| HORIZON HEALTH CORP /DE/ ITEM 1A RISK FACTORS The business and prospects of the Company are subject to the risks described below and other portions of this report |
| If any of the following risks or other risks and uncertainties that are not yet identified or that we currently think are immaterial actually occur, our business, financial condition and results of operations could be materially and adversely affected |
| The Company has announced that it has retained UBS Securities, LLC as its financial advisor to assist the Company in exploring strategic alternatives to enhance shareholder value |
| On October 6, 2006, the Company announced that it has engaged UBS Securities, LLC to assist the Board of Directors in evaluating the assets and operations of the Company in order to review possible alternative strategies to achieve greater shareholder value |
| These alternatives may include a complete or partial sale of the Company, a merger, or a decision to take no action at this time |
| No assurance can be given that a transaction will be pursued or, if a transaction is pursued, that it will be consummated |
| If a transaction is eventually consummated, no assurance can be given with respect to the terms and conditions thereof, including the price |
| If we fail to comply with extensive laws and government regulations, we could suffer penalties or be required to make significant changes to our operations |
| The health care industry is required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things: · billing for services; · relationships with physicians and other referral sources; · adequacy of medical care; · quality of medical equipment and services; · qualifications of medical and support personnel; · confidentiality, maintenance and security issues associated with health-related information and medical records; · licensure; · hospital rate or budget review; · operating policies and procedures; and · addition of facilities and services |
| Among these laws are the anti-kickback provision of the Social Security Act (the “Anti-kickback Statute”) and the provision of the Social Security Act commonly known as the “Stark Law |
| ” These laws impact the relationships that certain health care providers, including our client hospitals and the behavioral health facilities we operate, may have with physicians and other referral sources |
| The Office of Inspector General (OIG) of the Department of Health and Human Services (“HHS”) has enacted safe harbor regulations that outline practices that are deemed protected from prosecution under the Anti-kickback Statute |
| The current relationships that our client hospitals or we have with physicians and other referral sources may not qualify for safe harbor protection under the Anti-kickback Statute |
| In order to comply with the Stark Law, the financial relationships between certain health care providers and physicians and their immediate family members must meet an exception |
| We structure and believe our client hospitals structure our respective relationships to meet an exception to the Stark Law, but the regulations 24 ______________________________________________________________________ implementing the exceptions, some of which are still under review, are detailed and complex, and certain of these relationships may not fully comply with the Stark Law |
| If we fail to comply with the Anti-kickback Statute, the Stark Law or other applicable laws and regulations, we could be subjected to penalties, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more inpatient behavioral health facilities), and exclusion of one or more of our inpatient behavioral health facilities from participation in the Medicare, Medicaid and other federal and state health care programs |
| In addition, if we do not operate our inpatient facilities in accordance with applicable law, the facilities may lose their licenses or the ability to participate in third party reimbursement programs |
| Our client hospitals face similar risks |
| Different interpretations or enforcement of these laws and regulations could subject our current or past practices or our client hospitals to allegations of impropriety or illegality or could require us or our client hospitals to make changes in our respective facilities, equipment, personnel, services, capital expenditure programs and operating expenses |
| A determination that we or our client hospitals have violated these laws or regulations, or the public announcement that we or they are being investigated for possible violations of these laws or regulations, could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly |
| In addition, other similar legislation or regulations at the federal or state level may be adopted |
| If the availability and amount of reimbursements to our client hospitals or our owned facilities by third party payors decreases, then our revenue and earnings could decrease |
| Insurers, managed care companies and governmental payors, including Medicare and Medicaid, have instituted cost containment measures designed to limit payments made to health care providers including our client hospitals and owned facilities |
| The availability and amount of the reimbursements impact the decisions of acute care hospitals regarding whether to offer behavioral health services pursuant to management contracts with us, as well as their decisions on whether to renew such contracts and the amounts paid to us thereunder |
| On November 15, 2004, Centers for Medicare and Medicaid Services (CMS), a federal agency within the US Department of Health and Human Services (HHS), published final regulations adopting a prospective payment system (PPS) for inpatient behavioral health services, which have historically been reimbursed based on reasonable cost, subject to a discharge ceiling |
| CMS has begun phasing in the PPS over a four-year period |
| The new system pays inpatient behavioral health facilities a per diem base rate adjusted by factors that influence the cost of an individual patient’s care, such as each patient’s diagnosis related group, certain other medical and psychiatric coexisting conditions that may complicate treatment and age |
| The final regulations provide for stop loss payments at 70prca, which is calculated on the PPS portion of the transitional rate compared to what behavioral health facilities and units in general acute care hospitals would have received under the old payment system |
| This stop loss provision expires at the end of the transition, ie when the facility is paid 100prca of the PPS rate |
| The prospective payment system rules may result in decreased reimbursements to our client hospitals and may lead to renegotiated contract management fees which could have an adverse effect on our revenues from behavioral health programs we manage |
| On May 7, 2004, CMS published a final rule to modify the criteria for being classified as an inpatient rehabilitation facility |
| The final rule, known as the “75prca Rule,” generally required that in order to meet the qualification requirement, 75prca of the patients of a physical rehabilitation services unit must have certain qualifying medical conditions |
| The final rule had a four-year phase-in period and eliminated polyarthritis and other medical conditions as qualifying medical conditions |
| On August 1, 2006, CMS published a final rule amending the existing 75prca rule by delaying the imposition of the full 75prca threshold by one year |
| Regardless of the one year delay, the result is that certain patients that previously satisfied a qualifying medical condition do not meet a qualifying medical condition under the new rule |
| The final rules together with similar prospective payment rules previously adopted for physical rehabilitation services have resulted and may continue to result in decreased reimbursements to our client hospitals which has led and may continue to lead to, among other things, renegotiated contract management fees which could have an adverse effect on our revenues from rehabilitation programs we manage |
| The Medicare and Medicaid programs are subject to additional statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings and funding restrictions, any of which could have the effect of limiting or reducing reimbursement levels to general acute care hospitals and freestanding behavioral health facilities for behavioral health and physical rehabilitation services provided by programs we 25 ______________________________________________________________________ manage or facilities we own/operate |
| Other future federal and state legislation and regulations may also result in reductions in the payments we receive for our services |
| With regard to the prospective payment system for services provided by inpatient behavioral health care hospitals the per diem amounts are calculated in part based on national averages, but will be adjusted for specific facility characteristics that increase the cost of patient care |
| The base rate per diem is intended to compensate a facility for costs incurred to treat a patient with a particular diagnosis, including nearly all labor and non-labor costs of furnishing covered inpatient behavioral health care services as well as routine, ancillary and capital costs |
| Payments rates for individual inpatient facilities will be adjusted to reflect geographic difference in wages and will allow additional outlier payments for expenses associated with extraordinary cases |
| Additionally, rural providers will receive an increased payment adjustment |
| Medicare will pay this per diem amount, as adjusted, regardless of whether it is more or less than a hospital’s actual costs |
| The per diem will not, however include the costs of bad debt and certain other costs that are paid separately |
| Future federal and state legislation may reduce the payments we receive for our services |
| Insurance and managed care companies and other third parties from whom we receive payment in our owned hospitals are increasingly attempting to control health care costs by requiring that facilities discount their fees in exchange for exclusive or preferred participation in their benefit plans |
| This trend may continue and may reduce the payments received by us for our services |
| A significant number of our management contracts require us to refund or renegotiate some or all of our management fee if either reimbursement for services provided to patients of the program we manage is denied or the fee paid to us is denied as a reimbursable cost |
| Medicare retrospectively audits cost reports of client hospitals upon reimbursement for services rendered |
| Some of our management contracts provide for renegotiation of their terms if the Medicare or Medicaid reimbursement for the mental health or physical rehabilitation services provided by the client hospital drop below a certain level |
| Any significant decrease in Medicare or Medicaid reimbursement levels, the imposition of significant restrictions on participation in the Medicare or Medicaid programs, or the disallowance of any significant portion of a hospital’s costs, including the management fee paid to us, may reduce our revenues |
| Furthermore, facilities which offer behavioral health or physical rehabilitation programs now or hereafter managed or owned/operated by us may not satisfy the requirements for participation in the Medicare or Medicaid programs |
| Recently acquired businesses and facilities, and businesses or facilities acquired in the future, will expose us to increased operating risks |
| We acquired two freestanding behavioral health facilities in fiscal 2004, three freestanding behavioral health facilities in fiscal 2005, and ten freestanding behavioral health facilities in fiscal 2006 |
| As part of our growth strategy, we intend to continue to pursue additional acquisitions, leases, joint ventures and similar transactions |
| This expansion exposes us to additional business and operating risks and uncertainties, including: · the ability to effectively assimilate and manage acquired behavioral health facilities; · the ability to realize our investment in the acquired behavioral health facilities; · the diversion of management’s time and attention from other business concerns; · the risks of entering markets in which we may have no or limited direct prior experience; · the potential loss of key employees of the acquired behavioral health facilities; · the risk that an acquisition could reduce our future earnings; · the exposure to unknown liabilities; and 26 ______________________________________________________________________ · our ability to meet contractual obligations |
| If we are unable to assimilate activities of the acquired behavioral health facilities and manage this expansion efficiently or effectively, or are unable to attract and retain additional qualified management personnel to run the expanded operations, it could result in financial expenditures and increased demands on management’s time and could have a material adverse effect on our business, financial condition and results of operations |
| If we fail to improve the operations of acquired inpatient facilities, we may be unable to achieve our growth strategy |
| We may be unable to maintain or increase the profitability of or operating cash flows at, any existing hospital or other acquired inpatient facility, effectively integrate the operations of any acquisition or otherwise achieve the intended benefit of our growth strategy |
| To the extent that we are unable to enroll in third party payor plans in a timely manner following an acquisition, we may experience a decrease in cash flow or profitability |
| If competition decreases our ability to acquire additional inpatient behavioral health facilities on favorable terms, we may be unable to execute our acquisition strategy |
| An important part of our business strategy is to acquire inpatient behavioral health facilities in attractive markets |
| Some of our competitors have greater financial resources and a larger, more experienced development staff focused on identifying and completing acquisitions |
| Regulatory requirements regarding inpatient behavioral health facilities could delay or prevent the acquisition of additional facilities |
| Some behavioral health facility acquisitions may require a longer period to complete than acquisitions in other industries and may be subject to additional regulatory uncertainty |
| Many states have adopted legislation restricting the sale or other disposition of facilities operated by not-for-profit entities |
| In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste |
| These legislative and administrative efforts focus primarily on the appropriate valuation of the assets divested and the use of the proceeds of the sale by the not-for-profit seller |
| In addition, the acquisition of facilities in certain states requires advance regulatory approval under “certificate of need” or state licensure regulatory regimes |
| These state-level procedures could seriously delay or even prevent us from acquiring inpatient facilities, even after significant transaction costs have been incurred |
| Additional financing may be necessary to fund our acquisition program and capital expenditures, and the financing may not be available when needed or may subject us to risks |
| Our acquisition program requires substantial capital resources |
| Likewise, the operation of existing inpatient behavioral health facilities requires ongoing capital expenditures for renovation, expansion and the upgrade of equipment and technology |
| Our level of indebtedness at any time may restrict our ability to borrow additional funds |
| If we are not able to obtain financing, we may not be able to consummate acquisitions or undertake capital expenditures |
| Currently we have approximately dlra99dtta0 million outstanding on the Company’s dlra175 million revolving credit facility |
| Additionally, we expect to incur additional indebtedness in the future |
| Our borrowed indebtedness could have important consequences, including: · increasing our vulnerability to general adverse economic and industry conditions; · requiring that an increased portion of our cash flow from operations be used for the payment of interest on our debt, thereby reducing our ability to use this cash flow to fund working capital, capital expenditures, acquisitions and general corporate requirements; 27 ______________________________________________________________________ · limiting our ability to sell assets, including capital stock of our restricted subsidiaries, merge or consolidate with other entities, and engage in transactions with our affiliates; · limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions and general corporate requirements; · limiting our flexibility in planning for, or reacting to, changes in our business and the health care industry; · restricting our ability or the ability of our restricted subsidiaries to pay dividends or make other payments; and · placing us at a competitive disadvantage to our competitors that have less indebtedness |
| In addition, our revolving credit facility requires us to maintain and meet specified financial ratios and tests that may require that we take action to reduce our debt or to act in a manner contrary to our business objectives |
| Events beyond our control, including changes in general business and economic conditions, may affect our ability to meet those financial ratios and tests |
| A breach of any of these covenants would result in a default under our revolving credit facility |
| If an event of default under our revolving credit facility occurs, the lenders could elect to declare all amounts outstanding thereunder, together with accrued, but unpaid, interest, to be immediately due and payable |
| Failure to renew contracts or extend contracts on the same terms may result in a significant decrease in our revenue |
| Approximately 32prca of our revenues for the year ended August 31, 2006 were derived from management contracts with general acute care hospitals to manage behavioral health and physical rehabilitation clinical programs of those hospitals |
| The contracts generally have initial terms of three to five years and many have automatic renewal terms subject to termination by either party |
| The contracts often provide for early termination either by the client hospital if specified performance criteria are not satisfied or by us under various other circumstances |
| Although our management contracts are frequently renewed or extended prior to their stated expiration dates, some contracts expire without renewal and others are terminated by us or the client hospital for various reasons prior to their scheduled expiration |
| Our continued success is subject to the ability to renew or extend existing management contracts and obtain new management contracts |
| Contract renewals and extensions are likely to be subject to competing proposals from other contract management companies as well as consideration by certain hospitals to convert from independently managed programs to programs operated internally or to terminate their programs in order to reassign patient beds for other health care purposes |
| A client hospital may not continue to do business with us following expiration or termination of its management contract |
| In addition, any limitations or reductions in reimbursements for services provided by programs managed by us could result in a reduction in the management fees paid to us or the early termination of existing management contracts and would adversely affect our ability to renew or extend existing management contracts and to obtain new management contracts |
| The termination or non-renewal of a material number of management contracts could result in a significant decrease in our net revenues |
| We may be required to spend substantial amounts of capital to comply with legislative and regulatory initiatives relating to privacy and security of patient health information and standards for electronic transactions |
| There are currently numerous legislative and regulatory initiatives at the federal and state levels addressing patient privacy and security concerns |
| In particular, federal regulations issued under the Health Insurance Portability Accountability Act of 1996 (HIPAA) contain provisions that have required, and in the future may require, our facilities to implement costly new computer systems and to adopt business procedures designed to protect the privacy and security of each of their patients’ individually identifiable health and related financial information |
| The privacy regulations have had a financial impact on the health care industry because they impose extensive new administrative requirements, restrictions on the use and disclosure of individually identifiable patient health and related financial information, provide patients with new rights with respect to their health information and require our inpatient facilities to enter into contracts extending many of the privacy regulation requirements to third parties who perform functions on our behalf involving health information |
| 28 ______________________________________________________________________ On February 20, 2003, HHS issued final security regulations under HIPAA Compliance with these security regulations was required by April 21, 2005 for most health care organizations, including our inpatient facilities |
| These security regulations require our inpatient facilities to implement administrative, physical and technical safeguards to protect the integrity, confidentiality and availability of electronically received, maintained or transmitted patient individually identifiable health and related financial information |
| Compliance with these regulations requires substantial expenditures that could negatively impact our financial results |
| In addition, our management has spent, and may spend in the future, substantial time and effort on compliance measures |
| HHS has issued regulations requiring most health care organizations, including our behavioral health facilities, to use standard data formats and code sets when electronically transmitting information in connection with several types of transactions, including health claims, health care payment and remittance advice and health claim status transactions |
| Violations of the privacy, security and transaction regulations could subject our inpatient facilities to civil penalties of up to dlra25cmam000 per calendar year for each provision contained in the privacy, security and transaction regulations that is violated and criminal penalties of up to dlra250cmam000 per violation for certain other violations |
| In addition to extensive government health care regulation, there are numerous initiatives on federal and state levels for comprehensive reforms affecting the payment for and availability of health care services |
| We are not certain what legislation on health care reform may ultimately be proposed or enacted or whether other changes in the administration or interpretation of governmental health care programs will occur |
| Currently proposed or future health care legislation or other changes in the administration or interpretation of governmental health care programs may have an adverse effect on us |
| Other companies within the health care industry continue to be the subject of federal and state investigations, which increases the risk that we may become subject to investigations in the future |
| Both federal and state government agencies as well as private payors have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of health care organizations |
| These investigations relate to a wide variety of topics, including: · cost reporting and billing practices; · quality of care; · financial relationships with referral sources; · medical necessity of services provided; and · treatment of uninsured patients |
| The OIG and the US Department of Justice (DOJ) have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse |
| Moreover, health care providers are subject to civil and criminal false claims laws, including the federal False Claims Act, which allows private parties to bring whistleblower lawsuits against private companies doing business with or receiving reimbursement under federal health care programs |
| Some states have adopted similar state whistleblower and false claims provisions |
| Publicity associated with the substantial amounts paid by other health care providers to settle these lawsuits may encourage our current and former employees and other health care providers to bring whistleblower lawsuits |
| Any investigations of our client hospitals or us could result in significant liabilities or penalties as well as adverse publicity |
| We may be subject to claims and legal actions for damages and other expenses that are not covered by insurance |
| We are, and may be in the future, party to litigation arising in the course of our business |
| Our insurance policies may not be adequate to substantially cover liabilities arising out of those claims or even cover any of such claims |
| Any material claim that is not covered by insurance may have an adverse effect on our business |
| Claims against us, regardless of their merit or outcome, may also have an adverse effect on our reputation and business |
| 29 ______________________________________________________________________ Facilities acquired by us may have unknown or contingent liabilities, including liabilities related to patient care and liabilities for failure to comply with health care laws and regulations, which could result in large claims and significant defense costs |
| Although we generally seek indemnification covering these matters from prior owners of facilities we acquire, such indemnification is often limited and material liabilities for past activities of acquired facilities may exist and such prior owners may not be able to satisfy their indemnification obligations |
| We are also susceptible to being named in claims brought related to patient care and other matters at inpatient facilities owned by third parties and at which we provide contract management services |
| In late 1999, a civil qui tam lawsuit brought under the Federal False Claims Act was filed under seal naming our psychiatric contract management subsidiary, Horizon Mental Health Management, Inc, as one of the defendants in the lawsuit |
| In March 2001, the relators served the complaint in the lawsuit |
| The lawsuit is United States ex reI Debra Hockett, MD, Linda Thompson, MD, and Chyrissa Staley, RN, Plaintiffs, v |
| The DOJ had previously declined to intervene in the lawsuit |
| The complaint alleges that certain of our on-site personnel acted in concert with other non-Company personnel to improperly inflate certain Medicare reimbursable costs associated with psychiatric services rendered at a Tennessee hospital prior to August 1997 |
| The complaint also alleges that the same actions occurred at other hospitals owned by the owner of the Tennessee hospital, a co-defendant in the suit, some of which also had management contracts with the Company |
| The parties are in discovery proceedings and no trial date has been set |
| Any judgment in this suit against us would not be covered by insurance |
| The loss of our key management personnel or our inability to attract and retain qualified clinical management, marketing and other personnel could have a material adverse effect on our business operations |
| Our continued success depends upon our executive officers and members of our management team, the loss of one or more of whom could adversely affect our business operations |
| Our success and growth strategy also depend on our ability to attract and retain qualified clinical, management, marketing and other personnel |
| We compete with general acute care hospitals and other health care providers for the services of psychiatrists, psychologists, social workers, therapists, physical therapists and other clinical personnel |
| Demand for clinical personnel for physical rehabilitation purposes is high and they are often subject to competing offers of employment |
| We may not be able to attract and retain the qualified personnel necessary for our business in the future |
| We operate in a highly competitive environment |
| If we do not compete effectively in our markets, then we could lose market share |
| The health care industry is highly competitive and subject to continual changes in the method in which services are provided and the types of companies providing services |
| We compete with several national competitors and many regional and local competitors, some of which have greater resources than us |
| In addition, acute care hospitals could elect to manage their own behavioral health or physical rehabilitation programs |
| Competition among contract managers for hospital-based behavioral health and physical rehabilitation programs is generally based upon reputation for quality, price, the ability to provide financial and other benefits for the hospital, and the management, operational and clinical expertise necessary to enable the hospital to offer behavioral health and physical rehabilitation programs that provide the full continuum of behavioral health and physical rehabilitation services in a quality and cost-effective manner |
| The pressure to reduce health care expenditures has strengthened the need to manage the appropriateness of behavioral health and physical rehabilitation services provided to patients |
| In addition, acute care hospitals offering behavioral health and physical rehabilitation programs managed by us compete for patients with other providers of behavioral health care services, including other acute care hospitals, freestanding behavioral health facilities, independent psychiatrists and psychologists, and with other providers of physical rehabilitation services, including other acute care hospitals, freestanding rehabilitation facilities and outpatient facilities |
| 30 ______________________________________________________________________ There are potential risks associated with our goodwill and other intangible assets |
| At August 31, 2006, goodwill and net intangible assets represented 47dtta4prca of our total assets |
| In addition, any significant decrease in the value of our intangible assets could have a material adverse effect on us |
| Under current generally accepted accounting principles, we are required to test impairment of goodwill and intangible assets at least annually |
| Because of the significance of goodwill and the identified indefinite lived assets to our consolidated balance sheet, impairment analyses are important |
| Changes in key assumptions about our business and its prospects, or changes in market conditions or other external factors, could result in an impairment charge and such a charge could have a material adverse effect on our financial condition and results of operations |
| We are subject to medical malpractice and other lawsuits due to the nature of the services we provide |
| Facilities acquired by us may have unknown or contingent liabilities, including liabilities related to patient care and liabilities for failure to comply with health care laws and regulations, which could result in large claims and significant defense costs |
| Although we generally seek indemnification covering these matters from prior owners of facilities we acquire, material liabilities for past activities of acquired facilities may exist and such prior owners may not be able to satisfy their indemnification obligations |
| We are also susceptible to being named in claims brought related to patient care and other matters at inpatient facilities owned by third parties and operated by us |
| To protect ourselves from the cost of these claims, professional malpractice liability insurance and general liability insurance coverage is maintained in amounts and with deductibles common in the industry |
| There are no assurances that our insurance will cover all claims (eg, claims for punitive damages) or that claims in excess of our insurance coverage will not arise |
| A successful lawsuit against us that is not covered by, or is in excess of, our insurance coverage may have a material adverse effect on our business, financial condition and results of operations |
| This insurance coverage may not continue to be available at a reasonable cost, especially given the significant increase in insurance premiums generally experienced in the health care industry |
| We depend on our relationships with physicians who use our inpatient facilities |
| Our business depends upon the efforts and success of the physicians who provide health care services at our inpatient facilities and the strength of the relationships with these physicians |
| Our business could be adversely affected if a significant number of physicians or a group of physicians: · terminate their relationship with, or reduce their use of, our inpatient facilities; · fail to maintain acceptable quality of care or to otherwise adhere to professional standards; · suffer damage to their reputation; or · exit the market entirely |
| Our stock price could be volatile |
| The market price of our common stock could fluctuate significantly in response to various factors, including: · problems achieving revenue enhancements and operating efficiencies; · actual and estimated earnings and cash flows; · quarter-to-quarter variations in operating results; · changes in market conditions in the behavioral health care industries; 31 ______________________________________________________________________ · changes in general economic conditions; · fluctuations in the securities markets in general; · operating results differing from analysts’ estimates; and · changes in analysts’ earnings estimates |