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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 8-K
Current Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report: August 27, 1997
MedPartners, Inc.
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(Exact Name of Registrant as Specified in its Charter)
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<S> <C> <C>
Delaware 0-27276 63-1151076
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(State or Other (Commission (I.R.S. Employer
Jurisdiction of Incorporation File Number) Identification No.)
or Organization)
3000 Galleria Tower, Suite 1000
Birmingham, Alabama 35244
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(Address of Principal (Zip Code)
Executive Offices)
Registrant's Telephone Number, (205) 733-8996
Including Area Code:
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ITEM 5. OTHER EVENTS
In June 1997, MedPartners, Inc., a Delaware corporation ("MedPartners"
or the "Company"), acquired InPhyNet Medical Management Inc. ("InPhyNet"), a
publicly traded physician practice management company, in exchange
for approximately 19.3 million shares of the Company's Common Stock having a
total value of approximately $413 million (the "InPhyNet Acquisition"). As a
result of the InPhyNet Acquisition and certain other acquisitions, the
Company believes that much of the information and disclosure previously
reported by the Company pursuant to the requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), should be updated and amended to
reflect the Company's current situation. Accordingly, the Company is filing
this Current Report on Form 8-K which contains an updated version of "Risk
Factors", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the consolidated financial statements of the
Company, restated to reflect the acquisition of InPhyNet as a pooling of
interests.
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RISK FACTORS
In addition to the other information contained in this Current Report on
Form 8-K, the factors entered below should be considered carefully. Unless the
context otherwise requires, as used herein, the terms "MedPartners" or the
"Company" refers collectively to MedPartners, Inc. and its respective
subsidiaries and affiliates.
RISKS RELATING TO THE COMPANY'S GROWTH STRATEGY; INTEGRATION IN CONNECTION WITH
ACQUISITIONS AND IDENTIFICATION OF GROWTH OPPORTUNITIES
The Company believes that its recent acquisitions of InPhyNet and Aetna
Professional Management Corporation ("APMC") represent additional steps in the
Company's consolidation initiative in the Physician Practice Management ("PPM")
business to develop integrated healthcare delivery systems through affiliation
with individual physicians, physician practices, hospitals and third-party
payors. The Company is still integrating these and other acquired businesses.
While the business plans of these acquired companies are generally similar,
their histories, geographical location, business models and cultures are
different in many respects. The Company's Board of Directors and senior
management of the Company face a significant challenge in their efforts to
integrate the businesses of the acquired companies so that the different
cultures and the varying emphases on managed care and fee-for-service can be
effectively managed to continue to grow the enterprise. The dedication of
management resources to such integration may detract attention from the
day-to-day business of the Company. There can be no assurance that there will
not be substantial costs associated with such activities or that there will not
be other material adverse effects as a result of these integration efforts. Such
effects could have a material adverse effect on the operating results and
financial condition of the Company.
Integration Risks. Acquisitions of PPM companies and physician practices
entail the risk that such acquisitions will fail to perform in accordance with
expectations and that the Company will be unable to successfully integrate such
acquired businesses and physician practices into its operations. The
profitability of the Company is largely dependent on its ability to develop and
integrate networks of physicians, to manage and control costs and to realize
economies of scale from acquisitions of PPM companies and physician practices.
The histories, geographic location, business models, including emphasis on
managed care and fee-for-service, and cultures of acquired PPM businesses and
physician practices may differ from the Company's past experiences. Dedicating
management resources to the integration process may detract attention from the
day-to-day business of the Company. Moreover, the integration of the acquired
businesses and physician practices may require substantial capital and financial
investments. These, together with other risks described herein, could result in
the incurrence of substantial costs in connection with acquisitions that may
never achieve revenue and profitability levels comparable to the Company's
existing physician networks, which could have a material adverse effect on the
operating results and financial condition of the Company.
The major acquisitions carried out by the Company since January 1995 have
been structured as poolings of interests. As a result, the operating income of
the Company has been reduced by the merger expenses incurred in connection with
those acquisitions, resulting in a net loss for the year ended December 31,
1996. Included in pre-tax loss for the six months ended June 30, 1997, are
merger costs totaling $59.4 million, $50.0 million of which is related to the
business combination with InPhyNet. See Note 5 to the financial statements
included in the Company's Report on Form 10-Q for the quarter ended June 30,
1997. There can
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be no assurance that future merger expenses will not result in further net
losses, nor can there be any assurance that: there will not be substantial
future costs associated with integrating acquired companies; MedPartners will be
successful in integrating such companies; or the anticipated benefits of such
acquisitions will be realized fully. The unsuccessful integration of such
companies or the failure of MedPartners to realize such anticipated benefits
fully could have a material adverse effect on the operating results and
financial condition of the Company. See "-- Risks Relating to Capital
Requirements".
Risks Relating to Capital Requirements. The Company's growth strategy
requires substantial capital for the acquisition of PPM businesses and physician
practice assets and for their effective integration, operation and expansion.
Affiliated physician practices may also require capital for renovation,
expansion and additional medical equipment and technology. The Company believes
that its existing cash resources, the use of Common Stock for selected practice
and other acquisitions and available borrowings under the $1.0 billion credit
facility (the "Credit Facility") with NationsBank, National Association (South),
as administrative bank to a group of lenders, or any successor credit facility,
will be sufficient to meet the Company's anticipated acquisition, expansion and
working capital needs for the next twelve months. The Company expects from time
to time to raise additional capital through the issuance of long-term or
short-term indebtedness or the issuance of additional equity securities in
private or public transactions, at such times as management deems appropriate
and the market allows in order to meet the capital needs of the Company. There
can be no assurance that acceptable financing for future acquisitions or for the
integration and expansion of existing networks can be obtained. Any of such
financings could result in increased interest and amortization expense,
decreased income to fund future expansion and dilution of existing equity
positions.
Ability to Pursue New Growth Opportunities. The Company intends to
continue to pursue an aggressive growth strategy for the foreseeable future
through acquisitions and internal development. The Company's successful pursuit
of new growth opportunities will depend on many factors, including, among
others, the Company's ability to identify suitable targets and to integrate its
acquired practices and businesses. There can be no assurance that the Company
will anticipate all of the changing demands that expanding operations will
impose on its management, management information systems and physician network.
Any failure by the Company to adapt its systems and procedures to those changing
demands could have a material adverse effect on the operating results and
financial condition of the Company.
Competition for Expansion Opportunities. The Company is subject to the
risk that it will be unable to identify and recruit suitable acquisition
candidates in the future. The Company competes for acquisition, affiliation and
other expansion opportunities with national, regional and local PPM companies
and other physician management entities. In addition, certain companies,
including hospital management companies, hospitals and insurers, are expanding
their presence in the PPM market. The Company's failure to compete successfully
for expansion opportunities or to attract and recruit suitable acquisition
candidates could have a material adverse effect on the operating results and
financial condition of the Company. The Company is also subject to the risk that
it will be unable to recruit and retain qualified physicians and other
healthcare professionals to serve as employees or independent contractors of
MedPartners and its affiliates.
Different Business Operations. The PPM business of the Company includes
the provision of pharmacy benefit management ("PBM") and disease management
services which are provided by subsidiaries of the Company. The PBM services
provided by the Company accounted for approximately 33% and 36% of the
Company's net revenue and operating expenses, respectively, for the six months
ended June 30, 1997. Specialty Services, which include disease management,
comprised 8% of the Company's net revenue and 8% of the Company's operating
expenses for the six months ended June 30, 1997.
Physician Compensation. Approximately 70% of the Company's PPM revenue for
the six months ended June 30, 1997, was derived from or through contracts
between the Company and hospitals or HMOs. The balance of the Company's PPM
revenue is generated through professional corporations ("PCs") that have entered
into contracts directly with HMOs or have the right to receive payment directly
from HMOs for the provision of medical services. The Company has a controlling
financial interest in these PCs by virtue of a long-term management agreement
that also provides for physician compensation.
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The most significant clinic expense, physician compensation, accounted for
39% of total expenses in the Company's PPM service area in the first six months
of 1997. Physicians that generated 7% of PPM revenue in the first six months of
1997 received a fixed-dollar amount plus a discretionary bonus based on
performance criteria goals. Physician compensation expense was 51% of this first
category of PCs' total net revenue in the first six months of 1997. Physicians
that were compensated on a fee-for-service basis produced approximately 15% of
the Company's PPM revenue in the first six months of 1997. Physician
compensation expense pursuant to such agreements represented 48% of this second
category of PCs' total net revenue in the first six months of 1997. The
remaining 8% of PPM revenues were generated by physicians who were provided a
salary, bonus and profit-sharing payment based on the PC's net income. Physician
compensation expense pursuant to such agreements represented 39% of this third
category of PCs' total net revenue in the first six months of 1997. Under each
of these arrangements, revenue is assigned to MedPartners by the PC, and
MedPartners is responsible and at risk for all clinic expenses. The
profitability of the Company is largely dependent on its ability to develop and
integrate networks of physicians from the affiliated practices, to manage and
control costs and to realize economies of scale. The Company's operating
results could be adversely affected in the event the Company incurs costs
associated with developing networks without generating sufficient revenues from
such networks.
Dependence on HMO Enrollee Growth. The Company is also largely dependent
on the continued increase in the number of HMO enrollees who use its physician
networks. This growth may come from development or acquisition of other PPM
entities, affiliation with additional physicians, increased enrollment in HMOs
currently contracting with MedPartners through its affiliated physicians and
additional agreements with HMOs. There can be no assurance that the Company will
be successful in identifying, acquiring and integrating additional medical
groups or other PPM companies or in increasing the number of enrollees. A
decline in enrollees in HMOs could have a material adverse effect on the
operating results and financial condition of the Company.
Dependence on Affiliated Physicians. MedPartners' revenue depends on
revenues generated by the physicians with whom MedPartners has practice
management agreements. These agreements define the responsibilities of the
physicians and MedPartners and govern all terms and conditions of their
relationship. The practice management agreements have terms generally of 20 to
40 years, subject to termination for cause, which includes bankruptcy or a
material breach. Practice management agreements with certain of the affiliated
practices contain provisions giving the physician practice the option to
terminate the agreement without cause, subject to significant limitations.
Because MedPartners cannot control the provision of medical services by its
affiliated physicians contractually or otherwise under the laws of California
and most other states in which MedPartners operates, affiliated physicians may
decline to enter into HMO agreements that are negotiated for them by MedPartners
or may enter into contracts for the provision of medical services or make other
financial commitments which are not intended to benefit MedPartners and which
could have a material adverse effect on the operating results and financial
condition of MedPartners.
RISKS RELATING TO CAPITATED NATURE OF REVENUES; CONTROL OF HEALTHCARE COSTS
A substantial portion of MedPartners' revenue is derived from agreements
with HMOs that provide for the receipt of capitated fees. Under these
agreements, the Company, through its affiliated physicians, is generally
responsible for the provision of all covered outpatient benefits, regardless of
whether the affiliated physicians directly provide the medical services
associated with the covered benefits. MedPartners is statutorily and
contractually prohibited from controlling any medical decisions made by any
healthcare provider. To the extent that enrollees require more care than is
anticipated or require supplemental medical care that is not otherwise
reimbursed by the HMO, aggregate capitation rates may be insufficient to cover
the costs associated with the treatment of enrollees. If revenue is insufficient
to cover costs, the operating results and financial condition of the Company
could be materially adversely affected. As a result, MedPartners' success will
depend in large part on the effective management of healthcare costs through
various methods, including utilization management, competitive pricing for
purchased services and favorable agreements with payors. Recently, many
providers, including MedPartners, have experienced pricing pressures with
respect to
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negotiations with HMOs. In addition, employer groups are becoming increasingly
successful in negotiating reductions in the growth of premiums paid for their
employees' health insurance, which tends to depress the reimbursement for
healthcare services. At the same time, employer groups are demanding higher
accountability from payors and providers of healthcare services with respect to
measurable accessibility, quality and service. If these trends continue, the
cost of providing physician services could increase while the level of
reimbursement could grow at a lower rate or could decrease. There can be no
assurance that these pricing pressures will not have a material adverse effect
on the operating results and financial condition of MedPartners. In addition,
changes in healthcare practices, inflation, new technologies, major epidemics,
natural disasters and numerous other factors affecting the delivery and cost of
healthcare could have a material adverse effect on the operating results and
financial condition of the Company.
The Company's financial statements include estimates of costs for covered
medical benefits incurred by HMO enrollees, but not yet reported. While these
estimates are based on information available at the time of calculation, there
can be no assurance that actual costs will approximate the estimates of such
amounts. If the actual costs significantly exceed the amounts estimated and
accrued, such additional costs could have a material adverse effect on the
operating results and financial condition of the Company.
The HMO agreements often contain shared-risk provisions under which
additional revenue can be earned or economic penalties can be incurred based
upon the utilization of hospital and non-professional services by HMO enrollees.
MedPartners' financial statements contain accruals for estimates of shared-risk
amounts receivable from or payable to the HMOs that contract with their
affiliated physicians. These estimates are based upon inpatient utilization and
associated costs incurred by HMO enrollees compared to budgeted costs.
Differences between actual contract settlements and amounts estimated as
receivable or payable relating to HMO risk-sharing arrangements are generally
reconciled annually. This may cause fluctuations from amounts previously
accrued. To the extent that HMO enrollees require more care than is anticipated
or require supplemental care that is not otherwise reimbursed by the HMOs,
aggregate capitation rates may be insufficient to cover the costs associated
with the treatment of enrollees. Any such insufficiency could have a material
adverse effect on the operating results and financial condition of the Company.
Physician groups that render services on a fee-for-service basis (as
opposed to a capitated plan) typically bill various third-party payors, such as
governmental programs (e.g., Medicare and Medicaid), private insurance plans and
managed care plans, for the healthcare services provided to their patients. A
significant portion of the revenue of MedPartners is derived from payments made
by these third-party payors. There can be no assurance that payments under
governmental programs or from other third-party payors will remain at present
levels. In addition, third-party payors can deny reimbursement if they determine
that treatment was not performed in accordance with the cost-effective treatment
methods established by such payors or was experimental or for other reasons. Any
material decrease in payments received from such third-party payors could have a
material adverse effect on the operating results and financial condition of the
Company.
RISKS RELATING TO CERTAIN CAREMARK LEGAL MATTERS
OIG Settlement and Related Claims. Caremark International, Inc.
("Caremark") agreed in June 1995 to settle with the Office of the Inspector
General (the "OIG") of the United States Department of Health and Human
Services (the "DHHS"), the United States Department of Justice (the "DOJ"),
the Veteran's Administration, the Federal Employee Health Benefits Program
("FEHBP"), the Civilian Health and Medical Program of the Uniformed Services
("CHAMPUS") and related state investigative agencies in all 50 states and the
District of Columbia a four-year-long investigation of Caremark (the "OIG
Settlement"). Under the terms of the OIG Settlement, which covered allegations
dating back to 1986, a subsidiary of Caremark pled guilty to two counts of mail
fraud -- one each in Minnesota and Ohio -- resulting in the payment of civil
penalties and criminal fines. The basis of these guilty pleas was Caremark's
failure to provide certain information to CHAMPUS, FEHBP and federally funded
healthcare benefit programs concerning financial relationships between Caremark
and a physician in each of Minnesota and Ohio.
In its agreement with the OIG and DOJ, Caremark agreed to continue to
maintain certain compliance-related oversight procedures. Should these oversight
procedures reveal credible evidence of legal or regulatory
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violations, Caremark is required to report such violations to the OIG and DOJ.
Caremark is, therefore, subject to increased regulatory scrutiny and, in the
event it commits legal or regulatory violations, Caremark may be subject to an
increased risk of sanctions or penalties, including disqualification as a
provider of Medicare or Medicaid services, which would have a material adverse
effect on the operating results and financial condition of the Company.
In connection with the matters described above relating to the OIG
Settlement, Caremark is a party to various non-governmental claims and may in
the future become subject to additional OIG-related claims. Caremark is a party
to, or the subject of, and may be subjected to in the future, various private
suits and claims (including stockholder derivative actions and an alleged class
action suit) being asserted in connection with matters relating to the OIG
Settlement by Caremark's stockholders, patients who received healthcare services
from Caremark and such patients' insurers. The Company cannot determine at this
time what costs or liabilities may be incurred in connection with future
disposition of non-governmental claims or litigation. Such additional costs or
liabilities, if incurred, could have a material adverse effect on the operating
results and financial condition of the Company.
In August and September 1994, stockholders, each purporting to represent a
class, filed complaints against Caremark and certain officers and employees of
Caremark in the United States District Court for the Northern District of
Illinois, alleging violations of the Securities Act of 1933 (the "Securities
Act") and the Securities Exchange Act of 1934 (the "Exchange Act") and fraud
and negligence in connection with public disclosures by Caremark regarding
Caremark's business practices and the status of the OIG investigation discussed
above. The complaints seek unspecified damages, declaratory and equitable
relief, and attorneys' fees and expenses. In June 1996, the complaint filed by
one group of stockholders alleging violations of the Exchange Act only, was
certified as a class. The parties continue to engage in discovery proceedings.
The Company intends to defend these cases vigorously. Management is unable at
this time to estimate the impact, if any, of the ultimate resolution of these
matters.
In May 1996, three home infusion companies, purporting to represent a class
consisting of all of Caremark's competitors in the alternate site infusion
therapy industry, filed a complaint against Caremark, a subsidiary of Caremark,
and two other corporations in the United States District Court for the District
of Hawaii alleging violations of the federal conspiracy laws, the antitrust laws
and of California's unfair business practices statute. The complaint seeks
unspecified treble damages, and attorneys' fees and expenses. MedPartners
intends to defend this case vigorously. Although management believes, based on
information currently available, that the ultimate resolution of this matter is
not likely to have a material adverse effect on the operating results and
financial condition of the Company, there can be no assurance that the ultimate
resolution of this matter, if adversely determined, would not have a material
adverse effect on the operating results and financial condition of the Company.
Private Payor Settlements. In March 1996, Caremark agreed to settle all
disputes with a number of private payors. These disputes relate to businesses
that were covered by the OIG Settlement. The settlements resulted in an
after-tax charge of approximately $43.8 million. In addition, Caremark paid
$24.1 million after-tax to cover the private payors' pre-settlement and
settlement-related expenses. An after-tax charge for the above amounts was
recorded in the first quarter of 1996 as discontinued operations.
Coram Litigation. In September 1995, Coram Healthcare Corporation
("Coram") filed a complaint in the San Francisco Superior Court against
Caremark, its subsidiary, Caremark Inc., and others. The complaint, which arose
from Caremark's sale to Coram of Caremark's home infusion therapy business in
April 1995 for approximately $209.0 million in cash and $100.0 million in
securities, alleged breach of the sale agreement and made other related claims
seeking compensatory damages, in the aggregate, of $5.2 billion. Caremark filed
counterclaims against Coram and also filed a lawsuit in the United States
District Court in Chicago against Coram, claiming securities fraud. On July 1,
1997, the parties to the Coram litigation announced that a settlement had been
reached pursuant to which Caremark will return for cancellation all of the
securities issued by Coram in connection with the acquisition and will pay to
Coram $45 million in cash on or before September 1, 1997. The settlement
agreement also provides for the termination and resolution of all disputes and
issues between the parties and for the exchange of mutual releases. The Company
recognized an after tax charge from discontinued operations of $75.4 million in
the second quarter of 1997 related to this settlement.
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RISKS RELATING TO EXPOSURE TO PROFESSIONAL LIABILITY; LIABILITY INSURANCE
In recent years, physicians, hospitals and other participants in the
healthcare industry have become subject to an increasing number of lawsuits
alleging medical malpractice and related legal theories. Many of these lawsuits
involve large claims and substantial defense costs. Although the Company does
not engage in the practice of medicine or provide medical services, and does not
control the practice of medicine by its affiliated physicians or the compliance
with regulatory requirements directly applicable to the affiliated physicians
and physician groups, there can be no assurance that the Company will not become
involved in such litigation in the future. Through the ownership and operation
of Pioneer Hospital ("Pioneer Hospital"), U.S. Family Care Medical Center
("USFMC") and Friendly Hills Hospital ("Friendly Hills"), acute care hospitals
located in Artesia, Montclair and La Habra, California, respectively, and its
hospital-based operations, the Company is subject to allegations of negligence
and wrongful acts by its hospital-based physicians or arising out of providing
nursing care, hospital-based medical care, credentialing of medical staff
members and other activities incident to the operation of an acute care
hospital. In addition, through its management of clinic locations and provision
of non-physician health care personnel, the Company could be named in actions
involving care rendered to patients by physicians employed by or contracting
with affiliated medical organizations and physician groups.
The Company maintains professional and general liability insurance and
other coverage deemed necessary by the Company. Nevertheless, certain types of
risks and liabilities are not covered by insurance and there can be no assurance
that the limits of coverage will be adequate to cover losses in all instances.
In addition, the Company's practice management agreements require the affiliated
physicians to maintain professional liability and workers' compensation
insurance coverage on the practice and on each employee and agent of the
practice, and the Company generally is indemnified under each of the practice
management agreements by the affiliated physicians for liabilities resulting
from the performance of medical services. However, there can be no assurance
that a future claim or claims will not exceed the limits of these available
insurance coverages or that indemnification will be available for all such
claims.
RISKS RELATING TO GOVERNMENT REGULATION
Federal and state laws regulate the relationships among providers of
healthcare services, physicians and other clinicians. These laws include the
fraud and abuse provisions of the Medicare and Medicaid statutes, which prohibit
the solicitation, payment, receipt or offering of any direct or indirect
remuneration for the referral of Medicare or Medicaid patients or for
recommendation, leasing, arranging, ordering or purchasing of Medicare or
Medicaid covered services, as well as laws that impose significant penalties for
false or improper billings for physician services. These laws also impose
restrictions on physicians' referrals for designated health services to entities
with which they have financial relationships. Violations of these laws may
result in substantial civil or criminal penalties for individuals or entities,
including large civil monetary penalties and exclusion from participation in the
Medicare and Medicaid programs. Such exclusion and penalties, if applied to the
Company's affiliated physicians, could result in significant loss of
reimbursement.
Moreover, the laws of many states, including California (from which a
significant portion of the Company's revenues are derived), prohibit physicians
from splitting fees with non-physicians and prohibit non-physician entities from
practicing medicine. These laws and their interpretations vary from state to
state and are enforced by the courts and by regulatory authorities with broad
discretion. The Company believes that it has perpetual and unilateral control
over the assets and operations of the various affiliated professional
corporations. There can be no assurance that regulatory authorities will not
take the position that such control conflicts with state laws regarding the
practice of medicine or other federal restrictions. Although the Company
believes its operations as currently conducted are in material compliance with
existing applicable laws, there can be no assurance that the existing
organization of the Company and its contractual arrangements with affiliated
physicians will not be successfully challenged as constituting the unlicensed
practice of medicine or that the enforceability of the provisions of such
arrangements, including non-competition agreements, will not be limited. There
can be no assurance that review of the business of the Company and its
affiliates by courts or regulatory authorities will not result in a
determination that could
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adversely affect their operations or that the healthcare regulatory environment
will not change so as to restrict existing operations or expansion thereof. In
the event of action by any regulatory authority limiting or prohibiting the
Company or any affiliate from carrying on its business or from expanding the
operations of the Company and its affiliates to certain jurisdictions,
structural and organizational modifications of the Company may be required,
which could have a material adverse effect on the operating results and
financial condition of the Company.
In addition to the regulations referred to above, significant aspects of
MedPartners' operations are subject to state and federal statutes and
regulations governing workplace health and safety, the operation of pharmacies,
repackaging of drug products, dispensing of controlled substances and the
disposal of medical waste. MedPartners' operations may also be affected by
changes in ethical guidelines and operating standards of professional and trade
associations and private accreditation commissions such as the American Medical
Association and the Joint Commission on Accreditation of Healthcare
Organizations. Accordingly, changes in existing laws and regulations, adverse
judicial or administrative interpretations of such laws and regulations or
enactment of new legislation could have a material adverse effect on the
operating results and financial condition of MedPartners. See "-- Risks Relating
to Pharmacy Licensing and Operation".
For the six months ended June 30, 1997, approximately 12% of the revenues
of the Company's affiliated physician groups are derived from payments made by
government-sponsored healthcare programs (principally, Medicare and state
reimbursement programs). As a result, any change in reimbursement regulations,
policies, practices, interpretations or statutes could adversely affect the
operations of MedPartners. There are also state and federal civil and criminal
statutes imposing substantial penalties (including civil penalties and criminal
fines and imprisonment) on healthcare providers that fraudulently or wrongfully
bill governmental or other third-party payors for healthcare services. The
Company believes it is in material compliance with such laws, but there can be
no assurance that MedPartners' activities will not be challenged or scrutinized
by governmental authorities or that any such challenge or scrutiny would not
have a material adverse effect on the operating results and financial condition
of the Company.
Certain provisions of the Social Security Act, commonly referred to as the
"Anti-Kickback Statute", prohibit the offer, payment, solicitation, or receipt
of any form of remuneration in return for the referral of Medicare or state
health program patients or patient care opportunities, or in return for the
recommendation, arrangement, purchase, lease or order of items or services that
are covered by Medicare or state health programs. Many states have adopted
similar prohibitions against payments intended to induce referrals of Medicaid
and other third-party payor patients. The Anti-Kickback Statute contains
provisions prescribing civil and criminal penalties to which individuals or
providers who violate such statute may be subjected. The criminal penalties
include fines up to $25,000 per violation and imprisonment for five years or
more. Additionally, the DHHS has the authority to exclude anyone, including
individuals or entities, who has committed any of the prohibited acts from
participation in the Medicare and Medicaid programs. If applied to the Company
or any of its subsidiaries or affiliated physicians, such exclusion could result
in a significant loss of reimbursement for the Company, up to a maximum of 12%
of the revenues of the Company's affiliated physician groups, which could have a
material adverse effect on the operating results and financial condition of the
Company. Although the Company believes that it is not in violation of the
Anti-Kickback Statute or similar state statutes, its operations do not fit
within any of the existing or proposed federal safe harbors.
Significant prohibitions against physician referrals were enacted by the
federal Omnibus Budget Reconciliation Act of 1993. Subject to certain
exemptions, a physician or a member of his immediate family is prohibited from
referring Medicare or Medicaid patients to an entity providing "designated
health services" in which the physician has an ownership or investment interest
or with which the physician has entered into a compensation arrangement. While
the Company believes it is in compliance with such legislation, future
regulations could require the Company to modify the form of its relationships
with physician groups. Some states have also enacted similar self-referral laws,
and the Company believes it is likely that more states will follow. MedPartners
believes that its practices fit within exemptions contained in such statutes.
Nevertheless, expansion of the operations of MedPartners into certain
jurisdictions may require structural and organizational modifications of
MedPartners' relationships with physician groups to comply with new or revised
state
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statutes. Such structural and organizational modifications could have a material
adverse effect on the operating results and financial condition of the Company.
The Knox-Keene Health Care Service Plan Act of 1975 (the "Knox-Keene Act"),
and the regulations promulgated thereunder, subject entities which are
licensed, as healthcare service plans in California to substantial regulation
by the California Department of Corporations (the "DOC"). In addition,
licensees under the Knox-Keene Act are required to file periodic financial data
and other information (which generally become available to the public), maintain
substantial tangible net equity on their balance sheets and maintain adequate
levels of medical, financial and operational personnel dedicated to fulfilling
the licensee's statutory and regulatory requirements. The DOC is empowered by
law to take enforcement actions against licensees that fail to comply with such
requirements. In March 1996, the DOC issued to Pioneer Provider Network, Inc., a
wholly-owned subsidiary of MedPartners, a healthcare service plan license (the
"Restricted License"). Non-compliance by Pioneer Network with the Knox-Keene Act
or other applicable laws and regulations could have a material adverse effect on
the operating results and financial condition of the Company.
The assumption of risk on a prepaid basis is being reviewed by various
state insurance commissioners as well as the National Association of Insurance
Commissioners ("NAIC") to determine whether the practice constitutes the
business of insurance. Any such determination could result in significant
additional regulation of the Company's business.
RISKS RELATING TO PHARMACY LICENSING AND OPERATION
The Company is subject to federal and state laws and regulations governing
pharmacies. Federal controlled substance laws require the Company to register
its pharmacies with the United States Drug Enforcement Administration and comply
with security, record-keeping, inventory control and labeling standards in order
to dispense controlled substances. State controlled substance laws require
registration and compliance with the licensing, registration or permit standards
of the state pharmacy licensing authority. State pharmacy licensing,
registration and permit laws impose standards on the qualifications of the
applicant's personnel, the adequacy of its prescription fulfillment and
inventory control practices and the adequacy of its facilities. In general,
pharmacy licenses are renewed annually. Pharmacists must also satisfy state
licensing requirements. Any failure to satisfy such pharmacy licensing statutes
and regulations could have a material adverse effect on the operating results
and financial condition of the Company.
RISKS RELATING TO HEALTHCARE REFORM; PROPOSED LEGISLATION
As a result of the continued escalation of healthcare costs and the
inability of many individuals to obtain health insurance, numerous proposals
have been, and other proposals may be, introduced in the United States Congress
and state legislatures relating to healthcare reform. There can be no assurance
as to the ultimate content, timing or effect of any healthcare reform
legislation, nor is it possible at this time to estimate the impact of potential
legislation, which may be material, on the Company.
ANTI-TAKEOVER CONSIDERATIONS
Certain provisions of the Company's Third Restated Certificate of
Incorporation, as amended (the "MedPartners Certificate of Incorporation"), the
Company's Second Amended and Restated Bylaws (the "MedPartners Bylaws") and the
General Corporation Law of the State of Delaware (the "Delaware General
Corporation Law" or "DGCL") could, together or separately, discourage potential
acquisition proposals or delay or prevent a change in control of the Company.
These provisions include a classified Board of Directors and the issuance,
without further stockholder approval, of preferred stock with rights and
privileges which could be senior to the Company's Common Stock. The Company also
is subject to Section 203 of the DGCL, which, subject to certain exceptions,
prohibits a Delaware corporation from engaging in any of a broad range of
business combinations with any "interested stockholder" for a period of three
years following the date that such stockholder became an interested stockholder.
In addition, the Company's rights plan, which provides for discount purchase
rights to certain stockholders of MedPartners upon certain acquisitions
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<PAGE> 11
of 10% or more of the outstanding shares of the Company's Common Stock, may also
inhibit a change in control of MedPartners.
POSSIBLE VOLATILITY OF STOCK PRICE
There may be significant volatility in the market price for the Company's
Common Stock. Quarterly operating results of the Company, changes in general
conditions in the economy, the financial markets or the health care industry, or
other developments affecting the Company or its competitors, could cause the
market price of the Company's Common Stock to fluctuate substantially. In
addition, in recent years, the stock market and, in particular, the health care
industry segment, has experienced significant price and volume fluctuations.
This volatility has affected the market prices of securities issued by many
companies for reasons unrelated to their operating performance.
11
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of the following discussion is to facilitate the understanding
and assessment of significant changes and trends related to the results of
operations and financial condition of the Company, including changes arising
from recent acquisitions by the Company, the timing and nature of which have
significantly affected the Company's results of operations. This discussion
should be read in conjunction with the consolidated financial statements of the
Company and the notes thereto included herein. See "-- Recent Developments".
GENERAL
In February and September of 1996, the Company combined with Pacific
Physician Services, Inc. ("PPSI") and Caremark, respectively. In June of 1997
the Company combined with InPhyNet. These business combinations were accounted
for as poolings of interests. The financial information referred to in this
discussion reflects the combined operations of these entities and several
additional immaterial entities accounted for as poolings of interests.
The Company is the largest PPM company in the United States. The Company
develops, consolidates and manages integrated healthcare delivery systems.
Through its network of affiliated group and IPA physicians, the Company provides
primary and specialty healthcare services to prepaid enrollees and fee-for-
service patients in the United States. The Company also operates independent PBM
programs and furnishes disease management services and therapies for patients
with certain chronic conditions.
The Company affiliates with physicians who are seeking the resources
necessary to function effectively in healthcare markets that are evolving from
fee-for-service to prepaid payor systems. The Company enhances clinic operations
by centralizing administrative functions and introducing management tools such
as clinical guidelines, utilization review and outcomes measurement. The Company
provides affiliated physicians with access to capital and advanced management
information systems. The Company's PPM revenue is derived primarily from the
contracts with HMOs that compensate the Company and its affiliated physicians on
a prepaid basis. In the prepaid arrangements, the Company typically is paid by
the HMO a fixed amount per member ("enrollee") per month ("professional
capitation") or a percentage of the premium per member per month ("percent of
premium") paid by employer groups and other purchasers of healthcare coverage to
the HMOs. In return, the Company is responsible for substantially all of the
medical services required by enrollees. In many instances, the Company and its
affiliated physicians accept financial responsibility for hospital and ancillary
healthcare services in return for payment from HMOs on a capitated or percent of
premium basis ("institutional capitation"). In exchange for these payments
(collectively, "global capitation"), the Company, through its affiliated
physicians, provides the majority of covered healthcare services to enrollees
and contracts with hospitals and other healthcare providers for the balance of
the covered services. These relationships provide physicians with the
opportunity to operate under a variety of payor arrangements and increase their
patient flow.
The Company offers medical group practices and independent physicians a
range of affiliation models which are described in the notes to the consolidated
financial statements of the Company incorporated herein by reference. These
affiliations are carried out by the acquisition of PPM entities or practice
assets, either for cash or through equity exchange, or by affiliation on a
contractual basis. In all instances, the Company enters into long-term practice
management agreements with the affiliated physicians that provide for both the
management of their practices by the Company and the clinical independence of
the physicians.
The Company also organizes and manages physicians and other healthcare
professionals engaged in the delivery of emergency, radiology and teleradiology
services, hospital-based primary care and temporary staffing and support
services to hospitals, clinics, managed care organizations and physician groups.
Under contracts with hospitals and other clients, the Company identifies and
recruits physicians and other healthcare professionals for admission to a
client's medical staff, monitors the quality of care and proper utilization of
services and coordinates the ongoing scheduling of staff physicians who provide
clinical coverage in designated areas of care.
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<PAGE> 13
The Company also manages outpatient prescription drug benefit programs for
clients throughout the United States, including corporations, insurance
companies, unions, government employee groups and managed care organizations.
The Company dispenses approximately 43,000 prescriptions daily through four mail
service pharmacies and manages patients' immediate prescription needs through a
network of national retail pharmacies. The Company is integrating its PBM
program with the PPM business by providing PBM services to the affiliated
physicians, clinics and HMOs. The Company's disease management services are
intended to meet the healthcare needs of individuals with chronic diseases or
conditions. These services include the design, development and management of
comprehensive programs that comprise drug therapies, physician support and
patient education. The Company currently provides therapies and services for
individuals with such conditions as hemophilia, growth disorders, immune
deficiencies, genetic emphysema, cystic fibrosis and multiple sclerosis.
RESULTS OF OPERATIONS
Through the Company's network of affiliated group and IPA physicians, the
Company provides primary and specialty healthcare services to prepaid enrollees
and fee-for-service patients. The Company also fills in excess of 50 million
prescriptions on an annual basis through its mail service and retail pharmacies
and provides services and therapies to patients with certain chronic conditions,
primarily hemophilia and growth disorders. The following table sets forth the
earnings summary by service area for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Physician Services
Net revenue............................. $1,323,889 $1,989,068 $2,964,162 $1,424,343 $1,783,634
Operating income........................ 48,577 103,528 158,771 71,480 118,377
Margin.................................. 3.7% 5.2% 5.4% 5.0% 6.6%
Pharmaceutical Services
Net revenue............................. $1,097,315 $1,432,250 $1,784,319 $ 865,154 $1,001,463
Operating income........................ 46,236 56,022 75,788 33,514 41,249
Margin.................................. 4.2% 3.9% 4.2% 3.9% 4.1%
Specialty Services
Net revenue............................. $ 487,820 $ 487,399 $ 473,538 $ 234,910 $ 243,436
Operating income........................ 75,139 70,762 56,006 29,626 28,314
Margin.................................. 15.4% 14.5% 11.8% 12.6% 11.6%
Corporate Services
Operating loss.......................... $ (40,079) $ (30,524) $ (31,555) $ (18,248) $ (12,737)
Percentage of total net revenue......... (1.4)% (0.8)% (0.6)% (0.7)% (0.4)%
</TABLE>
Physician Practice Management Services
The Company's PPM revenues have increased substantially over the past three
years primarily due to growth in prepaid enrollment, existing practice growth
and new practice affiliations. Of the total 1996 PPM revenue, $1.7 billion can
be attributed to acquisitions (accounted for as either poolings of interests or
purchase transactions) made during the year. The Company's PPM operations in the
Western region of the country function in a predominantly prepaid environment.
MedPartners' PPM operations in the other regions of the country are in
predominantly fee-for-service environments with limited but increasing managed
care
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penetration. The following table sets forth the breakdown of net revenue for the
PPM services area for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Prepaid........................................ $ 714,112 $1,096,789 $1,593,538 $ 649,449 $ 928,089
Fee-for-Service................................ 585,791 872,653 1,356,084 766,239 845,894
Other.......................................... 23,986 19,626 14,540 8,655 9,651
---------- ---------- ---------- ---------- ----------
Total net revenue from PPM service
area................................ $1,323,889 $1,989,068 $2,964,162 $1,424,343 $1,783,634
========== ========== ========== ========== ==========
</TABLE>
The Company's prepaid revenue reflects the number of HMO enrollees for whom
it receives monthly capitation payments. The Company receives professional
capitation to provide physician services and institutional capitation to provide
hospital care and other non-professional services. The table below reflects the
growth in enrollment for professional and global capitation:
<TABLE>
<CAPTION>
AT DECEMBER 31, AT JUNE 30,
------------------------------- ---------------------
1994 1995 1996 1996 1997
------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Professional enrollees............. 548,821 603,391 983,543 867,753 998,380
Global enrollees (professional and
institutional)................... 286,034 531,608 719,152 647,452 959,135
------- --------- --------- --------- ---------
Total enrollees.......... 834,855 1,134,999 1,702,695 1,515,205 1,957,515
======= ========= ========= ========= =========
</TABLE>
During 1996, prepaid revenues increased 45.3% while prepaid enrollees
increased 50%. The reason for this difference relates to the mix of professional
capitation enrollment to total enrollment (which includes institutional
capitation). Therefore, the higher percentage of professional capitation
enrollment accounts for the lower percentage increase in prepaid revenue as
compared to the percentage increase in total enrollment. The percentage of
professional capitation enrollment to total enrollment was 57.8% at December 31,
1996, compared to 53.2% at December 31, 1995. Revenue per enrollee for
professional capitation is substantially lower than for global capitation as
discussed below.
The Company has developed strong relationships with many of the national
and regional managed care organizations and has demonstrated its ability to
deliver high-quality, cost-effective care. The Company is strategically
positioned to capitalize on the industry's continued evolution toward a prepaid
environment, specifically by increasing the number of prepaid enrollees and
converting existing enrollees from professional to global capitation. These
changes have resulted in significant internal growth. During the first six
months of 1997, the Company converted approximately 225,000 lives from
professional capitation to global capitation.
The Company has consolidated the majority of its acquisitions into its
management infrastructure, eliminating substantial overhead expenses and
improving integration of medical, administrative and operational management. The
integration of various acquisitions into existing networks has allowed the
conversion of thousands of prepaid enrollees from professional capitation to
global capitation. This integration has been a significant factor in increasing
operating margins in the PPM service area from 3.7% at year end 1994 to 6.6% at
June 30, 1997.
The Company operates the largest hospital-based physician group in the
United States with over 2,200 physicians providing services at over 320 sites,
primarily hospitals, nationwide. The Company provides emergency medicine,
radiology, anesthesiology, primary care and other hospital-based physician
services. The Company also provides comprehensive medical services to inmates in
various state and local correctional institutions. As of June 30, 1997, the
Company had contracts with 45 correctional institutions. The Company provides
physicians, nurses and clerical support services for active duty and retired
military personnel and their dependents in emergency departments, ambulatory
care centers and primary care clinics operated by the Department of Defense. At
June 30, 1997, the Company's military medical services were provided under 15
contracts with the Department of Defense.
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<PAGE> 15
In addition to the increased revenues and operational efficiencies realized
through acquisition and consolidation, the Company is profiting from synergies
produced by the exchange of ideas among physicians and managers across
geographical boundaries and varied areas of specialization. The PPM service
area, for example, has established medical management committees that meet
monthly to discuss implementation of the best medical management techniques to
assist the Company's affiliated physicians in delivering the highest quality of
care at lower costs in a consistent fashion. The Company is capitalizing on the
knowledge of its Western groups, which have significant experience operating in
a prepaid environment, to transfer the best practices to other groups in markets
with increasing managed care penetration. Through interaction between physicians
and managers from various medical groups, significant cost savings continue to
be identified at several of the Company's larger affiliated groups.
The PPM service area has also created a national medical advisory
committee, which is developing procedures for the identification, packaging and
dissemination of the best clinical practices within the Company's medical
groups. The committee also provides the Company's affiliated physicians a forum
to discuss innovative ways to improve the delivery of healthcare.
The Company has also initiated integration efforts between the PPM, PBM and
disease management areas. A project is in process to integrate patient care data
from several of the Company's affiliated clinics with the PBM's healthcare
information system. Through this database, which combines medical and claims
data with the prescription information tracked by the PBM area, the Company will
have access to the industry's most complete and detailed collection of
information on successful treatment patterns. Another synergy arising from
integration is the opportunity which the existing PBM infrastructure affords to
affiliated physician groups to further expand services by providing pharmacy
services ranging from fee-for-service retail claims processing to full drug
capitation programs. The Company is also beginning to integrate the disease
management area's expertise in an effort to formulate and implement disease
management programs for the Company.
Pharmacy Benefit Management Services
Pharmaceutical Services revenues continue to exhibit sustained growth
reflecting increases in both mail and retail related services. Revenue for the
six months ended June 30, 1997 increased 15.8% over the same period in 1996.
This growth was due to increased pharmacy transaction volume (6.1%), drug cost
inflation, product mix and pricing (9.7%). Key factors contributing to this
growth include high customer retention, additional penetration of retained
customers and new customer contracts, such as the National Association of Letter
Carriers which became effective January 1, 1997. The majority of Pharmaceutical
Services revenue is earned on a fee-for-service basis through contracts covering
one to three-year periods. Revenues for selected types of services are earned
based on a percentage of savings achieved or on a per-enrollee or per-member
basis; however, these revenues are not material to total revenues.
Operating income increased 23.1% in the first six months of 1997 compared
to the same period of 1996. Operating margins increased from 3.9% to 4.1% for
the six months ended June 30, 1996 and 1997, respectively. Lower margin retail
service revenue continues to grow at a faster rate than mail related revenue.
However, reductions in operating expenses along with the termination of accounts
with unacceptable levels of profitability have offset any impact on operating
margins and have contributed to the overall growth in operating income.
Operating income experienced accelerated growth in 1995 and 1996 while
margins fell slightly from 4.2% in 1994 to 3.9% in 1995 but returned to a 4.2%
level in 1996. Operating income and margins in 1996 were enhanced by reduced
information systems costs achieved through renegotiation of a contract with an
outsource service vendor, continued improvements in the acquisition costs of
drugs, increased penetration of higher margin value-oriented services and an
overall 13% reduction in selling and administrative expenses. Partially
offsetting these cost reductions were continued declines in prices to customers.
Margins in Pharmaceutical Services are also affected by the mix between
mail and retail service revenues. Margins on mail-related service revenues
currently are higher than those on retail service revenues. Revenues in both
mail and retail services continue to grow; although, the growth rate of retail
services in 1995
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<PAGE> 16
and 1996 was greater than the growth rate of mail services. In 1996, retail
service revenues grew to represent nearly 49% of PBM revenues. The Company has
little or no influence over certain other factors, including demographics of the
population served and plan design, which can affect the mix between mail and
retail services. Consequently, margin percentage trends alone are not a
sufficient indication of progress. The Company's pricing and underwriting
strategies are closely linked to its working capital and asset management
strategies and focus on return on investment and overall improvements in return
on capital deployed in the business.
The Company has recently reorganized its sales and corporate accounts
management activities into eight geographic and two additional specialty areas.
This will enable the Company to improve its account retention, client service
and growth initiatives even further as a result of increased accountability and
focus. As mentioned under "-- Physician Practice Management Services", the
Company is pursuing a number of PPM and PBM integration opportunities.
Specialty Services
Specialty services concentrates on providing high quality products and
services in the home. Domestically, these services focus on low incidence
chronic diseases. Internationally, the Company has established home care
businesses in Canada, Germany, the Netherlands, and the United Kingdom. Revenue
growth is due primarily to sales of the Company's new multiple sclerosis drug,
Copaxone, and other products. Margins for specialty services had been declining
slightly as a result of managed care pricing pressures, restructuring of benefit
plans by payors and reduced reimbursement for Medicaid and other state agency
payors. However, margins have increased slightly from the first quarter of 1997
to the second quarter of 1997. This increase can be attributed to the reduction
in operating expenses through increased efficiencies. Cost of service expenses
rose due to programs targeted at launching the Company's sale of the drug
Copaxone.
Discontinued Operations
During 1995, Caremark divested its Caremark Orthopedic Services, Inc.
subsidiary as well as its Clozaril patient management system, home infusion
business and oncology management services business. The Company's consolidated
financial statements present the operating income and net assets of these
discontinued operations separately from continuing operations. Prior periods
have been restated to conform with this presentation. Discontinued operations
for 1995 reflect the net after-tax gain on the disposal of the Clozaril patient
management system, the home infusion business and a $154.8 million after-tax
charge for the settlement discussed in the notes to the audited consolidated
financial statements included herein related to the OIG investigation.
Discontinued operations for 1996 reflects a $67.9 million after-tax charge
related to settlements with private payors discussed in the notes to the
audited consolidated financial statements included herein and an after-tax
gain on disposition of the nephrology services business, net of disposal costs,
of $2.5 million. During the second quarter of 1997, the Company settled a
dispute with Coram Health Corporation arising from Caremark's sale of its home
infusion therapy business to Coram, also discussed in Note 4 of the unaudited
financial statements included in the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997. In accordance with APB 30, which
addresses the reporting for disposition of business segments, the Company's
consolidated financial statements present the operating income of these
discontinued operations separately from continuing operations.
Results of Operations -- Six Months Ended June 30, 1997 and 1996
For the six months ended June 30, 1997, net revenue was $3,028.5 million,
compared to $2,524.4 million for the same period in 1996, an increase of 20.0%.
The increase in net revenue primarily resulted form affiliations with new
physician practices and the increase in pharmaceutical services net revenue,
which accounted for $109.0 million and $136.3 million of the increase in net
revenue, respectively. Additional increases resulted from the shift of enrollees
from professional only to global capitation (approximately 225,000 enrollees
shifted in the six months ended June 30, 1997). The majority of the remainder of
the increase in PPM net revenue can be attributed to growth in existing
physician practices.
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<PAGE> 17
Income from continuing operations, excluding merger expenses, for the
physician services and pharmaceutical services areas grew for the six months
ended June 30, 1997, as compared to the same period of 1996, 65.6% and 23.1%,
respectively. The increase in the physician services area is the result of
higher net revenue and increases in operating margins resulting from the
spreading of fixed overhead expenses over a larger revenue base and continued
integration of operations. The pharmaceutical services area's increase in
operating income was primarily due to reductions in operating expenses, more
efficient use of system resources and higher net revenue. Operating income and
margins declined in the corresponding periods for the specialty services area as
a result of continued pricing pressures for certain products.
Included in pre-tax loss for the six months ended June 30, 1997 and 1996
were merger expenses totaling $59.4 and $34.7 million. The major components of
the $59.4 million, $50 million of which relates to the business combination
with InPhyNet, are listed in Note 5 to the unaudited consolidated financial
statements included in the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997. The $34.7 million relates primarily to the
business combination with Pacific Physician Services, Inc. in 1996. Also
included in the pre-tax loss for the six months ended June 30, 1997 were other
non-recurring charges from discontinued operations of $75.4 million, which are
discussed in Note 4 to the unaudited consolidated financial statements included
in the Company's Quarterly Report on Form 10-Q or the quarter ended June 30,
1997.
Results of Operations for the Years Ended December 31, 1996 and 1995
For the year ended December 31, 1996, net revenue was $5,222.0 million,
compared to $3,908.7 million for 1995, an increase of 33.6%. The increase in net
revenue resulted primarily from affiliations with new physician practices and
the increase in PBM net revenue, which accounted for $339.9 million and $352.1
million of the increase in net revenue, respectively. The most significant
physician practice acquisition during this period was the CIGNA Medical Group
which was acquired in January 1996. This acquisition accounted for 92% of the
new practice revenue. The increase in PBM net revenue is attributable to
pharmaceutical price increases, the addition of new customers, further
penetration of existing customers and the sale of new products.
Operating income for the PPM and PBM services areas increased 53.4% and
35.3%, respectively, for 1996 compared to 1995. This growth was the result of
higher net revenues in both areas and increases in operating margins resulting
from the spreading of fixed overhead expenses over a larger revenue base and
continued integration of operations in the PPM services area. Operating income
and margins declined in the corresponding periods for the specialty services
area as a result of lower volumes in the hemophilia business and continued
pricing pressures for growth hormone products.
Included in the pre-tax loss for 1996 were merger expenses totaling $308.9
million related to the business combinations with Caremark, PPSI and several
other entities, the major components of which are listed in notes to the audited
consolidated financial statements included herein.
Results of Operations for the Years Ended December 31, 1995 and 1994
Net revenue for the year ended December 31, 1995 was $3,908.7 million, an
increase of $999.7 million, or 34.4%, over the year ended December 31, 1994. The
increase in net revenue resulted primarily from affiliation with new physician
practices and the increase in PBM net revenue, which accounted for $240.1
million and $334.9 million of the increase in net revenue, respectively.
Additional increases resulted from an increase in prepaid enrollees at existing
affiliated physician practices. The most significant physician practice
acquisition affecting this period was the Friendly Hills Healthcare Network
which was acquired in May 1995. This acquisition accounted for 53% of the new
practice revenue. The increase in PBM net revenue resulted from increases in
covered lives due to new customer contracts and greater penetration of existing
customers.
Operating income grew 113.1% and 21.2% for 1995, compared to 1994, for the
PPM and PBM service areas, respectively. This growth is the result of higher net
revenues in both areas. The PPM service area also had a significant increase in
operating margin, from 3.7% in 1994 to 5.2% in 1995, which resulted from the
leveraging of fixed overhead expenses over a substantially larger revenue base,
integration of operations and
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<PAGE> 18
the impact of the varying margins of new physician practice affiliations.
Operating income and margins declined in the corresponding periods for the
specialty services areas as a result of pricing pressures for growth hormone
products.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The future operating results and financial condition of the Company are
dependent on the Company's ability to market its services profitably,
successfully increase market share and manage expense growth relative to revenue
growth. The future operating results and financial condition of the Company may
be affected by a number of additional factors, including: the Company's growth
strategy, which involves the ability to raise the capital required to support
growth, competition for expansion opportunities, integration risks and
dependence on HMO enrollee growth; efforts to control healthcare costs; exposure
to professional liability; and pharmacy licensing, healthcare reform and
government regulation. Changes in one or more of these factors could have a
material adverse effect on the future operating results and financial condition
of the Company.
The Company completed the acquisition of Caremark in September 1996. There
are various Caremark legal matters which, if materially adversely determined,
could have a material adverse effect on the Company's operating results and
financial condition.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1997, and December 31, 1996, the Company had working capital
of $277.8 and $226.4 million, respectively, including cash and cash equivalents
of $134.2 and $127.4 million, respectively. For the six-month period ended June
30, 1997, cash flow from continuing operations was $101.2 million. Cash flow
from continuing operations for the fiscal years ended December 31, 1996, 1995
and 1994 was $176.5 million, $147.0 million and $52.4 million, respectively.
For the six-month period ended June 30, 1997 and the fiscal year ended
December 31, 1996, respectively, the Company invested $150.5 and $160.5 million,
respectively, in acquisitions of the assets of physician practices and $37.4 and
$126.9 million, respectively, in property and equipment. These expenditures were
funded by approximately $39.5 and $271.9 million, respectively, derived from
equity proceeds and $149.4 and $124.4 million, respectively, in net incremental
borrowings. For the six months ended June 30, 1996 the Company invested $104.3
million in acquisitions of the assets of physician practices and $72.1 million
in property and equipment. These expenditures were funded by a portion of the
$224.1 million derived from a stock offering in March 1996. For the year ended
December 31, 1995, the Company invested $212.1 million in acquisitions of the
assets of physician practices and $128.4 million in property and equipment.
These expenditures were funded by approximately $100.4 million derived from
equity proceeds and $69.5 million in net incremental borrowings. For the year
ended December 31, 1994, the Company's investing activities totaled $261.0
million, which was composed primarily of $134.7 million related to practice
acquisitions and $106.2 million related to the purchase of property and
equipment. These expenditures were funded by $150.1 million derived from equity
proceeds and $225.0 million in net incremental borrowings. Investments in
acquisitions and property and equipment are anticipated to continue to be
substantial uses of funds in future periods.
The Company entered into the $1 billion Credit Facility, which became
effective simultaneously with the closing of the Caremark acquisition, on
September 5, 1996, replacing its then existing credit facility. At the Company's
option, pricing on the Credit Facility is based on either a debt to cash flow
test or the Company's senior debt ratings. No principal is due on the facility
until its maturity date of September 2001. As of June 30, 1997, there was $383.0
million outstanding under the facility. The Credit Facility contains affirmative
and negative covenants which include requirements that the Company maintain
certain financial ratios (including minimum net worth, minimum fixed charge
coverage ratio and maximum indebtedness to cash flow), and establishes certain
restrictions on investments, mergers and sales of assets. Additionally, the
Company is required to obtain bank consent for acquisitions with an aggregate
purchase price in excess of $75 million and for which more than half of the
consideration is to be paid in cash. The Credit Facility is unsecured but
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<PAGE> 19
provides a negative pledge on substantially all assets of the Company. As of
June 30, 1997, the Company was in compliance with the covenants in the Credit
Facility.
Effective October 8, 1996, the Company completed a $450 million senior note
offering. These ten-year notes carry a coupon rate of 7 3/8%. The notes are not
redeemable by the Company prior to maturity and are not entitled to the benefit
of any mandatory sinking fund. The notes are general unsecured obligations of
the Company ranking senior in right of payment to all existing and future
subordinated indebtedness of the Company and pari passu in right of payment with
all existing and future unsubordinated and unsecured obligations of the Company.
The notes are effectively subordinated to all existing and future indebtedness
and other liabilities of the Company's subsidiaries. The notes are rated
BBB/Baa3 by Standard & Poors and Moody's Investor Services, respectively. The
Company is the only physician practice management company to earn an investment
grade debt rating. Net proceeds from the offering were used to reduce amounts
under the Credit Facility.
On October 30, 1996, the Company completed its tender offer for Caremark's
$100 million 6 7/8% notes due August 15, 2003. Of the $100 million principal
amount of such notes outstanding, $99.9 million principal amount were tendered
and purchased. The total consideration for each $1,000 principal amount of
outstanding notes tendered was $1,017.72.
The Company's growth strategy requires substantial capital for the
acquisition of PPM businesses and assets of physician practices, and for their
effective integration, operation and expansion. Affiliated physician practices
may also require capital for renovation, expansion and additional medical
equipment and technology. The Company believes that its existing cash resources,
the use of the Company's Common Stock for selected practice and other
acquisitions, the issuances of the Securities and the Notes and available
borrowings under the $1.0 billion Credit Facility or any successor credit
facility, will be sufficient to meet the Company's anticipated acquisition,
expansion and working capital needs for the next twelve months. The Company
expects from time to time to raise additional capital through the issuance of
long-term or short-term indebtedness or the issuance of additional equity
securities in private or public transactions, at such times as management deems
appropriate and the market allows in order to meet the capital needs of the
Company. There can be no assurance that acceptable financing for future
acquisitions or for the integration and expansion of existing networks can be
obtained. Any of such financings could result in increased interest and
amortization expense, decreased income to fund future expansion and dilution of
existing equity positions.
RECENT DEVELOPMENTS
On August 20, 1997, the Company commenced a cash tender offer to purchase
all of the issued and outstanding common stock, par value $.01 per share, of
Talbert at a price of $63.00 net per share, in cash, or an aggregate acquisition
price of approximately $200 million. Talbert Medical Management Holdings
Corporation ("Talbert") is a physician practice management company representing
282 primary and specialty care physicians and operating 52 clinics in five
southwestern states. The Talbert acquisition will be accounted for as a
purchase transaction, and is subject to the normal
19
<PAGE> 20
conditions for a transaction of this kind, including the tender of a minimum
number of shares of Talbert common stock and compliance with the
Hart-Scott-Rodino Anti-Trust Improvements Act of 1976.
On July 1, 1997, the Company announced that a settlement had been reached
in the Coram litigation pursuant to which Caremark will return for cancellation
all of the securities issued by Coram in connection with its acquisition of
Caremark's home infusion therapy business and will pay to Coram $45 million in
cash on or before September 1, 1997. The settlement agreement also provides for
the termination and resolution of all disputes and issues between the parties
and for the exchange of mutual releases. The Company recognized an after-tax
charge of $75.4 million during the second quarter of 1997 related to this
settlement.
In June 1997, the Company acquired InPhyNet, a publicly traded PPM company
based in Fort Lauderdale, Florida and specializing in HBP operations and
correctional care in exchange for approximately 19.3 million shares of the
Company's Common Stock having a total value of approximately $413 million,
creating the largest HBP group in the United States with over 2,200 physicians.
In June 1997, the Company also acquired Fischer Mangold, a California-based
contract management group providing administrative management and physician
staffing to 28 hospital clients in 11 states.
In May 1997, the Company acquired the business assets and assumed the
liabilities of most of the operations of APMC, a PPM Company and affiliate of
Aetna Inc. based in Glastonbury, Connecticut. For accounting purposes, this
acquisition is being treated as an asset purchase. As a part of this
acquisition, the Company entered into a 10-year Master Network Agreement with
Aetna U.S. Healthcare, pursuant to which the members of the Company's networks
of affiliated physicians will be authorized providers for many of the 14 million
members of Aetna U.S. Healthcare's health plan.
20
<PAGE> 21
QUARTERLY RESULTS (UNAUDITED)
The following tables set forth certain unaudited quarterly financial data
for 1995, 1996 and the first two quarters of 1997. In the opinion of the
Company's management, this unaudited information has been prepared on the same
basis as the audited information and includes all adjustments (consisting of
normal recurring items) necessary to present fairly the information set forth
therein. The operating results for any quarter are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
----------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1995 1995 1995 1995 1996 1996 1996
--------- --------- ------------- ------------ ---------- ---------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenue........... $876,747 $ 961,290 $1,016,228 $ 1,054,452 $1,237,715 $1,286,692 $1,313,019
Operating expenses.... 836,052 915,796 963,265 993,816 1,181,064 1,226,971 1,246,846
Net interest
expense........... 6,551 2,549 5,883 4,131 7,030 4,158 5,395
Merger expenses..... -- 1,051 3,473 64,540 34,448 250 263,000
Losses on
investments....... -- -- -- 86,600 -- -- --
Other, net.......... (406) 5 (27) 236 (107) 51 328
-------- --------- ---------- ----------- ---------- ---------- ----------
Income (loss) from
continuing
operations before
income taxes........ 34,550 41,889 43,634 (94,871) 15,280 55,262 (202,550)
Income tax expense
(benefit)......... 12,876 15,729 17,644 (53,236) 8,878 19,271 (53,423)
-------- --------- ---------- ----------- ---------- ---------- ----------
Income (loss) from
continuing
operations.......... 21,674 26,160 25,990 (41,635) 6,402 35,991 (149,127)
Discontinued
operations:
Income (loss) from
discontinued
operations........ (2,605) (144,011) (5,791) (15,935) (71,221) -- --
Net gains (losses)
on sales of
discontinued
operations........ 10,895 (3,810) -- 24,729 2,523 -- --
-------- --------- ---------- ----------- ---------- ---------- ----------
Income (loss) from
discontinued
operations.......... 8,290 (147,821) (5,791) 8,794 (68,698) -- --
-------- --------- ---------- ----------- ---------- ---------- ----------
Net income
(loss)........ $ 29,964 $(121,661) $ 20,199 $ (32,841) $ (62,296) $ 35,991 $ (149,127)
======== ========= ========== =========== ========== ========== ==========
<CAPTION>
QUARTER ENDED
--------------------------------------
DECEMBER 31, MARCH 31, JUNE 30,
1996 1997 1997
------------ ---------- ----------
<S> <C> <C> <C>
Net revenue........... $1,384,593 $1,467,933 $1,560,600
Operating expenses.... 1,308,128 1,386,301 1,467,029
Net interest
expense........... 8,132 9,781 12,549
Merger expenses..... 11,247 -- 59,434
Losses on
investments....... -- -- --
Other, net.......... (1,347) -- --
---------- ---------- ----------
Income (loss) from
continuing
operations before
income taxes........ 58,433 71,851 21,588
Income tax expense
(benefit)......... 28,489 27,454 19,540
---------- ---------- ----------
Income (loss) from
continuing
operations.......... 29,944 44,397 2,048
Discontinued
operations:
Income (loss) from
discontinued
operations........ -- -- (75,434)
Net gains (losses)
on sales of
discontinued
operations........ -- -- --
---------- ---------- ----------
Income (loss) from
discontinued
operations.......... -- -- (75,434)
---------- ---------- ----------
Net income
(loss)........ $ 29,944 $ 44,397 $ (73,386)
========== ========== ==========
</TABLE>
The Company's historical unaudited quarterly financial data have been
restated to include the results of all businesses acquired prior to June 30,
1997 that were accounted for as poolings of interests (collectively, the
"Mergers"). The Company's Quarterly Reports on Form 10-Q set forth below were
filed prior to the Mergers and thus, differ from the amounts for the quarters
included herein. The differences caused solely by the operation of the merged
companies are summarized as follows:
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------------------------------
MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 MARCH 31, 1997
----------------------- ----------------------- ------------------------ ------------------------
FORM 10-Q AS RESTATED FORM 10-Q AS RESTATED FORM 10-Q AS RESTATED FORM 10-Q AS RESTATED
--------- ----------- --------- ----------- ---------- ----------- ---------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue.............. $332,549 $1,237,715 $360,398 $1,286,692 $1,182,015 $1,313,019 $1,332,271 $1,467,933
Income (loss) from
continuing operations
before income taxes.... (21,435) 15,280 16,153 55,262 (207,168) (202,550) 65,411 71,851
Income tax expense
(benefit).............. (5,935) 8,878 6,129 19,271 (55,634) (53,423) 24,925 27,454
Loss from discontinued
operations............. -- (68,698) -- -- -- -- -- --
Net income (loss)........ $(15,500) $ (62,296) $ 10,024 $ 35,991 $ (151,534) $ (149,127) $ 40,486 $ 44,397
</TABLE>
21
<PAGE> 22
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF MEDPARTNERS, INC.
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C>
MEDPARTNERS, INC.
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Consolidated Balance Sheets as of December 31, 1995 and 1996 . . . . . . . . . . . . . . . 24
Consolidated Statements of Operations for the years ended December 31, 1994, 1995
and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995
and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . 28
</TABLE>
22
<PAGE> 23
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
MedPartners, Inc.
We have audited the accompanying consolidated balance sheets of MedPartners,
Inc. as of December 31, 1995 and 1996, and the related consolidated statements
of operations, stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinions.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MedPartners,
Inc. at December 31, 1995 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Birmingham, Alabama
August 25, 1997
ERNST & YOUNG LLP
23
<PAGE> 24
MEDPARTNERS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1996
---- ----
(IN THOUSANDS)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................... $ 87,581 $ 127,397
Marketable securities.............................. 35,567 --
Accounts receivable, less
allowances for bad debts of
$102,119 in 1995 and $143,449 in 1996............. 576,544 660,150
Inventories........................................ 122,337 150,586
Deferred tax assets, net........................... 97,040 52,261
Income tax receivable.............................. 2,229 2,496
Prepaid expenses and other current assets.......... 46,179 69,225
----------- -----------
Total current assets............................ 967,477 1,062,115
Property and equipment, net.......................... 469,966 516,769
Intangible assets, net............................... 397,071 686,975
Deferred tax asset, net.............................. -- 18,333
Other assets......................................... 93,316 138,928
Net assets of discontinued operations................ 36,300 --
----------- -----------
Total assets.................................... $ 1,964,130 $ 2,423,120
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 288,572 $ 288,023
Other accrued expenses and liabilities............. 242,363 404,334
Accrued medical claims payable..................... 52,434 114,753
Notes payable...................................... 81,900 --
Current portion of long-term debt.................. 16,042 28,596
----------- -----------
Total current liabilities....................... 681,311 835,706
Long-term debt, net of current portion............... 541,391 715,996
Other long-term liabilities.......................... 42,053 34,010
Deferred tax liabilities, net........................ 24,933 --
Contingencies (Note 13)
Stockholders' equity:
Common stock, $.001 par value; 400,000 shares
authorized, issued-- 164,905 in 1995 and 183,950
in 1996........................................... 165 184
Additional paid-in capital......................... 541,230 855,162
Notes receivable from stockholders................. (1,930) (1,665)
Unrealized gain on marketable securities, net of
taxes............................................. 149 --
Unamortized deferred compensation.................. (2,682) --
Shares held in trust, 9,317 in 1995 and 1996....... (150,200) (150,200)
Retained earnings.................................. 287,710 133,927
----------- -----------
Total stockholders' equity...................... 674,442 837,408
----------- -----------
Total liabilities and stockholders' equity...... $ 1,964,130 $ 2,423,120
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 25
MEDPARTNERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995 1996
------------ ------------ --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net revenue....................................... $ 2,909,024 $ 3,908,717 $ 5,222,019
Operating expenses:
Clinic expenses................................. 1,200,291 1,785,564 2,683,107
Non-clinic goods and services................... 1,365,203 1,688,075 2,019,895
General and administrative expenses............. 169,273 172,896 173,428
Depreciation and amortization................... 44,384 62,394 86,579
Net interest expense............................ 16,214 19,114 24,715
Merger expenses................................. -- 69,064 308,945
Losses on investments........................... -- 86,600 --
Other, net...................................... (143) (192) (1,075)
----------- ----------- -----------
Income (loss) from continuing operations
before income taxes...................... 113,802 25,202 (73,575)
Income tax expense (benefit)...................... 50,292 (6,987) 3,215
----------- ----------- -----------
Income (loss) from continuing operations... 63,510 32,189 (76,790)
Discontinued operations:
Income (loss) from discontinued
operations, net of taxes of $18,000,
$(72,100) and $(35,849) in 1994,
1995 and 1996, respectively.................. 25,902 (168,342) (71,221)
Net gains on sales of discontinued operations... -- 31,814 2,523
----------- ----------- -----------
Income (loss) from discontinued
operations.............................. 25,902 (136,528) (68,698)
----------- ----------- -----------
Net income (loss)................................. $ 89,412 $ (104,339) $ (145,488)
=========== =========== ===========
Earnings per common and common equivalent shares
outstanding:
Income (loss) from continuing operations........ $ 0.43 $ 0.20 $ (0.44)
Income (loss) from discontinued operations...... 0.18 (0.86) (0.39)
----------- ----------- -----------
Net income (loss)................................. $ 0.61 $ (0.66) $ (0.83)
=========== =========== ===========
Weighted average common and common equivalent
outstanding..................................... 146,773 158,109 174,269
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 26
MEDPARTNERS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995 1996
---------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
COMMON STOCK:
Balance, beginning of year....................... $ 121 $ 136 $ 165
Beginning balance of immaterial
poolings of interests entities................ -- 1 6
Common stock issued and capital contributions.... 11 10 10
PPSI common stock issued during the two
months ended December 31, 1995.................. -- -- 1
Conversion of preferred stock.................... -- 7 --
Stock issued in connection with acquisitions..... 4 2 2
Contributions to employee benefit trust.......... -- 9 --
--------- ---------- ----------
Balance, end of year............................. 136 165 184
ADDITIONAL PAID-IN-CAPITAL:
Balance, beginning of year....................... 154,506 246,494 541,230
Beginning balance of immaterial poolings
of interests entities.......................... -- 6 620
PPSI common stock issued during the two
months ended December 31, 1995................. -- -- 588
Common stock issued and capital contributions.... 83,479 115,027 226,190
Capital distributions............................ (18,743) (30,970) --
Exercise of stock options........................ 802 2,335 46,654
Deferred compensation on issuance of options..... 4,350 -- --
Transfer of predecessor company retained
earnings to additional paid in capital
upon conversion from an S to a C Corporation... 16,277 1,780
Conversion of preferred stock.................... -- 19,994 --
Stock issued in connection with acquisitions..... 5,823 36,373 39,880
Contribution to employee benefit trust........... -- 150,191 --
--------- ---------- ----------
Balance, end of year............................. 246,494 541,230 855,162
NOTES RECEIVABLE FROM STOCKHOLDERS:
Balance, beginning of year....................... (2,396) (2,349) (1,930)
Net change in notes receivable from stockholders. 47 419 265
--------- ---------- ----------
Balance, end of year............................. (2,349) (1,930) (1,665)
UNREALIZED GAIN (LOSS) ON MARKETABLE SECURITIES:
Balance, beginning of year....................... (163) 17 149
Unrealized gain (loss) on marketable
securities, net of taxes....................... 180 132 (149)
--------- ---------- -----------
Balance, end of year............................. 17 149 --
UNAMORTIZED DEFERRED COMPENSATION:
Balance, beginning of year....................... -- (3,552) (2,682)
Amortization of deferred compensation............ 798 870 2,682
Deferred compensation on issuance of options..... (4,350) -- --
--------- ---------- ----------
Balance, end of year............................. (3,552) (2,682) --
SHARES HELD IN TRUST:
Balance, beginning of year....................... -- -- (150,200)
Contribution to employee benefit trust........... -- (150,200) --
--------- ---------- ----------
Balance, end of year............................. -- (150,200) (150,200)
RETAINED EARNINGS:
Balance, beginning of year....................... 338,971 404,172 287,710
Beginning balance of immaterial poolings of
interests entities............................. -- 1,472 (238)
Net income (loss)................................ 89,412 (104,339) (145,488)
Adjustment to reflect change in accounting
method for equity investments.................. 696
Dividends and distributions paid................. (14,289) (11,815) --
Transfer of predecessor company retained
earnings to additional paid in capital
upon conversion from an S to a C Corporation... (16,277) (1,780)
Pro forma tax provision of pooled entities....... 5,659 -- --
Net loss for two months ended December 31,
1995 for PPSI.................................. -- -- (8,057)
Balance, end of year............................. --------- ---------- ----------
404,172 287,710 133,927
--------- ---------- ----------
Total stockholders' equity............... $ 644,918 $ 674,442 $ 837,408
========= ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE> 27
MEDPARTNERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995 1996
------------ ------------ -----------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM CONTINUING OPERATIONS:
Income (loss) from continuing operations............ $ 63,510 $ 32,189 $ (76,790)
Adjustments for non-cash items:
Depreciation and amortization..................... 44,384 62,394 86,579
Provision (benefit) for deferred taxes............ 12,725 (68,422) (36,056)
Merger expenses................................... -- 69,064 308,945
Loss on sale of investments....................... -- 86,600 --
Other............................................. 9,394 1,505 1,161
Changes in operating assets and liabilities,
net of effects of acquisitions.................... (77,626) (36,337) (107,342)
---------- ---------- -----------
Net cash and cash equivalents provided by
continuing operations........................ 52,387 146,993 176,497
Investing activities:
Cash paid for merger expense...................... -- (53,600) (143,285)
Net cash used to fund acquisitions................ (134,749) (212,063) (160,485)
Additions to intangibles.......................... -- (7,235) (19,515)
Purchase of property and equipment................ (106,156) (128,428) (126,873)
(Purchases) proceeds of marketable securities..... (17,560) 1,636 27,558
Other............................................. (2,554) 1,964 1,083
---------- ---------- -----------
Net cash and cash equivalents used
in investing activities...................... (261,019) (397,726) (421,517)
Financing activities:
Common stock issued and capital contributions..... 150,109 100,380 271,882
Capital distributions............................. (21,045) (37,771) --
Proceeds from debt................................ 283,414 182,880 1,791,198
Repayment of debt................................. (58,384) (113,418) (1,666,775)
Dividends and distributions paid.................. (18,243) (9,355) --
Other............................................. 68 (3) 266
---------- ---------- -----------
Net cash and cash equivalents provided
by financing activities...................... 335,919 122,713 396,571
Cash flow from discontinued operations, net of
divestiture proceeds............................. (180,000) 114,500 (115,835)
---------- ---------- -----------
(52,713) (13,520) 35,716
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year...... 153,814 101,101 88,386
Beginning cash and cash equivalents of
immaterial poolings of interests entities......... -- -- 3,295
---------- ---------- -----------
Cash and cash equivalents at end of year............ $ 101,101 $ 87,581 $ 127,397
========== ========== ===========
Supplemental Disclosure of Cash Flow Information
Cash paid received) during the period for:
Interest....................................... $ 19,546 $ 35,204 $ 42,979
========== ========== ===========
Income taxes................................... $ 30,664 $ 24,939 $ (16,848)
========== ========== ===========
</TABLE>
Non-cash investing activities include notes and other obligations issued for
acquisitions of $1.8 and $30.8 million in 1994 and 1995, respectively, and
$123.6 million in notes and other securities received from divestitures in 1995.
Non-cash financing activities include the issuance of $55.1 and $39.9 million of
stock for acquisitions in 1995 and 1996, respectively.
See accompanying notes to consolidated financial statements.
27
<PAGE> 28
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. ACCOUNTING POLICIES
Description of Business
MedPartners, Inc. (The "Original Predecessor") was incorporated in January
1993, and affiliated with its initial physician practice in November 1993.
Mullikin Medical Enterprises, L.P. ("MME") was formed by the merger of several
physician partnerships in 1994, and the original business was organized in 1957.
MedPartners/Mullikin, Inc. was formed as a result of the November 1995 business
combination between the Original Predecessor and MME. In February and September
of 1996, MedPartners/Mullikin, Inc. combined with Pacific Physician Services,
Inc. ("PPSI") and Caremark International Inc. ("Caremark"), respectively. These
business combinations were accounted for as poolings of interests. The combined
companies were renamed MedPartners, Inc. (herein referred to as the "Company" or
"MedPartners") in conjunction with the business combination with Caremark. In
June 1997, MedPartners combined with InPhyNet Medical Management Inc.
("InPhyNet") in a business combination accounted for as a pooling of interests.
The financial information referred to in this discussion reflects the combined
operations of these entities and several additional immaterial entities
accounted for as poolings of interests.
MedPartners is the largest physician practice management ("PPM") company in
the United States. The Company develops, consolidates and manages integrated
healthcare delivery systems. Through its network of affiliated group and
independent practice association ("IPA") physicians, the Company provides
primary and specialty healthcare services to prepaid enrollees and
fee-for-service patients. The Company also operates one of the largest
independent prescription benefit management ("PBM") programs in the United
States and provides disease management services and therapies for patients with
certain chronic conditions.
The Company affiliates with physicians who are seeking the resources
necessary to function effectively in healthcare markets that are evolving from
fee-for-service to prepaid payor systems. The Company enhances clinic operations
by centralizing administrative functions and introducing management tools, such
as clinical guidelines, utilization review and outcomes measurement. The Company
provides affiliated physicians with access to capital and advanced management
information systems. In addition, MedPartners contracts with health maintenance
organizations and other third-party payors that compensate the Company and its
affiliated physicians on a prepaid basis (collectively "HMOs"), hospitals and
outside providers on behalf of its affiliated physicians. These relationships
provide physicians with the opportunity to operate under a variety of payor
arrangements and increase their patient flow.
The Company also contracts with various state and local government agencies
and the United States Department of Defense to provide medical services. The
Company's contracts with the Department of Defense provide for payment to the
Company based on the number of patient visits or the number of hours worked. The
Company is at risk for the medical services provided if the number of patient
visits or hours worked exceed certain limits as defined in the contracts.
The Company provides comprehensive medical services, including mental health
and dental services, to inmates in various state and local correctional
institutions. The Company provides primary care physician services directly and
typically subcontracts other services with hospitals and medical specialists on
either a capitated or discounted fee-for-service basis.
The Company offers medical group practices and independent physicians a
range of affiliation models. These affiliations are carried out by the
acquisition of PPM entities or practice assets, either for cash or through
equity exchange, or by affiliation on a contractual basis. The Company enters
into long-term practice management agreements with the affiliated physicians
that provide for the management of their practices by the Company while at the
same time providing for the clinical independence of the physicians.
The Company also manages outpatient prescription drug benefit programs for
clients throughout the United States, including corporations, insurance
companies, unions, government employee groups and managed care organizations.
The Company dispenses national prescriptions daily through four mail service
pharmacies and manages patients' immediate prescription needs through a national
network of retail pharmacies. The Company is in the process of integrating its
PBM program with the PPM business by
28
<PAGE> 29
providing pharmaceutical services to the affiliated physicians, clinics and
HMOs. The Company's disease management services are intended to meet the
healthcare needs of individuals with chronic diseases or conditions. These
services include the design, development and management of comprehensive
programs that comprise drug therapies, physician support and patient education.
The Company currently provides therapies and services for individuals with such
conditions as hemophilia, growth disorders, immune deficiencies, genetic
emphysema, cystic fibrosis and multiple sclerosis.
Basis of Presentation
The consolidated financial statements have been prepared on the accrual
basis of accounting and include the accounts of the Company and its
subsidiaries. The Company also consolidates professional corporations (PCs) in
which it obtains a controlling financial interest by virtue of a long-term
practice management agreement (and, in some cases, a transfer agreement) between
a wholly-owned subsidiary of the Company and the PC.
Where there is a transfer agreement with the PC, it enables the Company to
require the stockholder(s) of the PC, at any time and for any reason, to
transfer, at a nominal price, shares of the PC to a transferee selected by the
Company. Where such agreements exist, the physician-stockholders of the PC are,
as a general rule, designated by the Company and are senior members of the
Company's management. Because each stockholder of the PC is the Company's
nominee, whom the Company can replace at will, the transfer agreement provides
the Company with unilateral control.
Contracts with hospitals and payors for the provision of medical services
which are entered into directly between the hospitals or the payor (e.g., HMOs
and health plans) and the Company or a wholly-owned subsidiary of the Company,
contributed approximately 70% of the Company's 1996 PPM revenue (40% of
consolidated revenue, since PPM revenue comprised 57% of consolidated revenue,
and PBM and Specialty Services comprised the remaining 43%). In these cases, the
contractual revenue is earned by the Company or a legal subsidiary of the
Company. In some cases, the Company contracts with its PCs to provide medical
services under these payor or hospital contracts. The Company consolidates these
PCs by virtue of its rights under a practice management agreement and, in most
cases, a transfer agreement. The PCs do not have any external revenue because,
as noted above, all revenue is generated through contracts with the Company.
Consolidation of these PCs, therefore, does not materially affect the Company's
consolidated financial statements.
For PCs that have directly entered into contracts with payors and/or that
have the right to receive payment directly from payors for the provision of
medical services in the Company's clinics, the Company consolidates these PCs
because it obtains a controlling financial interest solely by virtue of a
long-term practice management agreement with the PC (the Company generally does
not have a transfer agreement with these types of PCs). The revenue earned by
these PCs represented 30% of PPM revenue (17% of consolidated revenue) during
1996. Practice management agreements with PCs that hold payor contracts and/or
the right to receive payment directly from payors provide three general types of
financial arrangements regarding the compensation of the physician-stockholders
of those PCs.
PCs that contributed 8% of PPM revenue (5% of consolidated revenue) during
1996 have practice management agreements that provide the physician-stockholders
a negotiated fixed dollar amount. At the Company's sole discretion, the
physicians are eligible to receive a bonus paid by the Company based on
performance criteria and goals. The amount of any discretionary bonus is
determined solely by the Company's management and is not directly correlated to
clinic revenue or gross profit. To the extent the clinic's net revenue increases
or decreases under these practice management agreements, physician compensation
will also increase or decrease, pro rata, based on the practice's compensation
as a percentage of the clinic net revenue.
PCs that contributed 14% of PPM revenue (8% of consolidated revenue) during
1996 have practice management agreements that compensate the
physician-stockholder on a fee-for-service basis. The respective clinics
generally earn revenue on a fee for service basis, and physician compensation
typically represents between 40 and 70 percent of the clinic's net revenue.
PCs that contributed 8% of PPM revenue (4% of consolidated revenue) during
1996 provided physician-stockholders with a salary, plus bonus, and a
profit-sharing payment of a percentage of the clinic's net income (i.e.,
contractual revenue less base physician compensation, bonus and clinic
expenses).
Under these various types of agreements, revenue is assigned to the Company
by the PC. The Company is responsible for the billing and collection of all
revenue for services provided at its clinics, as well as for paying all
expenses, including physician
29
<PAGE> 30
compensation. The Company compensates the PCs, which in turn compensate the
physicians. The Company is not reimbursed for the clinic expenses, rather it is
responsible and at risk for all such expenses. In effect, the Company retains
any residual from the operations of its PCs (and funds any deficit). No earnings
accumulate in its PCs or are available for the payment of dividends to the
physician-stockholders. In addition, the legal owners of its PCs do not have a
substantive capital investment that is at risk and the Company has substantially
all of the capital at risk. Based on the terms of the practice management
agreement, there is no economic value attributable to the capital stock of those
PCs.
The Company's practice management agreements with its PCs are long-term. The
practice management agreements include the following provisions: (i) the initial
term is 20 to 40 years; (ii) renewal provisions call for automatic and
successive extension periods; (iii) the PCs cannot unilaterally terminate their
agreements with the Company unless the Company fails to cure a breach of its
contractual responsibilities thereunder within 30 days after notification of
such breach; (iv) the Company is obligated to maintain a continuing investment
of capital; (v) the Company employs the non-physician personnel of its PCs, and;
(vi) the Company assumes full responsibility for the operating expenses of the
PC in return for an assignment of the PC's revenue.
The Company has unilateral control over its PCs because the practice
management agreements provide the following: (i) the Company has exclusive
authority over all operating decision making (except for the dispensing of
medical services); (ii) the Company has the exclusive authority to negotiate and
execute contracts on behalf of its PCs: (iii) the Company has the exclusive
authority to establish and approve operating and capital budgets of its PCs,
including establishing total amounts to be paid to the physicians (budgets are
established with the advice of an Advisory Board composed of physicians and
members of the Company's management); (iv) the Company has the authority to
hire, assign and terminate non-medical personnel employed by its PCs; (v) the
practice management agreement establishes guidelines for the selection, hiring
and termination of physicians by its PCs, and the Company recruits candidates
for physician openings; (vi) the physician-stockholders of its PCs are required
to cooperate with the Company to expand their respective practices at the
Company's direction; (vii) where the physicians are eligible for bonuses,
determination of the amount of the bonus is within the sole discretion of the
Company; (viii) the Company manages and administers all business functions of
its PCs, including billing and collecting all medical service revenue, paying
all expenses and purchasing all capital assets; (ix) the Company receives an
assignment from its PCs of all rights to receive revenue from the provision of
medical services; (x) the Company owns all the operational and depository
accounts and has total control of all cash deposits related to clinic revenue;
(xi) under an assignment, the Company owns all of its PCs' accounts receivable;
(xii) the Company contracts for the provision of medical care with each of its
PCs and not with individual physicians; and (xiii) the Company performs the
negotiations and controls the implementation and administration of all payor
contracts. The execution of any contracts on behalf of the Company's PCs by
physician-stockholders of those PCs is simply perfunctory. The approval of the
physician-stockholders of the PC is required with respect to the financial and
operational actions of the PC only in rare and isolated cases. In all
circumstances, the rights of the legal owners of the PC are protective in nature
and do not allow the legal owners of the PC to participate in the control of the
PC in any substantive fashion.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the accompanying consolidated
financial statements and notes. Actual results could differ from those
estimates.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The carrying amounts of
all cash and cash equivalents approximate fair value.
Marketable Securities
Effective August 1, 1994, the Company adopted Financial Accounting Standards
Board Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," which requires that investments in equity securities that have
readily determinable fair values and investments in debt securities be
classified in three categories: held-to-maturity, trading and
available-for-sale. Based on the nature of the assets held by the Company and
management's investment strategy, the Company's investments have been classified
as available-for-sale.
30
<PAGE> 31
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported in a separate component of stockholders'
equity unless a decline in value is judged other than temporary. When this is
the case, unrealized losses are reflected in the results of operations. The
amortized cost of debt securities in this category is adjusted for amortization
of premiums and accretion of discounts to maturity. Such amortization is
included in interest income. The cost of securities sold is based on the
specific identification method.
Inventories
Inventories, which are primarily finished goods, consist of pharmaceutical
drugs, medical equipment and supplies and are stated at the lower of cost
(first-in, first-out method) or market.
Property and Equipment
Property and equipment are stated at cost, which for the used assets being
acquired is usually determined by an independent appraisal. Depreciation of
property and equipment is calculated using either the declining balance or the
straight-line method over the shorter of the estimated useful lives of the
assets or the term of the underlying leases. Estimated useful lives range from 3
to 10 years for equipment, 10 to 20 years for leasehold improvements and 10 to
40 years for buildings and improvements based on type and condition of assets.
Routine maintenance and repairs are charged to expense as incurred, while costs
of betterments and renewals are capitalized.
Interest costs associated with the construction of certain capital assets
are capitalized as part of the cost of those assets. Interest costs
approximating $4.3 million were capitalized in 1996. The Company also
capitalizes purchased and internally developed software costs to the extent they
are expected to benefit future operations.
Intangible Assets
Excess of cost over fair value of assets acquired (goodwill) is being
amortized using the straight-line method over terms of the related practice
management agreements, generally 20 to 40 years. The carrying value of goodwill
is reviewed if the facts and circumstances suggest that it may be impaired. If
this review indicates that goodwill will not be recoverable, as determined based
on the undiscounted cash flows of the entity acquired over the remaining
amortization period, the carrying value of the goodwill is reduced by the
estimated shortfall of cash flows. Costs of obtaining practice management
agreements are capitalized as incurred and are amortized using the straight-line
method. These costs include all direct costs of obtaining such agreements, which
include such items as filing fees, legal fees and travel and related development
costs. The Company has elected to amortize these costs over a period not to
exceed the term of the related practice management agreements. Other intangible
assets include costs associated with obtaining long-term financing, which are
being amortized, and included in interest expense, systematically over the terms
of the related debt agreements.
Restatement of Financial Statements
The Company has merged with several entities during 1996 and 1997 in
transactions that were accounted for as poolings of interests. Accordingly, the
financial statements for all periods prior to the effective dates of these
mergers have been restated to include these entities (see Note 11).
Income Taxes
The Company is a corporation subject to federal and state income taxes.
Deferred income taxes are provided for temporary differences between financial
and income tax reporting relating primarily to net operating losses which must
be carried forward to future periods for income tax reporting purposes.
Prior to the poolings of interests noted previously, several entities were S
Corporations and MME and related real estate entities were partnerships and were
therefore not subject to federal and state income taxes. Pro forma income tax
provisions are reflected in income tax expense in the consolidated statements of
operations for 1994 to provide for additional federal and state income taxes
which would have been incurred had these entities been taxed as C Corporations.
The pro forma income tax expense included in 1994 operations was $8.5 million.
31
<PAGE> 32
Net Revenue
Net revenue is reported at the estimated realizable amounts from patients,
third-party payors and others for services rendered. Revenue under certain
third-party payor agreements is subject to audit and retroactive adjustments.
Provisions for estimated third-party payor settlements and adjustments are
estimated in the period the related services are rendered and are adjusted in
future periods as final settlements are determined.
During 1994, 1995 and 1996, approximately 7% of net revenue was received
from governmental programs. Governmental programs pay physician services based
on fee schedules which are determined by the related government agency.
The Company has contracts with various managed care organizations to provide
physician services based on negotiated fee schedules. Under various contracts
with HMOs, capitation is received to cover all physicians and hospital services
needed by the HMO members. Capitation payments are recognized as revenue on the
accrual basis, and represent approximately 24%, 28% and 31% of the Company's
total net revenue in 1994, 1995 and 1996, respectively. Liabilities for
physician services provided and hospital services incurred are accrued in the
month services are rendered. The provision for accrued claims payable, which
represents the amount payable for services incurred by patients not yet paid, is
validated by actuarial review. Management believes that the provision at
December 31, 1996 is adequate to cover claims which will ultimately be paid.
Reclassifications
Certain prior-year balances have been reclassified to conform with the
current year's presentation. Such reclassifications had no material effect on
the previously reported consolidated financial position, results of operations
or cash flows of the Company.
Fiscal Year
At January 1, 1996, PPSI changed its fiscal year-end from July 31 to
December 31. Amounts consolidated for PPSI prior to January 1, 1996 were based
on an October 31 year-end. As a result, the consolidated financial statements
for the years ended December 31, 1994 and 1995 include the 12 months of
operations of PPSI for the years ended October 31, 1994 and 1995.
Stock Option Plans
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its stock-based compensation plans. The
Company applies APB 25 and related interpretations in accounting for its plans
because the alternative fair value accounting provided for under FASB Statement
No. 123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
Impairment of Long-Lived Assets
Effective December 31, 1995, the Company adopted FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." Statement 121 requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount. The Statement also addresses the
accounting for long-lived assets that are expected to be disposed of. Statement
121 is applicable for most long-lived assets, identifiable intangibles and
goodwill related to those assets; it does not apply to financial instruments and
deferred taxes. Management has determined that long-lived assets are fairly
stated in the accompanying balance sheets, and that no indicators of impairment
are present. In accordance with the new rules, the Company's prior year
financial statements have not been restated to reflect the change in accounting
principle.
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<PAGE> 33
2. DISCONTINUED OPERATIONS
During 1995, Caremark divested several non-strategic businesses. In
accordance with APB 30, which addresses the reporting for disposition of
business segments, the Company's Consolidated Financial Statements present the
operating results and net assets of discontinued operations separately from
continuing operations. Prior periods have been restated to conform with this
presentation.
Effective March 31, 1995, Caremark sold its Clozaril(R) Patient Management
System to Health Management, Inc. for $23.3 million in cash and notes. This
business involved managing the care of schizophrenia patients nationwide through
the distribution of the Clozaril drug and related testing services to monitor
patients for potentially serious side effects. Net revenue of this business was
$12.3 million for the three months ended March 31, 1995 and $84.0 million for
the year ended December 31, 1994. The after-tax gain on disposition of this
business was $11.1 million.
Effective April 1, 1995, Caremark sold its home infusion business to Coram
Healthcare Corporation ("Coram") for $309 million in cash and securities,
subject to post-closing adjustments based on the net assets transferred. The
sale included Caremark's home intravenous infusion therapy, women's health
services and the Home Care Management System. Certain severance and legal
obligations remained with Caremark (see Note 13). Net revenue of this business
was $96.1 million for the period ended April 1, 1995 and $441.9 million for the
year ended December 31, 1994. The after-tax loss on disposition of this business
was $4.0 million. In 1995 net losses from this business reflected in
discontinued operations include $154.8 million related to the legal settlement
discussed in Note 13.
Effective September 15, 1995, Caremark sold its Oncology management services
business to Preferred Oncology Networks of America, Inc., for securities valued
at $3.6 million. The business provides management services to single-specialty
oncology practices. Net revenue of this business for the 1995 period up to the
date of sale was $8.9 million and $29.4 million for the year ended December
1994. There was no after-tax gain or loss on the disposition.
Effective December 1, 1995, Caremark sold its Caremark Orthopedic Services,
Inc. subsidiary to HealthSouth Corporation for $127.0 million in cash, subject
to post-closing adjustments. This business provides outpatient physical therapy
and rehabilitation services. Net revenue of this business for the 1995 period up
to the date of sale was $69.1 million and $55.8 million for the year ended
December 31, 1994. The after-tax gain on disposition of this business was $24.7
million.
Effective February 29, 1996, Caremark sold its Nephrology Services business
to Total Renal Care, Inc. for $49.0 million in cash, subject to certain
post-closing adjustments. The after-tax gain on disposition of this business,
net of disposal costs, was $2.5 million, which was included in 1995 discontinued
operations.
3. FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents,
investments in marketable and non-marketable securities and debt obligations.
The carrying value of marketable and non-marketable securities, which
approximated fair value, was $84.1 and $44.9 million at December 31, 1995 and
1996, respectively. The carrying value of debt obligations was $168.6 and $450.0
million at December 31, 1995 and 1996, respectively. The fair value of these
obligations approximated $156.4 and $451.9 million at December 31, 1995 and
1996, respectively. The fair value of marketable securities is determined using
market quotes and rates. The fair value of non-marketable securities are
estimated based on information provided by these companies. The fair value of
long-term debt has been estimated using market quotes.
During 1995, the Company recorded a pre-tax charge to income of $86.6
million ($52.0 million after tax) to reflect unrealized losses on investments
that were judged other than temporary.
Interest expense totaled $23.1, $32.9 and $35.6 million in 1994, 1995 and
1996, respectively. Interest income totaled $6.9, $13.8 and $10.9 million in
1994, 1995 and 1996, respectively.
4. INTANGIBLE ASSETS
Goodwill, which totaled $355.5 and $640.1 million at December 31, 1995 and
1996, respectively, represents the excess of consideration paid for companies
acquired in purchase transactions over the fair value of net assets acquired.
Also included in
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<PAGE> 34
intangible assets for the years ended December 31, 1995 and 1996 were
organizational costs of $20.3 and $23.1 million, respectively. As of December
31, 1995 and 1996, intangible assets, including goodwill, are stated net of
accumulated amortization of $29.2 and $56.7 million, respectively.
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996
---------- ---------
(IN THOUSANDS)
<S> <C> <C>
Land..................................... $ 38,498 $ 54,340
Buildings and leasehold improvements..... 193,262 186,406
Equipment................................ 325,226 409,911
Construction in progress................. 81,879 91,923
---------- ----------
638,865 742,580
Less accumulated depreciation and
amortization............................. (168,899) (225,811)
---------- ----------
$ 469,966 $ 516,769
========== ==========
</TABLE>
The net book value of capitalized lease property approximated $9.8 and $11.1
million at December 31, 1995 and 1996, respectively. Capitalized software costs
included in construction in progress approximated $56.5 million at December 31,
1996, the majority of which was placed into service on January 1, 1997.
6. LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Advances under Credit Facility, due 2001............ $ 290,000 $ 213,000
6 7/8% Senior Notes due 2003, less
unamortized discount of $0.4 million.............. 99,600 --
Bonds Payable with interest at 7 3/8%,
interest only paid semi-annually, due in 2006..... -- 450,000
Convertible subordinated debentures with interest
at 5.50%, interest only paid semi-annually,
due in 2003....................................... 69,000 --
Notes payable to physicians and stockholders
in annual installments through 2001,
interest rates ranging from 5% to 12%............. 15,329 14,118
Other long-term notes payable....................... 70,758 49,221
Capital lease obligations........................... 12,746 18,253
--------- ---------
557,433 744,592
Less amounts due within one year.................... (16,042) (28,596)
--------- ---------
$ 541,391 $ 715,996
========= =========
</TABLE>
The Company entered into a $1 billion Revolving Credit and Reimbursement
Agreement (the "Credit Facility"), which became effective simultaneously with
the closing of the Caremark acquisition on September 5, 1996, replacing its then
existing credit facility. At the Company's option, pricing on the Credit
Facility is based on either a debt to cash flow test or the Company's senior
debt ratings. No principal is due on the facility until its maturity date of
September 2001. As of December 31, 1996, there was $213 million outstanding
under the facility and the rate approximated 6.5%. The Credit Facility contains
affirmative and negative covenants which, among other things, require the
Company to maintain certain financial ratios (including minimum net worth,
minimum fixed charge coverage ratio, maximum indebtedness to cash flow), and set
certain restrictions on investments, mergers and sales of assets. Additionally,
the Company is required to obtain bank consent for acquisitions with an
aggregate purchase price in excess of $75 million and which have more than half
of the consideration paid in cash. The Credit Facility is unsecured but provides
a negative pledge on substantially all assets of the Company. As of December 31,
1996, the Company was in compliance with the covenants in the Credit Facility.
Effective October 8, 1996, the Company completed a $450 million Senior Note
offering. The ten year notes carry a coupon rate of 7 3/8%. Interest on the
notes is payable semi-annually on April 1 and October 1 of each year. The notes
are not redeemable by the
34
<PAGE> 35
Company prior to maturity and are not entitled to the benefit of any mandatory
sinking fund. The notes are general unsecured obligations of the Company,
ranking senior in right of payment to all existing and future subordinated
indebtedness of the Company and pari passu in right of payment with all existing
and future unsubordinated and unsecured obligations of the Company. The notes
are effectively subordinated to all existing and future secured indebtedness of
the Company and to all existing and future indebtedness and other liabilities of
the Company's subsidiaries. Net proceeds from the note offering were used to
reduce amounts under the Credit Facility.
On October 30, 1996, the Company completed its tender offer for Caremark's
$100 million 6 7/8% notes due August 15, 2003. Of the $100 million principal
amount of such notes outstanding, approximately $99.9 million principal amount
were tendered and purchased. The total consideration for each $1,000 principal
amount of outstanding notes tendered was $1,017.72.
The following is a schedule of principal maturities of long-term debt as of
December 31, 1996:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1997.................................. $ 30,605
1998.................................. 17,964
1999.................................. 8,044
2000.................................. 6,449
2001.................................. 215,674
Thereafter............................ 469,984
Amounts representing interest and
discounts........................... (4,128)
--------
Total....................... $744,592
========
</TABLE>
Operating Leases: Operating leases generally consist of short-term lease
agreements for professional office space where the medical practices are located
and administrative office space. These leases generally have five-year terms
with renewal options. The following is a schedule of future minimum lease
payments under noncancelable operating leases as of December 31, 1996:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1997......... $ 80,367
1998......... 80,419
1999......... 63,614
2000......... 53,314
2001......... 44,920
Thereafter... 170,794
--------
Total.... $493,428
========
</TABLE>
7. INCOME TAX EXPENSE
At December 31, 1996, the Company had a cumulative net operating loss
("NOL") carryforward for federal income tax purposes of approximately $184
million available to reduce future amounts of taxable income. If not utilized to
offset future taxable income, the net operating loss carryforwards will expire
on various dates through 2011.
Deferred income taxes reflect the net tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1996
--------- ----------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Merger/acquisition costs............... $ 38,326 $ 51,696
Bad debts.............................. 15,007 15,971
Securities write-down.................. 33,708 --
Accrued and deferred compensation
benefits.............................. 6,780 --
Accrued vacation....................... -- 5,427
NOL carryforward....................... 23,970 72,484
Alternative minimum tax credit
carryforward.......................... -- 20,195
Other.................................. 22,154 32,147
--------- ---------
Gross deferred tax assets................ 139,945 197,920
Valuation allowance for deferred tax
assets................................. (1,249) (2,419)
Deferred tax liabilities
State taxes............................ 1,721 2,264
Merger reserves........................ -- 4,235
Legal reserve.......................... 26,800 4,400
Shared risk receivable................. 7,182 7,135
Securities write-down.................. -- 13,449
Excess tax depreciation................ 2,974 30,363
Goodwill............................... 8,103 9,648
Other amortization..................... -- 31,115
Other.................................. 19,809 22,298
--------- ---------
Gross deferred tax liabilities........... 66,589 124,907
--------- ---------
Net deferred tax asset................... $ 72,107 $ 70,594
========= =========
</TABLE>
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<PAGE> 36
Income tax expense (benefit) on continuing operations is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1994 1995 1996
---------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal $ 29,301 $ 50,768 $ 34,508
State.. 8,266 10,667 4,763
-------- -------- --------
37,567 61,435 39,271
Deferred:
Federal 10,939 (58,950) (30,054)
State.. 1,786 (9,472) (6,002)
-------- -------- --------
12,725 (68,422) (36,056)
-------- -------- --------
$ 50,292 $ (6,987) $ 3,215
======== ======== ========
</TABLE>
The differences between the provision (benefit) for income taxes and the
amount computed by applying the statutory federal income tax rate to income
before taxes were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995 1996
---------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Federal tax at statutory rate.......... $ 39,831 $ 8,821 $(25,751)
Add (deduct):
State income tax, net of federal tax
benefit............................ 6,221 (713) (401)
Increase (decrease) in valuation
allowance.......................... -- (14,240) 1,170
Non deductible merger expense........ -- -- 24,786
Other................................ 4,240 (855) 3,411
-------- -------- --------
$ 50,292 $ (6,987) $ 3,215
======== ======== ========
</TABLE>
8. CAPITALIZATION
The Company's Third Restated Certificate of Incorporation provides that the
Company may issue 9.5 million shares of Preferred Stock, par value $0.001 per
share, .5 million shares of Series C Junior Participating Preferred Stock, par
value $0.001 per share, and 400 million shares of Common Stock, par value $0.001
per share. As of December 31, 1996 no shares of the preferred stock were
outstanding.
On February 28, 1995, the Company completed an initial public offering of
5.1 million shares of its common stock. Gross and net proceeds of the offering
were $65.8 million and $60.4 million, respectively. Proceeds of the offering
were used to pay outstanding indebtedness under the bank credit facility. Net
proceeds were also used to fund acquisitions of certain assets of physician
practices, expansion of physician services, working capital and other general
corporate purposes.
On March 13, 1996, the Company completed a secondary public offering of 6.6
million shares of its common stock. The net proceeds of the offering were $194.0
million. Proceeds of the offering were used to pay outstanding indebtedness
under the then existing credit facility. In April 1996, $69 million of the
proceeds were used to repay PPSI's convertible subordinated debentures. The
remainder of the net proceeds were used to fund acquisitions of certain assets
of physician practices, expansion of physician services, working capital and
other general corporate purposes.
36
<PAGE> 37
9. STOCK BASED COMPENSATION PLANS
The Company sponsors employee stock purchase plans that promote the sale of
its common stock to employees. The purchase price to employees is the lower of
85% of the closing market price on the date of subscription, or 85% of the
closing market price on the date funds are actually used to purchase stock for
employees. Under the plans the Company sold 743,117, 582,132 and 267,232 shares
to employees in 1994, 1995 and 1996, respectively. The compensation cost for the
stock purchase plan is included in the pro forma information below. Compensation
cost is recognized for the fair value of the employee's purchase rights, which
was estimated using the same valuation model and assumptions below with the
exception of an expected purchase right expected life of one year. The
weighted-average fair value of those purchase rights granted in 1995 and 1996
was $6.47 and $8.66, respectively.
The Company offers participation in stock option plans to certain employees
and individuals. All of the outstanding options under these plans were granted
at 100% of the market value of the stock on the dates of grant. Awarded options
typically vest and become exercisable in incremental installments over five
years and expire no later than ten years and one day from the date of grant. The
number of shares authorized under the various plans was 25.7 million as of
December 31, 1996.
The following table summarizes stock option activity for the indicated
years:
<TABLE>
<CAPTION>
1995 1996
---------------------------- -----------------------------
WEIGHTED- WEIGHTED-
OPTIONS AVERAGE OPTIONS AVERAGE
(IN THOUSANDS) EXERCISE PRICE (IN THOUSANDS) EXERCISE PRICE
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Outstanding:
Beginning of year........ 15,110 $ 10.42 17,008 $ 13.71
Granted.................. 6,297 19.09 12,448 19.11
Exercised................ (1,889) 6.99 (4,281) 10.87
Canceled/expired......... (2,510) 12.55 (5,881) 23.98
-------- --------
End of year.............. 17,008 13.70 19,294 14.69
Exercisable at end of year. 5,680 13.24 12,472 13.57
Weighted-average fair
value of options
granted during the
year..................... $ 9.98 $ 12.06
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- ----------------------------------
OPTIONS WEIGHTED-AVERAGE OPTIONS
EXERCISE PRICE OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
RANGE AT 12/31/96 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/96 EXERCISE PRICE
------------------ --------------- ------------------ ----------------- --------------- ----------------
(IN THOUSANDS) (YEARS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
under $12.00.... 980 6.78 $ 4.41 655 $ 5.93
$12.00-$16.99... 14,597 7.74 14.21 11,133 13.65
$17.00 and
above......... 3,717 7.94 19.22 684 19.54
</TABLE>
Under various plans, the Company has made grants of restricted common stock
to provide incentive compensation to key employees. Restricted stock activity is
summarized below:
<TABLE>
<CAPTION>
1995 1996
------- ---------
(IN THOUSANDS)
<S> <C> <C>
Restricted stock
outstanding:
Beginning of year....... 320 278
Granted................. 339 1
Canceled................ (26) (6)
Vested (free of
restrictions)......... (355) (273)
------ ------
End of year............. 278 --
====== ======
</TABLE>
Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its stock-based compensation plans under the fair value method as
described in Statement 123. The fair value for these options and employee
purchase rights was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions:
37
<PAGE> 38
<TABLE>
<CAPTION>
1995 1996
---- ----
<S> <C> <C>
Risk-free interest rates......... 6.15% 6.21%
Expected volatility.............. .448 .442
Expected option lives (years).... 5.3 5.4
Expected stock purchase lives
(years)........................ 1.0 1.0
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of Statement 123, the Company's net income
(loss) and earnings (loss) per share would have been reduced (increased) to pro
forma net income (loss) from continuing operations of $20.9 and $(123.0) million
and pro forma net losses of $(115.6) and $(191.7) million for the years ended
December 31, 1995 and 1996, respectively. Per share amounts would have been
reduced to pro forma net income (loss) from continuing operations of $0.13 and
$(0.71) and pro forma net losses per share of $(0.73) and $(1.10) for the years
ended December 31, 1995 and 1996, respectively.
10. ACQUISITIONS
During the years ended December 31, 1994, 1995 and 1996, the Company,
through its wholly-owned subsidiaries, acquired certain operating assets of
various medical practices. Simultaneously with each medical practice
acquisition, the Company entered into a practice management agreement which
generally has a 20-40 year term. (See "Basis of Presentation" in Note 1.)
In May 1995, Caremark entered into a long-term affiliation agreement with
Friendly Hills HealthCare Network ("Friendly Hills"), an integrated health care
delivery system headquartered in La Habra, California. Friendly Hills operates
18 medical offices and an acute care hospital. Caremark acquired substantially
all of the assets of Friendly Hills for approximately $140 million and agreed to
provide various management and administrative services. The transaction has been
accounted for by the purchase method of accounting. The Company invested
approximately $151.2 million in cash, stock and notes for other acquisitions in
1995.
In January 1996, Caremark completed its agreement with CIGNA Healthcare of
California, a managed healthcare subsidiary of CIGNA Corporation, to acquire
substantially all of the assets of CIGNA Medical Group, CIGNA Healthcare's Los
Angeles area staff model delivery system ("CIGNA") for approximately $80.4
million in cash. The transaction has been accounted for by the purchase method
of accounting. During the year ended December 31, 1996, $160.5 million in cash
and 2 million shares of stock valued at $39.9 million were given in exchange for
the net assets of CIGNA and other entities. Results of operations would not have
been materially different in 1994, 1995 and 1996 had these transactions occurred
as of the beginning of the respective years.
All of the aforementioned acquisitions have been accounted for by the
purchase method of accounting. As such, operating results of acquired businesses
are included in the Company's consolidated financial statements as of their
respective dates of acquisition.
11. MERGERS
Effective February 22, 1996 and September 5, 1996, the Company merged with
PPSI and Caremark, respectively, in transactions that were accounted for as
poolings of interests. The Company exchanged 11.0 million and 90.5 million
shares of its common stock for all of the outstanding common stock of PPSI and
Caremark, respectively. During the year ended December 31, 1996, the Company
also exchanged 11.3 million shares of its common stock in additional
transactions accounted for as poolings of interests. Effective June 27, 1997,
the Company merged with InPhyNet in a transaction that was accounted for as a
pooling of interests. The Company exchanged approximately 19.3 million shares of
its common stock for all outstanding common stock of InPhyNet. The Company's
historical financial statements for all periods have been restated to include
the results of all material transactions accounted for as poolings of interests.
38
<PAGE> 39
<TABLE>
<CAPTION>
OTHER
POOLINGS COMBINED
MEDPARTNERS PPSI CAREMARK INPHYNET OF INTERESTS (AS REPORTED)
----------- ---- -------- -------- ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1994
Net revenue............... $ 506,818 $ 308,226 $1,775,200 $ 270,370 $ 48,410 $2,909,024
Net (loss) income......... (10,660) 7,598 80,400 9,366 2,708 89,412
Year ended December 31,1995
Net revenue............... 742,388 411,132 2,374,300 325,340 55,557 3,908,717
Net (loss) income......... (9,717) 10,205 (116,300) 11,288 185 (104,339)
Year ended December 31, 1996
Net revenue............... 1,071,819 410,102 3,203,512 408,520 128,066 5,222,019
Net (loss) income......... (141,680) (10,464) (3,359) 13,041 (3,026) (145,488)
</TABLE>
Prior to its merger with the Company, PPSI reported on a fiscal year ending
on July 31. The restated financial statements for all periods prior to and
including December 31, 1995 are based on a combination of the Company's results
for its December 31 fiscal year and an October 31 fiscal year for PPSI.
Beginning January 1, 1996, PPSI adopted a December 31 fiscal year end;
accordingly, all consolidated financial statements for periods after December
31, 1995 are based on a consolidation of all of the Company's subsidiaries on a
December 31 year end. PPSI's historical results of operations for the two months
ending December 31,1995 are not included in the Company's consolidated
statements of operations or cash flows. An adjustment has been made to
stockholders' equity as of January 1, 1996 to adjust for the effect of excluding
PPSI's results of operations for the two months ending December 31, 1995. The
net loss for the two month period ended December 31, 1995 relates primarily to
increases in PPSI's reserves to conform to the Company's methodology of
calculating reserves. The following is a summary of operations and cash flow for
the two months ending December 31, 1995 (in thousands):
<TABLE>
<S> <C>
Statement of Operations Data:
Net revenue .................................. $ 69,850
Operating expenses:
Affiliated physician services ................ 32,600
Outside medical expenses ..................... 14,861
Clinic expenses .............................. 26,034
General and administrative expenses .......... 5,235
Depreciation and amortization ................ 2,371
Net interest expense ......................... 426
Loss on disposal of assets ................... 41
--------
Net operating expenses .................... 81,568
Loss before taxes ............................ (11,718)
Income tax benefit ........................... (3,661)
Net loss ..................................... $ (8,057)
Statement of Cash Flow Data:
Net cash used by operating activities ........ $ (3,569)
Net cash provided by investing activities .... 4,455
Net cash used in financing activities ........ (81)
--------
Net increase in cash and cash equivalents .... $ 805
========
</TABLE>
Included in pre-tax loss for the year ended December 31, 1996 are merger
costs totaling $308.9 million. Approximately $32.5 and $251.3 million relate to
the mergers with PPSI and Caremark, respectively. The components of this cost
are as follows (in thousands):
<TABLE>
<S> <C>
Investment banking fees ........................ $ 31,774
Professional fees .............................. 16,674
Other transaction costs ........................ 11,645
Transition and debt restructuring .............. 39,011
Severance costs for identified
employees .................................... 56,948
Impairment of assets ........................... 41,616
Abandonment of facilities ...................... 15,921
Noncompatible technology ....................... 9,498
Conforming of accounting policies .............. 23,728
Operational restructuring ...................... 30,324
Other charges .................................. 31,806
--------
Total .......................................... $308,945
========
</TABLE>
39
<PAGE> 40
12. RETIREMENT SAVINGS PLAN
Effective April 4, 1994, the Company adopted the MedPartners, Inc. and
Subsidiaries Employee Retirement Savings Plan (the "Plan"). The Plan is a Code
Section 401(k) Plan which requires the attainment of age 21 and one year of
service, with a minimum of 1,000 hours worked to become a participant in the
Plan. Service for a predecessor employer will be considered for participation
requirements in the Plan for all employees employed through acquisition
activities. The Company, at its sole discretion, may contribute an amount which
it designates as a qualified nonelective contribution. The Company made a
required contribution of approximately 3% percent of non-key employee salaries
for the Plan year ended December 31, 1996, however, no additional contributions
are anticipated at this time. Company contributions are gradually vested over a
six-year service period. The various entities that were acquired or merged into
the Company during 1996 and 1997 also had various employee retirement plans that
will, or have been, incorporated into the Company's Plan. Participants of
Caremark's 401(k) Plan may contribute up to 12% of their annual compensation to
the plan and Caremark matches the participants' contributions up to 3% of
compensation. The expenses related to all plans during the years ended December
31, 1994, 1995 and 1996 were approximately $7.9 million, $6.0 million and $7.7
million, respectively.
Caremark sponsored retirement plans for all qualifying domestic employees
and certain employees in other countries. Benefits are typically based on years
of service and the employee's compensation during five of the last 10 years of
employment as defined by the plans. Caremark's funding policy is to make
contributions that meet or exceed the minimum requirements of the Employee
Retirement Income Security Act of 1974, based on the projected unit credit
actuarial cost method, and to limit such contributions to amounts currently
deductible for federal income tax reporting purposes.
The following table summarizes the components of net pension expense and
related actuarial assumptions used at the January 1 valuation date for the
respective years related to the Caremark sponsored defined benefit plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
--------- --------- --------
<S> <C> <C> <C>
Assumptions:
Discount rate ................................. 8.75% 7.25% 8.75%
Increase in compensation levels ............... 5.0% 5.0% 5.0%
Expected long-term return on assets ........... 10.5% 9.5% 9.5%
Components (in thousands):
Service cost-benefits earned .................. $ 4,600 $ 2,100 $ 3,024
Interest cost on projected obligation ......... 2,300 2,200 2,635
Actual return on assets ....................... (1,300) (1,700) (3,121)
Net amortizations ............................. 700 100 698
Deferred asset gain ........................... -- -- 1,233
Merger expenses:
Special termination benefits .................. -- -- 4,675
Curtailment loss .............................. -- -- 502
-------- -------- ------
Net pension expense ........................... $ 6,300 $ 2,700 $9,646
======== ======== ======
</TABLE>
The following table presents the funded status of the Caremark plans, the
net pension liability recognized in the consolidated balance sheets and related
actuarial assumptions as of December 31:
<TABLE>
<CAPTION>
1995 1996
------- -------
<S> <C> <C>
Assumptions:
Discount rate ............................................ 7.25% 8.75%
Increase in compensation levels .......................... 5.0% 5.0%
Funded status and net pension liability (in thousands):
Actuarial present value of benefit obligations:
Vested benefits ....................................... $22,200 $37,453
Accumulated benefits .................................. 25,000 41,141
Effect of future salary increases ..................... 7,200 --
------- -------
Projected benefits .................................... 32,200 41,141
Less: plan assets at fair value (1) ........................ 20,900 24,977
------- -------
Projected benefit obligations in excess of plan assets ..... 11,300 16,164
Less: unrecognized net loss ................................ (4,800) --
------- -------
Net pension liability ...................................... $ 6,500 $16,164
======= =======
</TABLE>
================================================================================
(1) Primarily equity and fixed income securities.
40
<PAGE> 41
13. CONTINGENCIES
In September 1995, Coram Healthcare Corporation ("Coram") filed a complaint
in the San Francisco Superior Court against Caremark, its subsidiary, Caremark
Inc., and others. The complaint, which arose from Caremark's sale to Coram of
Caremark's home infusion therapy business in April 1995 for approximately $209.0
million in cash and $100.0 million in securities, alleged breach of the sale
agreement and made other related claims seeking compensatory damages of $5.2
billion, in the aggregate. Caremark filed counterclaims against Coram and also
filed a lawsuit in the United States District Court in Chicago against Coram,
claiming securities fraud. On July 1, 1997, the parties to the Coram litigation
announced that a settlement had been reached pursuant to which Caremark will
return for cancellation all of the securities issued by Coram in connection with
the acquisition and will pay to Coram $45 million in cash on or before September
1, 1997. The settlement agreement also provides for the termination and
resolution of all disputes and issues between the parties and for the exchange
of mutual releases. The settlement resulted in a 1997 second quarter after-tax
charge from discontinued operations of approximately $75.4 million.
In March 1996, Caremark agreed to settle all disputes with a number of
private payors. The settlements resulted in an after-tax charge of $43.8
million. These disputes related to businesses that were covered by Caremark's
settlement with federal and state agencies in June 1995 discussed below. In
addition, Caremark agreed to pay $24.1 million after-tax to cover the private
payors' pre-settlement and settlement-related expenses. An after-tax charge for
the above amounts has been recorded in first quarter 1996 discontinued
operations. During the year ended December 31, 1996, Caremark paid $105.1
million, with an additional $3.3 million plus interest to be paid over the next
six months, related to the settlements.
In June 1995, Caremark agreed to settle an investigation of Caremark with
the U.S. Department of Justice, the Office of the Inspector General of the U.S.
Department of Health and Human Services, the Veterans Administration, the
Federal Employees Health Benefits Program, the Civilian Health and Medical
Program of the Uniformed Services and related state investigative agencies in
all 50 states and the District of Columbia (the "OIG investigation"). Under the
terms of the OIG Settlement, which covered allegations dating back to 1986, a
subsidiary of Caremark pled guilty to two counts of mail fraud, one each in
Minnesota and Ohio, resulting in the payment of civil penalties and criminal
fines. The basis of these guilty pleas was Caremark's failure to provide certain
information to CHAMPUS, FEHBP and federal funded healthcare benefit programs,
concerning financial relationships between Caremark and a physician in each of
Minnesota and Ohio. Caremark took an after-tax charge to discontinued operations
of $154.8 million in 1995 for these settlement payments, costs to defend ongoing
derivative, security and related lawsuits and other associated costs.
The Company cannot determine at this time what costs may be incurred in
connection with future disposition of nongovernmental claims or litigation. The
Company does not believe that the above-referenced settlements will materially
affect its ability to pursue its long-term business strategy. There can be no
assurances, however, that additional costs, claims and damages will not occur or
that the ultimate costs related to the settlements will not exceed estimates in
the preceding paragraphs.
In May 1996, three home infusion companies, purporting to represent a class
consisting of all of Caremark's competitors in the alternate site infusion
therapy industry, filed a complaint against Caremark International Inc.,
Caremark, Inc. and two other corporations in the United States District Court
for the District of Hawaii alleging violations of the federal conspiracy laws,
the antitrust laws and of California's unfair business practice statute. The
complaint seeks unspecified treble damages, attorneys' fees and expenses. The
Company intends to defend this case vigorously. Management is unable at this
time to estimate the impact, if any, of the ultimate resolution of this matter.
In August and September 1994, stockholders, each purporting to represent a
class, filed complaints against Caremark and certain officers and employees of
Caremark in the United States District Court for the Northern District of
Illinois, alleging violations of the Securities Act of 1933 and the Securities
Exchange Act of 1934, and fraud and negligence in connection with public
disclosures by Caremark regarding Caremark's business practices and the status
of the OIG investigation discussed above. The complaints seek unspecified
damages, declaratory and equitable relief, and attorneys' fees and expenses. In
June 1996, the complaint filed by one group of stockholders alleging violations
of the Securities Exchange Act of 1934 only, was certified as a class. The
parties to all of the complaints continue to engage in discovery proceedings.
The Company intends to defend these cases vigorously. Management is unable at
this time to estimate the impact, if any, of the ultimate resolution of these
matters.
In late August 1994, certain patients of a physician who prescribed human
growth hormone distributed by Caremark and the sponsor of a health insurance
plan of one of those patients filed complaints against Caremark, employees of
Caremark and others in the United States District Court for the District of
Minnesota. Each complaint purported to be on behalf of a class and alleged
41
<PAGE> 42
violations of the federal mail and wire fraud statutes, the federal conspiracy
statute and the state consumer fraud statute, as well as conspiracy to breach a
fiduciary duty, negligence and fraud. Each complaint sought unspecified treble
damages, and attorneys' fees and expenses. In July 1996, these plaintiffs also
filed a separate lawsuit in the Minnesota State Court in the County of Hennepin
against a subsidiary of Caremark purporting to be on behalf of a class and
alleging all of the claims contained in the complaint filed with the Minnesota
federal court other than the federal claims contained therein. The state
complaint seeks unspecified damages, attorneys' fees and expenses and an award
of punitive damages. In November 1996, in response to a motion by the
plaintiffs, the Court dismissed the United States District Court cases without
prejudice. In July 1995, another patient of the same physician filed a separate
complaint in the District of South Dakota against the physician, Caremark and
another corporation alleging violations of the federal laws prohibiting payment
of remuneration to induce referral of Medicare and Medicaid beneficiaries, and
the federal mail fraud and conspiracy statutes. The complaint also alleges the
intentional infliction of emotional distress and seeks trebling of at least
$15.9 million in general damages, attorneys' fees and costs, and an award of
punitive damages. In August 1995, the parties to the case filed in South Dakota
agreed to a stay of all proceedings until final judgment has been entered in a
criminal case that is presently pending against this physician. The Company
intends to defend these cases vigorously. Management is unable at this time to
estimate the impact, if any, of the ultimate resolution of these matters.
Beginning in September 1994, Caremark was named as a defendant in a series
of new lawsuits added to a pending group of actions (including a class action)
brought in 1993 under the antitrust laws by local and chain retail pharmacies
against brand name pharmaceutical manufacturers, wholesalers and prescription
benefit managers other than Caremark. The new lawsuits, filed in federal
district courts in at least 38 states (including the United States District
Court for the Northern District of Illinois), allege that at least 24
pharmaceutical manufacturers provided unlawful price and service discounts to
certain favored buyers and conspired among themselves to deny similar discounts
to the complaining retail pharmacies (approximately 3,900 in number). The
complaints charge that certain defendant prescription benefit managers,
including Caremark, were favored buyers who knowingly induced or received
discriminatory prices from the manufacturers, in violation of the
Robinson-Patman Act. Each complaint seeks unspecified treble damages,
declaratory and equitable relief, and attorneys' fees and expenses. All of these
actions have been transferred by the Judicial Panel for Multidistrict Litigation
to the United States District Court for the Northern District of Illinois for
coordinated pretrial procedures. Caremark was not named in the class action. In
April 1995, the Court entered a stay of pretrial proceedings as to certain
Robinson-Patman Act claims in this litigation, including the Robinson-Patman Act
claims brought against Caremark, pending the conclusion of a first trial of
certain of such claims brought by a limited number of plaintiffs against five
defendants not including Caremark. On July 1, 1996, the district court directed
entry of a partial final order in the class action approving an amended
settlement with certain of pharmaceutical manufacturers. The amended settlement
provides for a cash payment by the defendants in the class action (which does
not include Caremark) of approximately $351.0 million to class members in
settlement of conspiracy claims as well as a commitment from the settling
manufacturers to abide by certain injunctive provisions. All class action claims
against non-settling manufacturers as well as all opt out and other claims
generally, including all Robinson-Patman Act claims against Caremark, remain
unaffected by the settlement. The district court also certified to the court of
appeals for interlocutory review certain orders relating to non-settled
conspiracy claims against the pharmaceuticals manufacturers and wholesalers.
These interlocutory orders do not relate to any of the claims brought against
Caremark. The Company intends to defend these cases vigorously. Although
management believes, based on information currently available, that the ultimate
resolution of this matter is not likely to have a material adverse effect on the
operating results and financial condition of the Company, there can be no
assurance that the ultimate resolution of this matter, if adversely determined,
would not have a material adverse effect on the operating results and financial
condition of the Company.
In December 1994, Caremark was notified by the Federal Trade Commission (the
"FTC") that it was conducting a civil investigation of the industry concerning
whether acquisitions, alliances, agreements or activities between pharmacy
benefit managers and pharmaceutical manufacturers, including Caremark's alliance
agreements with certain drug manufacturers, violate Sections 3 or 7 of the
Clayton Act or Section 5 of the Federal Trade Commission Act. The specific
nature, scope, timing and outcome of this investigation are not currently
determinable. Under the statutes, if violations are found, the FTC could seek
remedies in the form of injunctive relief to set aside or modify Caremark's
alliance agreements and an order to cease and desist from certain marketing
practices and from entering into or continuing with certain types of agreements.
Management is unable at this time to estimate the impact, if any, of the
ultimate resolution of this matter.
In May 1996, two stockholders, each purporting to represent a class, filed
complaints against Caremark and each of its directors in the Court of Chancery
of the State of Delaware alleging breaches of the directors' fiduciary duty in
connection with Caremark's then proposed merger with the Company. The complaints
seek unspecified damages, injunctive relief, and attorneys' fees and expenses.
42
<PAGE> 43
The plaintiffs in these actions have made no effort to pursue these claims and
the Company does not believe that these complaints will have a material adverse
effect on the operating results and financial condition of the Company.
Although the Company cannot predict with certainty the outcome of
proceedings described above, based on information currently available,
management believes that the ultimate resolution of such proceedings,
individually and in the aggregate, is not likely to have a material adverse
effect on the Company.
The Company is party to various other commitments, claims and routine
litigation arising in the ordinary course of business. Management does not
believe that the result of such commitments, claims and litigation, individually
or in the aggregate, will have a material adverse effect on the Company's
business or its results of operations, cash flows or financial condition.
14. SUBSEQUENT EVENTS
The Company plans during the third quarter of 1997 to raise an additional
$350 million in capital through a hybrid convertible offering of $350 million in
Threshold Appreciation Price Securities (TAPS) plus $350 million of senior
subordinated notes, both due in three years. The TAPS require that the investor
purchase the Company's common stock in three years at a price at or above the
Company's current stock price. The $350 million in proceeds from the TAPS
offering will be used to purchase Treasury Notes, which will pay the TAPS
investor interest plus an interest premium and be pledged to a collateral agent
to secure the investor's obligation to purchase stock. Proceeds from the
maturation of the Treasury Notes will be used to purchase the $350 million in
common stock from the Company.
On August 14, 1997, the Company announced it has entered into a definitive
agreement to acquire Talbert Medical Management Holdings Corporation of Costa
Mesa, California, pursuant to a tender offer followed by a merger, for $63 per
share in cash, or approximately $200 million. Talbert Medical Management is a
physician practice management company representing 282 primary and specialty
care physicians and operating 52 clinics in five Southwestern states. The
acquisition will be accounted for as a purchase transaction with the Company
assuming all asset and liabilities of Talbert. The transaction is contingent on
receiving approval from the Federal Trade Commission under the provision of the
Hart-Scott-Rodino Anti-Trust Improvements Act of 1976.
On May 2, 1997, the Company completed a transaction in which it acquired
Aetna Professional Management Corporation ("APMC"), Aetna U.S. Healthcare's
physician practice management business, and most of the Health Ways Family
Medical Centers and affiliated group practices. The Company's acquisition of
Health Ways Family Medical Centers includes 47 Health Ways and affiliated
medical centers which employ 189 physicians; and the six independent practice
associations ("IPAs"), to which APMC provides practice management and other
services. Health Ways and the affiliated centers are located in seven
metropolitan markets where the Company already has a presence, including
Atlanta, the Baltimore/D.C. and northern Virginia area, Philadelphia, Dallas,
Akron, Chicago, and southern California. Health Ways and the affiliated centers
provide primary and specialty care to approximately 280,000 individuals,
including 40,000 Aetna U.S. Healthcare members. As part of the APMC acquisition,
the Company has entered into a 10-year agreement which will allow the members of
the Company's networks of affiliated physicians to be authorized providers for
many of the 14 million members of Aetna U.S. Healthcare's health plan.
43
<PAGE> 44
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
The following are filed as Exhibits to this Report:
Exhibit (23) Consent of Ernst & Young LLP.
Exhibit (27) Financial Data Schedule.
<PAGE> 45
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 hereunto duly authorized.
Date: August 26, 1997
MedPartners, Inc.
By /s/ Harold O. Knight, Jr.
----------------------------------
Harold O. Knight, Jr.
Executive Vice President
and Chief Financial Officer
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements (Form S-3 No. 333-30921 and Form S-3 No. 333-30923) of MedPartners,
Inc. and the related Prospectuses of our report dated August 25, 1997, with
respect to the consolidated financial statements of MedPartners, Inc., included
in this Current Report on Form 8-K dated August 27, 1997 and filed with the
Securities and Exchange Commission.
Ernst & Young L.L.P.
Birmingham, Alabama
August 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 127,397
<SECURITIES> 0
<RECEIVABLES> 660,150
<ALLOWANCES> 143,449
<INVENTORY> 150,586
<CURRENT-ASSETS> 1,062,115
<PP&E> 516,769
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,423,120
<CURRENT-LIABILITIES> 835,706
<BONDS> 715,996
0
0
<COMMON> 184
<OTHER-SE> 837,224
<TOTAL-LIABILITY-AND-EQUITY> 2,423,120
<SALES> 0
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<OTHER-EXPENSES> (1,075)
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<INCOME-PRETAX> (73,575)
<INCOME-TAX> 3,215
<INCOME-CONTINUING> (76,790)
<DISCONTINUED> (68,698)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (145,488)
<EPS-PRIMARY> (0.83)
<EPS-DILUTED> (0.83)
</TABLE>
