation shares of Common Stock already owned by the holder. The shares so delivered or withheld shall have a fair market value equal to such tax obligation. The fair market value of the shares used to satisfy such tax obligation shall be determined by the Corporation as of the date that the amount of tax shall be determined in accordance with Section 8. A Restricted Stock recipient who has made an election pursuant to this Section 11(a) may only satisfy his or her tax obligation with shares of Common Stock which are not subject to any repurchase, forfeiture, unfulfilled vesting or other similar requirements.
(b) If the recipient of Restricted Stock under the Plan elects, in accordance with Section 83(b) of the Code, to recognize ordinary income in the year of acquisition of any shares awarded under the Plan, the Corporation will require at the time of such election an additional payment for withholding tax purposes based on the difference, if any, between the
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purchase price of such shares and the fair market value of such shares as of the date immediately preceding the date on which the Restricted Stock is awarded.
17. CHANGE IN CONTROL. A “Change in Control” shall be deemed to have occurred if:
(i) the acquisition (other than from the Corporation) by any person, entity or “group” (within the meaning of Sections 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, but excluding, for this purpose, the Corporation or its subsidiaries, or any employee benefit plan of the Corporation or its subsidiaries which acquires beneficial ownership of voting securities of the Corporation) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934) of 25% or more of either the then-outstanding shares of Common Stock or the combined voting power of the Corporation’s then-outstanding voting securities entitled to vote generally in the election of directors; or
(ii) individuals who, as of January 1, 2004, constitute the Board of Directors (as of such date, the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any person becoming a director subsequent to such date whose election, or nomination for election, was approved by a vote of at least a majority of the directors then constituting the Incumbent Board (other than an election or nomination of an individual whose initial assumption of office is in connection with an actual or threatened election contest relating to the election of directors of the Corporation) shall be, for purposes of this Section 17(ii), considered as though such person were a member of the Incumbent Board; or
(iii) consummation of a reorganization, merger, consolidation or share exchange, in each case with respect to which persons who were the stockholders of the Corporation immediately prior to such reorganization, merger, consolidation or share exchange do not, immediately thereafter, own more than 75% of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged, consolidated or other surviving entity’s then-outstanding voting securities, or approval by the stockholders of the Corporation of a liquidation or dissolution of the Corporation or consummation of the sale of all or substantially all of the assets of the Corporation.
18. CERTAIN DEFINITIONS. The following terms shall have the meanings set forth below:
(i) “Director Disability” means that the Outside Director (i) has established to the satisfaction of the Board that the Outside Director is unable to perform his or her duties as a member of the Board by reason of any medically determinable physical or mental impairment which can be expected to last for a continuous period of not less than twelve (12) months and (ii) has satisfied any requirement imposed by the Committee in regard to evidence of such disability.
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(ii) “Director Misconduct” means the occurrence of any one or more of the following (i) the willful and continued failure by a Outside Director to substantially perform his or her duties (other than any such failure resulting from Director Disability, death or Director Retirement), after a written demand for substantial performance is delivered by the Board to the Outside Director that specifically identifies the manner in which the Board believes that the Outside Director has not substantially performed his or her duties, and the Outside Director has failed to remedy the situation within thirty (30) calendar days of receiving such notice or (ii) a Outside Director’s conviction for committing an act of fraud, embezzlement, theft or another act constituting a felony or a crime involving moral turpitude or (iii) substantial dependence or addiction to any drug illegally taken or to alcohol that is in either event materially and demonstrably injurious to the Corporation or (iv) the engaging by a Outside Director in gross misconduct materially and demonstrably injurious to the Corporation. No act or failure to act, on a Outside Director’s part shall be considered “willful” unless done, or omitted to be done, by the Outside Director not in good faith and without reasonable belief that his action or omission was in the best interest of the Corporation. Director Misconduct shall be determined by the Board in exercise of good faith and reasonable judgment.
(iii) “Director Retirement” means mandatory retirement from service as a member of the Board pursuant to the Corporation’s policies.
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EXHIBIT 10.12.2
Print Name of Participant:[ ]
HEALTHSOUTH CORPORATION
2004 AMENDED AND RESTATED DIRECTOR INCENTIVE PLAN
RESTRICTED STOCK UNIT AGREEMENT
This RESTRICTED STOCK UNIT AGREEMENT, made as of [ ] (the “Grant Date”), by and between HealthSouth Corporation., a Delaware corporation (the “Company”), pursuant to the HealthSouth Corporation 2004 Amended and Restated Director Incentive Plan (the “Plan”) and [ ] (the “Participant”). Except as otherwise expressly set forth herein, this Agreement shall be construed in accordance with the provisions of the Plan and any capitalized terms not otherwise defined in this Agreement shall have the definitions set forth in the Plan.
1. Grant of Award . The Company hereby grants to the Participant, as of the Grant Date and subject to the terms and conditions of the Plan and subject further to the terms and conditions set forth herein, [ ] (including the provisions of Section 11 thereof) number of RSUs.
2. Vesting . The RSUs granted to the Participant shall be fully vested as of the Grant Date and shall be settled on the earlier of (i) the consummation of a Change in Control transaction, provided that such Change in Control constitutes a “change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of a corporation” within the meaning of Section 409A of the Code (any regulations promulgated thereunder) or (ii) the six month anniversary of date on which the Participant ceases to serve on the Board of Directors for any reason (the “Settlement Date” ).
3. Form of Payment . Each RSU granted hereunder shall represent the right to receive one share of Common Stock upon the settlement of each RSU, subject to adjustment pursuant to Section 11 of the Plan.
4. Dividend Equivalents . Additional RSUs shall be credited to the Participant’s account as of each date (a “Dividend Date”) on which cash dividends and/or special dividends and distributions are paid with respect to Common Stock, provided that the record date with respect to such dividend or distribution occurs prior to the Settlement Date. The number of RSUs to be credited to the Participant’s account under the Plan as of any Dividend Date shall equal the quotient obtained by dividing (a) the product of (i) the number of the RSUs credited to such account on the record date for such dividend or distribution and (ii) the per share dividend (or distribution value) payable on such Dividend Date, by (b)
the fair market value of a share of Common Stock as of such Dividend Date, determined in accordance with Section 8 of the Plan.
5. Restrictions on Transfer . RSUs may not be transferred or otherwise disposed of by the Participant, including by way of sale, assignment, transfer, pledge, hypothecation or otherwise, except as permitted by the Committee, or by will or the laws of descent and distribution. No purported sale, assignment, mortgage, hypothecation, transfer, pledge, encumbrance, gift, transfer in trust (voting or other) or other disposition of, or creation of a security interest in or lien on, any of the RSUs by any holder thereof in violation of the provisions of this Agreement shall be valid, and the Company will not transfer any of such RSUs on its books, nor will any dividends be paid thereon, unless and until there has been full compliance with such provisions to the satisfaction of the Company. The foregoing restrictions are in addition to and not in lieu of any other remedies, legal or equitable, available to enforce said provisions.
6. Approvals . No shares of Common Stock shall be issued under this Agreement unless and until all legal requirements applicable to the issuance of such shares have been complied with to the satisfaction of the Committee. The Committee shall have the right to condition any issuance of shares to the Participant on the Participant’s undertaking in writing to comply with such restrictions on the subsequent disposition of such shares as the Committee shall deem necessary or advisable as a result of any applicable law or regulation.
7. Taxes . The Participant understands that the Participant (and not the Company) shall be responsible for any tax liability that may arise as a result of the transactions contemplated by this Agreement. At the time the Participant recognizes taxable income in respect to the RSUs, the Participant shall owe to the Company an amount equal to the federal, state and/or local taxes the Company determines it is required to withhold under applicable tax laws with respect to the payment of the RSUs. At the Company’s discretion, the Participant may satisfy the foregoing requirement by one or a combination of the following methods: (a) making a payment to the Company in cash or cash equivalents; (b) with the consent of the Company, by authorizing the Company to withhold cash otherwise due to the Participant; (c) authorizing the Company to withhold a portion of the shares of Common Stock to be received hereunder having a value equal to or less than the minimum amount required to be withheld or (d) a combination of the foregoing.
8. Compliance with Law and Regulations . This Agreement, the Award granted hereby and any obligation of the Company hereunder shall be subject to all applicable federal, state and local laws, rules and regulations and to such approvals by any government or regulatory agency as may be required.
9. Incorporation of Plan . This Agreement is made under the provisions of the Plan (which is incorporated herein by reference) and shall be interpreted in a manner consistent with it. To the extent that this Agreement is silent with respect to, or in any way inconsistent with, the terms of the Plan, the provisions of the Plan shall govern and this Agreement shall be deemed to be modified accordingly.
10. Binding Agreement; Successors . This Agreement shall bind and inure to the benefit of the Company, its successors and assigns, and the Participant and the Participant’s personal representatives and beneficiaries.
11. Governing Law . This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware. The Committee shall have final authority to interpret and construe the Plan and this Agreement and to make any and all determinations under them, and its decision shall be binding and conclusive upon all Persons.
12. Amendment . This Agreement may be amended or modified by the Company at any time; Notwithstanding the foregoing, no amendment or modification that is adverse to the rights of the Participant as provided by this Agreement shall be effective unless set forth in a writing signed by the parties hereto.
IN WITNESS WHEREOF, the Company has caused this Agreement to be duly executed by its officer thereunder duly authorized and the Participant has hereunto set his hand, all as of the day and year set forth below.
HEALTHSOUTH CORPORATION
Name: Title:
The undersigned hereby acknowledges having read this Agreement and the Plan and hereby agrees to be bound by all provisions set forth herein and in the Plan.
PARTICIPANT
Dated as of:
Exhibit 10.34
IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ALABAMA
AMENDED CLASS ACTION SETTLEMENT AGREEMENT
This AMENDED CLASS ACTION SETTLEMENT AGREEMENT is entered into by and among Settlement Class Representatives for themselves and on behalf of the Settlement Class, the Settling Defendants and the Underwriters. Italicized and capitalized terms and phrases have the meanings provided in Section 1 below.
RECITALS
WHEREAS, Settlement Class Representatives have commenced actions comprising the ERISA Action asserting various Claims for relief against the Named Settling Defendants, all of which Claims are disputed by the Settling Defendants;
WHEREAS, a dispute exists with respect to the existence and/or extent of insurance coverage available or exclusions or policy defenses applicable to certain Defendants under the Insurance Policies;
WHEREAS, the parties have engaged in mediation before the Mediator to explore settlement possibilities, and the Mediator has conducted a series of mediation sessions in which the Settling Parties have participated;
WHEREAS, the Settling Parties are desirous of promptly and fully resolving and settling with finality all of the Released Claims asserted by Settlement Class Representatives, for themselves and on behalf of the Settlement Class, against the Settling Defendants, and the Settling Defendants and Underwriters are desirous of promptly and fully resolving and settling with finality any Claims against each other relating to the Insurance Policies;
WHEREAS, on June 3, 2005, the Settlement Class Representatives, the Underwriters, and the Settling Defendants (with the exceptions of Messrs. Scrushy, Martin, Owens, and Beam) executed a term sheet setting forth their settlement agreement in principle, and pursuant thereto, on June 17, 2005, the Company and the Underwriters deposited the Settlement Amount into the Settlement Fund;
X
:
IN RE HEALTHSOUTH CORP. ERISA LITIGATION :
: CV-03-BE-1700
:
X
WHEREAS, the Court issued an Order on August 22, 2005 in which it encouraged the parties to reach a global settlement to which Messrs. Scrushy, Martin, Owens, and Beam would be parties;
WHEREAS, pursuant to the Court’s August 22, 2005 Order, the Settling Parties resumed negotiations and have reached a settlement by and through their respective counsel on the terms and conditions set forth in this Amended Settlement Agreement;
NOW, THEREFORE, the Settling Parties, in consideration of the promises, covenants and agreements herein described and for other good and valuable consideration acknowledged by each of them to be satisfactory and adequate, and intending to be legally bound, do hereby mutually agree as follows:
1. As used in this Amended Settlement Agreement, italicized and capitalized terms and phrases not otherwise defined have the meanings provided below:
1.1 “Affiliate” shall mean: any entity which owns or controls, is owned or controlled by, or is under common ownership or control with, a Person. For purposes of this definition, “control” shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or otherwise.
1.2 “Agreement Execution Date” shall mean: the date on which this Amended Settlement Agreement is fully executed, as provided in Section 20.13 below.
1.3 “Approval Order” shall have the meaning set forth in Section 2.2.
1.4 “Bar Order” shall have the meaning set forth in Section 2.2 below.
1.5 “Bar Order Notice” shall mean: the form of notice appended as Exhibit C to the form of Preliminary Approval Order attached hereto as Exhibit 1.
1.6 “Barred Persons” shall have the meaning set forth in Section 9.1.
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1.7 “Claims” shall mean: any and all claims of any nature whatsoever (including claims for any and all losses, damages, unjust enrichment, attorneys’ fees, disgorgement of fees, litigation costs, injunction, declaration, contribution, indemnification or any other type or nature of legal or equitable relief), whether accrued or not, whether already acquired or acquired in the future, whether known or unknown, in law or equity, brought by way of demand, complaint, cross-claim, counterclaim, third-party claim or otherwise.
1.8 “Class Exemption” shall mean: Prohibited Transaction Exemption 2003-39, “Release of Claims and Extensions of Credit in Connection with Litigation” issued December 31, 2003, by the United States Department of Labor, 68 Fed. Reg. 75,632.
1.9 “Class Notice” shall mean: the form of notice appended as Exhibit A to the form of Preliminary Approval Order attached hereto as Exhibit 1.
1.10 “Class Period” shall mean: the period from January 1, 1996 to the date of the Fairness Hearing.
1.11 The “Company” shall mean: HEALTHSOUTH Corporation, a Delaware corporation, each of its Affiliates, as well as each of its predecessors and Successors-In-Interest.
1.12 The “Court” shall mean: the United States District Court for the Northern District of Alabama.
1.13 “Custodian” shall mean: Wells Fargo Bank, N.A., as custodian of the Settlement Fund.
1.14 “Derivative Actions” shall mean all derivative actions filed by shareholder plaintiffs in the name of the Company, including but not limited to Tucker v. Scrushy, No. CV-02-5212 (Ala. Cir. Ct).
1.15 “DOL” shall mean: the United States Department of Labor.
1.16 “ERISA” shall mean: the Employee Retirement Income Security Act of 1974, as amended, including all regulations promulgated and case law thereunder.
1.17 “ERISA Action” shall mean: In re HealthSouth Corp. ERISA Litigation, CV-03-BE-1700, a consolidated action pending in the Court, and any and all cases now or hereafter consolidated therewith.
1.18 “Fairness Hearing” shall have the meaning set forth in Section 2.2.
1.19 “Final” shall mean: with respect to the Approval Order, that such order shall have been entered by the Court and the time for appeal or writ of certiorari shall have expired without the initiation of an appeal or petition for writ of certiorari, or, if an appeal or petition for writ of certiorari has been timely initiated, that there has occurred a full and final disposition of any such appeal or writ of certiorari without a reversal or modification, including the exhaustion of proceedings in any remand and/or subsequent appeal after remand. Notwithstanding any other provision hereof, the Approval Order shall be deemed Final regardless of whether the Court has entered an order regarding
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the Plan of Allocation or the award of legal fees and expenses and regardless of whether any such order, if entered, has become Final.
1.20 “ Independent Fiduciary ” shall mean: a Plan fiduciary retained at the Company’s expense that has no “relationship to” or “interest in” (as those terms are used in the Class Exemption) any of the Settling Parties .
1.21 “ Insurance Policies ” shall mean: (a) Federal Insurance Company Excess Policies Nos. 5152-84-82 and 8152-84-82A-BHM; and (b) Travelers Casualty & Surety Company of America Policy No. 076 FF 103027063 BCM.
1.22 “ Judgment Reduction Amount ” shall have the meaning set forth in Section 10.
1.23 “ Lead Counsel ” shall mean: Keller Rohrback, L.L.P., as lead counsel for the Settlement Class Representatives in the ERISA Action.
1.24 “ Mediator ” shall mean: Eric Green.
1.25 “ Named Settling Defendants ” shall mean: the Company, Brandon Hale, Dennis Wade, Kimberly McCracken, Marca Pearson, Barbara Roper, Philip Watkins, James P. Bennett, P. Daryl Brown, John S. Chamberlin, Larry D. Striplin, Jr., Charles W. Newhall, III, George H. Strong, Richard F. Celeste, C. Sage Givens, Joel C. Gordon, Larry R. House, Anthony J. Tanner, Raymond J. Dunn, III, Allan R. Goldstein, Robert P. May, Jan L. Jones, Jon F. Hanson, Lee S. Hillman, Richard M. Scrushy, Aaron Beam, Jr., William T. Owens, and Michael D. Martin.
1.26 “ Net Settlement Amount ” shall have the meaning set forth in Section 5.
1.27 This paragraph is hereby deleted.
1.28 “ Person ” shall mean: an individual, partnership, corporation, governmental entity or any other form of entity or organization.
1.29 “ Plan ” shall mean: the HealthSouth Corporation Employee Stock Benefit Plan, including all amendments thereto in effect at any point between January 1, 1991 and the present.
1.30 “ Plan of Allocation ” shall mean: the plan of allocation approved by the Court as contemplated by Section 13.
1.31 “ Preliminary Approval Order ” shall have the meaning set forth in Section 2.
1.32 “ Preliminary Motion ” shall have the meaning set forth in Section 2.
1.33 “ Released Claims ” shall have the meaning set forth in Section 7.
1.34 “ Releasees ” shall mean: the Settling Defendants, the Plan, the Underwriters, and the present and former Representatives of each of them.
1.36 “ RICO ” shall mean: the Racketeer Influenced and Corrupt Organizations Act of 1970, as amended, including all regulations promulgated and case law thereunder.
1.37 “ Securities Actions ” shall mean: all securities actions pertaining to the Company, including but not limited to the action proceeding as a consolidated class action captioned In re HealthSouth Corp. Securities Litig., No. CV-03-BE-1500-S (N.D. Ala.), and all actions that are or will be consolidated therein.
1.38 “ Settlement ” shall mean: the settlement to be consummated under the Amended Settlement Agreement pursuant to the Amended Approval Order.
1.39 “ Amended Settlement Agreement ” shall mean this Amended Class Action Settlement Agreement.
1.40.1 “ Supplemental Settlement Amount ” shall mean: $4,500,000, to be paid to resolve all Released Claims in this case against Defendant Richard M. Scrushy. Payment shall be made as follows:
1.40.1.1 Defendant Scrushy will pay $1,500,000 within six (6) months of Preliminary approval of the Settlement, or 30 days after the Approval Order becomes Final, whichever is later.
1.40.1.2 In addition to the amounts already provided in connection with the Settlement Agreement executed in July 2005, the Underwriters shall pay $2,000,000 to the Settlement Fund within twenty (20) business days of execution of the Amended Settlement Agreement by each of the Settling Parties.
1.40.1.3 In addition to the amounts already provided in connection with the Settlement Agreement executed in July 2005, in the event that the Company recovers all or any portion of the judgment entered on January 3, 2006 against Defendant Scrushy in the HealthSouth Corporation 2002 Derivative Litigation (CV 02-5212) (the “Bonus Judgment”), the Company shall pay the first $1,000,000 collected from the Bonus Judgment, net of plaintiff’s attorney’s fees, to the Settlement Fund in a manner that is approved by the Court (such that a total of $1,000,000 is contributed to the Supplemental Settlement Amount). If the Company fails to collect any of the Bonus Judgment, the Company shall have no obligation to pay any of the Supplemental Settlement Amount and the Supplemental Settlement Amount shall be reduced to $3,500,000.
1.40.2 “ Martin Supplemental Settlement Amount ” shall mean: $350,000, to be paid by Defendant Michael D. Martin to resolve all Released Claims in this case against Defendant Martin. Payment shall be made within ten (10) days of the execution of the Amended Settlement Agreement.
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1.40.3 “ Combined Settlement Amount ” shall mean the combination of the Settlement Amount, the Supplemental Settlement Amount, and the Martin Supplemental Settlement Amount.
1.41 “ Settlement Class ” shall have the meaning set forth in Section 12.
1.42 “ Settlement Class Representatives ” shall mean: the following Persons, as plaintiffs on behalf of themselves and on behalf of all members of the Settlement Class: Kim Coggins, Kim French, and Robert J. Lancaster and each of their Successors-In-Interest. Settlement Class Representatives intend that all rights and obligations that are binding on Settlement Class Representatives under this Amended Settlement Agreement, including each and every covenant, agreement, and warranty, also shall be binding on all members of the Settlement Class.
1.43 “ Settlement Fund ” shall mean: an account established by Lead Counsel at Wells Fargo Bank, N.A., denominated HealthSouth ERISA Litigation Settlement Fund.
1.44 “ Settling Defendants ” shall mean: the Named Settling Defendants, each of their respective Affiliates, predecessors, and Successors-in-Interest, and any directors, officers or employees of the Company.
1.45 “ Settling Defendant’s Counsel ” or “ Underwriter’s Counsel ” shall mean, for each Settling Defendant or Underwriter, as the case may be, the counsel identified as such Settling Defendant’s or Underwriter’s counsel in Section 20.9.
1.46 “ Settling Parties ” shall mean: the Settlement Class Representatives, the Settling Defendants, and the Underwriters.
1.47 “ Successor-In-Interest ” shall mean: a Person’s estate, legal representatives, heirs, successors or assigns.
1.47 “ Underwriters ” shall mean: Travelers Casualty & Surety Company of America and Federal Insurance Company and each of their respective Affiliates, predecessors, and Successors-In-lnterest.
2. As soon as practicable following the complete execution of this Amended Settlement Agreement by all Settling Parties, Settlement Class Representatives will file a motion (“ Preliminary Motion ”) with the Court for an order substantially in the form annexed hereto as Exhibit 1, including the exhibits thereto (the “Preliminary Approval Order”). The Settlement Class Representatives and the Settling Defendants shall request that a preliminary hearing to consider the compromise and settlement before the Court be held as soon as practicable thereafter.
2.1 On the date and in the manner set by the Court in its Preliminary Approval Order, the Settlement Class Representatives shall cause the Class Notice and the Bar Order Notice to be (a) transmitted in the form and manner approved by the Court to the Persons as directed by the Court in the Preliminary Approval Order, and (b) published as directed by the Court in the Preliminary Approval Order. Costs associated with the publication and service of notice,
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establishment of the Settlement Fund, and tax payments relating to the Settlement Fund shall be paid from the Combined Settlement Amount. Lead Counsel agrees to be responsible for arranging publication and distribution of the Class Notice and Bar Order Notice to the proposed Settlement Class and other Persons as required by the Preliminary Approval Order. The Settling Defendants and the Underwriters shall have no responsibility for providing publication or distribution of the Settlement or the notice of the Settlement to the Settlement Class, but Settling Defendants reserve the right to approve the contents of the Class Notice and the Bar Order Notice. The Settlement Class Representatives and the Settling Defendants shall request that a hearing before the Court to consider final approval of the Settlement be held as soon as possible following preliminary approval and due and proper notice being served or published.
2.2 On or after the date set by the Court for the hearing to consider final approval of the Settlement (the “Fairness Hearing”) the Settlement Class Representatives and the Settling Defendants shall request that the Court determine: (i) whether to enter judgment finally approving the Settlement and entering a bar order satisfying all of the terms of Section 9 below (the “Bar Order”), all substantially in the form attached hereto as Exhibit 2 (which judgment is referred to herein as the “Approval Order”); (ii) whether the distribution of the Combined Settlement Amount as provided in the Plan of Allocation should be approved; and (iii) what legal fees, compensation and further expenses should be awarded or reserved for award to Lead Counsel and other counsel for Settlement Class Representatives as contemplated by Section 4 of this Amended Settlement Agreement.
3. Settlement Class Representatives, on behalf of the Settlement Class and the Plan, agree to settle and folly resolve the Claims asserted in the ERISA Action against all Settling Defendants (except Defendants Richard M. Scrushy and Michael D. Martin) for the Settlement Amount, against Defendant Scrushy for the Supplemental Settlement Amount, and against Defendant Martin for the Martin Supplemental Settlement Amount, as set forth below.
3.1 In consideration of all the promises and agreements set forth in the Amended Settlement Agreement, Defendants Scrushy and Martin, the Underwriters, and the Company shall have caused their respective portions of the Settlement Amount, Supplemental Settlement Amount, and Martin Supplemental Settlement Amount to be deposited into the Settlement Fund in the manner set forth in the Amended Settlement Agreement; except that the Company’s obligation to contribute $1,000,000 from the Bonus Judgment is subject to the conditions set forth in section 1.40.1.3. Interest earned on the Combined Settlement Amount shall be applied to the expenses of settlement administration, if any, or otherwise shall accrue for the benefit of the Settlement Class. The Settlement Fund shall be invested only in United States Treasury securities, and/or securities issued by government entities backed by the full faith and credit
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of the United States Treasury, and/or securities of United States Government Sponsored Enterprises that carry a rating of Aaa, and money market mutual funds that invest exclusively in the foregoing securities.
3.2 The Settlement Fund shall be structured and managed to qualify as a Qualified Settlement Fund under Section 468B of the Internal Revenue Code and Treasury regulations promulgated thereunder and shall make tax filings and provide reports to Lead Counsel for tax purposes. The Settling Parties shall not take a position in any filing or before any tax authority inconsistent with such treatment.
3.3 The Settlement Amount, Supplemental Settlement Amount, and Martin Supplemental Settlement Amount shall be the fall and sole monetary payments made by or on behalf of the Settling Defendants and the Underwriters to the Settlement Class in connection with the Settlement.
4. Upon the entry by the Court of the Approval Order and an order granting Lead Counsel’s request for attorneys’ fees and costs as contemplated by Section 2.2(iii), Lead Counsel shall be entitled to withdraw from the Settlement Fund attorneys’ fees and costs as approved by the Court based on the common fund doctrine. Settling Defendants shall take no position with respect to the amount of the costs or attorneys’ fees sought by Lead Counsel in this matter, and shall leave the amount to the sound discretion of the Court. Upon the entry by the Court of the Approval Order, the three Settlement Class Representatives may apply to the Court for compensation in an amount not to exceed five thousand dollars ($5,000) for each of the three Settlement Class Representatives, payable solely from the Settlement Fund to the extent awarded by the Court. The Court’s consideration of Lead Counsel’s request for attorneys’ fees and costs and the Settlement Class Representatives’ application for compensation are matters separate and apart from the Settlement between the Settling Parties, and no decision by the Court concerning the Lead Counsel’s attorneys’ fees and costs or the Settlement Class Representatives’ compensation shall affect the validity of the Amended Settlement Agreement or finality of the Settlement in any manner.
5. The Combined Settlement Amount plus interest earned, less costs of administration pursuant to Section 2.1, Lead Counsel’s reasonable expenses, costs, and attorneys’ fees, and Settlement Class Representatives’ compensation as approved by the Court (“Net Settlement Amount”), shall be released from escrow and paid to the Plan, subject to the procedures set forth in Section 6, upon written notification to the Custodian that the Approval Order is Final. The Net Settlement Amount will be paid to the Plan in order to preserve to the fullest extent possible its tax protected status under ERISA.
5.1 Within 180 days after the Approval Order becomes Final, the Company shall take any action that it deems necessary or appropriate, as determined in its sole discretion, including but not limited to amending,
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terminating, or in any way changing the Plan, with the intent that the Net Settlement Amount is not invested or paid from the Plan as benefits in the form of the Company’s common stock, and is not invested in cash except as necessary to administer the Plan. Such amendments or changes may include, but are not limited to, any amendments or changes to the Plan that permit all or a portion of the Net Settlement Amount allocated to Class members who are then current participants in the HealthSouth Retirement Investment Plan to be invested by them in the same or similar investment options available under the HealthSouth Retirement Investment Plan or successors thereto.
6. In the event the Approval Order is not approved by the Court or does not become Final, the Settling Parties shall negotiate in good faith in order to modify the terms of the Amended Settlement Agreement in order to revive the Settlement. In the event that such efforts are not successful:
(i) the Combined Settlement Amount, plus any interest at the rate of the escrow account, minus the amount already reasonably applied to costs of Settlement as permitted in Section 2.1, shall be immediately returned to the Company, Scrushy, Martin, and the Underwriters in proportion to the parties’ contributions thereto, less a reserve sufficient to meet the income tax liability of the Settlement Fund with respect to its earnings, with Lead Counsel being jointly and severally liable for any failure to return this amount;
(ii) the Settling Defendants will not be deemed to have consented to the certification of any class, and the agreements and stipulations in this Amended Settlement Agreement concerning class definition or class certification shall not be used as evidence or argument to support class certification or class definition, and the Settling Defendants will retain all rights to oppose class certification, including certification of a class identical to that provided for in this Amended Settlement Agreement for any other purpose; and
(iii) the Settlement and this Amended Settlement Agreement, including but not limited to the releases and orders therein, shall become null and void and of no further force and effect, the parties shall be deemed to have reverted to their respective status and positions as of the date immediately before the date of the execution hereof, and the parties shall proceed in all respects as if this Amended Settlement Agreement had not been executed.
7. Upon the entry of the Approval Order by the Court, Settlement Class Representatives, on behalf of the Settlement Class and the Plan, will absolutely and unconditionally release and discharge the Releasees from:
(i) any and all ERISA-based and RICO -based Claims related to the acquisition, disposition, or retention of stock by the Plan and/or its fiduciaries during the Class Period;
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(ii) any and all Claims related to the appointment, removal, or monitoring of any fiduciary for the Plan;
(iii) any and all Claims related to the preparation or dissemination, directly or indirectly, to Plan participants and beneficiaries of information relating to Company stock;
(iv) any and all Claims related to the Insurance Policies;
(v) any and all ERISA-based Claims asserted, or that could have been asserted, in the ERISA Action and ERISA -based Claims, known or unknown, arising from or related to the acts, omissions, facts or events alleged in the ERISA Action;
(vi) any and all Claims in connection with, based upon, arising out of, or relating to the Settlement, but excluding Claims to enforce the terms of the Settlement; and
(vii) any and all Claims based upon, arising out of, or relating to any Person’s liability to the Settlement Class or the Plan for Claims set forth in any of the preceding subsections (i) through (vi),
and any fees, costs, judgments, and/or settlement amounts arising out of such Claims. The Claims described above in subparagraphs (i)-(vii) shall be referred to collectively as the Released Claims. Released Claims do not include and Settlement Class Representatives cannot release any securities Claims brought or that could have been brought in the Securities Actions, or insurance for such Claims, if any. Released Claims do not include and Settlement Class Representatives and the Company cannot release any Claims brought or that could have been brought in the Derivative Actions, or insurance for such Claims, if any. Released Claims do not include and Settlement Class Representatives cannot release any benefit Claims or other ERISA- based Claims that any individual Plan participant or beneficiary has now or may have in the future with respect to the Plan or any other Company benefit plan, to the extent that such Claims do not relate to or arise out of the Released Claims and/or the ERISA Action.
8. This Amended Settlement Agreement will not release or in any way bar, preclude, or compromise any Claims, demands, interests, rights or obligations that the Settling Parties may have with respect to insurance other than the Insurance Policies.
9. It is an essential element to the Settling Defendants’ and the Underwriters’ participation in the Settlement that they obtain the fullest possible release from further liability to anyone relating to the Released Claims, as set forth below, and it is the intention of the Settling Parties that the Settlement eliminate all further risk and liability of the Settling Defendants and the Underwriters relating to the Released Claims, as set
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forth below. Accordingly, the Settling Parties agree that the Court shall include in the Approval Order a Bar Order that meets all of the following requirements, or such lesser requirements as are acceptable to the Settling Defendants and the Underwriters :
9.1. Except as noted in paragraph 9.3.1, all Released Claims brought by any Person (except the DOL) against the Settling Defendants or the Underwriters shall be permanently barred, including but not limited to any Claim for contribution or indemnification (whether contractual or otherwise), and any Person receiving notice of the Class Notice or the Bar Order Notice, or having actual knowledge of the Class Notice or the Bar Order Notice, or having actual knowledge of sufficient facts that would cause such Person to be charged with constructive notice of the Class Notice or the Bar Order Notice (except the DOL) shall be permanently enjoined from bringing, either derivatively or on behalf of themselves, or through any Person purporting to act on their behalf or purporting to assert a Claim under or through them, any Released Claims against the Settling Defendants or the Underwriters in any forum, action or proceeding of any kind. For purposes of the Amended Settlement Agreement and Bar Order, Barred Persons shall be defined as any Person who is barred and/or enjoined by this Section 9.1; including, but not limited to, Settlement Class Representatives, the Settlement Class, the Plan, and the other Settling Parties, but not including the DOL;
9.2. From and after the date of its entry, the Bar Order shall permanently bar and enjoin all Claims by any Barred Person or any Settling Party against the Underwriters, and each of them, (i) under or in any way involving the Insurance Policies, or (ii) upon any Released Claim or for coverage under the Insurance Policies for any Released Claim; provided, however, that nothing in the Amended Settlement Agreement or Bar Order in any way bars or enjoins the Settling Defendants from asserting any rights they may have under any insurance policies other than the Insurance Policies, or from bringing or maintaining any Claims, whether direct or indirect, to the extent that such Claims are not based on the Insurance Policies and are based upon, arise from, are in consequence of or relate to litigation other than the ERISA Action, including, but not limited to, the Securities Actions and the Derivative Actions, irrespective of the extent, if any, to which such rights and Claims may be related to the Released Claims and/or the ERISA Action;
9.3. Except as noted in paragraph 9.3.1, the Settling Defendants shall be permanently barred and enjoined from bringing against the Barred Persons or other Settling Defendants, either derivatively or on behalf of themselves, or through any Person purporting to act on their behalf or purporting to assert a Claim under or through them, any of the
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Released Claims in any forum, action or proceeding of any kind; provided, however, that a Settling Defendant shall not be barred or enjoined from bringing Released Claims against a Barred Person or Settling Defendant if for any reason such Barred Person or Settling Defendant asserts, or is legally not barred by the Bar Order from bringing Released Claims against such Settling Defendant; and further provided that nothing in the Amended Settlement Agreement or Bar Order in any way bars or enjoins the Settling Defendants from asserting any rights they may have under any insurance policies other than the Insurance Policies, or from bringing or maintaining any Claims, whether direct or indirect, to the extent that such Claims are not based on the Insurance Policies and are based upon, arise from, are in consequence of or relate to litigation other than the ERISA Action, including, but not limited to, the Securities Actions and the Derivative Actions, irrespective of the extent, if any, to which such rights and Claims may be related to the Released Claims and/or the ERISA Action;
9.3.1 Nothing in the Amended Settlement Agreement shall be construed to bar, waive, release, or limit in any way contractual or statutory indemnity claims, if any, of Defendant Scrushy against the Company based on or arising out of the ERISA Action or the Settlement. The Company shall not be deemed to have waived any defense thereto, nor shall anything in the Amended Settlement Agreement be deemed a presumption, concession, or admission by the Company of any breach of duty, liability, default, or wrongdoing.
9.4. The Underwriters shall be permanently barred and enjoined from bringing any Released Claim against any Settling Party or Barred Person, either derivatively or on behalf of themselves, or through any Person purporting to act on their behalf or purporting to assert a Released Claim under or through them, in any forum, action or proceeding of any kind; provided, however, that an Underwriter shall not be barred or enjoined from bringing Released Claims against a Barred Person if for any reason such Barred Person asserts, or is legally not barred by the Bar Order from bringing Released Claims against such Underwriter; and further provided that nothing in this Amended Settlement Agreement or Bar Order in any way bars or enjoins the Underwriters from asserting any rights they may have under any insurance policies other than the Insurance Policies, or from bringing or maintaining any Claims, whether direct or indirect, to the extent that such Claims are not based on the Insurance Policies and are based upon, arise from, are in consequence of or relate to litigation other than the ERISA Action, including, but not limited to, the Securities Actions and the Derivative Actions, irrespective of the extent, if any, to which such rights
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and Claims may be related to the Released Claims and/or the ERISA Action;
9.5. Because the Barred Persons are barred from asserting any Released Claims against the Releasees, any judgments entered against Barred Persons in the ERISA Action will be reduced by the Judgment Reduction Amount as that term is defined in Section 10;
9.6. This paragraph is hereby deleted.
9.7. Nothing in the Amended Settlement Agreement or Bar Order shall be deemed to create or acknowledge the existence or validity of any Claim of the Barred Persons or limit any defense to any such Claim;
10. The Court shall include a Judgment Credit with respect to the Barred Persons that shall provide as follows:
10.1. “Judgment Reduction Amount” shall mean, with respect to any Barred Person, an amount determined by the Court at the time of entry of any judgment against such Barred Person, equal to the greater of (a) the “Settlement Credit,” and (b) the “Contribution Credit”;
10.2. The “Settlement Credit” shall mean (a) the Settlement Amount ($29,850,000, or $28,850,000 as per paragraph 1.40.1.3) — constituting the maximum possible aggregate of the Settlement Amount, Supplemental Settlement Amount, and Martin Supplemental Settlement Amount; unless the Court shall determine when assessing liability against the Barred Person that some portion of the damages claimed which were settled by the Settlement, are different from those for which the Barred Person is liable, then (b) the Settlement Amount ($29,850,000, or $28,850,000 as per paragraph 1.40.1.3) minus the portion of the Combined Settlement Amount determined by the Court to have been paid with respect to such different damages claimed; provided that the Settlement Credit shall not reduce the total amount of the Settlement Class’ recovery against all Barred Persons by more than the Settlement Amount; and further provided that nothing in this paragraph shall permit the Settlement Class to recover more than their total amount of damages for the Claims asserted in the ERISA Action;
10.3. To the extent the Court finds that a right of contribution or equitable indemnity exists under ERISA, the “Contribution Credit” shall mean an amount equal to the value of the contribution or equitable indemnification Claim, if any, that the Court determines such Barred
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Person would be entitled to assert against one or more Settling Defendants but for operation of the Bar Order, which shall be equal to the aggregate proportionate shares of liability, if any, of the Settling Defendants as determined by the Court at the time of entry of any judgment against any Barred Person, adjusted to reflect any limitation on the financial capability of any Settling Defendants to pay their respective proportionate shares of liability to the Barred Person had the Barred Person obtained a contribution or equitable indemnification judgment against them in such amount, or in the absence of the Settlement, had a judgment been entered against any or all Settling Defendants in this case;
10.4 Nothing herein shall be construed as indicating that ERISA provides contribution or indemnity rights among fiduciaries, and Settlement Class Representatives expressly dispute that any such right or entitlement exists under ERISA. In addition, nothing herein or in the Amended Settlement Agreement shall be deemed to create or acknowledge the existence or validity of any Claim of the Barred Persons or limit any defense to any such Claim.
11. Upon the Approval Order becoming Final, the Settling Defendants will absolutely and unconditionally release and discharge any and all past, present, or future Claims or causes of action (including bad faith Claims), whether known or unknown, under or relating to the Insurance Policies and against the Underwriters. Subject to Section 9.4, the Underwriters shall release any and all past, present, or future Claims or causes of action (including without limitation any subrogation or fraud Claims against any Person), whether known or unknown, under or relating to the Insurance Policies and against the Settling Defendants. Nothing in this Amended Settlement Agreement or Bar Order in any way bars or enjoins the Settling Defendants or the Underwriters from asserting any rights they may have under any insurance policies other than the Insurance Policies, or from bringing or maintaining against any Person any Claims, whether direct or indirect, to the extent that such Claims are not based on the Insurance Policies and are based upon, arise from, in consequence of or relate to litigation other than the ERISA Action, including, but not limited to, the Securities Actions and the Derivative Actions, notwithstanding that such rights and Claims may be related to the Released Claims.
12. The Settlement Class Representatives and the Settling Defendants agree to jointly petition the Court for certification, pursuant to Rule 23(b)(l) and/or 23(b)(2), of a non-opt-out class for settlement purposes only consisting of: (a) all Persons who held any Company stock in their Plan accounts at any time during the Class Period, and (b) all beneficiaries, successors-in-interest, and any other payees of any Plan participant with respect to the Plan participant’s Claim in the ERISA Action, except specifically excluding from the Settlement Class Brandon Hale, Philip Watkins, James P. Bennett, P. Daryl Brown, John S. Chamberlin, Larry D. Striplin, Jr., Charles W. Newhall, III, George H. Strong, C. Sage Givens, Joel C. Gordon, Larry R. House, Anthony J. Tanner,
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Raymond J. Dunn, III, Allan R. Goldstein, Robert P. May, Jan L. Jones, Jon F. Hanson, Lee S. Hillman, Richard M. Scrushy, Aaron Beam, Jr., Michael D. Martin, and William T. Owens. For purposes of this Amended Settlement Agreement, the term “Settlement Class” shall refer both to each Person described in (a) and (b), and all of them collectively. This petition will be included in the joint motion(s) for Preliminary and Final Approval of the Settlement. A non-opt-out class is an essential condition of the Settlement.
13. Prior to the Fairness Hearing, Settlement Class Representatives shall propose a Plan of Allocation with respect to the Net Settlement Amount, which shall be submitted to the Court for approval. The costs (but not including Lead Counsel’s attorneys’ fees) of allocating the Settlement Amount pursuant to the Plan of Allocation shall be split evenly by the Company and the Settlement Class, with the Settlement Class’s 50% portion paid by the Plan. Lead Counsel shall administer the allocation and distribution of the Combined Settlement Amount. Settling Defendants shall in good faith facilitate the allocation process by providing Plan and participant and beneficiary information that is necessary for the allocation process. To the extent that the Plan record keeper or other agents of the Plan are required under existing contracts to perform services pertaining to the allocation of the Settlement Amount, any additional charges for such services shall not be included in the costs of allocating the Settlement Amount, and shall be paid by the Company. Neither the Settling Defendants nor the Underwriters shall have responsibility for the allocation and distribution of the Combined Settlement Amount, and neither the Settling Defendants nor the Underwriters shall have liability to the Settlement Class Representatives or Settlement Class for such allocation and distribution. Neither the Settling Defendants nor the Underwriters shall take any position with respect to the Plan of Allocation, and, instead, will leave the matter to the sound discretion of the Court. Lead Counsel shall furnish the Plan of Allocation to the Independent Fiduciary prior to submission thereof to the Court, and shall consider in good faith any comments of the Independent Fiduciary on the proposed Plan of Allocation. If Lead Counsel and the Independent Fiduciary are unable to reach agreement with respect to the proposed Plan of Allocation, the Independent Fiduciary shall have the right to comment on or object to the proposed Plan of Allocation submitted to the Court by Lead Counsel. The Plan of Allocation is a matter separate and apart from the Settlement between the Settling Parties, and no decision by the Court concerning the Plan of Allocation shall affect the validity of the Amended Settlement Agreement or finality of the Settlement in any manner.
14. The Settling Parties agree that the Court shall retain exclusive jurisdiction to resolve any disputes or challenges that may arise as to the performance of the Amended Settlement Agreement or any challenges as to the performance, validity, interpretation, administration, enforcement or enforceability of the Class Notice, the Bar Order or this Amended Settlement Agreement or the termination of this Amended Settlement Agreement; except as otherwise directed by the Court or by separate agreement of the Settling Parties.
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15. The Settling Parties agree that the Amended Settlement Agreement is a compromise of disputed Claims, and that nothing in this Amended Settlement Agreement shall be an admission of, or constitute a finding of: (i) fiduciary status under ERISA or wrongdoing by or liability of any of the Settling Defendants in the ERISA Action or any other proceeding; or (ii) coverage under the Insurance Policies or wrongdoing or liability of the Underwriters. This Amended Settlement Agreement shall not be offered or received in evidence in the ERISA Action or any other action for any purpose other than enforcement of the Amended Settlement Agreement.
16. Each Settling Party shall have the right, in his, her or its sole discretion, to terminate this Amended Settlement Agreement at any time up until the Court issues its Approval Order if: (a) the Plan, acting through an Independent Fiduciary, does not approve the Amended Settlement Agreement and does not grant a release, effective upon the Court’s entry of the Approval Order, containing the same terms and conditions of the Amended Settlement Agreement, or if different, terms mutually agreeable to the Settling Parties, and that meets the requirements of the Class Exemption, or (b) the DOL files any objection to the Amended Settlement Agreement in the Court, brings a Claim against any Settling Defendant relating to the Released Claims, or notifies any Settling Defendant that it intends to file such a Claim; and, with respect to subsections (a) and/or (b), the Settling Parties have been unable in good faith to negotiate a resolution, despite their best efforts. In the event of such termination, this Amended Settlement Agreement shall be null and void in toto. The costs of retaining an Independent Fiduciary shall be borne by the Company and the Underwriters, in whatever proportion they so desire. Under no circumstances shall the Plan, the Settlement Class, Settlement Class Representatives, or Lead Counsel have any obligation to pay in any manner the costs of retaining an Independent Fiduciary.
17. Except for attorney notes, pleadings, other court submissions and transcripts of depositions and exhibits thereto, Settlement Class Representatives agree to return to the Settling Defendants, at the Settling Defendants’ option, all discovery obtained from the Settling Defendants within thirty (30) days after the Approval Order is Final; provided that the Settling Defendants requesting the return of such materials shall reimburse Settlement Class Representatives for the costs of shipping such materials.
18. Lead Counsel shall be responsible for filing tax returns for the Settlement Fund and for paying any taxes owed with respect to the Settlement Fund . All taxes on the income of the Settlement Fund and all expenses incurred in connection with the taxation of the Settlement Fund (including, but not limited to, the expenses of tax attorneys and accountants) shall be paid out of the Settlement Fund .
19. The Settling Parties, and each of them, represent and warrant:
19.1 That they are voluntarily entering into this Amended Settlement Agreement as a result of arm’s-length negotiations among their counsel, with the assistance and recommendation of the Mediator, that in
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executing this Amended Settlement Agreement they are relying solely upon their own judgment, belief and knowledge, and the advice and recommendations of their own independently selected counsel, concerning the nature, extent and duration of their rights and Claims hereunder and regarding all matters which relate in any way to the subject matter hereof, and that, except as provided herein, they have not been influenced to any extent whatsoever in executing this Amended Settlement Agreement by any representations, statements or omissions pertaining to any of the foregoing matters by any party or by any Person representing any party to this Amended Settlement Agreement. Each Settling Party assumes the risk of mistake as to facts or law; and
19.2 That they have carefully read the contents of this Amended Settlement Agreement, and this Amended Settlement Agreement is signed freely by each Person executing this Amended Settlement Agreement on behalf of each of the Settling Parties. The Settling Parties, and each of them, further represent and warrant to each other that he, she or it has made such investigation of the facts pertaining to the Settlement, this Amended Settlement Agreement and all of the matters pertaining thereto, as he, she or it deems necessary.
19.3 Each individual executing this Amended Settlement Agreement on behalf of any other Person does hereby personally represent and warrant to the other Settling Parties that he or she has the authority to execute this Amended Settlement Agreement on behalf of, and fully bind, each principal which such individual represents or purports to represent.
20. Miscellaneous Provisions .
20.1 This Amended Settlement Agreement shall be governed by the laws of the United States, including federal common law, except to the extent that, as a matter of federal law, State law controls, in which case Alabama law shall apply.
20.2 The Settling Parties intend and agree that the releases provided or granted in the Amended Settlement Agreement shall be effective as a bar to any and all currently unsuspected, unknown or partially known claims within the scope of their express terms and provisions. Accordingly, subject to paragraphs 7 and 8 above, the Settlement Class Representatives hereby expressly waive, on their own behalf, on behalf of all members of the Settlement Class, and the Settling Defendants and Underwriters hereby expressly waive on their own behalf, any and all rights and benefits (if any) respectively conferred upon them by the provisions of Section 1542 of the California Civil Code and all similar provisions of the statutory or common laws of any other State, Territory or other jurisdiction. Section 1542 reads in pertinent part: “A general release does not extend to claims that the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor.”
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20.3 The provisions of this Amended Settlement Agreement are not severable.
20.4 Before entry of the Approval Order, the Amended Settlement Agreement may be modified or amended only by written agreement signed by or on behalf of all Settling Parties. Following entry of the Approval Order, the Amended Settlement Agreement may be modified or amended only by written agreement signed on behalf of all Settling Parties, and approved by the Court.
20.5 The provisions of this Amended Settlement Agreement may be waived only by an instrument in writing executed by the waiving party. The waiver by any party of any breach of this Amended Settlement Agreement shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent, or contemporaneous, of this Amended Settlement Agreement.
20.6 The following principles of interpretation apply to this Amended Settlement Agreement :
20.6.1 The headings of this Amended Settlement Agreement are for reference purposes only and do not affect in any way the meaning or interpretation of this Amended Settlement Agreement.
20.6.2 Definitions apply to the singular and plural forms of each term defined.
20.6.3 Definitions apply to the masculine, feminine, and neuter genders of each term defined.
20.6.4 Whenever the words “include,” “includes” or “including” are used in this Amended Settlement Agreement, they shall not be limiting but rather shall be deemed to be followed by the words “without limitation.”
20.6.5 None of the Settling Parties hereto shall be considered to be the drafter of this Amended Settlement Agreement or any provision hereof for the purpose of any statute, case law or rule of interpretation or construction that would or might cause any provision to be construed against the drafter hereof.
20.7 Each of the Settling Parties agrees, without further consideration, and as part of finalizing the Settlement hereunder, that
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they will in good faith execute and deliver such other documents and take such other actions as may be necessary to consummate and effectuate the subject matter and purpose of this Amended Settlement Agreement.
20.8 All representations, warranties and covenants set forth in this Amended Settlement Agreement shall be deemed continuing and shall survive the expiration of this Amended Settlement Agreement, except in the event the Amended Settlement Agreement is terminated pursuant to Sections 6 or 16, in which case those provisions shall govern.
20.9 Any notice, demand or other communication under this Amended Settlement Agreement (other than the Class Notice, the Bar Order Notice, or other notices given at the direction of the Court) shall be in writing and shall be deemed duly given upon mailing if it is addressed to each of the intended recipients as set forth below and personally delivered, sent by registered or certified mail (postage prepaid), sent by confirmed facsimile, or delivered by reputable express overnight courier:
IF TO PLAINTIFFS :
Lynn Lincoln Sarko, Esq. Derek W. Loeser, Esq. Gary A. Gotto, Esq. KELLER ROHRBACK, LLP 1201 Third Avenue, Suite 3200 Seattle, WA 98101-3052 Phone (206) 623-1900 Fax: (206) 623-3384 Email: [email protected]
Richard R. Rosenthal, Esq. Law Offices of Richard R. Rosenthal, PC 200 Title Building 300 North Richard Arrington Jr. Blvd. Birmingham, Alabama 35203 Phone: 205-252-4907 Fax: 205.252-1146 Email: [email protected]
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IF TO SETTLING DEFENDANTS :
Edward P. Welch, Esq. Robert S. Saunders, Esq. Stephen D. Dargitz, Esq. SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP One Rodney Square P.O. Box 636 Wilmington, Delaware 19801 Fax: (302) 651-3001
-and-
Gregory L. Doody, Esq. Executive Vice President, General Counsel and Secretary HEALTHSOUTH Corporation One HealthSouth Parkway Birmingham, Alabama 35243 Fax: (205) 969-4719
Counsel for HEALTHSOUTH Corporation
N. Lee Cooper, Esq. Patrick C. Cooper, Esq. James L. Goyer, III, Esq. MAYNARD COOPER & GALE PC 2400 AmSouth/Harbert Plaza 190 16 th Avenue North Birmingham, Alabama 35203 Fax: (205) 254-1999
Counsel to P. Daryl Brown, Richard F. Celeste, Raymond J. Dunn, III, Allan R. Goldstein, Brandon O. Hale, Larry House, Jan L. Jones, Kimberly S. McCracken, Marca Pearson, Barbara Roper, Dennis Wade and Phillip C. Watkins
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Gregory C. Braden, Esq. ALSTON & BIRD LLP One Atlantic Center 1201 West Peachtree Street Atlanta, Georgia 30309-3424 Fax: (404) 881-7777
Counsel to P. Daryl Brown, Richard F. Celeste, Allan R. Goldstein, Brandon O. Hale, Jan L. Jones, Kimberly S. McCracken, Marca Pearson, Barbara Roper, Dennis Wade and Phillip C. Watkins
Martin L. Seidel, Esq. Kathryn Fleury Shreeves, Esq. CADWALADER, WICKERSHAM & TAFT LLP 100 Maiden Lane New York, New York 10038 Fax: (212) 504-6666
Counsel to Jon F. Hanson, Lee S. Hillman and Robert P. May
Michael J. Chepiga, Esq. Paul C. Gluckow, Esq. SIMPSON THACHER & BARTLETT LLP 425 Lexington Avenue New York, New York 10017 Fax: (212) 455-2502
Counsel to John S. Chamberlin, C. Sage Givens, Joel C. Gordon, Charles W. Newhall, III, Larry D. Striplin, Jr., and George H. Strong
Don B. Long, Jr., Esq. James F. Henry, Esq. JOHNSTON BARTON PROCTOR & POWELL LLP 2900 AmSouth/Harbert Plaza 1901 Sixth Avenue North Birmingham, Alabama 35203-2618 Fax: (205) 458-9500
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Counsel to James P. Bennett
Jackson R. Sharman III, Esq. James F. Hughey, III, Esq. LIGHTFOOT, FRANKLIN & WHITE LLC The Clark Building 400 North 20 th Street Birmingham, Alabama 35203 Fax: (205) 581-0799
Counsel to Anthony J. Tanner
David G. Russell, Esq. J. Marbury Rainer, Esq. PARKER, HUDSON, RAINER & DOBBS LLP 1500 Marquis Two Tower 285 Peachtree Center Ave., N.E. Atlanta, Georgia 30303 Fax: (404) 522-8409
Counsel to Richard M. Scrushy
C. Lee Reeves, Esq. SIROTE & PERMUTT 2311 Highland Avenue South Birmingham, Alabama 35205 Fax: (205) 930-5101
Counsel to Michael D. Martin
Aaron Beam, pro se 16848 Black Devine Road Loxley, Alabama 36551
William T. Owens, pro se 118 Highland View Drive Birmingham, Alabama 35242
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IF TO UNDERWRITERS
Thomas A. Doyle, Esq. Matthew G. Allison, Esq. BAKER & MCKENZIE One Prudential Plaza 130 East Randolph Drive, Suite 3500 Chicago, Illinois 60601 Fax: (312) 861-2899
Counsel to Travelers Casualty & Surety Company of America
Peter R. Bisio, Esq. Christopher R. Zaetta, Esq. HOGAN & HARTSON LLP Columbia Square 555 Thirteenth Street, NW Washington, DC 20004-1109 Fax: (202) 637-5910
Counsel to Federal Insurance Company
Any Settling Party may change the address at which it is to receive notice by written notice delivered to the other Settling Parties in the manner described above.
20.10 The Amended Settlement Agreement contains the entire agreement among the Settling Parties relating to this Settlement. The Amended Settlement Agreement supersedes any settlement terms or settlement agreements previously agreed upon orally or in writing by any of the Settling Parties.
20.11 This Amended Settlement Agreement may be executed by exchange of faxed executed signature pages, and any signature transmitted by facsimile for the purpose of executing this Amended Settlement Agreement shall be deemed an original signature for purposes of this Amended Settlement Agreement. This Amended Settlement Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original, but all of which, taken together, shall constitute one and the same instrument.
20.12 This Amended Settlement Agreement binds and inures to the benefit of the parties hereto, their assigns, heirs, administrators, executors and successors.
20.13 The date on which the final signature is affixed below shall be the Agreement Execution Date.
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IN WITNESS WHEREOF, the Settling Parties have executed this Amended Settlement Agreement on the dates set forth below.
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SETTLEMENT CLASS REPRESENTATIVES:
/s/ Lynn Lincoln Sarko Lynn Lincoln Sarko Derek W. Loeser Gary A. Gotto KELLER ROHRBACK L.L.P. 1201 Third Avenue, Suite 3200 Seattle, WA 98101-3052 Phone (206) 623-1900 Fax: (206) 623-3384
Lead Counsel for ERISA Plaintiffs
Date: Feb 19, 2006
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THE SETTLING DEFENDANTS:
/s/ Patrick C. Cooper N. Lee Cooper Patrick C. Cooper James L. Goyer, III MAYNARD COOPER & GALE PC 2400 AmSouth/Harbert Plaza 190 16th Avenue North Birmingham, Alabama 35203
Counsel to P. Daryl Brown, Richard F. Celeste, Raymond J. Dunn, III, Allan R. Goldstein, Brandon O. Hale, Larry House, Jan L. Jones, Kimberly S. McCracken, Marca Pearson, Barbara Roper, Dennis Wade and Phillip C. Watkins
Date:
/s/ Gregory C. Braden Gregory C. Braden ALSTON & BIRD LLP One Atlantic Center 1201 West Peachtree Street Atlanta, Georgia 30309-3424
Counsel to P. Daryl Brown, Richard F. Celeste, Allan R. Goldstein, Brandon O. Hale, Jan L. Jones, Kimberly S. McCracken, Marca Pearson, Barbara Roper, Dennis Wade and Phillip C. Watkins
Date:
26
/s/ Martin L. Seidel Martin L. Seidel Kathryn Fleury Shreeves CADWALADER, WICKERSHAM & TAFT LLP One World Financial Center New York, New York 10281
Counsel to Jon F. Hanson, Lee S. Hillman and Robert P. May
Date:
/s/ Paul C. Gluckow Michael J. Chepiga Paul C. Gluckow SIMPSON THACHER & BARTLETT LLP 425 Lexington Avenue New York, New York 10017
Counsel to John S. Chamberlin, C. Sage Givens, Joel C. Gordon, Charles W. Newhall, III, Larry D. Striplin, Jr., and George H. Strong
Date: 2/21/06
/s/ Don B. Long, Jr. Don B. Long, Jr. James F. Henry JOHNSTON BARTON PROCTOR & POWELL LLP 2900 AmSouth/Harbert Plaza 1901 Sixth Avenue North Birmingham, Alabama 35203-2618
Counsel to James P. Bennett
Date: 2/22/06
27
/s/ James F. Hughey, III Jackson R. Sharman III James F. Hughey, III LIGHTFOOT, FRANKLIN & WHITE LLC The Clark Building 400 North 20th Street Birmingham, Alabama 35203
Counsel to Anthony J. Tanner
Date: 2/21/06
/s/ J. Marbury Rainer David G. Russell J. Marbury Rainer PARKER, HUDSON, RAINER & DOBBS LLP 1500 Marquis Two Tower 285 Peachtree Center Avenue NE Atlanta, GA 30303
Arthur W. Leach 2310 Marin Drive Birmingham, AL 35243
Counsel to Richard M. Scrushy
Date: Feb. 21, 2006
/s/ C. Lee Reeves C. Lee Reeves, Esq. SIROTE & PERMUTT 2311 Highland Avenue South Birmingham, Alabama 35205
Counsel to Michael D. Martin
Date: March 6, 2006
28
/s/ Edward P. Welch Edward P. Welch Robert S. Saunders Stephen D. Dargitz SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP One Rodney Square P.O. Box 636 Wilmington, Delaware 19801
Counsel to HEALTHSOUTH Corporation
Date:
THE UNDERWRITERS
/s/ Matthew G. Allison Thomas A. Doyle Matthew G. Allison BAKER & MCKENZIE One Prudential Plaza 130 East Randolph Drive, Suite 3500 Chicago, Illinois 60601
Counsel to Travelers Casualty & Surety Company of America
Date: 3/03/06
29
/s/ Peter R. Bisio Peter R. Bisio Christopher R. Zaetta HOGAN & HARTSON LLP Columbia Square 555 Thirteenth Street, NW Washington, DC 20004-1109
Counsel to Federal Insurance Company
Date: 3/6/06
30
THE SETTLING DEFENDANTS (CONTINUED FROM PAGE 28)
/s/ Aaron Beam, Jr., Aaron Beam, Jr., pro se 16848 Black Devine Road Loxley, Alabama 36551
31
/s/ William T. Owens William T. Owens, pro se 118 Highland View Drive Birmingham, Alabama 35242
EXHIBIT 10.35.2
KEY EXECUTIVE INCENTIVE AWARD AGREEMENT
THIS AGREEMENT (“Agreement”) is made by and between HEALTHSOUTH CORPORATION , a Delaware corporation (the “Company”), and , (“Executive”), as of November , 2005.
RECITALS
A. The Company has adopted and approved the HealthSouth Corporation Key Executive Incentive Program pursuant to which the Executive has been granted an award (the “Award”); and
B. The Award shall consist of a grant of stock options, restricted stock and a cash bonus, subject to the terms and conditions set forth in this Agreement; and
C. The Executive has accepted the grant of the Award and hereby agrees to the terms and conditions hereinafter stated; and
D. Capitalized terms used herein and not otherwise defined herein shall have the meanings set forth in the Company’s Change in Control Benefits Plan.
NOW THEREFORE, IN CONSIDERATION OF THE FOREGOING RE CITALS AND OF THE PROMISES AND CONDITIONS HEREIN CONTAINED, IT IS AGREED AS FOLLOW S:
ARTICLE I GRANT OF OPTION
Section 1.1 - Grant of Option.
Subject to the provisions of this Agreement, the Company has granted effective November , 2005 (the “Grant Date”), to the Executive the right and option to purchase all or any part of shares of common stock, par value $.01 per share (“Stock”), of the Company, subject to adjustment pursuant to Section 4.1. The Option granted pursuant to this Agreement is not intended to qualify as an “incentive stock option” within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”).
Section 1.2 - Exercise Price.
The exercise price of the Option shall be $ per share of Stock.
Section 1.3 - Vesting and Exercisability.
The Option shall become 100 percent vested as of January 1, 2009, provided the Executive has been continuously employed by the Company or a subsidiary until such
date. Prior to becoming 100 percent vested, the Option shall become exercisable in three cumulative installments as follows and shall remain exercisable until the tenth anniversary of the Grant Date (the “Option Term”), subject to the forfeiture provisions set forth in Section 1.4 and the acceleration of vesting provisions set forth in Section 4.2:
Section 1.4 - Expiration of Option.
(a) Except as set forth in subsections (b) or (d) below or Sections 1.7 and 4.2, an Option may not be exercised unless the Executive is then in the employ of the Company or a subsidiary, and unless the Executive has remained continuously so employed, or continuously maintained such relationship, since the Grant Date.
(b) If the Executive’s employment or service terminates because of Executive’s death or disability (as defined in Section 409A(a)(2)(C) of the Code)(“Disability”), all of the Executive’s Options (regardless of the extent to which such Options are then exercisable) shall be exercisable as of such date of termination and remain outstanding until the expiration of the term of the Option.
(c) If the Executive’s employment or service is terminated for Cause, the Option (whether or not vested) shall terminate on the date of the Executive’s termination of employment or service.
(d) If the Executive’s employment or service with the Company and its subsidiaries terminates (including by reason of the subsidiary which employs the Executive ceasing to be a subsidiary of the Company) other than as described in subsections (b) and (c) above, the portions of the outstanding Option that are exercisable as of the date of such termination of employment or service shall remain exercisable until the earlier of (i) 90 days following the date of such termination of employment or service and (ii) expiration of the term of the Option and shall thereafter terminate. All portions of the Option which are not exercisable as of the date of such termination of employment or service, shall terminate upon the date of such termination of employment or service.
Section 1.5 - Manner of Exercise.
(a) The Option, to the extent then vested and exercisable, shall be exercisable by delivery to the Company of a written notice stating the number of shares as to which
% Number of Shares Date First Available
For Exercise 25% January 1, 2007 25% January 1, 2008 50% January 1, 2009
the Option is exercised pursuant to this Agreement and a designation of the method of payment of the exercise price with respect to Stock to be purchased. An Option may not be exercised for less than 100 shares of Stock (or the number of remaining shares of Stock subject to the Option if less than 100).
(b) The exercise price of the Option, or portion thereof, with respect to Stock to be purchased, shall be paid in full at the time of exercise; payment may be made in cash, which may be paid by check, or other instrument or in any other manner acceptable to the Company. In addition, any amount necessary to satisfy applicable federal, state or local tax requirements shall be paid promptly upon notification of the amount due. The Compensation Committee of the Board of Directors of the Company (the “Committee”) may permit, in its sole discretion, such amount to be paid in Stock previously owned by the employee, or a portion of Stock that otherwise would be distributed to such employee upon exercise of the Option, or a combination of cash and such Stock.
Section 1.6 - Transferability of Option.
Unless the Committee determines otherwise, the Option is nontransferable except by will or the laws of descent and distribution.
Section 1.7 - Securities Act Requirements.
(a) The Company has not filed financial statements for any periods ended after December 31, 2004. The Company does not expect to become current with respect to all of its previously unfiled financial statements until at least the first quarter of 2006 and will not file any registration statement until after such time. Unless an exemption is available, no Option may be exercised until the Company complies with its reporting obligations under the Federal securities laws and a registration statement is declared effective by the Securities and Exchange Commission with respect to shares of Stock issuable under this Agreement.
(b) In addition to the requirements set forth in Section 1.7(a), (i) the Option shall be exercisable in whole or in part, and the Company shall not be obligated to sell any shares of Stock subject to any such Option, if such exercise and sale or issuance would, in the opinion of counsel for the Company, violate the Securities Act of 1933 (the “1933 Act”) or other Federal or state statutes having similar requirements, as they may be in effect at that time; and (ii) each Option shall be subject to the further requirement that, at any time that the Board of Directors or the Committee, as the case may be, shall determine, in their respective discretion, that the listing, registration or qualification of the shares of Stock subject to such Option under any securities exchange requirements or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the issuance of shares of Stock, such Option may not be exercised in whole or in part unless such listing, registration, qualification, consent or approval shall have been effected or obtained free
of any conditions not acceptable to the Board of Directors or the Committee, as the case may be.
Section 1.8 - Taxes and Withholdings.
Not later than the date of exercise of the Option granted hereunder, Executive shall pay to the Company or make arrangements satisfactory to the Committee regarding payment of any federal, state or local taxes of any kind required by law to be withheld upon the exercise of such Option. The Company shall, to the extent permitted or required by law, have the right to deduct from any payment of any kind otherwise due to Executive federal, state, and local taxes of any kind required by law to be withheld upon the exercise of such Option.
ARTICLE II GRANT OF RESTRICTED STOCK
Section 2.1 - Grant of Restricted Stock.
Subject to the provisions of this Agreement, the Company has granted as of the Grant Date shares of Stock pursuant to the terms, conditions and restrictions of this Agreement (the “Restricted Stock”).
Section 2.2 - Restrictions and Restricted Period.
(a) Restrictions . Shares of Restricted Stock granted hereunder may not be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of and shall be subject to a risk of forfeiture as described in Section 2.4 below until the lapse of the Restricted Period (as defined below) (the “Restrictions”).
(b) Restricted Period . Subject to the forfeiture provisions set forth in Section 2.4(a) or the provisions set forth in Section 4.2, the Restrictions shall lapse and the shares of Restricted Stock shall become vested and transferable (provided, that such transfer is in accordance with Section 2.6 and otherwise in compliance with Federal and state securities laws) in accordance with and subject to the following schedule:
% Number of Shares Date Restrictions Lapse 25% January 1, 2007 50% January 1, 2008 100% January 1, 2009
Section 2.3 - Rights of a Stockholder.
From and after the Grant Date and for so long as the Restricted Stock is held by or for the benefit of the Executive, the Executive shall have all the rights of a stockholder of the Company with respect to the Restricted Stock, including, but not limited to, the rights to vote and receive ordinary dividends. In the event that the Committee approves an adjustment to the Restricted Stock pursuant to Section 4.1 of the Agreement, then in such event, any and all new, substituted or additional securities to which the Executive is entitled by reason of the Restricted Stock shall be immediately subject to the Restrictions with the same force and effect as the Restricted Stock subject to such Restrictions immediately before such event.
Section 2.4 - Cessation of Employment.
(a) Forfeiture . If the Executive’s employment or service with the Company or any Subsidiary or Affiliate is terminated at any time while the Executive is holding Restricted Stock for any reason other than those set forth in Section 2.4(b) and 4.2 of this Agreement, then any unvested shares of Restricted Stock shall be forfeited to the Company and neither the Executive nor any of Executive’s successors, heirs, assigns, or personal representatives shall thereafter have any further rights or interests in such shares of Restricted Stock.
(b) Acceleration . If the Executive’s employment or service with the Company or any subsidiary is terminated as a result of the Executive’s death or Disability, all restrictions on the Restricted Stock shall lapse and the Restricted Stock shall immediately vest in full.
Section 2.5 - Certificates.
Restricted Stock granted herein may be evidenced in such manner as the Committee shall determine. If certificates representing Restricted Stock are registered in the name of the Executive, then the Company may retain physical possession of the certificate until the Restricted Period has lapsed.
Section 2.6 - Securities Act Requirements.
(a) The issuance of the Restricted Stock has not been registered under the 1933 Act, and is being issued to the Executive in reliance upon the exemption from such registration provided by Section 4(2) of the 1933 Act.
(b) The Executive hereby confirms that he or she has been informed that the shares of Restricted Stock are restricted securities under the 1933 Act and may not be resold or transferred unless such shares are first registered under the federal securities laws or unless an exemption from such registration is available. Accordingly, the Executive hereby acknowledges that he or she is prepared to hold the Restricted Stock for
an indefinite period and that the Executive is aware that Rule 144 promulgated by the Securities and Exchange Commission is not presently available to exempt the resale of the Restricted Stock from the registration requirements of the 1933 Act. The Executive is aware of the adoption of Rule 144 by the Commission, promulgated under the 1933 Act, which permits limited public resales of securities acquired in a nonpublic offering, subject to the satisfaction of certain conditions. The Executive understands that under Rule 144, the conditions include, among other things: the availability of certain current public information about the issuer, the resale occurring not less than one year after the party has purchased and paid for the securities to be sold, the sale being through a broker in an unsolicited “broker’s transaction” and the amount of securities being sold during any three-month period not exceeding specified limitations. The Executive acknowledges and understands that the Corporation may not be satisfying the current public information requirement of Rule 144 at the time the Executive wishes to sell the Restricted Stock or other conditions under Rule 144 which are required of the Corporation. If so, the Executive understands that Executive will be precluded from selling the securities under Rule 144 even if the one-year holding period of said rule has been satisfied. Prior to the Executive’s acquisition of the Restricted Stock, the Executive acquired sufficient information about the Company to reach an informed knowledgeable decision to acquire the Restricted Stock. The Executive has such knowledge and experience in financial and business matters as to make the Executive capable of utilizing said information to evaluate the risks of the prospective investment and to make an informed investment decision. The Executive is able to bear the economic risk of his or her investment in the Restricted Stock. The Executive agrees not to make, without the prior written consent of the Company, any public offering or sale of the Restricted Stock although permitted to do so pursuant to Rule 144(k) promulgated under the 1933 Act, until all applicable conditions and requirements of the Rule (or registration of the Restricted Stock under the 1933 Act) and this Agreement have been satisfied.
(c) In order to reflect the restrictions on disposition of the Restricted Stock, the stock certificates for the Restricted Stock will be endorsed with a restrictive legend, in substantially the following form:
“THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “ACT”) AND ARE “RESTRICTED SECURITIES” AS DEFINED IN RULE 144 PROMULGATED UNDER THE ACT. THEY MAY NOT BE SOLD OR OFFERED FOR SALE OR OTHERWISE DISTRIBUTED EXCEPT (1) IN CONJUNCTION WITH AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE ACT, OR EVIDENCE SATISFACTORY TO THE CORPORATION OF AN EXEMPTION THEREFROM, AND (2) IN COMPLIANCE WITH THE DISPOSITION PROVISIONS OF A WRITTEN AGREEMENT BETWEEN THE CORPORATION AND THE REGISTERED HOLDER OF THE SHARES (OR THE PREDECESSOR IN INTEREST TO THE SHARES). SUCH AGREEMENT IMPOSES CERTAIN RESTRICTIONS
IN CONNECTION WITH THE DISPOSITION OF THE SHARES. THE SECRETARY OF THE CORPORATION WILL, UPON WRITTEN REQUEST, FURNISH A COPY OF SUCH AGREEMENT TO THE HOLDER HEREOF WITHOUT CHARGE.
If required by the authorities of any state in connection with the issuance of the shares of Stock, the legend or legends required by such state authorities will also be endorsed on all such certificates.
Section 2.7 - Taxes.
The Executive shall pay to the Company promptly upon request, at the time the Executive recognizes taxable income in respect of the shares of Restricted Stock, an amount equal to the federal, state and/or local taxes the Company determines it is required to withhold under applicable tax laws with respect to the shares of Restricted Stock. In lieu of collecting payment from the Executive, the Company may, in its discretion, distribute vested shares of Stock net of the number of whole shares of Stock the fair market value of which is equal to the minimum amount of federal, state and local taxes required to be withheld under applicable tax laws.
ARTICLE III GRANT OF CASH BONUS
Section 3.1 - Grant of Cash Bonus.
The Executive shall be eligible to earn a cash bonus in an aggregate amount of $ (the “Bonus”). Such Bonus shall be payable on the date set forth in Section 3.2 (each, a “Payment Date”), subject to the ability of the Company, in the discretion of the Committee, to make such payments and subject further to the Executive being employed in good standing on a full-time basis on the Payment Date. Notwithstanding the foregoing, the Committee shall have exclusive authority o determine whether a pro rata portion of any Bonus installment shall be payable to the Executive in the event that the Executive is not employed by the Company on any Payment Date.
Section 3.2 - Payment Schedule
Subject to Section 3.1, the Bonus shall be payable as follows:
(a)
Section 3.3 - Taxes and Withholding.
The Company shall withhold all applicable income and other taxes from the Bonus payment, including any federal, FICA, state and local taxes.
ARTICLE IV MISCELLANEOUS
Section 4.1 - Adjustment of and Changes in Capitalization.
(a) In the event that the outstanding shares of Stock shall be changed in number or class by reason of split-ups, combinations, mergers, consolidations or recapitalizations, or by reason of stock dividends, the number or class of shares which thereafter may be issued pursuant to Awards, both in the aggregate and as to any individual, and the number and class of shares then subject to Awards theretofore granted and the price per share payable upon exercise of the Option shall be adjusted so as to reflect such change, all as determined by the Board of Directors or the Committee. In the event there shall be any other change in the number or kind of the outstanding shares of Stock, or of any stock or other securities or property into which such Stock shall have been changed, or for which it shall have been exchanged, then if the Board of Directors or the Committee shall, in its sole discretion, determine that such change equitably requires an adjustment in any outstanding Award, such adjustment shall be made in accordance with such determination.
(b) Notice of any adjustment shall be given by the Company to the Executive with an Award which shall have been so adjusted and such adjustment (whether or not such notice is given) shall be effective and binding for all purposes of this Agreement.
(c) Fractional shares resulting from any adjustment in the Option or Restricted Stock pursuant to this Section 4.1 may be settled in cash or otherwise as the Board of Directors or the Committee may determine.
% Amount Payment Date 25% January 1, 2007 25% January 1, 2008 50% January 1, 2009
Section 4.2 - Accelerated Vesting of Equity Awards.
Notwithstanding anything to the contrary in this Agreement, upon the occurrence of a Change in Control of the Company
(a) the Option shall become automatically vested and exercisable and shall remain exercisable for such period of time applicable to the Executive under Section 2.04(a)(ii) of the Change in Control Benefits Plan (whether or not the Executive is subject to such provisions at that time); provided, that the Option shall remain subject to the terms and conditions set forth in Section 1.7; and
(b) all Restrictions shall lapse and the shares of Restricted Stock shall become vested and transferable; provided that the provisions of Section 2.6 shall continue to govern any transfer of the Restricted Stock.
Section 4.3 - Governing Law.
This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware. The Committee shall have final authority to interpret and construe this Agreement and to make any and all determinations under them, and its decision shall be binding and conclusive upon the Executive and the Executive’s legal representative in respect of any questions arising under this Agreement.
Section 4.4 - Notices.
Any notice to be given under the terms of this Agreement shall be in writing and addressed to the Company at One HealthSouth Parkway, Birmingham, Alabama 35243, Attention: General Counsel, and to Executive at the address set forth below or at such other address as either party may hereafter designate in writing to the other by like notice.
Section 4.5 - Effect of Agreement.
Except as otherwise provided hereunder, this Agreement shall be binding upon and shall inure to the benefit of any successor or successors of the Company.
Section 4.6 - Amendment.
This Agreement may not be amended in any manner except by an instrument in writing signed by both parties hereto. The waiver by either party of compliance with any provision of this Agreement shall not operate or be construed as a waiver of any other provision of this Agreement or of any subsequent breach of such party of a provision of this Agreement.
Section 4.7 - No Right to Continued Employment.
Nothing in this Agreement shall be deemed to confer on the executive any right to continued employment with the Company.
Section 4.8 - Section 409A.
This Agreement is intended to comply with the requirements of Section 409A of the Code and shall be interpreted accordingly. In the event that any provision of this Agreement would or may cause this Agreement to fail to comply with Section 409A, such provision may be deemed null and void and the Company and the Executive agree to amend or restructure this Agreement, to the extent necessary and appropriate to avoid adverse tax consequences under Section 409A.
Section 4.9 - Entire Agreement.
This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and supersedes any other prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto.
IN WITNESS WHEREOF , the Company has caused this Agreement to be executed on its behalf by a duly authorized officer and Executive has hereunto set Executive’s hand.
OPTION granted in Birmingham, Alabama on February 23, 2006 (the “Date of Grant”), by HEALTHSOUTH Corporation, a Delaware corporation (the “Corporation”), to [ ] (the “Grantee”).
1. GRANT OF OPTION . The Corporation hereby grants to the Grantee the irrevocable Option to purchase, on the terms and subject to the conditions set forth herein and in the Plan (as defined below), up to [ ] fully paid and nonassessable shares of the Corporation’s Common Stock, par value $.01 per share, at the option price of $5.31 per share, being not less than 100% of the fair market value of such Common Stock on the Date of Grant.
The Option is granted pursuant to the Corporation’s 2005 Equity Incentive Plan (the “Plan”), a copy of which is attached hereto. The Option is subject in its entirety to all the applicable provisions of the Plan as in effect on the Date of Grant, which are hereby incorporated herein by reference.
2. PERIOD OF OPTION. Except as otherwise provided in the Plan, the Option is cumulatively exercisable in installments in accordance with the following schedule:
The Option may be exercised from time to time during the option period as to the total number of shares allowable under this Section 2, or any lesser amount thereof. The Option is not exercisable before February 23, 2007 or after February 23, 2017.
3. SECURITIES ACT REQUIREMENTS .
(a) The Company has not filed financial statements for any periods ended after December 31, 2004. The Company does not expect to become current with respect to all of its previously unfiled financial statements until at least the first quarter of 2006 and will not file any registration statement until after such time. NO OPTION MAY BE EXERCISED UNTIL THE COMPANY COMPLI ES WITH ITS REPORTING OBLIGATIONS UNDER THE FEDERAL SECURITIES LAWS AND A REGISTRATION STATEMENT IS DECLARED EFFECTIVE BY THE SECURITIES AND EXCHANGE C OMMISSION WITH RESPECT TO SHARES OF STOCK ISSUABLE UNDER THIS AGREEMENT.
(b) In addition to the requirements set forth herein and in the Plan, (i) the Option shall not be exercisable in whole or in part, and the Company shall not be obligated to issue any shares of Stock subject to any such Option, if such exercise and sale or issuance would, in the opinion of counsel for the Company, violate the Securities Act of 1933 (the “1933 Act”) or other Federal or state statutes having similar requirements, as they may be in effect at that time; and (ii) each Option shall be subject to the further requirement that, at any time that the Board of Directors or the Committee, as the case may be, shall determine, in their respective discretion, that the listing, registration or qualification of the shares of Stock subject to such Option under any securities exchange requirements or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the issuance of shares of Stock, such Option may not be exercised in whole or in part unless such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Board of Directors or the Committee, as the case may be.
4. METHOD OF EXERCISE OF OPTION . Subject to the provisions of the Plan and Paragraph 3 hereof, the Option may be exercised in whole or in part by the Grantee’s giving written notice, specifying the number of shares which the Grantee elects to purchase and the date on which such purchase is to be made to the Corporation or its designated broker.
5. TRANSFERABILITY . The Option is not transferable otherwise than by will or pursuant to the laws of descent and distribution, and is exercisable during the Grantee’s lifetime only by the Grantee.
6. BINDING AGREEMENT. This Stock Option Agreement shall be binding upon and shall inure to the benefit of any successor or assign of the Corporation, and, to the extent herein provided, shall be binding upon and inure to the benefit of the Grantee’s beneficiary or legal representatives, as the case may be.
7. ENTIRE AGREEMENT. This Stock Option Agreement and the Plan set forth the entire agreement of the parties with respect to the Option granted hereby and may not be changed orally but only by an instrument in writing signed by the party against whom enforcement of any change, modification or extension is sought.
If the foregoing is in accordance with your understanding and approved by you, please so confirm by signing and returning the duplicate of this Stock Option Agreement enclosed for that purpose.
ARTICLE II REPRESENTATION AND WARRANTIES OF SELLERS 4
Section 2.1 Financial Reporting 4 Section 2.2 Reduced Business 5 Section 2.3 Authority 5 Section 2.4 Corporate Status 5 Section 2.5 Title to Assets and Power to Convey 5 Section 2.6 No Conflicts 5 Section 2.7 Real Property 5 Section 2.8 Leases 6 Section 2.9 Contractual and Other Obligations 6 Section 2.10 Employment Matters 6 Section 2.11 Trademarks, Service Marks, Trade Names, Copyrights and Data Processing Systems 6 Section 2.12 Insurance 6 Section 2.13 Environmental Matters 6 Section 2.14 Litigation and Regulatory Investigations 7 Section 2.15 Other Consents 7 Section 2.16 No Brokers 7 Section 2.17 Provider Numbers 8 Section 2.18 Taxes 8 Section 2.19 License 8 Section 2.20 Records 8 Section 2.21 Sufficiency of Assets 8 Section 2.22 Facility Compliance 8 Section 2.23 Absence of Certain Developments 8
ARTICLE III 8
REPRESENTATIONS AND WARRANTIES OF PURCHASER 8
Section 3.1 Organization 8
ii
Section 3.2 Authority 8 Section 3.3 No Conflicts 9 Section 3.4 No Brokers 9 Section 3.5 Due Diligence 9
ARTICLE IV 9
CERTAIN COVENANTS OF SELLERS 9
Section 4.1 Satisfaction of Conditions 9 Section 4.2 The MetroWest Beds 10 Section 4.3 Certificate of Need 10 Section 4.4 Real Estate Investment Trust 10 Section 4.5 Negative Covenant 10 Section 4.6 Due Diligence 10 Section 4.7 Operations 10 Section 4.8 Continued Operation Until Closing 11
ARTICLE V CERTAIN COVENANTS OF PURCHASER 11
Section 5.1 Satisfaction of Conditions 11 Section 5.2 The MetroWest Beds 11 Section 5.3 Certificate of Need 11 Section 5.4 Cooperation with purchaser of Digital Hospital 11
ARTICLE VI ADDITIONAL COVENANTS AND AGREEMENTS 12
Section 6.1 Public Announcements 12 Section 6.2 Further Assurances 12 Section 6.3 MetroWest Beds 12 Section 6.4 Outpatient Center 12 Section 6.5 Pita Stop Property, Bernstein Condominium Unit, McCoy Condominium Unit 12 Section 6.6 Gamma Knife Partnership 12
ARTICLE VII CONDITIONS TO THE OBLIGATIONS OF PURCHASER 13
Section 7.1 Representations and Warranties True 13 Section 7.2 Compliance with this Agreement 13 Section 7.3 Documents to be Delivered 13 Section 7.4 No Injunctions 13 Section 7.5 The MetroWest Beds 13 Section 7.6 Certificate of Need 14 Section 7.7 Real Estate Investment Trust 14 Section 7.8 Absence of Certain Developments 14 Section 7.9 Due Diligence 14
ARTICLE VIII CONDITIONS TO THE OBLIGATIONS OF SELLERS 14
Section 8.1 Representations and Warranties True 14
iii
Section 8.2 Compliance with this Agreement 14 Section 8.3 Payment of Purchase Price 15 Section 8.4 Documents to be Delivered 15 Section 8.5 No Injunction 15 Section 8.6 Digital Hospital 15
ARTICLE IX SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNIFICATION 15
Section 9.1 Survival of Representations and Warranties 15 Section 9.2 Indemnification by the Sellers 15 Section 9.3 Indemnification by Purchaser 16 Section 9.4 Notice of Claims 16 Section 9.5 Deductible Amount 17 Section 9.6 Limitation 17
Schedule 2.5 Exceptions to the Title to the Assets
Schedule 2.8 Leases
Schedule 2.9 Contractual and Other Obligations
Schedule 2.10 Employment Matters
Schedule 2.11 Intellectual Property
Schedule 2.12 Insurance
Schedule 2.13 Environmental Matters
Schedule 2.14 Litigation and Regulatory Investigations
Schedule 2.15 Required Consents or Approvals
Schedule 2.17 Provider Numbers
Schedule 2.18 Delinquent Taxes
Schedule 2.18(a) Contested Taxes
Schedule 2.21 Sufficiency of the Assets
EXHIBITS
Exhibit A Real Property Description
Exhibit B Description of Pita Stop Property
Exhibit C Description of Bernstein Condominium and McCoy Condominium
Exhibit D Form of Deed
Exhibit E Form of Title Policy
EXECUTION COPY
ASSET PURCHASE AGREEMENT
THIS ASSET PURCHASE AGREEMENT (this “Agreement”) is made and entered into as of July 20, 2005, by and among HealthSouth Corporation, a Delaware corporation (“HealthSouth”), HealthSouth Medical Center, Inc., an Alabama corporation (“HMC”) (HealthSouth and HMC, collectively, “Sellers”; each a “Seller”) and The Board of Trustees of The University of Alabama (“Purchaser”).
W I T N E S S E T H:
WHEREAS, Sellers desires to sell, and Purchaser desires to purchase, certain assets comprising Sellers’ facilities and assets comprising the HealthSouth Medical Center in Jefferson County, Alabama (the “Hospital”) and its related assets, including, without limitation, the real property, fixtures, furniture, equipment, improvements, and inventory currently utilized by such Hospital (collectively with the Hospital, the “Business”);
WHEREAS, HMC, or its Affiliate, will retain the certificate of need under which the Hospital operates and the 219 beds currently licensed at the Hospital;
WHEREAS, an Affiliate of Purchaser will manage the Hospital pursuant to that certain Management Agreement between Purchaser and HMC, dated simultaneously herewith (the “Management Agreement”);
WHEREAS, as a condition to Closing, Purchaser must obtain a certificate of need to offer, subsequent to Closing, at the Hospital, the same services as those currently offered at Purchaser’s hospital in Birmingham, Alabama; and
WHEREAS, in contemplation of the execution of this Agreement and subject to the terms hereinafter set forth, Sellers have transferred to Purchaser, the ownership of 199 licensed beds located at HealthSouth Metro-West Hospital located in Fairfield, Alabama (the “MetroWest Beds”).
NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows:
ARTICLE I
Section 1.1 Assets Purchased at the Closing. On the basis of the representations and warranties and subject to the terms and conditions set forth in this Agreement, at the Closing, Purchaser agrees to purchase from Sellers, and Sellers, for themselves and their Affiliates, agree to sell, assign, bargain, convey and deliver to Purchaser, the following assets of Sellers (collectively, the “Assets”), free from any liens, claims and encumbrances, except those listed on Schedule 1.3 hereto:
(a) the Real Property currently known as “HealthSouth Medical Center” located at 1201 11th Avenue South, Birmingham, Alabama as more particularly described on Exhibit A hereto, excluding the following properties: the Pita Stop Property, as described on
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Exhibit B hereto, the Bernstein Condominium and the McCoy Condominium, as described on Exhibit C hereto;
(b) all of Sellers’ rights under those contracts listed on Schedule 1.1(b) hereto (as well as any contracts specifically related to the Hospital and mutually approved in writing by Sellers and Purchasers); and
(c) all operating assets, as materially listed on Schedule 1.1(c) hereto, including, without limitation, the real property, intellectual property, personal property, furniture, fixtures, equipment, improvements, vehicles, patient records, financial records, personnel files, inventory and supplies.
Section 1.2 Excluded Assets. Purchaser and Sellers acknowledge and agree that Purchaser is not acquiring any cash, accounts receivable, working capital, the operating business unit comprising the outpatient center (apart from the real property on which such business is located and which is part of the Assets) located on the campus of the Hospital, the certificate of need under which the Hospital currently operates, the licensed beds operated by HMC at the Hospital, or the real property or improvements thereon associated with the hospital being constructed by Sellers on U.S. Highway 280 in Jefferson County (the “Digital Hospital”). Although Sellers’ interest in the Gamma Knife Partnership is not included in the Assets, Sellers shall convey such interest to Purchaser as of January 1, 2007 pursuant to Section 6.6 of this Agreement.
Section 1.3 Assumed Liabilities, Contracts and Leases.
(a) As of the Closing, Purchaser agrees to assume the liabilities listed on Schedule 1.3 hereto (with those obligations in Section 1.3(c) hereof, the “Assumed Liabilities”), including all leases and subleases to which any of the Assets are subject. Purchaser does not assume any liabilities not specifically set forth on Schedule 1.3 . Sellers agree to provide Purchaser with all books and records relating to the Assumed Liabilities.
(b) Purchaser assumes and agrees to pay or perform, as the case may be, all obligations for the time period after the Closing with respect to those contracts, purchase orders, agreements and leases which are set forth on Schedule 1.3 hereto.
Section 1.4 Purchase Price.
(a) Unless adjusted pursuant to Section 1.4(b), the purchase price (the “Purchase Price”) for the Assets shall be THIRTY THREE MILLION DOLLARS ($33,000,000). The Purchase Price shall be paid via bank wire transfer at the Closing by Purchaser.
(b) The Purchase Price shall be subject to adjustment as follows:
(i) To the extent that any of the following real properties are not conveyed at the Closing in accordance with Section 6.5 hereof, the Purchase Price shall be reduced by the amount reflected for such non-conveyed real property as shown below:
(ii) The Purchase Price shall be increased by the cost of any capital improvements to the Assets made by Sellers after the date of delivery of this Agreement if Purchaser agrees in writing to such addition to the Purchase Price.
(iii) The Purchase Price shall be reduced to $20,000,000 if on or after June 1, 2006: (A) Sellers elect to terminate this Agreement pursuant to Section 10.1(e) of this Agreement upon ten (10) days written notice to Purchaser; (B) Purchaser has not received both: (i) the CON for operation of the Assets and (ii) all regulatory approval for the relocation of the MetroWest Beds to the Purchaser’s campus, and (C) Purchaser agrees to purchase the Assets without any condition related to a CON or license for operation of the Assets. In order to exercise its right to purchase the Assets at the reduced Purchase Price provided in this Section 1.4(b)(iii), Purchaser must notify Sellers in writing within ten (10) business days of Sellers’ written notice hereunder. If Purchaser notifies Sellers that it is willing to accept these conditions for closing in exchange for the Purchase Price reduction, all representations, covenants and warranties of Sellers under this Agreement with respect to operation of the Assets as a health care facility shall be of no further force and effect, and the Closing shall occur within ten (10) business days of Purchaser’s written acceptance to Sellers and in no event later than June 30, 2006.
Section 1.5 Allocation of Purchase Price. The Purchase Price for the Assets being conveyed herein shall be allocated by Purchaser and Sellers among the Assets being sold by Sellers to Purchaser hereunder in accordance with the allocation contained on Schedule 1.5 hereto and such allocation shall be used by all parties hereto for all applicable tax and financial purposes.
Section 1.6 The Closing. The closing of the transactions contemplated by Section 1.1 (the “Closing”) shall occur as soon as practicable after the satisfaction of the conditions to Closing outlined in Article VII and Article VIII hereof. The Closing of the transactions contemplated by this Agreement shall occur at the offices of Balch & Bingham LLP, 1901 Sixth Avenue North, Suite 2600, Birmingham, Alabama, or at such other location as Purchaser and Sellers may agree upon.
Section 1.7 Prorations. All taxes, rent, revenues, water charges, utilities, or any other similar items relating to the Assets shall be prorated by the parties as of 12:01 a.m. on the day closing occurs (the “Closing Date”) as if Purchaser were vested with title to the Assets during the entire day upon which the Closing occurs. For purposes of proration, municipal ad valorem taxes shall be assumed to have been paid in advance and all other ad valorem taxes shall be assumed to be paid in arrears. Any expense amount which cannot be ascertained with certainty as of the Closing Date shall be prorated on the basis of the parties’ reasonable estimates of such
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amount, and shall be the subject of a final proration sixty (60) days after the Closing Date, or as soon thereafter as the precise amounts can be ascertained. Purchaser shall promptly notify Sellers when it becomes aware that any such estimated amount has been ascertained. Once all rental and expense amounts have been ascertained, Purchaser shall prepare, and certify as correct, a final proration statement which shall be subject to Sellers’ approval. Upon Sellers’ acceptance and approval of any final proration statement submitted by Purchaser, such statement shall be conclusively deemed to be accurate and final. The parties shall prorate payments with respect to patient services provided by HMC prior to Closing and Purchaser subsequent to Closing for patients who are inpatients of the Hospital at the Closing to the extent payment for such services is received on a single DRG or similar basis.
Section 1.8 Costs. Except as otherwise expressly provided for in this Agreement, each party will bear its own expenses incurred in connection with the preparation, execution and performance of its obligations under this Agreement.
Section 1.9 Purchaser’s Costs. Purchaser shall pay (i) all transfer taxes relating to the transfer of the Real Property to Purchaser; (ii) the cost of any environmental report required by Purchaser; (iii) the cost of any recordation fees to put the deed of record with the appropriate governmental authority; (iv) recordation fees and transfer taxes; (v) the cost of its legal counsel, advisors and other professionals employed by Purchaser in connection with its purchase of the Assets from Sellers; and (vi) the cost of all items for which Purchaser is expressly obligated to pay under this Agreement.
Section 1.10 Sellers’ Costs. Sellers shall pay (i) the cost of the premium for the Title Policy; (ii) the cost of an ALTA survey of the Real Property in form and substance satisfactory to Purchaser; (iii) and other expenses related to the discharge of any lien or encumbrance on the Real Property; (iv) the costs of its legal counsel, advisors and other professionals employed by Sellers in connection with the sale of the Assets to Purchaser; and (v) the cost of all items for which Sellers are expressly obligated to pay under this Agreement.
ARTICLE II
REPRESENTATION AND WARRANTIES OF SELLERS
Sellers hereby represent and warrant to Purchaser, as of the date of execution of this Agreement, as follows:
Section 2.1 Financial Reporting. HealthSouth is restating its historical financial reports on a consolidated corporate group basis and on June 27, 2005, filed with the United States Securities and Exchange Commission its Form 10-K Annual Report for the years ended December 31, 2002 and 2003, which included restatements of previously issued consolidated financial statements for the years ended December 31, 2000 and 2001. Such restatements have not been completed for the individual subsidiaries which make up the HealthSouth consolidated group. HMC’s financial reports have not been restated and Sellers make no representation as to the validity or accuracy of any financial information regarding HMC.
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Section 2.2 Reduced Business. Purchaser has been informed that the scope of the Hospital’s operations has materially changed since January 1, 2005, and, notwithstanding any other provision of this Agreement, Sellers make no representation that further changes will not occur prior to the Closing.
Section 2.3 Authority. Sellers and Sellers’ officers have full power and authority to execute, deliver and perform this Agreement and all agreements executed and delivered by Sellers pursuant to this Agreement, and have taken all action required by law or otherwise to authorize the execution, delivery and the performance of this Agreement and related documents. This Agreement and the transactions contemplated by this Agreement have been duly authorized by the Board of Directors of each of the Sellers. This Agreement constitutes a valid and legally binding obligation of Sellers, enforceable against Sellers in accordance with its terms. Sellers and each of the officers of Sellers have full power and authority, duly and validly authorized by its Board of Directors, and no further proceedings on the part of Sellers are necessary, to execute and deliver this Agreement and to consummate the transactions contemplated hereby. HMC’s sole shareholder has approved the transactions contemplated by this Agreement.
Section 2.4 Corporate Status. HMC is a corporation duly organized, validly existing and in good standing under the laws of the State of Alabama, and has all requisite power and authority to own, lease, and operate its properties and assets, and to carry on its business as is now being conducted. HealthSouth is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite power and authority to own, lease, and operate its properties and assets, and to carry on its business as is now being conducted.
Section 2.5 Title to Assets and Power to Convey. Except as set forth in Schedule 2.5 , HMC is the sole owner of, and has good and marketable title to all of the Assets and has full right and capacity to sell and deliver the Assets contemplated by this Agreement. Upon the Closing, Purchaser shall have acquired from HMC, good and marketable, legal and equitable title to the Assets, free and clear of all pledges, liens, security interests, claims, charges, restrictions, options, or encumbrances of any nature whatsoever, except as specified on Schedule 2.5 hereto.
Section 2.6 No Conflicts. Neither the execution and delivery of this Agreement by Sellers nor the consummation of the transactions contemplated hereby will: (a) conflict with or violate any provision of the articles of incorporation or bylaws of either Seller; (b) violate, conflict with, constitute a default (or an event which, with or without notice, lapse of time or both, or the occurrence of any other event, would constitute a default) under, result in the termination of, accelerate the performance required by, cause the acceleration of the maturity of any debt or obligation pursuant to, or result in the creation or imposition of any security interest, lien or other encumbrance upon any property or assets of Sellers or Sellers’ interests under any agreement or commitment to which Sellers are a party or by which Sellers are bound or to which the property of Sellers is subject, except such violations, conflicts or defaults which would not have a Material Adverse Effect; or (c) violate any federal, state or local law or any judgment, decree, order, regulation or rule of any court or governmental authority.
Section 2.7 Real Property. Exhibit A hereto describes the Real Property. Except as set forth in Schedule 2.5 and except for Permitted Encumbrances, Sellers have title in fee simple
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in the Real Property, free and clear of any Encumbrance, except for the Pita Stop Property and the Bernstein Condominium and the McCoy Condominium.
Section 2.8 Leases. Schedule 2.8 contains an accurate and complete list of all leases and subleases pursuant to which Sellers lease real or personal property with respect to the Assets. Except as set forth in Schedule 2.8 , all such leases are valid, binding and enforceable in accordance with their terms, except to the extent that such enforcement may be subject to bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to creditors’ rights and remedies generally, and are in full force and effect; there are no existing defaults by Sellers thereunder; no event of material default has occurred which (whether with or without notice, lapse of time or the happening or occurrence of any other event) would constitute a material default thereunder by any party thereto.
Section 2.9 Contractual and Other Obligations. Schedule 2.9 lists all of the material written or oral contracts, agreements, and commitments of Sellers which pertain to the Assets.
Section 2.10 Employment Matters. As relates to the Assets, Schedule 2.10 contains a list of all full and part-time employees of Sellers, their wages and other remuneration of every kind. Except as set forth in Schedule 2.8 , the employment of each employee listed on Schedule 2.8 is terminable at will by Sellers, without restriction, penalty or payment of any kind.
Section 2.11 Trademarks, Service Marks, Trade Names, Copyrights and Data Processing Systems. All trademarks, service marks, trade names and copyrights (including trademarks, service marks, trade names and copyrights relating to computer software and hardware) used by Sellers at the Hospital are described and set forth in Schedule 2.11.
Section 2.12 Insurance. A complete list of the insurance policies maintained by Sellers and a description of all areas of the Hospital that are self-insured by Sellers and self-insurance reports are set forth in Schedule 2.12. To Sellers’ Knowledge, there are no notices of any pending or threatened termination or premium increases with respect to any of such policies.
Section 2.13 Environmental Matters. Except as set forth in Schedule 2.13 , as relates to the Assets, to Sellers’ Knowledge:
(i) Sellers have obtained all permits, licenses and other authorizations which are required in connection with the conduct of the Hospital under regulations relating to pollution or protection of the environment, including regulations relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including without limitation ambient air, surface water, groundwater, or land), or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport, or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes (“Environmental Laws”);
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(ii) Sellers have obtained and are in material compliance with the terms and conditions of all permits, licenses and other authorizations required under Environmental Laws;
(iii) Sellers have not received notice of any past or present events, conditions, circumstances, activities, practices, incidents, actions or plans that may interfere with or prevent continued compliance with the permits, licenses and other authorizations referred to above or Environmental Laws;
(iv) No asbestos or equipment containing polychlorinated biphenyls or leaking underground or above-ground storage tanks is contained in or located at any facility owned, leased or controlled by Sellers;
(v) Sellers have fully disclosed all known past and present noncompliance with such Environmental Law, and all known past “releases” of a “reportable quantity” of any “hazardous substance”, or releases of oil, that could form the basis of any claim, action, suit, proceeding, hearing or investigation under any Environmental Law; and
(vi) Sellers have not received notice of any past or present events, conditions, circumstances, activities, practices, incidents, actions or plans that have resulted in or threaten to result in any common law or legal liability, or otherwise form the basis of any claim, action, suit, proceeding, hearing or investigation under any Environmental Law with respect to the Hospital.
Section 2.14 Litigation and Regulatory Investigations. Except as disclosed on Schedule 2.14 hereto, as it may relate to the Hospital, there are no pending litigation or regulatory proceedings by or against the Sellers or the Assets. To Sellers’ Knowledge, there is no pending or threatened action, proceeding, investigation, order, consent, decree or agreement with regulatory authorities with respect to the Assets, neither of the Sellers or any other person or entity, which questions the validity of this Agreement or could prevent or adversely affect any action taken or to be taken pursuant hereto or which would result in any revocation, suspension or limitation of any regulatory authority of the Assets or would have a Material Adverse Effect.
Section 2.15 Other Consents. Except as disclosed on Schedule 2.15 hereto, no consent, approval or authorization of, or notice to, any non-governmental (federal, state or local) person or entity, including, without limitation, parties to loans, contracts, leases or other agreements, is required in connection with the execution, delivery and performance of this Agreement by Sellers or the consummation by it of the transactions contemplated hereby.
Section 2.16 No Brokers. Sellers have not contracted for the services of any broker, salesperson, finder, agent, investment banker or any other person to whom a commission or fee will be due as a result of the transactions contemplated by this Agreement. Sellers hereby indemnify and hold Purchaser harmless from any claim by any other person or entity for a commission or fee arising out of Sellers’ actions and as a result of the transactions contemplated by this Agreement.
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Section 2.17 Provider Numbers. Attached hereto as Schedule 2.17 is a list of all Medicaid and Medicare provider numbers (the “Provider Numbers”) in the name of the Hospital. The Provider Numbers are in full force and effect as of the date of this Agreement. Sellers shall reasonably cooperate with Purchaser with respect to the issuance of a new provider number.
Section 2.18 Taxes. Except as provided on Schedule 2.18 hereto, HMC has filed or caused to be filed on a timely basis all material tax returns and all material reports with respect to taxes that are or were required to be filed pursuant to applicable requirements. HMC has paid, or made provision for the payment of, all material taxes that have or may become due for all periods covered by the tax returns or otherwise, or pursuant to any assessment received by HMC, except such taxes, if any, as are listed on Schedule 2.18(a) and are being contested in good faith and as to which adequate reserves (determined in accordance with generally accepted accounting principles) have been established by Sellers.
Section 2.19 License. As of the date of this Agreement, HMC holds a valid license to operate as an acute care hospital issued by the Alabama Department of Public Health (the “DPH License”), and otherwise has the legal ability to operate as an acute care hospital.
Section 2.20 Records. The non-financial records of HMC are complete and correct in all material respects, subject to the representations provided in Sections 2.1 and 2.2 herein.
Section 2.21 Sufficiency of Assets. Except as provided on Schedule 2.21 hereto, to Sellers Knowledge, the Assets constitute all of the tangible assets, of any nature whatsoever, necessary to operate the Hospital in the manner presently operated by HMC.
Section 2.22 Facility Compliance. To Sellers’ Knowledge, Sellers are not in violation of any building code, zoning or other ordinance relating to the Real Property.
Section 2.23 Absence of Certain Developments. Subject to the representations provided in Sections 2.1 and 2.2 herein: (i) there has been no action of eminent domain with respect to the Real Property and (ii) except as contemplated in Section 5.3 herein, there are no governmental (federal, state or local) restrictions to prevent the Hospital from operating as an acute care hospital.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PURCHASER
Purchaser hereby represents and warrants to Sellers as of the date hereof as follows:
Section 3.1 Organization. Purchaser is an Alabama corporation, validly existing and in good standing under the laws of the State of Alabama, and has all requisite power and authority to own, lease, and operate its properties and assets, and to carry on its business as is now being conducted.
Section 3.2 Authority. Purchaser has the power and authority to execute, deliver and perform this Agreement and all agreements executed and delivered pursuant to this Agreement,
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and has taken all actions required by law and its Bylaws to authorize the execution, delivery and the performance of this Agreement and related documents.
Section 3.3 No Conflicts. The execution and delivery by Purchaser of this Agreement does not, and the performance by Purchaser of its obligations under this Agreement and the consummation of the transactions contemplated hereby will not violate any provision of any agreement of Purchaser or any provisions of or result in the acceleration of any obligation under any mortgage, lien, lease, agreement, instrument, order, arbitration, award, judgment or decree to which Purchaser is a party or by which it is bound.
Section 3.4 No Brokers. Purchaser has not contracted for the services of any broker, salesperson, finder, agent, investment banker or any other person to whom a commission or fee will be due as a result of the transactions contemplated by this Agreement. Purchaser does hereby indemnify and hold Sellers harmless from any claim by any other person or entity for a commission or fee arising out of Purchaser’s actions and as a result of the transactions contemplated by this Agreement.
Section 3.5 Due Diligence. Purchaser and its attorneys, accountants, and other authorized representatives have been provided access to the Assets and to documents and records of each Seller related to the Assets in order to afford Purchaser such reasonable opportunity of review, examination and investigation. All due diligence associated with such review, examination and investigation has been completed to the satisfaction of Purchaser prior to the date of this Agreement, except due diligence associated with (i) contracts to be executed subsequent to the date of this Agreement; (ii) environmental matters which would result in a violation Section 2.13 and are not otherwise disclosed in Schedule 2.13 hereto or known to Purchaser as of the date of this Agreement; and (iii) matters related to the condition of the building improvements to the Real Property not known to Purchaser as of the date of this Agreement (collectively, the “Continued Due Diligence Matters”.) Notwithstanding anything herein to the contrary, Sellers and Purchasers have agreed to finalize, by mutual written agreement, the form of Schedule 1.5 (Allocation) and Schedule 2.5 (Exceptions to the Title to the Assets) as well as Schedule 2.14 (only with respect to Michael Yelapi, et. al. v. St. Petersburg Surgery Center, et. al. ) on or before July 31, 2005. In the event the parties cannot reach written agreement on such schedules on or before July 31, 2005, any party to this Agreement may terminate this Agreement by sending written notice to the other parties.
ARTICLE IV
CERTAIN COVENANTS OF SELLERS
Sellers hereby covenant to and agree with Purchaser as follows:
Section 4.1 Satisfaction of Conditions. Sellers shall use reasonable good faith efforts to satisfy or cause the satisfaction of the conditions specified in Article VII hereof in an expeditious fashion.
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Section 4.2 The MetroWest Beds. Sellers shall act in good faith to support Purchaser’s efforts to obtain all regulatory approvals necessary for the relocation of the MetroWest Beds to the Purchaser’s hospital in Birmingham, Alabama.
Section 4.3 Certificate of Need. Sellers shall act in good faith to support Purchaser’s efforts to obtain a certificate of need in Purchaser’s name to operate the Hospital as an acute care facility in Jefferson County, Alabama with the same services as currently offered at Purchaser’s hospital in Birmingham, Alabama (the “CON”).
Section 4.4 Real Estate Investment Trust. Sellers shall use their best faith efforts expeditiously to obtain title in fee simple, free and clear of any encumbrances, except for any subleases, to any of the Assets described in Exhibit A which is or has been held by Healthcare Realty Trust.
Section 4.5 Negative Covenant. Except as otherwise expressly permitted herein, between the date of this Agreement and the Closing Date, HMC shall not, and HealthSouth shall not permit HMC to, without the prior written consent of Purchaser, (i) make any modification to any material contract; or (ii) enter into any material compromise or settlement of any litigation (other than litigation involving allegations of malpractice or employment issues), proceeding or governmental investigation relating exclusively to the Assets, the business of HMC or the Assumed Liabilities.
Section 4.6 Due Diligence. Between the date hereof and the Closing, and upon reasonable advance notice by Purchaser to Sellers, Sellers shall provide Purchaser reasonable access to HMC’s contracts, other documents, data and the building improvements to the Real Property as is relevant to Purchaser’s investigation into the Continued Due Diligence Matters. In addition, Purchaser shall have the right to have the Assets inspected by the Purchaser at Purchaser’s sole cost and expense for purposes related to the Continued Due Diligence Matters.
Section 4.7 Operations. Between the date hereof and the Closing, HMC shall:
(a) maintain the Assets in accordance with applicable accrediting standards of JCAHO;
(b) keep the DPH License in full force and effect without amendment, except as otherwise provided in Section 4.8;
(c) comply with all material contractual obligations applicable to the operations of HMC’s business;
(d) continue in full force and effect the insurance coverage under the existing insurance policies maintained by HMC or substantially equivalent policies;
(e) cooperate with Purchaser and assist Purchaser in identifying the governmental authorizations required by Purchaser to operate the Assets as an acute care hospital from and after the Closing; and
(f) maintain all records as they relate to the DPH License.
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Section 4.8 Continued Operation Until Closing. Sellers agree to continue operation of the Hospital until either the Closing occurs or this Agreement is terminated; provided, however, that Sellers may cease operation of the Hospital after December 31, 2005 if Purchaser declines to enter into a written agreement with Sellers in which Purchaser agrees to pay, each month, to Sellers the amount of any negative EBITDAM (as defined in the Management Agreement) for the period from January 1, 2006 through the Closing Date. If Purchaser and Sellers enter into a written agreement in which Purchaser agrees to pay, each month, to Sellers the amount of any negative EBITDAM (as defined in the Management Agreement) for the period from January 1, 2006 through the Closing Date, Sellers shall continue operations of the Hospital through the earlier of: (a) termination of such written agreement or (b) the termination of this Agreement.
ARTICLE V
CERTAIN COVENANTS OF PURCHASER
Purchaser hereby covenants to and agrees with Sellers as follows:
Section 5.1 Satisfaction of Conditions. Purchaser shall use reasonable good faith efforts to satisfy or cause the satisfaction of the conditions specified in Article VIII hereof in an expeditious fashion.
Section 5.2 The MetroWest Beds. Purchaser shall act in good faith and use its best efforts to secure all regulatory approvals necessary for the relocation of the MetroWest Beds to the Purchaser’s hospital in Birmingham, Alabama as soon as possible. Notwithstanding the foregoing, Purchaser shall file its application with SHPDA for the relocation of the MetroWest beds no later than August 15, 2005. Without the consent of the Sellers, Purchaser shall not attempt to delay or postpone any hearing relating to the MetroWest Beds.
Section 5.3 Certificate of Need. Purchaser shall use its good faith best efforts to successfully obtain the CON as soon as possible. Notwithstanding the foregoing, Purchaser shall file its application with SHPDA for the CON no later than August 31, 2005. Without the consent of the Sellers, Purchaser shall not attempt to delay or postpone any hearing relating to the CON.
Section 5.4 Cooperation with purchaser of Digital Hospital. Purchaser agrees not to oppose or challenge, directly or indirectly, (i) any application filed with SHPDA for a change of ownership and/or operation of the Digital Hospital by a prospective purchaser of the Digital Hospital or either of the Sellers, provided that such operation is consistent in all material respects with the existing CON for the Digital Hospital, or (ii) Sellers’ efforts to obtain from the Alabama State Health Planning and Development Agency a declaratory ruling which preserves and confirms the beds which can be replaced and the services which may legally be provided by the Digital Hospital as those beds and services provided by the Hospital as of the date of the issuance of the Digital Hospital’s Certificate of Need.
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ARTICLE VI
ADDITIONAL COVENANTS AND AGREEMENTS
Section 6.1 Public Announcements. Purchaser and Sellers shall collectively make or issue any announcement or written statement concerning this Agreement and the transactions contemplated hereby for dissemination to the general public upon execution of this Agreement.
Section 6.2 Further Assurances. If at any time any party hereto shall reasonably request any further action by any other party to carry out the purposes of this Agreement or to further effectuate the transactions contemplated hereby, such other party, at the expense of the requesting party, shall promptly take such action (including the prompt execution and delivery of further instruments and documents).
Section 6.3 MetroWest Beds. In contemplation of the execution of this Agreement and subject to the terms herein, Sellers have transferred the MetroWest Beds to Purchaser. In the event of the termination of this Agreement pursuant to Section 10.1 herein, Purchaser shall, at Purchaser’s sole option, (i) pay to Sellers ONE HUNDRED THOUSAND DOLLARS AND NO/100 ($100,000) as consideration for the transfer of the MetroWest Beds within five business days of such termination or (ii) transfer the MetroWest Beds back to Sellers within five business days of such termination.
Section 6.4 Outpatient Center. Prior to the Closing, Purchaser and HealthSouth shall negotiate in good faith for a temporary agreement for the continued operation by HealthSouth of the outpatient center located at the Hospital, provided that such temporary use by HealthSouth does not impair Purchaser’s use of the Hospital in any material respect.
Section 6.5 Pita Stop Property, Bernstein Condominium Unit, McCoy Condominium Unit. At or subsequent to Closing, in the event HealthSouth resolves or settles all outstanding disputes or litigation with respect to the Pita Stop Property, HealthSouth shall allow Purchaser, for a period of sixty (60) days from the date of such resolution or settlement, the option to acquire, via statutory warranty deed, the Pita Stop Property for $415,000. At or subsequent to Closing, in the event HealthSouth acquires title to Bernstein Condominium Unit, HealthSouth shall convey, and Purchaser shall acquire, via statutory warranty deed, the Bernstein Condominium Unit for $195,000 during a sixty day period subsequent to such acquisition. At or subsequent to Closing, in the event HealthSouth acquires title to McCoy Condominium Unit, HealthSouth shall convey, and Purchaser shall acquire, via statutory warranty deed, the McCoy Condominium Unit for $235,000 during a sixty day period subsequent to such acquisition.
Section 6.6 Gamma Knife Partnership. Sellers shall convey Sellers’ interest in the Gamma Knife Partnership to Purchaser as of January 1, 2007 for no additional consideration; provided, however, HMC shall be entitled to its prorata share of any distributions accruing for the period through December 31, 2006. Subsequent to Closing through December 31, 2006, Purchaser agrees to lease space to the Gamma Knife Partnership upon the current terms and conditions of that certain Gamma Knife Agreement, dated as of October 31, 1995, by and between HMC and the Gamma Knife Partnership, and to assume HMC’s obligations as lessor under such agreement.
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ARTICLE VII
CONDITIONS TO THE OBLIGATIONS OF PURCHASER
All obligations of Purchaser under this Agreement are subject to the fulfillment or satisfaction, prior to or at the Closing, of each of the following conditions precedent:
Section 7.1 Representations and Warranties True. The representations and warranties of Sellers contained in this Agreement shall be materially true and accurate as of the Closing. Notwithstanding the foregoing, Sellers shall be permitted, immediately prior to Closing, to update the schedules to this Agreement; provider, however, any material modifications to such schedules shall require the approval of Purchaser as a condition to Closing by Purchaser. Notwithstanding anything in this Section 7.1 to the contrary, in the event, that such material updates have a collective value or impact of $500,000 or less, Sellers shall, up to an amount mutually agreed by Sellers and Purchasers in writing (with a collective maximum of $500,000), at Sellers’ option, either (a) execute an indemnification agreement; (b) make the necessary repairs or remediation or (c) accept a reduction in the Purchase Price in the amount of such liability or defect.
Section 7.2 Compliance with this Agreement. Sellers shall have materially performed and complied with all agreements and conditions required by this Agreement to be performed or complied with by it prior to or at the Closing.
Section 7.3 Documents to be Delivered. At or prior to Closing, Purchaser shall have received from Sellers:
(i) a certificate of each Seller, dated as of the Closing, certifying in such detail as Purchaser may reasonably request that the conditions specified in Sections 7.1 and 7.2 hereof have been fulfilled;
(ii) a bill of sale for the Assets, properly executed for transfer to Purchaser, with all required documentation relating thereto;
(iii) the Deed, properly executed for transfer to Purchaser, and the Title Insurance; and
(iv) certificates of the Secretary of State of the State of Alabama and the Department of Revenue of the State of Alabama as to the existence and good standing, respectively, of HMC as of a date reasonably acceptable to Purchaser.
Section 7.4 No Injunctions. There shall be no effective injunction, writ, preliminary restraining order or any order of any nature issued by a court of competent jurisdiction prohibiting or imposing any condition on the consummation of any of the transactions contemplated hereby.
Section 7.5 The MetroWest Beds. Purchaser shall have obtained all regulatory approval for the relocation of the MetroWest Beds to the Purchaser’s campus.
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Section 7.6 Certificate of Need. Purchaser shall have received final agency action from SHPDA approving the CON, and no appeal of such final agency action shall be properly and timely pending.
Section 7.7 Real Estate Investment Trust. Sellers shall have obtained title in fee simple, free and clear of any encumbrances, except for any subleases, to any of the Assets described in Exhibit A which is or has been held by Healthcare Realty Trust. At the Closing, Purchaser shall assume all obligations with respect to any leases or subleases with respect to any such property.
Section 7.8 Absence of Certain Developments. Between the date hereof and the Closing, (i) there has been no action of eminent domain with respect to the Real Property; and (ii) except as contemplated in Section 5.3 herein, there have been no governmental (federal, state or local) restrictions to prevent the Hospital from operating as an acute care hospital.
Section 7.9 Due Diligence. Purchaser, in its continued due diligence pursuant to Section 3.5, shall not have discovered any unsatisfactory item or items with respect to the Continued Due Diligence Matters which would result in any environmental liability to Purchaser, unknown to Purchaser as of the date of this Agreement, or structural defect at the Hospital for which Sellers are not willing to either, at Sellers’ option, to (a) execute an indemnification agreement; (b) make the necessary repairs or remediation or (c) accept a reduction in the Purchase Price in the amount of such liability; provided, however, in the event, that such additional due diligence item (as permitted by this Section 7.9 hereof) has a value or adverse impact of $500,000 or less, Sellers shall, up to an amount mutually agreed by Sellers and Purchasers in writing (with a collective maximum of $500,000), at Sellers’ option, either (a) execute an indemnification agreement; (b) make the necessary repairs or remediation or (c) accept a reduction in the Purchase Price in the amount of such liability or defect.
ARTICLE VIII
CONDITIONS TO THE OBLIGATIONS OF SELLERS
All obligations of Sellers under this Agreement are subject to the fulfillment or satisfaction, prior to or at the Closing, of each of the following conditions precedent:
Section 8.1 Representations and Warranties True. The representations and warranties of Purchaser contained in this Agreement shall be materially true and accurate in all respects as of the Closing. Notwithstanding the foregoing, Purchaser shall be permitted, immediately prior to Closing, to update the schedules to this Agreement; provider, however, any material modifications to such schedules shall require the approval of Sellers as a condition to Closing by Sellers.
Section 8.2 Compliance with this Agreement. Purchaser shall have materially performed and complied with all agreements and conditions required by this Agreement to be performed or complied with by it prior to or at the Closing.
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Section 8.3 Payment of Purchase Price. At Closing, Purchaser shall deliver to Sellers the Purchase Price by wire transfer to an account designated by Sellers.
Section 8.4 Documents to be Delivered. At or prior to Closing, Sellers shall have received from Purchaser (i) a certificate of Purchaser, dated as of the date of Closing, certifying in such detail as Sellers may reasonably request that the conditions specified in Sections 8.1 and 8.2 hereof have been fulfilled and (ii) certificates of the Secretary of State of the State of Alabama and the Department of Revenue of the State of Alabama as to the existence and good standing, respectively, of the Purchaser as of a date reasonably acceptable to Sellers.
Section 8.5 No Injunction. There shall be no effective injunction, writ, preliminary restraining order or any order of any nature issued by a court of competent jurisdiction prohibiting or imposing any condition on the consummation of any of the transactions contemplated hereby.
Section 8.6 Digital Hospital. The CON Review Board shall have issued a declaratory ruling which preserves and confirms the beds which can be replaced and the services which may legally be provided by the Digital Hospital are those beds and services provided by the Hospital as of the date of the issuance of the Digital Hospital’s Certificate of Need, that Sellers may shut down the Digital Hospital and that Sellers may convey the Hospital without jeopardizing the certificate of need for the Digital Hospital. Notwithstanding the foregoing, this condition to Closing shall no longer be in effect subsequent to December 31, 2005.
ARTICLE IX
SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNI FICATION
Section 9.1 Survival of Representations and Warranties. All representations and warranties made by the parties hereto in this Agreement or in any certificate, schedule, statement, document or instrument furnished hereunder or in connection with the negotiation, execution and performance of this Agreement shall survive for a period of one (1) year after the Closing.
Section 9.2 Indemnification by the Sellers. Subject to and to the extent provided in this Article IX, Sellers hereby covenant and agree to protect, defend and indemnify Purchaser, and to hold it harmless, against and with respect to any and all loss, liability, damage and expense (including, without limitation, all actions, suits, proceedings, claims, demands, assessments, judgments, costs, fines, expenses, injunctions and penalties, and any and all legal and accounting fees incident to any of the foregoing) (“Losses”) suffered or incurred as a result of (i) the breach by Sellers of any covenant, term, condition or agreement contained in this Agreement or any certificate or document delivered by Sellers pursuant to this Agreement, (ii) any inaccuracy in a representation or warranty by Sellers set forth herein, (iii) any claims, demands, liabilities and causes of action in connection with any act, event, condition or occurrence relating in any way to the Assets and/or the Sellers prior to the Closing, not specifically assumed by Purchaser in Section 1.3 of this Agreement, (iii) any obligation for pension or retirement payments, calculators, liabilities, demands or the like with respect to any individual who worked (or is currently working) at or for the Assets with respect to the period
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when such individual was employed by either of the Sellers, or (iv). any obligation for employee benefits accrued as of the Closing Date (including assumed vacation, sick or ETO balances), with respect to any individual who worked (or is currently working) at or for the Assets with respect to the period when such individual was employed by either of the Sellers,
Section 9.3 Indemnification by Purchaser. Subject to and to the extent provided in this Article IX, Purchaser hereby covenants and agrees to protect, defend and indemnify each of the Sellers and to hold them harmless, against and with respect to any and all Losses suffered or incurred as a result of (i) the breach by Purchaser of any covenant, term, condition or agreement contained in this Agreement, (ii) any inaccuracy in a representation or warranty of Purchaser set forth herein, (iii) for the period subsequent to the Closing, any claims, demands, liabilities and causes of action in connection with any act, event, condition or occurrence relating in any way to the Assets and/or the Purchaser after the Closing, except for any liabilities retained by Sellers under this Agreement and (iv) any obligation subsequent to Closing with respect to those contracts or liabilities assumed by Purchaser pursuant to Section 1.3 of this Agreement. The parties hereto acknowledge and agree that Sellers are expressly retaining liability for any and all pension obligations for the period prior to Closing with respect to any current or former employees at the Hospital.
Section 9.4 Notice of Claims.
(a) Promptly after receipt by an indemnified party of written notice of the commencement of any investigation, claim, proceeding or other action in respect of which indemnity may be sought from the indemnitor under either Section 9.2 or 9.3 (each, an “Action”), such indemnified party shall notify the indemnitor in writing of the commencement of such Action; but the omission to so notify the indemnitor shall not relieve it from any liability that it may otherwise have to such indemnified party, except to the extent that the indemnitor is materially prejudiced or forfeits substantive rights or defenses as a result of such failure. In connection with any Action in which the indemnitor and any indemnified party are parties, the indemnitor shall be entitled to participate therein, and may assume the defense thereof. Notwithstanding the assumption of the defense of any such Action by the indemnitor, each indemnified party shall have the right to employ separate counsel and to participate in the defense of such Action, and the indemnitor shall bear the fees, costs and expenses of such separate counsel to such indemnified party if: (i) the indemnitor shall have agreed to the retention of such separate counsel, (ii) the defendants in, or target of, any such Action include more than one indemnified party or both an indemnified party and the indemnitor shall have concluded that representation of such indemnified party by the same counsel would be inappropriate due to actual or, as reasonably determined by such indemnified party’s counsel, potential differing interests between them in the conduct of the defense of such Action, or if there may be legal defenses available to such indemnified party that are different from or additional to those available to the other indemnified party or to the indemnitor, or (iii) the indemnitor shall have failed to employ counsel reasonably satisfactory to such indemnified party within a reasonable period of time after notice of the institution of such Action. If such indemnified party retains separate counsel in cases other than as described in clauses (i), (ii), or (iii) above, such counsel shall be retained at the expenses of such indemnified party. Except as provided above, it is hereby agreed and understood that the indemnitor shall not, in connection with any Action in the same jurisdiction, be liable for the fees and expenses of more than one
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counsel for all such indemnified parties (together with appropriate local counsel). The party from whom indemnification is sought shall not, without the written consent of the party seeking indemnification (which consent shall not be unreasonably withheld), settle or compromise any claim or consent to entry of any judgment that does not include an unconditional release of the party seeking indemnification from all liabilities with respect to such claim.
(b) In the event one party hereunder should have a claim for indemnification that does not involve a claim or demand being asserted by a third party, the party seeking indemnification shall promptly send notice of such claim to the party from whom indemnification is sought.
Section 9.5 Deductible Amount. Notwithstanding any other provision of this Agreement, Sellers shall have no liability under Article 9 until the total of all Losses with respect to such matters exceeds $75,000 (the “Deductible Amount”), at which time Sellers shall be responsible for aggregate Losses in excess of the Deductible Amount. Notwithstanding any other provision of this Agreement, Purchaser shall have no liability under Article 9 until the total of all Losses with respect to such matters exceed the Deductible Amount, at which time Purchaser shall be responsible for aggregate Losses in excess of the Deductible Amount.
Section 9.6 Limitation. Notwithstanding any other provision of this Agreement, the maximum aggregate liability of Sellers collectively under Article 9 shall be 50% of the Purchase Price. Notwithstanding any other provision of this Agreement, the maximum aggregate liability of Purchaser under Article 9 shall be 50% of the Purchase Price.
ARTICLE X
TERMINATION
Section 10.1 Termination Events. This Agreement may, by notice given prior to or at the Closing, be terminated:
(a) by either Purchaser or Sellers if a Breach of any provision of this Agreement has been committed by the other party and such Breach has not been waived;
(b) (i) by Purchaser if any of the conditions in Article VII has not been satisfied as of the Closing or if satisfaction of such a condition is or becomes impossible (other than through the failure of Purchaser to comply with its obligations under this Agreement) and Purchaser has not waived such condition on or before the Closing; or (ii) by Sellers, if any of the conditions in Article VIII has not been satisfied of the Closing or if satisfaction of such a condition is or becomes impossible (other than through the failure of Sellers to comply with their obligations under this Agreement) and Sellers have not waived such condition on or before the Closing;
(c) by mutual consent of Purchaser and Sellers;
(d) by Purchaser (i) after December 31, 2005 if the CON has not been issued by December 31, 2005 or (ii) after January 15, 2006 if the Closing has not occurred on or before
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January 15, 2006; provided that Purchaser shall have used its best efforts to assist in the completion of the transactions contemplated by this Agreement;
(e) by Sellers on or subsequent to June 1, 2006, provided that Sellers shall have used their best efforts to assist in the completion of the transaction contemplated by this Agreement and Sellers shall have given Purchaser ten days prior written notice (which notice may be provided prior to June 1, 2006) of its intent to terminate and allowed Purchaser to consummate the transactions contemplated by this Agreement in accordance with Section 1.4(b)(iii);or
(f) by either Purchaser or Sellers if the CON is contested by any third party resulting in an administrative hearing or litigation (a “Contest”), and after good faith negotiation Purchaser and Sellers cannot reach agreement as to the allocation of the expenses to be incurred in further efforts to obtain the CON as a direct result of such Contest. Notwithstanding the foregoing, this Agreement may not be terminated pursuant to this Section 10.1(f) if either Purchaser or Sellers elects to bear the entire cost of such Contest.
Section 10.2 Effect of Termination. Each party’s right of termination under Section 10.1 is in addition to any other rights it may have under this Agreement or otherwise, and the exercise of a right of termination will not be an election of remedies. If this Agreement is terminated pursuant to Section 10.1, all further obligations of the parties under this Agreement will terminate, except that the obligations in Sections 11.2, 11.6 and 6.1 will survive; provided however, that if this Agreement is terminated by a party because of a Breach of the Agreement by the other party or because one or more of the conditions to the terminating party’s obligations under this Agreement is not satisfied as a result of the other party’s failure to comply with its obligations under this Agreement, the terminating party’s right to pursue all legal remedies will survive such termination unimpaired.
ARTICLE XI
MISCELLANEOUS PROVISIONS
Section 11.1 Amendment. This Agreement may be amended only by a written agreement signed by the parties.
Section 11.2 Expenses. Each Party to this Agreement will bear its respective expenses incurred in connection with the preparation, execution and performance of this Agreement and the Closing, including all fees and expenses of agents, representations, counsel and accountants. Notwithstanding the foregoing, in the case of a Contest, Purchaser and Seller may agree to allocate the expenses incurred as a direct result of such Contest, and either Purchaser or Seller may elect to bear all of the expenses of such Contest.
Section 11.3 Waiver of Compliance. Any waiver of any failure to comply with any obligation, covenant, agreement or condition under this Agreement must be in writing and signed by the parties. Any waiver or failure to insist upon strict compliance with any obligation, covenant, agreement or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure.
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Section 11.4 Notices. All notices, requests, demands and other communications required or permitted hereunder shall be provided in writing and shall be deemed to have been duly given if delivered by hand or sent by facsimile or certified or registered mail, with postage prepaid:
HealthSouth Corporation HealthSouth Medical Center, Inc. One HealthSouth Parkway Birmingham, Alabama 35243 Phone: (205) 967-7116 Fax: (205) 969-4620 Attn: Jay Grinney, Chief Executive Officer
with a copy to:
HealthSouth Corporation HealthSouth Medical Center, Inc. One HealthSouth Parkway Birmingham, Alabama 35243 Phone: (205) 967-7116 Fax: (205) 970-5913 Attn: Greg Doody, Esq.
with a copy to:
Colin H. Luke, Esq. Balch & Bingham LLP 1901 Sixth Avenue North, Suite 2600 Birmingham, Alabama 35203 Telephone: 205-226-8729 Telecopy: 205-226-8799
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(i) If to Sellers, to:
THE BOARD OF TRUSTEES OF THE UNIVERSITY OF ALABAMA 500 22nd Street South, Suite 408 Birmingham, AL 35233 Telephone: (205) 975-5412 Telecopy: (205) 975-9175 Attn: Steve Pickett, Executive Vice President
with a copy to:
UAB Health System 500 22nd Street South, Suite 408 Birmingham, AL 35233 Telephone: (205) 975-4844 Telecopy: (205) 975-0129 Attn: Kathleen Kauffman
with a copy to:
J. Hobson Presley, Jr. Presley LLC 2801 Highway 280 South Suite 700 Birmingham, AL 35223-2483 Telephone: (205) 423-3601 Telecopy: (205) 423-3610
or to such other person or address as a party shall notify all other parties in writing.
Section 11.5 Assignment. Neither this Agreement nor any of the rights, interests or obligations hereunder may be assigned by any of the parties hereto without the prior written consent of the other parties. This Agreement and all of the provisions hereof shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. Notwithstanding the foregoing, Purchaser may assign its rights and obligations under this Agreement to UAB Health System, an Alabama nonprofit corporation, or an Affiliate of Purchaser.
Section 11.6 Dispute Resolution.
(a) Any dispute, controversy or claim arising out of or in relation to or in connection with: (a) this Agreement, including without limitation any dispute as to the construction, validity, interpretation, enforceability or breach of this Agreement; (b) the operations carried out under this Agreement; or (c) any deadlock between the parties to this Agreement (a “Dispute”) shall be settled by binding arbitration in Birmingham, Alabama, in accordance with the Commercial Arbitration Rules of the American Arbitration Association
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(ii) If to Purchaser, to:
(“AAA”). The arbitrator shall be selected by agreement of the parties from the National Roster in accordance with the AAA rule regarding the selection of arbitrators or, if they cannot agree on an arbitrator within ten days after submission of the Dispute to arbitration, then an arbitrator without any relationship to the parties shall be selected by AAA from the National Roster.
(b) The determination reached in such arbitration shall be final and binding on all parties hereto without any right of appeal except as provided by the Federal Arbitration Act. The arbitrator shall not have the authority to award punitive, exemplary, indirect or consequential damages. Each party shall be responsible for its own attorney’s fees and the costs of arbitration shall be equally borne.
(c) Any court of competent jurisdiction may enforce any determination or award of the arbitrator. The parties also agree that, in the event that the need for emergency measures of protection (including preliminary injunction or temporary restraint proceedings) arises, the AAA Optional Rules for Emergency Measures of Protection shall apply to the proceedings.
(d) The parties acknowledge and agree that this Agreement and the transactions contemplated hereby evidence transactions that involve a substantial nexus with interstate commerce. THE PARTIES HEREBY EXPRESSLY WAIVE ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION OR CAUSE OF ACTION ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE BREACH THEREOF, PROVIDED THAT NOTHING IN THIS AGREEMENT SHALL PRECLUDE A PARTY FROM SEEKING TO COMPEL ARBITRATION IN A STATE OR FEDERAL COURT OF COMPETENT JURISDICTION.
Section 11.7 Counterparts; Facsimile. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement may be executed by telefacsimile.
Section 11.8 Headings. The headings of the Articles and Sections of this Agreement are inserted for convenience only and shall not constitute a part hereof or affect in any way the meaning or interpretation of this Agreement.
Section 11.9 Entire Agreement. This Agreement, including the Schedules hereto, and the Management Agreement, as well as the other documents and certificates delivered pursuant hereto set forth the entire agreement and understanding of the parties hereto with respect to the subject matter hereof, and supersede all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any manager, partner, member, employee or representative of any party hereto.
Section 11.10 Third Parties. Except as specifically set forth or referred to herein, nothing expressed or implied herein is intended or shall be construed to confer upon or give to any person or entity other than the parties hereto, and their successors or permitted assigns, any rights or remedies under or by reason of this Agreement.
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Section 11.11 Performance Following Closing. Nothing in this Agreement shall be construed to limit any covenant or agreement of the parties hereto which by its terms contemplates performance after the Closing.
Section 11.12 Governing Law. This Agreement and the legal relations among the parties hereto shall be governed by and construed in accordance with the laws of the State of Alabama without regard to conflict of interest doctrine.
ARTICLE XII
DEFINITIONS
For the purposes of this Agreement, the following terms have the meanings specified or referred to in this Article XII:
“Action” has the meaning set forth in Section 9.4.
“Affiliate” of a Person means any other Person that directly or indirectly controls, is controlled by or is under common control with the Person.
“Agreement” has the meaning provided in the first sentence of this document.
“Assets” has the meaning set forth in Section 1.1.
“Assumed Liabilities” has the meaning set forth in Section 1.3.
“Beds” has the meaning of those certain 199 acute care beds located at Metro-West.
“Berstein Condominium” means that certain condominium unit located at 1422 14th Avenue South as further described on Exhibit C hereto.
“Breach” – a “Breach” of a representation, warranty, covenant, obligation, or other provision of this Agreement or any instrument delivered pursuant to this Agreement will be deemed to have occurred if there is or has been (a) any inaccuracy in or breach of, or any failure to perform or comply with, such representation, warranty, covenant, obligation, or other provision, or (b) any claim (by any Person) or other occurrence or circumstance that is or was inconsistent with such representation, warranty, covenant, obligation, or other provision, and the term “Breach” means any such inaccuracy, breach, failure, claim, occurrence or circumstance.
“Closing” has the meaning set forth in Section 1.6.
“Closing Date” has the meaning provided in Section 1.7.
“CON” has the meaning set forth in Section 4.3.
“Contest” has the meaning set forth in Section 10.1(f).
“Deductible Amount” shall have the meaning set forth in Section 9.5.
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“Deed” means the statutory warranty deed in form of Exhibit D hereto.
“Digital Hospital” has the meaning set forth in Section 1.2.
“DPH License” has the meaning set forth in Section 2.19.
“Encumbrance” – any charge, claim, community property interest, condition, equitable interest, lien, option, pledge, security interest, right of first refusal, or restriction of any kind, including any restriction on use, voting transfer, receipt of income, or exercise of any other attribute of ownership.
“ERISA” – the Employee Retirement Income Security Act of 1974 or any successor law, and regulations and rules issued pursuant to that Act or any successor law.
“Gamma Knife Partnership” means HEALTHSOUTH/UAB Gamma Knife L.L.C.
“HealthSouth” means HealthSouth Corporation, a Delaware corporation.
“Hospital” means HMC’s acute care hospital located at 1201 11 th Avenue South in Birmingham, Alabama.
“HMC” means HealthSouth Medical Center, Inc., an Alabama corporation.
“Knowledge”, with respect to any particular fact or other matter, means:
(a) an individual is actually aware of such fact or other matter; or
(b) an individual is or was in the possession of written information confirming such fact or other matter.
Knowledge of Sellers will include only to the actual knowledge of any individual who is serving as a manager, partner, director, officer, member, employee, executor, or trustee of either such Seller.
“Losses” shall have the meaning provided in Section 9.2.
“McCoy Condominium” means that certain condominium unit located at 1422 14th Avenue South as further described on Exhibit C hereto.
“Management Agreement” shall mean that certain Management Agreement between an Affiliate of Purchaser and HMC, dated simultaneously herewith.
“Material Adverse Effect” means any change in, or effect on, the Hospital as currently operated by Sellers that is or is reasonably likely to be materially adverse to the Hospital taken as a whole or the results of operations or financial condition of the Hospital taken as a whole, except for any such changes or effects resulting from (i) changes in general economic, regulatory or political conditions or changes that affect the industry in general and (ii) this Agreement or the transactions contemplated hereby or the announcement hereof.
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“MetroWest Beds” shall mean the 199 beds transferred to Purchaser and formerly located at the HealthSouth Metro-West Hospital in Fairfield, Alabama.
“Party” shall mean each of the Sellers and Purchaser individually, collectively the “Parties.”
“Permitted Encumbrances” means (i) liens for taxes and assessments not yet due and payable and (ii) encumbrances created by Purchaser.
“Person” means any individual, corporation or partnership, limited liability company, limited partnership, association or other entity of any kind.
“Pita Stop Property” means that property described on Exhibit B hereto.
“Provider Numbers” has the meaning set forth in Section 2.17.
“Purchase Price” has the meaning set forth in Section 1.4.
“Purchaser” means The Board of Trustees of The University of Alabama.
“Real Property” means that certain real property on which the Hospital is located as more particularly described on Exhibit A hereto.
“Sellers” means HealthSouth and HMC collectively.
“SHPDA” means the Alabama State Health Planning and Development Agency.
“Title Policy” shall mean the title policy issued in favor of Purchaser by Alabama Title Co., Inc. with respect to the Real Property in the form of Exhibit E.
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IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the date first set forth above.
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PURCHASER:
ATTEST THE BOARD OF TRUSTEES OF THE UNIVERSITY OF ALABAMA
/s/ Katrina Belt /s/ Steve Pickett By: Steve Pickett Its: UAB Health System, Executive Vice President
SELLERS:
ATTEST HealthSouth Medical Center, Inc. an Alabama corporation
/s/ Audra Szush /s/ Mike Snow By: Mike Snow Its: Vice President
HEALTHSOUTH Corporation ATTEST a Delaware corporation
/s/ Audra Szush /s/ Mike Snow By: Mike Snow Its: EVP & COO
Exhibit 10.37.2
EXECUTION COPY
AMENDED AND RESTATED
ASSET PURCHASE AGREEMENT
AMONG
HEALTHSOUTH CORPORATION,
HEALTHSOUTH MEDICAL CENTER, INC.
AND
THE BOARD OF TRUSTEES OF THE UNIVERSITY OF ALABAMA
ARTICLE VII CONDITIONS TO THE OBLIGATIONS OF PURCHASER 11
Section 7.1 Representations and Warranties True 11 Section 7.2 Compliance with this Agreement 12 Section 7.3 Documents to be Delivered 12 Section 7.4 No Injunctions 12 Section 7.5 Change of Ownership Approval from SHPDA, License and CHOW Application 12 Section 7.6 Real Estate Investment Trust 12 Section 7.7 Absence of Certain Developments 12
ARTICLE VIII CONDITIONS TO THE OBLIGATIONS OF SELLERS 13
Section 8.1 Representations and Warranties True 13 Section 8.2 Compliance with this Agreement 13 Section 8.3 Payment of Purchase Price 13 Section 8.4 Documents to be Delivered 13
iii
Section 8.5 No Injunction 13
ARTICLE IX SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNIFICATION 13
Section 9.1 Survival of Representations and Warranties 13 Section 9.2 Indemnification by the Sellers 13 Section 9.3 Indemnification by Purchaser 14 Section 9.4 Notice of Claims 15 Section 9.5 Deductible Amount 16 Section 9.6 Limitation 16
Schedule 2.5 Exceptions to the Title to the Assets
Schedule 2.8 Leases
Schedule 2.9 Contractual and Other Obligations
Schedule 2.10 Employment Matters
Schedule 2.11 Intellectual Property
Schedule 2.12 Insurance
Schedule 2.13 Environmental Matters
Schedule 2.14 Litigation and Regulatory Investigations
Schedule 2.15 Required Consents or Approvals
Schedule 2.17 Provider Numbers
Schedule 2.18 Delinquent Taxes
Schedule 2.18(a) Contested Taxes
Schedule 2.21 Sufficiency of the Assets
EXHIBITS
Exhibit A Real Property Description Exhibit B Description of Pita Stop Property Exhibit C Description of Bernstein Condominium and McCoy Condominium Exhibit D Form of Deed Exhibit E Form of Title Policy
AMENDED AND RESTATED ASSET PURCHASE AGREEMENT
THIS AMENDED AND RESTATED ASSET PURCHASE AGREEMENT (this “Agreement”) is made and entered into as of December 31, 2005, by and among HealthSouth Corporation, a Delaware corporation (“HealthSouth”), HealthSouth Medical Center, Inc., an Alabama corporation (“HMC”) (HealthSouth and HMC, collectively, “Sellers”; each a “Seller”) and The Board of Trustees of The University of Alabama (“Purchaser”).
W I T N E S S E T H:
WHEREAS, the parties hereto have previously executed an Asset Purchase Agreement, dated as of July 20, 2005 (the “Existing Agreement”) concerning the subject matter hereof, and wish to amend and restate the Existing Agreement in its entirety; and
WHEREAS, in the Existing Agreement, Sellers were to retain the certificate of need, 219-bed license and existing services at HealthSouth Medical Center (the “Hospital”) for use in connection with a sale of Seller’s Digital Hospital. Pursuant to this Agreement, Sellers will sell the Hospital and all related operating rights (including Sellers’ interest in the certificate of need, 219-bed license and existing services for the Hospital). The parties have agreed that, upon consummation of the sale provided for in this Agreement, such related rights will no longer be retained by Seller for use in connection with the Digital Hospital or otherwise.
NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree to amend and restate the Existing Agreement in its entirety as follows:
ARTICLE I
Section 1.1 Assets Purchased at the Closing. On the basis of the representations and warranties and subject to the terms and conditions set forth in this Agreement, at the Closing, Purchaser agrees to purchase from Sellers, and Sellers, for themselves and their Affiliates, agree to sell, assign, bargain, convey and deliver to Purchaser, the following assets of Sellers (collectively, the “Assets”), free from any liens, claims and encumbrances, except those listed on Schedule 1.3 hereto:
(a) the medical center and Real Property currently known as “HealthSouth Medical Center” located at 1201 11th Avenue South, Birmingham, Alabama as more particularly described on Exhibit A hereto, excluding the following properties: the Pita Stop Property, as described on Exhibit B hereto, the Bernstein Condominium and the McCoy Condominium, as described on Exhibit C hereto;
(b) all of Sellers’ rights under those contracts listed on Schedule 1.1(b) hereto (as well as any contracts specifically related to the Hospital and mutually approved in writing by Sellers and Purchasers);
(c) all operating assets, as materially listed on Schedule 1.1(c) hereto, including, without limitation, the real property, intellectual property, personal property, furniture, fixtures,
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equipment, improvements, vehicles, patient records, financial records, personnel files, inventory and supplies; and
(d) all of Sellers’ interests in the rights to operate the Hospital as a 219-acute care licensed hospital with all health services permitted to be provided therein as of the date of this Agreement, including without limitation the rights granted to Sellers under all applicable licenses (including the DPH license), permits, franchises, certificates of need and any other right possessed or held by Sellers relating to the ownership and operation of the Hospital (if any of such licenses, permits, franchises, certificates of need or other authorizations (each an “Authorization”) shall not be transferable, then Seller shall relinquish those items in favor of Purchaser and cooperate in all reasonable ways to facilitate the issuance of such Authorizations in favor of Purchaser).
Section 1.2 Excluded Assets. Purchaser and Sellers acknowledge and agree that Purchaser is not acquiring any cash, accounts receivable, working capital, the operating business unit comprising the outpatient center (apart from the real property on which such business is located and which is part of the Assets) located on the campus of the Hospital or the real property or improvements thereon associated with the hospital being constructed by Sellers on U.S. Highway 280 in Jefferson County (the “Digital Hospital”). Although Sellers’ interest in the Gamma Knife Partnership is not included in the Assets, Sellers shall convey such interest to Purchaser as of December 31, 2006 pursuant to Section 6.6 of this Agreement.
Section 1.3 Assumed Liabilities, Contracts and Leases.
(a) As of the Closing, Purchaser agrees to assume the liabilities listed on Schedule 1.3 hereto (with those obligations in Section 1.3(c) hereof, the “Assumed Liabilities”), including all leases and subleases to which any of the Assets are subject. Purchaser does not assume any liabilities not specifically set forth on Schedule 1.3. Sellers agree to provide Purchaser with all books and records relating to the Assumed Liabilities.
(b) Purchaser assumes and agrees to pay or perform, as the case may be, all obligations for the time period after the Closing with respect to those contracts, purchase orders, agreements and leases which are set forth on Schedule 1.3 hereto.
Section 1.4 Purchase Price.
(a) Unless adjusted pursuant to Section 1.4(b), the purchase price (the “Purchase Price”) for the Assets shall be THIRTY THREE MILLION DOLLARS ($33,000,000) plus the amount of any negative EBITDAM (as defined in the Management Agreement) for the period from January 1, 2006 through the Closing Date. The $33,000,000 portion, less any deductions provided hereunder, of the Purchase Price shall be paid via bank wire transfer at the Closing by Purchaser, and the amount of EBITDAM shall be determined by Sellers and paid by Purchaser as soon as possible after Closing; provided, however, Purchaser shall be given the opportunity to review and confirm Sellers’ calculation of negative EDITDAM.
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(b) The Purchase Price shall be subject to adjustment as follows:
(i) To the extent that any of the following real properties are not conveyed at the Closing in accordance with Section 6.5 hereof, the Purchase Price shall be reduced by the amount reflected for such non-conveyed real property as shown below:
(ii) The Purchase Price shall be increased by the cost of any capital improvements to the Assets made by Sellers after the date of delivery of this Agreement if Purchaser agrees in writing to such addition to the Purchase Price.
Section 1.5 Allocation of Purchase Price. The Purchase Price for the Assets being conveyed herein shall be allocated by Purchaser and Sellers among the Assets being sold by Sellers to Purchaser hereunder in accordance with the allocation contained on Schedule 1.5 hereto and such allocation shall be used by all parties hereto for all applicable tax and financial purposes.
Section 1.6 The Closing. The closing of the transactions contemplated by Section 1.1 (the “Closing”) shall occur on February 6, 2006 so long as the conditions to Closing outlined in Article VII and Article VIII hereof have been satisfied or waived. If the conditions to Closing outlined in Article VII and Article VIII hereof have been not been satisfied or waived on or before February 6, 2006, the Closing shall occur as soon as such conditions to Closing have been satisfied or waived. The Closing of the transactions contemplated by this Agreement shall occur at the offices of Balch & Bingham LLP, 1901 Sixth Avenue North, Suite 2600, Birmingham, Alabama, or at such other location as Purchaser and Sellers may agree upon.
Section 1.7 Prorations. All taxes, rent, revenues, water charges, utilities, or any other similar items relating to the Assets shall be prorated by the parties as of 12:01 a.m. on the day closing occurs (the “Closing Date”) as if Purchaser were vested with title to the Assets during the entire day upon which the Closing occurs. For purposes of proration, municipal ad valorem taxes shall be assumed to have been paid in advance and all other ad valorem taxes shall be assumed to be paid in arrears. Any expense amount which cannot be ascertained with certainty as of the Closing Date shall be prorated on the basis of the parties’ reasonable estimates of such amount, and shall be the subject of a final proration sixty (60) days after the Closing Date, or as soon thereafter as the precise amounts can be ascertained. Purchaser shall promptly notify Sellers when it becomes aware that any such estimated amount has been ascertained. Once all rental and expense amounts have been ascertained, Purchaser shall prepare, and certify as correct, a final proration statement which shall be subject to Sellers’ approval. Upon Sellers’ acceptance and approval of any final proration statement submitted by Purchaser, such statement shall be conclusively deemed to be accurate and final. The parties shall prorate payments with respect to patient services provided by HMC prior to Closing and Purchaser subsequent to Closing for patients who are inpatients of the Hospital at the Closing to the extent payment for such services is received on a single DRG or similar basis.
Section 1.8 Costs. Except as otherwise expressly provided for in this Agreement, each party will bear its own expenses incurred in connection with the preparation, execution and performance of its obligations under this Agreement.
Section 1.9 Purchaser’s Costs. Purchaser shall pay (i) all transfer taxes relating to the transfer of the Real Property to Purchaser; (ii) the cost of any environmental report required by Purchaser; (iii) the cost of any recordation fees to put the deed of record with the appropriate governmental authority; (iv) recordation fees and transfer taxes; (v) the cost of its legal counsel, advisors and other professionals employed by Purchaser in connection with its purchase of the Assets from Sellers; and (vi) the cost of all items for which Purchaser is expressly obligated to pay under this Agreement.
Section 1.10 Sellers’ Costs. Sellers shall pay (i) the cost of the premium for the Title Policy; (ii) the cost of an ALTA survey of the Real Property in form and substance satisfactory to Purchaser; (iii) and other expenses related to the discharge of any lien or encumbrance on the Real Property; (iv) the costs of its legal counsel, advisors and other professionals employed by Sellers in connection with the sale of the Assets to Purchaser; and (v) the cost of all items for which Sellers are expressly obligated to pay under this Agreement.
ARTICLE II
REPRESENTATION AND WARRANTIES OF SELLERS
Sellers hereby represent and warrant to Purchaser, as of the date of execution of this Agreement, as follows:
Section 2.1 Financial Reporting. HealthSouth is restating its historical financial reports on a consolidated corporate group basis and on June 27, 2005 and December 2, 2005, filed with the United States Securities and Exchange Commission its Form 10-K Annual Reports for the years ended December 31, 2002, 2003 and 2004, which included restatements of previously issued consolidated financial statements for the years ended December 31, 2000 and 2001. Such restatements have not been completed for the individual subsidiaries which make up the HealthSouth consolidated group. HMC’s financial reports have not been restated and Sellers make no representation as to the validity or accuracy of any financial information regarding HMC.
Section 2.2 Reduced Business. Purchaser has been informed that the scope of the Hospital’s operations has materially changed since January 1, 2005, and, notwithstanding any other provision of this Agreement, Sellers make no representation that further changes will not occur prior to the Closing.
Section 2.3 Authority. Sellers and Sellers’ officers have full power and authority to execute, deliver and perform this Agreement and all agreements executed and delivered by Sellers pursuant to this Agreement, and have taken all action required by law or otherwise to authorize the execution, delivery and the performance of this Agreement and related documents. This Agreement and the transactions contemplated by this Agreement have been duly authorized by the Board of Directors of each of the Sellers. This Agreement constitutes a valid and legally
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binding obligation of Sellers, enforceable against Sellers in accordance with its terms. Sellers and each of the officers of Sellers have full power and authority, duly and validly authorized by its Board of Directors, and no further proceedings on the part of Sellers are necessary, to execute and deliver this Agreement and to consummate the transactions contemplated hereby. HMC’s sole shareholder has approved the transactions contemplated by this Agreement.
Section 2.4 Corporate Status. HMC is a corporation duly organized, validly existing and in good standing under the laws of the State of Alabama, and has all requisite power and authority to own, lease, and operate its properties and assets, and to carry on its business as is now being conducted. HealthSouth is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite power and authority to own, lease, and operate its properties and assets, and to carry on its business as is now being conducted.
Section 2.5 Title to Assets and Power to Convey. Except as set forth in Schedule 2.5, HMC is the sole owner of, and has good and marketable title to all of the Assets and has full right and capacity to sell and deliver the Assets contemplated by this Agreement. Upon the Closing, Purchaser shall have acquired from HMC, good and marketable, legal and equitable title to the Assets, free and clear of all pledges, liens, security interests, claims, charges, restrictions, options, or encumbrances of any nature whatsoever, except as specified on Schedule 2.5 hereto.
Section 2.6 No Conflicts. Neither the execution and delivery of this Agreement by Sellers nor the consummation of the transactions contemplated hereby will: (a) conflict with or violate any provision of the articles of incorporation or bylaws of either Seller; (b) violate, conflict with, constitute a default (or an event which, with or without notice, lapse of time or both, or the occurrence of any other event, would constitute a default) under, result in the termination of, accelerate the performance required by, cause the acceleration of the maturity of any debt or obligation pursuant to, or result in the creation or imposition of any security interest, lien or other encumbrance upon any property or assets of Sellers or Sellers’ interests under any agreement or commitment to which Sellers are a party or by which Sellers are bound or to which the property of Sellers is subject, except such violations, conflicts or defaults which would not have a Material Adverse Effect; or (c) violate any federal, state or local law or any judgment, decree, order, regulation or rule of any court or governmental authority.
Section 2.7 Real Property. Exhibit A hereto describes the Real Property. Except as set forth in Schedule 2.5 and except for Permitted Encumbrances, Sellers have title in fee simple in the Real Property, free and clear of any Encumbrance, except for the Pita Stop Property and the Bernstein Condominium and the McCoy Condominium.
Section 2.8 Leases. Schedule 2.8 contains an accurate and complete list of all leases and subleases pursuant to which Sellers lease real or personal property with respect to the Assets. Except as set forth in Schedule 2.8, all such leases are valid, binding and enforceable in accordance with their terms, except to the extent that such enforcement may be subject to bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to creditors’ rights and remedies generally, and are in full force and effect; there are no existing defaults by Sellers thereunder; no event of material default has occurred which (whether with or without
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notice, lapse of time or the happening or occurrence of any other event) would constitute a material default thereunder by any party thereto.
Section 2.9 Contractual and Other Obligations. Schedule 2.9 lists all of the material written or oral contracts, agreements, and commitments of Sellers which pertain to the Assets.
Section 2.10 Employment Matters. As relates to the Assets, Schedule 2.10 contains a list of all full and part-time employees of Sellers, their wages and other remuneration of every kind. Except as set forth in Schedule 2.10, the employment of each employee listed on Schedule 2.10 is terminable at will by Sellers, without restriction, penalty or payment of any kind.
Section 2.11 Trademarks, Service Marks, Trade Names, Copyrights and Data Processing Systems. All trademarks, service marks, trade names and copyrights (including trademarks, service marks, trade names and copyrights relating to computer software and hardware) used by Sellers at the Hospital are described and set forth in Schedule 2.11 .
Section 2.12 Insurance. A complete list of the insurance policies maintained by Sellers and a description of all areas of the Hospital that are self-insured by Sellers and self-insurance reports are set forth in Schedule 2.12 . To Sellers’ Knowledge, there are no notices of any pending or threatened termination or premium increases with respect to any of such policies.
Section 2.13 Environmental Matters. Except as set forth in Schedule 2.13, as relates to the Assets, to Sellers’ Knowledge:
(i) Sellers have obtained all permits, licenses and other authorizations which are required in connection with the conduct of the Hospital under regulations relating to pollution or protection of the environment, including regulations relating to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes into the environment (including without limitation ambient air, surface water, groundwater, or land), or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport, or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes (“Environmental Laws”);
(ii) Sellers have obtained and are in material compliance with the terms and conditions of all permits, licenses and other authorizations required under Environmental Laws;
(iii) Sellers have not received notice of any past or present events, conditions, circumstances, activities, practices, incidents, actions or plans that may interfere with or prevent continued compliance with the permits, licenses and other authorizations referred to above or Environmental Laws;
(iv) No asbestos or equipment containing polychlorinated biphenyls or leaking underground or above-ground storage tanks is contained in or located at any facility owned, leased or controlled by Sellers;
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(v) Sellers have fully disclosed all known past and present noncompliance with such Environmental Law, and all known past “releases” of a “reportable quantity” of any “hazardous substance”, or releases of oil, that could form the basis of any claim, action, suit, proceeding, hearing or investigation under any Environmental Law; and
(vi) Sellers have not received notice of any past or present events, conditions, circumstances, activities, practices, incidents, actions or plans that have resulted in or threaten to result in any common law or legal liability, or otherwise form the basis of any claim, action, suit, proceeding, hearing or investigation under any Environmental Law with respect to the Hospital.
Section 2.14 Litigation and Regulatory Investigations. Except as disclosed on Schedule 2.14 hereto, as it may relate to the Hospital, there are no pending litigation or regulatory proceedings by or against the Sellers or the Assets. To Sellers’ Knowledge, there is no pending or threatened action, proceeding, investigation, order, consent, decree or agreement with regulatory authorities with respect to the Assets, neither of the Sellers or any other person or entity, which questions the validity of this Agreement or could prevent or adversely affect any action taken or to be taken pursuant hereto or which would result in any revocation, suspension or limitation of any regulatory authority of the Assets or would have a Material Adverse Effect.
Section 2.15 Other Consents. Except as disclosed on Schedule 2.15 hereto, no consent, approval or authorization of, or notice to, any non-governmental (federal, state or local) person or entity, including, without limitation, parties to loans, contracts, leases or other agreements, is required in connection with the execution, delivery and performance of this Agreement by Sellers or the consummation by it of the transactions contemplated hereby.
Section 2.16 No Brokers. Sellers have not contracted for the services of any broker, salesperson, finder, agent, investment banker or any other person to whom a commission or fee will be due as a result of the transactions contemplated by this Agreement. Sellers hereby indemnify and hold Purchaser harmless from any claim by any other person or entity for a commission or fee arising out of Sellers’ actions and as a result of the transactions contemplated by this Agreement.
Section 2.17 Provider Numbers. Attached hereto as Schedule 2.17 is a list of all Medicaid and Medicare provider numbers (the “Provider Numbers”) in the name of the Hospital. The Provider Numbers are in full force and effect as of the date of this Agreement.
Section 2.18 Taxes. Except as provided on Schedule 2.18 hereto, HMC has filed or caused to be filed on a timely basis all material tax returns and all material reports with respect to taxes that are or were required to be filed pursuant to applicable requirements. HMC has paid, or made provision for the payment of, all material taxes that have or may become due for all periods covered by the tax returns or otherwise, or pursuant to any assessment received by HMC, except such taxes, if any, as are listed on Schedule 2.18(a) and are being contested in good faith and as to which adequate reserves (determined in accordance with generally accepted accounting principles) have been established by Sellers.
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Section 2.19 License. As of the date of this Agreement, HMC holds a valid license to operate as an acute care hospital issued by the Alabama Department of Public Health (the “DPH License”), and otherwise has the legal ability to operate as an acute care hospital.
Section 2.20 Records. The non-financial records of HMC are complete and correct in all material respects, subject to the representations provided in Sections 2.1 and 2.2 herein.
Section 2.21 Sufficiency of Assets. Except as provided on Schedule 2.21 hereto, to Sellers Knowledge, the Assets constitute all of the tangible assets, of any nature whatsoever, necessary to operate the Hospital in the manner presently operated by HMC.
Section 2.22 Facility Compliance. To Sellers’ Knowledge, Sellers are not in violation of any building code, zoning or other ordinance relating to the Real Property.
Section 2.23 Absence of Certain Developments. Subject to the representations provided in Sections 2.1 and 2.2 herein: (i) there has been no action of eminent domain with respect to the Real Property and (ii) except as contemplated in Section 5.3 herein, there are no governmental (federal, state or local) restrictions to prevent the Hospital from operating as an acute care hospital.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PURCHASER
Purchaser hereby represents and warrants to Sellers as of the date hereof as follows:
Section 3.1 Organization. Purchaser is an Alabama corporation, validly existing and in good standing under the laws of the State of Alabama, and has all requisite power and authority to own, lease, and operate its properties and assets, and to carry on its business as is now being conducted.
Section 3.2 Authority. Purchaser has the power and authority to execute, deliver and perform this Agreement and all agreements executed and delivered pursuant to this Agreement, and has taken all actions required by law and its Bylaws to authorize the execution, delivery and the performance of this Agreement and related documents.
Section 3.3 No Conflicts. The execution and delivery by Purchaser of this Agreement does not, and the performance by Purchaser of its obligations under this Agreement and the consummation of the transactions contemplated hereby will not violate any provision of any agreement of Purchaser or any provisions of or result in the acceleration of any obligation under any mortgage, lien, lease, agreement, instrument, order, arbitration, award, judgment or decree to which Purchaser is a party or by which it is bound.
Section 3.4 No Brokers. Purchaser has not contracted for the services of any broker, salesperson, finder, agent, investment banker or any other person to whom a commission or fee will be due as a result of the transactions contemplated by this Agreement. Purchaser does hereby indemnify and hold Sellers harmless from any claim by any other person or entity for a
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commission or fee arising out of Purchaser’s actions and as a result of the transactions contemplated by this Agreement.
Section 3.5 Due Diligence. Purchaser and its attorneys, accountants, and other authorized representatives have been provided access to the Assets and to documents and records of each Seller related to the Assets in order to afford Purchaser such reasonable opportunity of review, examination and investigation. All due diligence associated with such review, examination and investigation has been completed to the satisfaction of Purchaser prior to the date of this Agreement.
ARTICLE IV
CERTAIN COVENANTS OF SELLERS
Sellers hereby covenant to and agree with Purchaser as follows:
Section 4.1 Satisfaction of Conditions. Sellers shall use reasonable good faith efforts to satisfy or cause the satisfaction of the conditions specified in Article VII hereof in an expeditious fashion.
Section 4.2 Real Estate Investment Trust. Sellers shall use their best faith efforts expeditiously to obtain title in fee simple, free and clear of any encumbrances, except for any subleases, to any of the Assets described in Exhibit A which is or has been held by Healthcare Realty Trust.
Section 4.3 Negative Covenant. Except as otherwise expressly permitted herein, between the date of this Agreement and the Closing Date, HMC shall not, and HealthSouth shall not permit HMC to, without the prior written consent of Purchaser, (i) make any modification to any material contract; or (ii) enter into any material compromise or settlement of any litigation (other than litigation involving allegations of malpractice or employment issues), proceeding or governmental investigation relating exclusively to the Assets, the business of HMC or the Assumed Liabilities.
Section 4.4 Operations. Between the date hereof and the Closing, HMC shall:
(a) maintain the Assets in accordance with applicable accrediting standards of JCAHO;
(b) keep the DPH License in full force and effect without amendment, except as otherwise provided in Section 4.8;
(c) comply with all material contractual obligations applicable to the operations of HMC’s business;
(d) continue in full force and effect the insurance coverage under the existing insurance policies maintained by HMC or substantially equivalent policies;
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(e) cooperate with Purchaser and assist Purchaser in identifying the governmental authorizations required by Purchaser to operate the Assets as an acute care hospital from and after the Closing; and
(f) maintain all records as they relate to the DPH License.
Section 4.5 Continued Operation Until Closing. Sellers agree to continue operation of the Hospital until either the Closing occurs or this Agreement is terminated.
ARTICLE V
CERTAIN COVENANTS OF PURCHASER
Purchaser hereby covenants to and agrees with Sellers as follows:
Section 5.1 Satisfaction of Conditions. Purchaser shall use reasonable good faith efforts to satisfy or cause the satisfaction of the conditions specified in Article VIII hereof in an expeditious fashion and shall make all necessary filings and applications as soon as reasonably possible after the execution of this Agreement.
Section 5.2 Cooperation with purchaser of Digital Hospital. Purchaser agrees not to oppose or challenge, directly or indirectly, any application filed with SHPDA for a change of ownership and/or operation of the Digital Hospital by a prospective purchaser of the Digital Hospital or either of the Sellers so long as such operation of the Digital Hospital does not contemplate a certificate of need for more than 219 acute care beds or services not performed at the Hospital when the Digital Hospital CON was approved by SHPDA.
ARTICLE VI
ADDITIONAL COVENANTS AND AGREEMENTS
Section 6.1 Public Announcements. Purchaser and Sellers shall collectively make or issue any announcement or written statement concerning this Agreement and the transactions contemplated hereby for dissemination to the general public upon execution of this Agreement.
Section 6.2 Further Assurances. If at any time any party hereto shall reasonably request any further action by any other party to carry out the purposes of this Agreement or to further effectuate the transactions contemplated hereby, such other party, at the expense of the requesting party, shall promptly take such action (including the prompt execution and delivery of further instruments and documents).
Section 6.3 MetroWest Beds. Purchaser agrees to notify Sellers in writing, at or before the Closing, that it shall either: (i) upon approval by SHPDA, as soon as possible after execution of this Agreement, transfer the MetroWest Beds back to Sellers or (ii) keep the MetroWest Beds and pay Sellers $100,000. Purchaser hereby agrees to take the action specified in the notice to Sellers as soon as practicable after Closing.
Section 6.4 Intentionally Deleted.
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Section 6.5 Pita Stop Property, Bernstein Condominium Unit, McCoy Condominium Unit. At or subsequent to Closing, in the event HealthSouth resolves or settles all outstanding disputes or litigation with respect to the Pita Stop Property, HealthSouth shall allow Purchaser, for a period of sixty (60) days from the date of such resolution or settlement, the option to acquire, via statutory warranty deed, the Pita Stop Property for $450,000. At or subsequent to Closing, in the event HealthSouth acquires title to Bernstein Condominium Unit, HealthSouth shall convey, and Purchaser shall acquire, via statutory warranty deed, the Bernstein Condominium Unit for $195,000 during a sixty day period subsequent to such acquisition. At or subsequent to Closing, in the event HealthSouth acquires title to McCoy Condominium Unit, HealthSouth shall convey, and Purchaser shall acquire, via statutory warranty deed, the McCoy Condominium Unit for $235,000 during a sixty day period subsequent to such acquisition.
Section 6.6 Gamma Knife Partnership. Sellers shall convey Sellers’ interest in the Gamma Knife Partnership to Purchaser as of December 31, 2006 for no additional consideration; provided, however, HMC shall be entitled to its prorata share of any distributions accruing for the period through December 31, 2006. Subsequent to Closing through December 31, 2006, Purchaser agrees to lease space to the Gamma Knife Partnership upon the current terms and conditions of that certain Gamma Knife Agreement, dated as of October 31, 1995, by and between HMC and the Gamma Knife Partnership, and to assume HMC’s obligations as lessor under such agreement.
Section 6.7 Provider Numbers; Cost Report. Sellers shall allow Purchaser to file change of ownership applications with respect to the Hospital’s provider numbers and to utilize such provider number for services performed subsequent to the Closing. Notwithstanding the foregoing, Purchaser shall not be entitled to any funds received with respect to services performed at the Hospital or for costs incurred at the Hospital prior to the Closing and shall remit to HMC promptly any such funds received. Notwithstanding the foregoing, Sellers shall not be entitled to any funds received with respect to services performed at the Hospital or for costs incurred at the Hospital subsequent to the Closing and shall remit to Purchaser promptly any such funds received. Sellers shall file a terminating Medicare cost report for the Hospital as soon as reasonably practicable after the Closing. Sellers shall reasonably cooperate with Purchaser with respect to the issuance of new provider numbers for the Hospital and the obtaining of governmental authorizations for the Hospital.
Section 6.8 Post-Closing Services. On mutually acceptable terms and conditions, Sellers agree to provide post-Closing services to the Hospital for a reasonable period of time.
ARTICLE VII
CONDITIONS TO THE OBLIGATIONS OF PURCHASER
All obligations of Purchaser under this Agreement are subject to the fulfillment or satisfaction, prior to or at the Closing, of each of the following conditions precedent:
Section 7.1 Representations and Warranties True. The representations and warranties of Sellers contained in this Agreement shall be materially true and accurate as of the Closing. Notwithstanding the foregoing, Sellers shall be permitted, immediately prior to
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Closing, to update the schedules to this Agreement; provider, however, any material modifications to such schedules shall require the approval of Purchaser as a condition to Closing by Purchaser. Notwithstanding anything in this Section 7.1 to the contrary, in the event, that such material updates have a collective value or impact of $500,000 or less, Sellers shall, up to an amount mutually agreed by Sellers and Purchasers in writing (with a collective maximum of $500,000), at Sellers’ option, either (a) execute an indemnification agreement; (b) make the necessary repairs or remediation or (c) accept a reduction in the Purchase Price in the amount of such liability or defect.
Section 7.2 Compliance with this Agreement. Sellers shall have materially performed and complied with all agreements and conditions required by this Agreement to be performed or complied with by it prior to or at the Closing.
Section 7.3 Documents to be Delivered. At or prior to Closing, Purchaser shall have received from Sellers:
(i) a certificate of each Seller, dated as of the Closing, certifying in such detail as Purchaser may reasonably request that the conditions specified in Sections 7.1 and 7.2 hereof have been fulfilled;
(ii) a bill of sale for the Assets, properly executed for transfer to Purchaser, with all required documentation relating thereto;
(iii) the Deed, properly executed for transfer to Purchaser, and the Title Insurance; and
(iv) certificates of the Secretary of State of the State of Alabama and the Department of Revenue of the State of Alabama as to the existence and good standing, respectively, of HMC as of a date reasonably acceptable to Purchaser.
Section 7.4 No Injunctions. There shall be no effective injunction, writ, preliminary restraining order or any order of any nature issued by a court of competent jurisdiction prohibiting or imposing any condition on the consummation of any of the transactions contemplated hereby.
Section 7.5 Change of Ownership Approval from SHPDA, License and CHOW Application. Purchaser shall have received all reasonably necessary governmental authorizations in accordance with customary practice to permit the operation of the Hospital by the Seller with the existing certificate of need, license and hospital services.
Section 7.6 Real Estate Investment Trust. Sellers shall have obtained title in fee simple, free and clear of any encumbrances, except for any subleases, to any of the Assets described in Exhibit A which is or has been held by Healthcare Realty Trust. At the Closing, Purchaser shall assume all obligations with respect to any leases or subleases with respect to any such property.
Section 7.7 Absence of Certain Developments. Between the date hereof and the Closing, (i) there has been no action of eminent domain with respect to the Real Property; and
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(ii) except as contemplated in Section 5.3 herein, there have been no governmental (federal, state or local) restrictions to prevent the Hospital from operating as an acute care hospital.
ARTICLE VIII
CONDITIONS TO THE OBLIGATIONS OF SELLERS
All obligations of Sellers under this Agreement are subject to the fulfillment or satisfaction, prior to or at the Closing, of each of the following conditions precedent:
Section 8.1 Representations and Warranties True. The representations and warranties of Purchaser contained in this Agreement shall be materially true and accurate in all respects as of the Closing. Notwithstanding the foregoing, Purchaser shall be permitted, immediately prior to Closing, to update the schedules to this Agreement; provider, however, any material modifications to such schedules shall require the approval of Sellers as a condition to Closing by Sellers.
Section 8.2 Compliance with this Agreement. Purchaser shall have materially performed and complied with all agreements and conditions required by this Agreement to be performed or complied with by it prior to or at the Closing.
Section 8.3 Payment of Purchase Price. At Closing, Purchaser shall deliver to Sellers the Purchase Price by wire transfer to an account designated by Sellers.
Section 8.4 Documents to be Delivered. At or prior to Closing, Sellers shall have received from Purchaser (i) a certificate of Purchaser, dated as of the date of Closing, certifying in such detail as Sellers may reasonably request that the conditions specified in Sections 8.1 and 8.2 hereof have been fulfilled and (ii) certificates of the Secretary of State of the State of Alabama and the Department of Revenue of the State of Alabama as to the existence and good standing, respectively, of the Purchaser as of a date reasonably acceptable to Sellers.
Section 8.5 No Injunction. There shall be no effective injunction, writ, preliminary restraining order or any order of any nature issued by a court of competent jurisdiction prohibiting or imposing any condition on the consummation of any of the transactions contemplated hereby.
ARTICLE IX
SURVIVAL OF REPRESENTATIONS AND WARRANTIES; INDEMNI FICATION
Section 9.1 Survival of Representations and Warranties. All representations and warranties made by the parties hereto in this Agreement or in any certificate, schedule, statement, document or instrument furnished hereunder or in connection with the negotiation, execution and performance of this Agreement shall survive for a period of one (1) year after the Closing.
Section 9.2 Indemnification by the Sellers. Subject to and to the extent provided in this Article IX, Sellers hereby covenant and agree to protect, defend and indemnify Purchaser,
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and to hold it harmless, against and with respect to any and all loss, liability, damage and expense (including, without limitation, all actions, suits, proceedings, claims, demands, assessments, judgments, costs, fines, expenses, injunctions and penalties, and any and all legal and accounting fees incident to any of the foregoing) (“Losses”) suffered or incurred as a result of (i) the breach by Sellers of any covenant, term, condition or agreement contained in this Agreement or any certificate or document delivered by Sellers pursuant to this Agreement, (ii) any inaccuracy in a representation or warranty by Sellers set forth herein, (iii) any claims, demands, liabilities and causes of action in connection with any act, event, condition or occurrence relating in any way to the Assets and/or the Sellers prior to the Closing, not specifically assumed by Purchaser in Section 1.3 of this Agreement, (iii) any obligation for pension or retirement payments, calculators, liabilities, demands or the like with respect to any individual who worked (or is currently working) at or for the Assets with respect to the period when such individual was employed by either of the Sellers, (iv) any obligation for employee benefits accrued as of the Closing Date (including assumed vacation, sick or ETO balances), with respect to any individual who worked (or is currently working) at or for the Assets with respect to the period when such individual was employed by either of the Sellers, and/or (v) Seller’s action or omissions with respect to billing or claims by Seller with respect to the period prior to the Closing under existing provider contracts that may be assigned to or assumed by Purchaser. In addition, Sellers shall protect, defend and indemnify Purchaser, and hold it harmless, against and with respect to, for the period subsequent to the date of this Agreement, any and all loss, liability, damage and expense (including, without limitation, all actions, suits, proceedings, claims, demands, assessments, judgments, costs, fines, expenses, injunctions and penalties, and any and all legal fees payable to Sellers’ counsel only, incident to any of the foregoing) arising from Purchaser’s attempts to perform its obligations under, or consummate the transaction contemplated by this Agreement or the Existing Agreement so long as Purchaser agrees to utilize Sellers’ counsel solely with respect to defending such matters and provided, however , Sellers shall not have any indemnification, defense or hold harmless obligations or have reimbursement obligations to Purchaser with respect to (x) any willful acts, malfeasance, misfeasance or misconduct by Purchaser or Purchaser’s agents or (y) Purchaser’s actions or inactions (other than those approved by Sellers) relating to the Metro West Beds subsequent to the date of this Agreement. Notwithstanding the foregoing, in the event Purchaser or Sellers’ counsel determines that Purchaser requires separate counsel with respect to claims or actions arising from Purchaser’s attempts to perform its obligations under, or consummate the transaction contemplated by this Agreement or the Existing Agreement, Purchaser shall retain such separate counsel at Purchaser’s sole expense. Purchaser shall reimburse Sellers for any indemnification costs or expenses made to Purchaser by Sellers that relates to Purchaser’s actions or inactions that are subsequently judicially determined to constitute malfeasance, misfeasance or misconduct by Purchaser or Purchaser’s agents.
Section 9.3 Indemnification by Purchaser. Subject to and to the extent provided in this Article IX, Purchaser hereby covenants and agrees to protect, defend and indemnify each of the Sellers and to hold them harmless, against and with respect to any and all Losses suffered or incurred as a result of (i) the breach by Purchaser of any covenant, term, condition or agreement contained in this Agreement, (ii) any inaccuracy in a representation or warranty of Purchaser set forth herein, (iii) for the period subsequent to the Closing, any claims, demands, liabilities and causes of action in connection with any act, event, condition or occurrence relating in any way to the Assets and/or the Purchaser after the Closing, except for any liabilities retained by Sellers
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under this Agreement, (iv) any obligation subsequent to Closing with respect to those contracts or liabilities assumed by Purchaser pursuant to Section 1.3 of this Agreement and/or (v) Purchaser’s action or omissions with respect to billing or claims by Purchaser with respect to the period subsequent to the Closing under existing provider contracts that may be assigned to or assumed by Purchaser. The parties hereto acknowledge and agree that Sellers are expressly retaining liability for any and all pension obligations for the period prior to Closing with respect to any current or former employees at the Hospital.
Section 9.4 Notice of Claims.
(a) Promptly after receipt by an indemnified party of written notice of the commencement of any investigation, claim, proceeding or other action in respect of which indemnity may be sought from the indemnitor under either Section 9.2 or 9.3 (each, an “Action”), such indemnified party shall notify the indemnitor in writing of the commencement of such Action; but the omission to so notify the indemnitor shall not relieve it from any liability that it may otherwise have to such indemnified party, except to the extent that the indemnitor is materially prejudiced or forfeits substantive rights or defenses as a result of such failure. In connection with any Action in which the indemnitor and any indemnified party are parties, the indemnitor shall be entitled to participate therein, and may assume the defense thereof. Notwithstanding the assumption of the defense of any such Action by the indemnitor, each indemnified party shall have the right to employ separate counsel and to participate in the defense of such Action, and the indemnitor shall bear the fees, costs and expenses of such separate counsel to such indemnified party if: (i) the indemnitor shall have agreed to the retention of such separate counsel, (ii) the defendants in, or target of, any such Action include more than one indemnified party or both an indemnified party and the indemnitor shall have concluded that representation of such indemnified party by the same counsel would be inappropriate due to actual or, as reasonably determined by such indemnified party’s counsel, potential differing interests between them in the conduct of the defense of such Action, or if there may be legal defenses available to such indemnified party that are different from or additional to those available to the other indemnified party or to the indemnitor, or (iii) the indemnitor shall have failed to employ counsel reasonably satisfactory to such indemnified party within a reasonable period of time after notice of the institution of such Action. If such indemnified party retains separate counsel in cases other than as described in clauses (i), (ii), or (iii) above, such counsel shall be retained at the expenses of such indemnified party. Except as provided above, it is hereby agreed and understood that the indemnitor shall not, in connection with any Action in the same jurisdiction, be liable for the fees and expenses of more than one counsel for all such indemnified parties (together with appropriate local counsel). The party from whom indemnification is sought shall not, without the written consent of the party seeking indemnification (which consent shall not be unreasonably withheld), settle or compromise any claim or consent to entry of any judgment that does not include an unconditional release of the party seeking indemnification from all liabilities with respect to such claim.
(b) In the event one party hereunder should have a claim for indemnification that does not involve a claim or demand being asserted by a third party, the party seeking indemnification shall promptly send notice of such claim to the party from whom indemnification is sought.
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Section 9.5 Deductible Amount. Notwithstanding any other provision of this Agreement, Sellers shall have no liability under Article 9 until the total of all Losses with respect to such matters exceeds $75,000 (the “Deductible Amount”), at which time Sellers shall be responsible for aggregate Losses in excess of the Deductible Amount. Notwithstanding any other provision of this Agreement, Purchaser shall have no liability under Article 9 until the total of all Losses with respect to such matters exceed the Deductible Amount, at which time Purchaser shall be responsible for aggregate Losses in excess of the Deductible Amount.
Section 9.6 Limitation. Notwithstanding any other provision of this Agreement, the maximum aggregate liability of Sellers collectively under Article 9 shall be 50% of the Purchase Price. Notwithstanding any other provision of this Agreement, the maximum aggregate liability of Purchaser under Article 9 shall be $16,500,000.
ARTICLE X
TERMINATION
Section 10.1 Termination Events. This Agreement may, by notice given prior to or at the Closing, be terminated:
(a) by either Purchaser or Sellers if a Breach of any provision of this Agreement has been committed by the other party and such Breach has not been waived;
(b) (i) by Purchaser if any of the conditions in Article VII has not been satisfied as of the Closing or if satisfaction of such a condition is or becomes impossible (other than through the failure of Purchaser to comply with its obligations under this Agreement) and Purchaser has not waived such condition on or before the Closing; or (ii) by Sellers, if any of the conditions in Article VIII has not been satisfied of the Closing or if satisfaction of such a condition is or becomes impossible (other than through the failure of Sellers to comply with their obligations under this Agreement) and Sellers have not waived such condition on or before the Closing; or
(c) by mutual consent of Purchaser and Sellers.
Section 10.2 Effect of Termination. Each party’s right of termination under Section 10.1 is in addition to any other rights it may have under this Agreement or otherwise, and the exercise of a right of termination will not be an election of remedies. If this Agreement is terminated pursuant to Section 10.1, all further obligations of the parties under this Agreement will terminate, except that the obligations in Sections 11.2, 11.6 and 6.1 will survive; provided however, that if this Agreement is terminated by a party because of a Breach of the Agreement by the other party or because one or more of the conditions to the terminating party’s obligations under this Agreement is not satisfied as a result of the other party’s failure to comply with its obligations under this Agreement, the terminating party’s right to pursue all legal remedies will survive such termination unimpaired.
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ARTICLE XI
MISCELLANEOUS PROVISIONS
Section 11.1 Amendment. This Agreement may be amended only by a written agreement signed by the parties.
Section 11.2 Expenses. Each Party to this Agreement will bear its respective expenses incurred in connection with the preparation, execution and performance of this Agreement and the Closing, including all fees and expenses of agents, representations, counsel and accountants.
Section 11.3 Waiver of Compliance. Any waiver of any failure to comply with any obligation, covenant, agreement or condition under this Agreement must be in writing and signed by the parties. Any waiver or failure to insist upon strict compliance with any obligation, covenant, agreement or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure.
Section 11.4 Notices. All notices, requests, demands and other communications required or permitted hereunder shall be provided in writing and shall be deemed to have been duly given if delivered by hand or sent by facsimile or certified or registered mail, with postage prepaid:
HealthSouth Corporation HealthSouth Medical Center, Inc. One HealthSouth Parkway Birmingham, Alabama 35243 Phone: (205) 967-7116 Fax: (205) 969-4620 Attn: Jay Grinney, Chief Executive Officer
with a copy to:
HealthSouth Corporation HealthSouth Medical Center, Inc. One HealthSouth Parkway Birmingham, Alabama 35243 Phone: (205) 967-7116 Fax: (205) 970-5913 Attn: Greg Doody, Esq.
with a copy to:
Colin H. Luke, Esq. Balch & Bingham LLP 1901 Sixth Avenue North, Suite 2600 Birmingham, Alabama 35203 Telephone: 205-226-8729 Telecopy: 205-226-8799
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(i) If to Sellers, to:
THE BOARD OF TRUSTEES OF THE UNIVERSITY OF ALABAMA 500 22nd Street South, Suite 408 Birmingham, AL 35233 Telephone: (205) 975-5412 Telecopy: (205) 975-9175 Attn: Steve Pickett, Executive Vice President
with a copy to:
UAB Health System 500 22nd Street South, Suite 408 Birmingham, AL 35233 Telephone: (205) 975-4844 Telecopy: (205) 975-0129 Attn: Kathleen Kauffman
with a copy to:
J. Hobson Presley, Jr. Presley LLC 2801 Highway 280 South Suite 700 Birmingham, AL 35223-2483 Telephone: (205) 423-3601 Telecopy: (205) 423-3610
or to such other person or address as a party shall notify all other parties in writing.
Section 11.5 Assignment. Neither this Agreement nor any of the rights, interests or obligations hereunder may be assigned by any of the parties hereto without the prior written consent of the other parties. This Agreement and all of the provisions hereof shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. Notwithstanding the foregoing, Purchaser may assign its rights and obligations under this Agreement to UAB Health System, an Alabama nonprofit corporation, or an Affiliate of Purchaser.
Section 11.6 Dispute Resolution.
(a) Any dispute, controversy or claim arising out of or in relation to or in connection with: (a) this Agreement, including without limitation any dispute as to the construction, validity, interpretation, enforceability or breach of this Agreement; (b) the operations carried out under this Agreement; or (c) any deadlock between the parties to this Agreement (a “Dispute”) shall be
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(ii) If to Purchaser, to:
settled by binding arbitration in Birmingham, Alabama, in accordance with the Commercial Arbitration Rules of the American Arbitration Association (“AAA”). The arbitrator shall be selected by agreement of the parties from the National Roster in accordance with the AAA rule regarding the selection of arbitrators or, if they cannot agree on an arbitrator within ten days after submission of the Dispute to arbitration, then an arbitrator without any relationship to the parties shall be selected by AAA from the National Roster.
(b) The determination reached in such arbitration shall be final and binding on all parties hereto without any right of appeal except as provided by the Federal Arbitration Act. The arbitrator shall not have the authority to award punitive, exemplary, indirect or consequential damages. Each party shall be responsible for its own attorney’s fees and the costs of arbitration shall be equally borne.
(c) Any court of competent jurisdiction may enforce any determination or award of the arbitrator. The parties also agree that, in the event that the need for emergency measures of protection (including preliminary injunction or temporary restraint proceedings) arises, the AAA Optional Rules for Emergency Measures of Protection shall apply to the proceedings.
(d) The parties acknowledge and agree that this Agreement and the transactions contemplated hereby evidence transactions that involve a substantial nexus with interstate commerce. THE PARTIES HEREBY EXPRESSLY WAIVE ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION OR CAUSE OF ACTION ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE BREACH THEREOF, PROVIDED THAT NOTHING IN THIS AGREEMENT SHALL PRECLUDE A PARTY FROM SEEKING TO COMPEL ARBITRATION IN A STATE OR FEDERAL COURT OF COMPETENT JURISDICTION.
Section 11.7 Counterparts; Facsimile. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement may be executed by telefacsimile.
Section 11.8 Headings. The headings of the Articles and Sections of this Agreement are inserted for convenience only and shall not constitute a part hereof or affect in any way the meaning or interpretation of this Agreement.
Section 11.9 Entire Agreement. This Agreement, including the Schedules hereto, and the Management Agreement, as well as the other documents and certificates delivered pursuant hereto set forth the entire agreement and understanding of the parties hereto with respect to the subject matter hereof, and supersede all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any manager, partner, member, employee or representative of any party hereto.
Section 11.10 Third Parties. Except as specifically set forth or referred to herein, nothing expressed or implied herein is intended or shall be construed to confer upon or give to any person or entity other than the parties hereto, and their successors or permitted assigns, any rights or remedies under or by reason of this Agreement.
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Section 11.11 Performance Following Closing. Nothing in this Agreement shall be construed to limit any covenant or agreement of the parties hereto which by its terms contemplates performance after the Closing.
Section 11.12 Governing Law. This Agreement and the legal relations among the parties hereto shall be governed by and construed in accordance with the laws of the State of Alabama without regard to conflict of interest doctrine.
ARTICLE XII
DEFINITIONS
For the purposes of this Agreement, the following terms have the meanings specified or referred to in this Article XII:
“Action” has the meaning set forth in Section 9.4.
“Affiliate” of a Person means any other Person that directly or indirectly controls, is controlled by or is under common control with the Person.
“Agreement” has the meaning provided in the first sentence of this document.
“Assets” has the meaning set forth in Section 1.1.
“Assumed Liabilities” has the meaning set forth in Section 1.3.
“Beds” has the meaning of those certain 199 acute care beds located at Metro-West.
“Berstein Condominium” means that certain condominium unit located at 1422 14th Avenue South as further described on Exhibit C hereto.
“Breach” – a “Breach” of a representation, warranty, covenant, obligation, or other provision of this Agreement or any instrument delivered pursuant to this Agreement will be deemed to have occurred if there is or has been (a) any inaccuracy in or breach of, or any failure to perform or comply with, such representation, warranty, covenant, obligation, or other provision, or (b) any claim (by any Person) or other occurrence or circumstance that is or was inconsistent with such representation, warranty, covenant, obligation, or other provision, and the term “Breach” means any such inaccuracy, breach, failure, claim, occurrence or circumstance.
“Closing” has the meaning set forth in Section 1.6.
“Closing Date” has the meaning provided in Section 1.7.
“Contest” has the meaning set forth in Section 10.1(f).
“Deductible Amount” shall have the meaning set forth in Section 9.5.
“Deed” means the statutory warranty deed in form of Exhibit D hereto.
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“Digital Hospital” has the meaning set forth in Section 1.2.
“DPH License” has the meaning set forth in Section 2.19.
“Encumbrance” – any charge, claim, community property interest, condition, equitable interest, lien, option, pledge, security interest, right of first refusal, or restriction of any kind, including any restriction on use, voting transfer, receipt of income, or exercise of any other attribute of ownership.
“ERISA” – the Employee Retirement Income Security Act of 1974 or any successor law, and regulations and rules issued pursuant to that Act or any successor law.
“Gamma Knife Partnership” means HEALTHSOUTH/UAB Gamma Knife L.L.C.
“HealthSouth” means HealthSouth Corporation, a Delaware corporation.
“Hospital” means HMC’s acute care hospital located at 1201 11 th Avenue South in Birmingham, Alabama.
“HMC” means HealthSouth Medical Center, Inc., an Alabama corporation.
“Knowledge” , with respect to any particular fact or other matter, means:
(a) an individual is actually aware of such fact or other matter; or
(b) an individual is or was in the possession of written information confirming such fact or other matter.
Knowledge of Sellers will include only to the actual knowledge of any individual who is serving as a manager, partner, director, officer, member, employee, executor, or trustee of either such Seller.
“Losses” shall have the meaning provided in Section 9.2.
“McCoy Condominium” means that certain condominium unit located at 1422 14th Avenue South as further described on Exhibit C hereto.
“Management Agreement” shall mean that certain Management Agreement between an Affiliate of Purchaser and HMC, dated simultaneously herewith.
“Material Adverse Effect” means any change in, or effect on, the Hospital as currently operated by Sellers that is or is reasonably likely to be materially adverse to the Hospital taken as a whole or the results of operations or financial condition of the Hospital taken as a whole, except for any such changes or effects resulting from (i) changes in general economic, regulatory or political conditions or changes that affect the industry in general and (ii) this Agreement or the transactions contemplated hereby or the announcement hereof.
“MetroWest Beds” shall mean the 199 beds transferred to Purchaser and formerly located at the HealthSouth Metro-West Hospital in Fairfield, Alabama.
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“Party” shall mean each of the Sellers and Purchaser individually, collectively the “Parties.”
“Permitted Encumbrances” means (i) liens for taxes and assessments not yet due and payable and (ii) encumbrances created by Purchaser.
“Person” means any individual, corporation or partnership, limited liability company, limited partnership, association or other entity of any kind.
“Pita Stop Property” means that property described on Exhibit B hereto.
“Provider Numbers” has the meaning set forth in Section 2.17.
“Purchase Price” has the meaning set forth in Section 1.4.
“Purchaser” means The Board of Trustees of The University of Alabama.
“Real Property” means that certain real property on which the Hospital is located as more particularly described on Exhibit A hereto.
“Sellers” means HealthSouth and HMC collectively.
“SHPDA” means the Alabama State Health Planning and Development Agency.
“Title Policy” shall mean the title policy issued in favor of Purchaser by Alabama Title Co., Inc. with respect to the Real Property in the form of Exhibit E .
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IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the date first set forth above.
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PURCHASER:
ATTEST THE BOARD OF TRUSTEES OF THE UNIVERSITY OF ALABAMA
/s/ Kathleen Kauffman /s/ Steve Pickett By: Steve Pickett Its: EVP
SELLERS:
ATTEST HealthSouth Medical Center, Inc. an Alabama corporation
/s/ Colin H. Luke /s/ Mike Snow By: Mike Snow Its: Vice President
ATTEST HEALTHSOUTH Corporation a Delaware corporation
/s/ Colin H. Luke /s/ Mike Snow By: Mike Snow Its: Chief Operating Officer
Exhibit 10.41
Securities Purchase Agreement
HealthSouth Corporation One HealthSouth Parkway Birmingham, Alabama 35243
Ladies and Gentlemen:
Each of the undersigned (each, an “ Investor ” and together, the “ Investors ”) hereby confirms its agreement with you as follows:
1. This Securities Purchase Agreement (the “ Agreement ”) is made as of February 28, 2006, between HealthSouth Corporation, a Delaware corporation (the “ Company ”), and the Investors listed on the signature pages hereto.
2. The Company has authorized the sale and issuance to the Investors (the “ Offering ”) of shares of its Convertible Perpetual Preferred Stock, par value $0.10 per share (the “ Securities ”), which are convertible into shares of the Company’s common stock, par value $0.01 per share (the “ Common Stock ”), and shall have the rights, powers and preferences set forth in the Certificate of Designations (the “ Certificate of Designations ”) of Convertible Perpetual Preferred Stock, a copy of which is attached hereto as Exhibit A. The Securities are being offered to qualified institutional buyers (“ QIBs ”) within the meaning of Rule 144A under the Securities Act of 1933, as amended (the “ Securities Act ”), pursuant to a private placement exemption from registration under the Securities Act.
3. The Company and the Investors agree that each Investor will purchase from the Company and the Company will issue and sell to such Investor up to the aggregate number of Securities set forth below on such Investor’s signature page for the aggregate purchase price of $1,000 per share; provided that if the Company sells and the Investor buys an amount of Securities less than the aggregate number of Securities set forth below on such Investor’s signature page, the total aggregate purchase price of such Securities will be reduced proportionately. The Securities shall be purchased pursuant to the Terms and Conditions for Purchase of Securities attached hereto as Annex I and incorporated herein by reference as if fully set forth herein. The Securities purchased by the Investors will be delivered by electronic book-entry through the facilities of The Depository Trust Company (“ DTC ”), to an account specified by each Investor on its signature page and will be released by Mellon Investor Services (the “ Escrow Agent ”) to such Investor at the Closing (as defined in Section 3 of Annex I hereto).
Maximum Number of Securities: $30,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 20,000
Aggregate Purchase Price: $20,000,000
AGREED AND ACCEPTED:
Name of Investor: Advent Capital Management
By: /s/ ROBERT WHITE Print Name: Robert White Title: Chief Financial Officer Address: 1065 Avenue of the Americas, 31 st Floor New York, NY 10018 Tax ID No.: 13-4168510 Contact Name: Robert White Telephone: 212-479-0675 Back office contact: Desmond Singh 212-479-0636
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 7,000
Aggregate Purchase Price: $7,000,000
AGREED AND ACCEPTED:
Name of Investor: AM Investment Partners, LLC
By: /s/ MARK FRIEDMAN Print Name: Mark Friedman Title: Principal Address: 350 Park Avenue, 4 th Floor New York, NY 10022 Tax ID No.: 74-3006802 Contact Name: Mark Friedman Telephone: 212-508-8909 Back office contact: Craig Cohen 212-508-8908
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 50,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 20,000
Aggregate Purchase Price: $20,000,000
AGREED AND ACCEPTED:
Name of Investor: Amaranth LLC, By Amaranth Advisors, LLC, its Trading Advisor
By: /s/ KARL J. WACHTER Print Name: Karl J. Wachter Title: Authorized Signatory Address: c/o Dundee Leeds Management Services (Cayman) Ltd. Waterfront Centre 28 N. Church Street, Georgetown, Grand Cayman Cayman Islands, B.W.I. Address for legal notices: c/o Amaranth Advisors LLC One America Lane, Greenwich, CT 06831, Attn: General Counsel Tax ID No.: 98-0385841 Contact Name: General Counsel Telephone: 203-422-3340 Back office contact: Sean Foronjy 203-422-3315
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 shares/$30,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 3,000
Aggregate Purchase Price: $3,000,000
AGREED AND ACCEPTED:
Name of Investor: AG Offshore Convertibles, Ltd.,
By: Angelo Gordon & Co., L.P. Its: Investment Manager
By: /s/ JOHN M. ANGELO Print Name: John M. Angelo Title: Chief Executive Officer Address: 245 Park Avenue, 26 th Floor New York, NY 10169 Tax ID No.: N/A Contact Name: Gary I. Wolf Telephone: 212-692-2058 Back office contact: George Fink
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: CNH CA Master Account, L.P.
Number of Securities Allocated to Investor: 12,000
Aggregate Purchase Price: $12,000,000
By: /s/ BRADLEY ASNESS Print Name: Bradley Asness Title: Secretary, Principal Address: Two Greenwich Plaza Greenwich, CT 06830 Tax ID No.: 42-1571441 Contact Name: Gildo Niutta Telephone: 203-742-3686 Back office contact:
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 shares/$30,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Argent Funds Group LLC
Number of Securities Allocated to Investor: 9,000
Aggregate Purchase Price: $9,000,000
By: /s/ BOBBY RICHARDSON Print Name: Bobby Richardson Title: Managing Director Address: 55 Vilcom Circle Chapel Hill, NC 27514 Tax ID No.: 06-1584984 Contact Name: Rich Godfrey Telephone: 919-869-8669 Back office contact: Rich Godfrey
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: $30,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Aristeia International Limited/Aristeia Partners LP
Number of Securities Allocated to Investor: 10,000
Aggregate Purchase Price: $10,000,000
By: /s/ ANTHONY FRASCELLA Print Name: Anthony Frascella Title: Principal Address: 136 Madison Avenue, 3 rd Floor New York, NY 10016 Tax ID No.: 13-3953126 Contact Name: Michael Meraldo Telephone: 212-842-8888 Back office contact: David Courtemnache 212-842-8881
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 shares, $30,000,000 principal amount
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: BASSO Capital Management, LP on behalf of 3-4 Basso Funds to be determined
Number of Securities Allocated to Investor: 7,500
Aggregate Purchase Price: $7,500,000
By: /s/ JOHN LEPORE Print Name: John Lepore Title: Authorized Signatory Address: 1266 East Main St. Stamford, CT 06902 Tax ID No.: Contact Name: Marc Seidenberg/John Lepore Telephone: 203-352-6154 Back office contact: Joe Schultz 203-352-6157
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000,000 face
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Camden Asset Management
Number of Securities Allocated to Investor: 9,000
Aggregate Purchase Price: $9,000,000
By: /s/ ALEXANDER A. LACH Print Name: Alexander A. Lach Title: Partner Address: 2049 Century Park East, Suite #330 Century City, CA 90067 Tax ID No.: 95-4319164 Contact Name: Alex Lach Telephone: 310-785-1630 Back office contact: Anthony Reyes 310-785-9755
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 7,500
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: CQS Convertible and Quantitative Strategies Master Fund Limited
Number of Securities Allocated to Investor: 5,000
Aggregate Purchase Price: $5,000,000
By: /s/ MICHAEL HINTZ Print Name: Michael Hintz Title: Director Address: PO Box 309GT, Ugland House, Souith Church Street Georgetown, Grand Cayman, Cayman Islands Tax ID No.: Contact Name: Paul Casey Telephone: 44-207 201 6973 Back office contact: Tim Dalgamo 44-207-201-6880
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Credit Suisse
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
By: /s/ ONU ODIM Print Name: Onu Odim Title: Managing Director Address: 11 Madison Avenue, 7 th Floor New York, NY 10010 Tax ID No.: N/A Contact Name: Onu Odim Telephone: 212-325-3622 Back office contact: Ross Jorsky 212-325-3188
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: D.E. Shaw Valence Portfolios, L.L.C
Number of Securities Allocated to Investor: 18,000
Aggregate Purchase Price: $18,000,000
By: D.E. Shaw & Co. L.P., as managing member
By: /s/ JOE PRIOR Print Name: Joe Prior Title: Authorized Signatory Address: 120 W. 45 th St. 39 th Floor New York, NY 10036 Tax ID No.: 13-4046559 Contact Name: Joe Prior Telephone: 212-478-0000 Back office contact: Kara Loe 212-478-0000
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Deerfield Management Company, L.P.
Number of Securities Allocated to Investor: 9,000
Aggregate Purchase Price: $9,000,000
By: /s/ DARREN LEVINE Print Name: Darren Levine Title: Chief Financial Officer Address: 780 3 rd Avenue, 37 th Floor New York, NY 10017 Tax ID No.: 13-3738772 Contact Name: Darren Levine Telephone: 212-551-1600 Back office contact: Darren Levine
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: $20,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: DRW Securities, LLC
Number of Securities Allocated to Investor: 5,000
Aggregate Purchase Price: $5,000,000
By: /s/ DONALD WILSON, JR. Print Name: Donald Wilson, Jr. Title: Manager Address: 10 S. Riverside Plaza, 21 st Floor Chicago, IL 60606 Tax ID No.: 36-4202848 Contact Name: Ilan Huberman Telephone: 312-542-1110 Back office contact: Jim Lange 312-541-1011
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 5,000
Aggregate Purchase Price: $5,000,000
Name of Investor: Empyrean Capital Partners, LP
By: /s/ ANTHONY THIMES Print Name: Anthony Thimes Title: Chief Financial Officer Address: 10250 Constellation Blvd, Suite 2950 Los Angeles, CA 92660 Tax ID No.: Contact Name: Tony Hynes Telephone: 310-843-3060 Back office contact:
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN
Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
Name of Investor: Forest Investment Management
By: /s/ JOHN McDONALD Print Name: John McDonald Title: Partner Address: 53 Forest Avenune Old Greenwich, CT 06870 Tax ID No.: 06-1354491 Contact Name: Jingyan Wang Telephone: 203-637-7773 Back office contact: Larry Diamond 203-637-6020
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: $30,000,000 of securities Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 9,000 Aggregate Purchase Price: $9,000,000
Name of Investor: GLG Partners LP
By: /s/ STEVE ROTH Print Name: Steve Roth Title: Portfolio Manager Address: 2 Curzon Street London W1J5HB, UK Tax ID No.: N/A Contact Name: Allistair Ling Telephone: 44 2070167057 Back office contact: Antonio Dos 44 2070167302
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: President and Fellows of Harvard College
Number of Securities Allocated to Investor: 5,000
Aggregate Purchase Price: $5,000,000
By: /s/ CRAIG SZEMAN Print Name: Craig Szeman Title: Vice President Address: 600 Atlantic Avenue Boston, MA 02210-2203 Tax ID No.: 042103580 Contact Name: Telephone: Back office contact: Sharon Legge 617-720-6713
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 ($30,000,000)
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: HBK Master Fund L.P.
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
By: HBK Investments L.P.
By: /s/ J. BAKER GENTRY, JR. Print Name: J. Baker Gentry, Jr. Title: Authorized Signatory Address: c/o Ugland House, South Church Street P.O. Box 309, Georgetown, Grand Cayman, Cayman Islands Notice Address: c/o HBK Investments, LP, 300 Crescent Court Suite 700, Dallas Texas 75201 Tax ID No.: 98-0215929 Contact Name: Legal Department Telephone: 214-758-6107 Back office contact: Sterling Abbott 214-758-6421
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Highbridge International LLC
Number of Securities Allocated to Investor: 18,000
Aggregate Purchase Price: $18,000,000
By: Highbridge Capital Management LLC
By: /s/ RICHARD POTAPCHUK Print Name: Richard Potapchuk Title: Managing Director Address: 9 West 57 th Street, 27 th Floor New York, NY 10019 Tax ID No.: N/A Contact Name: Telephone: 212-287-4910 Back office contact: Chris Edele
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 3,965
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 1,586
Aggregate Purchase Price: $1,586,000
Name of Investor: Highfields Capital I LP
By: /s/ JENNIFER L. STIER Print Name: Jennifer L. Stier Title: Chief Operating Officer Address: John Hancock Tower, 200 Clarendon St. 51 st Floor Boston, MA 02116 Tax ID No.: 04-3419486 Contact Name: Joseph Mazzellan Telephone: 617-850-7500 Back office contact: Brian Quinn 617-850-7564
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 9,585
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 3,834
Aggregate Purchase Price: $3,834,000
Name of Investor: Highfields Capital II LP
By: /s/ JENNIFER L. STIER Print Name: Jennifer L. Stier Title: Chief Operating Officer Address: John Hancock Tower, 200 Clarendon St. 51 st Floor Boston, MA 02116 Tax ID No.: 04-3419488 Contact Name: Joseph Mazzellan Telephone: 617-850-7500 Back office contact: Brian Quinn 617-850-7564
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 36,450
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 14,580
Aggregate Purchase Price: $14,580,000
Name of Investor: Highfields Capital Ltd.
By: /s/ JENNIFER L. STIER Print Name: Jennifer L. Stier Title: Chief Operating Officer Address: c/o Goldman Sachs (Cayman) Trust Ltd., Harbour Centre, 2 nd Floor P.O. Box 896, Georgetown, Grand Cayman, Cayman Islands, B.W.I. Tax ID No.: N/A Contact Name: Telephone: 345-914-8011 Back office contact:
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
Name of Investor: JD Capital Management
By: /s/ ANDREW BARNARD Print Name: Andrew Barnard Title: Portfolio Manager Address: 2 Greenwich Plaza 2 nd Floor Greenwich, CT 06830 Tax ID No.: Contact Name: Don McCarthy, CFO Telephone: 203-485-8820 Back office contact: Michael Owens 203-485-8823
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 8,500
Aggregate Purchase Price: $8,500,000
Name of Investor: JMG Capital Partners LP
By: /s/ JONATHAN GLASS Print Name: Jonathan Glass Title: Manager of the GP Address: 11601 Wilshire Blvd., Suite 2180 Los Angeles, CA 90025 Tax ID No.: 68-0271606 Contact Name: Noelle Newton Telephone: 310-601-2825 Back office contact:
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 ($30 million notional)
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Kamunting Street Master Fund, Ltd.
Number of Securities Allocated to Investor: 10,000
Aggregate Purchase Price: $10,000,000
By: /s/ GREGOR DANNALHER Print Name: Gregor Dannalher Title: Senior Analyst Address: 140 East 45 th Street, 15 th Floor New York, NY 10017 Tax ID No.: 98-0427034 Contact Name: Christopher Falsetta Telephone: 212-490-4343 Back office contact: Jason Abrams 212-490-4355
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: KBC Financial Products Cayman Islands Ltd.
Number of Securities Allocated to Investor: 12,000
Aggregate Purchase Price: $12,000,000
By: /s/ JASON CUEVAS Print Name: Jason Cuevas Title: Managing Director Address: 140 East 45 th Street, 42 nd Floor New York, NY 10017 Tax ID No.: 061556254 Contact Name: Ann Difilppo Telephone: 212-845-2833 Back office contact: Ben Locascio 212-845-2916
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 5,000
Aggregate Purchase Price: $5,000,000
Name of Investor: LibertyView Funds, L.P.
By: /s/ STEVEN S. ROGERS Print Name: Steven S. Rogers Title: Authorized Signatory Address: LibertyView Capital Management, Attn: Spencer Kornreich 111 River Street – Suite 1000, Hoboken, NJ 07030 Tax ID No.: Contact Name: Spencer Kornreich Telephone: 201-595-2992 Back office contact: Robert Olsen 201-216-8606
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 shares
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 8,500
Aggregate Purchase Price: $8,500,000
Name of Investor: Linden Capital L.P.
By: /s/ CRAIG JARVIS Print Name: Craig Jarvis Title: Authorized Signatory Address: 18 Church Street, Skando House Hamilton, HM11, Bermuda Tax ID No.: 98-0430338 Contact Name: Craig Jarvis Telephone: 646-840-3510 or 3500 Back office contact: Peter Greenberg 646-840-3539
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 20,000 shares ($20 million of notional)
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
Name of Investor: Marathon Global Convertible Master Fund, Ltd.
By: /s/ CHRISTOPHE THOMAS Print Name: Christophe Thomas Title: Managing Director Address: 461 Fifth Avenue, 10 th Floor New York, NY 10017 Tax ID No.: N/A Contact Name: Christophe Thomas Telephone: 212-381-4421 Back office contact: David Hazan 212-381-4487
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 15,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 10,000
Aggregate Purchase Price: $10,000,000
Name of Investor: OZ Master Fund, Ltd.
By: /s/ JOEL FRANK Print Name: Joel Frank Title: Chief Financial Officer Address: 9 West 57 th St., 39 th Floor New York, NY 10019 Tax ID No.: 13-3982250 Contact Name: Joel M. Frank Telephone: 212-790-0160 Back office contact: Sean Rhatigan 212-790-0166
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 shares
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Parabolic Parners Cap. Mgt LLC, as investment advisor of Parabolic Partners Master Fund, Ltd.
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
By: /s/ A. PAUL BOWYER Print Name: A. Paul Bowyer Title: Managing Member Address: 396 Springfield Ave. Summet, NJ 07901 Tax ID No.: 98-0462853 Contact Name: Paul Bowyer Telephone: 908-918-0118 Back office contact: Sophie Chen 908-918-0118
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Polygon Global Opportunities Master Fund
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
By: Polygon Investment Partners LP
By: /s/ WILLIAM W. HOBAN Print Name: William W. Hoban Title: Portfolio Manager Address: 598 Madison Ave. 14 th Floor New York, NY 10022 Tax ID No.: 98-0397839 Contact Name: William W. Hoban Telephone: 212-359-7487 Back office contact: James Piachard 212-359-7336
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Ramius Capital Group for Ramius Master Fund LTD (tax ID: 98-0395643) And RCG Latitude Master Fund LTD (tax ID: 98-0223347)
Number of Securities Allocated to Investor: 5,000
Aggregate Purchase Price: $5,000,000
By: /s/ MORGAN STARK Print Name: Morgan Stark Title: Managing Partner Address: 616 Third Avenue, 26 th Floor New York, NY 10017 Tax ID No.: Contact Name: Robert Ryon Telephone: 212-845-7924 Back office contact: James Wilk
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Radcliffe SPC Ltd. For and on behalf of the Class A Convertible Crossover Segregated Portfolio,
By: RG Capital Management, L.P., By: RGC Management Company LLC
Number of Securities Allocated to Investor: 15,000
Aggregate Purchase Price: $15,000,000
AGREED AND ACCEPTED:
By: /s/ GERALD STAHLECKER Print Name: Gerald F. Stahlecker Title: Managing Director Address: 3 Bala Plaza East, Suite 501 Bala Cynwyd, PA 19004-3481 Tax ID No.: 98-0381209 Contact Name: Gerald F. Stahlecker Telephone: 610-617-5900 Back office contact: Mike Campbell 610-617-5900
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 shares [purchase price = $30 million]
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Funds Managed by Rumson Capital LLC
Address: The Galleria, Bldg. Three, 2 Bridge Ave. Red Bank, NJ 07701 Tax ID No.: XAVEX: 300245670, ZURICH: 13-4147177, NAVESINK: 98-0346624, ALPHA: 13-4129748, MSS: (Cayman Islands) Contact Name: Bill Brennan Telephone: 732-450-7410 Back office contact: Mitch Gordon 732-450-7408 _____________________________________________
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
AGREED AND ACCEPTED:
By: /s/ JOHN BURKE Print Name: John Burke Title: Managing Partner
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 30,000 ($30,000,000)
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Sandelman Partners
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
AGREED AND ACCEPTED:
By: /s/ MICHAEL J. PASCULTI Print Name: Michael J. Pasculti Title: Partner Address: 500 Park Avenue New York, NY 10022 Tax ID No.: 980456839 Contact Name: Chris Zabark Telephone: 212-299-7604 Back office contact: Eric Roppa 212-299-7607
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 50,000 shares ($50,000,000 liquidation preference)
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Satellite Credit Opportunities Fund, Ltd.
Number of Securities Allocated to Investor: 2,500
Aggregate Purchase Price: $2,500,000
AGREED AND ACCEPTED:
By: Satellite Management, L.P., its Investment Manager
By: /s/ SIMON RAYKHER Print Name: Simon Raykher Title: General Counsel Address: 623 Fifth Avenue, 19 th floor New York, NY 10022 Tax ID No.: N/A Contact Name: Gene Gaeta Telephone: 212-209-2045 Back office contact: Heather Campbell 212-209-2018
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 50,000 shares ($50,000,000 liquidation preference)
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Satellite Convertible Arbitrage Master Fund LLC
Number of Securities Allocated to Investor: 2,500
Aggregate Purchase Price: $2,500,000
AGREED AND ACCEPTED:
By: Satellite Management, L.P., its Investment Manager
By: /s/ SIMON RAYKHER Print Name: Simon Raykher Title: General Counsel Address: 623 Fifth Avenue, 19 th floor New York, NY 10022 Tax ID No.: 98-0399374 Contact Name: Ramin Mozaffarian Telephone: 212-209-2093 Back office contact: Heather Campbell 212-209-2018
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 24,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Shephred Investments International, Ltd.
Number of Securities Allocated to Investor: 8,000
Aggregate Purchase Price: $8,000,000
By: /s/ MICHAEL A. ROTH Print Name: Michael A. Roth Title: Managing Member of its Investment Manager Address: c/o Stark Offshore Management LLC 3600 South Lake Drive, St. Francis, WI 53235 Tax ID No.: 30-0044149 Contact Name: Robert Prellwitz Telephone: 414-294-7000 Back office contact: James Rittenhouse 414-294-7000
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 6,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 2,000
Aggregate Purchase Price: $2,000,000
Name of Investor: Stark Trading
By: /s/ MICHAEL A. ROTH Print Name: Michael A. Roth Title: Managing Member of its Managing General Partner Address: 3600 South Lake Drive St. Francis, WI 53235 Tax ID No.: 98-0148910 Contact Name: Robert Prellwitz Telephone: 414-294-7000 Back office contact: James Rittenhouse 414-294-7000
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: $20,000,000.00
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 12,000
Aggregate Purchase Price: $12,000,000
Name of Investor: Susquehanna Capital Group
By: /s/ JACK GREENBERG Print Name: Jack Greenberg Title: Managing Director Address: 401 City Ave. Bala Cynwyd, PA 19004 Tax ID No.: 23-2795205 Contact Name: Michael Ferry Telephone: 610-617-2802 Back office contact: John Riccardi 610-617-2826
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 50,000 shares
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 12,000
Aggregate Purchase Price: $12,000,000
Name of Investor: SuttonBrook Capital Portfolio LP
By: /s/ BRETT SPECTOR Print Name: Brett Spector Title: Authorized Person Address: 598 Madison Ave. 6 th Floor New York, NY 10022 Tax ID No.: 98-0367010 Contact Name: Brett Spector Telephone: 212-588-6622 Back office contact: Brett Spector 212-588-6622
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 440,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 9,000
Aggregate Purchase Price: $9,000,000
Name of Investor: TQA Investors LLC
By: /s/ DARREN J. LONGIS Print Name: Darren J. Longis Title: Principal Address: 333 Ludlow St. Stamford, CT 06902 Tax ID No.: 98-0220992 Contact Name: Bart Tesoriero Telephone: 203-653-3020 Back office contact: Aaron Warun
AGREED AND ACCEPTED: HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities:
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
Name of Investor: UBS A.G. (London Branch)
By: /s/ RICHARD SIMPSON Print Name: Richard Simpson Title: Managing Director Address: 1285 6 th Ave., 9 th FLoor New York, NY 10019 Tax ID No.: 13-3873456 Contact Name: _________________________________ Telephone: 203-719-8581 Back office contact: Rosmarie Mancuso
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: $25,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Whitebox Advisors, LLC – investment manager to: Whitebox Convertible Arbitrage Partners LP, Whitebox Diversified Convertible Arbitrage Partners, L.P., HFR RVA Combined Master Trust, Guggenheim Portfolio XXXI, LLC
Number of Securities Allocated to Investor: 6,500
Aggregate Purchase Price: $6,500,000
By: /s/ ANDREW REDLEAF Print Name: Andrew Redleaf Title: Managing Member of the General Partner Address: 3033 Excelsior Blvd, Suite 300 Minneapolis, MN 55416 Tax ID No.: N/A Contact Name: Rob Vogel Telephone: 612-253-6028 Back office contact: Andrea Schroeder 612-253-6060
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
Maximum Number of Securities: 40,000 shares or $40,000,000
Please confirm that the foregoing correctly sets forth the agreement between us by signing in the space provided below for that purpose.
Name of Investor: Zazove Associates, LLC, as investment advisor with discretionary authority
Number of Securities Allocated to Investor: 15,000
Aggregate Purchase Price: $15,000,000
By: /s/ STEVE KLIEMAN Print Name: Steve Klieman Title: COO Address: 940 Southwood, Suite 200 Incline Village, NV 89451 Tax ID No.: 36-3984373 Contact Name: Steve Klieman Telephone: 847-239-7100 Back office contact: Tami Kuha 775-832-6250
AGREED AND ACCEPTED:
HealthSouth Corporation, a Delaware corporation
By: /s/ JOHN WORKMAN Name: John Workman
Title: Executive Vice President and Chief Financial Officer
INSTRUCTION SHEET FOR INVESTOR
(to be read in conjunction with the entire Agreement)
Complete the following items in the Agreement:
1. Provide the information regarding the Investor requested on page 2. The Agreement must be executed by an individual authorized to bind the Investor.
2. Return the signed Agreement to:
Citigroup Global Markets Inc. 390 Greenwich St., 5th Floor New York, NY 10013 Attn: Equity Syndicate Phone: 212-723-7300 Fax: 646-843-3922
An executed original signature page to the Agreement or a facsimile transmission thereof must be received by 12:00 noon New York time on February 28, 2006. Investors who send a facsimile transmission prior to such deadline must also submit an original via courier as soon thereafter as practicable.
ANNEX I TO THE SECURITIES PURCHASE AGREEMENT
TERMS AND CONDITIONS FOR PURCHASE OF SECURITIES
1. Authorization and Sale of Securities . The Company has authorized the sale of up to 400,000 Securities. The Company reserves the right to increase or decrease this number.
2. Agreement to Sell and Purchase the Securities; Placement Agents.
2.1. Upon the terms and subject to the conditions hereinafter set forth, at the Closing (as defined in Section 3), the Company will sell to each Investor, and each Investor will purchase from the Company, up to the aggregate number of Securities set forth on each Investor’s signature page hereto at the purchase price of $1,000 per share; provided that, if the Company sells and the Investor buys an amount of Securities less than the aggregate number of Securities set forth on such Investor’s signature page hereto, the total aggregate purchase price of such Securities will be reduced proportionately.
2.2. Each Investor acknowledges that the Company intends to pay Citigroup Global Markets Inc., J.P. Morgan Securities Inc., Merrill
Lynch, Pierce, Fenner and Smith Incorporated, Deutsche Bank Securities Inc., Goldman Sachs & Co. and Wachovia Capital Markets, LLC (collectively, the “ Placement Agents ” ) a fee in respect of the sale of Securities to the Investors.
3. Closings and Delivery of Securities and Funds .
3.1. The completion of the purchase and sale of the Securities (the “ Closing ”) shall occur at the offices of the Company’s counsel on March 7, 2006 (the “ Scheduled Closing Date ”), unless the Closing is delayed by the Company pursuant to Section 3.2 hereof (the date on which the Closing occurs being the “ Closing Date ”). At the Closing, (i) the Company shall cause the Escrow Agent to deliver to the Investors the Accepted Securities (as defined below) registered in the name of the applicable Investors, and (ii) the aggregate purchase price for the Accepted Securities (as defined below) shall be delivered by or on behalf of the Investors to the Company.
3.2. The Closing shall occur on the Scheduled Closing Date (i) if the aggregate amount of funds deposited by the Investors with the Escrow Agent is at least $150,000,000 on such date and (ii) the conditions set forth in Section 6 are satisfied. If the aggregate amount of funds deposited by the Investors with the Escrow Agent is less than $150,000,000 on the Schedule Closing Date, the Company may either (a) proceed with the Closing on such date or (b) delay the Closing until a date that is no later than March 9, 2006 (the “ Delayed Closing Date ”), at which time the Closing shall occur if, at such time, at least $150,000,000 in aggregate amount of funds shall have been deposited by the Investors with the Escrow Agent. If the Closing is delayed pursuant to clause (b) above and the aggregate amount of funds deposited by the Investors with the Escrow Agent remains less than $150,000,000 on the Delayed Closing Date, the Company may either (x) proceed with the Closing on the Delayed Closing Date or (y) terminate this Agreement on the Delayed Closing Date without liability on the part of the non-defaulting Investors or on the part of the Company, except for the Company’s obligation to pay Investor’s fees and expenses in accordance with Section 5.11. Nothing contained herein shall relieve a defaulting Investor of any liability it may have to the Company or any non-defaulting Investor for damages caused by its default.
3.3. If, (i) on the Scheduled Closing Date or (ii) on the Delayed Closing Date, any Investor defaults on its obligation to purchase the Accepted Securities that it has agreed to purchase, the Company and the non-defaulting Investors may in their discretion arrange for the purchase of such Accepted Securities by any Investor on the terms contained in this Agreement, which purchase shall occur (a) if the Closing occurs on the Scheduled Closing Date, on the Scheduled Closing Date or at any time thereafter until the Delayed Closing Date or (b) if the Closing occurs on the Delayed Closing Date, on the Delayed Closing Date, or (c) with respect to defaults that occur on the Delayed Closing Date, as soon as practicable after the Delayed Closing Date.
3.4. If the Company accepts the Investors’ offer to buy Securities in whole or in part, the Company or its representatives shall notify
each Investor at the telephone number provided on such Investor’s
Such funds shall be held in escrow until the Closing and delivered by the Escrow Agent on behalf of the Investors to the Company upon the satisfaction of the conditions to the obligations of the Investors set forth in Section 6 hereof. If the Investor does not remit the necessary funds to purchase its Accepted Securities on or prior to the Closing Date as specified above, the Investor shall as soon as practicable following the Closing Date purchase such Accepted Securities from the Company as required by this Agreement at a price per Accepted Security that shall include accumulated and unpaid dividends on the Accepted Securities from and including the Closing Date to but excluding the date of payment, computed on the basis of a 360-day year consisting of twelve 30-day months.
signature page hereto of the number of Securities (the “ Accepted Securities ”) that the Company shall sell to such Investor and such Investor shall buy. Payment by an Investor for the Accepted Securities shall be made by wire transfer of immediately available funds to the Escrow Agent in accordance with Section 3.6 below. If the Escrow Agent determines that the conditions to the Closing are satisfied (which determination may be made based upon delivery of an officers’ certificate of the Company pursuant to Section 6.2(b) hereof), it shall deliver each Investor’s payment to the Company and the corresponding Accepted Securities to the DTC account specified in the Investor signature pages hereto. If such conditions to the Closing are not satisfied, the Escrow Agent shall return each Investor’s funds to the applicable Investor.
3.5. Subject to the provisions of Sections 3.2 and 3.3, the Company’s obligation to issue and sell the Accepted Securities to the Investors shall be subject only to the accuracy of the representations and warranties made by the Investors and the fulfillment of those undertakings of the Investors to be fulfilled prior to the Closing. The Investors’ respective obligations to purchase the Accepted Securities shall be subject to the conditions set forth in Section 6 hereof.
3.6. Promptly after the Company notifies each Investor of the Accepted Securities that the Company shall sell to such Investor, but in any event no later than one business day prior to the Closing Date, such Investor shall remit by wire transfer the amount of funds equal to the aggregate purchase price for the Accepted Securities being purchased by such Investor to the following account designated by the Company pursuant to the terms of the Escrow Agreement (the “ Escrow Agreement ”) a copy of which is attached hereto as Exhibit B relating to the offering of the Securities and entered into by and among the Company and the Escrow Agent:
Bank Name: JP MorganChase New York, NY Bank ABA: 021-000-021 BNF Acct.: 323-161413 BNF Acct Name: Mellon Investor Services LLC Re: HealthSouth Corporation Attn: Vivian Gibson Tel. No.: (201) 680-3306
3.7. Prior to or promptly after the execution of this Agreement by the Investors and the Company, each Investor shall direct the broker-dealer at which the account or accounts to be credited with its Securities are maintained (which broker/dealer shall be a DTC participant) to set up a Deposit/Withdrawal at Custodian (“ DWAC ”) instructing the Escrow Agent to credit such account or accounts with the Securities by means of an electronic book-entry delivery. Such DWAC shall indicate the settlement date for the deposit of the Securities, which date shall be provided to the Investors by the Placement Agents. Simultaneously with the delivery to the Company by the Escrow Agent of the funds held in escrow pursuant to Section 3.6 above, the Company shall direct the Escrow Agent to credit each Investor’s account or accounts with the Securities pursuant to the information contained in the DWAC.
4. Representations, Warranties and Covenants of the Company . The Company hereby represents and warrants to, and covenants with, each Investor, that:
4.1. The Company has full right, power, authority and capacity to enter into this Agreement, to issue and sell the Securities and to
consummate the other transactions contemplated hereby, and has taken all
necessary action to authorize the execution, delivery and performance of this Agreement. This Agreement is a legally valid and binding obligation of the Company enforceable against the Company in accordance with its terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and other laws of general application affecting enforcement of creditors’ rights generally, rules of law governing specific performance, injunctive relief and equitable remedies. The Securities will be, as of the Closing Date, duly authorized by the Company and, when issued, delivered to and paid for by the Investors in accordance with this Agreement, will be validly issued, fully paid and non-assessable and entitled to the rights, privileges and preferences set forth in the Certificate of Designations and will be free of restrictions on transfer, other than restrictions of transfer under this Agreement and under applicable state and federal securities laws. Neither the issuance, sale or delivery of the Securities nor, upon the conversion thereof, the issuance or delivery of the Common Stock is subject to any preemptive right of stockholders of the Company arising under law or the restated certificate of incorporation or by-laws of the Company, or to any contractual right of first refusal or other right in favor of any person.
4.2. As of December 31, 2005, the Company’s authorized capital stock consisted of 600,000,000 shares of Common Stock, 397,708,468
of which are outstanding, and 1,500,000 shares of preferred stock, none of which are outstanding.
4.3. Neither the Company nor any of its subsidiaries is, or after giving effect to the offering and sale of the Securities and upon application of the proceeds as described in the private placement memorandum dated February 28, 2006, relating to the offering and sale of the Securities (including any documents incorporated by reference therein and as supplemented or amended prior to the Closing Date, the “ Private Placement Memorandum ”) will be, an “investment company” or a company “controlled” by an “ investment company” within the meaning of the Investment Company Act of 1940, as amended.
4.4. Both the preliminary copy and the final copy of the Private Placement Memorandum, as of their respective dates and (in the case of the final copy of the Private Placement Memorandum) as of the Closing Date, in each case taken together with the Company’s Exchange Act Filings (as defined below) that are publicly filed on or prior to such date, did not and will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. The Company notes that as of the date hereof, it has not filed, and does not intend to file, its quarterly reports with the Securities and Exchange Commission (“ Commission ”) for its fiscal quarters ending March 31, 2005, June 30, 2005 and September 30, 2005, and in connection with the purchase of the Securities the Investors will not have access to the information that would have been contained therein.
4.5. Assuming the accuracy of the representations and warranties made by the Investors contained in this Agreement, the issuance and sale to the Investors of the Securities in the manner contemplated by this Agreement are exempt from the registration requirements of the Securities Act. No form of general solicitation or general advertising within the meaning of Regulation D was used by the Company or, to the best of the Company’s knowledge, any of its representatives in connection with the offer and sale of the Securities.
4.6. The Company has been duly organized and is validly existing and in good standing under the laws of the State of Delaware and has been duly qualified to do business and is in good standing as a foreign entity in each jurisdiction in which its ownership or lease of property or the conduct of its business requires such qualification (except such failures to qualify as are not, either individually or in the aggregate, material to the Company and its subsidiaries taken as a whole and except for jurisdictions not recognizing the legal concept of good standing), and has all power and authority necessary to own or hold its properties and to conduct its business.
4.7. As of December 31, 2005, all of the issued shares of capital stock of the Company have been duly authorized and validly issued and
are fully paid and non-assessable. The shares of Common Stock initially issuable upon conversion of the Securities have been duly authorized and reserved for issuance or delivery out of treasury upon such conversion and, when issued and delivered or delivered
out of treasury in accordance with the provisions of the restated certificate of incorporation of the Company, will be validly issued, fully paid and non-assessable. All of the issued shares of capital stock of each subsidiary of the Company have been duly and validly authorized and issued and are fully paid and non-assessable and (except (i) for directors’ qualifying shares or foreign national qualifying capital stock, if applicable, (ii) as otherwise set forth in the Company’s public filings on Forms 10-K, 10-Q and 8-K, including any amendments thereto (collectively, the “ Exchange Act Filings ”), and (iii) as pledged to secure indebtedness of the Company and/or its subsidiaries pursuant to credit facilities, indentures and other instruments evidencing indebtedness as contemplated by the Company’s Exchange Act Filings and existing or to be entered into on the Closing Date) are owned directly or indirectly by the Company, free and clear of all liens, encumbrances, equities or claims (except where such failures to own are not, either individually or in the aggregate, material to the Company and its subsidiaries taken as a whole).
4.8. The Certificate of Designations has been duly authorized by the Company. Upon issuance and delivery of the Securities in
accordance with this Agreement, the Securities will be convertible at the option of the holder thereof into the Common Stock in accordance with the terms of the Certificate of Designations.
4.9. The Company has all requisite corporate power and authority to enter into the Registration Rights Agreement to be entered into with the Investors on the Closing Date (the “ Registration Rights Agreement ”). The Registration Rights Agreement has been duly authorized by the Company and, when executed and delivered by the Company, will be validly executed and delivered and (assuming the due authorization, execution and delivery thereof by the Investors) will be the legally valid and binding obligation of the Company, enforceable against the Company in accordance with its terms subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and other laws of general application affecting enforcement of creditors’ rights generally, rules of law governing specific performance, injunctive relief and equitable remedies.
4.10. (a) The issue and sale of the Securities, the compliance by the Company with all of the provisions of the Securities, the authorization, execution and delivery and compliance by the Company with all of the provisions of and performance of the Certificate of Designations, the Registration Rights Agreement and this Agreement, the use of the proceeds from the sale of the Securities and the consummation of the other transactions contemplated hereby and thereby (i) will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any indenture, mortgage, deed of trust, loan agreement, lease or other agreement or instrument to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries is bound or to which any of the property or assets of the Company or any of its subsidiaries is subject, (ii) will not result in any violation of the provisions of the restated certificate of incorporation or by-laws of the Company and (iii) will not violate any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties or assets; and (b) no consent, approval, authorization or order of, or filing, registration or qualification with, any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties or assets is required for the issue and sale of the Securities, the consummation by the Company of the transactions contemplated by the Registration Rights Agreement or this Agreement (including, without limitation, the use of the proceeds from the sale of the Securities), except (w) in the cases of clauses (a)(i) and (iii) only, for such conflicts, breaches, defaults and violations as would not reasonably be expected to have, either individually or in the aggregate, a material adverse change, or any development involving a prospective material adverse change, in or affecting the management, condition (financial or otherwise), stockholders’ equity, results of operations, business or prospects of the Company and its subsidiaries, taken as a whole (a “ Material Adverse Effect ”); (x) for such consent, approvals, authorizations, orders, filings, registrations or qualifications that have been obtained; and (y) for the filing of a registration statement by the Company with the Commission pursuant to the Securities Act as required by the Registration Rights Agreement.
4.11. Except as described in the Company’s Exchange Act Filings, there are no contracts, agreements or understandings between the
Company and any person granting such person the right to require the
Company to file a registration statement under the Securities Act with respect to any securities of the Company owned or to be owned by such person or to require the Company to include such securities in the securities registered pursuant to the Registration Rights Agreement or in any securities being registered pursuant to any other registration statement filed by the Company under the Securities Act.
4.12. During the six-month period preceding the date of the Private Placement Memorandum and from the date of the Private Placement Memorandum through the Closing Date, none of the Company or any other person acting on behalf of the Company has offered or sold to any person any Securities, or any securities of the same or a similar class as the Securities, other than Securities offered or sold to the Investors pursuant to this Agreement.
4.13. The Company’s financial statements included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed with the Commission on December 2, 2005, present fairly the consolidated financial position, results of operations and cash flows of the Company and its subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended; such financial statements and related schedules and notes have been prepared in accordance with U.S. generally accepted accounting principles (“ GAAP ” ) consistently applied throughout the periods involved, except as disclosed therein.
4.14. Neither the Company nor any of its subsidiaries has sustained, since the date of the latest audited financial statements of the Company, any material loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Company’s Exchange Act Filings and, since such date, there has not been any material change in the stockholders’ equity or long-term debt of the Company or any of its subsidiaries or any Material Adverse Effect, either individually or in the aggregate, otherwise than as set forth in the Company’s Exchange Act Filings.
4.15. The Company and each of its subsidiaries has good and marketable title in fee simple to all real property and good and marketable title to all personal property owned by them, in each case free and clear of all liens, encumbrances and defects (“ Encumbrances ”), except (i) for liens for taxes not yet due or payable, (ii) as are described in the Exchange Act Filings and (iii) as would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect; and all real property and buildings held under lease by the Company or any of its subsidiaries are held by them under valid, subsisting and enforceable leases, except as would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.
4.16. Each of the Company and its subsidiaries holds and is operating in compliance (in all material respects) with all material franchises, grants, authorizations, licenses, permits, easements, consents, certificates and orders of any governmental or self-regulatory body required for the conduct of its business, and all of such are valid and in full force and effect, and each of the Company and its subsidiaries is in compliance in all material respects with all laws, regulations, orders and decrees applicable to it which have a material effect on its business, properties or assets.
4.17. To the best of the Company’s knowledge after reasonable investigation, neither the Company nor any subsidiary, nor any employee
or agent thereof, has made any payment of funds of the Company or any subsidiary or received or retained any funds in violation of any law, rule or regulation, which violation could have, either individually or in the aggregate, a Material Adverse Effect.
4.18. The Company and each of its subsidiaries carry, or are covered by, insurance in such amounts and covering such risks as is adequate for the conduct of their respective businesses and the value of their respective properties and as is customary for companies engaged in similar businesses in similar industries, except as would not reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect.
4.19. The Company and each of its subsidiaries (i) own or possess adequate rights to use all patents, patent applications, trademarks,
service marks, trade names, trademark registrations, service mark registrations, copyrights and licenses necessary for the conduct of their respective businesses and
(ii) have no reason to believe that the conduct of their respective businesses will conflict with, and have not received any written notice of any claim of conflict with, any such rights of others, except with respect to clauses (i) and (ii) as would not reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect.
4.20. Except as described in the Company’s Exchange Act Filings, there are no legal or governmental proceedings pending to which the Company or any of its subsidiaries is a party or to which any property or assets of the Company or any of its subsidiaries is the subject that, if determined adversely to the Company or any of its subsidiaries, could have, either individually or in the aggregate, a Material Adverse Effect, and to the best of the Company’s knowledge, no such proceedings are threatened by governmental authorities or threatened by others.
4.21. The Company is in compliance in all material respects with all presently applicable provisions of the Employee Retirement Income Security Act of 1974, as amended, including the regulations and published interpretations thereunder (“ ERISA ”); no “reportable event” (as defined in ERISA) has occurred with respect to any “pension plan” (as defined in ERISA) for which the Company would have any liability; the Company has not incurred and does not expect to incur liability under Title IV of ERISA with respect to termination of, or withdrawal from, any such “pension plan”; no such “pension plan” for which the Company would have any liability has incurred an “accumulated funding deficiency” as defined in Section 412 of the Internal Revenue Code of 1986, as amended, including the regulations and published interpretations thereunder (the “ Code ”), as of the last day of the most recent fiscal year of such plan ended before the date hereof, nor does the Company have or expect to incur liability for a tax under Section 4971 of the Code; and each such “pension plan” for which the Company would have any liability that is intended to be qualified under Section 401(a) of the Code is so qualified in all material respects and nothing has occurred, whether by action or by failure to act, which would cause the loss of such qualification.
4.22. The Company has filed within the time prescribed by law (including extensions of time approved by the appropriate taxing authority) all federal, state and local income and franchise tax returns required to be filed through the date hereof, except where the failure to file would not, individually or in the aggregate, have a Material Adverse Effect and has paid all taxes shown as due thereon other than those taxes contested in good faith and where the failure to pay would not, individually or in the aggregate, have a Material Adverse Effect, and no tax deficiency has been determined adversely to the Company or any of its subsidiaries that has had (nor does the Company have any knowledge of any tax deficiency that, if determined adversely to the Company or any of its subsidiaries, might have) or could reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect.
4.23. Except as disclosed in the Company’s Exchange Act Filings there are not currently, and will not be as a result of the offering of the
Securities, any outstanding subscriptions, rights, warrants, calls, commitments of sales or options to acquire, or instruments convertible into or exchangeable for, any capital stock or equity interest of the Company or any of its subsidiaries.
4.24. Except as disclosed in Company’s Exchange Act Filings and except in the case of clause (i), but only with respect to subsidiaries of the Company, and clauses (ii) and (iii) for such violations and defaults that would not, individually or in the aggregate, reasonably be expected to result in a Material Adverse Effect, neither the Company nor any of its subsidiaries (i) is in violation of its charter, by-laws or applicable organizational documents, (ii) is in default, and no event has occurred that, with notice or lapse of time or both, would constitute such a default, in the due performance or observance of any term, covenant, condition or other obligation contained in any indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which it is a party or by which it is bound or to which any of its properties or assets is subject or (iii) is in violation of any law, ordinance, governmental rule, regulation or court decree to which it or its property or assets may be subject or has failed to obtain or maintain any license, permit, certificate, franchise or other governmental authorization or permit necessary to the ownership of its property or to the conduct of its business.
4.25. Except as disclosed in Company’s Exchange Act Filings, and except for such matters as would not, individually or in the aggregate, result in a Material Adverse Effect, the Company and its subsidiaries (1) are conducting and have conducted their businesses, operations and facilities in compliance with Environmental Laws (as defined below); (2) have not received any written notice from a governmental authority or any other third party alleging any violation of Environmental Law or liability thereunder (including, without limitation, liability as a “potentially responsible party” and/or for costs of investigating or remediating sites containing Hazardous Substances (as defined below) and/or damages to natural resources); (3) are not subject to any pending or, to the knowledge of the Company or any of its subsidiaries, threatened claim or other legal proceeding under any Environmental Laws against the Company or its subsidiaries; and (4) do not have any knowledge of any pending Environmental Law or any release of Hazardous Substances that, individually or in the aggregate, would reasonably be expected to form the basis of any such claim or legal proceeding under any Environmental Law against the Company or its subsidiaries or to require any material capital expenditures to maintain the Company’s or the subsidiaries’ compliance with Environmental Law. As used in this paragraph, “ Environmental Laws ” means any and all applicable federal, state, local, and foreign laws, statutes, ordinances, rules, regulations, enforceable requirements and common law, or any enforceable administrative or judicial interpretation, order, consent, decree or judgment thereof, relating to pollution or the protection of human health or the environment, including, without limitation, those relating to, regulating or imposing liability or standards of conduct concerning (i) noise or odor; (ii) emissions, discharges, releases or threatened releases of Hazardous Substances into ambient air, surface water, groundwater or land; (iii) the generation, manufacture, processing, distribution, use, treatment, storage, disposal, release, transport or handling of, or exposure to, Hazardous Substances; or (iv) the investigation, remediation or cleanup of any Hazardous Substances. As used in this paragraph, “ Hazardous Substances ” means pollutants, contaminants or hazardous, dangerous, toxic, biohazardous or infectious substances, materials, constituents or wastes or toxins, petroleum, petroleum products and their breakdown constituents, or any other hazardous or toxic chemical substance regulated under Environmental Laws or exhibiting a hazardous waste characteristic including, but not limited to, corrosivity, ignitability, toxicity or reactivity, whether solid, gaseous or liquid in nature.
4.26. The Securities will satisfy, as of the date of the Private Placement Memorandum and as of the Closing Date, the eligibility
requirements of Rule 144A(d)(3) under the Securities Act.
4.27. The Company shall have obtained all necessary Blue Sky law permits and qualifications, or have the availability of exemptions
therefrom, required by any state for the offer and sale of the Securities.
4.28. With respect to Securities that are no longer “restricted securities” within the meaning of Rule 144(a)(3) under the Securities Act on a conversion date (as such term is defined in the Certificate of Designation), either as a result of a resale of the Securities pursuant to a registration statement or otherwise, all shares of Common Stock distributed upon conversion will be freely transferable without restriction under the Securities Act, other than by affiliates of the Company.
4.29. Each significant subsidiary of the Company, as defined in accordance with regulation S-X promulgated under the Securities Act of 1933, (1) has been duly organized and is validly existing and in good standing under the laws of the jurisdiction of its incorporation and has all power and authority necessary to own or hold its properties and to conduct its business, except those the absence of which would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect; and (2) has been duly qualified to do business and is in good standing as a foreign entity in each jurisdiction in which its ownership or lease of property or the conduct of its business requires such qualification, except for those failures to be so qualified which would not, either individually or in the aggregate, reasonably be expected to have a Material Adverse Effect and except for jurisdictions not recognizing the legal concept of good standing.
5. Further Agreements of the Company . The Company further covenants with each Investor that:
5.1. For so long as any of the Securities remain outstanding and are “restricted securities” within the meaning of Rule 144(a)(3) under
the Securities Act, the Company will make available at its expense, upon request, to any holder of such Securities and any prospective purchasers thereof the information
specified in Rule 144A(d)(4) under the Securities Act, unless the Company is then subject to Section 13 or 15(d) of the Exchange Act.
5.2. The Company shall reserve and keep available at all times, free of preemptive rights, shares of Common Stock for the purpose of
enabling the Company to satisfy any obligation to issue shares of its Common Stock upon conversion of the Securities.
5.3. The Company will take such steps as shall be necessary to ensure that neither the Company nor any of its subsidiaries becomes an
“investment company” or a company “controlled” by an “investment company” within the meaning the Investment Company Act of 1940, as amended.
5.4. The Company will comply, in all material respects, with all applicable securities and other applicable laws, rules and regulations, including, without limitation, the Sarbanes Oxley Act, and to use its best efforts to cause the Company’s directors and officers, in their capacities as such, to comply with such laws, rules and regulations, including, without limitation, the provisions of the Sarbanes Oxley Act.
5.5. For a period of two years (calculated in accordance with paragraph (d) of Rule 144 under the Securities Act) following the date any
Securities are acquired by the Company or any of its affiliates (as defined in Rule 144A under the Securities Act), none of the Company or any of its affiliates will sell any such Securities.
5.6. The Company will use all commercially reasonable efforts to (i) cause the Securities to be designated as PORTAL-eligible
securities in accordance with the rules and regulations adopted by the NASD relating to trading in the NASD’s Portal Market and (ii) cause the Securities to be eligible for clearance and settlement through The Depository Trust Company.
5.7. The Company has not taken, and will not take, directly or indirectly, any action designed to or that would constitute or that might
reasonably be expected to cause or result in, under the Exchange Act or otherwise, stabilization or manipulation of the price of any security of the Company.
5.8. The Company will take reasonable precautions to ensure that any offer or sale, direct or indirect, in the United States or to any U.S. person (as defined in Rule 902 under the Securities Act), of any Securities or any substantially similar security issued by the Company, within six months subsequent to the date on which the distribution of the Securities has been completed, is made under restrictions and other circumstances reasonably designed not to affect the status of the offer and sale of the Securities in the United States and to U.S. persons contemplated by this Agreement as transactions exempt from the registration provisions of the Securities Act, including any sales pursuant to Rule 144A under, or Regulation D or S of, the Securities Act.
5.9. Without the prior written consent of Citigroup Global Markets Inc., J.P. Morgan Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, for a period of 90 days from the date of the Private Placement Memorandum, the Company agrees not to (a) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any equity securities of the Company or any securities convertible into or exercisable or exchangeable for equity securities of the Company or (b) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the equity securities of the Company, whether any such transaction described in clause (a) or (b) above is to be settled by delivery of equity securities or such other securities, in cash or otherwise, other than (i) the Securities, (ii) the shares of Common Stock issuable upon conversion of the Securities, (iii) the issuance by the Company of shares of Common Stock upon the exercise of an option or a warrant or the conversion of a security, in each case outstanding on the date of the Private Placement Memorandum, (iv) the grant by the Company of employee, officer or director stock options and the issuance by the Company of any shares of Common Stock upon the exercise of any option (regardless of when issued) under any employee, officer or director stock option or similar benefit plan, (v) the issuance by the Company of shares of Common Stock, stock appreciation rights or common stock equivalents or warrants, rights or options to purchase any of the foregoing, pursuant to any employee, officer or director stock option, stock purchase or similar benefit plans and (vi) the issuance by the Company of any shares of
Common Stock, warrants or other securities or any securities issuable upon conversion of such warrants or other securities in connection with the Company’s previously announced preliminary agreement in principle to settle litigation filed against the Company, certain of its former directors and officers and certain other parties in the United States District Court for the Northern District of Alabama and the Circuit Court in Jefferson County, Alabama.
5.10. The Company will cooperate with the Investors and their counsel to qualify the Securities and the Common Stock or any other Securities into which it is Convertible for offer and sale under the securities or “Blue Sky” laws of such jurisdictions as any Investor shall reasonably request and will continue such qualifications in effect so long as required for the offering and resale of the Securities; provided that the Company shall not be required to (i) qualify as a foreign corporation or other entity or as a dealer in securities in any such jurisdiction where it would not otherwise be required to so qualify, (ii) take any action that would subject it to general service of process in any such jurisdiction or (iii) take any action that would subject itself to taxation in any such jurisdiction if it is not otherwise so subject.
5.11. The Company agrees to pay the costs and expenses relating to the following matters: (i) the preparation, printing or reproduction of the Private Placement Memorandum and each amendment or supplement thereto; (ii) the printing (or reproduction) and delivery (including postage, air freight charges and charges for counting and packaging) of such copies of the Private Placement Memorandum and all amendments or supplements thereto, as may, in each case, be reasonably requested for use in connection with the offering and sale of the Securities; (iii) the preparation, printing, authentication, issuance and delivery of certificates for the Securities, including any stamp or transfer taxes in connection with the original issuance and sale of the Securities; (iv) the printing (or reproduction) and delivery of this Agreement, the closing documents and all other agreements or documents printed (or reproduced) and delivered in connection with the offering of the Securities; (vi) the transportation and other expenses incurred by or on behalf of Company representatives in connection with presentations to prospective purchasers of the Securities; (vi) the fees and expenses of the Company’s accountants and the fees and expenses of counsel (including local and special counsel) for the Company; (vii) the fees and expenses of Debevoise & Plimpton LLP, special counsel to the Investors; (viii) the fees and disbursements of any transfer agent or registrar for the Securities; and (ix) all other costs and reasonable expenses incident to the performance by the Company of its obligations hereunder.
5.12. The Company agrees that neither it nor any other person acting on its behalf will provide any Investor or its agents or counsel with any information that the Company believes constitutes material non-public information, unless prior thereto such Investor shall have executed a written agreement regarding the confidentiality and use of such information. The Company understands and confirms that each Investor shall be relying on the foregoing representations in effecting transactions in securities of the Company. Notwithstanding the requirements in this Section 5.12, in the event of a breach of the foregoing agreement by the Company, any of its subsidiaries, or any of its or their respective officers, directors, employees and agents, in addition to any other remedy provided herein, any Investor shall have the right to make a public disclosure, in the form of a press release, public advertisement or otherwise, of such material, non-public information without the prior approval by the Company, its subsidiaries, or any of its or their respective officers, directors, employees or agents. No Investor shall have any liability to the Company, its subsidiaries, or any of its or their respective officers, directors, employees, stockholders or agents for any such disclosure.
6. Conditions of Investors’ Obligations . The obligation of each Investor to purchase Securities on the Closing Date is subject to the following conditions:
6.1. On the Closing Date the Company shall have delivered to Debevoise & Plimpton LLP (the “ Designated Investor Counsel ”), for
the benefit of the Investors, the opinion, dated the Closing Date and addressed to the Investors, of Skadden, Arps, Slate, Meagher & Flom LLP, counsel for the Company, substantially in the form set forth in Exhibit C to this Agreement.
On or before the Closing Date, the Company shall have delivered to the Designated Investors Counsel, for the benefit of the Investors, such further documents, certificates, letters and schedules or instruments relating to the business, corporate, legal and financial affairs of the Company and its subsidiaries as the Investors shall have reasonably requested from the Company reasonably in advance of the Closing Date so long as such further documents, certificates, letters and schedules or instruments are reasonable and customary for the transactions contemplated by this Agreement. Delivery of any such documents, certificates, letters and schedules or instruments to the Designated Investors Counsel shall be deemed to constitute delivery to the applicable Investors for all purposes hereunder.
All such documents, opinions, certificates, letters, schedules or instruments delivered pursuant to this Agreement will comply with the provisions hereof only if they are reasonably satisfactory in all material respects to the Designated Investors Counsel. The Company shall furnish to the Investors such conformed copies of such documents, certificates, letters, schedules and instruments in such quantities as the Investors shall reasonably request.
6.2. (a) (i) The representations and warranties of the Company contained in this Agreement shall be true and correct on and as of the date hereof and on and as of the Closing Date as if made on and as of the Closing Date, (ii) the statements of the Company’s officers made pursuant to any certificate delivered in accordance with the provisions hereof shall be true and correct on and as of the date made and on and as of the Closing Date, (iii) the Company shall have performed all covenants and agreements and satisfied all conditions on its part to be performed or satisfied hereunder at or prior to the Closing Date, (iv) except as described in the Company’s Exchange Act Filings (exclusive of any such filings after the date hereof), subsequent to December 31, 2004, there shall have been no event or development, and no information shall have become known, that, individually or in the aggregate, has or would be reasonably likely to have a Material Adverse Effect, and (v) the sale of the Securities hereunder and the use of the Private Placement Memorandum shall not be enjoined (temporarily or permanently) on the Closing Date and (b) on the Closing Date the Company shall have delivered to the Designated Investors Counsel, for the benefit of the Investors, a certificate of the Company, dated the Closing Date, signed on behalf of the Company by its Chief Financial Officer, to the effect that the conditions set forth in clause (a) above have been satisfied in all respects.
6.3. The Certificate of Designations shall have been duly executed and acknowledged by the Company and filed with the Secretary of
State of the State of Delaware and shall have become effective in accordance with the provisions of the General Corporation Law of the State of Delaware.
6.4. Citigroup Global Markets Inc., J.P. Morgan Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated have received the “lockup” agreements substantially in the form set forth in Exhibit D to this Agreement signed by certain officers and directors of the Company set forth in Schedule A hereto relating to sales and certain other dispositions of shares of the equity securities or certain other securities of the Company, and such agreements shall be in full force and effect on the Closing Date.
6.5. On the Closing Date the Investors shall have received the Registration Rights Agreement executed by the Company, and such
agreement shall be in full force and effect.
6.6. The Company shall have delivered to the Designated Investors Counsel, for the benefit of the Investors, satisfactory evidence of the good standing of the Company in its jurisdiction of organization and its good standing as a foreign entity in each jurisdiction in which its ownership or lease of property or the conduct of its businesses requires such qualification (except where the failure to so qualify is not material to the Company and its subsidiaries taken as a whole, and except for jurisdictions not recognizing the legal concept of good standing), in each case in writing or any standard form of telecommunication, from the appropriate governmental authorities of such jurisdictions.
THIS SECURITY (OR ITS PREDECESSOR) WAS ORIGINALLY ISSUED IN A TRANSACTION EXEMPT FROM REGISTRATION UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND THIS SECURITY MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN APPLICABLE EXEMPTION THEREFROM. EACH PURCHASER OF THIS SECURITY IS HEREBY NOTIFIED THAT THE SELLER OF THIS SECURITY MAY BE RELYING ON THE EXEMPTION FROM THE PROVISIONS OF SECTION 5 OF THE SECURITIES ACT PROVIDED BY RULE 144A THEREUNDER.
THE HOLDER OF THIS SECURITY AGREES FOR THE BENEFIT OF THE COMPANY THAT (A) THIS SECURITY MAY BE OFFERED, RESOLD, PLEDGED OR OTHERWISE TRANSFERRED, ONLY (I) TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER (AS DEFINED IN RULE 144A UNDER THE SECURITIES ACT) IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A, (II) PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT PROVIDED BY RULE 144 THEREUNDER (IF AVAILABLE), (III) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR (IV) TO THE COMPANY OR ANY OF ITS SUBSIDIARIES, IN EACH OF CASES (I) THROUGH (IV) IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES, AND (B) THE HOLDER WILL, AND EACH SUBSEQUENT HOLDER IS REQUIRED TO, NOTIFY ANY SUBSEQUENT PURCHASER OF THIS SECURITY FROM IT OF THE RESALE RESTRICTIONS REFERRED TO IN CLAUSE (A) ABOVE.
7. Representations, Warranties and Covenants of the Investors . Each Investor severally, and not jointly, hereby represents and warrants to, and covenants with, the Company, that:
7.1. The Investor is (a) a QIB, (b) aware that the sale to it is being made in reliance on a private placement exemption from registration
under the Securities Act and (c) acquiring the Securities for its own account or for the account of a QIB and not with a view to the distribution thereof.
7.2. The Investor understands that the Securities and the Common Stock issuable upon conversion of the Securities are being offered in a transaction not involving any public offering within the meaning of the Securities Act, that the Securities and the Common Stock issuable upon conversion of the Securities have not been and, except as described in the Private Placement Memorandum, will not be registered under the Securities Act and that (a) if prior to the expiration of the applicable holding period specified in Rule 144(k) of the Securities Act it decides to offer, resell, pledge or otherwise transfer any of the Securities or Common Stock issued upon conversion of the Securities, such Securities and Common Stock may be offered, resold, pledged or otherwise transferred only (i) to a person whom the seller reasonably believes is a QIB in a transaction meeting the requirements of Rule 144A, (ii) pursuant to an exemption from registration under the Securities Act provided by Rule 144 thereunder (if available), (iii) pursuant to an effective registration statement under the Securities Act or (iv) to the Company or one of its subsidiaries, in each of cases (i) through (iv) in accordance with any applicable securities laws of any state of the United States, and that (b) the Investor will, and each subsequent holder of the Securities is required to, notify any subsequent purchaser of the Securities or the Common Stock issued upon conversion of the Securities of the resale restrictions referred to in clause (a) above and will provide the Company and the transfer agent such certificates and other information as they may reasonably require to confirm that the transfer by it complies with the foregoing restrictions, if applicable.
7.3. The Investor understands that the Securities and the Common Stock issuable upon conversion of the Securities will, until the expiration of the applicable holding period set forth in Rule 144(k) of the Securities Act, unless sold pursuant to a registration statement that has been declared effective under the Securities Act or in compliance with Rule 144, bear a legend substantially to the following effect:
7.4. The Investor (a) is able to fend for itself in the transactions contemplated by the Private Placement Memorandum, (b) has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its prospective investment in the Securities and (c) has the ability to bear the economic risks of its prospective investment in the Securities and can afford the complete loss of such investment.
7.5. The Investor has received a preliminary copy of the Private Placement Memorandum and upon delivery by the Company prior to Closing of the final copy of the Private Placement Memorandum will have received a final copy of the Private Placement Memorandum and acknowledges that (a) it has conducted its own investigation of the Company and the terms of the Securities and, in conducting its examination, it has not relied on, and will not rely on, any Placement Agent, any statements or other information provided by any Placement Agent concerning the Company or the terms of this offering or any due diligence investigation that any of the Placement Agents or their respective affiliates, or any person acting on behalf of any of them, may conduct or may have conducted with respect to the Securities or the Company, (b) it has had access to the Company’s public filings with the Securities and Exchange Commission and to such financial and other information as it deems necessary to make its decision to purchase the Securities, acknowledging that the Company has not filed with the Commission certain required quarterly reports and that the Company cannot assure such Investor that such information would not have been relevant to the Investor’s decision to purchase the Securities, (c) it has been offered the opportunity to ask questions of the Company and, if asked questions, received answers thereto, as it deemed necessary in connection with the decision to purchase the Securities and (d) it is aware that there may be additional non-public information with respect to the Securities and the Company that the Company has made itself available to provide to the Investor upon execution by such Investor of a confidentiality agreement, and that the Investor has either executed such confidentiality agreement and received such additional information that it has requested or has elected in its sole discretion not to request such information.
7.6. The Investor, its affiliates and any of its and their directors, officers, employees, agents, advisors and controlling persons are aware that the U.S. securities laws prohibit any person that has material non-public information about a company from purchasing or selling, directly or indirectly, securities of such company (including entering into hedging transactions involving such securities) or from communicating such information to any other person under circumstances in which it is reasonably foreseeable that such other person is likely to purchase or sell such securities.
7.7. The Investor understands that the Company, each Placement Agent and others will rely upon the truth and accuracy of the foregoing representations, acknowledgements and agreements and agrees that if any of the representations and acknowledgements deemed to have been made by it by its purchase of the Securities are no longer accurate, the Investor shall promptly notify the Company and each Placement Agent. The Investor hereby consents to such reliance. If the Investor is acquiring the Securities as a fiduciary or agent for one or more investor accounts, it represents that it has sole investment discretion with respect to each such account and it has full power to make the foregoing representations, acknowledgements and agreements on behalf of such account.
7.8. The Investor has not solicited offers for, or offered or sold, and will not solicit offers for, or offer to sell, the Securities by means of
any form of general solicitation or general advertising within the meaning of Rule 502(c) of Regulation D under the Securities Act or in any manner involving a public offering within the meaning of Section 4(2) of the Securities Act.
7.9. The Investor acknowledges that no action has been or will be taken in any jurisdiction outside the United States by the Company or any Placement Agent that would permit an offering of the Securities, or possession or distribution of offering materials in connection with the issue of the Securities, in any jurisdiction outside the United States where action for that purpose is required. Each Investor outside the United States will comply with all applicable laws and regulations in each foreign jurisdiction in which it purchases, offers, sells or delivers Securities or has in its possession or distributes any offering material, in all cases at its own expense.
7.10. The Investor further represents and warrants to, and covenants with, the Company that the Investor has full right, power, authority
and capacity to enter into this Agreement and to consummate the transactions contemplated hereby and has taken all necessary action to authorize the execution, delivery and performance of this Agreement.
7.11. The Investor understands that nothing in the Private Placement Memorandum, this Agreement, the Company’s public filings with
the Commission or any other materials presented to the Investor in
connection with the purchase and sale of the Securities constitutes legal, tax or investment advice. The Investor has consulted such legal, tax and investment advisors and made its own assessments as it, in its sole discretion, has deemed necessary or appropriate in connection with its purchase of Securities.
8. Survival of Representations, Warranties and Agreements . Notwithstanding any investigation made by any party to this Agreement, all covenants, agreements, representations and warranties made by the Company and the Investor herein shall survive the execution of this Agreement, the delivery to the Investor of the Securities being purchased and the payment therefor.
9. Notices . All notices, requests, consents and other communications hereunder shall be in writing, shall be delivered (A) if within the domestic United States, by first-class registered or certified mail, or nationally recognized overnight express courier, postage prepaid, or by facsimile, or (B) otherwise by International Federal Express or facsimile, and shall be deemed given (i) if delivered by first-class registered or certified mail, three business days after so mailed, (ii) if delivered by a nationally recognized overnight carrier, one business day after so mailed, (iii) if delivered by International Federal Express, two business days after so mailed and (iv) if delivered by facsimile, upon electronic confirmation of receipt and shall be delivered as addressed as follows:
(a) if to the Company, to: HealthSouth Corporation One HealthSouth Parkway Birmingham, Alabama 35243 Attention: General Counsel Telecopy No.: (205) 970-5913
with a copy to:
Richard B. Aftanas, Esq. Skadden, Arps, Slate, Meagher & Flom LLP Four Times Square New York NY 10036 Telecopy No.: (917) 777-4112
(b) if to an Investor, at its address on the signature page hereto, or at such other address or addresses as may have been furnished to the Company in writing.
with a copy to:
Steven J. Slutzky, Esq. Debevoise & Plimpton LLP 919 Third Avenue New York NY 10022 Telecopy No.: (212) 909-6836
10. Persons Entitled to Benefit of Agreement . This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and any controlling persons referred to herein, and the directors, officers, employees, advisors, affiliates and agents of each Investor. Nothing in this Agreement is intended, or shall be construed, to give any other person any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision contained herein.
11. Changes . This Agreement may not be modified or amended except pursuant to an instrument in writing signed by the Company and the Investors.
12. Headings . The headings of the various sections of this Agreement have been inserted for convenience or reference only and shall not be deemed to be part of this Agreement.
13. Severability. In case any provision contained in this Agreement should be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby.
14. Applicable Law . This Agreement will be governed by and construed in accordance with the laws of the State of New York applicable to contracts made and to be performed within the State of New York.
15. Counterparts . This Agreement may be signed in one or more counterparts, each of which shall constitute an original and all of which together shall constitute one and the same agreement.
Schedule A
Officers and Directors Who Have Signed the Lockup Agreements
Steven R. Berrard Edward A. Blechschmidt Donald L. Correll Yvonne M. Curl Gregory L. Doody Charles M. Elson Jay Grinney Jon F. Hanson Leo I. Higdon, Jr. John Markus John E. Maupin, Jr. L. Edward Shaw, Jr. Michael D. Snow John L. Workman
Exhibit 11
HealthSouth and Subsidiaries
Computation of Per Share Earnings
For the years ended December 31, 2005 2004 2003
Numerator:
Loss from continuing operations before cumulative effect of accounting change $ (384,585 ) $ (54,128 ) $ (426,920 ) Loss from discontinued operations, net of income tax expense (61,409 ) (120,342 ) (5,181 ) Cumulative effect of accounting change, net of income tax expense — — (2,456 )
Net loss $ (445,994 ) $ (174,470 ) $ (434,557 )
Denominator:
Basic – weighted average common shares outstanding 396,563 396,423 396,132
Diluted—weighted average common shares outstanding 398,021 397,625 405,831
Basic loss per share:
Loss from continuing operations before cumulative effect of accounting change $ (0.97 ) $ (0.14 ) $ (1.08 ) Loss from discontinued operations, net of income tax expense (0.15 ) (0.30 ) (0.01 ) Cumulative effect of accounting change, net of income tax expense — — (0.01 )
Net loss $ (1.12 ) $ (0.44 ) $ (1.10 )
*Diluted loss per share:
Loss from continuing operations before cumulative effect of accounting change $ (0.97 ) $ (0.14 ) $ (1.05 ) Loss from discontinued operations, net of income tax expense (0.15 ) (0.30 ) (0.01 ) Cumulative effect of accounting change, net of income tax expense — — (0.01 )
Net loss $ (1.12 ) $ (0.44 ) $ (1.07 )
* Diluted loss per share is antidilutive.
Exhibit 12
HealthSouth and Subsidiaries
Computation of Ratio of Earnings to Fixed Charges
For the year ending December 31, 2003, we had an earnings-to-fixed charges coverage deficiency of approximately $369 million.
Year Ended December 31, 2005 2004 2003 (In Thousands)
COMPUTATIONS OF EARNINGS:
Pretax (loss) income from continuing operations before cumulative effect of accounting change, adjustments for minority interests in earnings of consolidated affiliates, or equity in net income of nonconsolidated affiliates $ (277,497 ) $ 42,226 $ (372,875 )
Fixed charges 338,701 311,047 270,459
Distributed income of equity investees 22,457 17,029 8,561
Interest capitalized — (8,412 ) (5,132 )
Total earnings $ 83,661 $ 361,890 $ (98,987 )
COMPUTATION OF FIXED CHARGES:
Interest expensed and capitalized $ 338,701 $ 311,047 $ 270,459
Total fixed charges $ 338,701 $ 311,047 $ 270,459
RATIO OF EARNINGS TO FIXED CHARGES 0.25 1.16 (0.37 )
Exhibit 14
As a leading provider of rehabilitative, ambulatory, and outpatient services, HealthSouth has an obligation to set high standards for quality and business integrity. Building our reputation for furnishing high quality medical services and maintaining integrity in regulatory compliance and financial reporting will play an important role in our future success. Our Standards of Business Conduct describe a set of shared principles upon which we can establish and maintain a reputation for excellence. These Standards apply to all aspects of our clinical and business operations and should serve as a guide for all Company employees and contractors when providing services on behalf of HealthSouth.
In today’s highly regulated health care environment, it is important to build a corporate culture that encourages a strong understanding and commitment to regulatory compliance. This applies equally to rules governing the integrity of internal accounting and public financial reporting systems. The past decade offers numerous examples of companies and individuals (including HealthSouth) that have paid significant financial and reputational penalties for failing to do so.
To overcome this challenge, we must remain true to our principles even under internal or external pressure to do otherwise. There can be no shortcuts or special exceptions. We must never lose the confidence of our patients or their physicians by failing to provide high quality medical care - or of our investors, our business partners, our payors, or government officials by failing to conduct our business and record our financial results with integrity.
The last several years have taught us the importance of shared principles and accountability. They have taught us to think and work as a team. Whether in clinical operations, billing and finance, marketing, or any other aspect of our business, each of us can make a positive contribution to our shared success.
At the core of this effort is an obligation for all of us to accept and adhere to the principles outlined in the Standards of Business Conduct. Everyone is expected to be familiar with the Standards and to use them to govern our conduct on behalf of the Company. Each of us is asked to sign a formal acknowledgement that we have read, understand, and agree to abide by the Standards.
Because no single set of business standards can address every situation, a number of other resources are available within the Company to provide assistance with specific questions or concerns. These include corporate and division policies covering a variety of operational and regulatory topics, Division Compliance Officers and Controllers assigned to each of the Company’s principal operating divisions, as well as corporate-level Compliance and Internal Audit Departments. Concerns and questions can also be addressed anonymously through the compliance hotline at (888) 800-577 or sent directly to the Board of Directors.
Please join us in embracing these Standards of Business Conduct as the foundation of a new corporate culture based on openness and integrity. Our shared commitment can make integrity the cornerstone of a strong and re-vitalized HealthSouth.
/s/ Jon Hanson /s/ Jay Grinney Jon Hanson Jay Grinney Chairman President Board of Directors Chief Executive Officer
CONTENTS
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Purpose of the Standards of Business Conduct 5 Who Is Covered 5 Our Corporate Compliance Program 5 Compliance – A Shared Commitment 7 Consequences of Non-Compliance 8 Getting Answers to Questions or Reporting a Possible Violation of Law or Company Policy 8
Standards of Business Conduct
Legal Obligations 13 Quality of Care and Treatment of Patients 13
Quality Services 13 Treatment of Patients 13 Safe Patient Care 14 Clinical Records 14 Protection of Patient Health Information (HIPAA) 14 Dispensing Drugs and Controlled Substances 14 Research 14
Sales and Marketing 14 Accuracy and Integrity 14 Fraud and Abuse Laws 14 Antitrust and Business Competition 15
Billing and Coding 15 Working Environment 16
Discrimination and Harassment 16 Workplace Violence 16 Use of Alcohol and Illegal Drugs 16 Professional Practice Acts 16 Health and Safety 16 Handling and Disposal of Infectious Materials 17 Administration 17
Accounting and Financial Reporting 17 Record Keeping and Management 17 Management Controls 17 Financial Reports 17 Financial Audits 17 Code of Ethical Conduct for Financial Managers 17
Management of Company Assets 18 Physical Assets 18 Financial Assets 18 Confidential or Proprietary Information 18 Use of Company Information Systems 18
Conflicts of Interest 18 Dealing with Vendors 19 Investments and Use of Inside Information 19
Dealing with Investors and the Media 19 Government Filings and Reports 20 Lobbying and Political Activities 20
Lobbying 20 Political Activities 20
Contacts by Government Agencies 21
Appendix A
HealthSouth Corporation Code of Ethical Conduct for Financial Managers 22
Supplement
Important Contact Information and Resources
PURPOSE OF THE STANDARDS OF BUSINESS CONDUCT
HealthSouth is committed to conducting business in compliance with federal, state, and local laws and regulations and to acting, at all times, in conformance with high standards of business integrity. The Standards of Business Conduct are designed to help us accomplish these objectives by establishing a general framework for acting with integrity and accountability in accordance with a shared set of principles. They cannot, however, address every issue that may arise in the course of our business. The Company has therefore developed a number of more focused policies and systems to address specific areas of our operations in greater detail. These policies may be found on the Company’s intranet site at https://healthsouth.policyiq.com. These policies should be consulted as a supplement to the Standards.
WHO IS COVERED
The Standards apply to all HealthSouth directors, officers, and employees. Company contractors (including medical directors) and other professionals who provide health care, financial, or accounting services (covered contractors) are also expected to conform to the Standards while providing services on behalf of HealthSouth. For convenience, these persons will be referred to jointly as “employees” throughout the Standards, unless otherwise specified.
OUR CORPORATE COMPLIANCE PROGRAM
The HealthSouth Corporate Compliance Program is overseen by the Board of Directors. The Board has appointed two committees to monitor the program. The Audit Committee oversees the integrity of financial reporting, accounting and tax functions, as well as the proper use and protection of Company assets. The Compliance Committee oversees all other aspects of regulatory compliance, including health care laws and payment rules. Each committee is composed of at least three independent Directors and meets regularly to receive reports from Company officers.
The Corporate Compliance Program is based on five elements -
Regulatory Compliance
The Company’s regulatory compliance program is supervised by the Chief Compliance Officer who reports directly to the Chief Executive Officer and the Compliance Committee of the Board of Directors. Each year, the Chief Compliance Officer prepares an annual corporate compliance plan for approval
The Standards of Business Conduct provide a general reference for HealthSouth directors, officers, and employees. They are not designed to describe all applicable laws or all HealthSouth policies or to give full details of any individual law or policy. If you have any questions, you should contact your Division Compliance Officer or Controller or the Corporate Compliance Office.
HealthSouth reserves the right to modify, revise, or alter any policy, procedure or condition of employment at its sole discretion. The Standards of Business Conduct are not an employment contract. Unless otherwise prescribed by contract or state law, employment with HealthSouth is at will and may be terminated by either the employee or HealthSouth at any time, for any reason or for no reason.
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• Development of effective regulatory compliance policies and financial and management controls for all Company operations and
lines of business;
• Dissemination of policies to managers, supervisors, and employees, and development of appropriate training mechanisms to ensure
that such policies are clearly understood and capable of being carried out effectively;
• Opportunities for employees to ask questions or report suspected violations of Company policies, regulatory obligations, or public
financial reporting obligations without fear of retaliation and the prompt investigation of all credible reports of such violations;
• Routine audit of Company functions and assessment of the effectiveness of internal controls to determine compliance with applicable
regulatory obligations and the integrity of public financial reports; and
• Accountability for violation of Company policies or regulatory obligations (including supervisors and managers who condone or
unreasonably fail to prevent improper conduct).
by the Compliance Committee of the Board. The Committee receives periodic reports on the Company’s progress in meeting the plan, including reports of all regulatory audits.
The Chief Compliance Officer is also the Chairman of the Executive Compliance Steering Committee. This Committee includes members of senior management including the Chief Executive Officer, the Chief Operating Officer, the presidents of each operating division, and the heads of each of the principal corporate departments. The Executive Compliance Steering Committee meets monthly to review and approve compliance policies and initiatives.
The Corporate Compliance Department is responsible for regulatory risk assessment, compliance policy development, education, management of the compliance hotline, and investigations of alleged regulatory or policy violations. It includes a separate and independent compliance audit staff. Oversight of compliance activities within each operating division is assigned to a full time Division Compliance Officer (DCO). Each DCO works directly with the Corporate Compliance Department on policy development, risk assessment, issue resolution, and other compliance-related activities.
All new employees and covered contractors are required to complete Compliance Orientation training within 30 days of hire. This includes a written acknowledgement that the employee understands and agrees to abide by the Standards of Business Conduct. All employees and covered contractors must also complete Compliance Refresher training annually.
Accounting, Financial Reporting, Safeguarding of Assets
The Internal Audit Department is responsible for evaluating and helping to improve internal controls and business practices; for investigating potential violations of accounting, financial reporting, asset protection and conflict of interest standards; and for providing an independent source of information to Company officers, the Audit Committee, and the Board of Directors on these and related matters. Internal Audit independence is maintained through a direct reporting relationship to the Audit Committee and open access to the Audit Committee Chairman and Committee members.
Annually, the Internal Audit Department conducts a Company-wide risk assessment. The results are used to prepare annual audit plans that are reviewed and approved by the Audit Committee. In addition to executing the audit plan, the Internal Audit Department investigates all tips and complaints relevant to its area of responsibility. The Internal Audit Department recommends appropriate corrective actions for accounting or management control gaps or failures and assists in the implementation of these corrective actions.
Corporate Integrity Agreement
HealthSouth entered into a Corporate Integrity Agreement with the Office of Inspector General (OIG) of the Department of Health and Human Services in December 2004. This Agreement requires the Company to:
• Create and maintain formal Standards of Business Conduct;
• Maintain a Compliance Committee of the Board of Directors, an Executive Compliance Steering Committee, and a Chief
Compliance Officer;
• Provide compliance training for all employees, directors, medical directors and other persons who furnish health care items and
services for more than 160 hours per year;
• Operate a confidential compliance hotline;
• Retain an Independent Review Organization to audit cost reports and billing and coding practices in the Inpatient and Outpatient
divisions;
• Notify the OIG of substantial overpayments by federal health care programs or violations of federal health care program
requirements;
• Report openings and closings of HealthSouth facilities; and
• Provide annual reports to the OIG.
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A copy of the Corporate Integrity Agreement is available on the Compliance home page on the HealthSouth intranet or can be requested from the Corporate Compliance Office. Each employee of HealthSouth is required to comply with the requirements of the Corporate Integrity Agreement and with all other federal health care program rules. Failure to comply with these obligations could have serious consequences for you, your fellow employees, and HealthSouth, including loss of eligibility to treat Medicare and other federal health care program beneficiaries. See “Consequences of Non-Compliance” on page 9. Violations or suspected violations of the Corporate Integrity Agreement or federal health care program requirements should be reported in accordance with the procedures set forth in “Getting Answers to Questions or Reporting a Possible Violation of Law or Company Policy” on page 10. Questions about the Corporate Integrity Agreement can be directed to a Division Compliance Officer or to the Corporate Compliance Department.
SEC Settlement
In June 2005, HealthSouth entered into a settlement agreement with the Securities and Exchange Commission (SEC). Among other obligations, the settlement agreement requires HealthSouth to -
COMPLIANCE – A SHARED COMMITMENT
Compliance is a shared commitment among all company employees.
Compliance is a shared commitment among all company employees. The Company, through the Board of Directors and senior management, is responsible for setting standards of business conduct and for developing policies, procedures, and systems to assist employees to understand and meet these standards. Employees are responsible for acting with integrity at all times and for upholding the Standards and policies established by the Company. Each employee is expected to -
Know the law.
Don’t be pressured.
Report suspected violations of law or company policy
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• Retain independent consultants to review the adequacy and effectiveness of the Company’s corporate governance and internal
accounting control policies and systems;
• Develop training programs for officers and employees covering securities laws and other obligations applicable to public financial
reporting; and
• Create a new position of Inspector General reporting directly to the Audit Committee of the Board of Directors to identify violations
of law or Company policy relating to accounting or public financial reporting.
• Apply the Standards of Business Conduct. You are expected to read and understand these Standards. Apply them every day in the
course of your job. Use good judgment and abide by both the letter and the spirit of the Standards. Questions about the Standards or how they apply to you can be directed to your supervisor or manager or to your DCO or division controller.
• Know the law. These Standards do not require you to be a legal expert. You are expected, however, to be familiar with the basic
laws that apply to your specific job and level of responsibility. Pay close attention to all training information and policies. Do not be afraid to ask questions.
• Don’t be pressured. You will never be expected to violate the law or any ethical standard of your profession, and you should never
feel pressured to do so. If you ever feel pressure to do something with which you are uncomfortable, seek guidance from your DCO, division controller or the Corporate Compliance or Internal Audit Department.
• Be part of a team. Offer suggestions to improve management controls or make Company policies and systems easier to understand
and use. Cooperate with Company representatives on audits and internal investigations.
• Report potential violations of law or Company policy. If you have doubts about the legal or policy implications of a situation, bring the matter to the attention of your supervisor, your DCO, the Corporate Compliance Department or another member of management. Matters involving accounting or financial reporting may be brought to the attention of your division controller or the Internal Audit Department. Do not assume that senior management already knows about or does not care about an issue.
Supervisors and managers have a special responsibility for compliance and integrity. Leadership requires setting a personal example of integrity on a daily basis.
Special Responsibilities of Supervisors and Managers
Supervisors and managers have a special responsibility for compliance and integrity. You should ensure that all employees understand and apply the principles outlined in the Standards of Business Conduct and other Company policies.
Leadership requires that you set a personal example of integrity in all aspects of your job. It is up to you to set the right tone for the people who report to you.
CONSEQUENCES OF NON-COMPLIANCE
Another material regulatory or financial reporting failure is not an option.
Failure to comply with the law, including the requirements of the Corporate Integrity Agreement and SEC settlement, could lead to serious consequences for you, your fellow employees, and the Company. These may include termination of employment, prison, personal or corporate fines, exclusion from Medicare and other health care programs, loss of credibility with investors and lending institutions, and loss of respect by physicians and patients.
Given our recent history, HealthSouth is particularly vulnerable to close scrutiny of any future regulatory compliance or financial reporting failures. We should not expect leniency from the Department of Justice, the OIG, or the SEC. Any future missteps could jeopardize our ability to participate in Medicare and other health care programs, our access to capital markets, and the value of our securities. Simply put, another material regulatory or financial reporting failure is not an option.
Because the consequences of another compliance or financial reporting failure are so serious, disciplinary action, up to and including termination of employment, will be taken against any employee who -
Disciplinary action will also be taken against any supervisor or manager who knew or should have known about a violation and failed to take reasonable actions to prevent or promptly report and correct the situation.
GETTING ANSWERS TO QUESTIONS OR REPORTING A POSSIBLE VIOLATION OF LAW OR COMPANY POLICY
Open discussion of legal and policy issues without fear of reprisal is vital to the effectiveness of the Company’s Compliance Program. Ask questions about policies or practices that you do not understand and report suspected violations of law or Company policy to a supervisor or other appropriate persons. Supervisors and managers should maintain an “open-door” policy for their direct
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• Report exclusions and convictions. Inform your supervisor, the Human Resources Department, or the Corporate Compliance Office
if you are convicted of a felony, have sanctions imposed against your professional license, or are informed by the OIG that you are no longer eligible to participate in federal or state reimbursement programs or contracts.
• Be proactive. Ensure that employees are properly trained and understand their obligations under the Standards. Ensure that policies
and procedures are in place to promote compliance with regulatory standards. Make it easy for employees to comply with the law and hard to get around it.
• Be receptive. Maintain an open-door policy. Make it clear that you are open to questions or concerns about compliance-related
issues from your direct reports or other employees who may bring concerns to you.
• Be responsive. Take prompt and appropriate action when a suspected violation of law or Company policy is brought to your
attention.
• Do not allow retaliation. Ensure that no one who, in good faith, reports a suspected violation of law or Company policy is subject to
retaliation.
• Authorizes or participates in any violation of law, the Standards of Business Conduct, or Company policies and procedures;
• Fails to report or conceals a violation;
• Refuses to cooperate with any internal investigation or audit; or
• Threatens or retaliates against any other employee who reports a violation.
reports and for other employees who may reach out to them with questions or concerns. Prompt identification and reporting will allow the Company to investigate and correct potential problems before they can do material financial or reputational damage to HealthSouth.
Any of the following resources may be used for this purpose.
Your Supervisor or Department Manager
Many questions and problems can best be addressed at the department or facility level. Your supervisor or manager knows you and the issues in your workplace better than anyone else in the Company. If they do not have an answer, they have access to other resources within the Company. Regulatory compliance issues may also be brought to the attention of the appropriate Division Compliance Officer. Financial and accounting issues may be brought to the attention of the Division Controller or to a member of the Corporate Accounting Department.
The Human Resources Department
If your question or concern involves a Human Resources or general workplace issue, contact your facility’s Human Resources Department (Inpatient Division) or the Corporate Human Resources Department (other divisions). The Corporate Human Resources Department can be reached at (800) 765-4772, ext. 4725.
A Division Compliance Officer or Controller
The DCOs and controllers for each division are available to answer questions about regulatory and accounting/financial reporting questions. They are also responsible for investigating and following up on potential violations of law or Company policy.
Internal Audit Department or Inspector General
Questions or concerns relating to accounting, financial reporting, safeguarding of assets, conflicts of interest, and/or general business standards and practices should be brought to the attention of the Internal Audit Department by phone (205-970-4049), or by email ([email protected]). The Inspector General may also be contacted directly on any of these issues.
Corporate Compliance Department
Questions or concerns relating to health care or other regulatory issues should be brought to the attention of the Corporate Compliance Department by phone (205-970-5900) or by email ([email protected]).
Ask questions about policies or practices that you do not understand and report any violations of law or Company policy to a supervisor or other appropriate person.
Compliance Hotline
If you have not been able to resolve to your satisfaction an issue through other channels or if you feel uncomfortable about raising an issue through your supervisor or other Company managers, you may call the toll-free Compliance Hotline at (888) 800-2577 to report a concern anonymously and without fear of retaliation. The Compliance Hotline operates 24 hours a day, 7 days a week. It is staffed by an independent company with no other relationship to HealthSouth or members of senior management. Your call will not be traced or recorded, and your anonymity will be protected up to the limits of the law if you wish to remain anonymous. The Compliance hotline has a Spanish speaking staff member available at all times, and its staff has access to interpreters of numerous other foreign languages.
All reports received by the hotline will be investigated. If substantiated, appropriate corrective actions will be taken, including disciplinary action against employee(s), changes to Company policies and systems, additional training, or disclosure of overpayments to government and/or commercial payors.
The hotline is intended to supplement, not replace, other channels for communicating questions and concerns within the Company. It should be used when you have exhausted other avenues of communication or are uncomfortable with disclosing your identity.
You may call the toll-free compliance hotline at 888-800-2577, 24 hours a day, 7 days a week to report a concern anonymously and without fear of retaliation.
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When you call the hotline, you will be given a case number and a call-back date, which is usually about two weeks from the date of the call. This will allow the Company to seek your help in answering questions that may have arisen during an initial investigation while fully protecting your anonymity. Calling back or responding to the questions is entirely voluntary, but may assist the Company in conducting an effective investigation.
By Mail
You may also bring a concern to the Corporate Compliance or Internal Audit Departments via letter or fax at:
Board of Directors
If an issue involves a member of senior management or anyone charged with supervising the Compliance or Internal Audit processes, you have the option of writing directly to the HealthSouth Board of Directors. All such written communication should be directed to:
HealthSouth Corporation Board of Directors P.O. Box 382827 Birmingham, AL 35238
If an issue involves possible accounting or financial irregularities or a possible violation of federal securities laws or the Sarbanes-Oxley Act of 2002 and you are unable to get a satisfactory resolution through other channels, you may contact the Audit Committee of the Board of Directors at:
HealthSouth Corporation Audit Committee of the Board of Directors P.O. Box 382827 Birmingham, AL 35238
HealthSouth will not retaliate against anyone who, in good faith, reports a compliance or financial integrity concern to the hotline or to Company management.
Confidentiality
Every employee should feel secure in asking questions or reporting concerns under the Corporate Compliance program. If you request confidentiality, we will do our best to honor your wishes. You may also consider placing an anonymous call to the Compliance Hotline. In either case, it is important to provide enough facts to allow for an effective investigation.
Non-Retaliation Policy
HealthSouth will not retaliate against anyone who, in good faith, reports a compliance or financial integrity concern to the hotline or to Company management. If you believe that you have been the subject of improper retaliation, please contact the Chief Compliance Officer or the General Counsel directly.
To Obtain a Copy in Spanish
The HealthSouth Standards of Business Conduct are available in Spanish. To obtain a copy in Spanish, please have your facility administrator or Human Resources Department print a copy from the Compliance home page on the intranet.
Para Obtener una Copia en Español
Las Normas de Conducta de HealthSouth en español están disponibles. Para obtener una copia en español, por favor consulte a su administrador o el departamento de Recursos Humanos (Personnel) para que les imprima una copia de las normas ubicada en nuestra red privada (“intranet”).
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HealthSouth Corporation HealthSouth Corporation Corporate Compliance Department Internal Audit Department P.O. Box 380243 One HealthSouth Parkway Birmingham, AL 35238 Birmingham, AL 35243 Fax: (205) 970-4854 Fax: (205) 262-3946
LEGAL OBLIGATIONS
Standard: HealthSouth will comply with federal, state, and local laws and regulations that apply to our business. We will not pursue any business opportunity that requires us to act illegally.
Competitive pressure or “industry practice” is never a valid basis for violating Company policy or regulatory standards. If you believe that a competitor is achieving a commercial advantage by ignoring legal or regulatory requirements, contact the Legal Services Department or the Corporate Compliance Department for assistance.
QUALITY OF CARE AND TREATMENT OF PATIENTS
Standard: HealthSouth will furnish high quality, cost-effective medical care to patients safely and in accordance with high professional standards. We will respect each patient’s dignity and right to privacy of medical information.
Furnishing high quality medical care to patients on a consistent basis is the primary goal of HealthSouth.
Quality Services . Furnishing high quality, cost-effective medical care to patients on a consistent basis is the primary goal of HealthSouth. Services should be furnished in accordance with medical orders issued by a physician or another authorized health care professional based on the needs of each patient.
No health care professional should ever furnish a service, or take any action, that would violate a professional code of ethics or practice act.
All patients should be treated with respect and dignity.
Treatment of Patients . All HealthSouth patients should be treated with respect and dignity. Patients will not be denied access to medical services at any HealthSouth facility based on race, sex, religion, national origin, or other classification prohibited by law.
Do not offer gifts or other financial benefits to Medicare beneficiaries to induce them to choose a HealthSouth facility to receive care.
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• You are expected to know the basic laws and regulations that apply to your job. If you have questions, ask a supervisor or contact one
of the Company resources listed in Appendix A. You are also expected to know and follow Company policies and procedures and to utilize Company processes and systems in accordance with those policies and procedures.
• The Company will not employ or contract with any person or entity that is ineligible to participate in federal health care programs.
• Suspected violations of law or Company policy must be promptly reported to a supervisor or another Company official. This is more
fully described in Getting Answers to Questions or Reporting a Possible Violation of Law or Company Policy.
• Medical services should be furnished skillfully and safely and in accordance with HealthSouth clinical policies and procedures,
government regulations, and professional standards.
• Services should be medically appropriate for the patient and furnished in a cost-effective manner.
• Only persons with appropriate training and professional credentials and licenses may furnish or supervise the delivery of medical
care. All professionally credentialed personnel are expected to keep their credentials current and to notify the Company promptly if sanctions are threatened or imposed on a professional license.
• The Company will stay abreast of significant research and practice developments in each field of medicine in which we furnish
services to patients.
• Respond promptly and courteously to patients’ questions and concerns.
• Provide adequate and accurate information to patients and their families in order to allow them to participate in treatment planning
whenever appropriate and to make informed treatment decisions.
• Safeguard the personal property of patients.
• Maintain complete and accurate medical records.
• Do not offer to, or accept gifts from, patients of more than nominal value. Avoid any perception that the quality of care furnished in a
HealthSouth facility is dependent on the offering of gifts or other gratuities.
Employees should take reasonable measures to protect the confidentiality of PHI, whether in written or electronic form.
Safe Patient Care . Safe care is essential to the well-being and recovery of patients. HealthSouth will promote a corporate-wide safety culture based on clinically appropriate policies, systems, and equipment.
Clinical Records. All clinical records should be accurate and complete. Copies, in paper or electronic format, should be protected from loss or unauthorized disclosure and maintained in accordance with government and Company record retention requirements.
Protection of Patient Health Information (HIPAA). The Health Insurance Portability and Accountability Act (HIPAA) sets the national standard for maintaining the confidentiality of patients’ protected health information (PHI). Many state laws impose additional obligations to prevent the unauthorized release of PHI. This requires that all patients’ medical and financial information be treated as confidential. Patient medical records, treatments, conditions, and personal affairs should only be discussed or shared with the attending physician, with persons authorized by the patient to receive such information, and with other HealthSouth employees and contractors who require access to the information to perform their duties. Only those who require patient information to furnish care, perform quality control activities, bill or collect charges for services, or furnish other administrative services are permitted access to PHI unless authorized under the law or by the patient.
This requires that all employees take reasonable measures to protect the confidentiality of PHI, whether that information is presented in oral, written, or electronic form. The Company has developed specific policies and systems to promote this objective. All employees should become familiar with these policies and systems and ensure that they are applied consistently.
Dispensing Drugs and Controlled Substances. Federal and state governments regulate the use of controlled drugs and other pharmaceuticals, including orders, storage, administration, and inventory. Employees dealing with controlled substances are responsible for knowing and complying with applicable laws and regulations. The loss or misuse of any controlled substance must be reported promptly to a supervisor or other manager.
Research. All research activities conducted at HealthSouth facilities must be approved in advance by the Corporate Clinical Research Coordinator. This will ensure that research protocols have been properly reviewed, that patients have been informed and given consent to participation, and that systems are in place to prevent inappropriate billing or disclosure of confidential information.
SALES AND MARKETING
Standard: HealthSouth will market our services fairly and in accordance with federal and state laws and regulations. We will not offer or accept any bribe, kickback, or other unlawful benefit for the purpose of inducing the referral of patients or health care products or services.
All sales and marketing information must fairly and accurately describe our services.
• Facilities should develop processes for continuous assessment and refinement of existing safety management systems.
• Equipment and facilities used to furnish medical services should be safe, effective, and in good working order at all times.
Maintenance should be performed and documented in accordance with manufacturer’s instructions.
Accuracy and Integrity. All sales and marketing presentations and literature must fairly and accurately describe our services. We should not advance claims that we cannot support or make promises that we cannot keep. We will not engage in deceptive sales or marketing practices. We will respect copyright and trademark rules when using materials published by others.
Fraud and Abuse Laws. Federal law, and many state laws, prohibit a health care provider from paying or receiving a kickback or other improper inducement to or from anyone for the referral of a patient or for the purchase of health care
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products or services. Such laws apply not only to physicians and other health care professionals, but also to all types of referral sources, such as hospitals, nursing homes, case managers, workers’ compensation attorneys, and any other individuals in a position to influence referrals or purchases. They cover both:
HealthSouth will not offer or accept any bribe, kickback or other unlawful benefit to induce the referral of patients or healthcare products or services.
Improper payments or inducements can take many forms. In addition to cash, kickbacks and inducements can include, but are not limited to:
Improper inducements may be indirect - e.g., a payment or concession made to a third party with the expectation that it will be passed on to a referral source. Even the mere offer of a kickback or improper inducement could be a violation of law and could subject you and the Company to criminal prosecution.
Federal law also prohibits the use of gifts or other financial benefits to induce a Medicare patient to receive care at a HealthSouth facility.
HealthSouth will compete vigorously but fairly in the marketplace.
Antitrust and Business Competition . HealthSouth will compete vigorously, but fairly in the marketplace. We will not seek to restrict competition through unlawful monopolistic or predatory practices. Employees should not:
Particular care should be taken when pursuing joint ventures or alliances with other health care providers. Care should also be taken when participating in trade associations. It is generally acceptable for trade association members to cooperate on quality or public policy-related activities. Other forms of cooperation should be avoided. Questions relating to antitrust and business competition should be directed to the Legal Services Department.
BILLING AND CODING
Standard: All claims for services must be fair, accurate, and conform to applicable regulatory and contractual requirements.
Coding must accurately reflect services rendered as well as relevant patient conditions and diagnosis.
Collecting the correct payment for the services we provide is a fundamental part of HealthSouth’s business. Accordingly, care should be taken to properly code, bill, and collect only for services actually rendered and that are documented in patients’ medical records. Under no circumstances should a claim be submitted that is known or suspected to be fraudulent, inaccurate, or fictitious.
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• The offer or payment of a kickback or other improper inducement to secure referrals; and
• The request or receipt of an improper payment in exchange for agreement to purchase a health care product or service from a
particular vendor or contractor.
• Above fair market value lease payments to a referral source (or free or below fair market value lease payments from a referral
source);
• Loans to referral sources with below market interest rates or other terms that do not meet commercial lending standards;
• Professional services contracts (e.g., medical director agreements) for more services than are needed or at rates in excess of fair
market value;
• Management fees that fail to cover the full cost of services furnished to a referral source; and
• Excessive gifts or entertainment.
• Discuss or agree with a competitor to set prices, divide sales territories, or compromise the integrity of a competitive bidding process;
• Exchange information with a competitor about pricing, margins, bids, contracts, plans, or other confidential business matters;
• Participate in group boycotts of other health care professionals, providers, or commercial payors; or
• Make any arrangement with a competitor to artificially reduce competition.
• Bills must be coded to accurately reflect the services rendered as well as relevant patient conditions and diagnoses.
• Billing, coding, and collection practices must conform to applicable government rules and commercial contractual obligations.
• Coders must be trained and qualified to perform such functions.
• Overpayments must be promptly identified and returned to payors.
If you discover an error or a suspected error in a claim or in any billing system, promptly alert your supervisor or another appropriate manager. All errors should be corrected before the claim is billed. If an error is identified after a bill has been filed, the payor should be notified to suspend improper payment or arrange for the refund of an overpayment.
WORKING ENVIRONMENT
Standard: HealthSouth strives to maintain a work environment where employees are treated fairly and with respect, where they can perform their jobs safely and effectively, and where they are encouraged to realize their full professional potential.
Additional information on the duties of each employee to promote these policies and programs is provided in the HealthSouth Employee Handbook. Failure to conform to the requirements of these policies and programs will result in disciplinary action, up to and including, termination of employment. Violations should be reported promptly to a supervisor or another manager, the Human Resources Department, or the Chief Administrative Officer.
HealthSouth does not tolerate unlawful discrimination or harassment by or against its employees, patients, visitors or medical staff members.
Discrimination and Harassment . HealthSouth values a diverse workforce and recognizes its contribution to creativity and business growth. The Company does not tolerate unlawful discrimination or harassment by or against its employees, patients, visitors, or medical staff members. All employees and applicants for employment must be afforded equal employment opportunities without regard to race, religion, sex, age, national origin, disability, or any other classification protected by law. Unlawful harassment may include, but is not limited to, slurs, epithets, threats, or derogatory comments. It also includes verbal or physical conduct of a sexual nature that creates an intimidating, hostile, or offensive working environment.
Workplace Violence . Physical violence or threats of violence is never acceptable. This includes abusive or aggressive behavior intended to threaten or intimidate another person. No employee, patient, visitor, or medical staff member (with the exception of authorized security personnel) is permitted to bring any weapon onto any HealthSouth property.
All employees are expected to be free from the influence of alcohol or illegal drugs in the workplace.
Use of Alcohol and Illegal Drugs . Employees are expected to be free from the influence of alcohol or drugs used illegally in the workplace. The use of alcohol or illegal drug use while conducting HealthSouth business jeopardizes the health and safety of patients, other employees, and visitors. It also compromises the ability of the employee to perform his or her responsibilities in a professional and effective manner. Employees who appear to be under the influence of drugs or alcohol in the workplace will be subject to drug or alcohol testing. Employees who suspect that a co-worker is intoxicated or under the influence of illegal drugs should notify a supervisor or the Human Resources Department.
Professional Practice Acts . HealthSouth employees are expected to conform to applicable state professional practice acts and professional codes of ethics at all times. Supervisors and managers are expected to be aware of such standards and to promote compliance. This is particularly important when a supervisor or manager is not governed by the same standards and professional ethical obligations as an employee.
Health and Safety : All employees are expected to be familiar with the potential hazards in their workplace and to comply with government regulations and Company policies relating to workplace safety. This includes Risk Management policies and requirements designed to protect employees from potential workplace hazards, including but not limited to:
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• Effective management controls, including routine audits, should be established to minimize the scope and frequency of billing errors.
• Employees are expected to cooperate fully with all internal and external audits of claims and billing systems.
• Safety Management Improvement Plans;
• Standard precautions for potentially infectious materials;
• Storage and use of hazardous materials;
• Facility-level safety and emergency plans;
All employees are expected to be familiar with the potential hazards in their workplace and comply with government regulations and Company policies relating to workplace safety.
Any unsafe conditions should be reported promptly to a supervisor or manager, or to the Corporate Risk Management Department at (205)-970-3404.
Handling and Disposal of Infectious Materials . Federal and state laws regulate the handling and disposal of many infectious materials. These include blood and other bodily fluids, used needles and syringes, potentially toxic chemicals, and other materials that may present a hazard to employees or to the local community if not properly controlled. All employees are expected to comply with Company policies and systems relating to infectious materials at all times.
Administration . Employees are expected to deal fairly and honestly with the Company in recording hours worked, scheduling and reporting time off, using Company property, seeking reimbursement for business-related expenses, and all similar matters.
ACCOUNTING AND FINANCIAL REPORTING
Standard: All accounting entries, as well as all internal and external Company financial reports must be prepared accurately and on a timely basis in accordance with generally accepted accounting principles and applicable government regulations. Public financial reports should fairly and accurately reflect the operations and financial condition of the Company.
Public financial reports should fairly and accurately reflect the operations and financial condition of the Company.
Record Keeping and Managemen t . The Company is required to prepare and maintain accounts, books, and other records that fairly reflect the results of the Company’s business operations. All transactions must be properly authorized, recorded in the period in which they were executed, and properly documented. Each employee is expected to be familiar and comply with Company record retention policies that apply to documents (both paper and electronic) in his or her custody or control. Special care should be taken to preserve documents that are known to be subject to a government investigation, commercial litigation, or audit.
Management Controls . Employees are expected to assist in the development and enforcement of effective internal controls to ensure that contracts, payments and other business transactions are properly authorized, conform to Company policies and procedures, and are recorded accurately in accordance with generally accepted rules of accounting. These controls form the basis for senior management certification of the accuracy and integrity of the Company’s publicly-reported financial results in accordance with the requirements of the Sarbanes-Oxley Act.
Financial Reports . All information provided to the public and to the SEC about the Company’s business, earnings, and financial condition should be complete, accurate, understandable, and timely filed. Each employee should promptly report any material error or omission that may affect our public disclosures, or any questionable accounting or auditing matters to a supervisor, to a Division Controller, to the Internal Audit Department, or to the Inspector General. Any incorrect information reported to the public or to a government agency should be corrected promptly.
All employees are expected to cooperate with the Company’s internal and outside independent financial auditors.
Financial Audits . All employees are expected to cooperate with the Company’s internal auditors and its independent auditors. Information provided to internal and independent auditors should be accurate, complete, and not misleading. Employees should avoid any action that could compromise, or appear to compromise, the objectivity of the Company’s independent auditors.
Code of Ethical Conduct for Financial Managers . Employees who supervise or manage accounting functions or the preparation of public financial reports are required to acknowledge and agree to abide by a special code of conduct stressing personal responsibility for integrity, completeness, and accuracy of financial recording and reporting. The Code requires full, fair, and accurate disclosure of material financial and operational information in periodic filings with the SEC and other public reports. A copy of the Code is attached to the Standards of Business Conduct as Appendix A.
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• Ergonomic safety;
• Infection control procedures; and
• Sentinel event and other incident reporting.
MANAGEMENT OF COMPANY ASSETS
Standard: HealthSouth employees are expected to manage Company assets and other resources honestly and wisely. This includes property of joint ventures or other entities that are controlled or managed by HealthSouth. Company assets should be used for HealthSouth business purposes only. Proper authorization in accordance with Company policies must be obtained prior to the commitment of Company funds or the disposition of other Company resources.
Company funds may never be diverted for personal use, even temporarily, or used for any purpose that is not authorized and approved in accordance with company policies. Physical Assets . Every employee has a duty to protect and not misuse HealthSouth property, assets, facilities, equipment, and supplies. When HealthSouth property becomes surplus, obsolete, or unusable, it should be disposed of in accordance with HealthSouth policies and procedures. Unauthorized use, removal, or disposal of any HealthSouth property is prohibited. Employees should immediately report missing property, as well as any unusual circumstances surrounding the disappearance of Company assets, to a supervisor, manager, or the Internal Audit Department.
Financial Assets . Employees responsible for managing Company financial assets are expected to do so honestly and in conformance with established Company policies, procedures, and internal controls. Company funds may never be diverted for personal use, even temporarily, or used for any purpose that is not authorized and approved in accordance with Company policies. Specific rules for approval of capital and operating expenses have been established by the Company (see Accounting Policy P001, Approval Authority.)
Confidential or proprietary information should be protected against theft, loss and unauthorized use.
Confidential or Proprietary Information . In addition to physical and financial assets, Company assets also include certain intangible or “intellectual” property. This includes confidential or proprietary formulas, processes, inventions, pricing information, provider agreements, financial information, development plans, and other information that has not been made public and that would be of interest to a competitor or other party if disclosed. No confidential or proprietary information should be disclosed to individuals outside the Company or to other employees who do not need the information to perform their duties unless expressly authorized by a supervisor or manager. All confidential or proprietary information should be protected against theft, loss, and unauthorized disclosure.
Use of Company Information Systems . The Company’s information systems, including all hardware and software used to support such systems, should be used for Company purposes. Employees should not share proprietary systems or software with other companies or persons. No software should be installed on Company computers or used for Company purposes without approval by the corporate Information Technology Department. Doing so could violate federal copyright laws or commercial licensing agreements as well as compromise the security and integrity of Company systems.
CONFLICTS OF INTEREST
Standard: Employees and Directors should avoid conflicts as well as the appearance of conflicts between their private interests and the interests of HealthSouth.
A conflict of interest occurs if a relationship with another person or entity interferes with your ability to perform your duties for HealthSouth in an objective manner.
A conflict of interest occurs if a business or personal relationship with another person or entity interferes with your ability to perform your duties for the Company in an objective manner. A conflict of interest may exist if:
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• You steer business to a vendor in which you or a family member have a personal financial interest;
• You conduct private business on Company time;
• Outside employment interferes with your responsibilities to HealthSouth;
• You try to take advantage of a business opportunity presented to the Company for your own purposes;
• You perform services for a company in direct competition with HealthSouth;
• You accept gifts, meals, or entertainment in excess of normal business courtesy that may appear to obligate HealthSouth to do
business with a particular contractor or vendor; or
• You develop a competitive business on Company time.
In general, employees are permitted to hold other jobs so long as doing so does not put the employee in a position to compromise confidential or proprietary information or prevent the employee from meeting the performance standards of their position at HealthSouth. Any outside employment should be disclosed to your supervisor and to the Human Resources Department.
If you have a question about whether a specific situation constitutes a conflict of interest, disclose the matter to your supervisor or manager or contact the Internal Audit Department. If you cannot resolve the matter at that level, contact the Legal Services Department.
All employees and Directors must disclose to the Legal Services Department any investment or other financial interest in a competitor or contractor with HealthSouth. This includes investments, financial interests, or employment by a spouse or other immediate family member.
Dealing with Vendors. Treat all vendors fairly and professionally. Follow all Company contracting policies and evaluate bids and vendors objectively on the merits of price and performance. Do not accept extravagant or frequent personal gifts or other personal benefits from vendors as doing so could compromise your objectivity or the integrity of the contracting and purchasing process. Employees may accept modest offers of meals or entertainment or other common “business courtesies” in connection with the discussion of HealthSouth business so long as doing so does not create an expectation that the decision to use a particular vendor will be based upon personal relationships rather than price and performance. Such gifts and other benefits should not exceed a value of $300 per calendar year from any vendor. This includes benefits to family members of employees. An employee should never request a personal gift or benefit from a vendor.
Employees should never use non-public information about HealthSouth for investment or other personal gain.
Investments and Use of Inside Information. HealthSouth employees may become aware of information concerning the Company that is not available to the public but that would be considered important by an investor in deciding whether to buy or sell Company stock or the stock of another company with a significant business relationship to HealthSouth. Employees should never use such non-public information for investment or other personal gain. An employee who discloses confidential information to outsiders may still be held accountable under federal law for any misuse of such information even if the employee does not buy or sell any securities. This requires caution in discussing Company information with friends or acquaintances or participating in internet “chat rooms.”
Employees are discouraged from frequent short-term buying and selling of HealthSouth securities or other companies with which HealthSouth does significant business. This will avoid the appearance of impropriety and promote investor confidence in the integrity of the Company’s public financial reporting systems.
DEALING WITH INVESTORS AND THE MEDIA
Standard: Employees are required to obtain specific approval from the Legal Services Department prior to disclosing any material confidential or non-public information to the public.
In general, only the Company’s executive officers and specifically designated members of the corporate Communications and Finance Departments should speak to investors, market professionals, or the media about HealthSouth. Local media contacts by facility personnel should be coordinated with the Corporate Communications Department.
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GOVERNMENT FILING AND REPORTS
Standard: HealthSouth will endeavor to make all required filings and reports to federal, state, and local government authorities accurately and in a timely manner.
All required filings and reports to federal, state and local governmental authorities should be made accurately and on time.
This includes, but is not limited to, Medicare cost reports and other required program filings, filings with the Securities and Exchange Commission, tax filings, and certificate of need filings and reports. False statements contained in a government filing or report could subject the Company and the individual(s) responsible for preparing and submitting the filing or report to civil or criminal penalties.
The Company will cooperate with authorized requests for information from government auditors and other officials. Non-routine requests for information should be brought to the attention of a DCO or the Legal Services Department.
Employees responsible for providing information to be included in a report or filing to be signed by a more senior manager are responsible for ensuring the accuracy of the information, providing the information in a timely manner, and disclosing any problems or concerns to a supervisor or manager before the final report or filing is submitted.
Documentation and work papers used to prepare or support information contained in a government report or filing should be retained in accordance with Company record retention policies.
LOBBYING AND POLITICAL ACTIVITIES
Standard: All lobbying and other government advocacy carried out by or on behalf of HealthSouth must conform to applicable federal and state regulations.
All lobbying must be approved by the Governmental Affairs Department.
Lobbying. The federal government and many state governments impose rules on lobbying or other types of government advocacy activities. These often include limits on meals and entertainment that may be furnished to government employees as well as requirements for registration and public disclosure of expenses incurred in connection with lobbying activities. To ensure compliance with these rules and to ensure that statements expressed by HealthSouth employees and consultants are consistent with Company policy positions, all lobbying and other government advocacy at the federal and state level must be approved and supervised by the corporate Government Affairs Department.
Do not seek reimbursement from the Company for personal political contributions.
Political Activities. In general, Company funds, facilities, and assets should not be used to support a political candidate or party. Exceptions, where expressly permitted by state law, must be approved by the Government Affairs Department.
Eligible employees may contribute to the HealthSouth Political Action Committee (PAC). However, no employee may be compelled or pressured to do so. Participation in political activities through Company channels or on a personal basis is entirely voluntary and no employee may be rewarded for participating (or penalized for not participating) in any Company sponsored political activity, including the HealthSouth PAC. This applies equally to Company contractors and medical staff members.
Employees should not seek reimbursement from the Company for any personal political contributions.
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CONTACTS BY GOVERNMENT AGENCIES
Standard: The Legal Services Department should be promptly notified if you or your facility are contacted by a government agent in connection with a non-routine investigation of HealthSouth or another person or company. The Risk Management Department should also be contacted for OSHA, EPA, or FDA investigations.
Never destroy or alter a document in anticipation of a government subpoena.
Document the name of the agent, the agency, the subject of the investigation, and any other relevant information. This will allow the Company attorneys to contact the agent to establish a basis for cooperating with the investigation. If the agent wishes to arrange a personal interview with you, Company attorneys can explain your rights and obligations and respond to any questions.
No employee may destroy or alter a Company document or record in anticipation of a government subpoena or other government request for documents or make any intentionally false or misleading statement to a government official or advise another HealthSouth employee to do so.
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Appendix A
CODE OF ETHICAL CONDUCT FOR FINANCIAL MANAGERS
The honesty, integrity and sound judgment of all HealthSouth “Financial Managers” is fundamental to the reputation and success of HealthSouth.
This Code of Ethical Conduct for Financial Managers (“Code”) applies to all HealthSouth “Financial Managers.” Financial Managers are defined as the Chief Executive Officer, Chief Financial Officer, Controller, Vice President Tax, Assistant Controller, Treasurer, Financial Director, Internal Audit and Financial Managers reporting to each of these officers who are responsible for accounting internal control and financial reporting. Financial Managers also include the controllers and managers of each operating unit, area offices, billing managers, and business office managers that are responsible for the processing and reporting of financial transactions.
This Code covers a wide range of financial and non-financial business practices and procedures and is in addition to the HealthSouth Standards of Business Conduct that covers all employees. This Code does not cover all issues and circumstances that may arise, but it sets out basic principles to guide all Financial Managers of HealthSouth. If an applicable law, rule or regulation conflicts with a policy in this Code, the Financial Manager must comply with the applicable law, rule or regulation. Questions about this Code should be directed to HealthSouth’s General Counsel, Controller, or the VP Internal Audit.
HealthSouth recognizes that Financial Managers hold an important and elevated role in corporate governance. They are uniquely capable and empowered to ensure that stakeholders’ interests are appropriately balanced, protected and preserved. Accordingly, this Code provides principles to which Financial Managers are expected to adhere and advocate. This Code embodies rules regarding individual and peer responsibilities, as well as responsibilities to HealthSouth, the public and other stakeholders.
Financial Managers who violate the standards of this Code will be subject to disciplinary action, which may include termination of employment.
Financial Code Principles and Responsibilities
Financial Managers shall adhere to and advocate to the best of their knowledge and ability the following principles and responsibilities governing their professional and ethical conduct.
Reporting of Violations of the Code, Illegal or Unethical Behavior
Employees and others are expected to report observed or suspected violations of the Code and illegal or unethical behavior to a senior financial officer (the Corporate Controller or Chief Financial Officer) OR to the SVP internal Audit, the Chief Compliance Officer or the General Counsel. Complaints regarding HealthSouth accounting, internal accounting controls or auditing matters may be addressed to the Audit Committee c/o HealthSouth Corporation, One HealthSouth Parkway Birmingham, Alabama 35243 or employees may use the HealthSouth Compliance Hotline (888-800-2577). Reports will be treated in a confidential manner. Investigations will be conducted by the SVP Audit Internal Audit or the Chief Compliance Officer. Employees are expected to cooperate fully and in good faith in internal investigations of misconduct and violations of this Code.
1. Act with honesty and integrity, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships. Intimidation or harassment of any associate is expressly prohibited.
2. Provide financial stakeholders, as well as peers, with information that is accurate, complete, objective, relevant, timely and understandable. For reports and documents that HealthSouth files with the Securities and Exchange Commission and releases to the public, the reports shall contain full, fair, accurate, timely and understandable information.
3. Ensure that all transactions are appropriately and adequately documented and that source and original documentation is organized, maintained and safeguarded.
4. Ensure all transactions are accurately reported, timely, and in accordance with Generally Accepted Accounting Principals (GAAP) and with HealthSouth policies. When a question or clarification is needed, approval from the appropriate division controller will be obtained prior to recording the transaction.
5. Comply with all applicable laws, rules and regulations of federal, state and local governments, as well as the rules and regulations of any stock exchange or other regulatory organization of with which HealthSouth is affiliated.
6. Act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or allowing their independent judgment to be subordinated.
7. Protect the confidentiality of proprietary information acquired in the course of their work. When authorized by a HealthSouth officer or otherwise legally obligated to so, disclose such information promptly and completely. Confidential information acquired in the course of their work shall in no event be used for personal advantage.
8. Share knowledge and maintain skills important and relevant to financial stakeholders and HealthSouth’s needs.
9. Proactively promote ethical behavior as a responsible partner among peers in the work environment.
10. Ensure responsible use of and control over all assets, resources and information employed or entrusted to them.
11. Be responsible for implementing and maintaining an adequate internal control structure and procedures for financial reporting, including disclosure controls.
12. Promptly report observed or suspected code violations.
Annual Certification
At least one time each calendar year, all Financial Managers subject to this code will be required to sign a statement stating that they have complied with this Code. A copy of the statement that each Financial Manager is required to sign annually is attached as Exhibit A.
Standards of Business Conduct
This Code is a supplement to, and not in replacement of, HealthSouth’s Standards of Business Conduct. You will be held accountable for your adherence to both this Code and the Standards of Business Conduct.
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HEALTHSOUTH CORPORATION
SAMPLE CODE OF ETHICAL CONDUCT FOR FINANCIAL MANAGE RS
EXHIBIT A
In my role as for HealthSouth Corporation, Division, at the location, I recognize that financial managers hold an important and elevated role in corporate governance. I am uniquely capable and empowered to ensure that stakeholders’ interests are appropriately balanced, protected and preserved. Accordingly, this Code provides principles to which financial managers are expected to adhere and advocate. The Code embodies rules regarding individual and peer responsibilities, as well as my responsibilities to the company, the public and other stakeholders.
I certify that I adhere to and advocate the following principles and responsibilities governing my professional and ethical conduct.
To the best of my knowledge and ability:
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1. I act with honesty and integrity, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships.
2. I have read and understand the HealthSouth Code of Ethical Conduct for Financial Managers.
3. I provide stakeholders with information that is accurate, complete, objective, relevant timely and understandable. For reports and documents the company files with the Securities and Exchange Commission and releases to the public, the reports shall contain full, fair, accurate, timely and understandable information in compliance with Generally Accepted Accounting Principals (GAAP).
4. I comply with rules and regulations promulgated by federal, state, and local governments, and other appropriate private and public regulatory agencies.
5. I act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or allowing my independent judgment to be subordinated.
6. I respect the confidentiality of information acquired in the course of my work except when authorized or otherwise legally obligated to disclose. Confidential information acquired in the course of my work is not used for personal advantage.
7. I am familiar with and comply with company financial policies and procedures.
8. I proactively promote ethical behavior as a responsible partner among peers in my work environment.
9. I achieve responsible use of and control over all assets and resources employed or entrusted to me.
10. I am responsible for implementing and maintaining an adequate internal control structure and procedures for financial reporting disclosure controls.
11. I will promptly report observed or suspected code violations to HealthSouth’s VP, Internal Audit or Chief Compliance Officer.
Signature Title
Print Name Business Unit
Date
IMPORTANT CONTACT INFORMATION AND RESOURCES
Corporate Compliance Office (Health Care Regulatory Issues)
Outpatient Nick Renda Phone: (205) 970-7578 E-mail: [email protected]
Diagnostic David Kanzler Phone: (205) 969-4529 E-mail: [email protected]
OTHER SOURCES
Policy IQ
Includes corporate level policies on a range of subjects. Includes the ability to search by key word or phrase.
Compliance Website
The Company maintains a compliance website as a resource for compliance information and contacts. The compliance website (http://compliance. healthsouth.com) contains helpful information, questions, answers, and other resources about the policies and procedures summarized in this booklet.
The HealthSouth Standards of Business Conduct are available in Spanish. To obtain a copy in Spanish, please have your facility administrator or Human Resources Department print a copy from the Compliance home page on the intranet.
Para Obtener una Copia en Español
Las Normas de Conducta de HealthSouth en español están disponibles. Para obtener una copia en español, por favor consulte a su administrador o el departamento de Recursos Humanos (Personnel) para que les imprima una copia de las normas ubicada en nuestra red privada (“intranet”).
Exhibit 24
POWER OF ATTORNEY
HEALTHSOUTH CORPORATION
KNOW ALL MEN BY THESE PRESENTS, that the undersigned directors of HealthSouth Corporation, a Delaware corporation (the “Company”), hereby constitute and appoint Gregory L. Doody, the undersigneds’ true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him or her and in his or her name, place, and stead, in any and all capacities to:
(1) execute for and on behalf of the undersigned, an Annual Report on Form 10-K of the Company for the fiscal year ended December 31, 2005, including any and all amendments and additions thereto (collectively, the “Annual Report”) in accordance with the Securities Exchange Act of 1934, as amended, and the rules thereunder;
(2) do and perform any and all acts for and on behalf of the undersigned which may be necessary or desirable to file, or cause to be filed, the Annual Report with all exhibits thereto (including this Power of Attorney), and other documents in connection therewith, with the United States Securities and Exchange Commission; and
(3) take any other action or any type whatsoever in connection with the foregoing which, in the opinion of such attorney-in-fact, may be of benefit to, in the best interest of, or legally required by, the undersigned, it being understood that the documents executed by such attorney-in-fact on behalf of the undersigned pursuant to this Power of Attorney shall be in such form and shall contain such terms and conditions as such attorney-in-fact may approve in such attorney-in-fact’s discretion.
The undersigned hereby grant to such attorney-in-fact full power and authority to do and perform any and every act and thing whatsoever requisite, necessary or proper to be done in the exercise of any of the rights and powers herein granted, as fully to all intents and purposes as the undersigned might or could do if personally present, with full power of substitution or revocation, hereby ratifying and confirming all that such attorney-in-fact, or such attorney-in-fact’s substitute or substitutes, shall lawfully do or cause to be done by virtue of this Power of Attorney and the rights and powers herein granted.
IN WITNESS WHEREOF, the undersigned have caused this Power of Attorney to be executed as of March 28, 2006.
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/s/ Jon F. Hanson Jon F. Hanson Chairman of the Board
/s/ Steven R. Berrard Steven R. Berrard Director
/s/ Edward A. Blechschmidt Edward A. Blechschmidt Director
/s/ Donald L. Correll Donald L. Correll Director
/s/ Yvonne M. Curl Yvonne M. Curl Director
/s/ Charles M. Elson Charles M. Elson Director
/s/ Jay Grinney Jay Grinney Director
/s/ Leo I. Higdon, Jr. Leo I. Higdon, Jr. Director
/s/ John E. Maupin, Jr., DDS John E. Maupin, Jr., DDS Director
/s/ L. Edward Shaw, Jr. L. Edward Shaw, Jr. Director
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER REQUIRED B Y RULE 13A-14(A) OR RULE 15D-14(A) OF THE SECURITIES AND EXCHANGE ACT O F 1934, AS ADOPTED
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Jay Grinney, certify that:
1. I have reviewed this annual report on Form 10-K of HealthSouth Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and 15d–15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated: March 28, 2006
By: /s/ Jay Grinney Jay Grinney President and Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER REQUIRED B Y RULE 13A-14(A) OR RULE 15D-14(A) OF THE SECURITIES AND EXCHANGE ACT O F 1934, AS ADOPTED
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John L. Workman, certify that:
1. I have reviewed this annual report on Form 10-K of HealthSouth Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and 15d–15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Dated: March 28, 2006
By: /s/ John L. Workman John L. Workman,
Executive Vice President and Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of HealthSouth Corporation on Form 10-K for the year ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jay Grinney, President and Chief Executive Officer of HealthSouth Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge and belief:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the company.
A signed original of this written statement required by Section 906 has been provided to HealthSouth Corporation and will be retained by HealthSouth Corporation and furnished to the Securities and Exchange Commission or its staff upon request.
Dated: March 28, 2006
By: /s/ Jay Grinney Jay Grinney, President and Chief Executive Officer
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of HealthSouth Corporation on Form 10-K for the year ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, John L. Workman, Executive Vice President and Chief Financial Officer of HealthSouth Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge and belief:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the company.
A signed original of this written statement required by Section 906 has been provided to HealthSouth Corporation and will be retained by HealthSouth Corporation and furnished to the Securities and Exchange Commission or its staff upon request.
Dated: March 28, 2006
By: /s/ John L. Workman John L. Workman,
Executive Vice President and Chief Financial Officer
