SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ______ to _______.
Commission file number: 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 07656
Park Ridge, New Jersey (Zip Code)
(Address of principal executive offices)
(201) 391-8700
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
The only class of voting securities of the Registrant is its common stock, par
value $.01 per share (the "Common Stock"), 19.5% of which is held by
non-affiliates of the Registrant. The Common Stock is not registered under the
Securities Act of 1933, as amended (the "Securities Act"), is not publicly
traded and does not have a quantifiable market value.
The number of shares of the Common Stock outstanding as of December 1, 1997:
29,396,158.
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DOCUMENTS INCORPORATED BY REFERENCE
The following documents filed by the Company with the Securities and Exchange
Commission are incorporated herein by reference and shall be deemed a part
hereof: (i) the Company's Registration Statement on Form S-4 (No. 33-80987)
under the Securities Act; (ii) the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1996 (as amended); (iii) the Company's Annual Report
on Form 10-K for the fiscal year ended September 30, 1996; and (iv) the
Company's Current Reports on Form 8-K filed on July 18, 1997, September 17,
1997, October 29, 1997 and November 19, 1997.
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MERIT BEHAVIORAL CARE CORPORATION
<CAPTION>
FORM 10-K
TABLE OF CONTENTS
<S> <C> <C> <C> <C> <C> <C>
Page
PART I
Item 1. Business........................................................................... 3
Item 2. Properties.........................................................................27
Item 3. Legal Proceedings................................................................. 27
Item 4. Submission of Matters to a Vote of Security Holders............................... 29
PART II
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters...............................................................29
Item 6. Selected Financial Data.............................................................29
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................................32
Item 8. Financial Statements and Supplementary Data.........................................40
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures..............................................40
PART III
Item 10. Directors and Executive Officers of the Registrant..................................41
Item 11. Executive Compensation..............................................................44
Item 12. Security Ownership of Certain Beneficial Owners
and Management....................................................................53
Item 13. Certain Relationships and Related Transactions......................................54
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K...............................................................57
SIGNATURES.....................................................................................................61
</TABLE>
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PART I
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Item 1. Business
GENERAL
Merit Behavioral Care Corporation ("MBC" or the "Company") is one of
the leading behavioral health managed care companies in the United States,
arranging for the provision of a full spectrum of behavioral healthcare services
on a nationwide basis. 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 provides behavioral
health managed care 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 efficient and
cost-effective manner. The Company manages behavioral healthcare programs for
its payor customers across all segments of the healthcare industry, including
health maintenance organizations ("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. The Company's
programs covered more than 20 million people as of September 30, 1997.
The Company's clinical care program includes the use of intake
coordinators and professional case managers who coordinate and manage the
delivery of treatment services. The Company offers a full continuum of
behavioral healthcare services through contractual arrangements with
approximately 37,000 third-party network providers and approximately 3,300
third-party treatment facilities, as well as approximately 160 "staff providers"
employed by professional corporations (the "Professional Corporations") which
provide treatment services principally on behalf of the Company. The Company's
third-party network and staff providers include psychiatrists, psychologists,
licensed clinical social workers, marriage, family and child therapists,
licensed clinical professional counselors and nurses. Treatment services
arranged for and managed by MBC include outpatient care programs (such as
counseling and therapy), intermediate care programs (such as sub-acute emergency
care, intensive outpatient programs and partial hospitalization services),
inpatient treatment services and alternative care services (such as residential
treatment, home- and community-based programs and rehabilitative and support
services).
On June 30, 1995, the Company and Medco Containment Services, Inc.
("Medco Containment"), the Company's previous owner, entered into an Agreement
and Plan of Merger (as amended, the "1995 Merger Agreement") with MDC
Acquisition Corp. ("MDC"), a company formed by Kohlberg Kravis Roberts & Co.,
L.P. ("KKR"). Pursuant to the 1995 Merger Agreement, on October 6, 1995, MDC was
merged with and into the Company (the "1995 Merger"), with the Company
continuing as the surviving corporation. Upon completion of the 1995 Merger,
which was accounted for as a recapitalization, Medco Containment, a subsidiary
of Merck & Co., Inc. ("Merck"), retained 15.0% of the Common Stock of the
post-merger Company, and affiliates of KKR and members of MBC management
(together with related entities) owned approximately 73.9% and 11.1%,
respectively, of the post-merger Common Stock. On September 12, 1997, the
Company acquired CMG Health, Inc. ("CMG"), a national managed behavioral
healthcare company providing services to over 2.5 million people.
The principal executive offices of the Company are located at One Maynard
Drive, Park Ridge, New Jersey 07656 and the Company's telephone number at that
address is (201) 391-8700. Unless the context indicates otherwise, all
references to the "Company" or "MBC" shall mean Merit Behavioral Care
Corporation and its consolidated subsidiaries.
PROPOSED MERGER WITH MAGELLAN HEALTH SERVICES, INC.
On October 24, 1997, the Company and Magellan Health Services, Inc.
("Magellan") entered into an Agreement and Plan of Merger (the "Magellan Merger
Agreement"), which provides that, subject to the fulfillment of certain
conditions, a subsidiary of Magellan will merge (the "Magellan Merger") with and
into the Company. As a result of the Magellan Merger, the Company will become a
wholly owned subsidiary of Magellan. Under the terms of the Magellan Merger
Agreement, Magellan will acquire all of the Company's outstanding stock and
other equity interests for approximately $458.3 million in cash, subject to
certain adjustments. In addition, all options outstanding under the Company's
stock option plans will fully vest or otherwise become exercisable and be
converted into cash upon closing of the transaction. Completion of the Magellan
Merger is subject to a number of conditions, including Magellan's receipt of
sufficient financing for the transaction, the receipt of certain healthcare and
insurance regulatory approvals, and other conditions. One such condition, the
expiration of the waiting period under the Hart- Scott-Rodino Antitrust
Improvements Act of 1974, has been satisfied. In connection with the execution
of the Magellan Merger Agreement, holders of more than 90% of the outstanding
Common Stock of MBC have agreed to vote in favor of the Magellan Merger pursuant
to Stockholder Support Agreements entered into with Magellan. The combined
company will be the nation's largest provider of managed behavioral healthcare
services, with an estimated 52.8 million covered lives under contract, and will
manage behavioral healthcare programs for over 4,000 customers. It is expected
that the Magellan Merger will close in the first calender quarter of 1998.
Consummation of the Magellan Merger and the related financing
arrangements would result in events of default under the Indenture, dated as of
November 22, 1995, as supplemented (the "Indenture"), by and between the Company
and Marine Midland Bank, as trustee, under which the Company's outstanding 11
1/2 Senior Subordinated Notes due 2005 (the "Notes") were issued. In connection
with the Magellan Merger and as a condition for Magellan to obtain the financing
for the Magellan Merger, the Company intends to refinance the Notes. No
assurance can be given that such refinancing will occur or that the Magellan
Merger will be consummated.
BEHAVIORAL HEALTH MANAGED CARE INDUSTRY
Overview
Behavioral healthcare costs have increased significantly in the United
States in recent years. According to industry sources, the direct medical costs
of behavioral health problems, combined with the indirect costs, such as lost
productivity due to mental illness and alcohol and drug abuse, were estimated at
more than $300 billion in 1990. In addition, according to industry sources,
direct behavioral healthcare treatment costs in 1995 amounted to approximately
$80 billion, or 8% of total healthcare industry spending. In response to these
escalating costs, behavioral health managed care companies, such as MBC, have
been formed. These companies focus on care management techniques with the goal
of improving early access to care, assuring an effective match between the
patient and the behavioral healthcare provider's specialty, and arranging for
the provision of an appropriate level of care in a cost-efficient and effective
manner. As behavioral health managed care companies have expanded access to a
full continuum
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of care, the result has been a significant decrease in occupancy rates and
average lengths of stay for inpatient facilities and an increase in outpatient
treatment and alternative care services.
According to Open Minds, a leading behavioral healthcare industry
publication, as of January 1997, approximately 149 million beneficiaries were
covered by some form of specialty behavioral health managed care plan (i.e., a
program typically operated by a vendor specializing in behavioral health managed
care services). This figure has grown from approximately 78 million
beneficiaries in 1992, representing an approximate 14% compound annual growth
rate.
Segmentation
Open Minds divides the behavioral healthcare industry into the
following categories of care, based on services provided, extent of care
management and level of risk assumption:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Beneficiaries
(In Percent
Category of Care Millions)(1) of Total
- ---------------------------------------------------------------------------------------- --------------- -----------
Utilization Review/Care Management Programs................................ 39.2 26.3%
Non-Risk-Based Network Programs............................................ 32.0 21.4
Risk-Based Network Programs................................................ 38.9 26.1
Employee Assistance Programs (EAPs)........................................ 28.3 19.0
Integrated Programs........................................................ 10.7 7.2
Total.................................................................... 149.1 100.0%
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(1) Source: Open Minds: Managed Behavioral Health Market Share in the United States, 1997-1998,
Gettysburg, Pennsylvania (1997).
</TABLE>
These categories of care are described briefly below:
Utilization Review/Case Management Programs. Under utilization
review/case management programs, a behavioral health managed care company
manages and often arranges for treatment, but does not assume any of the
responsibility for the cost of providing treatment services. These programs are
typically categorized as administrative services only ("ASO") programs.
Non-Risk-Based Network Programs. Under non-risk-based network programs,
which also are typically categorized as ASO programs, the behavioral health
managed care company provides a full array of managed care services, including
selecting, credentialling and managing a network of providers (such as
psychologists, psychiatric hospitals, substance abuse clinics, etc.), and
performs utilization review, claims administration and case management
functions; however, the third-party payor remains responsible for the cost of
providing the treatment services rendered.
Risk-Based Network Programs. Under risk-based network programs, the
behavioral health managed care company assumes all or a portion of the
responsibility for the cost of providing a full or specified range of treatment
services. Most of these programs have payment arrangements in which the
behavioral health managed care company agrees to provide services in exchange
for a fixed fee per
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covered member per month (a "capitated" program) that varies depending on the
profile of the beneficiary population, or otherwise shares the responsibility
for providing all or some portion of the treatment services at a specific cost
per person. Under these programs, the behavioral health managed care company not
only approves and monitors a course of treatment, but also arranges and pays for
the provision of patient care (either through its third-party network providers
or staff providers or some combination thereof).
Employee Assistance Programs. An EAP is a worksite-based program
designed to assist in the early identification and resolution of productivity
problems associated with behavioral conditions or other personal concerns of
employees. Under an EAP, staff or network providers or other affiliated
clinicians provide assessment and referral services to employee beneficiaries.
These services consist of evaluating a patient's needs and, if indicated,
providing limited counseling and/or identifying an appropriate provider,
treatment facility or other resource for more intensive treatment services.
Integrated Programs. EAPs are utilized in a preventive role and in
facilitating early intervention and brief treatment of behavioral healthcare
problems before more extensive treatment is required. Consequently, EAPs often
are marketed and sold in tandem with behavioral health managed care programs
through "integrated" product offerings. Integrated programs offer employers
comprehensive management and treatment of all aspects of behavioral healthcare
by consolidating EAP and managed care services into a single program.
Areas of Growth
Management believes that the behavioral health managed care industry is
growing across all customer segments as payors of behavioral healthcare benefits
are seeking to reduce the costs of treatment and shift the responsibility for
such costs to other entities while maintaining high quality care. Management
believes that a number of opportunities exist in the behavioral health managed
care industry for future growth, primarily for risk-based products, but also for
Medicaid and Medicare recipients and uninsured individuals.
Risk-Based Products. According to Open Minds, industry enrollment in
risk-based (capitated) products has grown from approximately 14 million covered
lives in 1993 to approximately 38.9 million covered lives in 1997, a compound
annual growth rate of over 29%. Despite this growth, according to Open Minds,
only approximately 26% of total managed behavioral healthcare covered lives are
enrolled in risk-based products. The Company believes that the market for
risk-based products has grown and will continue to grow as payors attempt to
reduce their responsibility for the cost of providing behavioral healthcare
while ensuring an appropriate level of access to care.
Medicaid Recipients. Medicaid is a joint state and federally funded
program to provide healthcare benefits to an estimated 36 million low income
individuals, including welfare recipients. According to the Health Care
Financing Administration ("HCFA") of the United States Department of Health and
Human Services (the "Department"), federal and state Medicaid spending increased
from $65 billion in 1990 to $165 billion in 1996, at an average annual rate of
approximately 16%, almost twice as fast as the annual increase in overall
healthcare spending. Furthermore, according to HCFA, from 1991 to 1996, the
number of Medicaid beneficiaries covered under full managed contracts has grown
at a compound annual rate of approximately 38% per year. The Balanced Budget Act
of 1997 (the "Budget Act"), passed by Congress in August 1997, is expected to
slow the growth of Medicaid spending by accelerating the trend of
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state Medicaid programs toward shifting beneficiaries into managed care programs
in order to control rising costs.
Despite the recent percentage increase in managed care enrollment of
Medicaid beneficiaries, Medicaid managed care enrollment as a percentage of all
Medicaid beneficiaries remains small. As of June 1996, according to the National
Institute for Health Care Management, only approximately 35% of all Medicaid
beneficiaries were enrolled in some form of managed care program, and less than
7% were enrolled in risk-based programs. The Company expects the number of
Medicaid recipients enrolled in managed behavioral healthcare programs to
increase through two avenues: (i) subcontracts with HMOs and (ii) direct
contracts with state agencies. As HMOs increase their penetration of the
Medicaid market, the Company expects that many HMOs will continue to (or begin
to) subcontract with managed behavioral healthcare companies to provide services
for Medicaid beneficiaries. State agencies have also begun to contract directly
with managed behavioral healthcare companies to provide services to their
Medicaid beneficiaries. Iowa, Massachusetts, Nebraska, Maryland, Tennessee and
Montana have decided to "carve out" behavioral healthcare from their overall
Medicaid managed care programs and have contracted or are expected to contract
directly with managed behavioral healthcare companies to provide such services.
The provisions of the Budget Act related to Medicaid give the states broad
flexibility to require most Medicaid beneficiaries to enroll in managed care
organizations that only do business with the Medicaid program, without obtaining
a waiver from the Secretary of the Department that was required under former
law.
Medicare Beneficiaries. Medicare is a federally funded healthcare
program for the elderly. Medicare has experienced an increase in its beneficiary
population over the past several years, as well as rapidly escalating healthcare
costs. According to HCFA, as of January 1, 1997, only approximately 4.9 million,
or 13%, of the approximately 38 million eligible Medicare beneficiaries were
enrolled in managed care programs. Although enrollment has increased from
approximately 7% of the eligible Medicare beneficiaries in 1993, it is still
considerably below that of the commercial population. The provisions of the
Budget Act related to Medicare would achieve the projected savings in Medicare
expenditures by, among other things, changes in managed care programs designed
to increase enrollment in managed care plans. The increase in Medicare
enrollment would be achieved, in part, by allowing provider-sponsored
organizations and PPOs to compete with Medicare HMOs for Medicare enrollees.
Uninsured Individuals. Approximately 42 million people, or 16% of the
nation's total population, are not covered by any form of health insurance.
Recently, certain states have enacted mandatory health insurance programs that
automatically enroll all uninsured persons in managed care plans. To the extent
that managed care plans increase their penetration among this large uninsured
population, the Company believes that uninsured individuals will continue to
represent an opportunity for growth among behavioral health managed care
companies.
GROWTH STRATEGY
The Company's objective is to expand its presence in both existing and
new behavioral health managed care programs by building on MBC's (i) proven
clinical care methodology, (ii) leading position and experience in managing
capitated programs, (iii) diverse and expanding customer base, particularly with
respect to HMOs and corporations, and (iv) experienced and clinically-oriented
management team. As part of its strategy, the Company intends to:
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Continue to Pursue Capitated Contracts. Management believes MBC is the
leading provider of capitated managed care programs. As of January
1997, according to Open Minds, only 27% of all beneficiaries covered by
specialty behavioral health managed care programs were enrolled in
risk-based or capitated programs. The Company believes that the market
for capitated managed care services will continue to increase at a more
rapid rate than the overall market for behavioral health managed care
services because capitated compensation arrangements allow payors to
reduce their risk with respect to the cost of providing behavioral
healthcare services while continuing to provide access to high quality
care. Management believes that MBC's past experience and success in
managing capitated contracts for HMOs, corporations and other payors,
as well as its status as the leading provider of capitated products,
will enable MBC to benefit from the expected growth in capitated
programs.
Increase Penetration of Medicaid Sector. The Company believes that the
Medicaid sector offers a significant opportunity for growth in the
behavioral health managed care industry over the near term. Management
believes that as more state governmental agencies turn to managed care
organizations to administer their Medicaid programs, MBC's expertise in
managing capitated programs, its experience in managing Medicaid
populations and its existing business relationships with HMOs, place
the Company in a position to capitalize on this potential growth
opportunity. MBC currently manages care for Medicaid beneficiaries in
connection with, among other programs, the State of Iowa's Mental
Health Access Program (the "Iowa Medicaid Program"), the State of
Tennessee's TennCare Partners Program ("TennCare") and the State of
Montana's Mental Health Access Plan.
PROGRAMS AND SERVICES
The following table sets forth the number of beneficiaries covered by
MBC for each type of program offered as of September 30, 1997, and the revenue
attributable to each such program in fiscal 1997:
<TABLE>
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<S> <C> <C> <C> <C> <C> <C>
Programs Beneficiaries Percent Revenue Percent
(In Millions, Except Percentages)
Risk-Based Programs...................... 10.6 51% $ 423.5 76%
EAPs..................................... 5.0 24 55.3 10
Integrated Programs...................... 2.5 12 42.9 8
ASO Programs............................. 2.7 13 15.4 3
Other.................................... - - 18.6 3
Total.................................. 20.8 100% $ 555.7 100%
</TABLE>
Risk-Based Programs. Under the Company's risk-based or "capitated"
programs, the Company typically arranges for the provision of a full range of
outpatient, intermediate and inpatient treatment services to beneficiaries of
its customers' healthcare benefit plans, primarily through fee arrangements in
which MBC assumes all or a portion of the responsibility for the cost of
providing such services. The Company arranges for the provision of treatment
services pursuant to a managed network model, under which care is delivered by
third-party network providers and, where appropriate, the Company's staff
providers. Management believes that the Company's mix of third-party network and
staff providers, as well as its experience in pricing capitated contracts and
managing the provision of care, allows it to structure programs to meet a
customer's specific healthcare benefits requirements.
Employee Assistance Programs. The Company's EAPs typically provide
assessment and referral services to employees of MBC's customers in an effort to
assist in the early identification and resolution of productivity problems
associated with employees who are impaired by behavioral conditions or other
personal concerns. For many EAP customers, MBC also provides limited outpatient
therapy (typically limited to eight or fewer sessions) to patients requiring
such services. For these services, the Company typically is paid a fixed fee per
member per month; however, the Company is usually not responsible for the cost
of providing care beyond these services. If further services are necessary
beyond limited outpatient therapy, the Company will refer the beneficiary to an
appropriate provider or treatment facility. A substantial majority of the
Company's existing customer contracts are EAP contracts. Management believes
that MBC is the leading provider (based on the number of beneficiaries covered)
of EAPs in the behavioral healthcare industry.
Integrated Programs. Under its integrated programs, the Company
typically establishes an EAP to function as the "front end" of a managed care
program that provides a full range of services, including more intensive
treatment services not covered by the EAP. The Company usually manages the EAP
and accepts all or some of the responsibility for the cost of any additional
treatment required upon referral out of the EAP, thus integrating the two
products and using both MBC's case management and clinical care techniques to
manage the provision of care.
ASO Programs. Under its ASO programs, the Company provides services
ranging from utilization review and claims administration to the arrangement for
and management of a full range of patient treatment services, but does not
assume any of the responsibility for the cost of providing treatment services.
CUSTOMERS, CONTRACTS AND MARKETING
Customers
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The following table sets forth the number of beneficiaries covered by
MBC in each of its market segments as of September 30, 1997 and the revenue
attributable to each such segment for fiscal 1997:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Market Beneficiaries Percent Revenue Percent
(In Millions, Except Percentages)
Corporations and Labor Unions............ 7.8 37% $105.0 19%
HMOs(1).................................. 6.2 30 151.3 27
Blue Cross/Blue Shield and
Insurance Companies................. 3.5 17 105.7 19
Medicaid Programs........................ 1.0 5 136.5 25
Governmental Agencies
(including CHAMPUS)................ 2.3 11 40.1 7
Other.................................... - - 17.1 3
Total.................................... 20.8 100% $ 555.7 100%
</TABLE>
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(1) For purposes of this table, the HMO segment excludes HMOs that focus on
Medicaid, Civilian Health and Medical Program of the Uniformed Services
("CHAMPUS") or state employee plan beneficiary populations.
Contracts
The Company's contracts with customers typically have terms of one to
five years, and in certain cases contain renewal provisions (at the customer's
option) for successive terms of between one and two years (unless terminated
earlier). Substantially all of these contracts are immediately terminable with
cause and many, including the Company's agreement with the State of Iowa for the
Iowa Medicaid Program (the "Iowa Mental Health Contract"), the Company's
contract relating to the TennCare program, the Company's contract relating to
the State of Montana's Mental Health Access Plan and the Company's contracts in
connection with the Empire Joint Venture (as described below), are terminable
without cause by the customer either upon the provision of requisite notice and
the passage of a specified period of time (typically between 60 and 180 days) or
upon the occurrence of other specified events. In addition, the Company's
contracts with federal, state and local governmental agencies, under both direct
contracts and subcontract arrangements with HMOs, generally are conditioned upon
financial appropriations by one or more governmental agencies. These contracts
generally can be terminated or modified by the agency or HMO, as applicable, if
such appropriations are not made. In the ordinary course of business, the
Company's business arrangements with certain customers may continue beyond
expiration of the stated term of the
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applicable contracts while the terms of new or renewed contracts are being
negotiated. In such cases, the customer may terminate the arrangements at any
time.
Marketing and Sales
The Company markets its services through its three operating divisions:
(i) the Employer and Union Division; (ii) the HMO/Insurance Division; and (iii)
the Public Sector Division (including Medicaid and Medicare). Each of these
three operating divisions, organized by the type of customer to be served, is
overseen by a President who reports to MBC's President and Chief Operating
Officer. For each specific industry segment, the Company employs integrated
teams of Sales Managers and Account Managers who work under the supervision of
the operating division President for that market. The Sales Managers and the
Account Managers, together with the Company's clinical management organization,
work closely to ensure that new customer programs are implemented successfully,
services delivered meet contract specifications and customer and member concerns
are promptly and effectively addressed.
The Company's sales and account management activities are supported by
the Company's Market Services staff, who assist in generating sales leads;
prepare proposals and responses to formal Requests for Proposals ("RFPs");
provide product development support; perform competitive analyses; and train
personnel for program implementation. Marketing personnel also support the
delivery of services to existing accounts through assistance with program
implementation and development of customer communications materials such as
program brochures, summary plan descriptions and orientation documentation.
RECENT ACQUISITION OF CMG HEALTH, INC.
In September 1997, the Company acquired all of the capital stock of CMG
Health, Inc. ("CMG"), a national behavioral health managed care company. The
acquisition was effected through the merger of a subsidiary of the Company with
CMG, as a result of which CMG became a wholly owned subsidiary of the Company.
The holders of CMG's common stock received approximately $48.7 million in cash,
739,358 shares of Common stock and rights to receive certain additional cash and
stock consideration based upon future events and the post-closing financial
performance of CMG. The Company financed the acquisition by executing an
extension of its existing credit facility. CMG was founded in 1986, and prior to
its acquisition by the Company, served over 2.5 million lives on behalf of more
than 20 clients through a network consisting of approximately 7,600 providers in
34 states. The acquisition of CMG expands MBC's presence in the provision of
behavioral health services to three key behavioral healthcare sectors: Medicaid
carve-out programs, CHAMPUS programs and HMO products. CMG arranges for the
provision of mental health services for Medicaid-eligible and other lower income
residents in the State of Montana under that state's Mental Health Access Plan.
In addition, CMG is also a provider of mental health benefits to CHAMPUS
beneficiaries in CHAMPUS Regions 3 and 4 through Choice Behavioral Healthcare
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Partnership, in which CMG is a 50% partner. CMG also provides behavioral
healthcare services to more than 20 HMOs, including Humana Inc., in various
regions of the United States.
OTHER RECENT ACQUISITIONS, JOINT VENTURES AND SIGNIFICANT
TRANSACTIONS
Empire. In September 1995, the Company invested $12.0 million to
acquire an 80% interest in a five-year joint venture (the "Empire Joint
Venture") with Empire Blue Cross and Blue Shield ("Empire") to provide
behavioral health managed care services in 28 counties in the State of New York
to approximately 750,000 enrollees as of September 30, 1995. After the repayment
of the Company's initial investment and the direct payment by Empire to the
Company of certain administrative fees, risk charges and other amounts, the
profits of the Empire Joint Venture will be distributed 80% to MBC and 20% to
Empire. In connection with the Empire Joint Venture, Empire has the right at any
time to require the Company to purchase Empire's interest therein at a cash
price equal to the fair market value of such interest. In addition, Empire may
terminate the Empire Joint Venture at any time for convenience on written notice
to the Company and upon payment to the Company of a specified portion of the
Company's $12.0 million investment (which portion declines over time and as
repayments of such investment are made to MBC during the life of the venture),
together with up to $2.0 million of expenses incurred by the Company in
connection with the termination of the venture. In March 1997, the term of the
Empire Joint Venture was extended to eight years, subject to the termination
rights described above.
Choate. In October 1995, the Company acquired Choate Health Management,
Inc. and certain related entities (collectively, "Choate"), a
Massachusetts-based integrated behavioral healthcare organization, for $8.7
million in cash at closing plus $1.3 million paid in July 1997. In September
1997, the Company sold Choate to UHSMS, Inc., an affiliate of Universal Health
Services, Inc., for approximately $4.8 million. The Company recognized a pre-tax
loss of approximately $6.9 million in connection with the transaction.
ProPsych. In December 1995, the Company acquired ProPsych, Inc.
("ProPsych"), a Florida-based behavioral health managed care company. The
Company acquired ProPsych for an initial payment of $0.1 million, a payment of
$2.9 million in January 1996 and a final payment of $0.4 million in November
1996.
Royal Health Care. In January 1996, the Company formed a joint venture
with the hospital sponsors of Neighborhood Health Providers LLC ("NHP") under
the name "Royal Health Care LLC" ("Royal"), in which each of the Company and NHP
holds 50% of the equity interests. In addition, MBC, NHP and Empire have formed
a second joint venture company, Empire Community Delivery Systems LLC ("ECDS"),
in which MBC, NHP and Empire hold 16 2/3%, 16 2/3% and 66 2/3%, respectively, of
the equity interests. Empire and ECDS have entered into an agreement under which
ECDS will exclusively manage and
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operate, on behalf of Empire, healthcare benefit programs (covering all services
except behavioral healthcare and vision care) in the five New York City boroughs
for Medicaid beneficiaries enrolled in Empire plans. Each of Empire, MBC and NHP
will provide specified administrative and management services to ECDS to support
its delivery of services to Empire under such agreement. Moreover, each of ECDS
and Royal will hold specified equity interests in certain independent practice
associations (IPAs) providing treatment services to the Empire Medicaid
beneficiaries. In addition, Empire has entered into an agreement with the Empire
Joint Venture (80% of which is owned by the Company, as described above) to
exclusively provide all behavioral healthcare services in New York City to such
Empire Medicaid enrollees. The Royal and ECDS joint ventures and related
agreements have five-year terms, with up to three five-year renewals (subject to
applicable regulatory approvals). Each such venture and the behavioral health
agreement also contains customary termination provisions.
Prudential. In June 1996, the Company entered into an Alliance
Agreement (the "Alliance Agreement") with The Prudential Insurance Company of
America ("Prudential"), under which Prudential selected the Company to provide
behavioral health managed care services to enrollees in specified Prudential
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 such services. Pursuant to the Alliance
Agreement, to date the Company has been selected to service Prudential enrollees
in New York State, Connecticut and New Jersey (the "TriState Area"), North
Texas, Oklahoma City, Oklahoma, St. Louis and Southern Illinois (the "St. Louis
Area"), and Delaware and Pennsylvania (the "Delaware Valley Area"). The Company
commenced providing services under the program for North Texas August 1, 1996,
the TriState Area September 5, 1996, Oklahoma City on July 1, 1997, the St.
Louis Area on September 1, 1997, and the Delaware Valley Area on November 1,
1997. The Alliance Agreement has an initial term of three years and six months
(expiring December 31, 1999), and will be automatically renewed for a period of
two years unless either party notifies the other that it does not intend to
renew. The Alliance Agreement is subject to certain rights of termination in
favor of Prudential, including the right to terminate upon certain change of
control transactions (including the Magellan Merger). Pursuant to a separate
agreement with Prudential, the Company assumed the responsibility for providing
services to those Prudential members currently serviced through Prudential's
service center operations in Houston, Texas. The Houston program commenced
August 1, 1996.
TennCare. In July 1996, the State of Tennessee implemented the TennCare
program, a mental health and substance abuse benefits program servicing
principally Medicaid eligibles and uninsured individuals residing in the State.
Two behavioral health organizations ("BHOs") were selected 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 (the "TBH-MBC BHO"), and served approximately 500,000
members as of September 30, 1997. The Company and TBH are
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parties to an agreement (the "BHO Agreement") under which they operate a joint
program to service TennCare beneficiaries through such BHO. Under the BHO
Agreement, the Company shares in 51%, and TBH shares in 49%, of the profits and
losses from their joint operation of the program, and each of the Company and
TBH holds one-half of the voting power on all program decisions. The BHO
Agreement provides that the TBH-MBC BHO will remain in effect until the earlier
of (i) the termination of the TennCare program or (ii) the fourth anniversary of
the BHO Agreement. The TennCare program commenced July 1, 1996. The current term
of the TennCare program is 18 months commencing July 1, 1997 and automatically
renews for successive 12-month periods unless either party gives notice of its
intention not to renew. The contract between the State and TBH, however, is
subject to certain rights of termination in favor of the State, including the
right to terminate for convenience.
CHAMPUS Regions 7 and 8. In August 1996, TriWest Healthcare Alliance
Corp. ("TriWest"), with which the Company previously entered into a Services
Agreement (the "Services Agreement") to provide behavioral health managed care
services as TriWest's subcontractor, entered into a prime contract with the
Office of CHAMPUS ("OCHAMPUS") to provide services to CHAMPUS beneficiaries in
certain geographic areas, principally in the southwest and midwestern United
States, designated as CHAMPUS Regions 7 and 8. This CHAMPUS program commenced
April 1, 1997 and services approximately 740,000 beneficiaries in such regions.
The Services Agreement has a term which is coterminous with that of TriWest's
prime contract, which has a term of one year with four option periods
exercisable by OCHAMPUS. The prime contract, however, is subject to certain
rights of termination in favor of OCHAMPUS, including the right of OCHAMPUS to
terminate such contract for convenience.
OPERATIONS
Administrative Structure
Divisional, Regional and Area Operations. The Company's behavioral
health managed care programs and EAPs are operated through an integrated service
system consisting of three divisions, which are organized into a national region
and a number of geographic regions (collectively, the "Regions"). These Regions
are divided into a number of separate area operations ("Areas"), with each Area
having independent administrative and management capabilities. All of the
Regions are supported by the Company's National Service Center, located in St.
Louis, Missouri (the "National Service Center"). MBC's National Region is
primarily responsible for servicing national corporate accounts. Particular
programs (such as state employee plans or Medicaid programs), however, require
local implementation due to the nature of the services provided or customer
requirements. Thus, each of the Areas delivers services to its local or regional
customers in a manner similar to the National Region's delivery of services on a
wider geographic scale to the Company's national accounts.
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National Service Center. The National Service Center is an integral
component of MBC's administrative and clinical operations, serving as the
headquarters of the National Region and the center for policy decisions on key
clinical and operations matters nationwide. The National Service Center also is
responsible for providing back-up to the other Regions for certain aspects of
Regional administration, oversight and service delivery. Functions provided by
the National Service Center's 500-plus member support staff include:
Centralized Client Services. The National Service Center
provides a 24-hour call center that performs after-hours
crisis intervention. During business hours, operators at the
call center also serve as customer service representatives,
providing basic benefit and provider network information,
supporting claims payment activities and responding to
customer inquiries.
Network Administration Services. The National Service Center
supports and coordinates provider network administration
needs, including credentialling and recredentialling
functions, while Region and Area personnel design and plan the
Region's network, recruit and interview candidates, negotiate
contracts with providers and perform on-site examinations of
potential facility providers.
Claims Administration Services. The National Service Center
provides centralized claims processing and payment services
for most of the Company's clients and programs. Processing
claims includes verifying eligibility and third party
liability and coordinating payments with other third party
payors.
Management Information Services. The National Service Center
is responsible for the operation, development and
implementation of the Company's management information
systems, including the AMISYS(R) system described below.
Clinical Oversight. The Company's clinical management team is
located at the National Service Center and sets standards for
all Region and Area network personnel, including guidelines
regarding contractual terms, credentialling criteria and
provider oversight procedures. In addition, the National
Service Center supports other clinical operations, including
monitoring of Area utilization performance, personnel training
and quality management.
Clinical Care Operations
The Company manages care 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. The fundamental principle of MBC's methodology in
managing care is that the efficacy, quality and cost-effectiveness of care are
enhanced by an accurate diagnosis and a targeted clinical
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assessment early in the therapeutic process that is followed by appropriate
treatment.
In order to access the Company's provider network, a beneficiary in
need of behavioral healthcare services typically initiates contact with the
Company by calling the appropriate toll-free telephone number, whereupon a
specially trained intake coordinator will assess the patient's eligibility and
arrange for inpatient admission or referral to an appropriate provider.
Beneficiaries in crisis will call the toll-free number or present themselves at
an inpatient facility, whereupon a clinician will assess the patient's needs
and, if indicated, arrange for an inpatient admission or a referral to an
appropriate provider. In both cases, the provider, in consultation with a
clinical case manager employed by the Company, will develop and implement a
treatment plan designed to meet the patient's needs. The designated provider and
case manager remain in contact throughout the course of the patient's treatment
in an effort to achieve an effective and efficient outcome. The provider's
efficiency and the quality of the treatment outcome are monitored by Company
personnel, with a view to determining which providers and treatment programs
produce the highest quality outcomes in the most efficient manner. As part of
MBC's case management, the Company's clinical services personnel prepare and
review utilization reports on a daily basis and monitor on a regular basis key
clinical statistics, such as referrals and facility admissions, average lengths
of stay and recidivism.
The Company's clinical care program includes the following components:
Intake. Upon responding to a call to the Company's toll-free telephone
number, the intake coordinator asks a series of questions designed to assess
whether the beneficiary requires crisis intervention, verifies eligibility and
refers the caller to an appropriate provider. By having one individual verify
eligibility and arrange for referral to a provider, the process is streamlined
for the beneficiary and made cost-effective for MBC.
Crisis Intervention. The Company provides crisis intervention on a
24-hour basis. As part of these services, clinicians attempt to stabilize the
patient's condition, assess the patient's particular needs and, if indicated,
make a referral for services or authorize reimbursement for admission to an
inpatient facility.
Case Management. Typically, within 24 hours of a crisis inpatient
admission or after initial assessment by an outpatient provider, the provider
and MBC's case manager agree on a treatment plan for the patient. Throughout a
patient's full course of assessment and treatment, an MBC case manager
coordinates all aspects of the delivery of services with network providers and
facilities by consulting with the providers regarding a course of treatment. The
Company's case management procedures are based on comprehensive and flexible
clinical guidelines and treatment protocols that are developed internally and
are consistent with established industry standards. Intake coordinators and case
managers are supervised by the Company's senior clinical staff, who are
available for consultation and review the work of case managers and offer advice
and suggestions for improvement. Where required, standardized
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inpatient case management procedures and protocols of the Company have been
accredited by the Utilization Review Accreditation Committee ("URAC"), an
independent organization based in Washington, D.C.
Quality Management. MBC has procedures in place to monitor quality
assurance (including the recruitment, credentialling, recredentialling, hiring
and orientation of providers and facilities), quality assessment (including
continuous audits of clinical utilization data, telephonic response times and
claims accuracy) and quality improvement (such as provider profiling and problem
identification and resolution). The Company's quality management program begins
with the initial selection of network and staff providers. Candidates for these
positions must satisfy an extensive set of professional and experience
requirements. In addition, many of the Company's providers also complete an
interview process designed to evaluate the practitioner's knowledge of clinical
principles and standards of ethical behavior. Staff providers typically are
required to complete orientation training in the Company's treatment philosophy
and administrative practices and are expected to participate in periodic
continuing education sessions. Network providers typically must participate in
periodic case conferences and accrue accredited continuing education credits to
enhance their skills in a behavioral health managed care delivery system. The
Company's continuing education programs are accredited by the American
Psychological Association for continuing education credit and by the Institute
of Behavioral Healthcare for continuing education units.
National Committee for Quality Assurance. The National Committee for
Quality Assurance ("NCQA"), an independent national managed care accreditation
organization, has established operating standards for independent evaluation of
the quality of care and services provided to enrolled members in managed care
insurance plans (primarily HMOs). Currently, MBC participates in NCQA audits in
connection with certain HMO customers. Although NCQA has yet to release its
standards for managed care arrangements with managed care plans other than HMOs,
the Company's non-HMO clients are increasingly expecting MBC to demonstrate
compliance with existing NCQA standards.
MBC has initiated the process to become accredited as a managed
behavioral healthcare organization ("MBHO") under NCQA standards by filing the
requisite corporate application and undergoing an NCQA corporate audit. The
corporate survey focused on policy, standards and corporate oversight processes.
NCQA's 1998 regional surveys will focus on direct care and service processes.
While the corporate audit does not generate an independent accreditation score,
MBC's corporate compliance assessment will be integrated with regional
compliance to determine regional accreditation.
A regional pre-assessment audit is anticipated to be conducted for
MBC's New York metropolitan area operation in the late spring of 1998, with the
accreditation survey scheduled for fall of 1998. The regional pre-assessment
audit will not yield a score, but will provide MBC with NCQA's assessment of the
Company's readiness for the actual survey. The accreditation survey is generally
conducted 4-6 months following the pre-assessment audit.
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Due to contractual requirements, the Company has also applied for accreditation
surveys in Florida and Kentucky. Expected surveys for both states are scheduled
for September 1998, with results expected approximately 90 days thereafter.
Failure by MBC to obtain NCQA MBHO accreditation could have a material adverse
effect on the Company.
NETWORK AND STAFF PROVIDERS; FACILITIES
The Company's behavioral health managed care and EAP treatment services
are provided by a combination of third-party network providers and treatment
facilities as well as staff providers. Network and staff providers include a
variety of specialized behavioral healthcare personnel such as psychiatrists,
psychologists, licensed clinical social workers, substance abuse counselors and
other professionals.
Network Providers. As of September 30, 1997, MBC had contractual
arrangements with approximately 37,000 third-party network providers. MBC's
network providers are independent contractors located throughout the local areas
in which MBC's customers' beneficiary populations reside. Network providers work
out of their own offices, although staff providers and other resources of the
Company are available to assist them with consultation and other needs. Network
providers include both individual practitioners, as well as group practices or
other licensed centers or programs. Network providers typically execute standard
contracts with the Company for which they are typically paid by the Company on a
fee-for-service basis. In some cases, network providers are paid on a "case
rate" basis, whereby the provider is paid a set rate for an entire course of
treatment, or through other risk sharing arrangements. A network provider's
contract with the Company typically has a one-year term, with automatic renewal
at the Company's option for successive one-year terms, and generally may be
terminated without cause by the Company or the provider upon 30 to 90 days
notice.
Staff Providers. Staff providers are behavioral healthcare
practitioners employed by the Professional Corporations to provide behavioral
treatment services principally to covered beneficiaries of certain MBC customers
under contracts between the Professional Corporations and the Company. As of
September 30, 1997, the Professional Corporations employed approximately 160
staff providers. Certain staff providers are also responsible for the
supervision of network providers, crisis assessment and monitoring compliance
with the Company's quality management procedures. The Company pays the
Professional Corporations a professional service fee under a participating
provider agreement; individual staff providers are paid by their respective
Professional Corporations on a salary basis. In addition, the Company provides
certain administrative and management services to each Professional Corporation
under separate administrative services agreements. These agreements between the
Company and each Professional Corporation typically have a one-year term that
automatically renews for successive one-year terms and generally may be
terminated by the Company upon 30 days notice following a substantial decrease
in enrollment of beneficiaries of plans to which the Professional Corporation
provides services.
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Facilities. As of September 30, 1997, MBC had contractual arrangements
with approximately 3,300 third-party treatment facilities, including inpatient
psychiatric and substance abuse facilities, intensive outpatient programs,
partial hospitalization facilities, community health centers and other
community-based programs, rehabilitative and support programs, and other
intermediate care and alternative care facilities or programs. This variety of
facilities and programs enables the Company to offer patients a full continuum
of care and refer patients to the most appropriate facility or program within
that continuum. Typically, the Company contracts with facilities on a per diem
or fee-for-service basis and, in some cases, on a "case rate" or capitated
basis. The contracts between the Company and inpatient and other facilities
typically are for one year terms and, in some cases, are automatically renewable
at the Company's option. Facility contracts are usually terminable by the
Company upon 30 to 120 days notice.
INFORMATION SYSTEMS
The Company has dedicated substantial resources to implementing and
utilizing information systems required to manage the delivery of care in a
cost-effective manner. AMISYS(R), a centralized system operating on a
Hewlett-Packard HP/3000 platform which is intended to more fully integrate the
Company's operations and achieve additional efficiencies in the overall
management of care, is the Company's primary system. In addition to AMISYS(R),
because MBC has grown in part through recent acquisitions, the Company utilizes
four other operating systems to enable the Company to track program enrollee
membership and verify beneficiaries' eligibility for coverage, access program
benefits, record and monitor authorizations for treatment and cost of care, and
process and pay claims. The four other primary information systems utilized by
MBC, in addition to AMISYS (R), are: (i) servers, supporting the delivery of
services to certain of the Company's HMOs, federal, state and local governmental
agencies and Blue Cross/Blue Shield organization and insurance company
customers; (ii) a system operating on a Hewlett-Packard HP/9000 platform,
supporting the delivery of services principally to certain of the Company's HMO
and insurance company customers; (iii) an IBM AS/400 system, supporting the
delivery of services principally to the Company's EAP and integrated/EAP managed
care customers; and (iv) a DEC VAX 4500 system, supporting the delivery of
services principally to customers in the State of Texas.
The Company believes that AMISYS(R), in conjunction with various
client-server applications, will enable the Company's intake coordinators,
clinical case managers and claims reviewers to efficiently determine eligibility
for coverage, authorize and manage treatment and adjudicate and process claims.
The Company also believes AMISYS(R) will enhance the services provided to both
its customers and beneficiaries while creating cost efficiencies for the Company
by, among other things, measuring the effectiveness of providers and treatment
programs, monitoring outcomes and enabling the Company to customize networks and
rate structures. It is MBC's intention to utilize AMISYS(R) to support most
significant programs implemented by MBC in the foreseeable future. The Company
licenses AMISYS(R) from
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Amisys, Inc.; however, the Company has made approximately $10.5 million of
custom enhancements to AMISYS(R) in order to adapt AMISYS(R) for use in the
Company's business.
To assist in the implementation of, and transition of its other four
systems to, AMISYS(R), MBC entered into an AMISYS Implementation and Systems
Integration Services Agreement with Perot Systems Corporation ("Perot") in
January 1996 (the "Perot Agreement"). As contemplated by the Perot Agreement,
the Company, utilizing both MBC and Perot personnel, has discontinued its use of
most of the servers formerly operating in its Area offices and replaced such
systems with AMISYS(R). In addition, the Company also intends to discontinue use
of its Hewlett-Packard HP/9000 platform and replace it with AMISYS(R) over the
next few years. The Company, with Perot's assistance, also began to utilize
AMISYS(R) to support certain of MBC's current programs during calendar 1996, and
implemented AMISYS(R) in a number of additional locations during fiscal 1997 to
service new business, including Texas, Oklahoma, Colorado, Arizona, Florida and
selected new accounts.
COMPETITION
The industry in which the Company conducts its business is highly
competitive. The Company competes with large insurance companies, HMOs,
preferred provider organizations ("PPOs"), third-party administrators ("TPAs"),
provider groups and other managed care companies. Many of the Company's
competitors are significantly larger and have greater financial, marketing and
other resources than the Company, and some of MBC's competitors provide a
broader range of services. The Company may also encounter substantial
competition in the future from new market entrants. Many of the Company's
customers that are managed care companies may, in the future, seek to provide
behavioral health managed care and EAP services to their employees or
subscribers directly or through affiliated organizations, rather than
contracting with the Company for such services. In addition, the Company
competes with a wide range of large and established providers of behavioral
healthcare treatment services, most of which have greater experience in the
delivery of care, and many of which have greater financial and other resources.
Because of competition, the Company does not expect to be able to rely on price
increases to achieve revenue growth and expects to continue experiencing
pressure on direct operating margins.
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EMPLOYEES
As of September 30, 1997, the Company employed approximately 3,600
persons who perform executive and administrative functions and engage in
marketing and sales, clinical, development, customer service and other
activities. The Professional Corporations employed approximately 372 additional
persons, approximately 160 of whom are staff providers, on such date. None of
the employees of the Company or the Professional Corporations is covered by a
collective bargaining agreement. The Company considers its relationships with
its employees to be good.
INSURANCE
The Company currently maintains professional liability insurance with
per claim and aggregate coverage limits per annual term of the policy. The
policy is subject to self-insured retentions on a per claim basis and on an
aggregate basis and must be renewed annually. The policy is a "claims made"
policy, meaning that if a person were to file suit against the Company after the
term of the policy with respect to an alleged injury that occurred while the
policy was in force, the policy would not cover any costs or judgments arising
therefrom. The Company renewed the policy effective October 6, 1997 for a
one-year term. The Company's professional liability policy also covers the
Professional Corporations and certain of the Company's administrative staff that
provide services to the Company. The current coverage terms have been in effect
since January 1, 1994.
With the exception of certain EAP providers, as described below, it is
the Company's policy to require each network and staff provider to carry
professional liability insurance in a minimum amount per claim and in a minimum
aggregate amount per year for physicians and doctoral level psychologists, as
well as all other providers. Historically, the Company has provided professional
liability insurance for its EAP providers. The Company has, however, begun to
phase out such coverage and to require its EAP providers to carry their own
professional liability insurance in the same amounts as the Company requires its
staff providers to carry.
All of the insurance coverage described above is subject to various
coverage limits, self-insured retentions and other conditions and limitations.
There can be no assurance that any such insurance will be sufficient to cover
any judgments, settlements or costs relating to any actions or claims, or that
any such insurance will be available to the Company or its network or staff
providers in the future on favorable terms, if at all. If the Company or its
providers are unable to secure adequate insurance in the future, or if the
insurance carried by the Company or its providers is not sufficient to cover any
judgments, settlements or costs relating to any present or future actions or
claims, there is no assurance that the Company or its providers will not be
subject to other liabilities which might have a material adverse effect on the
Company.
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The Company also maintains general liability, property, automobile,
workers compensation and other insurance. The Company believes that it maintains
insurance coverage customary in the behavioral healthcare services industry, and
that such insurance is adequate as to the risks covered and the amounts of
coverage.
REGULATION
The managed healthcare industry and the provision of behavioral
healthcare treatment services are subject to extensive and evolving state and
federal regulation. The Company is subject to certain state laws and
regulations, including those governing: (i) the licensing of insurance
companies, HMOs, PPOs, TPAs and companies engaged in utilization review; (ii)
the licensing of healthcare professionals, including restrictions on business
corporations from practicing, controlling or exercising excessive influence over
behavioral healthcare services through the direct employment of psychiatrists
or, in a few states, psychologists and other behavioral healthcare
professionals; and (iii) the establishment and operation of behavioral
healthcare programs, clinics and facilities. These laws and regulations vary
considerably among states, and the Company may be subject to different types of
laws and regulations depending on the specific regulatory approach adopted by
each state to regulate the managed care business and the provision of behavioral
healthcare treatment services. In addition, the Company is subject to certain
state and federal laws by virtue of its relationships with its staff and network
providers and with certain customers, such as governmental agencies and HMOs
maintaining health benefits programs for Medicaid and Medicare beneficiaries,
and as a result of the role the Company assumes in connection with managing its
customers' employee benefit plans.
The Company believes its operations are structured to materially comply
with applicable laws and regulations, and that it has received, or is in the
process of applying for, all licenses and approvals that are material to the
operation of its business. However, regulation of the managed healthcare
industry is evolving, with new legislative enactments and regulatory initiatives
at the state and federal levels being implemented on a regular basis.
Consequently, it is possible that a court or regulatory agency may take a
position under existing or future laws or regulations, or as a result of a
change in the interpretation thereof, that such laws or regulations apply to the
Company in a different manner than the Company believes such laws or regulations
apply. Moreover, any such position may require significant alterations to the
Company's business operations in order to comply with such laws or regulations,
or interpretations thereof. Expansion of the Company's business to cover
additional geographic areas, to serve different types of customers, to provide
new services or to commence new operations could also subject the Company to
additional licensure requirements and/or regulation.
Licensure. Certain regulatory agencies having jurisdiction over the
Company possess discretionary powers when issuing or renewing licenses or
granting approval of proposed
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actions such as mergers, a change in ownership, transfer or assignment of
licenses and certain intracorporate transactions. One or multiple agencies may
require as a condition of such licensure or approval that the Company cease or
modify certain of its operations in order to comply with applicable regulatory
requirements or policies. In addition, the time necessary to obtain licensure or
approval varies from state to state, and difficulties in obtaining a necessary
license or approval may result in delays in the Company's plans to expand
operations in a particular state and, in some cases, lost business
opportunities. Compliance activities, mandated changes in the Company's
operations, delays in the expansion of the Company's business or lost business
opportunities as a result of regulatory requirements or policies could have a
material adverse effect on the Company.
Insurance, HMO and PPO Activities. To the extent that the Company
operates or is deemed to operate in one or more states as an insurance company,
HMO, PPO or similar entity, it may be required to comply with certain laws and
regulations that, among other things, may require the Company to maintain
minimum levels of deposits, capital, surplus, reserves or net worth. In many
states, entities that assume risk under contracts with licensed insurance
companies or HMOs have not been considered by state regulators to be conducting
an insurance or HMO business. As a result, the Company has not sought licensure
as either an insurer or HMO in certain states. The National Association of
Insurance Commissioners (the "NAIC") has undertaken a comprehensive review of
the regulatory status of entities arranging for the provision of healthcare
services through a network of providers that, like the Company, may assume risk
for the cost and quality of healthcare services, but that are not currently
licensed as an HMO or similar entity. As a result of this review, the NAIC
developed a "health organizations risk-based capital" formula, designed
specifically for managed care organizations, that establishes a minimum amount
of capital necessary for a managed care organization to support its overall
operations, allowing consideration for the organization's size and risk profile.
The NAIC initiative will likely result in the adoption of a model NAIC
regulation in the areas of health plan standards and financial solvency
standards for such entities, which could be adopted by individual states in
whole or in part. Individual states have also recently adopted their own
regulatory initiatives that generally subject entities such as the Company to
additional regulation in the area of insurance or HMO standards, including but
not limited to requiring licensure, and greater financial solvency protections.
These laws and regulations may also limit the ability of the Company to pay
dividends, make certain investments and repay certain indebtedness. Licensure as
an insurance company, HMO or similar entity could also subject the Company to
regulations governing reporting and disclosure, mandated benefits, and other
traditional insurance regulatory requirements. PPO regulations to which the
Company may be subject may require the Company to register with the state and
provide information concerning its operations, particularly relating to provider
and payor contracting. Based on the information presently available to it, the
Company does not believe that the imposition of requirements related to
maintaining prescribed levels of deposits, capital, surplus, reserves or net
worth, or complying with other regulatory requirements applicable to its
insurance company, HMO, PPO or similar operations, would have a material adverse
effect on the Company. Notwithstanding the foregoing, the imposition
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of such requirements could increase the Company's cost of doing business and
could delay the Company's conduct or expansion of its business in some areas.
The licensure process under state insurance laws can be lengthy and, unless the
applicable state regulatory agency allows the Company to continue to operate
while the licensure process is ongoing, the Company could experience a material
adverse effect on its operating results and financial condition while its
licensure application is pending. In addition, failure by the Company to obtain
and maintain required licenses typically also constitutes an event of default
under the Company's contracts with its customers. The loss of business from one
or more of the Company's major customers as a result of such an event of default
or otherwise could have a material adverse effect on the Company.
Utilization Review and Third-Party Administrator Activities. Numerous
states in which the Company does business have adopted, or are expected to
adopt, regulations governing entities engaging in utilization review and TPA
activities. Utilization review regulations typically impose requirements with
respect to the qualifications of personnel reviewing proposed treatment,
timeliness and notice of the review of proposed treatment, and other matters.
TPA regulations typically impose requirements regarding claims processing and
payments and the handling of customer funds. Utilization review and TPA
regulations may increase the Company's cost of doing business in the event that
compliance therewith requires the Company to retain additional personnel to meet
the regulatory requirements and to take other required actions and make
necessary filings. Although compliance with utilization review regulations has
not had a material adverse effect on the Company, there can be no assurance that
specific regulations adopted in the future would not have such a result,
particularly since the nature, scope and specific requirements of such
provisions vary considerably among states that have adopted regulations of this
type.
There is a trend among states to require licensure or certification of
entities performing utilization review or TPA activities; however, certain
federal courts have held that such licensure requirements are preempted by the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"). ERISA
preempts state laws that mandate employee benefit structures or their
administration, as well as those that provide alternative enforcement
mechanisms. The Company believes that its TPA activities performed for its
self-insured employee benefit plan customers are exempt from otherwise
applicable state licensing or registration requirements based upon federal
preemption under ERISA and has relied on this general principle in determining
not to seek licensure for certain of its activities in many states. Existing
case law is not uniform on the applicability of ERISA preemption with respect to
state regulation of TPA activities. There can be no assurance that additional
licensure will not be required with respect to utilization review or TPA
activities in certain states.
"Any Willing Provider" Laws. Several states in which the Company does
business have adopted, or are expected to adopt, "any willing provider" laws.
Such laws typically impose upon insurance companies, HMOs or other types of
third-party payors an obligation to contract with, or pay for the services of,
any healthcare provider willing to meet the terms of the
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payor's contracts with similar providers. The Company is not subject to such
laws in any states in which it currently does business, although it has
undertaken to comply with any willing provider contracting requirements at the
request of certain customers. In addition, the Company could become subject to
such laws in the future if they are adopted by states in which the Company is
licensed as an insurance company, HMO or similar entity, or if the Company's
customers become subject to such laws. Compliance with any willing provider laws
could increase the Company's costs of assembling and administering provider
networks and could, therefore, have a material adverse effect on its operations.
Professional Services. The provision of behavioral healthcare treatment
services by psychiatrists, psychologists and other providers is subject to state
regulation with respect to the practice of licensed healthcare professionals,
limitations on the ability of business corporations to directly provide, control
or exercise excessive influence over the services of licensed healthcare
professionals, and limitations on fee-splitting and payments for referrals.
Although under the Company's programs all direct clinical services other than
brief counseling services typically are provided by licensed professionals who
are either staff providers employed by or under contract with one of the
Professional Corporations, or are network providers under independent contractor
arrangements with the Company, state regulatory authorities or courts may in
certain instances determine that these relationships between the Company and the
Professional Corporations are unenforceable. With respect to the Company's
crisis intervention program, additional licensure of clinicians who provide
telephonic assessment or stabilization services to beneficiaries who are calling
from out-of-state may be required if such assessment or stabilization services
are deemed by regulatory agencies to be treatment provided in the beneficiary's
state. The Company believes that it could, if necessary, restructure its
operations to comply with changes in the interpretation or enforcement of such
laws and regulations, and that such restructuring would not have a material
adverse effect on its operations.
Direct Contracting with Licensed Insurers. Regulators in several states
in which the Company does business have adopted policies that require HMOs or,
in some instances, insurance companies, to contract directly with licensed
healthcare providers, entities or provider groups, such as IPAs, for the
provision of treatment services, rather than with unlicensed intermediary
companies. In such states, the Company's customary model of contracting directly
with its customers may need to be modified so that, for example, the
Professional Corporations or IPAs (rather than the Company) contract directly
with the HMO or insurance company, as appropriate, for the provision of
treatment services. The Company intends to work with a number of these HMO
customers to restructure existing contractual arrangements, upon contract
renewal or in renegotiations, so that the entity which contracts with the HMO
directly is a Professional Corporation or IPA. The Company does not expect this
method of contracting to have a material adverse effect on its operations.
Other Regulation of Healthcare Providers. The Company's business is
affected indirectly by regulations imposed upon healthcare providers.
Regulations imposed upon healthcare providers include provisions relating to
the conduct of, and ethical considerations
25
<PAGE>
involved in, the practice of psychiatry, psychology, social work and related
behavioral healthcare professions and, in certain cases, the common law duty to
warn others of danger or to prevent patient self-injury. Confidentiality and
patient privacy requirements are particularly strict in the field of behavioral
healthcare services, and additional legislative initiatives relating to
confidentiality are expected. The Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") included a provision that prohibits the
wrongful disclosure of certain "individually identifiable health information."
HIPAA requires the Secretary of the Department of Health and Human Services to
adopt standards relating to the transmission of such health information by
healthcare providers and healthcare plans. Although the Company believes that
such regulations do not at present materially impair the Company's operations,
there can be no assurance that such indirect regulations will not have a
material adverse effect on the Company in the future.
Regulation of Customers. Regulations imposed upon the Company's
customers include, among other things, benefits mandated by statute, exclusions
from coverages prohibited by statute, procedures governing the payment and
processing of claims, record keeping and reporting requirements, requirements
for and payment rates applicable to coverage of Medicaid and Medicare
beneficiaries, provider contracting and enrollee rights, and confidentiality
requirements. Although the Company believes that such regulations do not at
present materially impair the Company's operations, there can be no assurance
that such indirect regulation will not have a material adverse effect on the
Company in the future.
Healthcare Programs, Clinics and Facilities. The Company is also
generally affected directly by regulations applicable to the operation of
healthcare programs, clinics and facilities. Regulations governing the operation
of behavioral health programs, clinics and facilities include provisions
relating to program, clinic or facility design, ownership, operation, treatment
procedures and medical records. In some instances, state laws require ownership
of clinics or facilities by licensed practitioners or individuals (rather than
corporations). In such cases, the Company maintains its relationship with the
clinic or facility other than through direct shareholder status, such as through
management services agreements between the Company and the Professional
Corporations. If the Company's contractual relationships with the licensed
clinics or facilities are deemed to convey an improper ownership interest in, or
improper control of, the clinic or facility, changes in the Company's operations
in the affected states could be required, and such contracts could potentially
be unenforceable. The existence of such restrictions in a given state may
present greater risks and may limit business opportunities as the Company
endeavors to expands its relationships with providers. Such restrictions could
have a material adverse effect on the Company.
ERISA. Certain of the Company's services are subject to the provisions
of ERISA. ERISA governs certain aspects of the relationship between
employer-sponsored healthcare benefit plans and certain providers of services to
such plans through a series of complex laws and regulations that are subject to
periodic interpretation by the Internal Revenue Service and the Department of
Labor. In some circumstances, and under certain customer contracts, the
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Company may be expressly named as a "fiduciary" under ERISA, or be deemed to
have assumed duties that make it an ERISA fiduciary, and thus be required to
carry out its operations in a manner that complies with ERISA requirements. The
Company believes that it complies with ERISA requirements in all material
respects, and that continuing ERISA compliance efforts will not have a material
adverse effect on the Company.
Medicaid and Medicare. The Company provides and may in the future
provide services to some program beneficiaries who are also beneficiaries of the
Medicaid program, the Medicare program, other government sponsored healthcare
programs, such as CHAMPUS, or the Federal Employees Health Benefits Program. The
Company's compensation for services provided to such beneficiaries has
historically been governed by the contracts with its customers having government
program recipients, as applicable, enrolled in their healthcare benefits plans.
Such customers typically have been either governmental agencies or HMOs. The
Company must also comply with any cost reporting or other reporting requirements
imposed by such government sponsored programs, as well as any reimbursement
limitations on what it may charge the program or program beneficiaries. Such
requirements may limit the amount of reimbursements that MBC may receive from
these programs or subject the Company to periodic audits. The compensation
received by the Company for such services under its private customer contracts
generally has not been affected by Medicaid or Medicaid fee schedules or similar
cost containment measures; however, the Company's provision of services to
Medicaid beneficiaries, or beneficiaries of other government sponsored
healthcare plans, through direct contracts with federal, state or local
government agencies, is affected by such measures, and there can be no assurance
that future legislation will not materially adversely affect the Company's
compensation for services provided to beneficiaries of government sponsored
healthcare programs under contracts with either government agencies or HMOs or
other similar entities.
The provision of services to beneficiaries of federally funded
healthcare programs may also subject the Company to various federal "fraud and
abuse" laws, including "anti-kickback" and "physician self-referral" laws.
Similar state laws could also govern the provision of services to beneficiaries
of state funded healthcare programs such as Medicaid. The federal anti-kickback
laws prohibit the knowing and willful solicitation, receipt or offering of any
remuneration or consideration, directly or indirectly, to induce or in exchange
for referrals of patients or for the ordering of services covered by federally
funded healthcare programs (excluding the Federal Employees Health Benefits
Program) and state funded healthcare programs, including Medicaid. The federal
physician self-referral laws impose restrictions on physician referrals of
patients for certain designated healthcare services to certain entities with
which the physician or any immediate family member has a compensation or
investment or ownership interest, and prevents the entity in question from
lawfully being reimbursed under the Medicaid and Medicare program for patients
improperly referred to it. Thus, these laws could impair the Company's ability
to enter into certain types of arrangements with physicians or other healthcare
providers. Certain state self-referral laws might apply to other types of
providers as well as a broader class of payors. With respect to its
non-governmental
27
<PAGE>
operations, the Company may be subject to similar laws and regulations in a
number of states, and proposed federal legislation would expand the scope of
some or all of the fraud and abuse restrictions to cover many private payors of
healthcare benefits. Penalties for violating existing fraud and abuse laws
include civil monetary penalties, criminal sanctions and exclusion from
participation in the Medicaid and Medicare programs. The Company believes that
its existing operations comply with such state and federal laws and regulations
based on their current interpretation and enforcement; however, because the
fraud and abuse laws, particularly anti-kickback provisions, have been broadly
construed to prohibit transactions in which any purpose of the transaction
violates the law, many transactions potentially could be held to be improper.
Uncertainty as to the scope and application of such laws continues; therefore,
there can be no assurance that future regulatory and enforcement actions will
not result in an interpretation of these laws and regulations that would require
the Company to materially change its operations or contractual relationships in
order to remain in compliance therewith.
Other Proposed Legislation. In the last five years, legislation has
periodically been introduced at the state and federal level providing for new
regulatory programs and materially revising existing regulatory programs. Any
such legislation, if enacted, could materially adversely affect the Company's
business, financial condition or results of operations. Such legislation could
include both federal and state bills affecting the Medicaid programs which may
be pending in or recently passed by state legislatures and which are not yet
available for review and analysis. Such legislation could also include proposals
for national health insurance and other forms of federal regulation of health
insurance and healthcare delivery. It is not possible at this time to predict
whether any such legislation will be adopted at the federal or state level, or
the nature, scope or applicability to the Company's business of any such
legislation, or when any particular legislation might be implemented. No
assurance can be given that any such federal or state legislation will not have
a material adverse effect on the Company.
In August 1997, Congress enacted the Budget Act. The Medicare-related
provisions of the Budget Act are designed to reduce Medicare expenditures over
the next five years by $115 billion, compared to projected Medicare expenditures
before adoption of the Budget Act. The Congressional Budget Office projected in
July 1997 that $43.8 billion of the reductions would come from reduced payments
to hospitals, $21.8 billion from increased enrollment in managed care plans and
$11.7 billion from reduced payments to physicians and ambulatory care providers.
The five-year savings in projected Medicare payments to physicians and hospitals
would be achieved under the Budget Act by reduced fee-for-service reimbursement
and by changes in managed care programs designed to increase enrollment of
Medicare beneficiaries in managed care plans. The increase in Medicare
enrollment in managed care plans would be achieved in part by allowing
provider-sponsored organizations and preferred provider organizations to compete
with Medicare HMOs for Medicare enrollees.
The Medicaid-related provisions of the Budget Act are designed to
achieve net federal Medicaid savings of $14.6 billion over the next five years
and $56.4 billion over the next ten
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<PAGE>
years. The Budget Act achieves federal Medicaid savings in three areas. First,
two-thirds of the savings over the next ten years are attributable to
limitations on federal matching payments to states for reimbursements to
"disproportionate share" hospitals. The next largest source of federal savings
is a provision allowing states to shift the cost of Medicare deductibles and
coinsurance requirements for low-income Medicare beneficiaries from their
Medicaid programs to physicians and other providers. Most of the remaining
savings derive from the repeal of the "Boren Amendment" and other minimum
payment guarantees for hospitals, nursing homes and community health centers
that service Medicaid patients. These changes may have an adverse effect on the
Company if they result in reduced payment levels for providers of managed
behavioral healthcare services.
The Medicaid-related provisions of the Budget Act also give states
broad flexibility to require most Medicaid to enroll in managed care products
that only cover Medicaid recipients without obtaining a waiver from the
Secretary of the Department of Health and Human Services. The Budget Act also
allows states to limit the number of managed care organizations with which the
state will contract to deliver care to Medicaid beneficiaries. These changes
could have a positive impact on the Company's business, if they result in
increased enrollment of Medicaid beneficiaries in managed care organizations and
increased Medicaid spending on managed care. However, these changes also may
have an adverse effect on the Company if a number of states decide to limit the
number of managed care organizations with which they will contract and to select
the organization solely on the basis of the cost of care.
MBC cannot predict the effect of the Budget Act, or other healthcare
reform measures that may be adopted by Congress or state legislatures, on its
operations and no assurance can be given that either the Budget Act or other
healthcare reform measures will not have an adverse effect on the Company.
CAUTIONARY STATEMENTS
This Form 10-K includes "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act.
Although the Company believes that its plans, intentions and expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such plans, intentions or expectations will be achieved.
Important factors that could cause actual results to differ materially from the
Company's forward-looking statements are set forth below and elsewhere in this
Form 10-K. All forward-looking statements attributable to the Company or persons
acting on behalf of the Company are expressly qualified in their entirety by the
cautionary statements set forth below.
Risk-Based Programs. In order for the Company's risk-based contracts to
be profitable, MBC must accurately estimate the rate of service utilization by
beneficiaries enrolled in its programs. The Company's assumptions as to service
utilization rates and costs may not accurately and adequately reflect actual
utilization rates and costs, and increases in behavioral healthcare costs and
higher than anticipated utilization rates, significant aspects of which are
outside the Company's control, could cause expenses associated with such
contracts to exceed the Company's revenue for such contracts. Furthermore,
certain of such contracts
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require the Company to reserve a specified amount of cash as financial assurance
that it can meet its obligations thereunder. Such amounts are not available to
the Company for general corporate purposes.
Customer Contracts. Substantially all of the Company's customer
contracts are immediately terminable for cause, and many, including some of
MBC's most significant contracts, are terminable without cause by the customer
or upon the occurrence of certain other specified events. The Company is aware
of several contracts expiring in fiscal 1997 that will not be renewed; however,
the Company does not believe the loss of such contracts will result in a
material adverse effect on its results of operations. The Company's ten largest
behavioral health managed care customers had 37 contracts with MBC which
accounted for approximately 54% of the Company's revenue for fiscal 1997. Such
contracts may not be extended or successfully renegotiated, and the terms of any
new or renegotiated contracts (particularly financial terms) may not be
comparable to those of existing contracts. The loss of certain of these
contracts could have a material adverse effect on the Company.
Competition. The industry in which the Company conducts its business is
highly competitive. The Company competes with large insurance companies, HMOs,
PPOs, TPAs, provider groups and other managed care companies. Many of the
Company's competitors are significantly larger and have greater financial,
marketing and other resources than the Company, and some of MBC's competitors
provide a broader range of services. The Company may also encounter substantial
competition in the future from new market entrants. Many of the Company's
customers that are managed care companies may, in the future, seek to provide
behavioral health managed care and EAP services to their employees or
subscribers directly or through affiliated organizations, rather than
contracting with the Company for such services. Because of competition, the
Company does not expect to be able to rely on price increases to achieve revenue
growth and expects to continue experiencing pressure on direct operating
margins.
Key Management. The Company's growth depends largely upon the abilities
and experience of certain key management personnel. The loss of the services of
one or more of such key personnel could have a material adverse effect on the
Company.
Information Systems. The Company's operation of its programs, as well
as the implementation of its growth strategy, is dependent on its ability to
store, retrieve, process and manage data. Interruption of data processing
capabilities for any extended period of time, loss of stored data, programming
errors or other system-related problems could have a material adverse effect on
the Company. An integral part of the Company's strategy to improve its operating
efficiency and management of care involves its investment in AMISYS(R), which is
expected to provide advantages over the Company's other current information
systems. The Company has implemented of AMISYS(R) into certain of its
operations, transitioned certain programs supported by its other existing
systems to AMISYS(R) and is continuing to migrate its other operating systems to
AMISYS(R). The installation and implementation of AMISYS(R) involves the risk of
unanticipated delay and expense. Failure to complete the modifications to
AMISYS(R) required to adapt such system to the Company's business or to
successfully implement AMISYS(R) into its operations could adversely impact
MBC's operating efficiency and management of care and could result in the loss
of existing customers, difficulties in attracting new customers, increases in
operating expenses and other adverse consequences.
Control by KKR. KKR Associates and its General Partners control the
Company, having the power to elect its directors and appoint management. The
interests of KKR and its General Partners may not always be consistent with
those of the Company's equity and debt holders and other constituencies.
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Dependence on Government Spending for Managed Healthcare; New
Legislation. A significant portion of the market for the Company's services is
funded directly or indirectly by governmental agencies, including Medicaid
programs. Any reduction in government spending for such programs could have a
material adverse effect on the Company. In addition, the Company's contracts
with governmental agencies generally are conditioned upon financial
appropriations, especially with respect to Medicaid programs. These contracts
generally can be terminated or modified by the customer if such appropriations
are not made. The Company's strategy for growth depends in part on the
engagement of managed care organizations to provide services to governmental
agencies, especially with respect to Medicaid programs. If such engagements do
not occur or if such contracts do not provide adequate pricing terms, the
Company could be materially adversely affected. In addition, legislation has
periodically been introduced at the state and federal level providing for new
regulatory programs and materially revising existing regulatory programs. Any
such legislation, if enacted, could materially adversely affect the Company. The
Company is unable to predict the impact on the Company's operations of future
regulations or legislation affecting government healthcare programs, or the
healthcare industry in general.
Regulation. The Company's business is subject to extensive state and
federal regulation. State laws and regulations vary considerably, and the
Company may be subject to different types of laws and regulations depending on
the specific regulatory approach adopted by each state. State and federal laws
regulate the Company's relationships with its providers and with certain
customers, such as governmental agencies and HMOs servicing Medicaid and
Medicare beneficiaries, and its management of its customers' employee benefit
plans. Because regulation of the Company's business is evolving, new laws or
regulations applicable to the Company may be enacted, and existing laws and
regulations may be interpreted to apply to the Company's operations in a
different manner than previously thought. Any such development may require the
Company to secure additional licenses or restructure its operations to comply
with such laws and regulations. Any delay or failure to secure or maintain
licenses or otherwise comply with applicable laws and regulations or to so
restructure operations could lead to lost business opportunities and have a
material adverse effect on the Company.
Professional Liability; Insurance. The Company is regularly subject to
lawsuits alleging malpractice and related legal theories, some of which involve
situations in which participants in the Company's programs have committed
suicide. The Company may also be subject to claims of professional liability for
alleged negligence in performing utilization management activities, as well as
for acts and omissions of the Company's staff and network providers. The Company
could also become subject to claims for the costs of healthcare services denied.
There can be no assurance that the Company's procedures for limiting liability
have been or will be effective, or that one or more lawsuits will not have a
material adverse effect on the Company in the future. While the Company carries
professional liability insurance, it is subject to certain self-insured
retentions, may not apply in certain circumstances and may not be sufficient to
cover all damages or costs relating to present or future claims. Upon expiration
thereof, sufficient insurance may not be available to the Company or its
providers on favorable terms, if at all. If the Company or its providers are
unable to secure adequate insurance in the future, or if the insurance carried
by the Company or its providers is not applicable or is not sufficient to cover
any damages or costs relating to any present or future claims, the Company and
its providers could be subject to a liability that could have a material adverse
effect on the Company.
Substantial Leverage and Related Considerations. The Company incurred
substantial indebtedness in connection with the 1995 Merger, and is highly
leveraged. Such indebtedness included borrowings under a $205.0 million senior
credit facility (the "Senior Credit Facility") provided under the Credit
Agreement dated
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as of October 6, 1995, as amended, among the Company, the lending institutions
listed therein and The Chase Manhattan Bank, N.A., as Agent (the "Credit
Agreement") entered into in connection with the 1995 Merger and the Notes.
Further, the Company borrowed an additional $80 million in connection with its
acquisition of CMG in September 1997. The Company's ability to make scheduled
payments of principal of, or to pay interest on, or to refinance its
indebtedness (including the Notes), depends on its future performance, which, to
a certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors beyond its control. There can be no
assurance that the Company's business will generate sufficient cash flow from
operations or that future working capital borrowings will be available in an
amount sufficient to enable MBC to service its indebtedness, including the
Notes, or make necessary capital expenditures. The Notes are general unsecured
obligations of the Company and are subordinated in right of payment to all
Senior Indebtedness (as defined in the Indenture), of the Company (which
includes all indebtedness under the Senior Credit Facility).
Item 2. Properties
The Company's principal executive offices, with approximately 37,500
square feet in the aggregate, are located in Park Ridge, New Jersey; the lease
for the Company's headquarters expires in 2006. The Company leases approximately
195,500 square feet in the aggregate for the National Service Center in St.
Louis, Missouri, under three leases expiring between 2001 and 2003. In addition,
the Company leases approximately 64,000 square feet in the aggregate in New York
City relating to the Empire Joint Venture and other business; the lease for the
New York City space expires in 2008. The Company also maintains an office with
approximately 24,800 square feet in the aggregate in San Francisco, California;
the lease for the San Francisco office expires in 2003. As of September 30,
1997, the Company also maintained approximately 150 other offices in 32 states
under leases which have terms of up to 10 years and range in size up to 30,000
square feet. Management believes that the Company's offices and other properties
are adequate for its current needs and that suitable additional space will be
available as required.
Item 3. Legal Proceedings
The management and administration of the delivery of behavioral health
managed care and EAP services, and the direct provision of behavioral health
treatment services, entail significant risks of liability. In recent years, the
Company and its network and staff providers have been subject to a number of
actions and claims alleging malpractice, professional negligence and other
related legal theories. Many of these actions and claims seek substantial
damages and therefore require the Company to incur significant fees and costs
related to their defense.
From time to time, the Company is subject to various actions and claims
arising from the acts or omissions of its staff providers, its employees, its
network providers or other parties. In the normal course of its business, the
Company receives reports relating to suicides and other serious incidents
involving patients enrolled in the Company's programs. Such incidents may give
rise to
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malpractice, professional negligence and other related actions and claims
against the Company, its employees and its network and staff providers. As the
number of beneficiaries covered by the Company grows, the number of providers
employed by the Professional Corporations or under contract with the Company
increases and the nature and scope of services provided by the Company in its
managed care and EAP business expands, actions and claims against the Company
(and, in turn, possible legal liability) predicated on malpractice, professional
negligence or other related legal theories can be expected to increase. In
addition, the Company may become subject to additional actions and claims
alleging malpractice, professional negligence and other related theories arising
from the behavioral health treatment services rendered directly to patients by
the Company.
The Company carries insurance in respect of liabilities arising from
actions and claims based on alleged malpractice, professional negligence and
other related theories. The Company's staff providers are also required to
maintain professional liability insurance on a per claim and aggregate basis.
All such insurance is subject to various coverage limits, self-insured
retentions and other limitations and conditions. To the extent the Company's
customers are entitled to indemnification under their contracts with the Company
relating to liabilities they incur arising from the operation of the Company's
programs, such indemnification may not be covered under the Company's insurance
policies. In addition, to the extent that certain actions and claims seek
punitive and compensatory damages arising from alleged intentional misconduct by
the Company, such damages, if awarded, may not be covered, in whole or in part,
by the Company's insurance policies. In the ordinary course of business, the
Company is also subject to actions and claims with respect to its employees,
staff providers, network providers and suppliers of services. The Company does
not believe that any pending action against the Company alleging malpractice,
professional negligence or other related theories will have a material adverse
effect on the Company. To date, claims and actions against the Company alleging
professional negligence have not resulted in material liabilities to the
Company; however, there can be no assurance that pending or future actions or
claims for professional liability will not have a material adverse effect on the
Company.
From time to time, the Company receives notifications from and engages
in discussions with various governmental agencies concerning its business and
operations. As a response to these contacts with regulators, the Company in many
instances implements changes to its operations, revises its filings with such
agencies and/or seeks additional licenses to conduct its business. In recent
years, in response to governmental agency inquiries or discussions with
regulators, the Company has determined to seek licensure as a single service
HMO, TPA or utilization review agent in one or more jurisdictions.
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists, psychologists and clinical social workers
brought an action under the federal antitrust laws in the United States District
Court for the Southern District of New York against nine behavioral health
managed care organizations, including the Company (collectively,
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"Defendants") entitled Edward M. Stephens, Jose A. Yaryura-Tobias, Judith Green,
Ph.D., Fugen Neziroglu, Ph.D., Ona Robinson, Ph.D., Laurie A. Baum, C.S.W.,
Agnes Wohl, C.S.W., and The On-Step Institute For Mental Health Research, Inc.,
individually and on behalf of all others similarly situated, v. CMG Health, FHC
Options, Inc., Foundation Health PsychCare Services, Inc., Green Spring Health
Services, Inc., Human Affairs International, Inc., Merit Behavioral Care Corp.,
MCC Behavioral Care Inc., United Behavioral Systems, Inc., and Value Behavioral
Health, Inc., 96 Civ. 7798 (KMW). The complaint alleges that Defendants violated
section 1 of the Sherman Act by engaging in a conspiracy to fix the prices at
which Defendants purchase services from mental healthcare providers such as
plaintiffs. The complaint further alleges that Defendants engaged in a group
boycott to exclude mental healthcare providers from Defendants' networks in
order to further the goals of the alleged conspiracy. The complaint also
challenges the propriety of Defendants' capitation arrangements with their
respective customers, although it is unclear from the complaint whether
plaintiffs allege that Defendants unlawfully conspired to enter into capitation
arrangements with their respective customers. The complaint seeks treble damages
against Defendants in an unspecified amount and a permanent injunction
prohibiting Defendants from engaging in the alleged conduct which forms the
basis of the complaint, plus costs and attorneys' fees. In January 1997,
Defendants filed a motion to dismiss the complaint. On July 21, 1997, a
court-appointed magistrate judge issued a report and recommendation to the
District Court recommending that Defendants' motion to dismiss the complaint
with prejudice be granted. On August 5, 1997, plaintiffs filed objections to the
magistrate judge's report and recommendation; such objections have not yet been
heard. The Company intends to vigorously defend itself in this litigation.
However, there can be no assurance that the outcome of this litigation will be
favorable to the Company. An unfavorable outcome could have a material adverse
effect on the Company.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of its security
holders during the fourth quarter of the fiscal year covered by this report.
PART II
- -------------------------------------------------------------------------
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
There is no established public trading market for the Common Stock.
There were approximately 70 holders of the Common Stock at December 1, 1997. The
Company has not paid dividends on the Common Stock to date and does not
currently intend to pay dividends on the Common Stock in the foreseeable future.
The payment of dividends is restricted by the Senior Credit Facility and the
Indenture. See Note 6 to the Company's consolidated financial statements set
forth in Part IV below.
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Item 6. Selected Financial Data
The following audited selected historical financial data were derived from,
and should be read in conjunction with, the historical consolidated financial
statements of the Company and of MBC prior to the acquisition of Medco
Containment by Merck (referred to herein as the "Predecessor"), including the
respective notes thereto, included elsewhere herein. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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<TABLE>
<CAPTION>
Predecessor(6) MBC
Fiscal Year Ended Oct. 1, 1993 Nov. 18, 1993 Fiscal Years Ended September 30,
September 30, to to
1993 Nov. 17, 1993 Sept. 30, 1994 1995 1996(10) 1997
<S> <C> <C> <C> <C> <C> <C>
Income Statement Data:
Revenue ......................$197.4 $31.0 $245.9 $361.5 $457.8 $555.7
Operating expenses(1)......... 180.5 29.3 225.4 335.8 426.2 517.0
Amortization of intangibles... 1.8 0.3 17.1 21.4 25.8 26.9
Restructuring charge.......... 1.7 --- --- --- 3.0 ---
Operating income (2)...... . 13.4 1.4 3.4 4.3 2.8 11.8
Other expense (income)(3).... (0.6) (0.1) (0.8) (1.5) (2.8) (3.5)
Interest expense.............. --- --- --- --- 23.8 25.1
Loss on disposed of subsidiary.. --- --- --- --- --- 6.9
Merger costs and special charges 2.4 --- --- --- 4.0 1.3
Income (loss) before income
taxes and cumulative
effect of accounting change11.6 1.5 4.2 5.8 (22.2) (18.0)
Provision (benefit) for
income taxes 6.1 0.6 2.1 4.5 (5.3) (4.1)
Income (loss) before
cumulative effect of
accounting change......... 5.5 0.9 2.1 1.3 (16.9) (13.9)
Cumulative effect of
accounting change (10)...... --- --- --- --- (1.0) ---
Net income (loss) 5.5 $ 0.9 $ 2.1 $ 1.3 $(17.9) $(13.9)
Pro forma net income
(loss) for the effect of
the accounting change(10)... $5.5 $ 0.9 $ 2.1 $ 0.3 $(16.9) $(13.9)
Deficiency of earnings
to fixed charges(7)........... $(22.2) $(18.0)
Balance Sheet Data (at end of periods):
Cash, cash equivalents and
short-term marketable
securities(5)............ $ 21.9 $ 32.7 $ 34.1 $ 53.0 $ 95.2
Total assets................. 91.9 259.3 305.4 344.8 $ 468.7
Due to parent
(noninterest bearing)....... 5.9 37.9 70.8 --- ---
Long-term debt................ 254.0 329.5
Stockholders' equity (deficit) 47.0 121.0 122.3 (29.5) (25.9)
Other Data:
Adjusted EBITDA(4)......... 20.0 2.2 25.5 34.0 45.1 54.7
Adjusted EBITDA margin(8) 10.1% 7.1% 10.4% 9.4% 9.9% 9.8%
Cash provided by
operating activities........$ 18.3 $ 2.9 $19.2 $ 26.1 $ 28.6 $ 26.9
Cash used for investing
activities............... (17.3) (1.6) (43.3) (54.2) (41.3) (62.1)
Cash provided by financing
activities.................... 4.9 0.5 31.6 32.9 30.6 75.2
Depreciation and
amortization(9).............. 4.3 0.7 21.3 28.2 36.5 39.4
Capital expenditures:
Information systems......... 8.6 0.2 15.0 23.2 15.7 16.3
Other capital expenditures. 1.0 1.0 1.8 8.3 8.1 7.7
Total capital expenditures 9.6 1.2 16.8 31.5 23.8 24.0
36
</TABLE>
<PAGE>
Notes to Selected Financial Data:
(1) Represents the sum of direct service costs and selling, general and
administrative expenses.
(2) Operating income equals income before income taxes, cumulative effect of
accounting change, interest expense, other income and expense and merger costs
and special charges.
(3) Represents primarily interest income.
(4) "Adjusted EBITDA" represents the sum of operating income, depreciation and
amortization, and other income and expense, excluding restructuring charges in
1993 and 1996. Adjusted EBITDA is presented because a similar measure is used in
the covenants contained in the Indenture and MBC believes that Adjusted EBITDA
is a widely accepted financial indicator of a company's ability to service debt.
However, Adjusted EBITDA should not be construed as an alternative to MBC's
operating income, net income or cash flow from operating activities (as
determined in accordance with generally accepted accounting principles) and
should not be construed as an indication of MBC's operating performance or as a
measure of MBC's liquidity. In addition, items excluded from EBITDA, such as
restructuring charges and depreciation and amortization, are significant
components in understanding and assessing the Company's financial performance.
(5) Includes restricted cash and short-term marketable securities classified as
a long-term asset. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations- -Liquidity and Capital Resources--Cash in
Claims Funds and Restricted Cash."
(6) On November 18, 1993, Merck acquired all of the outstanding shares of Medco
Containment in a transaction accounted for by the purchase method. The amounts
related to periods prior to November 18, 1993 were derived from Predecessor
financial statements. The historical cost basis of the Predecessor differs from
that of the Company due to the allocation of a portion of the total purchase
price of Medco Containment to the Company's assets and liabilities.
(7) For purposes of this computation, earnings consist of income before taxes
plus fixed charges. Fixed charges consist of interest expense (including
amortization of deferred financing fees) and one-third of rental expense,
representing that portion of rental expense deemed by MBC to be attributable to
interest. For the period presented, earnings were insufficient to cover fixed
charges and, therefore, such deficiency is presented above. The ratios of
earnings to fixed charges for the periods prior to October 6, 1995 are not
presented because the Company did not have interest expense prior to
consummation of the 1995 Merger.
(8) "Adjusted EBITDA margin" represents Adjusted EBITDA as a percentage of
revenue. As noted in footnote (4) above, Adjusted EBITDA is presented because
MBC believes it is a
37
<PAGE>
widely accepted financial indicator of a company's ability to service debt.
However, Adjusted EBITDA margin should not be construed as an alternative to
MBC's operating income as a percentage of revenue or net income as a percentage
of revenue (as derived from operating income and net income determined in
accordance with generally accepted accounting principles). Adjusted EBITDA
margin should not be construed as an indication of MBC's operating performance
or as a measure of MBC's liquidity.
(9) Excludes amortization of deferred financing costs.
(10) 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 $1.8 million ($1.0 million after taxes)
in its fiscal 1996 first quarter results of operations as a cumulative effect of
the change in accounting. Had the Company adopted this accounting principle in
the prior year, fiscal 1995 net income would have been $0.3 million. There was
no pro forma effect of this change for fiscal years prior to 1995.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
Revenue
Typically, the Company charges each of its HMO, Blue Cross/Blue Shield
organization, insurance company, corporate, union, governmental and other
customers a flat monthly capitation fee for each beneficiary enrolled in such
customer's behavioral health managed care plan or EAP. This capitation fee is
generally paid to MBC in the current month. Contract revenue billed in advance
of performing related services is deferred and recognized ratably over the
period to which it applies. For a number of the Company's behavioral health
managed care programs, the capitation fee is divided into outpatient and
inpatient fees, which are recognized separately. Outpatient revenue is
recognized monthly as it is received; inpatient revenue is recognized monthly
and in most cases is (i) paid to the
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<PAGE>
Company monthly (in cases where the Company is responsible for the payment of
inpatient claims) or in certain cases (ii) retained by the customer for payment
of inpatient claims. When the customer retains the inpatient revenue, actual
inpatient costs are periodically reconciled to amounts retained and the Company
receives the excess of the amounts retained over the cost of services, or
reimburses the customer if the cost of services exceeds the amounts retained. In
certain instances, such excess or deficiency is shared between the Company and
the customer.
Direct Service Costs and Margins
Direct service costs are comprised principally of expenses associated
with managing, supervising and providing the Company's services, including
third-party network provider charges, various charges associated with the
Company's staff offices, inpatient facility charges, costs associated with
members of management principally engaged in the Company's clinical operations
and their support staff, and rent for certain offices maintained by the Company
in connection with the delivery of services. Direct service costs are recognized
in the month in which services are expected to be rendered. Network provider and
facility charges for authorized services that have not been reported and billed
to the Company (known as incurred but not reported expenses, or "IBNR") are
estimated and accrued based on historical experience, current enrollment
statistics, patient census data, adjudication decisions, and other information.
The Company has experienced an increase in direct service costs as a
percentage of revenue (which have been offset to varying degrees by various
initiatives described below) primarily as a result of changing product mix and
pricing pressure associated with both the competitive bid process for new
contracts and negotiations to extend existing contracts. The portion of MBC's
revenue attributable to capitated managed care programs has continuously been
increasing. Because capitated managed care programs require the Company to incur
greater direct service costs than EAP and ASO managed care programs, the direct
profit margins attributable to such programs are lower than the direct profit
margins attributable to the Company's EAP and ASO programs. The Company is
continuing to focus on reducing direct service costs. Efforts intended to reduce
these costs include: (i) negotiating better rates and/or different compensation
arrangements (such as retainer arrangements, volume discounts, case rates and
capitation of fees) with third-party network providers and treatment facilities;
(ii) contracting with treatment facilities that provide a broader spectrum of
treatment programs in an effort to expand beneficiary access to a broader
continuum of care, thereby achieving more cost-effective treatment; (iii)
focusing management and clinical care techniques on patients requiring more
intensive treatment services to assure that such patients receive the
appropriate level of care in a cost- efficient and effective manner; (iv)
implementing a new information system intended to enable MBC to improve the
productivity and efficiency of its operations; and (v) increasing the overall
efficiency of MBC's staff provider system by closing or consolidating less
efficient staff offices, streamlining operations and increasing the efficiency
of remaining staff offices.
39
<PAGE>
Selling, General and Administrative Expenses
Selling, general and administrative expenses are comprised principally
of corporate and regional overhead expenses, such as marketing and sales, legal,
finance, information systems and administrative expenses, as well as
professional and consulting fees, and the compensation of members of the
Company's senior management. The Company expects selling, general and
administrative expenses to grow over the near term, primarily due to growth in
information systems expenses related to the implementation of AMISYS(R) as well
as increases in regional administration and sales and marketing operations
necessary to support the growth of the Company's business; however, the Company
expects selling, general and administrative expenses to grow at a rate less than
that of anticipated revenue growth in the future. There can be no assurance,
however, that anticipated revenue growth will occur or that any such revenue
growth will occur at a rate greater than the rate of growth in selling, general
and administrative expenses.
Amortization of Intangibles
As a result of Merck's acquisition of Medco Containment in November
1993, the Company's financial statements include an allocation by Merck of the
excess of its cost over fair market value of the net assets acquired.
Accordingly, goodwill and other acquisition-related intangibles in the amount of
$160.0 million were recorded on the Company's balance sheet as of November 1993
and are being amortized over various periods. A noncurrent deferred tax
liability of $47.8 million was established to reflect the tax consequences of
the difference between the financial and tax reporting bases of the identified
intangibles. The Company's total goodwill also includes goodwill associated with
the Company's acquisitions of Group Plan Clinic, Inc., and of BenesYs, Inc.
(collectively, "BenesYs"), a Houston-based behavioral health managed care
organization, and CMG. In addition, the payment made to Empire in connection
with the Empire Joint Venture, the acquisition of ProPsych in December 1995, and
various contingent consideration payments, together with the goodwill recognized
from the BenesYs and CMG transactions, resulted in the incurrence of additional
goodwill of approximately $117.8 million. Amortization of acquisition-related
intangibles was $20.1 million in fiscal 1995, $23.0 million in fiscal 1996, and
$23.8 million in fiscal 1997.
The Company also capitalizes certain start-up expenses related to new
contracts and amortizes these amounts over the life of the contracts. When the
Company enters into a new contract or significantly expands services for an
existing customer, the Company typically incurs up-front start-up costs that
historically have ranged from $50,000 to $2.5 million per program. These
start-up costs include, among other things, the costs of recruiting,
interviewing and training providers and support staff, establishing offices and
other facilities, acquiring furniture, computers and other equipment, and
implementing information systems. As of September 30, 1997, the Company's
balance sheet reflected $9.0 million of deferred start-up costs, net of
amortization, categorized under long-term assets.
40
<PAGE>
Liquidity
The Company's liquidity is affected by the one-to-four-month lag
between the time the Company receives cash from capitation payments under new
contracts and the time when the Company pays the claims for services rendered by
third-party network providers and treatment facilities relating to such
capitation payments. During the first few months of a new contract, the Company
builds cash balances as capitation payments are received and also builds a
payables balance as direct service costs are accrued based on expected levels of
service. After the first several months of a contract, monthly claims payments
typically increase to normal levels and the contract generates cash commensurate
with the expected profit margin for that contract. When a contract is
terminated, monthly capitation payments cease on contract termination, but
claims for services rendered prior to termination continue to be received and
paid for several months. This post contract termination period is often referred
to as the "run- off" period. To date, contract terminations have not had a
material impact on the Company's liquidity.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information, which
will be effective for the Company beginning October 1, 1998. SFAS No. 131
redefines how operating segments are determined and requires disclosure of
certain financial and descriptive information about a company's operating
segments. The Company has not yet completed its analysis with respect to which
operating segments of its business it will provide such information.
41
<PAGE>
RESULTS OF OPERATIONS
Selected Operating Results
The following table sets forth certain statement of operations items of MBC
expressed as a percentage of revenue:
<TABLE>
<CAPTION>
Fiscal Year Ended September 30,
<S> <C> <C> <C>
1995 1996 1997
Revenue.......................................... 100.0% 100.0% 100.0%
Direct service costs............................. 79.1 79.0 80.9
Direct profit margin........................... 20.9 21.0 19.1
Selling, general and administrative
expenses....................................... 13.8 14.1 12.2
Amortization of intangibles...................... 5.9 5.7 4.8
Restructuring charge............................. --- 0.6 ---
Operating Income.............................. 1.2 0.6 2.1
Other income..................................... 0.4 0.6 0.6
Interest expense................................. --- (5.2) (4.5)
Loss on disposal of subsidiary................... --- --- (1.2)
Merger costs and special charges................. --- (0.8) (0.2)
Income (loss) before income taxes and
cumulative effect of accounting change 1.6 (4.8) (3.2)
Provision (benefit) for income taxes............. 1.2 (1.1) (0.7)
Income (loss) before cumulative effect
of accounting change...................... 0.4% (3.7)% (2.5)%
Adjusted EBITDA margin................... 9.4% 9.9% 9.8%
</TABLE>
Fiscal 1997 Compared to Fiscal 1996
Revenue. Revenue increased by $97.9 million, or 21.4%, to $555.7
million for fiscal 1997 from $457.8 million for fiscal 1996. Of this increase,
$71.3 million was attributable to the inclusion of revenue from certain
contracts that commenced during the prior fiscal year as well as 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; and $65.8
million was attributable to new customers commencing service in the current
year, a significant portion of which was derived from the Company's contract
relating to CHAMPUS Regions 7 and 8, under which services commenced on April 1,
1997. In addition, the Company's acquisition of CMG on September 12, 1997
contributed an additional $7.0 million in revenue for fiscal
42
<PAGE>
1997. These revenue increases were partially offset by a $46.2 million decrease
in revenue as a result of the termination of certain contracts, $29.1 million of
which was due to contract terminations that occurred in various periods of the
prior fiscal year. Contract price increases were not a material factor in the
increase in revenue.
Direct Service Costs. Direct service costs increased by $87.9 million,
or 24.3%, to $449.6 million for fiscal 1997 from $361.7 million for fiscal 1996.
As a percentage of revenue, direct service costs increased from 79.0% in the
prior year period to 80.9% in the current year period. The increase in cost as a
percentage of revenue was due primarily to the lower than average direct profit
margin earned on the TennCare Partners and the Delaware County Medicaid
programs, partially offset by a year over year decline in healthcare treatment
services utilization in the Company's overall business. In addition, the
Delaware County carve-out program replaced a program under which beneficiaries
previously received their mental health benefit through membership in various
HMOs servicing this area. Direct profit margins under contracts that the Company
held with certain of these HMOs, which terminated or membership in which
decreased substantially as a result of the Delaware County program, were higher
than the direct profit margins for the Delaware County program and the Company's
overall average direct profit margins. Excluding the effect of the TennCare
Partners and the Delaware County contracts, however, the Company experienced a
decline in the direct service cost percentage as a result of overall lower
healthcare utilization in the current year period as compared to the prior year
period, due to the Company's continued development and deployment of alternative
treatment programs designed to achieve more cost-effective treatment and the
Company's increased focus on clinical care techniques directed at patients
requiring more intensive treatment services. Also positively impacting the
direct cost percentage were the effect of (i) a nationwide recontracting program
with providers which began in the second quarter of fiscal 1996, and (ii) the
closing of certain underperforming staff offices pursuant to a plan implemented
by MBC in the fourth quarter of 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $2.9 million, or 4.5%, to $67.4 million for
fiscal 1997 from $64.5 million for fiscal 1996. 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, (ii) expenses
associated with the expansion of both the Company's National Service Center
located in St. Louis, Missouri and the Company's headquarters located in Park
Ridge, New Jersey, (iii) expenses related to the planned deployment of the
Company's new information systems, and (iv) inclusion of CMG's results of
operations since the acquisition date. As a percentage of revenue, selling,
general and administrative expenses decreased from 14.1% in the prior year
period to 12.2% in the current year period primarily as a result of these
expenses being allocated over a larger revenue base. Contributing significantly
to this decrease were the TennCare Partners and the Delaware County programs,
which are large, self-contained programs requiring minimal selling, general and
administrative expenses or Company operational support, thereby mitigating, in
large part, the effects of their lower than average
43
<PAGE>
direct service cost margins described above.
Amortization of Intangibles. Amortization of intangibles increased by
$1.0 million, or 4.0%, to $26.9 million for fiscal 1997 from $25.9 million for
fiscal 1996. The increase was primarily due to an increase in amortization of
goodwill recognized in connection with the acquisitions of ProPsych and CMG as
well as to increases in the amortization of deferred contract start-up costs
related to new contracts.
Other Income (Expense). For fiscal 1997, other income and expense
consisted of (i) interest expense of $25.1 million related to debt incurred as a
result of the 1995 Merger in October 1995, (ii) interest and other income of
$3.5 million relating primarily to investment earnings on the Company's
short-term marketable securities and restricted cash and investment balances,
(iii) a loss of $6.9 million recognized in September 1997 on the disposal of
Choate, (iv) $0.7 million of expenses associated with uncompleted acquisition
transactions, and (v) $0.6 million of nonrecurring employee benefit costs
associated with the exercise of stock options by employees of the Company under
plans administered by Merck. The year over year increase in interest expense of
$1.2 million was primarily attributable to (i) the full period impact of the
indebtedness incurred in October 6, 1995 by the Company in connection with the
1995 Merger; (ii) the full period impact of the Notes, which bore interest at a
higher rate than the bridge financing facility that the Notes replaced, and
(iii) the increase in the senior credit facility as a result of the acquisition
of CMG. The year over year increase in interest income of $0.7 million was
primarily attributable to both an increase in average invested cash balances as
compared to the prior year period and interest earned on advances to certain
joint ventures.
Income Taxes. The Company recorded a benefit for income taxes during
fiscal 1997, based upon the Company's pre-tax loss in such period.
Fiscal 1996 Compared to Fiscal 1995
Revenue. Revenue increased by $96.3 million, or 26.6%, to $457.8
million for fiscal 1996 from $361.5 million for fiscal 1995. Of this increase,
$87.7 million was attributable to the inclusion of revenue for the entire period
from certain contracts that commenced during the prior fiscal year as well as
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;
and $26.4 million was attributable to new customers commencing service in the
current year, the majority of which was derived from two contracts totaling
$20.9 million. In addition, the Company's acquisitions of Choate and ProPsych
contributed an additional $18.4 million in revenue for fiscal 1996. These
revenue increases were partially offset by a $36.2 million decrease in revenue
as a result of the termination of certain contracts, five of which accounted for
$21.1 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.
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<PAGE>
Direct Service Costs. Direct service costs increased by $75.7 million,
or 26.5%, to $361.7 million for fiscal 1996 from $286.0 million for fiscal 1995.
As a percentage of revenue, direct service costs decreased from 79.1% for fiscal
1995 to 79.0% for fiscal 1996. This net decrease in the direct service cost
percentage was due to a variety of largely offsetting factors. The direct
service cost percentage was positively impacted by lower inpatient utilization
in fiscal 1996 as compared to 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. In
addition, the Company started to realize the benefits in fiscal 1996 of a
nationwide recontracting program with providers which began in the second
quarter of such year. The Company is continuing its efforts to reduce direct
service costs to mitigate the effects of pricing pressure, which is expected to
continue in fiscal 1997, associated with the competitive bid process for new
contracts and negotiations to extend existing contracts. The direct service cost
percentage 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. In addition, the
Company earned a lower than average direct profit margin on a significant state
Medicaid program which was not in effect for the entire twelve month period in
the prior year. Furthermore, in the fourth quarter of fiscal 1996, the Company
commenced providing services under the TennCare Partners program. Due to the
unusual structure of the TennCare Partners program, the direct profit margin
under such contract was lower than the Company's average direct profit margin
for fiscal 1996 and is expected to continue to be lower in future periods.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $14.7 million, or 29.5%, to $64.5 million
for fiscal 1996 from $49.8 million for fiscal 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, (ii)
expenses associated with the expansion of the National Service Center, which
will allow for growth beyond MBC's 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 14.1% for
fiscal 1996 from 13.8% for fiscal 1995. The increase in such expenses, coupled
with unanticipated delays in the planned start dates of significant new
contracts (including the TennCare Partners program) secured by the Company,
contributed to the increase in selling, general and administrative expenses as a
percentage of revenue.
Amortization of Intangibles. Amortization of intangibles increased by
$4.5 million, or 21.0%, to $25.9 million for fiscal 1996 from $21.4 million for
fiscal 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 Empire Joint Venture, as well as to increases in the amortization of
deferred contract start-up costs related to new contracts.
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<PAGE>
Restructuring Charge. The Company recorded a pre-tax restructuring
charge of $3.0 million related to a plan, adopted and approved in the fourth
quarter of 1996, to restructure its staff offices by exiting certain geographic
markets and streamlining the field and administrative management organization of
Continuum Behavioral Healthcare Corporation, a subsidiary of the Company. This
decision was in response to the results of underperforming locations affected by
the lack of sufficient patient flow in the geographic areas serviced by these
offices and the Company's ability to purchase healthcare services at lower rates
from its provider network. In addition, it was determined that the Company would
be able to expand beneficiary access to specialists and other providers thereby
achieving more cost-effective treatment and to favorably shift a portion of the
economic risk, in some cases, of providing outpatient healthcare to the provider
through the use of case rates and other alternative reimbursement methods. The
restructuring charge was comprised primarily of accruals for employee severance,
real property lease terminations and write-off of certain assets in geographic
markets which were being exited. The restructuring plan was substantially
completed during fiscal 1997.
Other Income (Expense). For fiscal 1996, other income and expense
consisted of (i) interest expense of $23.8 million incurred as a result of the
increase in long-term debt resulting from the 1995 Merger; (ii) merger expenses
of $4.0 million consisting primarily of professional and advisory fees; and
(iii) interest and other income of $2.8 million relating primarily from
investment earnings on the Company's short-term investments and restricted cash
balances.
Income Taxes. The Company recorded a benefit for income taxes during
fiscal 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 incurred prior to the commencement of
services 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 $1.8 million ($1.0 million
after taxes) in the first quarter of fiscal 1996 as a cumulative effect of a
change in accounting. The pro forma
46
<PAGE>
impact of this change for the year ended September 30, 1995 would be to increase
costs and expenses by $1.8 million ($1.0 after taxes). There was no pro forma
effect on periods prior to fiscal 1995. The effect of the change on fiscal 1996
cannot be reasonably estimated.
Liquidity and Capital Resources
General. For fiscal 1997, operating activities provided cash of $26.9
million, investing activities used cash of $62.1 million and financing
activities provided cash of $75.2 million, resulting in a net increase in cash
and cash equivalents of $40.0 million. Investing activities in fiscal 1997
consisted principally of (i) capital expenditures of $24.0 million related
primarily to the continued development of the Company's new information systems
and expansion of the National Service Center, (ii) payments totaling $35.2
million (net of cash acquired) for the acquisition of CMG, (iii) payments
totaling $2.6 million for funding under joint venture agreements, primarily with
Empire Community Delivery Systems, LLC and Community Sector Systems, Inc., and
(iv) expenditures of $4.1 million for the purchase of short-term investments
made to satisfy obligations under contracts held by the Company.
Acquisition. On September 12, 1997, the Company acquired all of the
outstanding capital stock of CMG for $48.7 million in cash and 739,358 shares of
the Company's common stock valued at $5.5 million. In addition, the Company
agreed to absorb certain expenses and other obligations of CMG totaling up to
$5.4 million. CMG is a Maryland-based national managed care company serving over
30 customers through a network consisting of approximately 7,600 providers in 34
states. CMG currently provides behavioral health managed care services to 2.5
million people under full risk capitation, ASO and other funding arrangements.
The clients include state and local governments, Blue Cross /Blue Shield
organizations, HMOs and insurance companies. As additional consideration for the
acquisition, the Company may be required to make certain future contingent cash
and stock payments over the next two years to the former shareholders of CMG
based upon the performance of certain CMG customer contracts. Such contingent
cash payments are subject to an aggregate maximum of $23.5 million. The
acquisition was accounted for using the purchase method. Accordingly, the
purchase price was allocated to assets acquired based on their estimated fair
values. This treatment resulted in approximately $64.7 million of cost in excess
of net tangible assets acquired as of September 30, 1997. Such excess is being
amortized on a straight line basis over periods ranging up to 40 years. The
inclusion of CMG from the date of acquisition did not have a significant impact
on the Company's results of operations.
Senior Indebtedness. As of September 30, 1997, $30.0 million of
revolving loans and $8.3 million of letters of credit were outstanding under the
revolving credit facility of the Company's Credit Agreement with The Chase
Manhattan Bank, N.A. (the "Senior Credit Facility"), and approximately $46.7
million was available for future borrowing.
Adjusted EBITDA. Adjusted EBITDA, a financial measure used in the
Senior Credit
47
<PAGE>
Facility and the Indenture, increased by $9.6 million, or 21.3%, to $54.7
million for fiscal 1997 from $45.1 million for 1996.
Cash in Claims Funds and Restricted Cash. As of September 30, 1997, the
Company had total cash, cash equivalents and investment balances of $95.2
million, of which $51.3 million was restricted under certain contractual,
fiduciary and regulatory requirements; moreover, of such amount, $3.7 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 September 30, 1997, the Company also held surplus cash balances,
classified as cash and cash equivalents and short-term marketable securities, as
required by the contracts held by the Company relating to Medicaid programs for
the States of Iowa and Montana and the TennCare Partners and Delaware County
Medicaid programs described above.
Availability of Cash. Prior to the 1995 Merger, the Company 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 currently and in the future expects to finance is
capital requirements through existing cash balances, cash generated from
operations and borrowings under the revolving credit facility of the Senior
Credit Facility. Based upon the current level of cash flow from operations and
anticipated growth, the Company believes that available cash, together with
available borrowings under the 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.
Pending Acquisition of MBC. On October 24, 1997, the Company and
Magellan signed the Magellan Merger Agreement, under which a subsidiary of
Magellan will merge into the Company. As a result of the Magellan Merger, the
Company will become a wholly owned subsidiary of Magellan. Under the terms of
the Magellan Merger Agreement, Magellan will purchase all of the Company's
outstanding stock and other equity interests for approximately $460 million in
cash and refinance the Company's existing debt. Completion of the Magellan
Merger is subject to a number of conditions, including Magellan's receipt of
financing for the transaction, the receipt of certain healthcare and insurance
regulatory approvals, and other conditions.
Item 8. Financial Statements and Supplementary Data
The financial statements of the Company set forth on pages F-1 through
F-23 hereof are incorporated herein by reference.
48
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None
PART III
- ---------------------------------------------------------------------------
Item 10. Directors and Executive Officers of the Registrant
Directors and Executive Officers
The following table sets forth certain information regarding MBC's
directors and executive officers:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
NAME AGE POSITION
- ----------------------------------------------------- ----------- -----------------------------------------
Albert S. Waxman, Ph.D.................... 57 Chairman and Chief Executive
Officer
Arthur H. Halper............................. 50 President and Chief Operating Officer
Henry R. Kravis............................... 53 Director
George R. Roberts........................... 54 Director
Edward A. Gilhuly........................... 38 Director
Todd A. Fisher................................. 32 Director
John A. Budnick, III.......................... 39 Executive Vice President and Chief
Financial Officer
John P. Docherty, M.D..................... 53 Executive Vice President and Chief
Medical Officer
Ronald D. Geraty, M.D..................... 51 Executive Vice President, New Business
Development and Director
Michael G. Lenahan, Esq.................. 38 Executive Vice President, Mergers &
Acquisitions, General Counsel and Secretary
David B. Stone.............................. 51 President, Employer & Union
Division
Richard C. Surles, Ph.D..................... 53 President, Advanced Clinical Delivery
Terry R. Thompson.......................... 39 Executive Vice President, Business
Operations and Director
</TABLE>
Albert S. Waxman, Ph.D. has served as Chief Executive Officer and as a Director
of MBC since its incorporation in March 1993. Dr. Waxman has served as Chairman
of the
49
<PAGE>
Board of Directors of MBC since December 1994 and served as Co-Chairman of the
Board of Directors of MBC from March 1993 until December 1994. Dr. Waxman also
served as President of MBC from March 1993 through December 1993. Dr. Waxman was
a co-founder of American Biodyne, Inc. ("American Biodyne"), which was acquired
by Medco Containment in 1992, and has served as its Chairman or Co-Chairman
since 1985, its Chief Executive Officer since December 1990, and also served as
its President from May 1990 until April 1993. Since January 1990, Dr. Waxman has
served as Chief Executive Officer of both Novatech Management Corporation and
Waxman Enterprises, private venture capital firms. Since June 1990, Dr. Waxman
has served as a member of the Board of Directors of Norland Corporation, a
medical device company in the osteoporosis field, and Oestech Inc., a medical
device company. Dr. Waxman founded Diasonics, Inc., a medical imaging company,
where he served as Chairman of the Board, Chief Executive Officer and President
from 1977 through 1987. Dr. Waxman holds Ph.D. and M.S. degrees in electrical
engineering from Princeton University, where he is a member of the advisory
council of the School of Engineering and Applied Sciences, and a B.S. degree in
electrical engineering from City College of New York.
Arthur H. Halper has served as a Director of MBC since May 1996 and as President
and Chief Operating Officer of MBC since August 1997. Mr. Halper served as
Executive Vice President and Chief Financial Officer of MBC from December 1994
to August 1997, Executive Vice President, Mergers and Acquisitions, of MBC from
November 1993 to December 1994 and Senior Vice President of Finance and
Treasurer of MBC from its incorporation in March 1993 through November 1993. Mr.
Halper has also served as Chief Financial Officer, Executive Vice President and
Treasurer of American Biodyne since December 1994, and served as a Senior Vice
President of American Biodyne from January 1994 to December 1994, as a Vice
President of American Biodyne from March 1993 to January 1994 and as Regional
Vice President of American Biodyne for the Mid-Atlantic Region from January 1992
through March 1993. Mr. Halper also has served as Chief Operating Officer of
AGCA, Inc. (acquired by American Biodyne in 1992) since November 1990. Mr.
Halper, a Certified Public Accountant, holds a B.A. degree in Business
Administration from Rutgers University.
Henry R. Kravis became a Director of MBC in October 1995. Mr. Kravis is a
Founding Partner of KKR and KKR Associates and is a managing member of the
Executive Committee of the limited liability company which serves as the General
Partner of KKR. Mr. Kravis is also a director of Amphenol Corporation, AutoZone,
Inc., Borden, Inc., Bruno's, Inc., Evenflo & Spalding Holdings Corp., The
Gillette Company, IDEX Corporation, KinderCare Learning Center, Inc., KSL
Recreation Group, Inc., Newsquest Capital PLC, Owens-Illinois, Inc.,
Owens-Illinois Group, Inc., Primedia Inc., Safeway Inc., Sotheby's Holdings
Inc., Union Texas Petroleum Holdings, Inc. and World Color Press, Inc.
George R. Roberts became a Director of MBC in October 1995. Mr. Roberts is a
Founding Partner of KKR and KKR Associates and is a managing member of the
Executive
50
<PAGE>
Committee of the limited liability company which serves as the General Partner
of KKR. Mr. Roberts is also a director of Amphenol Corporation, AutoZone, Inc.,
Borden, Inc., Bruno's, Inc., Evenflo & Spalding Holdings Corp., IDEX
Corporation, KinderCare Learning Center, Inc., KSL Recreation Group, Inc.,
Newsquest Capital PLC, Owens-Illinois, Inc., Owens-Illinois Group, Inc.,
Primedia Inc., Safeway Inc., Union Texas Petroleum Holdings, Inc. and World
Color Press, Inc.
Edward A. Gilhuly became a Director of MBC in October 1995. Mr. Gilhuly was a
General Partner of KKR from January 1995 until January 1996, when he became a
member of the limited liability company which serves as the General Partner of
KKR. Mr. Gilhuly is also a General Partner of KKR Associates and, prior to 1995,
was an Executive of KKR. Mr. Gilhuly is also a director of Doubletree
Corporation, Layne Christensen Company, Owens-Illinois, Inc., Owens-Illinois
Group, Inc. and Union Texas Petroleum Holdings, Inc.
Todd A. Fisher became a Director of MBC in October 1995. Mr. Fisher has been an
Executive of KKR since June 1993 and a Limited Partner of KKR Associates since
December 1993. From 1992 to June 1993, Mr. Fisher was an associate at Goldman,
Sachs & Co. Mr. Fisher is also a director of Layne Christensen Company.
John A. Budnick, III has served as Executive Vice President and Chief Financial
Officer of MBC since August 1997. Mr. Budnick served as Executive Vice
President, Finance from January 1997 to August 1997, Senior Vice President of
Finance from January 1995 to January 1997 and Vice President of Finance from
April 1994 to January 1995. Prior to joining MBC, Mr. Budnick worked in the
finance department of Medco Containment from September 1991 to April 1994. Mr.
Budnick, a Certified Public Accountant, holds a B.S.degree in Business
Administration from Georgetown University.
John P. Docherty, M.D. has served as Executive Vice President and Chief Medical
Officer of MBC since March 1997. Dr. Docherty previously served as the Chief of
the Psychosocial Treatments Research Branch of the National Institute of Mental
Health, and has held faculty positions with Yale University, Tufts University,
Harvard University and the University of California at Los Angeles. Dr. Docherty
founded Northeast Psychiatric Associates, P.C., a private psychiatric practice,
where he held the position of President and Executive Medical Director. He is
currently on the faculty of Cornell University Medical College and chairs the
National Institute on Drug Abuse (NIDA), Treatment Development and Review
Committee. Dr. Docherty holds an M.D. degree from the University of Pennsylvania
School of Medicine.
Ronald D. Geraty, M.D. has served as a Director of MBC since May 1996 and an
Executive Vice President of MBC since its incorporation in March 1993. Dr.
Geraty has also served as Senior Vice President, New Business Development of
American Biodyne since May 1992 and as Vice President of American Biodyne from
December 1991 to May 1992. He
51
<PAGE>
served as President of Assured Health Systems, Inc. (acquired by American
Biodyne in 1991) from September 1989 through May 1992. In addition, he is
currently an Instructor in Psychiatry at the Harvard Medical School. Dr. Geraty
holds an M.D. from the Loma Linda University School of Medicine, Loma Linda,
California and attended Columbia Union College in Washington, D.C.
Michael G. Lenahan, Esq. has served as Executive Vice President, Mergers &
Acquisitions of MBC since January 1996, Executive Vice President, General
Counsel and Secretary of MBC since November 1993, and General Counsel or
Executive Vice President, Legal of American Biodyne and each of MBC's other
subsidiaries (other than CMG and its subsidiaries) since January 1994. Mr.
Lenahan held the position of Vice President-Legal of Medco Containment from
March 1993 until August 1995. Prior thereto, Mr. Lenahan was an associate with
the New York law firm of Shearman & Sterling. Mr. Lenahan holds a J.D. degree
from New York University School of Law and a B.A. degree in Political Science
from the State University of New York at Binghamton.
David B. Stone has served as President, Employer and Union Division, of MBC
since August 1997, as Executive Vice President and Chief Marketing Officer of
MBC from June 1994 to August 1997 and as Senior Vice President of MBC from
January 1994 to June 1994. Mr. Stone also served as Vice President of MBC from
its incorporation in March 1993 to January 1994. Mr. Stone has served as
President of Personal Performance Consultants, Inc. ("PPC"), a subsidiary of
MBC, since August 1994 and served as Senior Vice President of Managed Care
Services and Chief Marketing Officer of PPC from June 1993 to August 1994. From
August 1988 to April 1992, Mr. Stone was Vice President of Sales and Marketing
for Preferred Health Care, Ltd. and Chief Marketing Officer of Empire Mental
Health Choice, a joint venture between Preferred Health Care Ltd. and Empire.
Mr. Stone holds an M.S.W. degree from the Columbia School of Social Work and an
M.B.A. degree from Pace University.
Richard C. Surles, Ph.D. has served as President, Advanced Clinical Delivery, of
MBC since August 1997 and Executive Vice President of MBC from November 1994 to
August 1997. Dr. Surles assumed the position of Executive Vice President,
Service System Development, of MBC in October 1995 and, from January 1996 to
August 1997, was Executive Vice President, Operations of MBC. Dr. Surles served
as the New York State Commissioner of Mental Health from October 1987 to
November 1994. Dr. Surles holds a Ph.D. degree in Administration and
Organizational Behavior from the University of North Carolina.
Terry R. Thompson served as a Director of MBC from October 1996 to October 1997
and as Executive Vice President, Business Operations of MBC from September 1996
to November 1997. Effective November 18, 1997, Mr. Thompson resigned all of his
positions and directorships with MBC and its subsidiaries.
Messrs. Kravis and Roberts are first cousins.
52
<PAGE>
Item 11. Executive Compensation
The following table sets forth in summary form all compensation for all
services rendered in all capacities to the Company paid or accrued during the
three fiscal years ended September 30, 1997 to the Chief Executive Officer of
the Company and the four other most highly compensated executive officers of the
Company (collectively, with the Chief Executive Officer, the "Named Executive
Officers"). Such table represents historical compensation and is not indicative
of future compensation to be received by the Named Executive Officers.
Historical Summary Compensation Table
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Long Term
Annual Compensation Compensation
Securities
Other Annual Underlying All Other
Named Executive Officer Year Salary Bonus Compensation MBC Options Compensation(1)
(#)
Albert S. Waxman, Ph.D. 1997 $558,750 --- --- --- ---
Chairman and 1996 435,000 $ 65,250 --- 2,800,000 ---
Chief Executive Officer 1995 405,417 70,000 --- --- ---
Terry R. Thompson 1997 350,000 --- --- --- ---
Executive Vice President, 1996 29,167 4,375 --- 350,000 ---
Business Operations
Arthur H. Halper 1997 331,250 --- --- 150,000 $3,000
President and 1996 250,000 37,500 --- 150,000 1,500
Chief Operating Officer 1995 210,000 20,625 --- --- 1,200
Ronald D. Geraty, M.D. 1997 275,000 --- --- --- 4,125
Executive Vice President, New 1996 275,000 41,250 --- 300,000 1,000
Business Development 1995 241,750 27,125 --- --- 800
Michael G. Lenahan 1997 262,750 50,000 --- 150,000 1,900
Executive Vice President, 1996 222,634 --- --- 150,000 950
Mergers and Acquisitions and 1995 79,000 --- --- --- ---
and General Counsel
- ----------------------
</TABLE>
(1) Represents the Company's matching contribution under the Merit Behavioral
Care Corporation 401(k) Plan.
53
<PAGE>
Options/SAR Grants in Fiscal 1997
The following table summarizes options to acquire shares of Common
Stock granted in fiscal 1997 to the Named Executive Officers.
<TABLE>
<CAPTION>
Individual Grants Potential Realizable Value
Number of % of Total of Assumed Annual Rates
Securities Options Granted Exercise of Stock Price Appreciation
Underlying to Employees Price Expiration for Option Term
Name Options Granted in Fiscal Year $/Share Date 5% 10%
<S> <C>
(#)
Albert S. Waxman --- --- --- --- --- ---
Ronald D. Geraty --- --- --- --- --- ---
Arthur H. Halper --- --- --- --- --- ---
Michael G. Lenahan 150,000 11.3% $ 7.50 8/31/2007 707,506 1,792,960
Terry R. Thompson --- --- --- --- --- ---
Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values
</TABLE>
The following table sets forth the number of shares covered by both
exercisable and unexercisable options to acquire shares of Common Stock held by
the Named Executive Officers as of September 30, 1997.
<TABLE>
<CAPTION>
Value of Unexercised
Number of Securities In the Money
Underlying Unexercised Options/SARs ptions/SARs at
at Fiscal Year End Fiscal Year End(1)
<S> <C> <C> <C> <C> <C> <C>
Shares
Acquired Value
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
(#)
Albert S. Waxman --- --- 560,000 2,240,000 --- ---
Ronald D. Geraty --- --- 60,000 240,000 --- ---
Arthur H. Halper --- --- 60,000 240,000 --- ---
Michael G. Lenahan --- --- 30,000 270,000 --- ---
Terry R. Thompson --- --- 70,000 280,000 --- ---
</TABLE>
- --------------
(1) Until such time there is a public market in which the Common Stock may be
traded, the value of such options is determined under a formula delineated
under the 1995 Option Plan. As of September 30, 1997, based on such
formula, no value was associated with such options.
54
<PAGE>
The following table sets forth the number of shares covered by both
exercisable and unexercisable options to acquire shares of common stock of Merck
held by the Named Executive Officers as of September 30, 1997.
<TABLE>
<CAPTION>
Value of Unexercised
Number of Securities In the Money
Underlying Unexercised Merck Options/SARs Merck Options/SARs
at Fiscal Year End at Fiscal Year End(1)
Shares
Acquired Value
<S> <C> <C> <C> <C> <C> <C>
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
(#) (#) (#)
Albert S. Waxman 10,000 $678,200 461,048 109,261 $36,244,716 $8,523,232
Ronald D. Geraty 12,100 649,260 --- --- --- ---
Arthur H. Halper 36,421 2,324,035 --- --- --- ---
Michael G. Lenahan 36,420 2,140,039 4,316 21,711 319,677 1,616,428
Terry R. Thompson --- --- --- --- --- ---
- ----------------
</TABLE>
(1) Values for "in-the-money" options represent the positive spread between the
respective exercise prices of outstanding options and $99.938, the value of
the common stock of Merck as of September 30, 1997, as reported on the New
York Stock Exchange Composite Tape.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of MBC's Board of Directors is comprised of Messrs.
Gilhuly and Fisher. Mr. Gilhuly is a member of the limited liability company
which serves as the General Partner of KKR and is also a General Partner of KKR
Associates. Mr. Fisher is an Executive of KKR and a Limited Partner of KKR
Associates. KKR Associates beneficially owned 71.4% of MBC's outstanding Common
Stock as of December 1, 1997. As a General Partner of KKR Associates, Mr.
Gilhuly may be deemed to share beneficial ownership of the Common Stock
beneficially owned by KKR Associates; however, Mr. Gilhuly disclaims any such
beneficial ownership.
Compensation of Directors
Each director who is not an employee of the Company receives an aggregate annual
fee of $25,000, payable in quarterly installments. Directors who are also
employees of the Company receive no remuneration for serving as directors.
Management Incentive Plan
The Board of Directors of MBC has adopted an Annual Incentive Plan for Key
Employees of MBC (the "Incentive Plan"). The Incentive Plan provides that each
fiscal year MBC senior management will designate as participants
("Participants") in the Incentive Plan those employees of MBC who are in a
position to significantly impact the performance of the Company. Participants
will be eligible to receive payments under the Incentive Plan equal to a
specified percentage of their base salaries if the Company attains certain
performance goals set by the Compensation Committee.
1995 Merit Stock Option Plan
In October 1995, MBC adopted the 1995 Stock Purchase and Option Plan for
Employees of Merit Behavioral Care Corporation and Subsidiaries (the "1995
Option Plan") providing for the issuance of up to
55
<PAGE>
8,561,000 shares of authorized but unissued or reacquired shares of Common
Stock, subject to adjustment to reflect certain events such as stock dividends,
stock splits, recapitalization, mergers or reorganizations of or by the Company.
The 1995 Option Plan is intended to assist the Company in attracting and
retaining employees of outstanding ability and to promote the identification of
their interests with those of the stockholders of the Company. The 1995 Option
Plan permits the issuance of Common Stock (the "Purchase Stock") and the grant
of Non-Qualified Stock Options (the "1995 Options") to purchase shares of Common
Stock (the issuance of Purchase Stock and the grant of Options pursuant to the
Plan being a "1995 Grant"). Unless sooner terminated by MBC's Board of
Directors, the 1995 Option Plan will expire on October 6, 2005. Such termination
will not affect the validity of any 1995 Grant outstanding on the date of
termination.
Each individual 1995 Option agreement provides that, upon certain events (each,
an "Acceleration Event"), the 1995 Options will become immediately exercisable.
The 1995 Option agreements provide that an Acceleration Event occurs if the
participant's employment with the Company is terminated by such participant for
"good reason" or by the Company without "cause" (each as defined in the MBC
Management Stockholder's Agreements (as defined)) within one year following
certain change in control events. The Magellan Merger Agreement provides that
the vesting of all 1995 Options will become accelerated upon consummation of the
Magellan Merger.
The 1995 Option Plan provides generally that the exercise price of 1995 Options
and the purchase price of any Common Stock granted for consideration will not be
less than 50% of the fair market value per share of Common Stock on the date of
such 1995 Grant. Each participant in the 1995 Option Plan is required to enter
into a stockholder's agreement with MBC substantially similar to the MBC
Management Stockholder's Agreements described below.
The Compensation Committee of MBC's Board of Directors administers the 1995
Option Plan, including, without limitation, the determination of the employees
to whom 1995 Grants will be made, the number of shares of Common Stock subject
to each 1995 Grant, and the various terms of such 1995 Grants. The Compensation
Committee of MBC's Board of Directors may from time to time amend the terms of
any 1995 Grant, but, except for adjustments made upon a change in the Common
Stock of the Company by reason of a stock split, spin-off, stock dividend, stock
combination or reclassification, recapitalization, reorganization,
consolidation, change of control, or similar event, such action shall not
adversely affect the rights of any participant under the 1995 Option Plan with
respect to the Purchase Stock and the 1995 Options without such participant's
consent. MBC's Board of Directors retains the right to amend, suspend or
terminate the 1995 Option Plan.
1996 Merit Stock Option Plan
In January 1996, MBC adopted the Merit Behavioral Care Corporation Employee
Stock Option Plan (the "1996 Option Plan") providing for the issuance of up to
1,000,000 shares of authorized but unissued or reacquired shares of Common
Stock, subject to adjustment to reflect certain events such as stock dividends,
stock splits, recapitalization, mergers or reorganizations of or by the Company.
The 1996 Option Plan is intended to provide incentive to employees of MBC to
remain in the employ of the Company and to increase their interest in the
success of the Company through the grant of stock options. Substantially all
full-time employees of MBC (other than those receiving 1995 Options) who
commenced employment with MBC prior to January 1, 1997 are eligible to
participate in the 1996 Option Plan. The 1996 Option Plan permits the grant of
Non-Qualified Stock Options (the "1996 Options") to purchase shares of Common
Stock (each such grant of 1996 Options being a "1996 Grant"). Unless sooner
terminated by the MBC Board of Directors, the 1996 Option Plan will expire on
January 1, 2006. Such termination will not affect the validity of any 1996 Grant
outstanding as the date of termination.
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<PAGE>
The Compensation Committee of the MBC Board of Directors administers the 1996
Plan, including, without limitation, the determination of employees to whom 1996
Grants will be made, the number of shares of Common Stock subject to each 1996
Grant, and the terms of such 1996 Grant. 1996 Grants to participants under the
1996 Option Plan are determined based on their length of service with the
Company, with reference to the following service categories: (a) less than one
year; (b) one to two years; (c) two to three years; and (d) greater than three
years. Each participant will be required to execute an agreement with MBC (a
"1996 Option Agreement") containing the following terms, among others: the
number of 1996 Options; the exercise price therefor; and the vesting schedule
for the 1996 Options. The MBC Board of Directors has reserved the right to amend
or terminate the 1996 Option Plan, provided that no such amendment or
termination may adversely affect the rights of participants in their 1996
Options.
The 1996 Option Agreements prohibit the participants from transferring 1996
Options, subject to enumerated exceptions. The 1996 Options are not exercisable
until after the date when at least 25% of the then outstanding shares of Common
Stock (on a fully diluted basis) have been sold in underwritten public offerings
under the Securities Act (the "Public Company Date") and, thereafter, only when
the shares of Common Stock underlying such 1996 Options have been registered
under the Securities Act and qualified under applicable state "blue sky" laws,
or MBC has determined that an exemption from such registration and "blue sky"
qualification is available. In addition, upon termination of the participant's
employment with MBC at any time, all unvested 1996 Options will be canceled and,
if such termination is for Cause (as defined in the 1996 Option Agreements), all
vested Options also will be canceled. If such employment is terminated prior to
the Public Company Date without Cause, MBC will have the right for three years
after such termination to require the participant to surrender for cancellation
all vested 1996 Options in exchange for a payment determined under the 1996
Option Plan. If such employment is terminated without Cause after the Public
Company Date, the participant's vested 1996 Options will remain exercisable for
90 days following such termination.
The Magellan Merger Agreement provides that the Board of Directors of MBC will
take such actions as are necessary to enable holders of 1996 Options to exercise
all of their outstanding 1996 Options upon consummation of the Magellan Merger.
Employment Agreements
Albert S. Waxman. American Biodyne has entered into an amended and restated
employment agreement, dated as of August 17, 1992 and amended as of October 1,
1993, with Albert S. Waxman. The agreement provides that Dr. Waxman will be
employed by American Biodyne for a period of five years and will receive a base
salary of $400,000 plus a yearly discretionary bonus. Such annual base salary
has been subsequently increased. American Biodyne may terminate the agreement
for cause or by mutual agreement with Dr. Waxman. Dr. Waxman may terminate the
agreement for good reason. If American Biodyne terminates the agreement for
reasons other than cause or if Dr. Waxman terminates the agreement for good
reason, Dr. Waxman will be entitled to (i) receive his base salary until the
earliest of five years, death or the occurrence of a circumstance that
constitutes cause or (ii) elect the employment status of Chairman Emeritus of
American Biodyne. Dr. Waxman has agreed that, subject to and upon consummation
of the Magellan Merger, he will become Chairman Emeritus of American Biodyne.
Michael G. Lenahan. The Company and Medco Containment have entered into an
employment agreement, dated as of February 1, 1995, with Michael G. Lenahan. The
agreement provides that Mr. Lenahan will be employed by the Company for a period
of three years and receive a base salary of $200,000 per year, plus a yearly
discretionary bonus and certain other fringe benefits. Such annual base salary
has been subsequently increased. Mr. Lenahan may terminate the agreement for
cause or upon a
57
<PAGE>
change of control of MBC. The Company may terminate the agreement for cause,
without cause upon 30 days' written notice or if Mr. Lenahan becomes disabled.
If Mr. Lenahan terminates the agreement or if the Company terminates the
agreement without cause, he is entitled to work for the Company as a consultant
for a period of one year and to be paid at the base compensation rate in effect
at the time of termination or, at his election, to assume a senior level
position in the legal department of Medco Containment. Mr. Lenahan's employment
agreement will terminate upon consummation of the Magellan Merger.
Richard C. Surles. The Company has entered into an employment agreement,
effective January 16, 1995, with Richard C. Surles. The agreement provides that
Dr. Surles will be employed by the Company for the period ending January 16,
1998 and receive (i) a minimum base salary of $250,000 per year, plus a yearly
discretionary bonus, (ii) loans in connection with his relocation and (iii) an
advance on his salary in the form of a loan of $25,000. The Company may
terminate the agreement for cause, if Dr. Surles becomes disabled or without
cause. Dr. Surles may terminate the agreement upon not less than six months'
written notice. If the Company terminates the agreement without cause, Dr.
Surles will be entitled to receive (i) his base compensation for the balance of
the term of the agreement (but in no event less than one year) and (ii)
insurance and medical benefits for the same term as base compensation is paid.
David B. Stone. The Company, American Biodyne and PPC have entered into a
management agreement, dated April 27, 1992 and amended as of April 30, 1993,
with David B. Stone. The agreement provides for an initial employment period
that ended on March 31, 1995, and has been automatically renewed according to
its terms until March 31, 1999. The agreement provides that Mr. Stone shall
receive a minimum base annual salary of $176,000, plus a discretionary bonus
based on targeted performance objectives, and certain other benefits. Such
annual base salary has been subsequently increased. Mr. Stone may terminate the
agreement for good reason and the Company may terminate the agreement for cause
or if Mr. Stone becomes disabled. If Mr. Stone terminates the agreement for good
reason or if the Company terminates the agreement for reasons other than for
cause, Mr. Stone will be entitled to compensation equal to the greater of (i)
his then current salary at the time of entering into the agreement for the
remainder of the term (up to two years) or (ii) his then current salary for a
period of one year.
John P. Docherty, M.D. The Company has entered into an employment agreement,
effective March 1, 1997, with John P. Docherty, M.D. The agreement provides that
during Dr. Docherty's employment with the Company he shall receive a minimum
base salary of $250,000 per year, plus a yearly discretionary bonus. The Company
may terminate the agreement for cause, if Dr. Docherty becomes disabled or
without cause. Dr. Docherty may terminate the agreement upon not less than
thirty days' written notice. If the Company terminates the agreement without
cause prior to March 1, 2000, Dr. Docherty will be entitled to receive his base
compensation for a defined period of time that is not less two years. If the
Company terminates the agreement without cause after March 1, 2000, Dr. Docherty
will be entitled to receive his base compensation for a defined period of time
that is not less one year. In either case, Dr. Docherty will be entitled to
receive insurance and medical benefits for the same term as base compensation is
paid.
Terry R. Thompson. The Company entered into an employment agreement, effective
as of September 3, 1996, with Terry R. Thompson. The agreement provided that Mr.
Thompson would receive a base salary of $350,000 per year during his employment
with the Company, plus a yearly discretionary bonus and certain other fringe
benefits. The Company and Mr. Thompson executed a separation agreement, dated
November 18, 1997, whereby Mr. Thompson resigned all officer and director
positions with the Company. Under the separation agreement, Mr. Thompson will be
paid, as severance compensation, his annual base salary through December 31,
1998. In
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addition, Mr. Thompson will retain the 100,000 shares of Common Stock he
purchased in 1996 and 140,000 of the 1995 Options granted to Mr. Thompson.
Severance Agreements
On October 6, 1995, the Company entered into severance agreements (collectively,
the "Severance Agreements") with Dr. Waxman, Dr. Geraty, Mr. Halper, Mr.
Lenahan, Mr. Stone and Dr. Surles. Each Severance Agreement provides that if,
prior to October 6, 2000, (i) the Company terminates employment of the
applicable officer for reasons other than for "cause" (as defined therein) or
(ii) the officer terminates employment on his own initiative for "good reason"
(as defined therein), such officer will be entitled, for a period of twelve
months, to be paid the excess, if any, of his base salary at the time of such
termination over any other payments made by the Company to such officer under
other employment or consulting agreements then in effect. In addition, Mr.
Budnick has a severance agreement with the Company that provides that he will be
entitled to one year of base compensation if his employment is terminated by the
Company other than for "cause".
Non-Competition Agreements
In connection with the execution of the Magellan Merger Agreement, each of Dr.
Waxman and Messrs. Halper, Lenahan and Budnick entered into a non-competition
agreements with Magellan and the Company (the "Non-Competition Agreements"). The
Non-Competition Agreements provide that, effective upon the consummation of the
Magellan Merger, the applicable executive will not compete against the Company
in the behavioral health managed care and EAP business for a period of three
years after the closing of the Magellan Merger. In consideration of entering
into such Non-Competition Agreement, each executive will receive payments
totaling two times his current base compensation, which payments will be in lieu
of any other severance consideration otherwise payable to such executive under
any employment, severance or other agreement to which the Company and such
executive are parties.
MBC Management Stockholder's Agreements
In connection with the 1995 Merger and from time to time thereafter, the Company
has entered into stockholder's agreements (each, an "MBC Management
Stockholder's Agreement") with all management employees and others that are
stockholders of MBC or holders of any 1995 Options (each, an "MBC Management
Stockholder"). Pursuant to each MBC Management Stockholder's Agreement, the MBC
Management Stockholder may not transfer any shares of Common Stock acquired
thereby or upon exercise of vested 1995 Options (collectively, the "Plan
Shares") within five years after the purchase date thereof, except as described
below and except (a) for certain transfers to family members, similar transfers
in the nature of estate planning and in connection with the loans described
under "Certain Relationships and Related Transactions," (b) pursuant to a
Qualified Public Offering (as defined therein), in which event only a stated
percentage of his Plan Shares becomes transferable or (c) pursuant to certain
sales of Common Stock by MBC Associates, L.P., an affiliate of KKR ("MBC
Associates"), in which event the MBC Management Stockholder is entitled to sell
a stated percentage of his Plan Shares. Each MBC Management Stockholder's
Agreement provides the MBC Management Stockholder with the right to (a) require
the Company to repurchase all of his Plan Shares and pay him a stated price for
cancellation of 1995 Options upon a Permitted Retirement (as defined therein),
death or disability, (b) until the later of
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five years after the purchase date or the first Qualified Public Offering, have
the Company register a stated percentage of his Plan Shares under the Securities
Act in connection with certain public offerings, and (c) prior to the fifth
anniversary of the first Public Offering (as defined therein), include a stated
percentage of his Plan Shares in any sale of Common Stock by MBC Associates or
an affiliate to any non-affiliated person (other than a Public Offering). Each
MBC Management Stockholder's Agreement also provides the Company with (a) prior
to a Public Offering, the right of first refusal to buy Plan Shares owned by
each MBC Management Stockholder on essentially the same terms and conditions as
such MBC Management Stockholder proposes in a sale of his Plan Shares to another
purchaser, (b) the right to repurchase all of the MBC Management Stockholder's
Plan Shares and pay him a stated price for cancellation of his 1995 Options upon
certain events, including termination of employment (with or without cause) or
an unpermitted transfer of Plan Shares and (c) prior to the fifth anniversary of
the first Public Offering, the right to require the MBC Management Stockholder
to sell a stated percentage of his Plan Shares in any sale of Common Stock by
MBC Associates or an affiliate to any non-affiliated person (other than a Public
Offering). Upon a "change of control" (as defined therein) of the Company, the
transfer restrictions, right of first refusal, and certain other rights with
respect to sale and repurchase of the Plan Shares and cancellation of 1995
Options as described above will lapse.
The repurchase price of the Plan Shares under the MBC Management Stockholder's
Agreements depends upon the nature of the event that triggers the repurchase and
whether such repurchase occurs at the election of the MBC Management Stockholder
or the Company. Generally, if the repurchase is at the participant's election,
the repurchase price per share will be the greater of the purchase price paid by
the MBC Management Stockholder (the "Plan Share Purchase Price") and the market
price; if the Common Stock is not then publicly traded, the repurchase price per
share will be the Plan Share Purchase Price plus the increase, if any, in book
value per share since the date of purchase of the Plan Shares.
Generally, if the repurchase is at the Company's election, the repurchase price
per share will be the lesser of (a) the market price and (b) the Plan Share
Purchase Price plus a stated percentage (the "Percentage") of the amount by
which the market price exceeds the Plan Share Purchase Price; if the Common
Stock is not then publicly traded, the repurchase price per share will be the
lesser of (a) the Base Value Per Share (as defined below) and (b) the Plan Share
Purchase Price, plus the Percentage multiplied by the increase, if any, in book
value per share since the date of the purchase of the Plan Shares. The
Percentage is 0% during the first year following the MBC Management
Stockholder's purchase of Plan Shares, and increases annually thereafter (up to
100%) in increments of 20%. The "Base Value Per Share" equals the Plan Share
Purchase Price per share plus the change (positive or negative) in book value
per share since the date of the purchase.
If the Company repurchases Plan Shares as described above, it also must pay the
MBC Management Stockholder the excess, if any, of the repurchase price applied
to the repurchase of Plan Shares, over the exercise prices of the applicable
1995 Options, multiplied by the number of Exercisable Option Shares. Each MBC
Management Stockholder's Agreement defines Exercisable Option Shares as shares
of Common Stock which, at the time of determination, could be purchased by the
MBC Management Stockholder upon exercise of his outstanding exercisable 1995
Options.
Certain MBC Management Stockholder's Agreements also contain noncompete
provisions, pursuant to which each MBC Management Stockholder has agreed, for
the term of his employment and one year thereafter, not to produce, sell or
distribute, directly or indirectly, any product or service sold or distributed
by the Company or its affiliated entities. The Company may extend the noncompete
period for one additional year by giving notice thereof and paying the MBC
Management Stockholder an amount equal to his annual base salary, calculated as
of the time of termination of employment (the "Noncompete Amount"). If the MBC
Management Stockholder's employment with the Company is terminated without
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"cause" or for "good reason" (each as defined therein), the noncompete
requirements will apply to the first year following termination of employment
only if the Company pays the MBC Management Stockholder the Noncompete Amount.
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Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information known to MBC as of
December 1, 1997 regarding the beneficial ownership of Common Stock by (i) all
persons who own beneficially more than 5% of the Common Stock, (ii) each
director of MBC, (iii) the Chief Executive Officer of MBC and each of the Named
Executive Officers and (iv) all directors and executive officers as a group.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Percentage
Number of of Common
Beneficial Owner Shares Stock
- ------------------------------------------------------------------- -------------------- -------------
KKR Associates(1)................................................... 21,000,000 71.4%
9 West 57th Street
New York, NY 10019
Merck & Co., Inc.(2).................................................. 4,262,800 14.5
One Merck Drive
Whitehouse Station, NJ 08889
The Albert S. Waxman Family
Charitable Remainder Unitrust(3)....................................... 1,000,000 3.4
Albert S. Waxman(4)........................................................ 1,055,100 3.6
Ronald D. Geraty(5)......................................................... 100,000 0.3
Terry R. Thompson(6)...................................................... 100,000 0.3
Arthur H. Halper(7)......................................................... 100,000 0.3
Michael G. Lenahan(8)...................................................... 100,000 0.3
All directors and executive officers as a group (9 persons)(9)............. 1,677,100 5.7
-------------------- ------------
Total................................................................... 27,939,900 95.0%
</TABLE>
(1) Shares of Common Stock shown as beneficially owned by KKR Associates are
held by MBC Associates and KKR Partners II, L.P. ("KKR Partners II"); KKR
Associates is the sole general partner of both MBC Associates and KKR Partners
II and possesses sole voting and investment power with respect to such shares.
KKR Associates is a limited partnership, the general partners of which are Henry
R. Kravis, George R. Roberts, Robert I. MacDonnell, Paul E. Raether, Michael W.
Michelson, Michael T. Tokarz, James H. Greene, Jr., Perry Golkin, Clifton S.
Robbins, Scott M. Stuart and Edward A. Gilhuly. Messrs. Kravis, Roberts and
Gilhuly are also directors of the Company. Such individuals may be deemed to
share beneficial ownership of the shares shown as beneficially owned by KKR
Associates. Such individuals disclaim beneficial ownership of any such shares.
(2) Represents shares held by Medco Holdings Corp., a subsidiary of Medco
Containment, which is a wholly owned subsidiary of Merck.
(3) Represents shares held by The Albert S. Waxman Family Charitable Remainder
Unitrust, of which Albert S. Waxman is trustee. As trustee, Dr. Waxman may be
deemed to have beneficial ownership of the shares shown as beneficially owned by
such trust. Dr. Waxman disclaims beneficial ownership of any such shares.
(4) Does not include options to acquire 1,120,000 shares of Common Stock that
are exercisable within 60 days of the date hereof.
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(5) Does not include options to acquire 120,000 shares of Common Stock that are
exercisable within 60 days of the date hereof.
(6) Does not include options to acquire 140,000 shares of Common Stock that are
exercisable within 60 days of the date hereof.
(7) Does not include options to acquire 120,000 shares of Common Stock that are
exercisable within 60 days of the date hereof.
(8) Does not include options to acquire 60,000 shares of Common Stock that are
exercisable within 60 days of the date hereof.
(9) Does not include options to acquire 1,707,200 shares of Common Stock in the
aggregate that are exercisable within 60 days of the date hereof.
Item 13. Certain Relationships and Related Transactions
Transactions with KKR. KKR Associates beneficially owned 71.4% of MBC's
outstanding Common Stock as of December 1, 1997. Messrs. Kravis, Roberts and
Gilhuly, directors of the Company, are members of the limited liability company
which serves as the General Partner of KKR and also are General Partners of KKR
Associates. Mr. Fisher, also a director of the Company, is an executive of KKR
and a Limited Partner of KKR Associates. KKR, an affiliate of KKR Associates,
received a fee of $5.5 million for negotiating the 1995 Merger and arranging the
financing therefor and, from time to time in the future, KKR may receive
customary investment banking fees for services rendered to the Company in
connection with divestitures, acquisitions and certain other transactions. In
addition, KKR renders management, consulting and financial services to the
Company. During fiscal 1997 and 1996, KKR received $500,000 and $400,000,
respectively, in fees for such services. Executives of KKR who also serve as
directors of the Company receive customary directors' fees. Upon consummation of
the Magellan Merger, KKR will receive a financial advisory fee from MBC of $5.0
million.
In connection with the 1995 Merger, the Company incurred $75.0 million
of subordinated indebtedness under the Bridge Loan provided by MBC Associates,
the general partner of which is KKR Associates. A portion of the net proceeds
from the offering of the Private Notes in November 1995 (which were subsequently
exchanged for the Notes) was applied to repay all indebtedness outstanding under
the Bridge Loan (including accrued interest).
MBC Associates and KKR Partners II (collectively, the "KKR Investors")
have the right, under certain circumstances and subject to certain conditions,
to require the Company to register under the Securities Act shares of Common
Stock held by them pursuant to a registration rights agreement entered into in
connection with the 1995 Merger and certain stockholders' agreements. Such
registration rights will generally be available to the KKR Investors until
registration under the Securities Act is no longer required to enable them to
resell the Common Stock owned by them. Such registration rights agreement
provides, among other things, that the Company will pay all expenses in
connection with the first six registrations requested by the KKR Investors and
in connection with any registration commenced by the Company as a primary
offering. In addition, other stockholders besides the KKR Investors, including
the MBC Management Stockholders and Medco Containment, will be allowed to
participate in any registration process, subject to certain conditions and
exceptions.
Transactions with Management. In connection with the 1995 Merger,
certain MBC Management Stockholders borrowed all or a portion of the purchase
price for the Plan Shares acquired by them pursuant to
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their respective MBC Management Stockholder's Agreements. Dr. Waxman borrowed
$5.0 million; Dr. Surles borrowed $200,000; Dr. Geraty borrowed $250,000; Mr.
Stone borrowed $250,000; and Mr. Morlan, the Company's former Executive Vice
President and Chief Information Officer, borrowed $100,000. In addition, in
connection with their purchases of Common Stock, Mr. Thompson, Mr. Halper, Mr.
Budnick, Mr. Lenahan and Dr. Docherty borrowed $500,000, $250,000, $375,000,
$375,000 and $80,000, respectively. All such borrowings are evidenced by
promissory notes from the applicable MBC Management Stockholder and are secured
by a pledge of such MBC Management Stockholder's Plan Shares. Each promissory
note provides for the payment of interest at a rate of 6.5% per annum. The
promissory notes of Dr. Waxman, Dr. Surles, Mr. Thompson, Mr. Halper, Mr.
Budnick and Dr. Docherty mature on December 31, 2000. In connection with Mr.
Morlan's separation from the Company, the Company acquired Mr. Morlan's shares
of Common Stock. As part of such transaction, the Company cancelled Mr. Morlan's
promissory note. Mr. Stone repaid his loan in November 1995, Dr. Geraty repaid
his loan in October 1996 and Mr. Lenahan repaid his loan in October 1997. Upon
consummation of the Magellan Merger, all such outstanding loans will be repaid
in full.
Dr. Waxman owns all of the shares of LNY Corp., a limited partner of 38
Newbury Ventures/MBC Limited Partnership ("38 Newbury"). In connection with the
1995 Merger, the Company entered into a Stock Purchase and Stockholder's
Agreement (the "38 Newbury Stockholder's Agreement"), dated as of October 6,
1995, with 38 Newbury and MBC Associates. Pursuant to the 38 Newbury
Stockholder's Agreement, 38 Newbury purchased 600,000 shares of Common Stock for
$3.0 million. The 38 Newbury Stockholder's Agreement provides the Company with
the right of first refusal to purchase shares of Common Stock on the same terms
and conditions as are proposed by a third party offer at any time prior to a
Public Offering (as defined therein). Also under the 38 Newbury Stockholder's
Agreement, at any time prior to the fifth anniversary of the first Public
Offering, (i) MBC Associates may require 38 Newbury to include a pro rata
portion of its shares of Common Stock in any sale by MBC Associates of its
holdings of Common Stock and (ii) 38 Newbury has the option to include a pro
rata portion of its shares in any sale by MBC Associates of its holdings of
Common Stock. The 38 Newbury Stockholder's Agreement further provides that, upon
the later of the first Public Offering and the fifth anniversary of the Stock
Closing (as defined therein), the parties will be bound by certain provisions of
the registration rights agreement discussed above between the Company and the
KKR Investors.
Transactions with Merck and Medco Containment. In connection with the
1995 Merger, the Company entered into a stockholders' agreement (the "Medco
Stockholders' Agreement") with the KKR Investors and Medco Containment (together
with the KKR Investors, the "Stockholders").
Pursuant to the Medco Stockholders' Agreement, Medco Containment has
the right to include a pro rata portion of its shares of Common Stock in any
proposed transfer of KKR Investors' Common Stock (other than to affiliates of
the KKR Investors) at the same price per share and upon the same terms and
conditions as such shares of KKR Investors' Common Stock would be sold to the
proposed transferee. The Medco Stockholders' Agreement also provides the KKR
Investors with the right to require Medco Containment to sell all of its shares
of Common Stock in a proposed transfer by the KKR Investors of 100% of the KKR
Investors' Common Stock.
Medco Containment will have the right, on two occasions following the
earlier to occur of (i) 180 days after the initial public offering of Common
Stock and (ii) five years from the closing date of the 1995 Merger, to cause the
Company to file a registration statement in connection with the sale of shares
of Common Stock held by Medco Containment. The Company has agreed to pay certain
expenses of such offerings. The Stockholders will, upon request, execute 180 day
market stand-off agreements in connection with the initial public offering of
Common Stock, if so requested by the underwriters for such an initial public
offering.
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After the Company's initial public offering, each time the Company
files a registration statement (other than on Form S-4 or S-8) in connection
with a sale of shares of Common Stock by the Company, the KKR Investors or any
of their respective Affiliates (as defined therein), the Company, at the request
of Medco Containment, will use its reasonable efforts to effect the registration
of all shares of Common Stock owned by Medco Containment that the Company has
been so requested to register by Medco Containment. In the event that the
managing underwriter or underwriters determines that a proposed offering
including shares of Medco Containment and the KKR Investors exceeds the number
of shares of Common Stock that can be sold without having a significant adverse
effect on such offering or that inclusion of such Stockholders' shares would
significantly and adversely affect the offering, the number of shares held by
the KKR Investors and Medco Containment, if any, to be registered shall be in
proportion to the relative sizes of their holdings of Common Stock.
In certain circumstances, including the issuance of Common Stock by the
Company to Affiliates of the KKR Investors, Medco Containment will have the
right to subscribe for and purchase additional shares of Common Stock at the
same price and upon the same terms and conditions so as to enable Medco
Containment to maintain its percentage of ownership of shares of Common Stock as
of the time of the Company's proposal to issue shares of Common Stock. In
addition, Medco Containment has the right to designate a person to observe all
Board of Directors' meetings and to approve certain transactions with affiliates
(other than transactions as to which no approval of institutional lenders is
required).
Pursuant to the 1995 Merger Agreement, Medco Containment agreed to
abide by a confidentiality provision relating to all information it possesses
regarding the Company. A portion of the purchase price for the Company was
allocated to the consideration paid to Merck in connection with the 1995 Merger.
In the ordinary course of business, the Company provides EAP services
to certain divisions of Merck and behavioral health managed care services to
Medco Containment.
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<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
PART IV
- --------------------------------------------------------------------------
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(1) Financial Statements. See accompanying Index to Financial Statements and Financial Statement
Schedules on page F-1.
(2) Financial Statement Schedules. See accompanying Index to Financial Statements and Financial
Statement Schedules on page F-1.
(3) Exhibits (Numbered in accordance with Item 601 of Regulation S-K).
Exhibit Sequentially
Number Description Numbered Pages
- ----------- ---------------------------------------------------------------------- --------------------
2.1 Agreement and Plan of Merger, dated as of June 30, 1995,
among Medco Containment Services, Inc., Medco Behavioral *
Care Corporation and MDC Acquisition Corp.
2.2 Amendment to Agreement and Plan of Merger, dated as of
October 6, 1995, among Medco Containment Services, Inc., *
Medco Behavioral Care Corporation and MDC Acquisition Corp.
2.3 Agreement and Plan of Merger by and among Merit Behavioral Care *
Corporation, Merit Merger Corp., and CMG Health, Inc. dated as of
July 14, 1997.
2.4 Form of Stockholder Support Agreement by and between Humana, Inc. *
in favor of Merit Behavioral Care Corporation, Merit Merger Corp., and
CMG Health, Inc. dated as of July 14, 1997.
2.5 Form of Stockholder Support Agreement, by and between and *
individual in favor of Merit Behavioral Care Corporation,
Merit Merger Corp., and CMG Health, Inc.
dated as of July 14, 1997.
2.6 Agreement and Plan of Merger, dated as of October 24, 1997, among *
Merit Behavioral Care Corporation, Magellan Health Services, Inc.
and MBC Merger Corporation.
2.7 Stockholder Support Agreement, dated as of October 24, 1997, by MBC **
Associates, L.P., KKR Partners II, L.P., 38 Newbury Ventures/MBC Limited
Partnership, Albert S. Waxman and the Albert S. Waxman Family Charitable
Remainder Unitrust to and for the benefit of Magellan Health Services, Inc.
2.8 Form of Non-Competition Agreement, dated as of October 24,
1997, among Magellan Health Services, Inc., MBC and certain **
key individual employees of MBC.
3.1 Certificate of Incorporation, as amended, of Merit Behavioral *
Care Corporation.
3.2 Certificate of Merger. *
3.3 By-Laws of Merit Behavioral Care Corporation. *
4.1 Indenture, dated as of November 22, 1995, between Merit
Behavioral Care Corporation and Marine Midland Bank, as trustee, *
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relating to $100,000,000 aggregate principal amount of 11 1/2% *
Senior Subordinated Notes due 2005.
4.2 Registration Rights Agreement, dated as of November 17, 1995,
among Merit Behavioral Care Corporation, BT Securities Corporation,
Chase Securities, Inc., Morgan Stanley & Co. Incorporated and *
Smith Barney Inc.
4.3 Specimen Form of 11 1/2% Senior Subordinated Notes due 2005 *
(included as part of Exhibit 4.1)
4.4 Specimen Form of 11 1/2% Senior Subordinated Notes due 2005 *
(included as part of Exhibit 4.1 hereto)
10.1 Credit Agreement, dated as of October 6, 1995, among Medco
Behavioral Care Corporation, Chase Manhattan Bank, N.A., as *
agent and the various lending institutions parties thereto.
10.2 First Amendment to Credit Agreement, dated as of October 6, 1995,
among Merit Behavioral Care Corporation, Chase Manhattan Bank, *
N.A., as agent, Bankers Trust Company, as documentation agent and
the various lending institutions party thereto.
10.3 Second Amendment to Credit Agreement, dated as of December 1,
1995, among Merit Behavioral Care Corporation, Chase Manhattan *
Bank, N.A., as agent, and the various lending institutions and
New Banks (as defined) party thereto.
10.4 Purchase Agreement, dated as of November 17, 1995, among
Merit Behavioral Care Corporation, BT Securities Corporation, *
Chase Securities, Inc., Morgan Stanley & Co. Incorporated
and Smith Barney Inc.
10.5 Sub-Sublease Agreement, dated as of August 17, 1993, between
Electronic Data Systems Corporation and Medco Behavioral *
Care Systems Corporation.
10.6 Lease with respect to the corporate headquarters in
Park Ridge, New Jersey. *
10.7 Agreement for the License/Sublicense of Computer Software
Products and the Purchase of Computer Equipment, dated as of *
April 28, 1993, between American International Healthcare, Inc. (now *
Amisys, Inc.) and Medco Behavioral Care Systems Corporation.
10.8 1995 Stock Purchase and Option Plan for Employees of Merit *
Behavioral Care Corporation and Subsidiaries.
10.9 Management Incentive Plan. *
10.9.1 1996 Merit Behavioral Care Corporation Employee Stock Option Plan. *
10.10 Stockholder's Agreement, dated as of October 6, 1995, among
Medco Behavioral Care Corporation, Albert S. Waxman and *
MBC Associates, L.P.
10.10.1 Non-Qualified Stock Option Agreement, dated as of October 6, 1995, *
between Medco Behavioral Care Corporation and Albert S. Waxman
10.11 Stockholder's Agreement, dated as of October 6, 1995, among Medco
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Behavioral Care Corporation, Albert S. Waxman Family Charitable *
Remainder Unitrust, Albert S. Waxman and MBC Associates, L.P.
10.12 Stock Purchase and Stockholder's Agreement, dated as of October 6,
1995, among Medco Behavioral Care Corporation, 38 Newbury *
Ventures/MBC Limited Partnership and MBC Associates, L.P.
10.13 Amended and Restated Employment Agreement, dated as of August
17, 1992, between American Biodyne, Inc. and Albert S. Waxman (the
"Waxman Employment Agreement.")
10.14 Amendment to the Waxman Employment Agreement, dated as of *
October 1, 1993.
10.16 Employment Agreement, dated as of February 1, 1995, among Medco *
Behavioral Care Corporation, Medco Containment Services, Inc.
and Michael G. Lenahan.
10.17 Employment Agreement, dated as of January 18, 1996, between Merit *
Behavioral Care Corporation and Richard C. Surles.
10.18 Management Agreement, dated as of April 27, 1992, between American
Biodyne, Inc. and David B. Stone (the "Stone Management Agreement"). *
10.19 Amendment to the Stone Management Agreement, dated as of
April 30, 1993, among American Biodyne, Inc., Medco Behavioral *
Care Corporation, Personal Performance Consultants, Inc. and
David B. Stone.
10.21 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and Ron Geraty.
10.22 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and Arthur Halper.
10.24 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and Michael G. Lenahan.
10.25 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and Dennis Moody.
10.26 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and David B. Stone.
10.27 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and Richard C. Surles.
10.28 Severance Agreement, dated as of October 6, 1995, between Medco *
Behavioral Care Corporation and Albert S. Waxman.
10.29 Registration Rights Agreement, dated as of October 6, 1995, among *
MDC Acquisition Corp., MBC Associates, L.P. and KKR Partners II, L.P.
10.30 Stockholders' Agreement, dated as of October 6, 1995, among
Medco Behavioral Care Corporation, MBC Associates, L.P., KKR *
Partners II, L.P. and Medco Containment Services, Inc.
10.31 Amisys Implementation and Systems Integration Services Agreement
between Perot Systems Corporation and Merit Behavioral Care *
Corporation, effective as of January 12, 1996 (confidential
treatment requested)
68
<PAGE>
10.32 Lease Agreement dated as of August 14, 1991 between Cooke *
Properties, Inc. and Empire Blue Cross and Blue Shield
10.33 Assignment and Assumption of Lease dated as of May 31, 1996 between
Empire Blue Cross and Blue Shield and Merit Behavioral
Care Corporation *
10.34 First Supplemental Agreement, dated as of May 31, 1996 between
Chrysler Properties Inc. (formerly, Cooke Properties, Inc.) and *
Merit Behavioral Care Corporation
10.35 Second Supplemental Agreement, dated as of October 1, 1996 between
Chrysler Properties Inc. and Merit Behavioral Care Corporation *
10.36 First Amendment to Lease Agreement, dated as of July 1, 1996 with
respect to corporate headquarters in Park Ridge, New Jersey by and *
between Sartak Holdings, Inc. and Merit Behavioral Care Corporation
10.37 Employment Agreement, dated as of September 3, 1996, between *
Merit Behavioral Care Corporation and Terry R. Thompson.
10.38 Employment and Consulting Agreement by and between CMG Health, Inc.,
and Alan J. Shusterman dated July 14, 1997. *
10.39 Letter Agreement by and between Douglass A. Kay, M.D. and CMG Health, Inc.
and Merit Behavioral Care Corporation. *
10.40 Employment Agreement by and between the Company and John P. Docherty,
M.D., dated as of November 26, 1996. **
25.1 Statement of Eligibility and Qualification (Form T-1) under the Trust *
Indenture Act of 1939 of Marine Midland Bank.
27.1 Financial Data Schedule (electronic filing only). **
----------------------
* Filed previously.
** Filed herewith.
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
(4) Reports on Form 8-K.
1. Current Report on Form 8-K filed July 18, 1997 related to the Company's agreement to acquire
CMG Health, Inc.
2. Current Report on Form 8-K filed July 29, 1997 related to the Company's corporate restructuring.
3. Current Report on Form 8-K filed September 17, 1997 related to the closing of the acquisition of
CMG Health, Inc.
4. Current Report on Form 8-K filed October 29, 1997 related to Magellan Health Services, Inc.
agreement to acquire the Company.
69
<PAGE>
5. Current Report on Form 8-K filed November 19, 1997
related to the Company's Management's Discussion and
Analysis of Financial Condition and Results of
Operations and Audited Financial Statements also
filed as part of this Annual Report on Form 10-K.
</TABLE>
70
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
MERIT BEHAVIORAL CARE CORPORATION
By: /s/ Albert S. Waxman, Ph.D.
Albert S. Waxman, Ph.D.
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this Report on Form 10-K has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Signature Title Date
/s/ Albert S. Waxman, Ph.D. Chairman and Chief December 29, 1997
Albert S. Waxman, Ph.D. Executive Officer
/s/ Arthur H. Halper President, December 29, 1997
Arthur H. Halper Chief Operating Officer
and Director
/s/ Ronald D. Geraty Executive Vice President, December 29, 1997
Ronald D. Geraty New Business Development
and Director
/s/ Henry R. Kravis Director December 29, 1997
Henry R. Kravis
/s/ George R. Roberts Director December 29, 1997
George R. Roberts
/s/ Edward A. Gilhuly Director December 29, 1997
Edward A. Gilhuly
/s/ Todd A. Fisher Director December 29, 1997
Todd A. Fisher
</TABLE>
71
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
INDEX TO FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
Financial Statements
Independents Auditors' Report......................................... F-1
Consolidated Balance Sheets........................................... F-2
Consolidated Statements of Operations.............................. F-3
Consolidated Statements of Stockholders' Equity.................. F-4
Consolidated Statements of Cash Flows............................. F-5
Notes to Consolidated Financial Statements........................ F-6
</TABLE>
Financial Statement Schedules
All schedules for which provision is made in the applicable
regulations of the Securities and Exchange Commission are omitted because they
are not required under the related instructions or are not applicable or the
required information is shown in the Consolidated Financial Statements or the
notes thereto.
To the Board of Directors
Merit Behavioral Care Corporation
We have audited the accompanying consolidated balance sheets of Merit Behavioral
Care Corporation (the "Company") as of September 30, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended September 30, 1997. 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 audits 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 opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Merit Behavioral Care
Corporation as of September 30, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended September 30,
1997, in conformity with generally accepted accounting principles.
As discussed in Note 4 to the financial statements, effective October 1, 1995,
the Company changed its method of accounting for deferred contract start-up
costs related to new contracts or expansion of existing contracts.
/s/ Deloitte & Touche
Deloitte & Touche
November 12, 1997
New York, New York
<PAGE>
<TABLE>
<CAPTION>
MERIT BEHAVIORAL CARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
September 30,
<S> <C> <C>
1997 1996
ASSETS
Current Assets:
Cash and cash equivalents.............................................. $ 87,368 $ 47,375
Accounts receivable, net of allowance for doubtful accounts of $2,603
and $1,996............................................................ 41,884 28,383
Short-term marketable securities....................................... 4,111 ---
Deferred income taxes.................................................. 6,616 2,296
Other current assets.................................................. 13,129 2,481
Total current assets............................................... 153,108 80,535
Property, plant and equipment, net..................................... 83,312 67,880
Goodwill and other intangibles, net of accumulated amortization of
$82,637 and $59,781............................................... 195,192 162,849
Restricted cash and investments........................................ 3,727 5,668
Deferred financing costs, net of accumulated amortization of $2,484
and $1,142........................................................ 10,634 11,362
Other assets........................................................... 22,772 16,507
Total assets........................................................... $468,745 $344,801
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable....................................................... $ 11,347 $ 5,888
Claims payable........................................................ 102,834 57,611
Deferred revenue....................................................... 8,131 6,577
Accrued interest....................................................... 5,161 5,008
Current portion of long-term debt...................................... 6,498 500
Other current liabilities.............................................. 18,386 13,079
Total current liabilities........................................ 152,357 88,663
Long-term debt......................................................... 323,002 253,500
Deferred income taxes.................................................. 15,388 30,669
Other long-term liabilities............................................ 3,862 1,451
Commitments and Contingencies (See Note 11)
Stockholders' Equity:
Common stock (40,000,000 shares authorized, $0.01 par value,
29,396,158 and 28,398,800 shares issued)............................ 294 284
Additional paid in capital............................................. 8,949 (9,756)
Accumulated deficit.................................................... (28,307) (14,435)
Notes receivable from officers......................................... (6,800) (5,470)
(25,864) (29,377)
Less common stock in treasury (21,000 shares)......................... --- (105)
Total stockholders' equity.......................................... (25,864) (29,482)
Total liabilities and stockholders' equity............................. $468,745 $344,801
The accompanying notes are an integral part of these
statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
MERIT BEHAVIORAL CARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30,
(dollars in thousands)
<S> <C> <C> <C>
1997 1996 1995
Revenue..................................... $555,717 $457,830 $361,549
Expenses:
Direct service costs...................... 449,563 361,684 286,001
Selling, general and administrative....... 67,450 64,523 49,823
Amortization of intangibles............... 26,897 25,869 21,373
Restructuring charge...................... --- 2,995 ---
543,910 455,071 357,197
Operating income............................ 11,807 2,759 4,352
Other income (expense):
Interest income and other................. 3,497 2,838 1,498
Interest expense.......................... (25,063) (23,826) ---
Loss on disposal of subsidiary............ (6,925) --- ---
Merger costs and special charges.......... (1,314) (3,972) ---
(29,805) (24,960) 1,498
(Loss) income before income taxes and
cumulative effect of accounting change.. (17,998) (22,201) 5,850
(Benefit) provision for income taxes........ (4,126) (5,332) 4,521
(Loss) income before cumulative effect
of accounting change...................... (13,872) (16,869) 1,329
Cumulative effect of accounting change
for deferred contract start-up costs, net
of tax benefit of $757.................... --- (1,012) ---
Net (loss) income........................... $ (13,872) $ (17,881) $ 1,329
Pro forma net (loss) income assuming the new method of accounting for deferred
contract start-up costs was applied
retroactively............................. $ (13,872) $ (16,869) $ 317
The accompanying notes are an integral part of
these statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
MERIT BEHAVIORAL CARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands)
Retained Earnings Notes
Common Stock Additional (Accumulated Receivable Common Stock
<S> <C> <C> <C> <C> <C> <C>
Shares Amount Paid In Capital Deficit) from Officers in Treasury
Balance September 30, 1994.................. 1,000,000$ 10 $ 118,877 $ 2,117 $ --- $
Net income.................................. --- --- --- 1,329 --- ---
---
Balance September 30, 1995.................. 1,000,000 10 118,877 3,446 --- ---
Recapitalization from merger:
Redemption of common stock................ (915,754) (9) (258,129) --- --- ---
Merger with MDC Acquisition Corp.......... 415,023 4 104,996 --- --- ---
Stock dividend............................ 24,763,531 247 (247) --- --- ---
Issuance of stock to management........... 3,156,000 32 15,748 --- (5,800) ---
Deferred taxes associated with merger..... --- --- 7,594 --- --- ---
Tax benefit from exercise of Merck
stock options............................. --- --- 1,505 --- --- ---
Repayment of notes receivable............... --- --- --- --- 265 ---
Cancellation of note receivable............. (20,000) --- (100) --- 100 ---
Repurchase of common stock.................. --- --- --- --- --- (600)
Sale of common stock........................ --- --- --- --- (35) 495
Net loss.................................... --- --- --- (17,881 --- ---
Balance September 30, 1996.................. 28,398,800 284 (9,756) (14,435) (5,470) (105)
Issuance of stock for CMG acquisition....... 739,358 7 5,538 --- --- ---
Tax benefit from exercise of Merck
stock options........................... --- --- 11,630 --- --- ---
Repayment of notes receivable............... --- --- --- --- 250 ---
Repurchase of common stock.................. --- --- --- --- --- (30)
Sale of common stock........................ 258,000 3 1,537 --- (1,580) 135
Net loss.................................... --- --- --- (13,872) --- ---
Balance September 30, 1997.................. 29,396,158 $ 294 $ 8,949 $(28,307) $ (6,800) $ ---
The accompanying notes are an integral part of
these statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
MERIT BEHAVIORAL CARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30,
(dollars in thousands)
<S> <C> <C> <C>
1997 1996 1995
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net (loss) income................................ $(13,872) $(17,881) $ 1,329
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Loss on sale of subsidiary..................... 6,925 --- ---
Cumulative effect of accounting change......... --- 1,012 ---
Depreciation and amortization.................. 39,400 36,527 28,150
Amortization of deferred financing costs....... 1,342 1,142 ---
Deferred taxes and other....................... (4,409) (6,068) 379
Restructuring charge........................... --- 2,995 ---
Changes in operating assets and liabilities, net of the effect of acquisitions:
Accounts receivable............................ (9,781) 265 (8,545)
Other current assets........................... (2,854) 536 (995)
Deferred contract start-up costs.............. (6,067) (4,816) (6,231)
Accounts payable and accrued liabilities...... 16,224 14,864 11,982
Net cash provided by operating activities........ 26,908 28,576 26,069
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchases of property, plant and equipment..... (23,951) (23,808) (31,529)
Cash used for acquisitions, net of cash
acquired................................... (35,645) (12,676) (9,580)
Investments in and advances to joint ventures.. (2,595) (2,931) (14,860)
Repayments of advances from joint ventures..... 675 420 ---
Sales (purchases) of marketable securities..... (4,111) 1,143 3,533
Long-term restrictions removed from
(placed on) cash............................ 1,941 (2,183) (211)
Change in non-current assets and other.......... 1,558 (1,282) (1,503)
Net cash used for investing activities.......... (62,128) (41,317) (54,150)
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from capital contribution............. --- 114,980 ---
Borrowings from parent......................... --- --- 32,882
Proceeds from bridge loan...................... --- 75,000 ---
Proceeds from revolving credit facility........ 187,500 163,500 ---
Proceeds from senior term loans................ 80,000 120,000 ---
Proceeds from sale of notes.................... --- 100,000 ---
Redemption of common stock..................... --- (258,138) ---
Repayment of due to parent..................... --- (67,878) ---
Repayment of bridge loan....................... --- (75,000) ---
Repayment of senior term loans................. (500) --- ---
Repayment of revolving credit facility......... (191,500) (129,500) ---
Payment of financing costs..................... (602) (12,504) ---
Other.......................................... 315 125 ---
Net cash provided by financing activities...... 75,213 30,585 32,882
INCREASE IN CASH AND
CASH EQUIVALENTS............................... 39,993 17,844 4,801
Cash and cash equivalents at beginning
of year........................................ 47,375 29,531 24,730
CASH AND CASH EQUIVALENTS AT
END OF YEAR.................................... $ 87,368 $ 47,375 $29,531
The accompanying notes are an integral part of
these statements.
</TABLE>
<PAGE>
MERIT BEHAVIORAL CARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
MERIT BEHAVIORAL CARE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997, 1996 AND 1995
(dollars in thousands)
1. ORGANIZATION
Merit Behavioral Care Corporation (the "Company") was incorporated in the State
of Delaware in March 1993 as a wholly-owned subsidiary of Medco Containment
Services, Inc. ("Medco"). The Company manages behavioral healthcare programs for
payors across all segments of the healthcare industry, including health
maintenance organizations, Blue Cross/Blue Shield organizations and other
insurance companies, corporations and labor unions, federal, state and local
governmental agencies, and various state Medicaid programs. 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.
On November 18, 1993, Merck & Co., Inc. ("Merck") acquired all of the
outstanding shares of Medco (See Note 3).
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. In connection
with the Merger, the Company changed its name from Medco Behavioral Care
Corporation to Merit Behavioral Care Corporation (See Note 2).
2. MERGER
Prior to the Merger, the Company was a wholly-owned subsidiary of Merck & Co.,
Inc. ("Merck"). As a result of the Merger, KKR and Company management and
related entities obtained approximately 85% of the post-Merger common stock of
the Company. In connection with the Merger, Merck received $326,016 in cash
(which reflects various final purchase price adjustments) and retained
approximately 15% 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
$258,138 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 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 related 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 $258,138, repay amounts due Merck of $67,878, and pay certain fees and
expenses related to the Merger. Of the total fees and expenses, $5,500 was paid
to KKR.
3. BASIS OF PRESENTATION
On November 18, 1993, Merck acquired all the outstanding shares of Medco in a
transaction accounted for by the purchase method. As a result of this
acquisition, a new basis of accounting was established and as such, the
appraised value of the Company's assets and liabilities was recognized as of
November 18, 1993.
<PAGE>
3. BASIS OF PRESENTATION--(Continued)
The appraisal determined that identified intangible assets, consisting
principally of customer contracts, had an appraised value of $112,000 and
related deferred taxes of $47,800 at the acquisition date. These identified
intangible assets are being amortized on a straight line basis over a weighted
average life of 12 years. Based on the allocation of the purchase price to the
net tangible and identified intangible assets and liabilities of the Company, an
excess of the allocated purchase price over the fair value of net assets
acquired of approximately $47,988 was recorded as goodwill. Such goodwill is
being amortized on a straight line basis over 40 years.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its majority-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
Cash and Cash Equivalents
The Company considers all liquid investment instruments with an original
maturity of three months or less to be the equivalent of cash for purposes of
balance sheet presentation.
Included in cash and cash equivalents at September 30, 1997 and 1996 is $11,020
and $11,713, respectively, of cash held under the terms of certain customer
contracts that require a claims fund to be established and segregated for the
purpose of paying customer behavioral healthcare claims. Under these
arrangements, a reconciliation process is typically conducted annually between
the customer and the Company to determine the amount of unexpended funds, if
any, accruing to the Company. This cash is unavailable to the Company for
purposes other than the payment of customer claims until such reconciliation
process has been completed. The amount of cash held under such arrangements in
excess of anticipated customer claims at September 30, 1997 and 1996 was $6,197
and $4,267, respectively.
The Company held surplus cash balances of $29,325 and $13,715 as of September
30, 1997 and 1996, respectively, as required by contracts with various state and
local governmental entities. In addition, at September 30, 1997 and 1996, the
Company held surplus cash balances of $3,137 and $1,214, respectively, as
required by various other contracts. These contracts require the segregation of
such cash as financial assurance that the Company can meet its obligations
thereunder.
The Company has a subsidiary organized in the State of Missouri that is licensed
to do business as a foreign corporation in the State of California and is
subject to regulation by the Department of Corporations of the State of
California. Pursuant to these regulatory requirements, certain amounts of cash
are required to be retained for the use of this subsidiary. Included in cash and
cash equivalents at September 30, 1997 and 1996 is $0 and $900, respectively,
under such requirements.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(Continued)
Short-Term Marketable Securities
Short-term marketable securities consist of treasury notes and certificates of
deposit, carried at amortized cost which approximates fair value. All of the
Company's short-term marketable securities are classified as held-to-maturity.
The Company held short-term marketable securities in the amount of $4,011 at
September 30, 1997 as required by the Company's contract with a governmental
entity.
Restricted Cash
At September 30, 1997 and 1996, $6,623 and $7,168, respectively, of cash and
marketable securities were held by subsidiaries of the Company that are
organized and regulated under state law as insurance companies. Such insurance
companies are required to maintain certain minimum statutory deposits and
reserves with respect to the payment of future claims. The amount of cash in
excess of the liabilities of such subsidiaries and not available for dividend to
the Company without prior regulatory approval was $3,559 and $5,510 at September
30, 1997 and 1996, respectively. As a result, such amounts of cash held by these
subsidiaries have been classified as a long-term asset in the accompanying
consolidated balance sheets.
All of the Company's long-term marketable investments are classified as
held-to-maturity; in addition, such investments are carried at amortized cost
which approximates fair value.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. For financial reporting
purposes, depreciation is provided principally on a straight line basis over the
estimated useful lives of the assets as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Machinery and equipment.............................. 5 Years
Integrated managed care information system........... 7 Years
Furniture and fixtures............................... 15 Years
Leasehold improvements............................... Life of lease
</TABLE>
Expenditures for maintenance, repairs and renewals of minor items are charged to
operations as incurred. Major betterments are capitalized.
The integrated managed care information system (the "System") represents costs
incurred in the development and adaptation of AMISYS(R) software for use in the
Company's business. In addition to purchased hardware and software costs, the
payroll and related benefits of employees who are exclusively engaged in the
development and deployment of the System are capitalized. The System was
substantially complete in October 1995 at which time the Company began
installing the System in various area and regional offices in the Company's
service delivery system. As the System is installed in an office, the office is
allocated a ratable portion of the total cost of the System, at which time the
allocated cost is depreciated over an estimated useful life of 7 years.
Goodwill and Other Intangibles
The Company amortizes costs in excess of the net assets of businesses acquired
on a straight line basis over periods not to exceed 40 years. Contingent
consideration is charged to goodwill when paid and is amortized over the
remaining life of such goodwill, not to exceed 40 years. The Company
periodically reviews the carrying value of goodwill to assess recoverability and
other than temporary impairments.
<PAGE>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(Continued)
Goodwill and intangible assets consisted of the following at September 30, 1997
and 1996:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---- ----
Customer Contracts.......................... $ 88,074 $ 80,000
Provider Network............................ 12,000 12,000
Trade Names and other....................... 20,000 20,000
Goodwill.................................... 157,755 110,630
$277,829 $222,630
</TABLE>
Deferred Contract Start-up Costs
The Company defers contract start-up costs related to new contracts or expansion
of existing contracts that require the implementation of separate, dedicated
service delivery teams, provider networks and delivery systems or the
establishment of a local clinical organization in a new geographic area to
service the new program. The Company defers only costs which (i) are separately
identified, incremental and segregated from ordinary operating expenses; (ii)
provide a direct, quantifiable benefit to future periods; and (iii) are fully
recoverable from contract revenues directly attributable to such benefit. The
incremental costs deferred by the Company include, among other things,
consulting fees, salary costs, travel costs, office costs and network and
reporting system development costs. Consulting fees deferred by the Company
relate primarily to the recruitment, credentialling and contracting of the
particular customer's provider network. The salary costs relate primarily to
employees of the Company dedicated to clinical protocol design, network
development activities and program reporting and information systems
customization for the specific customer. These contract start-up costs are
capitalized and amortized on a straight line basis over the initial term of the
related contract. The amortization periods range from one to five years, with a
weighted-average life at September 30, 1997 and 1996 of 4.3 and 3.3 years,
respectively. Amortization of deferred contract start-up costs was $3,096,
$2,848, and $1,315 for the periods ended September 30, 1997, 1996, and 1995,
respectively. During the periods ended September 30, 1997, 1996, and 1995, the
Company deferred contract start-up costs of $6,067, $4,816, and $6,231,
respectively. Other non-current assets include $9,036 and $6,077 of unamortized
deferred contract start-up costs at September 30, 1997 and 1996, respectively.
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 amortize start-up costs beyond the initial contract period. The
change was made to increase the focus on controlling costs associated with
contract start-ups.
The pro forma effect of the change, had the Company adopted this new accounting
policy in prior years, is to decrease total assets by $1,769 and decrease total
liabilities by $757 as of September 30, 1995, and to increase costs and expenses
by $1,769 ($1,012 after taxes) for the year ended September 30, 1995. The effect
of the change on fiscal 1996 and 1997 cannot be reasonably estimated.
Revenue Recognition
Typically, the Company charges each of its customers a flat monthly capitation
fee for each beneficiary enrolled in such customer's behavioral health managed
care plan or Employee Assistance Program ("EAP"). This capitation fee is
generally paid to the Company in the current month. Contract revenue billed in
advance of performing related services is deferred and recognized ratably over
the period to which it applies. For a number of the Company's
<PAGE>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(Continued)
behavioral health managed care programs, the capitation fee is divided into
outpatient and inpatient fees, which are recognized separately.
Outpatient revenue is recognized monthly as it is received; inpatient revenue is
recognized monthly and is in most cases (i) paid to the Company monthly (in
cases where the Company is responsible for the payment of inpatient claims) or
in certain cases (ii) retained by the customer for payment of inpatient claims.
When the customer retains the inpatient revenue, actual inpatient costs are
periodically reconciled to amounts retained and the Company receives the excess
of the amounts retained over the cost of services, or reimburses the customer if
the cost of services exceeds the amounts retained. In certain instances, such
excess or deficiency is shared between the Company and the customer. A
significant portion of the Company's revenue is derived from capitated
contracts.
Direct Service Costs
Direct service costs are comprised principally of expenses associated with
managing, supervising and providing the Company's services, including
third-party network provider charges, various charges associated with the
Company's staff offices, inpatient facility charges, costs associated with
members of management principally engaged in the Company's clinical operations
and their support staff, and rent for certain offices maintained by the Company
in connection with the delivery of services. Direct service costs are recognized
in the month in which services are expected to be rendered. Network provider and
facility charges for authorized services that have not been reported and billed
to the Company (known as incurred but not reported expenses, or "IBNR") are
estimated and accrued based on historical experience, current enrollment
statistics, patient census data, adjudication decisions and other information.
Such costs are included in the caption "Claims payable" in the accompanying
consolidated balance sheets.
Income Taxes
Deferred taxes are provided for the expected future income tax consequences of
events that have been recognized in the Company's financial statements. Deferred
tax assets and liabilities are determined based on the temporary differences
between the financial statement carrying amounts and the tax bases of assets and
liabilities using enacted tax rates in effect in the years in which the
temporary differences are expected to reverse.
Long-Lived Assets
The Financial Accounting Standards Board issued SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, in
March 1995. The general requirements of this statement are applicable to the
properties and intangible assets of the Company and require impairment to be
considered whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. If the sum of expected
future cash flows (undiscounted and without interest charges) is less than the
carrying amount of the asset, an impairment loss is recognized. The Company
adopted this standard on October 1, 1996. No impairment losses have been
identified by the Company.
Stock-Based Compensation Plans
During fiscal 1997, the Company adopted SFAS No. 123, Accounting for Stock-Based
Compensation ("SFAS 123"). The new standard defines a fair value method of
accounting for stock options and similar equity instruments. Under the fair
value method, compensation cost is measured at the grant date based on the fair
value of the award and is recognized over the service period, which is usually
the vesting period. As permitted by SFAS 123, however, the Company has elected
to continue to recognize and measure compensation for its stock rights and stock
option plans in accordance with the existing provisions of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). See
Note 16 for pro forma disclosures of net loss as if the fair value-based method
prescribed by SFAS No. 123 had been applied.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(Continued)
Disclosure of Fair Value of Financial Instruments
The carrying amount reported in the consolidated balance sheets for cash and
cash equivalents, accounts receivable, accounts payable and accrued liabilities
approximates fair value because of the immediate or short-term maturity of these
financial instruments. The Company's short-term marketable securities and
long-term marketable investments are carried at amortized cost which
approximates fair value. The carrying amount of loans made to certain joint
ventures engaged in the development of Medicaid programs (Note 9) approximates
fair value which was estimated by discounting future cash flows using rates at
which similar loans would be made to borrowers with similar credit ratings. The
carrying value for the variable rate debt outstanding under the Senior Credit
Facility (as described in Note 6) approximates the fair value. The fair value of
the Company's senior subordinated notes (see Note 6) is estimated to be $109,000
at September 30, 1997 (based on quoted market prices) which compares to the
carrying value of $100,000.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of trade receivables. Concentrations of credit
risk with respect to trade receivables are limited due to the large number of
customers comprising the Company's customer base and the dispersion of such
customers across different businesses and geographic regions.
5. PROPERTY, PLANT, AND EQUIPMENT
Property, plant and equipment consisted of the following at September 30:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---- ----
Machinery and equipment.............................. $ 58,988 $ 44,896
Integrated managed care information system........... 38,914 28,349
Furniture and fixtures............................... 16,665 12,795
Leasehold improvements............................... 3,443 2,977
118,010 89,017
Accumulated depreciation and
amortization....................................... (34,698) (21,137)
$83,312 $67,880
Depreciation and amortization related to property, plant and equipment was $12,503, $10,658, and $6,776 for the periods
ended September 30, 1997, 1996, and 1995, respectively.
</TABLE>
6. LONG TERM DEBT
Long-term debt consisted of the following at September 30:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---- ----
Revolving Loans ................... $ 30,000 $ 34,000
Senior Term Loan A................. 70,000 70,000
Senior Term Loan B................. 129,500 50,000
Notes.............................. 100,000 100,000
329,500 254,000
Less current portion............... (6,498) (500)
$323,002 $253,500
</TABLE>
<PAGE>
6. LONG-TERM DEBT--(Continued)
Senior Credit Facility - In October 1995, the Company entered into a credit
agreement (the "Credit Agreement"), which provided for secured borrowings from a
syndicate of lenders. The Senior Credit Facility consisted initially of (i) a
six and one-half year revolving credit facility (the "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"). On September 12, 1997, the Senior Term Loan B was increased by
$80,000 to $130,000 with the maturity extended one and one-half years. The
additional borrowings from Senior Term Loan B were primarily obtained to fund
the acquisition of CMG Health, Inc. ("CMG"), as discussed in Note 8. At
September 30, 1997, $30,000 of revolving loans and five letters of credit
totaling $8,313 were outstanding under the Revolving Credit Facility, and
approximately $46,687 was available for future borrowing. At September 30, 1996,
$34,000 of revolving loans and three letters of credit totaling $425 were
outstanding under the Revolving Credit Facility, and approximately $50,575 was
available for future borrowings.
In October 1996, a scheduled repayment of $500 was made on Senior Term Loan B.
The annual amortization schedule of the Senior Term Loans is $6,498 in 1998,
$10,000 in 1999, $12,500 in 2000, $20,000 in 2001, $25,000 in 2002 and $125,502
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. Proceeds in the
amount of $4,735 received in October 1997 as a result of the disposal of one of
the Company's subsidiaries (See Note 17) have been classified as current in
accordance with the mandatory prepayment loan provision. At September 30, 1997,
approximately $662 has been classified as current in accordance with mandatory
prepayment requirements for Excess Cash Flow.
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 borrowing outstanding under the Senior Credit Facility averaged 8.1%
and 8.3% for the years ended September 30, 1997 and 1996, respectively.
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 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.
<PAGE>
6. LONG-TERM DEBT-- (Continued)
The Credit Agreement and the Notes Indenture contain restrictive covenants that,
among other things and under certain conditions, limit the ability of the
Company to incur additional indebtedness, to acquire (including a limitation on
capital expenditures) or to dispose of assets or operations, to incur liens on
its property or assets, to make advances, investments and loans, and to pay any
dividends. The Company must also satisfy certain financial covenants and tests.
Borrowings under the Credit Agreement are secured by a first priority lien on
the capital stock of certain of the Company's subsidiaries.
7. 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 $1,615 were made to officers for the purchase of
shares of common stock. 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. Notes receivable totaling
$250 and $265 were repaid during the periods ended September 30, 1997 and 1996,
respectively. Also a note for $100 was canceled in January 1996 for receipt of
shares of common stock. The remaining outstanding notes are due as follows: $20
in 1998 and $6,780 in 2001. The notes are shown as a reduction of stockholders'
equity in the accompanying consolidated balance sheets.
8. ACQUISITIONS
On September 12, 1997, the Company paid an initial $48,740 and issued 739,358
shares of Company common stock to acquire all of the capital stock of CMG, a
Maryland-based provider of managed behavioral healthcare services. The
acquisition was accounted for as a purchase transaction. The consolidated
financial statements of the Company include the operating results of CMG from
the date of the acquisition. The purchase price for CMG was allocated to the net
assets acquired based upon their estimated fair values. The Company common stock
issued in the acquisition was assigned a value of $7.50 per share based on a
valuation analysis performed by an independent third party. The excess of the
purchase price over the net tangible assets acquired amounted to $64,715 and is
being amortized over periods up to 40 years using the straight-line method. The
purchase price allocation was based on preliminary estimates and may be revised
upon final valuation. The Company is obligated to make contingent payments to
the former shareholders of CMG if the financial results of certain contracts
exceed specified base-line amounts. Such contingent payments are subject to an
aggregate maximum of $23,500. Any such additional payments will be recorded as
goodwill.
The following summary of the unaudited pro forma consolidated results of
operations of the Company for the years ended September 30, 1997 and 1996
assumes the CMG acquisition occurred as of the beginning of the respective
periods. The pro forma results include the combined historical results of the
Company and CMG, and pro forma adjustments to reflect (i) interest expense
associated with the debt incurred to finance the acquisition, (ii) changes to
depreciation and amortization related to the allocation of the cost of CMG to
the assets acquired and liabilities assumed and (iii) reductions of salaries,
benefits and certain other costs included in the historical results of CMG which
will be eliminated as a result of the acquisition. These pro forma results have
been prepared for comparative purposes only and do not purport to be indicative
of the results of operations which actually would have resulted had the
acquisition occurred at the beginning of the respective periods, or which may
result in the future.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
1997 1996
Revenue............................ $653,477 $522,857
Net loss........................... (15,048) (16,939)
</TABLE>
<PAGE>
8. ACQUISITIONS--(Continued)
In August 1996, the Company paid approximately $340 to acquire Orion Life
Insurance Company ("Orion"), a Delaware life and health insurance company. Orion
holds insurance licenses in 17 states and provides the Company with the ability
to underwrite future business in those states should a customer require that a
licensed insurance entity underwrite its behavioral health program.
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. As of September 30, 1996,
the Company recorded additional goodwill in the amount of $400 for a final
contingent payment made to the former shareholders of ProPsych in November 1996.
On October 5, 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. The Company made a contingent
consideration payment of $1,278 to the former shareholders of Choate in July
1996; such payment was recorded as goodwill. In June 1997, the Company and the
former Choate shareholders signed an agreement which provided for the settlement
of the contingent consideration related to Choate. Such agreement required no
further payments by the Company. Choate was sold by the Company in September
1997 (See Note 17).
In September 1995, a contingent payment of $8,550 was made to the former
shareholders of BenesYs, a subsidiary of the Company, in full settlement of any
and all contingent consideration due to such former shareholders. In April 1995,
a final payment of $650 was made related to the acquisition of the clinical
protocols of the Washton Institute.
9. JOINT VENTURES
CMG, which was acquired on September 12, 1997, is a 50% partner in CHOICE
Behavioral Health Partnership ("Choice"), a managed behavioral healthcare
company. The Company reports its investment in Choice using the equity method.
Although the Company reports its share of earnings from the joint venture, the
financial statements of Choice are not consolidated with those of the Company.
All revenue of the joint venture is from a contract for the Civilian Health and
Medical Program of the Uniformed Services ("CHAMPUS") with Humana, Inc.
Summarized financial information of the joint venture, representing 100% of its
business, as of September 30, 1997 and for the period from September 12, 1997
through September 30, 1997, is as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Current Assets $ 38,286 Net Revenues $ 3,333
Non-Current Assets 700 Cost of Providing Services 2,973
Total Assets $ 38,986
=========
Gross Profit 360
Total Liabilities $ 37,141
Partners' Capital 1,845 Other Expenses 106
Total Liabilities & P.C. $ 38,986 Net Income $ 254
========= ========
</TABLE>
In March 1994, the Company entered into a joint venture partnership with
Community Sector Systems, Inc. ("CSS"), a software development company, to
market a proprietary clinical information, communications and case documentation
software package. The Company contributed $125 in capital, loaned $1,375 to CSS
in 1994 and made an additional loan of $300 to CSS in 1995. In December 1996,
the Company converted the $1,375 loan and the accrued interest receivable on the
loan of $369 into an equity interest in CSS, and made an additional capital
contribution of $500. Additionally, in February 1997 the Company contributed
capital of $350 and loaned CSS $150. As of September 30, 1997, the Company has a
net loan receivable from CSS of $450 and an equity investment in CSS of $2,719.
9. JOINT VENTURES--(Continued)
In April 1995, the Company entered into a contractual arrangement with Community
Health Network of Connecticut, Inc. ("CHN"), an organization consisting of 11
not-for-profit health centers in Connecticut, under which the Company has agreed
to provide CHN with up to a total of $4,000 in unsecured debt to help finance
CHN's Medicaid program development costs. As of September 30, 1997 and 1996, the
Company had net advances to CHN outstanding of $1,732 and $2,079, respectively.
Also, in April 1995, the Company entered into a joint venture with Neighborhood
Health Providers, LLC ("NHP"), an organization consisting of five hospitals
located in Brooklyn and Queens, New York, under which the Company agreed to fund
a portion of NHP's Medicaid program development costs in the form of $1,500 in
unsecured debt. As of September 30, 1997 and 1996, the Company had net advances
of $1,500 to NHP.
In September 1995, the Company paid $12,010 to Empire Blue Cross and Blue Shield
("Empire") for the right to provide behavioral health managed care services to
approximately 750,000 Empire enrollees in the State of New York for a period of
eight years. In connection therewith, the Company formed a limited liability
company (the "Empire Joint Venture") with the Company and Empire receiving
ownership interests of 80% and 20%, respectively. The payment was charged to
goodwill and is being amortized over the life of the underlying contract.
In January 1996, the Company formed a joint venture with the hospital sponsors
of NHP under the name Royal Health Care LLC ("Royal"), in which the Company and
NHP each holds a 50% equity interest. Royal has management services contracts
with certain organizations including NHP and Empire Community Delivery Systems
LLC ("ECDS"). During fiscal 1996, the Company made an equity contribution and an
unsecured working capital loan to Royal in the amounts of $200 and $228,
respectively. During fiscal 1997, the Company made an additional capital
contribution of $100 to Royal.
ECDS, which was formed in fiscal 1996, is a joint venture company in which the
Company, NHP and Empire hold interests of approximately 16.7%, 16.7%, and 66.6%,
respectively. The Company made capital contributions to ECDS in 1997 and 1996 of
$667 and $458, respectively. Also, in 1997 and 1996 the Company provided loans
to NHP, the proceeds of which were used to fund NHP's capital contributions to
ECDS, of $667 and $458, respectively. The loans to NHP are secured by NHP's
interest in ECDS. Empire and ECDS have entered into an agreement under which
ECDS will exclusively manage and operate, on behalf of Empire, health care
benefit programs (covering all services except behavioral healthcare and vision
care) in the five New York City boroughs for Medicaid beneficiaries enrolled in
Empire plans. Each of Empire and Royal will provide specified administrative and
management services to ECDS to support its delivery of services to Empire under
such agreement. Moreover, each of ECDS and Royal will hold specified equity
interests in certain independent practice associations (IPAs) providing
treatment services to the Empire Medicaid beneficiaries. In addition, Empire has
entered into an agreement with the Empire Joint Venture to exclusively provide,
on behalf of Empire, all behavioral healthcare services in New York City to such
Empire Medicaid enrollees. The Royal and ECDS joint ventures and related
agreements have five year terms, with up to three five-year renewals (subject to
applicable regulatory approvals). Each such venture and agreement also contains
customary termination provisions.
The receivables from, and the investments in, CSS, NHP, CHN, Royal and ECDS are
reflected in "other assets" in the accompanying balance sheets.
<PAGE>
10. INCOME TAXES
Prior to the Merger, the Company filed a consolidated federal income tax return
with Merck. Though no formal tax sharing agreement existed between the Company
and Merck, the Company computed federal income taxes on a separate return basis
and recorded such taxes in the caption "Due to parent".
The components of income tax expense (benefit) for the periods ended September
30, are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1997 1996 1995
---- ---- ----
Current:
Federal................................ $ --- $ --- $3,030
State.................................. 283 736 1,112
283 736 4,142
Deferred :
Federal ............................... (4,848) (5,495) 200
State.................................. 439 (573) 179
(4,409) (6,068) 379
Total....................................... $(4,126) $ (5,332) $4,521
</TABLE>
The differences between the U.S. federal statutory tax rate and the Company's
effective tax rate are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1997 1996 1995
---- ---- ----
U.S. federal statutory tax rate............. (35.0)% (35.0)% 35.0%
State income taxes (net of federal benefit). 0.6 0.4 14.4
Capital loss................................ 6.9 --- ---
Merger expenses............................. --- 5.8 ---
Goodwill.................................... 3.1 2.3 13.1
Expenses without tax benefit............... 1.6 2.0 13.9
Other....................................... (0.1) 0.5 0.9
Effective tax rate.......................... (22.9)% (24.0)% 77.3%
===== ===== ====
</TABLE>
At September 30, 1997 and 1996, the Company had $46,733 and $23,707,
respectively, of deferred income tax assets and $55,505 and $52,080,
respectively, of deferred income tax liabilities which have been netted for
presentation purposes. The significant components of these amounts are shown on
the balance sheet as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
1997 1996
Current Non Current Current Non Current
Asset Liability Asset Liability
Provision for estimated expenses............ $ 7,023 $ 507 $ 2,630 $ 2,161
Capitalized expenses........................ (407) (1,224) (334) (1,436)
Net operating loss carryforwards............ --- 28,502 --- 9,170
Accelerated depreciation.................... --- (20,194) --- (14,605)
Intangible asset differences................ --- (22,979) --- (25,959)
$ 6,616 $ (15,388) $ 2,296 $(30,669)
======== ========= ========= ========
</TABLE>
Management believes that the deferred tax assets will be fully realized based on
future reversals of existing taxable temporary differences and projected
operating results of the Company. As a result, no valuation allowance has been
provided. At September 30, 1997, the Company had U.S. federal net operating loss
carryforwards of approximately $76,630 for tax purposes. Approximately $5,920 of
the carryforwards expire in 2010, $21,460 expire in 2011 and $49,250 expire in
2012.
<PAGE>
11. COMMITMENTS AND CONTINGENCIES
a. Leases
The Company leases office facilities and equipment under various noncancelable
operating leases.
At September 30, 1997, the minimum aggregate rental commitments under
noncancelable leases, excluding renewal options, are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1998................................................. $13,469
1999................................................. 11,606
2000................................................. 9,892
2001................................................. 8,699
2002................................................. 6,382
Thereafter........................................... 18,219
Minimum lease payments............................... 68,267
Less amounts representing sublease income............ (2,060)
$66,207
</TABLE>
Several of the leases contain escalation provisions due to increased maintenance
costs and taxes. Scheduled rent increases are amortized on a straight-line basis
over the lease term. Total rent expense for the periods ended September 30,
1997, 1996 and 1995 amounted to $15,842, $13,059 and $10,115, respectively.
b. Employment Agreements
The Company and certain of its subsidiaries have employment agreements with
various officers and certain other management personnel that provide for salary
continuation for a specified number of months under certain circumstances. The
aggregate commitment for future salaries at September 30, 1997, excluding
bonuses, was approximately $2,735.
c. Legal Proceedings
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists and clinical social workers brought an action
under the federal antitrust laws in the United States District Court for the
Southern District of New York against nine behavioral health managed care
organizations, including the Company (collectively, "Defendants"). The complaint
alleges that Defendants violated section 1 of the Sherman Act by engaging in a
conspiracy to fix the prices at which Defendants purchase services from mental
healthcare providers such as plaintiffs. The complaint further alleges that
Defendants engaged in a group boycott to exclude mental healthcare providers
from Defendants' networks in order to further the goals of the alleged
conspiracy. The complaint also challenges the propriety of Defendents'
capitation arrangements with their respective customers, although it is unclear
from the complaint whether plaintiffs allege that Defendants unlawfully
conspired to enter into capitation arrangements with their respective customers.
The complaint seeks treble damages against Defendants in an unspecified amount
and a permanent injunction prohibiting Defendants from engaging in the alleged
conduct which forms the basis of the complaint, plus costs and attorneys' fees.
In January 1997, Defendants filed a motion to dismiss the complaint. On July 21,
1997, a court-appointed magistrate judge issued a report and recommendation to
the District Court recommending that Defendants' motion to dismiss the complaint
with prejudice be granted. On August 5, 1997, plaintiffs filed objections to the
magistrate judge's report and recommendation; such objections have not yet been
heard. The Company intends to vigorously defend itself in this litigation. No
amounts are recorded on the books of the Company in anticipation of a loss as a
result of this contingency.
11. COMMITMENTS AND CONTINGENCIES--(Continued)
The Company is engaged in various other 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.
d. Insurance
Under the Company's professional liability insurance policy, coverage is limited
to the period in which a claim is asserted, rather than when the incident giving
rise to such claim occurred. The Company has obtained professional liability
insurance through October 6, 1998; however, in the event the Company was unable
to obtain professional liability insurance at the expiration of the current
policy period, it is possible that the Company would be uninsured for claims
asserted after the expiration of the current policy period. Historical
experience of the Company does not indicate that losses, if any, arising from
claims asserted after the expiration of the current professional liability
policy period would have a material effect on the Company's financial position,
liquidity or results of operations.
e. CHAMPUS Contract
On April 1, 1997, the Company began providing mental health and substance abuse
services, as a subcontractor, to beneficiaries of CHAMPUS in the Southwestern
and Midwestern United States, designated as CHAMPUS Regions 7 and 8. The fixed
monthly amounts that the Company receives for medical costs and records as
revenue are subject to a one-time retroactive adjustment scheduled to be
determined in August 1998 based upon actual healthcare utilization during the
period known as the "data collection period". The data collection period is the
year ended March 31, 1997. Because of the inherent uncertainty surrounding
factors included in the determination of the final retroactive adjustment,
management has not been able to quantify a range of potential adjustment, and
accordingly no adjustments have been recorded as of September 30, 1997. As a
result, the amount of recorded revenue and income from the CHAMPUS contract may
differ significantly from the amount that would have been recorded had the
actual factors been known.
12. RELATED PARTY TRANSACTIONS
During the period ended September 30, 1997, the Company paid consulting fees and
board fees to KKR totaling approximately $500. During the period ended September
30, 1996, the Company paid consulting fees and board fees to KKR totaling
approximately $5,900; of such amount, $5,500 related to the Merger and
associated financing transactions.
Prior to the merger, Medco disbursed funds on behalf of the Company for the
payment of certain of the Company's U.S. federal, state and local income taxes
and certain acquisition transactions described in Note 8.
Included in expense for the periods ended September 30, 1997, 1996 and 1995 are
charges totaling $1,467, $1,218 and $703, respectively, related to a
prescription drug benefit program administered by Medco.
<PAGE>
12. RELATED PARTY TRANSACTIONS--(Continued)
The average balance due to the parent (Medco) for fiscal 1995 was $40,996; such
balance was repaid in full on October 6, 1995 in connection with the Merger. A
summary of intercompany activity with the parent is as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
Due to parent, October 1, 1994....................... $ 37,931
Allocation of costs from parent...................... 379
Intercompany purchases............................... 659
Income taxes paid by parent.......................... 3,795
Cash transfer from parent............................ 28,049
Due to parent, September 30,1995..................... 70,813
Adjustment to income taxes paid by parent ........... (2,935)
Repayment made in connection with the Merger......... (67,878)
Due to parent, September 30,1996..................... $ ---
</TABLE>
13. RESTRUCTURING CHARGE
The Company recorded a pre-tax restructuring charge of $2,995 related to a plan,
adopted and approved in the fourth quarter of 1996, to restructure its staff
offices by exiting certain geographic markets and streamlining the field and
administrative management organization of Continuum Behavioral Healthcare
Corporation, a subsidiary of the Company. This decision was in response to the
results of underperforming locations affected by the lack of sufficient patient
flow in the geographic areas serviced by these offices and the Company's ability
to purchase healthcare services at lower rates from the network. In addition, it
was determined that the Company would be able to expand beneficiary access to
specialists and other providers, thereby achieving more cost-effective
treatment, and to favorably shift a portion of the economic risk, in some cases,
of providing outpatient healthcare to the provider through the use of case rates
and other alternative reimbursement methods. The restructuring charge was
comprised primarily of accruals for employee severance, real property lease
terminations and write-off of certain assets in geographic markets which were
being exited. The restructuring plan was substantially completed during fiscal
1997.
14. MAJOR CUSTOMERS
For fiscal 1997, revenue derived from a state Medicaid contract accounted for
approximately 12% of the Company's operating revenues. For fiscal 1996 and 1995,
no customer accounted for more than 10% of the Company's operating revenues.
15. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) savings plan covering substantially all employees who
have completed one year of active employment during which 1,000 hours of service
has been credited. Under the plan, an employee may elect to contribute on a
pre-tax basis to a retirement account up to 15% of the employee's compensation
up to the maximum annual contributions permitted by the Internal Revenue Code.
The Company matches employee contributions at the rate of 50% (25% for periods
prior to January 1, 1997) of the employee's contributions to the 401(k) savings
plan, up to a maximum of 6% of an employee's annual compensation. The Company's
401(k) savings plan contribution recognized as expense for the periods ended
September 30, 1997, 1996 and 1995 was $1,289, $542 and $330, respectively.
16. STOCK OPTIONS AND AWARDS
Effective October 1, 1996, the Company adopted SFAS No. 123. As permitted by the
standard, the Company has elected to continue following the guidance of APB 25
for measurement and recognition of stock-based transactions with employees.
Accordingly, no compensation cost has been recognized for the Company's option
plans. Had the determination of compensation cost for these plans been based on
the fair value as of the grant dates for awards under these plans, the Company's
net loss for the years ending September 30, 1997 and 1996 would have increased
to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---- ----
Net loss:
As reported............................... $(13,872) $(17,881)
Pro forma (unaudited)..................... (15,729) (19,428)
</TABLE>
The resulting compensation expense may not be representative of compensation
expense to be incurred on a pro forma basis in future years.
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 permits the issuance of common stock and the
grant of up to 8,561,000 non-qualified stock options (the "1995 Options") to
purchase shares of common stock to key employees of the Company. The exercise
price of 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. An option's maximum term is 10
years.
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 covers all employees not included in the
1995 Option Plan whose employment commenced prior to January 1, 1997. The 1996
Employee Option Plan permits the grant of up to 1,000,000 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. An option's maximum term is
10 years.
The fair value of each option grant is estimated on the date of grant by using
the Black-Scholes option-pricing model. The following weighted-average
assumptions were used for grants in the years ending September 30, 1997 and
1996:
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---- ----
Expected dividend yield.......................... 0.00% 0.00%
Expected volatility.............................. 1.00% 1.00%
Risk-free interest rates......................... 6.44% 6.08%
Expected option lives (years).................... 7.0 7.0
</TABLE>
<PAGE>
16. STOCK OPTIONS AND AWARDS--(Continued)
Information regarding the Company's stock option plans is summarized below:
<TABLE>
<CAPTION>
1995 Option Plan 1996 Employee Option Plan
Weighted average Weighted average
<S> <C> <C> <C> <C> <C> <C>
Shares Exercise Price Shares Exercise Price
Outstanding at October 1, 1995....... --- ---
Granted.............................. 5,698,000 $5.00 835,175 $7.50
Canceled............................. (585,000) $5.00 (119,625) $7.50
Outstanding at September 30, 1996.... 5,113,000 $5.00 715,550 $7.50
Granted.............................. 1,327,075 $7.22 254,400 $7.50
Exercised............................ (3,000) $5.00 --- ---
Canceled............................. (202,000) $5.74 (212,300) $7.50
Outstanding at September 30, 1997.... 6,235,075 $5.45 757,650 $7.50
</TABLE>
The weighted-average fair values of options granted during fiscal 1997 and 1996
for the 1995 Option Plan were $1.42 and $1.72, respectively. The
weighted-average fair values of options granted during fiscal 1997 and 1996 for
the 1996 Employee Option Plan were $0.87 and $0.01, respectively.
The following table summarizes information about stock options outstanding as of
September 30, 1997:
<TABLE>
<CAPTION>
<S> <C> <C>
1995 Option Plan 1996 Employee Option Plan
Range of exercise price $5.00-$7.50 $7.50
Weighted-average remaining
contracted life (years) 8.38 8.51
</TABLE>
As of September 30, 1997, 993,600 shares pertaining to the 1995 Option Plan were
exercisable with an exercise price of $5.00. No shares were exercisable for the
1996 Employee Option Plan as of September 30, 1997.
Prior to the Merger, employees of the Company participated in stock option plans
administered by Merck. Pursuant to these plans, options were granted at the fair
market value of Merck common stock on the date of grant and generally vest over
a period of five years. The Company realizes an income tax benefit when Company
employees exercise either (a) nonqualified Merck stock options; or (b) Merck
incentive stock options, assuming the underlying common stock is sold within one
year from the date that the incentive stock option was exercised. This benefit
results in a decrease in tax liabilities and an increase in additional paid in
capital. During 1997 and 1996, the Company recorded tax benefits of $11,630 and
$1,505, respectively, from the exercise of Merck options. Information regarding
the options outstanding under these plans held by employees of the Company at
September 30, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Shares Option Price Per Share
1997 1996 1997 1996
Vested............................. 497,353 905,504 $ 3.78 to $25.87 $3.78 to $35.75
Unvested........................... 127,472 391,169 $21.93 to $22.24 $3.78 to $35.75
Total.............................. 624,825 1,296,673
</TABLE>
16. STOCK OPTIONS AND AWARDS--(Continued)
Through September 30, 1995, employees of the Company participated in an Employee
Stock Purchase Plan administered by Merck. The stock plan permitted employees of
the Company to purchase Merck common stock at the end of each quarter at a price
equal to 85% of the fair market value at that date.
17. DISPOSAL OF SUBSIDIARY
In September 1997, the Company sold Choate for approximately $4,775 ($4,735 of
which was received in October 1997.) The Company recognized a loss of
approximately $6,925 relating to the transaction.
18. MERGER COSTS AND SPECIAL CHARGES
In fiscal 1997, the Company recognized approximately $733 of expenses associated
with uncompleted acquisition transactions. Also, the Company incurred other
special charges of approximately $581 related to nonrecurring employee benefit
costs associated with the exercise of stock options by employees of the Company
under plans administered by Merck. A significant number of these stock options,
which were granted prior to the Merger, required exercise by September 30, 1997.
19. SUPPLEMENTAL INFORMATION
Supplemental cash flow information and noncash investing and financing
activities are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1997 1996 1995
---- ---- ----
Supplemental Cash Flow Information:
Cash (received) paid for income taxes.. $ (596) $1,100 $2,167
Cash paid for interest................. 23,568 17,676 ---
Supplemental Noncash Investing and
Financing Activities:
Record deferred taxes associated
with the Merger..................... --- 7,594 ---
Exercise of Merck stock options........ 11,630 1,505 ---
Acquisitions:
Fair value of assets acquired,
other than cash.................. 82,412 14,360 ---
Liabilities assumed................ (41,622) (2,962) ---
Total consideration paid........... 40,790 11,398 ---
Stock consideration paid........... (5,545) --- ---
Cash consideration paid............ 35,245 11,398 ---
Contingent consideration........... 400 1,278 9,580
Cash used for acquisitions,
net of cash acquired................. $35,645 $ 12,676 $ 9,580
</TABLE>
<PAGE>
20. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, which will
be effective for the Company beginning October 1, 1998. SFAS No. 131 redefines
how operating segments are determined and requires disclosure of certain
financial and descriptive information about a company's operating segments. The
Company has not yet completed its analysis with respect to which operating
segments of its business it will provide such information
21. SUBSEQUENT EVENT
On October 24, 1997, the Company signed a definitive merger agreement under
which a subsidiary of Magellan Health Services, Inc. ("Magellan") will merge
into the Company. As a result of this merger, the Company will become a wholly
owned subsidiary of Magellan. Under the terms of the merger agreement, Magellan
will purchase all of the Company's outstanding stock and other equity interests
for approximately $460 million in cash and refinance the Company's existing
debt. In addition, all options outstanding under the 1995 Option Plan and the
1996 Employee Option Plan will fully vest upon closing of the transaction.
Completion of the merger transaction is subject to a number of conditions,
including Magellan's receipt of sufficient financing for the transaction, the
expiration or early termination of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1974, the receipt of certain
healthcare and insurance regulatory approvals, and other conditions.
STOCKHOLDER SUPPORT AGREEMENT
THIS STOCKHOLDER SUPPORT AGREEMENT dated as of October 24,
1997 (this "Agreement"), is entered into by MBC Associates, L.P., a Delaware
limited partnership ("MBC Associates"), KKR Partners II, L.P., a Delaware
limited partnership ("KKR Partners"), 38 Newbury Ventures/MBC Limited
Partnership, a Massachusetts limited partnership ("Newbury"), Albert S. Waxman,
the Albert S. Waxman Family Charitable Remainder Unitrust (the "Waxman Trust"),
Arthur H. Halper, Michael G. Lenahan and John A. Budnick to and for the benefit
of Magellan Health Services, Inc., a Delaware corporation ("Parent"). Each of
MBC Associates, KKR Partners, Newbury, Albert S. Waxman, the Waxman Trust,
Arthur H. Halper, Michael G. Lenahan and John A. Budnick are referred to herein
as a "Stockholder" and collectively as the "Stockholders." Capitalized terms
used and not otherwise defined herein shall have the respective meanings
assigned to them in the Merger Agreement referred to below.
WHEREAS, as of the date hereof, MBC Associates and KKR
Partners own of record and beneficially 20,678,600 shares and 321,400 shares,
respectively (such aggregate 21,000,000 shares being referred to herein
collectively as the "KKR Shares"), of common stock, par value $.01 per share
("Common Stock"), of Merit Behavioral Care Corporation, a Delaware corporation
(the "Company");
WHEREAS, as of the date hereof, Newbury owns of record and
beneficially 600,000 shares (the "Newbury Shares") of Common Stock;
WHEREAS, as of the date hereof, Albert S. Waxman and the
Waxman Trust own of record and beneficially 1,055,100 and 1,000,000 shares,
respectively (such aggregate 2,055,100 shares being referred to collectively as
the "Waxman Shares"), of Common Stock;
WHEREAS, as of the date hereof Arthur H. Halper owns of record
and beneficially 100,000 shares of Common Stock (the "Halper Shares");
WHEREAS, as of the date hereof Michael G. Lenahan owns of
record and beneficially 100,000 shares of Common Stock (the "Lenahan Shares");
WHEREAS, as of the date hereof John A. Budnick owns of record
and beneficially 50,000 shares of Common Stock (the "Budnick Shares," and
collectively with the KKR Shares, Newbury Shares, Waxman Shares, Halper Shares
and Lenahan Shares, together with any other voting or equity securities of the
Company hereafter acquired by any Stockholders beneficially or of record, prior
to the termination of this Agreement, the "Shares");
1
<PAGE>
WHEREAS, concurrently with the execution of this Agreement,
Parent, the Company and MBC Merger Corporation, a Delaware corporation ("Merger
Sub"), are entering into an Agreement and Plan of Merger, dated as of the date
hereof (the "Merger Agreement"), pursuant to which, upon the terms and subject
to the conditions thereof, Merger Sub will be merged with and into the Company
(the "Merger") such that the Company will become a wholly-owned subsidiary of
Parent; and
WHEREAS, as a condition to the willingness of Parent to enter
into the Merger Agreement, Parent has requested the Stockholders agree, and in
order to induce Parent to enter into the Merger Agreement, the Stockholders are
willing to consent to the adoption of the Merger Agreement and the approval of
the Merger and to agree, severally but not jointly, to certain other matters,
all upon the terms and subject to the conditions set forth herein.
NOW, THEREFORE, in consideration of the foregoing and the
mutual covenants and agreements contained herein, and intending to be legally
bound hereby, the parties hereby agree, severally and not jointly, as follows:
Section 1. Consent; Voting of Shares. Each Stockholder hereby
(a) agrees that, at any meeting of the stockholders of the Company, however
called, and in any action by consent of the stockholders of the Company in lieu
of a meeting, such Stockholder will vote all of its respective Shares in favor
of the adoption of the Merger Agreement and approval of the Merger and the other
transactions contemplated by the Merger Agreement and hereby irrevocably
consents to the adoption of the Merger Agreement and the approval of the Merger
and the other transactions contemplated by the Merger Agreement, (b) agrees
that, at any meeting of the stockholders of the Company, however called, and in
any action by consent of the stockholders of the Company in lieu of a meeting,
such Stockholder will vote all of the Shares against any action or agreement
that would result in a breach of any representation, warranty, covenant,
agreement or other obligation of the Company under the Merger Agreement or which
could result in any of the conditions to the Company's obligations under the
Merger Agreement not being fulfilled, and (c) agrees that until the termination
of this Agreement in accordance with the terms hereof at any meeting of the
stockholders of the Company, however called, and , in any action by written
consent of the stockholders of the Company, such Stockholder will vote all of
its respective Shares in favor of any other matter necessary to the consummation
of the transactions contemplated by the Merger Agreement. In addition, each
Stockholder agrees that it will, upon request by Parent, furnish written
confirmation, in form and substance reasonably satisfactory to Parent, of such
Stockholder's support for the Merger Agreement and the Merger. Each Stockholder
acknowledges receipt and review of a copy of the Merger
2
<PAGE>
Agreement.
Section 2. Transfer of Shares. Except as contemplated hereby
or by the Merger Agreement, each Stockholder agrees not to (a) offer to sell,
sell, assign, transfer (including by merger or otherwise by operation of law),
pledge, encumber or otherwise dispose of any of its respective Shares, (b)
deposit any of its respective Shares into a voting trust or enter into a voting
agreement or arrangement with respect to any such Shares or grant any proxy or
power of attorney with respect thereto or (c) enter into any contract, option or
other arrangement or undertaking with respect to the direct or indirect sale,
assignment, transfer (including by merger or otherwise by operation of law) or
other disposition of or transfer of any interest in or the voting of any of its
respective Shares or any other securities of the Company.
Section 3. No Solicitation. From the date hereof until the
Effective Time, each Stockholder hereby covenants and agrees not to (a) solicit,
encourage or entertain inquiries or proposals or initiate, enter into or
continue any discussions, negotiations or agreements relating to the sale or
other disposition of the Company (whether through a merger, reorganization,
stock purchase of otherwise) or a material portion of it assets, properties,
businesses or operations (a "Proposed Acquisition") to or with any person or
entity other than Parent or Merger Sub, (b) provide any assistance or any
information to any person or entity other than Parent or Merger Sub relating to
any Proposed Acquisition, or (c) take any action inconsistent with the purposes
and provisions of this Agreement. Each Stockholder agrees that it will
immediately cease and cause to be terminated any existing activities,
discussions or negotiations with any parties (other than Parent or Merger Sub)
heretofore conducted, or the provision of any information to any party (other
than Parent or Merger Sub) to which information heretofore has been provided,
with respect to any Proposed Acquisition. If, after the date hereof, any
Stockholder receives any such inquiry or proposal or request for information, or
offer to discuss or negotiate any Proposed Acquisition, such Stockholder will
immediately provide notice thereof to Parent.
Section 4. Termination. This Agreement shall terminate upon
the earlier to occur of (i) the Effective Time or (ii) any termination of the
Merger Agreement in accordance with the terms thereof; provided that the
provisions of Section 8 shall survive any termination of this Agreement, and
provided further that no such termination shall relieve any party of liability
for a breach hereof prior to termination.
Section 5. Representations. Each Stockholder
represents and warrants to Merger Sub and Parent as follows:
3
<PAGE>
(a) Such Stockholder is the sole record and beneficial owner
of, and has good title to, all of the Shares it owns as specified in the
Recitals hereof, and there exist no restrictions on transfer, options, proxies,
voting agreements, voting trusts or liens affecting said Shares, except as
imposed by law or as contained in the respective agreements to which such
Stockholder is a party disclosed in Section 3.03 of the Company Disclosure
Schedule (collectively with respect to all Stockholders, the "Stockholder
Agreements").
(b) The execution and delivery of this Agreement by such
Stockholder does not, and the performance by such Stockholder of its obligations
hereunder will not, constitute a violation of, conflict with, result in a
default (or an event which, with notice or lapse of time or both, would result
in a default) under, or result in the creation of any lien on any of its Shares
under, (i) any contract commitment, agreement, understanding, arrangement or
restriction of any kind to which such Stockholder is a party or by which such
Stockholder or its Shares are bound (other than the Stockholder Agreements
applicable to such Stockholder), (ii) any judgment, writ, decree, order or
ruling affecting such Stockholder or its Shares, or (iii) the organizational
documents of such Stockholder to the extent such Stockholder is not an
individual.
(c) Such Stockholder has full power and authority to execute,
deliver and perform this Agreement and to consummate the transactions
contemplated hereby. This Agreement has been duly and validly authorized by such
Stockholder, and the execution, delivery and performance of this Agreement and
the consummation of the transactions contemplated hereby have been duly and
validly authorized and no other actions on the part of such Stockholder are
necessary to authorize this Agreement or to consummate the transactions
contemplated hereby. This Agreement has been duly and validly executed and
delivered by such Stockholder and, assuming due authorization, execution and
delivery by the Parent and Merger Sub, constitutes a valid and binding agreement
of such Stockholder, enforceable against such Stockholder in accordance with its
terms, except to the extent that enforceability may be limited by applicable
bankruptcy, reorganization, insolvency, moratorium or other laws affecting the
enforcement of creditor's rights generally and by general principles of equity,
regardless of whether such enforceability is considered in a proceeding in
equity or at law.
Section 6. Appraisal Rights. Until the termination of this
Agreement in accordance with the terms hereof, each Stockholder agrees that it
will not exercise any rights to dissent from the Merger or request appraisal of
its respective Shares pursuant to Section 262 of the DGCL or any other similar
provisions of Law.
Section 7. Specific Performance. The parties hereto
agree that irreparable damage would occur in the event any provision of this
Agreement were not performed in accordance with the
4
<PAGE>
terms hereof and that the parties shall be entitled to specific performance of
the terms hereof, in addition to any other remedy at law or in equity.
Section 8. Miscellaneous.
(a) This Agreement constitutes the entire agreement between the parties hereto
with respect to the subject matter hereof and supersedes all prior agreements
and understandings, both written and oral, between the parties with respect
thereto. This Agreement may not be amended, modified or rescinded except by an
instrument in writing signed by each of the parties hereto.
(b) If any term or other provision of this Agreement is invalid, illegal or
incapable of being enforced by any rule of law, or public policy, all other
conditions and provisions of this Agreement shall nevertheless remain in full
force and effect. Upon such determination that any term or other provision is
invalid, illegal or incapable of being enforced, the parties hereto shall
negotiate in good faith to modify this Agreement so as to effect the original
intent of the parties as closely as possible to the fullest extent permitted by
applicable law in a mutually acceptable manner in order that the terms of this
Agreement remain as originally contemplated to the fullest extent possible.
(c) This Agreement shall be governed by and construed in accordance with the
laws of the State of Delaware without regard to the principles of conflicts of
law thereof.
(d) Notwithstanding anything herein to the contrary, the covenants and
agreements set forth herein shall not prevent any of the Stockholders'
designees, partners or affiliates serving on the Board of Directors of the
Company from taking any action, subject to the applicable provisions of the
Merger Agreement, while acting in such capacity as a director of the Company.
(e) Notwithstanding any provisions hereof, none of the obligations of any
Stockholder under or contemplated by this Agreement shall be an obligation of
(i) any officer, director, stockholder, limited partner, general partner or
owner of such Stockholder, or any of their respective officers, directors,
stockholders, limited partners, general partners or owners, or successors or
assigns or (ii) any other Stockholder. Each Stockholder shall be the only person
or entity liable with respect to its obligations. Any monetary liability of a
Stockholder under this Agreement shall be satisfied solely out of the assets of
such Stockholder. Each Stockholder hereby irrevocably waives any right it may
have against any such officer, director, stockholder, limited partner, general
partner, owner, successor or assign identified above as a result of the
performance of the provisions under or
5
<PAGE>
contemplated by this Agreement. Nothing in this Section 8(e) shall prevent
Parent from obtaining specific enforcement of the obligations of any Stockholder
under this Agreement. (f) This Agreement may be executed in counterparts, each
of which shall be deemed an original and all of which together shall constitute
one and the same instrument.
6
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be
signed by their respective duly authorized officers as of the date first written
above.
MBC ASSOCIATES, L.P.
By: KKR Associates, L.P.
Its: General Partner
/s/ JAMES H. GREENE, JR.
By: James H. Greene, Jr.
Its: General Partner
KKR PARTNERS II, L.P.
By: KKR Associates, L.P.
Its: General Partner
/s/ JAMES H. GREENE, JR.
By: James H. Greene, Jr.
Its: General Partner
38 NEWBURY VENTURES/MBC LIMITED PARTNERSHIP
By: Samuel E. Bain Jr.
Its: General Partner
/s/ SAMUEL E. BAIN JR.
By:
Its:
ALBERT S. WAXMAN
/s/ ALBERT S. WAXMAN
Albert S. Waxman
THE ALBERT S. WAXMAN FAMILY
CHARITABLE REMAINDER UNITRUST
/s/ ALBERT S. WAXMAN
By: Albert S. Waxman
Its: Trustee
ARTHUR H. HALPER
/s/ ARTHUR H. HALPER
Arthur H. Halper
MICHAEL G. LENAHAN
/s/ MICHAEL G. LENAHAN
Michael G. Lenahan
JOHN A. BUDNICK
/s/ JOHN A. BUDNICK
John A. Budnick
Agreed and Acknowledged:
MAGELLAN HEALTH SERVICES, INC.
/s/ CRAIG MCKNIGHT
By: Craig McKnight
Its: Executive Vice President/Chief Financial Officer
1
<PAGE>
FORM OF NON-COMPETITION AGREEMENT
THIS NON-COMPETITION AGREEMENT (this "Agreement"), dated as of
October 24, 1997, among Magellan Health Services, Inc., a Delaware corporation
(the "Parent"), Merit Behavioral Care Corporation, a Delaware corporation (the
"Company"), and ___________ (the "Shareholder"),
W I T N E S S E T H:
WHEREAS, the Parent and the Company are parties to that
certain Agreement and Plan of Merger dated October 24, 1997 (the "Merger
Agreement") pursuant to which the Parent, by virtue of the merger contemplated
thereby, will acquire from the shareholders of the Company all of the issued and
outstanding shares of capital stock of the Company (the "Shares") upon the terms
and subject to the conditions set forth herein;
WHEREAS, in order to induce the Parent to consummate the
transactions contemplated by the Merger Agreement, the Shareholder has agreed to
enter into this Agreement for and in favor of the Parent and the Company;
NOW, THEREFORE, in consideration of the mutual covenants
contained herein and other good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereby agree as follows:
SECTION 1. DEFINITIONS.
Section 1.1 Definitions. Unless the context otherwise
requires, as used in this Agreement, the following terms shall have the
following meanings (terms defined in the singular to have the same meanings when
used in the plural and vice versa):
(a) "Affiliate" shall have the meaning set forth in the Merger Agreement.
(b) "Agreement" shall have the meaning set forth in the introductory paragraph
hereto.
(c) "Behavioral Health Services" shall mean integrated and managed behavioral
health care services or providing behavioral health care services, including
integrated and managed mental health programs and substance abuse programs,
employee assistance programs, and utilization management, care management and
network management concerning behavioral health care services.
(d) "Business" shall mean the business of providing or administering (or owning,
operating, administering or managing a company or facility which provides or
administers) Behavioral Health Services, as conducted by the Company and the
Company Subsidiaries, for and on behalf of a health care plan (including
self-insured plans) for a fee (or any other financial benefit).
1
<PAGE>
(e) "Closing" shall have the meaning set forth in the Merger Agreement.
(f) "Closing Date" shall have the meaning set forth in the Merger Agreement.
(g) "Code" shall have the meaning set forth in the Merger Agreement.
(h) "Company" shall have the meaning set forth in the introductory paragraph
hereto.
(i) "Company Subsidiary" shall have the meaning set forth in the Merger
Agreement.
(j) "Confidential Information" shall mean information that is not generally
known to the public and that is used, developed or obtained by the Company or
Company Subsidiaries in connection with its business, including but not limed to
(i) products or services, (ii) fees, costs and pricing structures, (iii)
designs, (iv) computer software, including operating systems, applications and
program listings, (v) flow charts, manuals and documentation, (vi) data bases,
(vii) accounting and business methods, (viii) inventions, devices, new
developments, methods and processes, whether patentable or unpatentable and
whether or not reduced to practice, (ix) customers and clients and customer or
client lists, (x) other copyrightable works, (xi) all technology and trade
secrets, and (xii) all similar and related information in whatever form.
Confidential Information will not include any information that has been
published in a form generally available to the public prior to the date the
Shareholder proposes to disclose or use such information.
(k) "Parent" shall have the meaning set forth in the introductory paragraph
hereto.
(l) "Person" shall mean any individual, corporation, partnership, limited
liability company, joint venture, association, joint-stock company, trust,
unincorporated organization or Governmental Authority.
(m) "Shareholder" shall have the meaning set forth in the introductory paragraph
hereto.
(n) "Territory" shall mean the United States of America, its territories and
possessions (including, without limitation, Puerto Rico).
Section 1.2 Principles of Construction. Definitions used in
this Agreement shall apply equally to both the singular and plural forms of the
terms defined. Whenever used in this Agreement, the words "include," "includes"
and "including" shall be deemed to be followed by the phrase "without
limitation." Unless the context otherwise requires, all references herein to
Articles, Sections, Exhibits and Schedules shall be deemed references to
articles and sections of, and schedules to this Agreement. All pronouns used
herein shall be deemed to refer to the masculine, feminine or
2
<PAGE>
neuter gender as the context requires. Unless the context otherwise requires,
the term "party" when used in this agreement means a party to this agreement,
and references to a party or other Person shall be deemed to include successors
and permitted assigns of such party. All references herein to any agreement or
document shall be deemed to include such agreement or document (unless specific
reference is made to that agreement or document as in effect on a specific
date), as the same may be amended, supplemented or otherwise modified from time
to time. The parties acknowledge and agree that they have been represented by
counsel and that each of the parties has participated in the drafting of this
Agreement. Accordingly, it is the intention and agreement of the parties that
the language, terms and conditions of this Agreement are not to be construed in
any way against or in favor of any party hereto by reason of the
responsibilities in connection with the preparation of this Agreement.
SECTION 2. COVENANTS; CONSIDERATION.
Section 2.1 Covenant Not to Compete.
(a) The Shareholder covenants and agrees that, for a period
commencing on the Closing Date and ending on the third anniversary of the
Closing Date, without the written consent of the Parent, the Shareholder shall
not, directly or indirectly, engage in or have any interest in any Person that
is engaged in (whether as an owner, proprietor, shareholder, partner, joint
venturer, investor, operator, manager, officer, director, employee, contractor,
consultant, licensor of technology, agent, broker, lender, guarantor, advisor or
otherwise) the Business anywhere in the Territory.
(b) Notwithstanding anything to the contrary set forth herein,
the restrictions set forth in this Section 2.1 shall not apply to the ownership
by the Shareholder of an aggregate of not more than 5% of the outstanding
capital stock of any public corporation that provides Behavioral Health
Services.
Section 2.2 Non-Solicitation of Customers. The Shareholder
covenants and agrees that, except as required in the performance of his duties
to the Company or any Affiliate of the Company, for a period commencing on the
Closing Date and ending on the third anniversary of the Closing Date, without
the written consent of the Parent, it will refrain from, directly or indirectly,
soliciting or accepting, or attempting to solicit or provide, itself or by
assisting others, any business from any of the Company's of Company Subsidiary's
customers, including actively sought prospective customers, for purposes of
providing products or services that are competitive with those provided by the
Company or any Company Subsidiary. In addition, the Shareholder covenants and
agrees that, for a period commencing on the Closing Date and ending on the third
anniversary of the Closing Date, that it will not advise any customer or
prospective customer of the Company or any Company Subsidiary to stop doing
business, either in whole or in part with the Company or any Company Subsidiary.
Section 2.3 Non-Solicitation of Contractors and Employees.
The Shareholder agrees for a period commencing on the Closing Date and ending
on the third anniversary of the
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<PAGE>
Closing Date, not, directly or indirectly, for itself or in the service of
another, to make, offer, solicit or induce to enter into, any written or oral
arrangement, agreement or understanding regarding employment or retention as a
consultant or independent contractor with any Person who is at the time of such
solicitation an employee of the Company or any Company Subsidiary, without the
written consent of the Parent.
Section 2.4 Restriction on Use and Disclosure. For a period
commencing on the Closing Date and ending on the third anniversary of the
Closing Date, the Shareholder will not disclose or use at any time any
Confidential Information of which the Shareholder is or becomes aware, whether
or not such information is developed by him, except to the extent that such
disclosure or use is directly related to and required by the Shareholder's
performance of duties, if any, assigned to the Shareholder by the Parent or the
Company, or such Confidential Information becomes public other than through
action of the Shareholder or is compelled by legal process. The Shareholder
hereby acknowledges and agrees that the prohibitions against disclosure of
Confidential Information recited herein are in addition to, and not in lieu of,
any rights or remedies which the Parent or the Company may have available
pursuant to the laws of any jurisdiction or at common law to prevent the
disclosure of trade secrets and other confidential proprietary data, and the
enforcement by the Parent or the Company of its rights and remedies pursuant to
this Agreement shall not be construed as a waiver of any other rights or
available remedies which it may possess in law or equity absent this Agreement.
Section 2.5 Consideration; Cancellation of Prior Agreements.
(a) The Shareholder acknowledges and agrees that the covenants
set forth in this Agreement are ancillary to the sale of the Shareholder's
shares of stock in the Company pursuant to the Merger Agreement. As additional
consideration for the covenants and agreements of the Shareholder set forth in
this Agreement, the Company agrees to pay the Shareholder the aggregate amount
of $________ payable in two (2) equal installments of $_________ each as
follows: the first installment shall be due and payable on the Closing Date and
the second installment shall be due and payable on the first anniversary of the
Closing Date. The amounts payable to the Shareholder pursuant to this Section
2.5(a) shall be subject to all applicable withholding obligations for federal,
state and local taxes.
(b) The Shareholder acknowledges and agrees that the payment
described in Section 2.5(a) shall be in full satisfaction and in lieu of (i) the
payment to which the Shareholder otherwise would be entitled pursuant to any and
all severance agreements between the Shareholder and the Company or any
Affiliate of the Company, including without limitation, pursuant to Section 2 of
that certain Severance Agreement dated October 6, 1995 to which the Shareholder
and Medco Behavioral Care Corporation are parties (the "Severance Agreement"),
and (ii) any other payment in the nature of severance from the Company or an
Affiliate of the Company under any employment, consulting or other agreement or
otherwise including, without, limitation, under Section 2(y) of the Severance
Agreement. The Shareholder acknowledges and agrees that any and all severance
and/or consulting agreements between the Shareholder and the Company or any
Affiliate of the Company
4
<PAGE>
shall terminate and be of no further force or effect as of the Closing Date.
Nothing set forth in this Section shall apply to or affect that certain Amended
and Restated Employment Agreement (the "Employment Agreement") dated August 17,
1992 between American Biodyne, Inc. ("ABI") and the Shareholder which shall
continue in full force and effect in accordance with its terms except as
modified by that certain letter dated October 24, 1997 pursuant to which the
Shareholder notified ABI of his election to change his status to that of
Chairman Emeritus and except that Section 4.4 of the Employment Agreement shall
be of no further force or effect.
(c) The payment of the consideration set forth in this
Agreement shall be contingent upon and subject to the receipt of the approval of
the shareholders of the Company pursuant to the provisions of Section 280G(b)(5)
of the Code.
(d) The Shareholder shall be eligible for health care coverage
with the health care plan of the Company, as the same may be amended from time
to time, at no cost to the Shareholder, which coverage shall be continued for
the period commencing on the later of (i) the Closing Date or (ii) the date the
Shareholder's eligibility for such coverage under the Company's health care plan
otherwise lapses and the date the Shareholder attains age sixty-five (65);
provided, that eligibility for health care coverage shall cease in the event the
Shareholder becomes eligible for health care coverage under either an individual
health care policy or a group health plan.
(e) The Parent and the Shareholder covenant and agree to enter
into a consulting agreement for a term of three (3) years commencing on the
Closing Date; upon the mutual consent of the Parent and the Shareholder, the
term of the agreement may be extended for a two (2) year renewal period after
the expiration of the initial term. The terms and conditions of the
Shareholder's consulting responsibilities shall be negotiated between the
parties and set forth in the consulting agreement. The Shareholder shall be
entitled under the consulting agreement to an annual consulting fee of $______,
which shall be payable under terms and conditions set forth in the consulting
agreement.
Section 2.6 Shareholder's Acknowledgments.
(a) The Shareholder acknowledges and agrees that it has
received adequate consideration for the execution, delivery and performance of
this Agreement. The Shareholder acknowledges and agrees further that the
execution and delivery of this Agreement is a mandatory condition to the Parent
entering into the Merger Agreement, without which the Parent would not enter
into the Merger Agreement.
(b) The Shareholder acknowledges and agrees that the
restrictions set forth in this Agreement, including the scope of the
restrictions in time, geography and activities in this Agreement is reasonable
and necessary to protect the legitimate business interests of the Parent
including the goodwill of the Company being acquired by the Parent pursuant to
the Merger Agreement and the substantial relationships (as reflected, in part,
in the contracts of the Company) with payors and other
5
<PAGE>
medical providers and patients that are enuring to the benefit of the Parent as
contemplated by the Merger Agreement.
SECTION 3. REMEDIES. The Shareholder acknowledges and agrees
that the rights of the Parent under this Agreement are of a specialized and
unique character, that a monetary remedy for a breach of the agreements set
forth in this Agreement will be inadequate and impracticable and that immediate
and irreparable damage will result to Parent and the Company if the Shareholder
fails to or refuse to perform its obligations under this Agreement.
Notwithstanding any election by any Person to claim damages from the Shareholder
as a result of any such failure or refusal, the Parent may, in addition to any
other remedies and damages available, seek temporary and permanent injunctive
relief (without the necessity of proving actual damages and without the posting
of a bond or other security) in a court of competent jurisdiction to restrain
any such failure or refusal and the Shareholder, for itself and its Affiliates
waives any defense that the aggrieved party has an adequate remedy at law. The
Shareholder agrees that, in addition to all other remedies available at law or
in equity, the Parent shall be entitled to such injunctive relief, including
temporary restraining orders, preliminary injunctions and permanent injunctions
as a court of competent jurisdiction shall determine.
SECTION 4. MISCELLANEOUS.
Section 4.1 Successors and Assigns; Restrictions on
Assignment. Except as otherwise provided in this Agreement, no party hereto
shall assign this Agreement or any rights or obligations hereunder without the
prior written consent of the other party hereto and any such attempted
assignment without such prior written consent shall be void and of no force and
effect, provided, that the Parent may assign its rights hereunder to any of its
Affiliates and any Person succeeding to the business and operations of the
Parent or the Company including, without limitation, any Person with which the
Parent or the Company may be merged, by which it may be acquired or to which it
sells substantially all of its assets or transfers its business. The Parent may
assign its rights to damages hereunder to the lender or lenders providing
financing to the Parent. This Agreement shall inure to the benefit of and shall
be binding upon the parties hereto and their respective successors, permitted
assigns, heirs, beneficiaries, estates, executors and personal representatives.
Section 4.2 Governing Law, Jurisdiction. This Agreement shall
be construed, performed and enforced in accordance with, and governed by, the
laws of the State of New York, without giving effect to the principles of
conflicts of laws thereof.
Section 4.3 Severability; Independence of Covenants. In the
event that any provision of this Agreement or any word, phrase, clause, sentence
or other portion thereof should be held to be unenforceable or invalid for any
reason, such provision or portion thereof shall be modified or deleted in such a
manner so as to make this Agreement, as modified, legal and enforceable to the
fullest extent permitted under applicable laws. The Shareholder, the Parent and
the Company hereby expressly authorize any court of competent jurisdiction to
enforce any such provision or portion thereof or to modify any such provision or
portion thereof in order that any such provision or portion thereof shall be
enforced by such court to the fullest extent permitted by applicable laws. In
the event
6
<PAGE>
that any part of this Agreement is declared by any court or other judicial or
administrative body to be null, void or unenforceable, said provision shall
survive to the extent it is not so declared, and all of the other provisions of
this Agreement shall remain in full force and effect.
Section 4.4 Notices. All notices, requests, demands and other
communications under this Agreement shall be in writing and shall be deemed to
have been duly given (i) on the date of service if served personally on the
party to whom notice is to be given; (ii) on the day of transmission if sent via
facsimile transmission to the facsimile number given below, and telephonic
confirmation of receipt is obtained promptly after completion of transmission;
(iii) on the day after delivery to Federal Express or similar overnight courier;
or (iv) on the fifth day after mailing, if mailed to the party to whom notice is
to be given, by first class mail, registered or certified, postage prepaid and
properly addressed, to the party as follows:
If to the Shareholder:
===============
===============
If to the Parent or Company:
Magellan Health Services, Inc.
3414 Peachtree Road, NE, Suite 1400
Atlanta, Georgia 30326
Attention: Vice President-Mergers and Acquisitions
Copy to:
Magellan Health Services, Inc.
3414 Peachtree Road, NE, Suite 1400
Atlanta, Georgia 30326
Attention: General Counsel
Any party may change its address for the purpose of this
Section by giving the other party written notice of its new address in the
manner set forth above.
Section 4.5 Amendments; Waivers. This Agreement may be amended
or modified, and any of the terms, covenants, representations, warranties or
conditions hereof may be waived, only by a written instrument executed by the
parties hereto, or in the case of a waiver, by the party waiving compliance. Any
waiver by any party of any condition, or of the breach of any provision, term,
covenant, representation or warranty contained in this Agreement, in any one or
more instances, shall not be deemed to be nor construed as further or continuing
waiver of any such condition, or of the breach of any other provision, term,
covenant, representation or warranty of this Agreement.
7
<PAGE>
Section 4.6 Entire Agreement. This Agreement contains the
entire understanding between the parties hereto with respect to the transactions
contemplated hereby and supersedes and replaces all prior and contemporaneous
agreements and understandings, oral or written, with regard to such
transactions.
Section 4.7 Section and Paragraph Headings. The section and
paragraph headings in this Agreement are for reference purposes only and shall
not affect the meaning or interpretation of this Agreement.
Section 4.8 Headings. The section and other headings in this
Agreement are inserted solely as a matter of convenience and for reference and
are not a part of this Agreement.
Section 4.9 Counterparts. This Agreement may be executed in
multiple counterpart copies, each of which will be considered an original and
all of which will constitute one and the same instrument, binding on all parties
hereto, even though all the parties are not signatory to the same counterpart.
Any counterpart of this Agreement which has attached to it separate signature
pages, which taken together contain the signature of all parties hereto, shall
for all purposes be deemed a fully executed original.
Section 4.10 Effectiveness; Termination. This Agreement shall
become effective as of the Closing Date. If the Merger Agreement is terminated
prior to the Closing Date, this Agreement shall be null and void and without any
legal effect.
8
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be executed either in an individual capacity or by their respective
officers thereunto duly authorized, as the case may be, as of the date first
above written.
SHAREHOLDER:
---------------------------------------
PARENT:
MAGELLAN HEALTH SERVICES, INC.
By:
Name:
Title:
COMPANY:
MERIT BEHAVIORAL CARE CORPORATION
By:
Name:
Title:
9
<PAGE>
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into
as of this 26th day of November, 1996 by and between MERIT BEHAVIORAL CARE
CORPORATION, a Delaware corporation (the "Company"), and John P. Docherty, M.D.,
an individual with an address at 21 Bloomingdale Road, White Plains, New York
10605 ("Employee").
WHEREAS, the Company desires to engage Employee to provide services pursuant to
the terms of this Agreement;
WHEREAS, Employee desires to provide such services to the Company pursuant to
this Agreement;
WHEREAS, this Agreement shall be effective on March 1, 1997; and
WHEREAS, both parties hereto acknowledge that the services to be performed by
Employee under this Agreement shall require a high degree of diligence,
creativity and responsiveness appropriate to the Company's business intentions;
NOW, THEREFORE, in consideration of the premises and the mutual covenants
contained in this Agreement, the parties agree as follows:
SELECTED DEFINITIONS
1.1 Defined Terms. As used herein, the terms below shall have the following
meanings:
"Affiliate" shall mean a subsidiary of the Company
and any other business entity controlled by, controlling, or
under common control with, the Company from time to time.
"Anniversary Date" means March 1, the anniversary of
the Effective Date of this Agreement.
"Board" shall mean the Board of Directors of the
Company.
<PAGE>
"Business" shall mean the business of the Company and
it subsidiaries, including, without limitation, the business
of providing and arranging for the provision of behavioral
health (including mental health and substance abuse) managed
care programs, behavioral health care delivery services, and
employee assistance programs.
"CEO" shall mean the Chairman of the Board and Chief
Executive Officer of the Company.
"Common Stock" shall mean the common stock, par value
$.01 per share, of the Company.
"Compensation Committee" shall have the meaning such
term is given in Section 4.1 hereof.
"Confidential Information" shall have the meaning
such term is given in Section 5.1 hereof.
"Designated Companies" shall have the meaning such
term is given in Section 5.3(b) hereof.
"Developments" shall have the meaning such term is
given in Section 5.2 hereof.
"Disability Termination Right" shall have the meaning
such term is given in Section 3.5 hereof.
"Effective Date" of this Agreement shall mean
March 1, 1997.
"Employee Note" has the meaning such term is given
in Section 4.4 hereof.
"Employment Period" shall have the meaning such term
is given in Section 3.1 hereof.
"MBC Corp." has the meaning such term is given in
Section 2.1 hereof.
"1995 Option Plan" shall mean the 1995 Stock Purchase
and Option Plan for employees of Medco Behavioral Care
Corporation and Subsidiaries.
"Non-Competition Period" shall have the meaning such
term is given in Section 5.3(a) hereof.
<PAGE>
"Option Agreement" shall have the meaning such term
is given in Section 4.3(a) hereof.
"Options" shall mean non-qualified options to
purchase newly issued shares of Common Stock.
"Purchase Shares" shall have the meaning such term is
given in Section 4.4 hereof.
"Post-Employment Compensation Period" shall mean the
period (which in no event shall exceed three (3) years)
commencing on the date of termination of Employee's employment
with the Company under Section 3.3 or 3.4 hereof and ending
twenty-four (24) months after the Anniversary Date of this
Agreement next succeeding the date of termination of
Employee's employment with the Company. For example, if
Employee's employment with the Company terminates under
Section 3.3 or 3.4 hereof on July 15, 1998, the
Post-Employment Compensation Period would commence on such
date and end on March 1, 2001. The Post-Employment
Compensation Period applies only in the case of a termination
under Section 3.3 or 3.4 hereof occurring prior to March 1,
2000.
"Section 5.3(a) Agreement" shall have the meaning
such term is given in Section 5.3(a).
"Stockholder's Agreement" shall have the meaning such
term is given in Section 4.4 hereof.
"Termination for Cause" shall have the meaning such
term is given in Section 3.2 hereof.
"Termination for Good Reason" shall have the meaning
such term is given in Section 3.4 hereof.
"Territory" means the United States of America, its
territories and possessions (including Puerto Rico).
"Total Base Compensation" shall have the meaning such
term is given in Section 4.1 hereof.
SECTION 2. EMPLOYMENT
2.1 Title; Duties. The Company agrees to employ Employee as Chief Medical
Officer of the Company and Executive Vice President, Clinical Services of MBC
Corp., the behavioral health managed care division of the Company ("MBC Corp."),
for the Employment
<PAGE>
Period, and Employee hereby accepts such employment. In such position, Employee
shall report to Richard C. Surles, Ph.D., Executive Vice President, Operations
of the Company; provided, that if Dr. Surles is no longer employed by the
Company, Employee shall report to the then current Executive Vice President,
Operations of the Company. Employee shall perform such duties with regard to the
Business as are assigned to him by Dr. Surles and as are generally performed by
such an employee of a company, and such other duties as may from time to time be
reasonably requested by the CEO or the Board.
2.2 Performance of Duties. (a) Subject to the other provisions of this Section
2.2:
(i) Employee agrees to devote his exclusive and full professional time and
attention to his duties as an employee of the Company and to perform such duties
in an efficient, trustworthy and businesslike manner. In addition, Employee
agrees that he will not render to others any service of any kind or engage in
any other business activity (including, without limitation, any involvement in
any business in which Employee has any administrative or operating
responsibility) which conflicts with the performance of his duties under this
Agreement (except as to any other activities which are approved in writing by
the Board, Dr. Surles or the CEO).
(ii) During the term of this Agreement, Employee agrees to devote his full
business time and efforts, and to otherwise use his best efforts, to manage the
operations of the Company and its subsidiaries, to maximize the Company's
results of operations and profits, to satisfy the directions of the Board, Dr.
Surles and the CEO, and to otherwise fulfill the agreements and covenants set
forth in this Agreement. Employee acknowledges that the failure to satisfy any
covenant set forth in this Agreement may cause the Company irreparable harm and
shall have denied the Company and the Affiliates of a substantial and valuable
asset.
(b) Employee represents and warrants that he is not bound by any employment,
consulting, noncompetition, confidentiality, finders, marketing or other
agreement or arrangement that would, or might reasonably be expected to,
prohibit or restrict him in any manner from performing his duties and
obligations hereunder.
(c) The Company acknowledges that Employee is involved in, and will continue to
participate in, certain other businesses and professional activities in the
health care field during the course of his employment with the Company. The
Company agrees that, notwithstanding the other provisions of this Section 2.2
and Article 5 hereof, Employee shall be permitted to engage in the following
activities:
(i) professional conferences and speaking engagements;
<PAGE>
(ii) professional consultations with drug companies, hospitals and universities,
provided, that such consultations shall not involve more than 100 hours in the
aggregate in any year during the term of this Agreement without the consent of
Dr. Surles or the CEO;
(iii) the businesses described in the last sentence of Section 5.3(a) hereof;
and
(iv) business and professional activities not related to the Business
specifically and the behavioral health business generally (i.e., except for
those described in the last sentence of Section 5.3(a) hereof, Employee will not
engage in the Business or the behavioral health business other than as an
employee of the Company).
With respect to the foregoing provisions, the Company and Employee agree that:
(A) in the event Employee contemplates engaging in any activity which might be
construed as the Business or another business in the behavioral health field,
Employee shall consult with Dr. Surles and the CEO prior to engaging in such
activity. Employee, Dr. Surles and the CEO will mutually determine in good faith
whether such activity constitutes the Business or another behavioral health
business.
(B) Notwithstanding any other term of this Section 2.2(c), Employee shall not be
permitted to engage in any of the activities described in Section
2.02(c)(i)-(iv) above to the extent such activities interfere (in the reasonable
judgment of Dr. Surles or the CEO) in the prompt and effective discharge by
Employee of his duties described in Section 2.1 hereof or would prevent Employee
from devoting his full (i.e., at least 40 hours per week) business time and
attention to his responsibilities to the Company.
2.3 Support. Employee shall be provided appropriate administrative support at
the Company's headquarters in Park Ridge, New Jersey, including both an
Executive Assistant and a Research Assistant.
2.4 Relocation Agreement. The Company and Employee agree to enter into the
Relocation Agreement attached hereto as Exhibit F.
SECTION 3. EMPLOYMENT PERIOD; TERMINATION OF EMPLOYMENT
3.1 Employment Period. Subject at all times to Section 3.3 hereof, this
Agreement and Employee's employment hereunder shall continue until terminated by
the earliest of (a) the Company's discharge of Employee and termination of this
Agreement pursuant to Sections 3.2, 3.3 or 3.5 hereof; (b) Employee's death; or
(c) Employee's termination of his employment and this Agreement pursuant to
Section 3.4 or 3.6 hereof. If Employee shall continue in the employ
<PAGE>
of the Company beyond the termination of this Agreement, such employment shall
be deemed to continue on a month-to-month basis terminable by either party on
thirty (30) days prior written notice. The period during which Employee is
employed by the Company under this Agreement or otherwise is referred to herein
as the "Employment Period." In all events, the post-termination provisions of
Section 5 hereof shall survive termination of the Employment Period and this
Agreement.
3.2 Termination by the Company for "Cause." The Company shall have the
right immediately (except as provided below) to discharge Employee and terminate
this Agreement, by written notice provided to Employee, for any or all of the
following "causes" (a "Termination for Cause"):
(a) Employee's conviction for, or entry of a plea of guilty or nolo contendere
with respect to, any felony or any crime involving an act of moral turpitude or
misuse or misappropriation of money or other property of the Company or any
Affiliate;
(b) Employee's commission of any act of fraud or dishonesty with respect to his
duties under this Agreement;
(c) Employee's conduct which is intentionally detrimental to the Company's or
any Affiliate's reputation, goodwill or business operations;
(d) Employee's gross or habitual neglect of his duties or his breach of his
duties or his misconduct in discharging his duties;
(e) Employee's absence from his duties without the consent of Dr. Surles, his
designee or his successor for a period of at least ten (10) business days, which
consent shall not be unreasonably withheld or delayed; or
(f) Employee's failure or refusal to comply with the directions of Dr. Surles,
his designee or his successor, or with the policies, standards and regulations
of the Company as may from time to time be made known to Employee; provided,
that -------- such directions, policies, standards and regulations are not
inconsistent with the provisions and terms of this Agreement or with applicable
law or regulations or with applicable professional ethical considerations; and
provided, further, that -------- ------- such failure or refusal is not remedied
by Employee within five (5) business days after notice from the Company
demanding such remedy.
3.3 Termination by the Company without "Cause." The Company shall have the right
to discharge Employee and terminate this Agreement, by written notice provided
to Employee not less than thirty (30) days prior to the intended date of
discharge and termination, without "cause" at any time during the Employment
Period, for any reason or for no reason.
<PAGE>
3.4 Termination by Employee for "Good Reason." Employee may terminate his
employment with the Company and this Agreement, by written notice provided to
the Company not more than thirty (30) days prior to the intended date of
termination, for any or all of the following reasons (a "Termination for Good
Reason"):
(a) a material adverse change in the nature of Employee's job duties without his
consent;
(b) a material reduction in the rate of Employee's Total Base Compensation; or
(c) a material breach by the Company of the Stockholder's Agreement;
and, in any such case, the Company fails to remedy the applicable situation or
cure such breach prior to the end of such thirty (30) day period.
3.5 Termination by the Company due to Disability of Employee. The Company shall
have the right to discharge Employee and terminate this Agreement, by written
notice provided to Employee not less than thirty (30) days prior to the intended
date of discharge and termination, upon the determination by the Board in good
faith and in its discretion that Employee is unable to engage in activities
required by his employment (or reasonable substitute employment) by reason of
any medically determined physical or mental impairment which can be expected to
result in death or which has lasted or can be expected to last for a continuous
period of not less than twelve (12) months (referred to herein as the
"Disability Termination Right").
3.6 Termination by Employee without "Good Reason." In addition to his
termination right under Section 3.4 hereof, Employee also may terminate his
employment with the Company and this Agreement, by written notice provided to
the Company not more than thirty (30) days prior to the intended date of
termination, for any reason.
3.7 Death. The Employment Period shall terminate forthwith upon the death of
Employee.
SECTION 4. COMPENSATION
4.1 Annual Salary. The Company shall pay to Employee during the Employment
Period base compensation at the rate of $250,000 per year ("Total Base
Compensation"), payable in equal installments pursuant to the Company's
customary payroll policies in force at the time of payment (but not less
frequently than monthly), less required payroll deductions. Employee shall be
entitled to annual increases of Total Base Compensation as may be determined
from time to time by the Board, or any compensation committee designated by the
Board from its members (the "Compensation Committee"), in either case in its
sole discretion.
<PAGE>
4.2 Bonus. In addition to Total Base Compensation, Employee shall be eligible
for a bonus based upon Employee's Total Base Compensation with respect to each
calendar year or portion of a calendar year during the Employment Period. Such
bonus shall be awarded pursuant to the existing bonus plan of the Company (a
copy of which has been provided to Employee prior to the date hereof) or a
successor plan applicable to executive officers of the Company adopted by the
Board or the Compensation Committee. For purposes of the existing bonus plan,
Employee's "Target Percentage" is twenty-five percent (25%); for any successor
plan, Employee's bonus percentage (subject to the applicable terms of the plan)
also shall be twenty-five percent (25%). Employee acknowledges and agrees that
bonuses under such existing plan (and any successor plan) are determined by the
CEO, the Board or the Compensation Committee, in his or its absolute discretion,
based upon the attainment of agreed financial targets and other factors, are not
guaranteed for any calendar year or period or in any specified amount, and may
be less than or greater than Employee's "Target Percentage" or bonus percentage,
as applicable, of his Total Base Compensation.
4.3 Options. Employee shall be granted Options to purchase 96,000 shares of
Common Stock on the Effective Date. The exercise price for such Options will be
$5.00 per share. Such Options will be granted pursuant to, and governed by, the
1995 Option Plan (a copy of which is attached hereto as Exhibit A) and the
Non-Qualified Stock Option Agreement to be entered into between the Company and
Employee on the Effective Date attached hereto as Exhibit B (the "Option
Agreement").
4.4 Purchase of Common Stock. On the Effective Date, the Company and Employee
will enter into the Stockholder's Agreement attached hereto as Exhibit C (the
"Stockholder's Agreement"), providing for the issuance and sale by the Company
to Employee, and the purchase by Employee from the Company, of 32,000 shares of
Common Stock at the price of $5.00 per share. The purchase of such shares of
Common Stock (the "Purchase Shares") will take place on the Effective Date.
Employee will effect payment for 16,000 of such shares by delivery to the
Company of $80,000 in cash, and will effect payment for the other 16,000 of such
shares by delivery to the Company of Employee's promissory note to the order of
the Company, attached hereto as Exhibit D, in the principal amount of $80,000
(the "Employee Note") in accordance with the terms of the Stockholder's
Agreement. The payment of the principal amount of, and all accrued and unpaid
interest under, the Employee Note will be secured by the pledge by Employee of
the 16,000 shares financed by the Employee Note pursuant to the Repayment and
Stock Pledge Agreement attached hereto as Exhibit E.
4.5 Reimbursement of Expenses. During the term of this Agreement, the Company
will reimburse Employee for all ordinary and necessary business expenses
incurred by Employee in connection with the Business. Reimbursement of such
expenses shall be paid on a regular basis, upon submission by Employee of
vouchers itemizing such expenses in a form satisfactory to the Company, properly
identifying the nature and business purpose of any expenditures.
<PAGE>
4.6 Benefits. During the term of this Agreement, the Company shall provide
Employee with such insurance, medical, sick leave, holiday and other benefits as
may be given from time to time to other officers of the Company as set forth
from time to time by the Board and management of the Company. Employee may take
such vacation period or periods during each year as shall be consistent, in the
Company's judgment, with Employee's responsibilities and the Company's vacation
policies and practices for other officers of the Company, but not more than four
(4) weeks during any full calendar year of the Employment Period.
4.7 Effect of Termination of Employment. (a) Termination by the Company for
"Cause," pursuant to the Disability Termination Right or upon Employee's Death.
In the event of termination of Employee's employment and this Agreement by the
Company pursuant to Sections 3.2, 3.5 or 3.7 hereof, Employee (or, if
applicable, his estate) shall be entitled to receive only payment of his earned
and unpaid compensation and benefits through the effective date of such
termination.
(b) Termination by the Company without "Cause" or by Employee for "Good Reason."
(i) Prior to March 1, 2000. In the event of termination of Employee's employment
and this Agreement by the Company under Section 3.3 hereof or by Employee under
Section 3.4 hereof prior to the third Anniversary Date of this Agreement (i.e.,
March 1, 2000), Employee shall be entitled to (A) continue to receive from the
Company Total Base Compensation in accordance with Section 4.1 hereof for the
Post-Employment Compensation Period and (B) subject to the terms of the
Stockholder's Agreement, exercise all Options granted in accordance with Section
4.3 hereof which are vested as of the date of termination (subject to and in
accordance with the terms of the 1995 Option Plan and the Option Agreement). The
shares of Common Stock purchased by Employee as described in Section 4.4 hereof
shall continue to be governed by the provisions of the Stockholder's Agreement.
(ii) On or after March 1, 2000 and prior to March 1, 2001. In the event of
termination of Employee's employment and this Agreement by the Company under
Section 3.3 hereof or by Employee under Section 3.4 hereof on or after the third
Anniversary Date, but prior to the fourth Anniversary Date, of this Agreement,
Employee shall be entitled to (A) continue to receive from the Company Total
Base Compensation in accordance with Section 4.1 hereof through the fifth
Anniversary Date of this Agreement and (B) subject to the terms of the
Stockholder's Agreement, exercise all Options granted in accordance with Section
4.3 hereof which are vested as of the date of termination (subject to and in
accordance with the terms of the 1995 Option Plan and the Option Agreement). The
shares of Common Stock purchased by Employee as described in Section 4.4 hereof
shall continue to be governed by the provisions of the Stockholder's Agreement.
(iii) On or after March 1, 2001. In the event of termination of Employee's
employment and this Agreement by the Company under Section 3.3 hereof or by
Employee under Section 3.4 hereof on or after the fourth Anniversary Date of
this Agreement, Employee shall be entitled to (A) continue to receive from the
Company Total Base Compensation in
<PAGE>
accordance with Section 4.1 hereof for a period of twelve (12) months from the
date of termination and (B) subject to the terms of the Stockholder's Agreement,
exercise all Options granted in accordance with Section 4.3 hereof which are
vested as of the date of termination (subject to and in accordance with the
terms of the 1995 Option Plan and the Option Agreement). The shares of Common
Stock purchased by Employee as described in Section 4.4 hereof shall continue to
be governed by the provisions of the Stockholder's Agreement.
(c) Termination by Employee without "Good Reason." In the event of termination
of Employee's employment and this Agreement by Employee under Section 3.6
hereof, Employee shall not be entitled to any compensation (other than the
payment of his earned and unpaid compensation and other benefits to the
effective date of termination) and, subject to the terms of the Stockholder's
Agreement, shall be entitled to exercise all Options granted in accordance with
Section 4.3 hereof which are vested as of the date of termination (subject to
and in accordance with the terms of the 1995 Option Plan and the Option
Agreement). The shares of Common Stock purchased by Employee as described in
Section 4.4 hereof shall continue to be governed by the terms of the
Stockholder's Agreement.
4.8 Release. The payments and other rights of Employee described in Section
4.7(b) hereof may, at the Company's option, be conditioned upon Employee's
execution and delivery of a general release of the Company and the Affiliates,
and its and their respective directors, officers, employees and agents, from any
claims or obligations arising out of this Agreement and the termination hereof,
other than the express obligations of the Company to make such payments and
provide such rights, if any, as are described in Section 4.7(b) hereof and to
pay to Employee his earned and unpaid compensation and other benefits to the
effective date of termination. Employee acknowledges that the payments and
rights under Section 4.7(b) hereof are in lieu of all such claims that Employee
may have against the Company and the Affiliates and are liquidated damages (and
not a penalty). Notwithstanding any termination hereunder, the Company shall
have no obligation to make such payments or provide such rights under Section
4.7(b) hereof, and the Options shall terminate immediately, in the event of a
breach by Employee of his covenants in Section 5 hereof.
SECTION 5. CONFIDENTIAL INFORMATION, DEVELOPMENTS,
NON-COMPETITION/NON-SOLICITATION AND RELATED MATTERS
5.1 Restrictions on Use and Disclosure. Employee will not disclose or use at any
time, for so long as Employee is employed by the Company or any Affiliate and
for a period of five years thereafter, any Confidential Information (as defined
below) of which Employee is or becomes aware, whether or not such information is
developed by him, except to the extent that such disclosure or use is directly
related to and required by Employee's performance of duties, if any, assigned to
Employee by Dr. Surles, the CEO or the Company, such Confidential Information
becomes public other than through action of Employee or is compelled by legal
process. In the event that Employee plans to speak at a professional conference
and information to be presented includes or may include Confidential
Information, Employee shall consult with
<PAGE>
Dr. Surles or the CEO concerning such Confidential Information prior to
participating in such conference and presenting such information. As used in
this Agreement, the term "Confidential Information" means information that is
not generally known to the public and that is used, developed or obtained by the
Company or any Affiliate in connection with its business, including, but not
limited to: (i) products or services, (ii) fees, costs and pricing structures,
(iii) designs, (iv) computer software, including operating systems, applications
and program listings, (v) flow charts, manuals and documentation, (vi) data
bases, (vii) accounting and business methods, (viii) inventions, devices, new
developments, methods and processes, whether patentable or unpatentable and
whether or not reduced to practice, (ix) customers, clients and providers, and
customer, client and provider lists, (x) other copyrightable works, (xi) all
technology and trade secrets, and (xii) all similar and related information in
whatever form. Confidential Information will not include any information that
has been published in a form generally available to the public prior to the date
Employee proposes to disclose or use such information. Employee will perform all
actions reasonably requested by the Company (whether during or after the
Non-Competition Period) to establish and confirm such ownership at the Company's
expense (including, without limitation, assignments, consents, powers of
attorney and other instruments).
Employee further agrees that he will not disclose to the Company, any Affiliate
or any of its or their respective directors, officers, employees, agents or
representatives, any of the information described in Section IV of the Section
5.3(a) Agreement (as defined below), and will not use any such information in
connection with the performance of his duties described in Sections 2.1 and 2.2
hereof.
5.2 Assignment of Developments. All Developments that are at any time made,
conceived or suggested by Employee, whether acting alone or in conjunction with
others, as a result of or in connection with Employee's employment with the
Company or any Affiliate shall be the sole and absolute property of the Company,
free of any reserved or other rights of any kind on Employee's part, provided,
that the Company will have no ownership interest in any Developments conceived
or developed by Employee which do not relate to the Business or do not arise out
of the activities of Employee in his capacity as an executive officer of the
Company. Employee shall promptly make full disclosure of any such Developments
to the Company and, at the Company's cost and expense, do all acts and things
(including, among others, the execution and delivery under oath of patent and
copyright applications and instruments of assignment) deemed by the Company to
be necessary or desirable at any time in order to effect the full assignment to
the Company of Employee's right and title, if any, to such Developments. For
purposes of this Agreement, the term "Developments" shall mean all data,
discoveries, findings, reports, designs, inventions, improvements, methods,
practices, techniques, developments, programs, concepts and ideas, whether or
not patentable, relating to the present or planned activities, or future
activities of which Employee is aware, or the products and services of the
Company or any Affiliate except for those relating to or arising from the
activities permitted under Section 5.3(d) hereof.
<PAGE>
5.3 Restriction on Competitive Employment. (a) Except under the circumstances
described in Section 5.3(b) or 5.3(c) below (which Section 5.3(b) or 5.3(c), as
applicable, will govern for all purposes), Employee shall not (as an individual,
principal, agent, employee, consultant or otherwise), directly or indirectly,
during the period commencing on the Effective Date and ending on the later of
(x) the first anniversary of termination of Employee's employment with the
Company or (y) if applicable, the date the Company is no longer required to make
the payments to Employee contemplated by Section 4.7(b) hereof (the applicable
period being the "Non-Competition Period"), absent the Company's prior written
approval, engage in activities in the Territory for, on behalf of or relating
to, or render services to, or have any equity, ownership or profit participation
interest in (other than as a 5% or less holder of the equity securities of a
public company), any firm or business engaged or about to become engaged in (i)
the Business or (ii) any other business in which the Company or any subsidiary
of the Company was engaged during Employee's employment with the Company and as
to which Employee had involvement during such employment or obtained
Confidential Information.
(b) In the event of termination of Employee's employment and this Agreement
under Section 4.7(b)(i), (ii) or (iii) hereof, Employee agrees that Employee
shall not (as an individual, principal, agent, employee, consultant or
otherwise), directly or indirectly, during the Non- Competition Period, absent
the Company's prior written approval, engage in activities in the Territory for
or on behalf of, or render services to, or have any equity, ownership or profit
participation interest in (other than as a 5% or less holder of the equity
securities of a public company), any of the companies listed on Schedule I or
any of their affiliates (as that term is defined in the federal securities laws)
(the "Designated Companies"); provided, that in the event Employee desires, at
any time after the first anniversary of the effective date of the termination of
his employment and this Agreement, to engage in activities on behalf of, or
render services to (as an individual, principal, agent, employee, consultant or
otherwise), any of the Designated Companies, Employee shall notify the Company
of such desire to do so. In such event, effective the date of receipt by the
Company of such notification, (i) Employee shall be released from his
obligations under this Section 5.3(b) and (ii) the Company shall be released
from its obligations to make the payments described in Section 4.7(b) (i), (ii)
or (iii), as applicable; provided, further, that nothing in the foregoing
provision shall be deemed to release Employee or the Company of any of his or
its obligations relating to the period prior to the Company's receipt of such
notification.
(c) In the event of termination of Employee's employment and this Agreement
under Section 4.7(c) hereof, Employee agrees that Employee shall not (as an
individual, principal, agent, employee, consultant or otherwise), directly or
indirectly, during the period commencing on the date of such termination and
ending on the first anniversary of such termination date, absent the Company's
prior written approval, engage in activities in the Territory for or on behalf
of, or render services to, or have an equity, ownership or profit participation
interest in (other than as a 5% or less holder of the equity securities of a
public company), any of the Designated Companies or their respective affiliates.
<PAGE>
(d) Notwithstanding anything in Section 5.3(a), (b) or (c) above, Employee shall
be permitted (A) to continue as a director, officer and shareholder of Expert
Knowledge Systems, (B) to invest in, consult with and become a director of, Mood
Sciences, Inc., (C) to continue the work in which he is involved on the date of
this Agreement in the field of disability remediation services, (D) to continue
as a director of HealthCare America, (E) to continue to provide private clinical
consultations, but only to patients in treatment with Employee on the date of
this Agreement or others as may from time to time be approved by Dr. Surles or
his successor (which approval will not be unreasonably withheld), (F) to
continue the work in which he is engaged described in the agreement described in
Schedule II (the "Section 5.3(a) Agreement") and (G) to engage in any activity
permitted pursuant to Section 2.2(c) hereof.
5.4 Restriction on Solicitation. During Employee's employment with the Company
and until the end of the Non-Competition Period, Employee shall not, directly or
indirectly, (i) solicit or contact for business purposes any existing customer,
provider or patient, or prospective customer, provider or patient, of the
Company or any subsidiary of the Company, (ii) induce, or attempt to induce, any
employees, agents, consultants or providers of or to the Company or any
subsidiary of the Company to do anything from which Employee is restricted by
reason of Sections 5.1 through 5.4 hereof, (iii) interfere with existing or
proposed contracts, business agreements or other arrangements, or knowingly
interfere with future contracts, business agreements or other arrangements,
between the Company or any subsidiary of the Company and any individual, firm or
enterprise including, but not limited to, third party payors, through disrupting
or diverting or attempting to divert such contracts, business agreements or
other arrangements to any other individual, firm or enterprise (including a
competitor of the Company or any subsidiary of the Company) or (iv) offer or aid
others to offer employment to anyone who is an employee, agent or consultant of
or to the Company or any subsidiary of the Company.
5.5 Equitable Relief. Employee acknowledges that a breach of the covenants
contained herein, including without limitation the covenants contained in
Sections 5.1 through 5.4 hereof, may cause irreparable damage to the Company or
one or more of its subsidiaries, the exact amount of which will be difficult to
ascertain, and that the remedies at law for any such breach will be inadequate.
Accordingly, Employee agrees that, in addition to any other remedy which may be
available at law or in equity, the Company and any such subsidiary shall be
entitled to specific performance and injunctive relief to prevent any actual,
intended or likely breach. The parties acknowledge that the time, scope,
geographic area and other provisions of Sections 5.1 through 5.4 hereof have
been specifically negotiated by sophisticated commercial parties and agree that
all such provisions are reasonable under the circumstances of the transactions
contemplated by this Agreement, including the compensation to Employee described
in Section 4 hereof. In the event that the agreements in Section 5.1 through 5.4
hereof or any other provision contained in this Agreement shall be determined by
any court of competent jurisdiction to be unenforceable by reason of their
extending for too great a period of time or over too great a geographical area
or by reason of their being too extensive in any other respect, such agreements
or provisions shall be interpreted to extend only over the maximum period of
time for which they may be enforceable and/or over the maximum geographical area
as to which they
<PAGE>
may be enforceable and/or to the maximum extent in all other respects as to
which they may be enforceable, all as determined by such court in such action so
as to be enforceable to the extent consistent with then applicable law. The
existence of any claim or cause of action which Employee may have against the
Company or any such subsidiary of the Company, as the case may be, shall not
constitute a defense or bar to the enforcement of any of the provisions of
Sections 5.1 through 5.4 hereof and shall be pursued through separate court
action by Employee.
5.6 Survival. Unless otherwise provided, the provisions of Sections 5.1 through
5.5 hereof shall survive the termination of this Agreement.
SECTION 6. INDEMNIFICATION
During the Employment Period, the Company shall provide Employee with directors
and officers indemnification as provided in the Company's articles of
incorporation and bylaws and directors and officers liability insurance coverage
as is generally afforded executive officers of the Company.
Employee agrees to indemnify, defend and hold harmless the Company, the
Affiliates and its and their respective directors, officers, employees, agents
and representatives from any liabilities, losses or expenses arising from
Employee's breach or alleged breach of the Section 5.3(a) Agreement or his
breach or alleged breach of the second paragraph of Section 5.1 hereof.
SECTION 7. MISCELLANEOUS PROVISIONS
7.1 Assignment and Successors. The rights and obligations of the Company under
this Agreement may be assigned, and shall inure to the benefit of and be binding
upon the successors and assigns of the Company. Employee's rights or obligations
hereunder may not be assigned to or assumed by any other person. No other
persons shall have any right, benefit or obligation hereunder.
7.2 Notices. Any notice, request, instruction or other document or communication
to be given hereunder shall be in writing and shall be deemed to have been duly
given (i) if mailed, at the time when mailed in any general or branch office of
the United States Postal Service, enclosed in a registered or certified
postage-paid envelope, (ii) if sent by facsimile transmission, when so sent and
receipt acknowledged by an appropriate telephone or facsimile receipt, or (iii)
if sent by other means, when actually received by the party to which such notice
has been directed, in each case at the respective addresses or numbers set forth
below or such other address or number as such party may have fixed by notice:
If to the Company:
Merit Behavioral Care Corporation
One Maynard Drive
<PAGE>
Park Ridge, NJ 07656
Attn: Executive Vice President and General Counsel
Fax: (201) 573-1324
If to Employee:
John P. Docherty, M.D.
_____________________
_____________________
7.3 Severability. If any provision or portion of this Agreement shall be or
become illegal, invalid or unenforceable in whole or in part for any reason,
such provision shall be ineffective only to the extent of such illegality,
invalidity or unenforceability without invalidating the remainder of such
provision or the remaining provisions of this Agreement. Upon such determination
that any term or other provision is invalid, illegal or incapable of being
enforced, the parties hereto shall negotiate in good faith to modify this
Agreement so as to effect the original intent of the parties as closely as
possible in an acceptable manner to the end that the agreements contemplated
hereby are fulfilled to the extent possible.
7.4 Amendment. This Agreement constitutes the entire agreement between the
parties hereto with respect to the subject matter hereof and may be modified,
amended or waived only by a written instrument signed by both parties hereto.
7.5 Counterparts. This Agreement may be executed and delivered (including by
facsimile transmission) in one or more counterparts, and by the different
parties hereto in separate counterparts, each of which when so executed and
delivered shall be deemed to be an original, but all of which taken together
shall constitute one and the same agreement.
7.6 Interpretation. The headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement. The language in all parts of this Agreement shall in all cases
be construed according to its fair meaning, and not strictly for or against any
party hereto. In this Agreement, unless the context otherwise requires, the
masculine, feminine and neuter genders and the singular and the plural include
one another.
7.7 Non-Waiver of Rights and Breaches. No failure or delay of any party hereto
in the exercise of any right given to such party hereunder shall constitute a
waiver thereof unless the time specified herein for the exercise of such right
has expired, nor shall any single or partial exercise of any right preclude
other or further exercise thereof or of any other right. The waiver of a party
hereto of any default of any other party shall not be deemed to be a waiver of
any subsequent default or other default by such party, whether similar or
dissimilar in nature.
<PAGE>
7.8 Governing Law; Consent to Jurisdiction. THIS AGREEMENT SHALL BE GOVERNED BY,
AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW JERSEY APPLICABLE
TO CONTRACTS EXECUTED IN AND TO BE PERFORMED IN THAT STATE. Each party hereby
irrevocably (i) submits to the jurisdiction of any New Jersey State or federal
court sitting in the City of Newark, New Jersey, with respect to matters arising
out of or relating hereto; (ii) agrees that all claims with respect to such
action or proceeding may be heard and determined in such New Jersey State or
federal court; (iii) waives, to the fullest possible extent, the defense of an
inconvenient forum; (iv) consents to service of process upon it by mailing or
delivering such service, in the case of the Company, as specified in Section 7.2
hereof or, in the case of Employee, to CT Corporation System as his agent (the
costs of which agent shall be borne by the Company), and Employee authorizes and
directs his agent to accept such service; and (v) agrees that a final judgment
in any such action or proceeding shall be conclusive and may be enforced in
other jurisdictions by suit on the judgment or in any other manner provided by
law.
EXECUTION
The parties, intending to be legally bound, executed this Agreement as
of the date first above written, whereupon it became effective in accordance
with its terms.
MERIT BEHAVIORAL CARE CORPORATION
By: /s/ Richard C. Surles
Richard C. Surles, Ph.D.
Executive Vice President, Operations
/s/ John P. Docherty
John P. Docherty, M.D.
<PAGE>
Schedule I
1. Value Behavioral Health, Inc.
2. CMG Health, Inc.
3. FHC Options, Inc.
4. Foundation Health PsychCare Services, Inc.
5. Green Spring Health Services, Inc.
6. Human Affairs International, Inc.
7. MCC Behavioral Care, Inc.
8. United Behavioral Systems, Inc.
9. United States Behavioral Health
10. Pacificare
<PAGE>
Schedule II
Agreement dated as of February 1, 1995 by and among Value Health Sciences, Inc.,
Employee and Dr. Joshua E. Freedman.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND THE CONSOLIDATED STATEMENTS OF OPERATIONS ON
PAGES F-2 THROUGH F-3 OF THE COMPANY'S FORM 10-K FOR THE FISCAL YEAR ENDED
SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS. </LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 87,368
<SECURITIES> 4,111
<RECEIVABLES> 44,487
<ALLOWANCES> 2,603
<INVENTORY> 0
<CURRENT-ASSETS> 153,108
<PP&E> 118,010
<DEPRECIATION> 34,698
<TOTAL-ASSETS> 468,745
<CURRENT-LIABILITIES> 152,357
<BONDS> 323,002
0
0
<COMMON> 294
<OTHER-SE> (26,158)
<TOTAL-LIABILITY-AND-EQUITY> 468,745
<SALES> 0
<TOTAL-REVENUES> 555,717
<CGS> 0
<TOTAL-COSTS> 449,563
<OTHER-EXPENSES> 26,897
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 25,063
<INCOME-PRETAX> (17,998)
<INCOME-TAX> (4,126)
<INCOME-CONTINUING> (13,872)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,872)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
