UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 33-80987
Merit Behavioral Care Corporation
(Exact name of registrant as specified in its charter)
Delaware 22-3236927
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
One Maynard Drive
Park Ridge, New Jersey 07656
(Address of principal executive offices)
(201) 391-8700
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports,
and (2) has been subject to such filing requirements for the past 90 days.
Yes..X... No.......
As of July 31, 1996, 28,377,800 shares of the registrant's common stock,
par value $.01 per share, which is the only class of common stock of the
registrant, were outstanding.
MERIT BEHAVIORAL CARE CORPORATION
Table of Contents
Form 10-Q for the Quarterly Period
Ended June 30, 1996
PART I FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at
June 30, 1996 and September 30, 1995 3
Condensed Consolidated Statements of
Operations for the three months ended
June 30, 1996 and June 30, 1995, and
the nine months ended June 30, 1996
and June 30, 1995. 4
Condensed Consolidated Statements of
Cash Flows for the nine months ended
June 30, 1996 and June 30, 1995. 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 11
PART II OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 17
MERIT BEHAVIORAL CARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(dollars in thousands)
June 30, September 30,
ASSETS 1996 1995
Current Assets: ------- --------
Cash and cash equivalents.................... $ 38,444 $ 20,611
Accounts receivable, net of allowance
for doubtful accounts
of $1,374 and $525......................... 31,722 27,648
Short-term marketable securities............. -- 1,143
Other current assets......................... 5,345 4,569
Total current assets....................... 75,511 53,971
Property, plant and equipment, net........... 63,051 54,974
Other Assets: ------- -------
Goodwill and other intangibles,
net of accumulated
amortization of $54,018 and $37,017........ 164,637 171,139
Restricted cash.............................. 4,501 12,405
Deferred financing costs, net of
accumulated amortization of $841........... 11,663 --
Other assets................................. 13,909 12,931
------- -------
194,710 196,475
------- -------
Total assets................................. $333,272 $305,420
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable............................ $ 3,063 $ 3,389
Claims payable.............................. 49,919 43,371
Deferred revenue............................ 7,798 9,582
Accrued interest............................ 2,182 --
Current portion of long-term debt........... 500 --
Other current liabilities................... 14,270 8,788
------- -------
Total current liabilities................. 77,732 65,130
Due to parent (noninterest bearing)......... -- 70,813
Long-term debt.............................. 248,500 --
Deferred income taxes....................... 31,309 44,744
Other long-term liabilities................. 2,343 2,400
Stockholders' Equity:
Common stock (40,000,000 shares authorized,
$0.01 par value, 28,398,800 shares issued
at June 30, 1996)......................... 284 10
Additional paid in capital.................. (12,162) 118,877
Retained (deficit) earnings................. (9,144) 3,446
Notes receivable from officers.............. (5,485) --
(26,507) 122,333
Less common stock in treasury (21,000 shares) (105) --
Total stockholders' equity................ (26,612) 122,333
------- -------
Total liabilities and stockholders' equity.. $ 333,272 $305,420
======= =======
See accompanying notes to condensed consolidated financial statements.
MERIT BEHAVIORAL CARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(dollars in thousands)
Three months ended Nine months ended
June 30, June 30,
-------------------- --------------------
1996 1995 1996 1995
------- ------- ------- -------
Revenue...................... $ 111,189 $ 97,924 $ 333,830 $ 262,065
Expenses:
Direct service costs....... 86,419 77,601 262,710 206,706
Selling, general
and administrative........ 17,313 13,211 47,328 36,590
Amortization of intangibles 6,454 5,447 19,291 15,736
110,186 96,259 329,329 259,032
Operating income............. 1,003 1,665 4,501 3,033
Other income (expense):
Interest income and other.. 681 409 2,019 1,074
Interest expense........... (6,077) -- (17,626) --
Merger costs............... -- -- (3,972) --
------- ------- ------- -------
(5,396) 409 (19,579) 1,074
------- ------- ------- -------
(Loss) income before income taxes
and cumulative effect of
accounting change.......... (4,393) 2,074 (15,078) 4,107
(Benefit) provision for
income taxes............... (1,364) 1,382 (3,500) 3,281
(Loss) income before cumulative
effect of accounting change. (3,029) 692 (11,578) 826
Cumulative effect of accounting
change for deferred contract
start-up costs, net of tax benefit
of $757...................... -- -- (1,012) --
------- ------- ------- -------
Net (loss) income.............. $(3,029) $ 692 $ (12,590) $ 826
======= ======= ======= =======
Pro forma net (loss) income assuming
the new method of accounting for
deferred contract start-up costs
is applied retroactively..... $(3,029) $ 409 $ (11,578) $ 99
See accompanying notes to condensed consolidated financial statements.
MERIT BEHAVIORAL CARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(dollars in thousands)
Nine months ended
June 30,
-------------------
1996 1995
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income..................... $ (12,590) $ 826
Adjustments to reconcile net (loss)
income to net cash
provided by operating activities:
Cumulative effect of accounting change. 1,012 --
Depreciation and amortization.......... 26,887 20,443
Amortization of deferred
financing costs...................... 841 --
Deferred taxes......................... (5,084) 284
Changes in operating assets and
liabilities, net of the
effect of acquisitions:
Accounts receivable.................... (2,073) (878)
Other current assets................... (252) 61
Deferred contract start-up costs....... (3,310) (4,740)
Accounts payable and
accrued liabilities.................. 5,451 3,022
------- -------
Net cash provided by operating activities. 10,882 19,018
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property,
plant and equipment................... (15,838) (21,576)
Sales of marketable securities.......... 1,143 3,345
Long-term restrictions removed from
(placed on) cash...................... 7,904 (6,153)
Investments in and advances
to joint ventures.................... (1,221) (998)
Repayments of advances
from joint ventures.................. 300 --
Cash used for acquisitions, contingent
consideration, and related expenses,
net of cash acquired................. (11,058) (1,030)
Other................................... (908) (44)
------- -------
Net cash used for investing activities.. (19,678) (26,456)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from capital contribution...... 114,980 --
Borrowings from parent.................. -- 1,314
Proceeds from bridge loan............... 75,000 --
Proceeds from revolving credit facility. 123,000 --
Proceeds from senior term loans......... 120,000 --
Proceeds from sale of notes............. 100,000 --
Repayment of notes receivable
from officers........................ 250 --
Redemption of common stock.............. (259,039) --
Preliminary adjustment to
common stock redemption.............. 4,895 --
Repayment of due to parent.............. (70,813) --
Repayment of bridge loan................ (75,000) --
Repayment of revolving credit facility.. (94,000) --
Payment of financing costs.............. (12,504) --
Net purchase of treasury stock.......... (140) --
------- -------
Net cash provided by
financing activities................. 26,629 1,314
------- -------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................. 17,833 (6,124)
Cash and cash equivalents
at beginning of period.............. 20,611 24,730
------- -------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD.................................. $ 38,444 $ 18,606
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid for income taxes.............. $ 1,002 $ 1,814
Cash paid for interest.................. $ 14,603 $ --
See accompanying notes to condensed consolidated financial statements.
MERIT BEHAVIORAL CARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in thousands)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed
consolidated financial statements include the accounts of
Merit Behavioral Care Corporation and its wholly-owned
subsidiaries (the "Company"), and have been prepared in
accordance with generally accepted accounting principles
for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X.
The condensed consolidated balance sheet at June 30, 1996
and the consolidated statements of operations and cash
flows for all periods presented are unaudited and reflect all
adjustments, consisting of normal recurring items, which
management considers necessary for a fair presentation.
Operating results for fiscal 1996 interim periods are not
necessarily indicative of results to be expected for the
entire year. The consolidated balance sheet at September
30, 1995 was derived from the Company's September 30,
1995 audited financial statements. Certain prior year
amounts have been reclassified to conform with the current
year's presentation. For further information, refer to the
Company's consolidated financial statements and notes
thereto for the year ended September 30, 1995 included in
the Company's filing on Form S-4 dated March 20, 1996.
2. MERGER
On October 6, 1995, the Company completed a merger (the
"Merger") with MDC Acquisition Corp. ("MDC"), a
company formed by Kohlberg Kravis Roberts & Co., L.P.
("KKR"), whereby MDC was merged with and into the
Company. Prior to the Merger, the Company was a
wholly-owned subsidiary of Merck & Co., Inc. ("Merck").
In connection with the Merger, Merck received $333,186
in cash and retained approximately 15.0% of the common
stock of the post-Merger Company. The Merger was
accounted for as a recapitalization which resulted in a
charge to equity of $259,039 to reflect the redemption of
common stock. In conjunction with the Merger, the
Company paid a stock dividend of approximately 49.6
shares for each share of the Company's common stock then
outstanding.
The Merger was financed with $114,980 of new cash
equity, consisting of $105,000 from affiliates of KKR and
$9,980 from Company management and affiliated entities
("Management"). Management acquired an additional
$5,800 of equity which was funded by loans from the
Company. The balance of the transaction was funded with
a $75,000 bridge loan (the "Bridge Loan") provided by an
affiliate of KKR and $155,000 of initial borrowings under
a $205,000 senior credit facility among the Company, The
Chase Manhattan Bank, N.A. and Bankers Trust Company
(the "Senior Credit Facility"). The aforementioned
proceeds were utilized to redeem common stock for
$259,039, repay amounts due Merck of $70,813, and pay
certain fees and expenses related to the Merger. Of the
total fees and expenses, $5,500 was paid to KKR.
3. LONG-TERM DEBT
At June 30, 1996, long-term debt consisted of the
following:
Revolving Loans $ 29,000
Senior Term Loan A 70,000
Senior Term Loan B 50,000
Notes 100,000
--------
249,000
--------
Less current portion (500)
________
$248,500
3. LONG-TERM DEBT (CONTINUED)
Senior Credit Facility - In October 1995, the Company
entered into a credit agreement (the "Credit Agreement"),
which provides for secured borrowings from a syndicate of
lenders. The Senior Credit Facility consists of (i) a six and
one-half year revolving credit facility providing for up to
$85,000 in revolving loans, which includes borrowing
capacity available for letters of credit of up to $20,000, and
(ii) a term loan facility providing for up to $120,000 in
term loans, consisting of a $70,000 senior term loan with
a maturity of six and one-half years ("Senior Term Loan
A"), and a $50,000 senior term loan with a maturity of
eight years ("Senior Term Loan B"). At June 30, 1996,
$29,000 of revolving loans and three letters of credit
totaling $425 were outstanding under the Revolving Credit
Facility, and approximately $55,575 was available for
future borrowings.
The annual amortization schedule of the Senior Term
Loans is $500 in fiscal 1997, $3,000 in 1998, $10,500 in
1999, $13,000 in 2000, $20,500 in 2001 and $72,500
thereafter. The Senior Term Loans are subject to
mandatory prepayment (i) with the proceeds of certain
asset sales and (ii) on an annual basis with 50% of the
Company's Excess Cash Flow (as defined in the Credit
Agreement) for so long as the ratio of the Company's Total
Debt (as defined in the Credit Agreement) to annual
Earnings Before Interest, Taxes, Depreciation and
Amortization ("EBITDA" as defined in the Credit
Agreement) is greater than 3.5 to 1.0.
The Company is charged a commitment fee calculated at
an EBITDA-dependent rate ranging from 0.250% to
0.500% per annum of the commitment under the
Revolving Credit Facility in effect on each day. The
Company is charged a letter of credit fee calculated at an
EBITDA-dependent rate ranging from 0.375% to 1.750%
per annum of the face amount of each letter of credit and
a fronting fee calculated at a rate equal to 0.250% per
annum of the face amount of each letter of credit. Loans
under the Credit Agreement bear interest at EBITDA-dependent floating
rates, which are, at the Company's option, based upon (i) the higher of
the Federal funds rate plus 0.5%, or bank prime rates, or (ii) Eurodollar
rates. Rates on borrowings outstanding under the Senior Credit
Facility averaged 8.3% for the nine months ended June 30, 1996.
Notes - On November 22, 1995, the Company issued
$100,000 aggregate principal amount of 11 1/2% senior
subordinated notes due 2005 (the "Private Notes"), the net
proceeds of which were applied to repay the Bridge Loan
(including accrued interest) and a portion of the revolving
loans under the Senior Credit Facility. On March 20, 1996,
the Company exchanged the Private Notes for $100,000
aggregate principal amount of 11 1/2% Senior
Subordinated Notes due 2005 that are registered under the
Securities Act of 1933 (the "Notes"). The Notes are senior
subordinated, unsecured obligations of the Company.
The Company may be obligated to purchase at the holders'
option all or a portion of the Notes upon a change of
control or asset sale, as defined in the indenture for the
Notes (the "Notes Indenture"). The Notes are not
redeemable at the Company's option prior to November 15,
2000, except that at any time on or prior to November 15,
1998, under certain conditions the Company may redeem
up to 35% of the initial principal amount of the Notes
originally issued with the net proceeds of a public offering
of the common stock of the Company. The redemption
price is equal to 111.50% of the principal amount if the
redemption is on or prior to November 15, 1997, and
110.50% if the redemption is on or prior to November 15,
1998. From and after November 15, 2000, the Notes will
be subject to redemption at the option of the Company, in
whole or in part, at various redemption prices, declining
from 105.75% of the principal amount to par on and after
November 15, 2004. The Notes mature on November 15, 2005.
4. NOTES RECEIVABLE FROM OFFICERS
In October 1995, the Company loaned several officers an
aggregate of $5,800 for the purchase of common stock of
the Company; subsequent to the Merger, additional loans
totaling $35 were made to officers for the purchase of
shares from treasury. Each loan is represented by a
promissory note which bears interest at a rate of 6.5% per
annum.
These notes are full recourse obligations of the officers, are
collateralized by the pledge of common stock of the
Company held by such officers and may be prepaid in part
or in full without notice or penalty. One note for $250 was
repaid as of December 31, 1995 and another note for $100
was canceled in January 1996. The remaining outstanding
notes are due as follows: $15 in 1996, $250 in 1997, $20
in 1998 and $5,200 in 2001. The notes are shown as a
reduction of stockholders' equity in the accompanying
condensed consolidated balance sheets.
5. ACQUISITIONS
In October 1995, the Company paid an initial $8,730 to
acquire Choate Health Management, Inc. and certain
related entities ("Choate"), a Massachusetts-based
integrated behavioral healthcare organization. On
December 19, 1995, the Company paid an initial $50 with
a subsequent payment of $2,950 in January 1996 to acquire
ProPsych, Inc. ("ProPsych"), a Florida-based behavioral
health managed care company. These acquisitions were
accounted for as purchase transactions in accordance with
Accounting Principles Board Opinion No. 16. The
condensed consolidated financial statements include the
operating results of Choate and ProPsych from their
respective dates of acquisition. Pro forma results of
operations have not been presented because the effect of
the acquisitions was not significant.
The Company is obligated to make contingent payments to
the former shareholders of Choate and ProPsych based on
future financial performance. Contingent consideration
related to Choate is calculated at six times calendar year
1997 pre-tax income of Choate, less $9,262. An interim payment
relating to such contingent consideration in the amount of
$1,262 was made by the Company to the former shareholders of Choate
in July 1996; such payment was recorded as goodwill. An additional
interim payment of the Choate contingent consideration may be required
based on the 1996 pre-tax income of Choate. Contingent
consideration related to ProPsych is calculated at three
times the sum of calendar year 1996 and 1997 pre-tax
income of ProPsych, less $3,000. Any additional payments related
to Choate or ProPsych will be recorded as goodwill.
The purchase price for each of the aforementioned
transactions was allocated to the net assets acquired based
upon their estimated fair market values. The excess of the
purchase price over the estimated fair value of net assets
acquired amounted to approximately $7,400 for Choate
and $3,100 for ProPsych. Such amounts have been
accounted for as goodwill and are being amortized over
periods up to 40 years using the straight line method.
These allocations were based on preliminary estimates and
may be revised at a later date.
6. STOCK OPTIONS AND AWARDS
In October 1995, the Company adopted the 1995 Stock
Purchase and Option Plan for Employees of Merit
Behavioral Care Corporation and Subsidiaries (the "1995
Option Plan"). The 1995 Option Plan provides for the
issuance of up to 8,561,000 shares of common stock to key
employees of the Company. The 1995 Option Plan permits
the issuance of common stock and the grant of non-qualified stock
options (the "1995 Options") to purchase shares of common stock.
The exercise price of the 1995 Options will not be less than 50% of
the fair market value per share of common stock on the date of such grant.
Such options vest at the rate of 20% per year over a period of
five years. As of June 30, 1996, 4,808,000 options with an
exercise price of $5.00 per share were issued and
outstanding under the 1995 Option Plan.
In January 1996, the Company adopted a second stock
option plan, the Merit Behavioral Care Corporation
Employee Stock Option Plan ("1996 Employee Option
Plan"). The 1996 Employee Option Plan, which covers all
employees not included in the 1995 Option Plan, provides for the issuance
of up to 1,000,000 shares of common stock of the
Company. The 1996 Employee Option Plan permits the
issuance of common stock and the grant of non-qualified
stock options (the "1996 Employee Options") to purchase
shares of common stock. The 1996 Employee Options vest
on the fourth anniversary of the date of grant, provided that
the employee remains employed with the Company on
such date. The 1996 Employee Options are exercisable
after an initial public offering of common stock of the
Company meeting certain requirements. As of June 30,
1996, 767,175 options with an exercise price of $7.50 per
share were issued and outstanding under the 1996
Employee Option Plan.
7. CONTINGENCIES
The Company is engaged in various legal proceedings that
have arisen in the ordinary course of its business. The
Company believes that the ultimate outcome of such
proceedings will not have a material effect on the
Company's financial position, liquidity or results of
operations.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of". SFAS 121 establishes
accounting standards for the impairment of long-lived
assets and certain identified intangibles to be disposed of
or held and used by an entity. SFAS 121 is effective for
fiscal years beginning after December 15, 1995. The
Company will adopt SFAS 121 in fiscal 1997 and does not
expect its implementation to have material effect on its
results of operations or its financial condition.
In October 1995, the FASB issued SFAS 123, "Accounting
for Stock-Based Compensation". SFAS 123 establishes
financial accounting and reporting standards for stock-based
employee compensation plans. SFAS 123 is effective for fiscal
years beginning after December 15, 1995. The Company will adopt
SFAS 123 in fiscal 1997 and does not expect its implementation to
have a material effect on its results of operations or its financial
condition.
9. ACCOUNTING CHANGE
Effective October 1, 1995, the Company changed its
method of accounting for deferred start-up costs related to
new contracts or expansion of existing contracts (i) to
expense costs relating to start-up activities incurred after
commencement of services under the contract, and (ii) to
limit the amortization period for deferred start-up costs to
the initial contract period. Prior to October 1, 1995, the
Company capitalized certain start-up costs related to the
completion of the provider networks and reporting systems
beyond commencement of contracts and, in limited
instances, amortized the start-up costs over a period that
included the initial renewal term associated with the
contract. Under the new policy, the Company does not
defer contract start-up costs after contract commencement
or include the initial renewal term in the amortization
period. The change was made to increase the focus on
controlling costs associated with contract start-ups.
9. ACCOUNTING CHANGE (CONTINUED)
The Company recorded a pre-tax charge of $1,769 ($1,012
after taxes) in its fiscal 1996 first quarter results of
operations as a cumulative effect of a change in
accounting. The pro forma impact of this change on the
prior year periods presented would be to increase costs and
expenses by $494 ($283 after taxes) for the three months
ended June 30, 1995 and by $1,270 ($727 after taxes) for
the nine months ended June 30, 1995. The effect of the
change on the current year periods presented cannot be
reasonably estimated.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Overview
The Company is one of the leading behavioral health
managed care companies in the United States, arranging
for a full spectrum of behavioral healthcare services on a
nationwide basis. The Company provides managed
behavioral healthcare services through a systematic clinical
approach with the objective of diagnosing problems
promptly and designing treatment plans to ensure that
patients receive the appropriate level of care in an effective
and cost-efficient manner. Behavioral healthcare involves
the treatment of a variety of behavioral health conditions
such as emotional and mental health problems, substance
abuse and other personal concerns that require counseling,
outpatient therapy or more intensive treatment services.
The Company manages behavioral healthcare programs for
approximately 1,000 payors across all segments of the
healthcare industry, including health maintenance
organization ("HMOs"), Blue Cross Blue Shield
organizations and other insurance companies, corporations
and labor unions, Federal, state and local governmental
agencies, and various state Medicaid programs.
Three Months Ended June 30, 1996 Compared to Three
Months Ended June 30, 1995
Revenue. Revenue increased by $13.3 million, or 13.6%,
to $111.2 million for the three months ended June 30, 1996
from $97.9 million for the three months ended June 30,
1995. Of this increase, $17.9 million was attributable to
additional revenue from existing customers generated by
an increase in both the number of programs managed by
the Company on behalf of such customers and an increase
in the number of beneficiaries enrolled in such customers'
programs, as well as the inclusion of revenue for the
current three month period from certain programs that
commenced during previous quarters. This revenue
increase was partially offset by a $9.8 million decrease in
revenue as a result of the termination of certain contracts,
four of which accounted for $6.8 million of such decrease.
Certain of these contracts had terminated in various periods
of the prior fiscal year. Contract price increases and
revenue derived from contracts with new customers under
which services commenced in the current quarter were not
material factors in the increase in revenue.
The Company completed two acquisitions during the
current fiscal year. On October 5, 1995, the Company
acquired Choate Health Management, Inc. and certain
related entities ("Choate"), and on December 19, 1995, the
Company acquired ProPsych, Inc. ("ProPsych"). These
acquisitions, which were accounted for under the purchase
method of accounting, contributed an additional $5.2
million in revenue for the three months ended June 30,
1996.
Direct Service Costs. Direct service costs increased by
$8.8 million, or 11.4%, to $86.4 million for the three
months ended June 30, 1996 from $77.6 million for the
three months ended June 30, 1995. As a percentage of
revenue, direct service costs decreased from 79.3% in the
prior year period to 77.7% in the current year period. This
decrease was primarily due to unusually high inpatient
utilization in the prior year quarter experienced under a
significant contract with an HMO focused on the Medicaid
beneficiary population. Changes made by the Company in
the management of such program and in the clinical
protocols utilized to deliver treatment services had the
effect of reducing such high inpatient utilization and
redirecting beneficiaries to more appropriate and cost-effective
levels of care.
Selling, General and Administrative Expenses. Selling,
general and administrative expenses increased by $4.1
million, or 31.1%, to $17.3 million for the three months
ended June 30, 1996 from $13.2 million for the three
months ended June 30, 1995. The increase in total selling,
general and administrative expenses was primarily
attributable to (i) growth in marketing and sales
administrative staff, corporate and regional management
and support systems associated with the higher sales
volume and relating to new contracts signed in previous
quarters the services under which have not yet commenced,
(ii) expenses associated with the expansion of the
Company's national service center located in St. Louis,
Missouri (the "National Service Center"), which will allow
for growth beyond its current needs, and (iii) expenses
related to the planned deployment of the Company's new
information systems. As a percentage of revenue, selling,
general and administrative expenses increased to 15.6% for
the current quarter from 13.5% in the prior year quarter.
The increase in such expenses, coupled with delays in the
planned start date of certain new contracts, contributed to
the increase in selling, general and administrative expenses
as a percentage of revenue.
Amortization of Intangibles. Amortization of intangibles
increased by $1.0 million, or 18.5%, to $6.5 million for the
three months ended June 30, 1996 from $5.5 million for
the three months ended June 30, 1995. The increase was
primarily due to an increase in amortization of goodwill
recognized in connection with the acquisitions of Choate
and ProPsych and the Company's joint venture with
Empire Blue Cross and Blue Shield, as well as to increases
in the amortization of deferred contract start-up costs
related to new contracts.
Other Income (Expense). For the three months ended
June 30, 1996, other income and expense consisted of (i)
interest expense of $6.1 million incurred as a result of the
increase in long-term debt resulting from the Merger; and
(ii) interest and other income of $0.7 million relating
primarily to investment earnings on the Company's short-term
investments and restricted cash balances.
Income Taxes. The Company recorded a benefit for
income taxes during the three months ended June 30, 1996
based upon the Company's pre-tax loss in such period.
Nine Months Ended June 30, 1996 Compared to Nine
Months Ended June 30, 1995
Revenue. The Company's revenue increased by $71.7
million, or 27.4%, to $333.8 million for the nine months
ended June 30, 1996 from $262.1 million for the nine
months ended June 30, 1995. Of this increase, $75.6
million was attributable to additional revenue from existing
customers generated by an increase in both the number of
programs managed by the Company on behalf of such
customers and an increase in the number of beneficiaries
enrolled in such customers' programs, as well as the
inclusion of revenue for the current nine month period
from certain programs that commenced during the prior
fiscal year; and $5.2 million was attributable to new
customers commencing service in the current nine month
period, the majority of which was derived from the
Company's contract with AT&T, services under which
commenced on January 1, 1996. This revenue increase
was partially offset by a $23.0 million decrease in revenue
as a result of the termination of certain contracts, four of
which accounted for $14.1 million of such decrease.
Certain of these contracts had terminated in various periods
of the prior fiscal year. Contract price increases were not
a material factor in the increase in revenue.
The Company's acquisitions of Choate and ProPsych
contributed an additional $13.9 million in revenue for the
nine months ended June 30, 1996.
Direct Service Costs. Direct service costs increased by
$56.0 million, or 27.1%, to $262.7 million for the nine
months ended June 30, 1996 from $206.7 million for the
nine months ended June 30, 1995. As a percentage of
revenue, direct service costs decreased from 78.9% in the
prior year period to 78.7% in the current year period. This
net decrease in the direct service cost percentage was due
to a variety of largely offsetting factors. The Company
experienced lower inpatient utilization in the current nine
month period as compared to the corresponding period in
the prior year related to a significant contract with an HMO
focused on the Medicaid beneficiary population. Such
decrease resulted from the implementation of changes in
program management and modification of the clinical
treatment protocols applicable to such contract. The direct
service cost percentage, however, was adversely impacted
by the loss in the fourth quarter of fiscal 1995 of two
contracts with higher than average direct profit margins
and a renewal of a significant contract on lower pricing
terms. Furthermore, the Company earned a lower than
average direct profit margin on a significant state Medicaid
program which was not in effect for the entire nine month
period in the prior year.
The Company is continuing its efforts to reduce direct
service costs to mitigate the effects of pricing pressure
associated with the competitive bid process for new
contracts and negotiations to extend existing contracts.
Related to this effort, the Company started to realize the
benefits in the third quarter of fiscal 1996 of a nationwide
recontracting program with providers which began in the
second quarter of such fiscal year.
Selling, General and Administrative Expenses. Selling,
general and administrative expenses increased by $10.7
million, or 29.3%, to $47.3 million for the nine months
ended June 30, 1996 from $36.6 million for the nine
months ended June 30, 1995. The increase in total selling,
general and administrative expenses was primarily
attributable to (i) growth in marketing and sales
administrative staff, corporate and regional management
and support systems associated with the higher sales
volume and relating to new contracts signed in the prior fiscal year
the services under which either have not yet commenced or commenced after
the beginning of the current fiscal year (ii) expenses associated with
the expansion of the Company's National Service Center, which will allow
for growth beyond its current needs, and (iii) expenses related
to the planned deployment of the Company's new
information systems. As a percentage of revenue, selling,
general and administrative expenses increased to 14.2% for
the current year period from 14.0% in the prior year period.
The increase in such expenses, coupled with delays in the
planned start dates of significant new contracts contributed
to the increase in selling, general and administrative
expenses as a percentage of revenue.
Amortization of Intangibles. Amortization of intangibles
increased by $3.6 million, or 22.6%, to $19.3 million for
the nine months ended June 30, 1996 from $15.7 million
for the nine months ended June 30, 1995. The increase
was primarily due to an increase in amortization of
goodwill recognized in connection with the acquisitions of
Choate and ProPsych and the Company's joint venture with
Empire Blue Cross and Blue Shield, as well as to increases
in the amortization of deferred contract start-up costs
related to new contracts.
Other Income (Expense). For the nine months ended June
30, 1996, other income and expense consisted of (i) interest
expense of $17.6 million incurred as a result of the increase
in long-term debt resulting from the Merger; (ii) merger
expenses of $4.0 million consisting primarily of
professional and advisory fees; and (iii) interest and other
income of $2.0 million relating primarily to investment
earnings on the Company's short-term investments and
restricted cash balances.
Income Taxes. The Company recorded a benefit for
income taxes during the nine months ended June 30, 1996
based upon the Company's pre-tax loss in such period. The
resulting income tax benefit has been partially offset by the
nondeductible nature of certain merger costs.
Cumulative Effect of Accounting Change. Effective
October 1, 1995, the Company changed its method of
accounting for deferred start-up costs related to new
contracts or expansion of existing contracts (i) to expense
costs relating to start-up activities incurred after
commencement of services under the contract, and (ii) to
limit the amortization period for deferred start-up costs to
the initial contract period. Prior to October 1, 1995, the
Company capitalized start-up costs related to the
completion of the provider networks and reporting systems
beyond commencement of contracts and, in limited
instances, amortized the start-up costs over a period that
included the initial renewal term associated with the
contract. Under the new policy, the Company does not
defer contract start-up costs after contract commencement
or include the initial renewal term in the amortization
period. The change was made to increase the focus on
controlling costs associated with contract start-ups.
The Company recorded a pre-tax charge of $1,769 ($1,012
after taxes) in its fiscal 1996 first quarter results of
operations as a cumulative effect of a change in
accounting. The pro forma impact of this change on the
prior year periods presented would be to increase costs and
expenses by $494 ($283 after taxes) for the three months
ended June 30, 1995 and by $1,270 ($727 after taxes) for
the nine months ended June 30, 1995. The effect of the
change on the current year periods presented cannot be
reasonably estimated.
Liquidity and Capital Resources
For the nine months ended June 30, 1996, operating
activities provided cash of $10.9 million, investing
activities used cash of $19.7 million and financing
activities provided cash of $26.6 million, resulting in a net
increase in cash and cash equivalents of $17.8 million.
Investing activities in the current nine month period
consisted principally of (i) capital expenditures of $15.8
million related primarily to the continued development of
the Company's new information systems and expansion of
the Company's National Service Center; (ii) payments
totaling $1.2 million for funding under joint ventures with
Neighborhood Health Providers, LLC and Community
Health Network of Connecticut, Inc.; (iii) payments
totaling $11.1 million for the acquisitions of Choate and
ProPsych; offset in part by (iv) a net decrease of $7.9
million in long-term restricted cash primarily due to the
reclassification of the Company's surplus cash balance with
the State of Iowa to short-term cash and cash equivalents.
In October 1995, the Company completed a merger with
MDC Acquisition Corp., a company formed by Kohlberg
Kravis Roberts & Co., L.P. ("KKR"). In connection with
the Merger, Merck & Co., Inc. ("Merck") received $333.2
million in cash and retained approximately 15% of the
common stock of the post-Merger Company. The Merger
was financed with $115.0 million of new cash equity from
affiliates of KKR and Company management. The balance
of the transaction was funded with a $75.0 million bridge
loan (the "Bridge Loan") provided by an affiliate of KKR
and $155.0 million of initial borrowings under a $205.0
million senior credit facility. The aforementioned proceeds
were utilized to redeem common stock for $259.0 million,
repay amounts due Merck of $70.8 million, and pay certain
fees and expenses related to the Merger. In November
1995, the Company issued $100.0 million aggregate
principal amount of 11 1/2% senior subordinated notes due
2005, the net proceeds of which were applied to repay the
Bridge Loan and a portion of the revolving loans under the
senior credit facility. In March 1996, the Company
exchanged such notes for $100.0 million aggregate
principal amount of 11 1/2% Senior Subordinated Notes
due 2005 registered under the Securities Act of 1933 (the
"Notes"). As of June 30, 1996, $29.0 million of revolving
loans and $0.4 million of letters of credit were outstanding
under the Company's revolving credit facility, and
approximately $55.6 million was available for future
borrowing.
Adjusted EBITDA (as defined in the covenants contained
in the indenture for the Notes) increased by $1.7 million,
or 18.3%, to $11.0 million for the three months ended June
30, 1996 from $9.3 million for the three months ended
June 30, 1995. For the nine months ended June 30, 1996,
Adjusted EBITDA increased by $8.8 million, or 35.8%, to
$33.4 million from $24.6 million for the comparable period
in the prior year.
In October 1995, the Company acquired Choate for $8.7
million; the Company is obligated to make contingent
payments relating to Choate based on future financial
performance. In July 1996, the Company made an interim
payment of contingent consideration to Choate's former
shareholders of $1.3 million. In December 1995, the
Company acquired ProPsych for an initial payment of $0.1
million and a payment of $2.9 million made in January
1996; the Company is obligated to make contingent
payments relating to ProPsych based on future financial
performance. From time to time, the Company has
engaged in and continues to engage in preliminary
discussions with respect to potential acquisitions.
As of June 30, 1996, the Company had total cash balances
(including cash equivalents) of $42.9 million, of which
$30.9 million was restricted under certain contractual,
fiduciary and regulatory requirements; moreover, of such
amount, $4.5 million was classified as a long-term asset on
the Company's balance sheet. Under certain contracts, the
Company is required to establish segregated claims funds
into which a portion of its capitation fee is held until a
reconciliation date (which reconciliation typically occurs
annually). Until that time, cash funded under these
arrangements is unavailable to the Company for purposes
other than the payment of claims. In addition, California
and Illinois state regulatory requirements restrict access to
cash held by the Company's subsidiaries in such states. As
of June 30, 1996, the Company also held a surplus cash
balance, classified as cash and cash equivalents, as required
by the contract with the State of Iowa to provide managed
mental health services to that state's Medicaid population
(the "Iowa Mental Health Contract") held by the Company.
Historically, the Company has funded its operations
primarily with cash generated from operations and through
the funding of certain acquisitions, investments and other
transactions by its former parent, Merck. The Company
expects to finance its capital requirements in the future
through existing cash balances, cash generated from
operations and borrowings under its revolving credit
facility. Based upon the current level of cash flows from
operations and anticipated growth, the Company believes
that available cash, together with available borrowings
under its revolving credit facility and other sources of
liquidity, will be adequate to meet the Company's
anticipated future requirements for working capital, capital
expenditures, and scheduled payments of principal and
interest on its indebtedness for the foreseeable future.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In July 1996, the Iowa Supreme Court affirmed an October 1994
decision of the Iowa District Court for Polk County (the "Iowa
District Court") disqualifying Value Behavioral Health, Inc., a competitor
of the Company which initially had been awarded the Iowa Mental Health
Contract (the "Competitor") from providing services under the contract.
After the Iowa District Court decision, the Iowa Department of Human
Services (the "Iowa DHS") awarded the contract to the Company in November
1994. The Company has been providing services under the Iowa Mental Health
Contract since March, 1995.
The legal proceedings relating to the Iowa Mental Health
Contract arose out of the decision of the Iowa DHS in May 1994 to
award the contract to the Competitor. The Company contested the decision
on the basis that, among other things, the Competitor should have been
disqualified from competing for the Iowa Mental Health Contract because of
certain conflicts of interest in the bidding process for the
contract. After the Iowa DHS denied the Company administrative relief,
the Company filed suit in the Iowa District Court, requesting that the
entry into the Iowa Mental Health Contract by the Iowa DHS and the
Competitor be stayed pending the court's ruling. The Iowa District Court
granted the Company's stay motion. Subsequently, the Iowa District Court
disqualified the Competitor from performing services under the Iowa Mental
Health Contract because of various conflicts of interest.
The Competitor appealed the Iowa District Court decision
to the Iowa Supreme Court and requested that the Iowa
Supreme Court stay the Iowa Mental Health Contract
between the Iowa DHS and the Company. The Competitor
also commenced an administrative proceeding with the
Iowa DHS to contest the award of the Iowa Mental Health
Contract to the Company. The Iowa DHS denied the
Competitor's protest and the Iowa Supreme Court denied
the stay motion in December 1994. In January 1995, the
Company and the Iowa DHS signed the definitive Iowa
Mental Health Contract. During this time, the Competitor's
appeal of the October 1994 Iowa District Court decision and its
challenge of the administrative decision by the Iowa DHS to award the
Iowa Mental Health Contract to the Company were
consolidated and submitted to the Iowa Supreme Court for
its review. As noted above, the Iowa Supreme Court affirmed the Iowa
District Court decision in July 1996.
The Competitor may petition the U.S. Supreme Court to seek its review
of the Iowa Supreme Court ruling. The U.S. Supreme Court has the
discretion to grant the Competitor's petition and review
such ruling. There can be no assurance that, if the U.S.
Supreme Court decides to review the Iowa Supreme Court
ruling, it will not overturn the Iowa Supreme Court
decision or that, should the Iowa Supreme Court decision
be overturned, the Iowa DHS will not terminate the Iowa
Mental Health Contract with the Company. The Iowa
Mental Health Contract, which is terminable for any reason
by the Iowa DHS upon 60 days notice, generated revenue
of $32.0 million for the nine months ended June 30, 1996.
In connection with entering into the Iowa Mental Health
Contract, the Company agreed to indemnify the Iowa DHS
for 50% of certain damages and related expenses (up to a
maximum payment by the Company of $2.5 million) that
the Iowa DHS incurs, if any, as a result of awarding the
Iowa Mental Health Contract to the Company. Termination of the
Iowa Mental Health Contract or a material damage award relating
thereto could have a material adverse effect on the Company.
ITEM 5. OTHER INFORMATION
In June 1996, TriWest Healthcare Alliance Corp. ("TriWest"), with
which the Company has entered into a Services Agreement (the "Services
Agreement") to provide managed behavioral care services as TriWest's
subcontractor, informed the Company that the Office of Civilian Health
and Medical Program of the Uniformed Services ("OCHAMPUS") has accepted
TriWest's proposal to provide services to Civilian Health and Medical
Program of the Uniformed Services ("CHAMPUS") beneficiaries in CHAMPUS
Regions 7 and 8 (the "CHAMPUS Program") and that OCHAMPUS intends to enter
into a prime contract with TriWest for such program. The CHAMPUS Program
is expected to service approximately 740,000 beneficiaries in such regions.
The Services Agreement, which was entered into by the Company and TriWest
in February 1996, has a term which is coterminous with that of the prime
contract for the CHAMPUS Program, which has a term of one year with
four option periods exercisable by OCHAMPUS. The prime contract for the
CHAMPUS Program, however, is subject to certain rights of termination in
favor of OCHAMPUS, including the right of OCHAMPUS to terminate such
contract for convenience. Promptly following notice by OCHAMPUS that
TriWest was awarded the prime contract, a competitor of TriWest filed a
protest challenging the award. In response to that protest, OCHAMPUS
issued a stop work order. Subsequently, that competitor withdrew its
protest, and the stop work order was lifted on August 12, 1996. Subject
to certain rights of OCHAMPUS to delay implementation of the program, the
prime contract for the CHAMPUS Program is expected to commence in the
second fiscal quarter of 1997 with a phase-in period to commence prior
to that date.
In June 1996, the Company entered into an Alliance
Agreement (the "Alliance Agreement") with The
Prudential Insurance Company of America ("Prudential"),
under which the Company has agreed to provide, on behalf
of Prudential, behavioral health managed care services to
enrollees in certain of Prudential's health benefit plans in
certain areas of the country. The Alliance Agreement
contemplates that Prudential, from time to time, will
designate geographic areas in which the Company will
provide behavioral health services to Prudential enrollees
and that, for each such area, Prudential and the Company
will enter into a service agreement containing additional
terms applicable to that area. Pursuant to the Alliance
Agreement, the Company initially will service Prudential
enrollees in New York State, Connecticut and New Jersey
(the "TriState Area"), as well as North Texas. The
Company commenced providing services under the
program for North Texas on August 1, 1996 and
anticipates (subject to Prudential's approval) providing
services for the TriState Area commencing September 1,
1996. The Alliance Agreement has an initial term of three
years, six months (expiring December 31, 1999), and will
be automatically renewed for a period of two years unless
either party notifies the other (at least eight months prior to
expiration of the initial term) that it does not intend to
renew the Alliance Agreement. The Alliance Agreement
is subject to certain rights of termination in favor of
Prudential. In addition, effective July 1, 1996, the
Company assumed the responsibility for providing services
to those Prudential members currently serviced through
Prudential's service center operations in Houston, Texas.
In July 1996, the Department of Mental Health and Mental
Retardation of the State of Tennessee ("TDMHMR")
commenced the"TennCare Partners Program", a mental
health and substance abuse benefits program servicing
principally Medicaid eligibles and uninsured individuals
residing in the State (collectively, "TennCare
Beneficiaries"). Two behavioral health organizations
("BHOs") were selected by TDMHMR to provide services
in connection with such program. One such BHO is
comprised of the Company and Tennessee Behavioral
Health, Inc. ("TBH"), a behavioral health company located
in Knoxville, Tennessee (such BHO being referred to as
the "TBH-Company BHO"). The Company and TBH have
entered into an agreement formalizing their BHO
arrangement (the "BHO Agreement"), under which they
have agreed to operate a joint program to service TennCare
Beneficiaries through such BHO. Pursuant to the BHO
Agreement, TBH entered into a direct contract with
TDMHMR to service the TennCare Beneficiaries allocated
to the TBH-Company BHO; the Company, in turn,
provides designated services on behalf of TBH in
performing its contract with TDMHMR. Under the BHO
Agreement, the Company will share in 51%, and TBH will
share in 49%, of the profits and losses from their joint
operation of the program. Each of the Company and TBH
holds one-half of the voting power on all decisions
concerning the program operated by the TBH-Company
BHO. The BHO Agreement provides that the TBH-Company BHO,
as well as the other arrangements contemplated by the BHO Agreement,
will remain in effect until the earlier of (i) the termination of the
TennCare Partners Program or (ii) the fourth anniversary of the BHO
Agreement. The term of the TennCare Partners Program
is 12 months commencing July 1, 1996 and automatically
renews for successive 12 month periods unless either party
gives notice of its intention not to renew. The contract
between TDMHMR and TBH for the TennCare Partners
Program, however, is subject to certain rights of
termination in favor of TDMHMR, including the right of
TDMHMR to terminate for convenience.
In connection with the departure from the Company of
Richard S. Chung, M.D., the Company's Executive Vice
President and Chief Clinical Officer, on May 31, 1996, the
Company purchased all shares of Common Stock acquired
by Dr. Chung on October 5, 1995 in connection with the
Merger. The Company is currently in the process of
recruiting a replacement for this position.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
*27 Financial Data Schedule (electronic
filing only).
*filed herewith
(b) Reports on Form 8-K
1. Current Report on Form 8-K dated May
23, 1996 related to the formation of a
strategic alliance between the Company
and Prudential.
2. Current Report on Form 8-K dated
August 6, 1996 related to the Company's
announcement that the Iowa Supreme
Court has affirmed the 1994 Iowa
district court decision disqualifying
Value Behavioral Health, Inc. from the
bidding process for Iowa's Mental
Health Access Plan.<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.
The signatory hereby acknowledges and adopts the typed
form of his name in the electronic filing of this document
with the Securities and Exchange Commission.
Date: August 13, 1996 Merit Behavioral Care Corporation
By:/s/ Arthur H. Halper
-------------------------------
Arthur H. Halper
Executive Vice President
and Chief Financial Officer
(Principal Financial Officer,
Accounting Officer and
Duly Authorized Officer)
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<LEGEND>
THIS LEGEND CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND THE CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS FROM THE COMPANY'S FORM 10-Q FOR THE QUARTERLY
PERIOD ENDED JUNE 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
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