10-Q 1 d95950e10-q.txt FORM 10-Q FOR QUARTER ENDED FEBRUARY 28, 2002 HORC 2ND QTR FY2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended February 28, 2002 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------- ------------ Commission file number 1-13626 HORIZON HEALTH CORPORATION (Exact name of registrant as specified in its charter) Delaware 75-2293354 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1500 Waters Ridge Drive Lewisville, Texas 75057-6011 (Address of principal executive offices, including zip code) (972) 420-8200 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] The number of shares outstanding of the registrant's Common Stock, $0.01 par value, as of April 5, 2002, was 5,430,313. INDEX HORIZON HEALTH CORPORATION PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS...................................................... 3 HORIZON HEALTH CORPORATION Consolidated Balance Sheets as of February 28, 2002 (unaudited) and August 31, 2001........................................................... 3 Consolidated Statements of Operations for the three months ended February 28, 2002 and 2001 (each unaudited)................................... 5 Consolidated Statements of Operations for the six months ended February 28, 2002 and 2001 (each unaudited)................................... 6 Consolidated Statements of Cash Flows for the six months ended February 28, 2002 and 2001 (each unaudited)................................... 7 Notes to Consolidated Financial Statements (unaudited)........................ 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................................... 15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................. 23 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS...................................................................... 24 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ................................... 24 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................... 25
2 PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS HORIZON HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS
FEBRUARY 28, 2002 AUGUST 31, 2001 ----------------- --------------- (UNAUDITED) CURRENT ASSETS: Cash and cash equivalents $ 1,569,795 $ 1,980,635 Accounts receivable less allowance for doubtful accounts of $3,143,567 at February 28, 2002 and $2,439,216 at August 31, 2001 13,350,757 12,289,274 Prepaid expenses and supplies 967,798 567,216 Income taxes receivable 72,415 59,024 Other receivables 331,843 52,384 Other assets 560,668 285,072 Deferred taxes 2,352,607 2,158,885 ----------- ----------- TOTAL CURRENT ASSETS 19,205,883 17,392,490 ----------- ----------- Property and Equipment, net (Note 4) 1,998,829 2,232,363 Goodwill (Note 5) 55,530,874 53,245,225 Contracts, net of accumulated amortization of $9,985,501 at February 28, 2002, and $9,106,190 at August 31, 2001 (Note 5) 3,817,201 4,014,753 Other non-current assets 182,915 294,852 ----------- ----------- TOTAL ASSETS $80,735,702 $77,179,683 =========== ===========
See accompanying notes to consolidated financial statements. 3 HORIZON HEALTH CORPORATION CONSOLIDATED BALANCE SHEETS
FEBRUARY 28, 2002 AUGUST 31, 2001 ----------------- --------------- (UNAUDITED) CURRENT LIABILITIES: Accounts payable $ 1,652,107 $ 1,369,180 Employee compensation and benefits 5,656,772 6,087,793 Medical claims payable 2,997,019 3,229,415 Accrued expenses 7,626,585 6,090,621 ------------ ------------ TOTAL CURRENT LIABILITIES 17,932,483 16,777,009 Other noncurrent liabilities 1,408,563 1,780,385 Long-term debt (Note 6) 4,500,000 6,900,000 Deferred income taxes 1,238,032 723,911 ------------ ------------ TOTAL LIABILITIES 25,079,078 26,181,305 ------------ ------------ Commitments and contingencies (Note 7) -- -- STOCKHOLDERS' EQUITY: Preferred stock, $.10 par value, 500,000 shares authorized; none issued or outstanding -- -- Common stock, $.01 par value, 40,000,000 shares authorized; 7,267,750 shares issued and 5,369,308 shares outstanding at February 28, 2002 and 7,267,750 shares issued and 5,322,439 shares outstanding at August 31,2001 72,678 72,678 Additional paid-in capital 18,011,527 17,990,859 Retained earnings 49,702,124 45,364,006 Treasury stock, at cost (1,898,442 shares at February 28, 2002 and 1,945,311 shares at August 31, 2001) (Note 8) (12,129,705) (12,429,165) ------------ ------------ 55,656,624 50,998,378 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 80,735,702 $ 77,179,683 ============ ============
See accompanying notes to consolidated financial statements. 4 HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED FEBRUARY 28, ------------------------------- 2002 2001 ------------ ------------ Revenues: Contract management revenues $ 24,061,111 $ 23,768,368 Premiums and fees 8,978,169 7,651,932 Other service revenue 902,424 451,136 ------------ ------------ Total revenues 33,941,704 31,871,436 Expenses: Salaries and benefits 19,544,720 17,848,605 Medical claims 3,061,066 2,668,256 Purchased services 2,970,561 3,023,709 Provision for doubtful accounts 271,533 199,652 Other 3,763,596 4,083,191 Depreciation and amortization (Note 5) 734,629 1,117,858 ------------ ------------ Operating expenses 30,346,105 28,941,271 Operating income 3,595,599 2,930,165 Other income (expense): Interest expense (48,437) (158,975) Interest and other income 48,503 58,150 Gain (loss) on disposal of fixed assets (2,304) 18,000 ------------ ------------ Income before income taxes 3,593,361 2,847,340 Income tax provision 1,394,222 1,124,700 ------------ ------------ Net income $ 2,199,139 $ 1,722,640 ============ ============ Earnings per common share (Notes 2 and 5): Basic $ .41 $ .31 ============ ============ Diluted $ .38 $ .30 ============ ============ Weighted average shares outstanding: Basic 5,344,036 5,579,777 ============ ============ Diluted 5,846,235 5,756,964 ============ ============
See accompanying notes to consolidated financial statements. 5 HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
SIX MONTHS ENDED FEBRUARY, 28 ------------------------------ 2002 2001 ------------ ------------ Revenues: Contract management revenue $ 47,547,723 $ 46,202,829 Premiums and fees 18,044,886 15,462,874 Other service revenue 2,139,434 1,026,691 ------------ ------------ Total revenues 67,732,043 62,692,394 Expenses: Salaries and benefits 37,701,102 34,406,316 Medical claims 6,273,820 5,648,803 Purchased services 6,238,357 5,935,711 Provision for doubtful accounts 546,845 558,676 Other 8,359,485 8,062,261 Depreciation and amortization (Note 5) 1,483,832 2,251,722 ------------ ------------ Operating expenses 60,603,441 56,863,489 ------------ ------------ Operating income 7,128,602 5,828,905 Other income (expense): Interest expense (121,388) (444,078) Interest and other income 72,286 212,068 Gain (loss) on disposal of fixed assets (2,304) 18,000 ------------ ------------ Income before income taxes 7,077,196 5,614,895 Income tax provision 2,739,078 2,226,194 ------------ ------------ Net income $ 4,338,118 $ 3,388,701 ============ ============ Earnings per common share (Notes 2 and 5): Basic $ .81 $ .57 ============ ============ Diluted $ .75 $ .56 ============ ============ Weighted average shares outstanding: Basic 5,333,334 5,917,188 ============ ============ Diluted 5,813,152 6,082,498 ============ ============
See accompanying notes to consolidated financial statements. 6 HORIZON HEALTH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED FEBRUARY 28, ------------------------------ 2002 2001 ------------ ------------ Operating Activities: Net income $ 4,338,118 $ 3,388,701 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization (Note 5) 1,483,832 2,251,722 Deferred income taxes 514,121 (222,321) Loss (gain) on disposal of fixed assets 2,304 (18,000) Changes in assets and liabilities: (Increase) in accounts receivable (1,065,559) (1,589,814) (Increase) decrease in income taxes receivable (13,391) 574,931 (Increase) decrease in other receivables (279,459) 3,982 (Increase) decrease in prepaid expenses and supplies (400,582) 455,292 (Increase) in other assets (357,382) (74,939) Increase (decrease) in accounts payable, employee compensation and benefits, medical claims payable, and accrued expenses 1,130,155 (512,530) (Decrease) increase in other non-current liabilities (371,822) 1,278,542 ------------ ------------ Net cash provided by operating activities 4,980,335 5,535,566 ------------ ------------ Investing activities: Purchase of property and fixed assets (375,406) (1,138,456) Proceeds from sale of fixed assets 2,150 18,000 Payments for OHCA purchase price adjustment (38,047) -- Payment for purchase of management contract business (2,900,000) -- ------------ ------------ Net cash used in investing activities (3,311,303) (1,120,456) ------------ ------------ Financing Activities: Payments on long term debt (43,000,000) (17,600,000) Proceeds from long term borrowings 40,600,000 11,700,000 Tax benefit associated with stock options exercised 88,249 183,397 Purchase of treasury stock -- (5,618,823) Issuance (surrenders) of treasury stock 231,879 (68,792) ------------ ------------ Net cash from used in financing activities (2,079,872) (11,404,218) ------------ ------------ Net decrease in cash and cash equivalents (410,840) (6,989,108) Cash and cash equivalents at beginning period 1,980,635 8,516,869 ------------ ------------ Cash and cash equivalents at end of period $ 1,569,795 $ 1,527,761 ============ ============ Supplemental disclosure of cash flow information Cash paid during the period for: Interest $ 146,962 $ 371,494 ============ ============ Income taxes $ 2,304,677 $ 1,844,600 ============ ============ Non-cash investing activities (A): Fair value of assets acquired $ 2,938,047 -- Cash paid (2,938,047) -- ------------ ------------ Liabilities assumed -- -- ============ ============
(A) Consists of the purchase of management contracts of Perspectives Health Management Corporation effective October 1, 2001 and an adjustment to the purchase price paid for Occupational Health Consultants of America, Inc. See Note 3. See accompanying notes to consolidated financial statements. 7 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION Horizon Health Corporation (the "Company" or "Horizon") is a provider of employee assistance programs ("EAP") and behavioral health services to businesses and managed care organizations as well as a contract manager of clinical and related services, primarily of mental health and physical rehabilitation programs, offered by general acute care hospitals in the United States. The management contracts are generally for initial terms ranging from three to five years, the majority of which have automatic renewal provisions. The Company currently has offices in the Dallas, Texas; Chicago, Illinois; Tampa, Florida; Orlando, Florida; Denver, Colorado; Philadelphia, Pennsylvania and Nashville, Tennessee metropolitan areas. The Company's National Support Center is in the Dallas suburb of Lewisville, Texas. BASIS OF PRESENTATION: The accompanying consolidated balance sheet at February 28, 2002, the consolidated statements of operations for the three and six months ended February 28, 2002 and 2001, and the consolidated statements of cash flows for the six months ended February 28, 2002 and 2001 are unaudited. These financial statements should be read in conjunction with the Company's audited financial statements for the year ended August 31, 2001. In the opinion of Company management, the unaudited consolidated financial statements include all adjustments, consisting only of normal recurring accruals, which the Company considers necessary for a fair presentation of the financial position of the Company as of February 28, 2002, and the results of operations for the three and six months ended February 28, 2002 and 2001. Operating results for the three and six month periods are not necessarily indicative of the results that may be expected for a full year or portions thereof. 2. EARNINGS PER SHARE Earnings per share has been computed in accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share ("SFAS 128"). Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if the Company's stock options were exercised. Such potential dilutive common shares are calculated using the treasury stock method. The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share computations.
2002 2001 -------------------------------------- ------------------------------------- Net Income Shares Per Share Net Income Shares Per Share Numerator Denominator Amount Numerator Denominator Amount ---------- ----------- --------- ---------- ----------- --------- For the three months ended February 28, BASIC EPS .............................. $2,199,139 5,344,036 $ .41 $1,722,640 5,579,777 $ .31 --------- --------- EFFECT OF DILUTIVE SECURITIES Options ............................... 502,199 177,187 ----------- ----------- DILUTED EPS ............................ $2,199,139 5,846,235 $ .38 $1,722,640 5,756,964 $ .30 ========== =========== ========= ========== =========== ========= For the six months ended February 28, BASIC EPS .............................. $4,338,118 5,333,334 $ .81 $3,388,701 5,917,188 $ .57 --------- --------- EFFECT OF DILUTIVE SECURITIES Options ............................ 479,818 165,310 ----------- ----------- DILUTED EPS ............................ $4,338,118 5,813,152 $ .75 $3,388,701 6,082,498 $ .56 ========== =========== ========= ========== =========== =========
8 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) During fiscal years 2002 and 2001, certain shares subject to options to acquire common stock were not included in certain computations of diluted EPS because the option exercise price was greater than the average market price of the common shares for the quarter. The computation for the quarter ended February 28, 2002 excluded 4,000 shares subject to options, with exercise prices of $23.75. The computation for the quarter ended February 28, 2001 excluded 757,657 shares subject to options, with exercise prices ranging from $6.91 to $23.75. The computation for the six months ended February 28, 2002 excluded an average of 4,335 shares subject to options, with exercise prices ranging from $13.50 to $23.75. The computation for the six months ended February 28, 2001 excluded an average of 781,758 shares subject to options, with exercise prices ranging from $6.91 to $23.75. 3. ACQUISITIONS PERSPECTIVES HEALTH MANAGEMENT CORPORATION Effective October 1, 2001, the Company purchased all the mental health management contracts of Perspectives Health Management Corporation ("PHM"), a wholly owned subsidiary of Legal Access Technologies, Inc. ("LAT"). The Company accounted for the acquisition by the purchase method as required by generally accepted accounting principles. PHM had 12 mental health management contract locations. The management contracts covered 12 inpatient mental health programs, one partial hospitalization mental health program and three intensive outpatient mental health programs. Currently, annualized revenues for the contracts approximate $4.4 million (unaudited). The management contracts constituted all of the business operations of PHM. The purchase price of approximately $2.9 million in cash was funded by the Company's revolving credit facility. Of the $2.9 million purchase price, $2,234,449 is recorded as goodwill and $681,760 as contract valuation. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented. OCCUPATIONAL HEALTH CONSULTANTS OF AMERICA, INC. Effective August 1, 2001, the Company acquired all of the outstanding capital stock of Occupational Health Consultants of America, Inc. ("OHCA") of Nashville, Tennessee for $3.5 million, and OHCA has been consolidated with the Company as of August 1, 2001. The Company accounted for the acquisition of OHCA by the purchase method. OHCA provides employee assistance programs and other related behavioral health care services to self-insured employers. OHCA had total revenues of approximately $2.4 million (unaudited) for the seven months ended July 31, 2001. As of February 28, 2002, the preliminary allocation of the purchase price exceeded the fair value of OHCA's tangible net assets by $3,503,997 of which $3,160,821 is recorded as goodwill and $343,176 as service contract valuation. Tangible assets acquired and liabilities assumed totaled $898,078 and $860,972 respectively. Pro forma financial data is not presented because the impact of this acquisition is not material to the Company's results of operations for any period presented. 4. PROPERTY AND EQUIPMENT Property and equipment consist of the following at February 28, 2002 and August 31, 2001:
FEBRUARY 28, AUGUST 31, 2002 2001 ------------ ------------ Computer Hardware $ 2,682,762 $ 2,588,003 Computer Software 1,449,382 1,449,041 Furniture and Fixtures 2,273,903 2,268,985 Office Equipment 1,204,452 944,993 Transportation (Vehicles) 65,539 65,539 Leasehold Improvements 579,683 571,734 ------------ ------------ 8,255,721 7,888,295 Less Accumulated Depreciation 6,256,892 5,655,932 ------------ ------------ $ 1,998,829 $ 2,232,363 ============ ============
9 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Depreciation expense for the three months ended February 28, 2002 and 2001 totaled $302,819 and $339,617, respectively and for the six months ended February 28, 2002 and 2001, depreciation expense totaled $604,519 and $695,242, respectively. 5. GOODWILL AND OTHER INTANGIBLE ASSETS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. ("SFAS") 141, Business Combinations ("SFAS 141") and SFAS 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination, whether acquired individually or with a group of other assets, and the accounting and reporting for goodwill and other intangibles subsequent to their acquisition. These standards require all future business combinations to be accounted for using the purchase method of accounting and goodwill not to be amortized but instead to be subject to impairment tests at least annually. The Company elected to adopt SFAS 141 and SFAS 142 on a prospective basis as of September 1, 2001; however, certain provisions of these new standards also apply to any acquisitions concluded subsequent to June 30, 2001. As a result of implementing these new standards, the Company discontinued the amortization of goodwill as of August 31, 2001. In addition, goodwill acquired in the acquisition of OHCA effective August 1, 2001 has not been amortized. The costs of certain management contracts acquired by the Company remain subject to amortization. Management contract amortization for the six months ended February 28, 2002 was $879,313. The following table sets forth the estimated amortization expense for management contracts subject to amortization for the remaining six months in the 2002 fiscal year and for each of the four succeeding fiscal years. For the six months ended 08/31/02 $ 671,595 For the year ended 08/31/03 $ 1,215,380 For the year ended 08/31/04 $ 993,731 For the year ended 08/31/05 $ 468,129 For the year ended 08/31/06 $ 171,496
The following table sets forth by business segment of the Company the amount of goodwill as of August 31, 2001 that is subject to impairment tests instead of amortization and the adjustments to the amount of such goodwill in the six months ended February, 28, 2002.
(A) (B) (C) (D) Horizon Horizon Mental Specialty Mental Behavioral Health Rehab Health Services Management Management Outcomes Consolidated ------------ ------------ ---------- -------- ------------ Balance as of August 31, 2001 $ 36,934,839 $ 14,606,719 $1,703,665 -- $ 53,245,223 Goodwill acquired during the period 51,200 2,234,449 -- -- 2,285,649 Balance as of February 28, 2002 $ 36,986,039 $ 16,841,168 $1,703,665 -- $ 55,530,872
(A) Horizon Behavioral Services provides managed behavioral care and employee assistance programs. Goodwill acquired during the period relates to the purchase price adjustment of Occupational Health Consultants of America. (B) Horizon Mental Health Management provides mental health contract management services to general acute care hospitals. Goodwill acquired during the period relates to the purchase of the contracts of Perspectives Health Management Corporation. (C) Specialty Rehab Management provides physical rehabilitation contract management services to general acute care hospitals. (D) Mental Health Outcomes provides outcome measurement information regarding the effectiveness of mental health treatment programs, data base services and Phase IV Clinical Research services. 10 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following table sets forth comparative net income and earnings per share data based on net income plus amortization expense related to goodwill, net of tax.
THREE MONTHS ENDED FEBRUARY 28, SIX MONTHS ENDED FEBRUARY 28, ------------------------------- ----------------------------- 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Reported net income $ 2,199,139 $ 1,722,640 $ 4,338,118 $ 3,388,701 Goodwill amortization, net of tax -- 259,661 -- 523,228 ------------ ------------ ------------ ------------ Adjusted net income $ 2,199,139 $ 1,982,301 $ 4,338,118 $ 3,911,929 ============ ============ ============ ============ Basic earnings per share: Reported net income $ .41 $ .31 $ .81 $ .57 Goodwill amortization, net of tax -- .05 -- .09 ------------ ------------ ------------ ------------ Adjusted net income $ .41 $ .36 $ .81 $ .66 ============ ============ ============ ============ Diluted earnings per share: Reported net income $ .38 $ .30 $ .75 $ .56 Goodwill amortization, net of tax -- .04 -- .08 ------------ ------------ ------------ ------------ Adjusted net income $ .38 $ .34 $ .75 $ .64 ============ ============ ============ ============
6. LONG-TERM DEBT At February 28, 2002 and August 31, 2001, the Company had long-term debt comprised of a revolving credit facility with an outstanding balances of $4.5 million and $6.9 million, respectively. On November 16, 2000, the Company entered into an Amended and Restated Credit Agreement, effective November 15, 2000 (the "Amended Credit Agreement"), with The Chase Manhattan Bank (now known as JP Morgan Chase), as Agent, which refinanced the term loan then outstanding under the existing credit agreement. The Amended Credit Agreement consists of a $15 million revolving credit facility to fund ongoing working capital requirements, refinance existing debt, repurchase shares (subject to certain limits) and finance future acquisitions by the Company. The revolving credit facility bears interest at (1) the Base Rate plus the Base Rate Margin, as defined or (2) the Adjusted Eurodollar Rate, plus the Eurodollar Margin, as defined. At February 28, 2002, the weighted average interest rate on outstanding indebtedness under the credit facility was 5.25%. The Eurodollar Margin varies depending on the debt coverage ratio of the Company. The revolving credit facility matures on November 15, 2003. On December 12, 2001, the Company received from JP Morgan Chase a letter of intent to provide the Company as agent bank, subject to acceptance by other participating bank(s), with an expanded credit facility. If the pending agreement is finalized, the revolving facility could be used for general corporate purposes, acquisitions, and to refinance the balance on the existing revolving facility. 11 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 7. COMMITMENTS AND CONTINGENCIES The Company leases various office facilities and equipment under operating leases. The following is a schedule of minimum rental payments under these leases, which expire at various dates: Six months ending August 31, 2002 $ 1,152,727 For the year ending August 31, 2003 1,952,313 For the year ending August 31, 2004 1,523,414 For the year ending August 31, 2005 1,105,330 For the years ending August 31, 2006 and thereafter 930,398 ----------- $ 6,664,182 ===========
Rent expense for the six months ended February 28, 2002 and 2001 totaled $1,323,304 and $1,071,208, respectively. Effective September 1996, the Company entered into a lease arrangement with an unconsolidated special purpose entity. The lease agreement, which had an initial term of five years that has been extended to November 2003, is for a building that had been constructed to the Company's specifications for use as its National Support Center. In connection with the transaction, a financial institution loaned to the special purpose entity approximately $4.4 million. The Company guaranteed on a limited basis approximately $900,000 of the loan. The loan is due at the end of the lease term. The Company also agreed to purchase the building for approximately $4.4 million at the end of the lease term, currently November 2003, if either the building is not sold to a third party or the Company does not further extend its lease. A recent independent appraisal indicated the fair market value of the building is at least equal to the loan amount and purchase price. The Company is insured for professional and general liability on a claims-made basis, with additional tail coverage being obtained when necessary. The Company is involved in litigation arising in the ordinary course of business, including matters involving general and professional liability. It is the opinion of management that the ultimate disposition of such litigation, net of any applicable insurance, would not be significantly in excess of any reserves or have a material adverse effect on the Company's financial position or results of operations. In late 1999, the Company became aware that a civil qui tam lawsuit had been filed under seal naming the Company's psychiatric contract management subsidiary, Horizon Mental Health Management (Horizon), as one of the defendants therein. In March 2001, the relators served the complaint in the lawsuit brought under the Federal False Claims Act. The U.S. Department of Justice had previously declined to intervene in the lawsuit. The Company has filed a motion to dismiss and discovery proceedings have been deferred until the court rules on the motion. The Company does not believe the claims asserted in the lawsuit, based on present allegations, represent a material liability to the Company. During the quarter there were no significant developments in connection with this suit. In early December 2000, the Company was served with a U.S. Department of Justice subpoena issued by the U.S. Attorney's Office for the Northern District of California. The subpoena requested the production of documents related to certain matters such as patient admissions, patient care, patient charting, and marketing materials, pertaining to hospital gero-psychiatric programs managed by the Company. The Company believes the subpoena originated as a result of a sealed qui tam suit and has furnished documents in response to the subpoena. No allegations or claims have been made against the Company. At this time, the Company cannot predict the ultimate scope or any particular future outcome of the investigation. During the quarter there were no significant developments in connection with this suit. 12 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 8. STOCK REPURCHASES On October 12, 2000 the Board of Directors authorized the repurchase of up to 1,000,000 shares of its common stock and on February 15, 2001 the Board of Directors authorized the repurchase of an additional 325,000 shares of its common stock. As of February 28, 2002, the Company had repurchased 1,103,563 shares of its common stock pursuant to such authorizations. The stock repurchase plans, as approved by the Board of Directors, authorized the Company to make purchases of its outstanding common stock from time to time in the open market or through privately negotiated transactions, depending on market conditions and applicable securities regulations. The repurchased shares are added to the treasury shares of the Company and may be used for employee stock plans and for other corporate purposes. A total of 394,421 and 347,552 treasury shares had been reissued pursuant to the exercise of certain stock options and in connection with the Employee Stock Purchase Plan as of February 28, 2002 and August 31, 2001, respectively. The shares were repurchased utilizing available cash and borrowings under the Company's credit facility. The Company accounts for the treasury stock using the cost method. 13 HORIZON HEALTH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 9. SEGMENT INFORMATION The following schedule represents revenues and operating results for the periods indicated by operating subsidiary:
(A) (B) (C) (D) (E) Horizon Mental Specialty Horizon Mental Health Rehab Behavioral Health Intercompany Management Management Services Outcomes Other Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ ------------ ------------ THREE MONTHS ENDED: FEBRUARY 28, 2002 Contract management revenue $ 20,295,066 $ 3,734,774 -- $ -- $ 31,271 -- $ 24,061,111 Premiums and fees -- -- $ 8,978,169 -- -- -- 8,978,169 Other service revenue 313,915 21,362 55,180 511,967 -- -- 902,424 Inter Company Revenues -- -- 101,384 254,149 -- (355,533) -- Operating Expenses (F) 14,517,528 2,930,020 8,429,439 960,132 3,129,890 (355,533) 29,611,476 Earnings before interest, taxes, depreciation and amortization (EBITDA) 6,091,453 826,116 705,294 (194,016) (3,098,619) -- 4,330,228 Total Assets 81,926,795 9,566,380 42,069,771 775,784 26,139,007 (79,742,035) 80,735,702 FEBRUARY 28, 2001 Contract management revenue $ 20,380,748 $ 3,337,741 -- $ -- $ 49,879 -- $ 23,768,368 Premiums and fees -- -- $ 7,651,932 -- -- -- 7,651,932 Other service revenue 68,966 13,800 33,677 334,693 -- -- 451,136 Inter Company Revenues -- -- 27,906 282,859 -- (310,765) -- Operating Expenses (F) 14,228,079 2,626,204 7,799,937 670,841 2,809,117 (310,765) 27,823,413 Earnings before interest, taxes, depreciation, and amortization (EBITDA) 6,221,635 725,337 (86,422) (53,289) (2,759,238) -- 4,048,023 Total Assets 80,005,036 7,412,456 41,194,234 222,672 25,992,950 (78,668,127) 76,159,221
(A) (B) (C) (D) (E) Horizon Mental Specialty Horizon Mental Health Rehab Behavioral Health Intercompany Management Management Services Outcomes Other Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ ------------ ------------ SIX MONTHS ENDED: FEBRUARY 28, 2002 Contract management revenue $ 40,113,628 $ 7,365,470 -- $ -- $ 68,625 -- $ 47,547,723 Premiums and fees -- -- $ 18,044,886 -- -- -- 18,044,886 Other service revenue 775,859 42,062 158,842 1,162,671 -- -- 2,139,434 Inter Company Revenues -- -- 140,720 517,349 -- (658,069) -- Operating Expenses (F) 29,321,431 5,671,641 16,758,851 1,817,325 6,208,430 (658,069) 59,119,609 Earnings before interest, taxes, depreciation and amortization (EBITDA) 11,568,056 1,735,891 1,585,597 (137,305) (6,139,805) -- 8,612,434 Total Assets 81,926,795 9,566,380 42,069,771 775,784 26,139,007 (79,742,035) 80,735,702 FEBRUARY 28, 2001 Contract Management revenue $ 39,663,475 $ 6,446,401 -- $ -- $ 92,953 -- $ 46,202,829 Premiums and fees -- -- $ 15,462,874 -- -- -- 15,462,874 Other service revenue 196,179 15,300 70,209 745,003 -- -- 1,026,691 Inter Company Revenues -- -- 47,111 599,149 -- (646,260) -- Operating Expenses (F) 28,167,167 5,396,144 15,181,732 1,231,572 5,281,412 (646,260) 54,611,767 Earnings before interest, taxes, depreciation, and amortization (EBITDA) 11,692,487 1,065,557 398,462 112,580 (5,188,459) -- 8,080,627 Total Assets 80,005,036 7,412,456 41,194,234 222,672 25,992,950 (78,668,127) 76,159,221
(A) Horizon Mental Health Management provides mental health contract management services to general acute care hospitals. (B) Specialty Rehab Management provides physical rehabilitation contract management services to general acute care hospitals. (C) Horizon Behavioral Services provides managed behavioral care and employee assistance programs. (D) Mental Health Outcomes provides outcome measurement information regarding the effectiveness of mental health treatment programs, data base services and Phase IV Clinical Research services. (E) "Other" represents the Company's primary general and administrative costs, i.e., expenses associated with the corporate offices and National Support Center located in the Dallas suburb of Lewisville, Texas which provides management, financial, human resource, and information system support for the Company and its subsidiaries. (F) Excludes depreciation and amortization. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a diversified health services company, currently with its service revenues derived from four business segments. The Company has grown both internally and through acquisitions, increasing both the variety of its services and the number of its contracts. The Company is a leading contract manager of mental health treatment programs and physical rehabilitation clinical programs offered by general acute care hospitals in the United States, the revenues of these two business segments comprise the primary components of the Company's "contract management" revenues. The Company had 146 management contracts as of February 28, 2002 with contract locations in 35 states and the District of Columbia. Of its management contracts, 123 relate to mental health treatment programs operated by the Company's Horizon Mental Health Management ("HMHM") subsidiary and 23 relate to physical rehabilitation programs operated by the Company's Specialty Rehabilitation Management ("SRM") subsidiary. Through its subsidiary, Horizon Behavioral Services, ("HBS") the Company is a provider of employee assistance plans ("EAP") and managed behavioral health care services to businesses and managed care organizations. Revenues of this business segment comprise the primary component of the Company's "premiums and fees" revenues. Through its subsidiary, Mental Health Outcomes ("MHO"), the Company has developed a proprietary mental health outcomes measurement system known as CQI+. Of the 164 outcomes measurement contracts at February 28, 2002, services are currently provided at 146 locations, with the remaining 18 not yet commenced. In addition, MHO provides to pharmaceutical companies retrospective and Phase IV Clinical Research services targeted towards the central nervous system therapeutic area. Of the 8 clinical research projects in operation at February 28, 2002, 5 relate to retrospective projects and 3 relate to Phase IV projects. The outcomes measurement and clinical research activities of this business segment primarily comprise the Company's "other service revenue". See Note 9 to the Consolidated Financial Statements, included elsewhere herein, for additional information concerning the business segments of the Company. CONTRACT MANAGEMENT REVENUE The fees received by the Company for its services under management contracts are paid directly by its client hospitals. Generally, contract fees are paid on a monthly basis. The client hospitals receive reimbursement under either the Medicare or Medicaid programs or payments from insurers, self-funded benefit plans or other third-party payors for the mental health and physical rehabilitation services provided to patients of the programs managed by the Company. As a result, the availability and amount of such reimbursement, which are subject to change, impacts the decisions of general acute care hospitals regarding whether to offer mental health and physical rehabilitation services pursuant to management contracts with the Company, as well as whether to continue such contracts (subject to contract termination provisions) and the amount of fees to be paid thereunder. Horizon Mental Health Management. The Balanced Budget Act of 1997 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services. Implementation began August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient prospective payment system utilizes a fixed reimbursement amount per patient day. The base reimbursement rate is a wage-adjusted rate of $206.82 per day, and will increase to a wage-adjusted rate of $212.27 per day effective April 1, 2002. This lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. This change adversely affected the ability of the Company to maintain and/or obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts. For the quarter ended February 28, 2002, the number of partial programs in operation decreased by 4 from 38 to 34. Over the last twelve months the number has decreased from 45 to 34. 15 Revenues from partial hospitalization services were $1.2 million or 5.0% of total contract management revenues for the quarter ended February 28, 2002, down approximately $500,000, or 29.4% from the prior fiscal year. Of the Company's 123 psychiatric mental health management contracts at February 28, 2002, 46 or 37.4% of the contracts include partial hospitalization services. Of the 46 contracts including partial hospitalization services, 34 program locations had partial hospitalization services in operation, 10 program locations were in operation but the partial hospitalization services were not in operation, and 2 program locations were not yet in operation for any of the services. The termination of all partial hospitalization contracts, while not expected, could reduce operating income by $1.5 million or more annually. In April 2000, the Centers for Medicare and Medicaid Services, or "CMS" (formerly Health Care Financing Administration or "HCFA") adopted new rules requiring a CMS determination that a facility has provider-based status (i.e. the right to bill Medicare, usually on a preferential basis as to amount) before a provider can bill Medicare for the services rendered at the facility. The new rules have been construed by CMS to apply to inpatient mental health units. The rules contain numerous requirements, some specifically applicable to facilities operated under management contracts that must be satisfied in order to receive a CMS determination of provider-based status. The rules are applicable to a provider for new programs at the beginning of its first Medicare cost reporting year that commences after January 10, 2001. Existing programs at October 1, 2000 were "grand-fathered", unless they elect early adoption, until October 1, 2002. The particular application of the rules to inpatient mental health units managed by the Company is currently unclear in several respects. CMS has indicated that it intends to issue guidelines under the new rules, which may provide clarification. At the current time, there is uncertainty with respect to both precisely how the new rules are to be applied to inpatient mental health units managed by the Company and uncertainty as to whether the current structure of the mental health management contracts of the Company will satisfy the requirements under the new rules. The Company is unable at this time to definitively determine the effect of the new provider-based rules on its business operations, but it is possible that the new provider-based rules (unless modified in applicability as discussed below) could result in amendment, termination or non-renewal of mental health management contracts if, under the new rules, it is not possible for a provider to obtain a determination of provider-based status of an inpatient unit operated under the company's current forms of management contracts or under a management contracts generally. The 1999 Balance Budget Refinement Act required CMS to propose a prospective payment system for inpatient psychiatric services by October 1, 2001 and to implement such a system by October 1, 2002. Notwithstanding the October 1, 2001 deadline, CMS has not proposed an inpatient prospective payment system to date. As a result, the Company does not know whether such a system will be implemented by October 1, 2002, but believes it is unlikely to occur by that date. As to the basis for such a system if and when it is proposed, the 1999 Balance Budget Refinement Act stated that the system must include an adequate patient classification system that reflects the differences in patient resource use and cost among hospitals and must maintain budget neutrality. A prospective payment system with reimbursement based on a patient classification system may raise or lower Medicare reimbursement levels to hospitals for inpatient psychiatric services. To the extent client hospital reimbursement decreases, this could adversely affect the ability of the Company to maintain and obtain management contracts for inpatient psychiatric services and the amount of fees paid to the Company under such contracts. Specialty Rehabilitation Services In February 2002, it was announced by CMS that inpatient rehabilitation units do not have to meet provider-based status to bill Medicare for services rendered to patients. It is the belief of the Company that this modification was made because of the phase in of a prospective payment system, whereby a set amount is paid for a given service regardless of costs incurred, and the associated phase out of the current cost based system. It is uncertain, what impact, if any, there would be as to the applicability of provider based regulations to inpatient psychiatric programs (discussed above) if a prospective payment system was also implemented for inpatient mental health services. Recent amendments to the Medicare statutes also provide for a phase-out of cost-based reimbursement of physical rehabilitation services over a two-year period, which began January 1, 2002. Depending on a hospital's Medicare fiscal year, the phase out period could be from 12 to 24 months. The phase in of a prospective payment system with reimbursement based on a functional patient classification may raise or lower Medicare per patient and/or overall 16 reimbursement levels to hospitals for physical rehabilitation services, subject to the subsequent relative changes in per patient costs and patient volumes. Where lower, this could adversely affect the ability of the Company to maintain and/or obtain management contracts for physical rehabilitation services and the amount of fees paid to the Company under such contracts. The Company believes its hospital based service delivery system is a cost efficient model in general terms as compared to alternative structures in the marketplace. However, at this time, the Company cannot meaningfully predict the impact prospective payment will have on the programs it currently manages or on its opportunities for obtaining new programs. PREMIUMS AND FEES REVENUE Horizon Behavioral Services At February 28, 2002, HBS had 680 contracts to provide EAP and managed behavioral health care services covering approximately 2.2 million lives. HBS offers an array of managed care products to corporate clients, self-funded employer groups, commercial HMO and PPO plans, government agencies, and third party payors. Revenues are derived from EAP services, administrative service only contracts, and at risk managed behavioral health services. This revenue consists primarily of capitation payments, which are calculated on the basis of a per-member/per-month fee, and also includes fee for service payments. For certain capitated managed care contracts the Company is `at risk' and bears the economic risk as to the adequacy of capitated revenue versus the actual cost of behavioral health care services incurred by covered members. In October 2000, HBS was awarded a three year, Full Accreditation (the highest level) from the National Committee for Quality Assurance (NCQA) under its 2000 standards for managed behavioral health care organizations (MBHOs). NCQA is an independent, not-for-profit organization dedicated to assessing and reporting on the quality of managed behavioral health care and other related organizations. The NCQA accreditation process is a voluntary review that evaluates how well a managed behavioral health care organization manages all parts of its delivery system in order to continuously improve health care for its members and to help organizations achieve the highest level of performance possible. OTHER SERVICE REVENUE Mental Health Outcomes MHO provides outcomes measurement services to acute care hospital-based programs, free standing psychiatric hospitals, community mental health centers, residential centers and outpatient clinics. In 1999, MHO developed and began marketing PsychScope database services, which allow pharmaceutical product marketers and researchers to access information on the clinical treatment of patients in behavioral health programs across the U.S. In 2001, MHO began offering Phase IV Clinical Research services related to the central nervous system therapeutic area. Revenues are recognized in the month in which services are rendered, at the estimated net realizable amounts. 17 SUMMARY STATISTICAL DATA
FEBRUARY 28, NOVEMBER 30, AUGUST 31, AUGUST 31, AUGUST 31, 2002 2001 2001 2000 1999 ------------ ------------ ---------- ---------- ---------- EAP AND MANAGED BEHAVIORAL HEALTH CARE SERVICES Covered Lives (000'S) 2,234 2,312 2,270 1,736 2,416 CONTRACT MANAGEMENT NUMBER OF CONTRACT LOCATIONS: Contract locations in operation 135 138 124 128 147 Contract locations signed and unopened 11 11 14 10 6 ------------ ------------ ---------- ---------- ---------- Total contract locations 146 149 138 138 153 ============ ============ ========== ========== ========== SERVICES COVERED BY CONTRACTS IN OPERATION: Inpatient 134 136 123 123 133 Partial Hospitalization 34 38 40 65 86 Outpatient 20 20 17 20 27 Home health 3 3 3 5 7 CQI + Psychscope (under contract) 172 172 168 115 106 TYPES OF TREATMENT PROGRAMS IN OPERATION: Geropsychiatric 113 121 109 137 165 Adult psychiatric 45 46 45 47 54 Substance abuse 2 1 1 3 4 Physical Rehabilitation 27 25 24 24 25 Other 4 4 4 3 5
RESULTS OF OPERATIONS The following table sets forth for the three and six months ended February 28, 2002 and 2001, the percentage relationship to total revenues of certain costs, expenses and income.
THREE MONTHS SIX MONTHS ENDED FEBRUARY 28, ENDED FEBRUARY 28, ------------------------- ------------------------- 2002 2001 2002 2001 ---------- ---------- ----------- ---------- Revenues: Contract management revenues 70.9% 74.6% 70.2% 73.7% Premiums and fees 26.4 24.0 26.6 24.7 Other service revenues 2.7 1.4 3.2 1.6 ---------- ---------- ----------- ---------- Total revenues 100.0 100.0 100.0 100.0 Operating revenues Salaries and benefits 57.6 56.0 55.7 54.9 Medical claims 9.0 8.4 9.3 9.0 Purchased services 8.7 9.5 9.2 9.5 Provision for doubtful accounts .8 .6 .8 .9 Other 11.1 12.8 12.3 12.8 Depreciation and amortization 2.2 3.5 2.2 3.6 ---------- ---------- ----------- ---------- Operating expenses 89.4 90.8 89.5 90.7 ---------- ---------- ----------- ---------- Operating income 10.6 9.2 10.5 9.3 ---------- ---------- ----------- ---------- Interest and other income(expenses), net -- (.3) (.1) (.4) ---------- ---------- ----------- ---------- Income before income taxes 10.6 8.9 10.4 8.9 Income tax provision 4.1 3.5 4.0 3.5 ---------- ---------- ----------- ---------- Net income 6.5% 5.4% 6.4% 5.4% ========== ========== =========== ==========
18 THREE MONTHS ENDED FEBRUARY 28, 2002 COMPARED TO THE THREE MONTHS ENDED FEBRUARY 28, 2001 Revenue. Revenues, which are comprised exclusively of revenue for services, for the three months ended February 28, 2002 were $33.9 million representing an increase of $2.0 million, or 6.3%, as compared to revenues of $31.9 million for the corresponding period in the prior fiscal year. Contract management revenue increased $300,000 primarily due to HMHM's acquisition of the psychiatric contracts of Perspectives Health Management ("PHM") (see Note 3 to Consolidated Financial Statements) and increases in same store sales. The PHM contract acquisition effective October 1, 2001 resulted in increased revenue of $1.1 million. Same store sales for contract management revenues, that is contracts in operation for the entire quarter in both the current fiscal year and prior fiscal year increased $511,000, or 2.7%. These increases were partially offset by a decrease in contract termination fees of $850,000 due to the recognition of contract termination fees of nearly $1.0 million in the quarter ended February 28, 2001 compared to $150,000 in the quarter ended February 28, 2002. In addition, psychiatric partial hospitalization program revenue decreased $495,000 resulting from the decline in psychiatric partial hospitalization programs in operation from 62 as of February 28, 2001 to 46 as of February 28, 2002. Premiums and fees increased $1.3 million primarily due to HBS's acquisition of OHCA on August 1, 2001 (see Note 3 to Consolidated Financial Statements) resulting in increased revenues of $1.1 million and a significant increase in covered lives at one managed care contract resulting in increased revenues of $281,000. Other service revenue increased $450,000 in part due to a $104,000 increase in PsychScope revenue related to three significant PsychScope projects and CQI+ contract fees of $73,000. Salaries and Benefits. Salaries and benefits for the three months ended February 28, 2002 were $19.5 million representing an increase of $1.7 million, or 9.6%, as compared to salaries and benefits of $17.8 million for the corresponding period in the prior fiscal year. Average full time equivalents for the three months ended February 28, 2002 were 1,199 representing an increase of 107 or 9.8%, as compared to average full time equivalents of 1,092 for the three months ended February 28, 2001. An increase of 46 full time equivalents, or $509,000 is attributable to the acquisition of OHCA effective August 1, 2001. An increase of 47 full time equivalents, or $615,000 is attributable to the acquisition of the contracts of PHM. Salary and benefits cost per full time equivalent for the three months ended February 28, 2002, excluding the OHCA and PHM contract full time equivalents, were $16,657 representing an increase of $357 per full time equivalent, or 2.2% as compared to salary and benefits cost of $16,300 per full time equivalent for the three months ended February 28, 2001. Other Operating Expenses (Including Medical Claims, Purchased Services, and Provision for Doubtful Accounts). Other operating expenses for the three months ended February 28, 2002 were $10.1 million, representing an increase of $100,000 or 1.0% as compared to other operating expenses of $10.0 million for the corresponding period in the prior fiscal year. The following components identify the primary variances between the periods reported. Medical claims expense for the three months ended February 28, 2002 was $3.1 million, representing an increase of $400,000 or 14.7%, as compared to medical claims expense of $2.7 million for the corresponding period in the prior fiscal year. Of this increase, $138,000 is due to the acquisition of OHCA. The additional increase is primarily due to an increase in the number of inpatient days, as well an overall increase in the average cost per day. Purchased services, which consists primarily of medical specialist fees, legal fees, and consulting fees, for both the three months ended February 28, 2002 and 2001 were $3.0 million. Provision for doubtful accounts expense was $270,000 for the three months ended February 28, 2002, as compared to bad debt expense of $200,000 for the corresponding period in the prior fiscal year. Other. Other expenses for the three months ended February 28, 2002 were $3.8 million representing a decrease of $300,000 or 7.8%, as compared to other expenses of $4.1 million for the corresponding period in the prior fiscal year. This decrease is primarily due to prior period HBS software development project related expenses, which were not incurred in the current year. 19 Depreciation and Amortization. Depreciation and amortization expenses for the three months ended February 28, 2002 were $700,000 representing a decrease of $400,000, or 36.4%, as compared to depreciation and amortization expenses of $1.1 million for the corresponding period in the prior fiscal year. This decrease was primarily due to the Company's adoption of SFAS 141 and SFAS 142 which address the initial recognition and measurement and the subsequent accounting and reporting for goodwill and other intangible assets. As a result of the implementation of these new standards, the Company discontinued the amortization of goodwill as of September 1, 2001 (see Note 5 to Consolidated Financial Statements). Interest and Other Income (Expense), Net. Interest income, interest expense, and other income for the three months ended February 28, 2002 was a net expense of $2,000, as compared to $83,000 for the corresponding period in the prior fiscal year. This change is primarily the result of a decrease in interest expense of $111,000 related to a reduction in the outstanding credit facility balance between the periods, as well as to lower interest rate levels. The weighted average outstanding balance for the three months ended February 28, 2002 was $4.6 million with an ending balance of $4.5 million. The weighted average outstanding balance for the corresponding period in the prior fiscal year was $7.4 million with an ending balance of $9.0 million. The decrease in interest expense is reduced by a reduction in other non-operating income of approximately $23,000 due to the receipt of an escrow settlement in the prior fiscal period related to the Specialty Healthcare acquisition. Income Tax Expense. For the three-month period ended February 28, 2002, the Company recorded federal and state income taxes of $1.4 million resulting in a combined tax rate of 38.8%. For the three-month period ended February 28, 2001, the Company recorded federal and state income taxes of $1.1 million resulting in a combined tax rate of 39.5%. SIX MONTHS ENDED FEBRUARY 28, 2002 COMPARED TO THE SIX MONTHS ENDED FEBRUARY 28, 2001 Revenue. Revenues, which are comprised exclusively of revenue for services, for the six months ended February 28, 2002 were $67.7 million representing an increase of $5.0 million, or 8.0%, as compared to revenues of $62.7 million for the corresponding period in the prior fiscal year. Contract management revenue increased $1.3 million primarily due to HMHM's acquisition of the psychiatric contracts of Perspectives Health Management ("PHM") (see Note 3 to Consolidated Financial Statements) and increases in same store sales. The PHM contract acquisition effective October 1, 2001 resulted in increased revenue of $1.9 million. Same store sales for contract management revenues, that is contracts in operation for the entire six months in both the current fiscal year and prior fiscal year increased $1.5 million, or 4.1%. These increases were partially offset by a decrease in contract termination fees of $800,000 due to the recognition of contract termination fees of nearly $1.0 million in the six months ended February 28, 2001 compared to $200,000 in the six months ended February 28, 2002. In addition, psychiatric partial hospitalization program revenue decreased $1.4 million resulting from the decline in psychiatric partial hospitalization programs in operation from 62 as of February 28, 2001 to 46 as of February 28, 2002. Premiums and fees increased $2.6 million primarily due to HBS's acquisition of OHCA on August 1, 2001 (see Note 3 to Consolidated Financial Statements) resulting in increased revenue of $2.1 million and a significant increase in covered lives at one managed care contract resulting in increased revenue of $463,000. Other service revenue increased $1.1 million in part due to collection fees of $346,000 arising from an agreement entered into in 2001, a $270,000 increase in PsychScope revenue related to three significant PsychScope projects and CQI+ contract fees $147,000. Salaries and Benefits. Salaries and benefits for the six months ended February 28, 2002 were $37.7 million representing an increase of $3.3 million, or 9.6%, as compared to salaries and benefits of $34.4 million for the corresponding period in the prior fiscal year. Average full time equivalents for the six months ended February 28, 2002 were 1,176 representing an increase of 81 or 7.4%, as compared to average full time equivalents of 1,095 for the six months ended February 28, 2001. An increase of 47 full time equivalents, or $1.1 million is attributable to the acquisition of OHCA effective August 1, 2001. An increase of 34 full time equivalents, or $991,000 is attributable to the acquisition of the contracts of PHM. Salary and benefits cost per full time equivalent for the six months ended February 28, 2002, excluding the OHCA and PHM contract full time equivalents, were $32,572 representing an increase of $1,156 per full time equivalent, or 3.7% as compared to salary and benefits cost of $31,416 per full time equivalent for the six months ended February 28, 2001. 20 Other Operating Expenses (Including Medical Claims, Purchased Services, and Provision for Doubtful Accounts). Other operating expenses for the three months ended February 28, 2002 were $21.4 million, representing an increase of $1.2 or 6.0% as compared to other operating expenses of $20.2 million for the corresponding period in the prior fiscal year. The following components identify the primary variances between the periods reported. Medical claims expense for the six months ended February 28, 2002 was $6.2 million, representing an increase of $600,000 or 11.1%, as compared to medical claims expense of $5.6 million for the corresponding period in the prior fiscal year. Of this increase, $308,000 is due to the acquisition of OHCA. The additional increase is primarily due to an increase in the number of inpatient days, as well as an overall increase in the average cost per day. Purchased services, which consists primarily of medical specialist fees, legal fees, and consulting fees, for the six months ended February 28, 2002 were $6.2 million representing an increase of $300,000 or 5.1%, as compared to purchased services of $5.9 million for the corresponding period in the prior fiscal year. Of this increase, $200,000 is due to clinical, consulting, and other services related to two MHO PsychScope projects. The additional $100,000 increase is primarily due to legal fees incurred by HBS for Knox-Keene California licensing. Provision for doubtful accounts expense was $550,000 for the six months ended February 28, 2002, as compared to bad debt expense of $560,000 for the corresponding period in the prior fiscal year. Other. Other expenses for the six months ended February 28, 2002 were $8.4 million representing a decrease of $300,000 or 3.7%, as compared to other expenses of $8.1 million for the corresponding period in the prior fiscal year. Insurance increased $100,000 primarily due to increased premium charges for fiscal year 2002. Rent increased $280,000 primarily due to the acquisition of leased space associated with OHCA and the consolidation of the HBS office space to a single location in Lake Mary. Travel expense increased $150,000 due to a higher level of travel including the impact of the two acquisitions. Line of credit loan fees increased $160,000 primarily due to amortizing the remaining capitalized costs related to the existing credit facility in conjunction with a commitment letter from JP Morgan Chase for a new credit facility as discussed previously (see Note 6 to Consolidated Financial Statements). Other operating expenses decreased $400,000 due to prior period HBS software development project related expenses, which were not incurred in the current fiscal year. Depreciation and Amortization. Depreciation and amortization expenses for the six months ended February 28, 2002 were $1.5 million, representing a decrease of $800,000, or 34.8%, as compared to depreciation and amortization expenses of $2.3 million for the corresponding period in the prior fiscal year. This decrease was primarily due to the Company's adoption of SFAS 141 and SFAS 142 which address the initial recognition and measurement and the subsequent accounting and reporting for goodwill and other intangible assets. As a result of the implementation of these new standards, the Company discontinued the amortization of goodwill as of September 1, 2001(see Note 5 to Consolidated Financial Statements). Interest and Other Income (Expense), Net. Interest income, interest expense, and other income for the six months ended February 28, 2002 was a net expense of $51,000, as compared to $214,000 for the corresponding period in the prior fiscal year. This change is primarily the result of a decrease in interest expense of $323,000 related to a reduction in the outstanding credit facility balance between the periods, as well as to lower interest rate levels. The weighted average outstanding balance for the six months ended February 28, 2002 was $5.2 million with an ending balance of $4.5 million. The weighted average outstanding balance for the corresponding period in the prior fiscal year was $10.7 million with an ending balance of $9.0 million. The decrease in interest expense is reduced by a decrease in interest income of approximately $114,000 due to lower average cash balances, a decrease in other non-operating income of approximately $23,000 due to the receipt of an escrow settlement in the prior fiscal period related to the Specialty Healthcare acquisition, and a decrease in gain on sale of assets of $18,000 due to the sale of two vans in the quarter ended February 28, 2001. Income Tax Expense. For the six-month period ended February 28, 2002, the Company recorded federal and state income taxes of $2.7 million resulting in a combined tax rate of 38.7%. For the three-month period ended February 28, 2001, the Company recorded federal and state income taxes of $2.2 million resulting in a combined tax rate of 39.6%. 21 LIQUIDITY AND CAPITAL RESOURCES The Company believes that its future cash flow from operations (which were $11.5 million for the last twelve months and $5.0 million for the six months ended February 28, 2002), along with cash of $1.6 million at February 28, 2002, and the $15.0 million revolving credit facility (of which $10.5 million was available at February 28, 2002), will be sufficient to cover operating cash requirements over the next 12 months, including estimated capital expenditures of $750,000. The Company may require additional capital to fund acquisitions. Effective November 15, 2000, the Company entered into an Amended and Restated Credit Agreement (the "Amended Credit Agreement"), with the Chase Manhattan Bank (now known as JP Morgan Chase), as Agent, to refinance the term loans outstanding under the existing credit agreement. The Amended Credit Agreement consists of a $15.0 million revolving credit facility to fund ongoing working capital requirements, refinance existing debt, repurchase shares (subject to certain limits) and finance future acquisitions by the Company. As of February 28, 2002, the Company had borrowings of $4.5 million outstanding against the revolving credit facility. The following summary of certain material provisions of the Amended Credit Agreement does not purport to be complete, and is subject to, and qualified in its entirety by reference to, the Amended Credit Agreement, a copy of which was previously filed as Exhibit 10.1 to a the Quarterly Report on Form 10-Q for the quarter ended November 30, 2000. The Company and one of its subsidiaries are the borrowers under the Amended Credit Agreement, which is unconditionally guaranteed by all material subsidiaries of the Company. Principal outstanding under the Amended Credit Agreement bears interest at the "Base Rate" (the greater of the Agent's "prime rate" or the federal funds rate plus .5%) plus .5% or the "Eurodollar Rate" plus 1.75% to 2.25% (depending on the Company's Indebtedness to EBITDA Ratio), as selected by the Company. The Company pays interest quarterly and incurs quarterly commitment fees ranging from .375% to .5% per annum (depending on the Indebtedness to EBITDA Ratio) on the unused portion of the revolving credit facility. The Company is subject to certain covenants which include prohibitions against (i) incurring additional debt or liens, except specified permitted debt or permitted liens, (ii) certain material acquisitions, other than specified permitted acquisitions (including any single acquisition not greater than $10.0 million or cumulative acquisitions not in excess of $15.0 million) during any twelve consecutive monthly periods without prior bank approval, (iii) certain mergers, consolidations or asset dispositions by the Company or changes of control of the Company, (iv) certain management vacancies at the Company, and (v) material change in the nature of business conducted. The Amended Credit Agreement allows the Company to redeem or repurchase up to $10.0 million of its capital stock (subject to certain limitations) of which $6.1 million had been utilized for such purpose as of February 28, 2002. In addition, the terms of the revolving credit facility require the Company to satisfy certain ongoing financial covenants. The revolving credit facility is secured by a first lien or first priority security interest in and/or pledge of substantially all of the assets of the Company and of all present and future subsidiaries of the Company. On December 12, 2001, the Company received from JP Morgan Chase a letter of intent to provide the Company as agent bank, subject to acceptance by other participating bank(s), with an expanded credit facility. If the pending agreement is finalized, the revolving facility could be used for general corporate purposes, acquisitions, and to refinance the balance on the existing revolving facility. Effective September 1996, the Company entered into a lease arrangement with an unconsolidated special purpose entity. The lease agreement, which had an initial term of five years that has been extended to November 2003, is for a building that had been constructed to the Company's specifications for use as its National Support Center. In connection with the transaction, a financial institution loaned to the special purpose entity approximately $4.4 million. The Company guaranteed on a limited basis approximately $900,000 of the loan. The loan is due at the end of the lease term. The Company also agreed to purchase the building for approximately $4.4 million at the end of the lease term, currently November 2003, if either the building is not sold to a third party or the Company does not further extend its lease. A recent independent appraisal indicated the fair market value of the building is at least equal to the loan amount and purchase price. 22 Effective October 1, 2001, the Company acquired all of the mental health management contracts of Perspectives Health Management ("PHM") for approximately $2.9 million in an asset purchase transaction. The acquisition was funded by incurring debt of $2.9 million under the revolving credit facility. Effective August 1, 2001, the Company acquired all of the outstanding capital stock of Occupational Health Consultants of America, Inc. ("OHCA") for approximately $3.5 million. The acquisition was funded by incurring debt of $3.5 million under the revolving credit facility. DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this report, other reports, filings with the Commission, press releases, conferences, or otherwise, are "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "project," "will be," "will continue," "will likely result," or words or phrases of similar meaning. Such statements involve risks, uncertainties or other factors which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by such forward looking statements. Certain risks, uncertainties and other important factors are detailed in this report and will be detailed from time to time in reports filed by the Company with the Commission, including Forms 8-K, 10-Q, and 10-K, and include, among others, the following: general economic and business conditions which are less favorable than expected; unanticipated changes in industry trends; decreased demand by general hospitals for the Company's services; the Company's inability to retain existing management contracts or to obtain additional contracts; adverse changes in reimbursement to general hospitals by Medicare or other third-party payers for costs of providing mental health or physical rehabilitation services; adverse changes to other regulatory requirements relating to the provision of mental health or physical rehabilitation services; adverse consequences of investigations by governmental regulatory agencies; fluctuations and difficulty in forecasting operating results; the ability of the Company to sustain, manage or forecast its growth; heightened competition, including specifically the intensification of price competition; the entry of new competitors and the development of new products or services by new and existing competitors; changes in business strategy or development plans; inability to carry out marketing and sales plans; business disruptions; liability and other claims asserted against the Company; loss of key executives; the ability to attract and retain qualified personnel; customer services; adverse publicity; demographic changes; and other factors referenced or incorporated by reference in this report and other reports or filings with the Commission. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company's business or the extent to which any factor may cause actual results to differ materially from those contained in any forward looking statements. These forward-looking statements represent the estimates and assumptions of management only as of the date of this report. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward looking statement contained herein to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In its normal operations, the Company has market risk exposure to interest rates due to its interest bearing debt obligations, which were entered into for purposes other than trading purposes. To manage its exposure to changes in interest rates, the Company uses both variable rate debt and fixed rate debt of short duration with maturities ranging from 30 to 180 days. The Company has estimated its market risk exposure using sensitivity analyses assuming a 10% change in market rates. At February 28, 2002, the Company had approximately $4.5 million of debt obligations outstanding with a weighted average interest rate of 5.25%. A hypothetical 10% change in the effective interest rate for these borrowings, 23 assuming debt levels as of February 28, 2002, would change interest expense by approximately $24,000 annually. This would be funded out of cash flows from operations, which were $5.0 million for the six months ended February 28, 2002. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS During the quarter there were no significant developments in connection with the civil qui tam lawsuit brought under the Federal False Claims Act naming the Company's psychiatric contract management subsidiary, Horizon Mental Health Management, Inc., as a defendant (described in Item 3 of Part I of the Company's Annual Report on Form 10-K for the year ended August 31, 2000). The U.S. Department of Justice declined to intervene in the lawsuit. During the quarter there were no significant developments in connection with the investigation initiated by the Northern California Office of the U.S. Department of Justice (described in Item 3 of Part I of the Company's Annual Report on Form 10-K for the year ended August 31, 2001). During the quarter there were no significant developments in connection with the lawsuit seeking damages for the unauthorized release of treatment records of a member of an employee assistance program operated by a predecessor of Horizon Behavioral Services, Inc., a subsidiary of the Company (described in Item 3 of Part I of the Company's Annual Report on Form 10-K for the year ended August 31, 2001). However, based on discovery in the case, the Company does not believe this lawsuit represents a material legal proceeding and will not be including information about this matter in future reports. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The annual meeting of stockholders of the Company was held on January 16, 2002. At the meeting, all seven directors of the Company were re-elected. James Ken Newman received 3,388,156 votes for re-election and 585,857 votes were withheld. James W. McAtee received 3,291,356 votes for re-election and 682,657 votes were withheld. Jack R. Anderson, George E. Bello, William H. Longfield, Donald E. Steen and James E. Buncher all received 3,402,056 votes for re-election and 571,957 votes were withheld. At the annual meeting of stockholders, the stockholders approved a proposal to amend the 1998 stock Option Plan, increasing the shares of common stock subject to the plan by 300,000 shares. 2,492,833 votes were cast for this proposal, 789,091 votes were cast against this proposal and 4,252 shares abstained. At the annual meeting of stockholders, the stockholders approved a proposal to amend the 1995 stock option plan for eligible outside directors, increasing the shares of common stock subject to the plan by 100,000 shares. 2,421,496 votes were cast for this proposal, 860,421 votes were cast against this proposal and 4,259 shares abstained. Also at the annual meeting of stockholders, the stockholders ratified the appointment of PricewaterhouseCoopers, LLP as the independent accountants for the Company for the fiscal year ending August 31, 2002. 3,972,897 votes were cast for this proposal, 21 votes were cast against this proposal, and 1,095 shares abstained. 24 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. NUMBER EXHIBIT 3.1 Certificate of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated August 11, 1997). 3.2 Amended and Restated Bylaws of the Company, as amended (incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 as filed with the Commission on February 16, 1995 to the Company's Registration Statement on Form S-1 filed with the Commission on January 6, 1995 (Registration No. 33-88314)). 4.1 Specimen certificate for the Common Stock, $.01 par value of the Company (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated August 11, 1997). 4.2 Rights Agreement, dated February 6, 1997, between the Company and American Stock Transfer & Trust Company, as Rights Agent (incorporated herein by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, Registration No. 000-22123, as filed with the Commission on February 7, 1997). 11.1 Statement Regarding Computation of Per Share Earnings (filed herewith). (b) The Company filed the following reports on Form 8-K during the quarter covered by this report: Current report on Form 8-K filed with the Commission on February 28, 2002. The item reported was Item 5, Other Events, announcing a publicly available conference call regarding the second quarter financial results on March 14, 2002. 25 SIGNATURES Pursuant to the requirements 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. DATE: APRIL 12, 2002 HORIZON HEALTH CORPORATION BY: /s/ RONALD C. DRABIK ---------------------------------------------------------------- RONALD C. DRABIK SENIOR VICE PRESIDENT-FINANCE AND ADMINISTRATION AND TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
26 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 Certificate of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated August 11, 1997). 3.2 Amended and Restated Bylaws of the Company, as amended (incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 as filed with the Commission on February 16, 1995 to the Company's Registration Statement on Form S-1 filed with the Commission on January 6, 1995 (Registration No. 33-88314)). 4.1 Specimen certificate for the Common Stock, $.01 par value of the Company (incorporated herein by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated August 11, 1997). 4.2 Rights Agreement, dated February 6, 1997, between the Company and American Stock Transfer & Trust Company, as Rights Agent (incorporated herein by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A, Registration No. 000-22123, as filed with the Commission on February 7, 1997). 11.1 Statement Regarding Computation of Per Share Earnings (filed herewith).