UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 33-80987
Merit Behavioral Care Corporation
(Exact name of registrant as specified in its charter)
Delaware 22-3236927
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
One Maynard Drive
Park Ridge, New Jersey 07656
(Address of principal executive offices)
(201) 391-8700
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes..X... No.......
As of January 31, 1997, 28,477,800 shares of the registrant's common stock, par
value $.01 per share, which is the only class of common stock of the registrant,
were outstanding.
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MERIT BEHAVIORAL CARE CORPORATION
Table of Contents
Form 10-Q for the Quarterly Period
Ended December 31, 1996
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PART I FINANCIAL INFORMATION PAGE
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Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at 3
December 31, 1996 and September 30, 1996
Condensed Consolidated Statements of
Operations for the three months ended
December 31, 1996 and December 31, 1995 4
Condensed Consolidated Statements of
Cash Flows for the three months ended
December 31, 1996 and December 31, 1995 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 7
PART II OTHER INFORMATION
Item 1. Legal Proceedings 10
Item 6. Exhibits and Reports on Form 8-K 10
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MERIT BEHAVIORAL CARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(dollars in thousands)
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December 31, September 30,
ASSETS 1996 1996
------------ ---------
Current Assets:
Cash and cash equivalents.......................................................$ 40,731 $ 47,375
Accounts receivable, net........................................................ 34,875 28,383
Other current assets............................................................ 6,113 4,777
----------- -----------
Total current assets.......................................................... 81,719 80,535
----------- -----------
Property, plant and equipment, net.............................................. 69,991 67,880
----------- -----------
Other Assets:
Goodwill and other intangibles, net............................................. 156,940 162,849
Restricted cash................................................................. 5,621 5,668
Deferred financing costs, net................................................... 11,029 11,362
Other assets.................................................................... 16,988 16,507
---------- ----------
190,578 196,386
---------- ----------
Total assets....................................................................$ 342,288 $ 344,801
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable................................................................$ 4,851 $ 5,888
Claims payable.................................................................. 60,812 57,611
Deferred revenue................................................................ 6,639 6,577
Accrued interest................................................................ 2,204 5,008
Current portion of long-term debt............................................... 500 500
Other current liabilities....................................................... 9,131 13,079
----------- ----------
Total current liabilities..................................................... 84,137 88,663
Long-term debt.................................................................. 258,000 253,500
Deferred income taxes........................................................... 25,796 30,669
Other long-term liabilities..................................................... 1,955 1,451
Stockholders' Equity:
Common stock (40,000,000 shares authorized, $0.01 par
value, 28,477,800 and 28,398,800 shares issued)............................... 285 284
Additional paid in capital...................................................... (4,858) (9,756)
Retained deficit................................................................ (17,307) (14,435)
Notes receivable from officers.................................................. (5,720) (5,470)
----------- -----------
(27,600) (29,377)
Less common stock in treasury (21,000 shares)................................... --- (105)
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Total stockholders' equity.................................................... (27,600) (29,482)
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Total liabilities and stockholders' equity......................................$ 342,288 $ 344,801
========= =========
See accompanying notes to condensed consolidated financial statements.
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MERIT BEHAVIORAL CARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(dollars in thousands)
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Three months ended
December 31,
1996 1995
------------ ----------
Revenue.......................................................$ 128,625 $110,920
Expenses:
Direct service costs........................................ 102,932 88,350
Selling, general and administrative......................... 16,579 14,308
Amortization of intangibles................................. 6,799 6,315
------------ -----------
126,310 108,973
Operating income.............................................. 2,315 1,947
Other income (expense):
Interest income and other................................... 780 541
Interest expense............................................ (6,186) (5,445)
Merger costs................................................ --- (3,972)
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(5,406) (8,876)
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Loss before income taxes and cumulative effect of
accounting change........................................... (3,091) (6,929)
Benefit for income taxes...................................... (219) (985)
------------- ------------
Loss before cumulative effect of accounting change... (2,872) (5,944)
Cumulative effect of accounting change for deferred
contract start-up costs, net of tax benefit of $757....... --- (1,012)
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Net loss................................................... $ (2,872) $ (6,956)
========== ==========
See accompanying notes to condensed consolidated financial statements.
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MERIT BEHAVIORAL CARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(dollars in thousands)
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Three months ended
December 31,
1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .............................................................. $ (2,872) $ (6,956)
Adjustments to reconcile net loss to net cash
(used for) provided by operating activities:
Cumulative effect of accounting change............................... --- 1,012
Depreciation and amortization........................................ 9,907 8,533
Amortization of deferred financing costs............................. 335 253
Deferred taxes....................................................... (369) (2,214)
Changes in operating assets and liabilities, net of the effect of acquisitions:
Accounts receivable.................................................. (6,492) 3,609
Other current assets................................................. (1,336) 369
Deferred contract start-up costs..................................... (637) (1,187)
Accounts payable and accrued liabilities............................. (4,526) 8,884
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Net cash (used for) provided by operating activities................... (5,990) 12,303
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment........................... (5,554) (6,670)
Sales of marketable securities....................................... --- 1,143
Long-term restrictions removed from (placed on) cash.............. 47 (1,193)
Investments in and advances to joint ventures........................ (850) (1,170)
Repayments of advances from joint ventures........................... 180 ---
Cash used for acquisitions, contingent consideration, and
related expenses, net of cash acquired............................. --- (8,501)
Other................................................................ 773 211
----------- ------------
Net cash used for investing activities............................... (5,404) (16,180)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from capital contribution................................... --- 114,980
Proceeds from bridge loan............................................ --- 75,000
Proceeds from revolving credit facility.............................. 40,000 51,500
Proceeds from senior term loans...................................... --- 120,000
Proceeds from sale of notes.......................................... --- 100,000
Repayment of notes receivable from officers.......................... 250 250
Redemption of common stock........................................... --- (259,039)
Repayment of due to parent........................................... --- (70,813)
Repayment of bridge loan............................................. --- (75,000)
Repayment of revolving credit facility............................... (35,000) (26,000)
Repayment of senior term loans....................................... (500) ---
Payment of financing costs........................................... --- (11,999)
----------- ------------
Net cash provided by financing activities............................ 4,750 18,879
----------- ------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.......................................................... (6,644) 15,002
Cash and cash equivalents at beginning of period..................... 47,375 29,531
--------- ------------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD...............................................................$ 40,731 $ 44,533
======== =========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash (received) paid for income taxes................................$ (124) $ 173
Cash paid for interest...............................................$ 8,655 $ 3,161
See accompanying notes to condensed consolidated financial statements.
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MERIT BEHAVIORAL CARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(dollars in thousands)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial statements
include the accounts of Merit Behavioral Care Corporation and its wholly-owned
subsidiaries (the "Company"), and have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
The condensed consolidated balance sheet at December 31, 1996 and the condensed
consolidated statements of operations and cash flows for all periods presented
are unaudited and reflect all adjustments, consisting of normal recurring items,
which management considers necessary for a fair presentation. Operating results
for fiscal 1997 interim periods are not necessarily indicative of results to be
expected for the entire year. The condensed consolidated balance sheet at
September 30, 1996 was derived from the Company's September 30, 1996 audited
financial statements. Certain prior year amounts have been reclassified to
conform with the current year's presentation.
Although the Company believes the accompanying disclosures are adequate, certain
information and disclosures normally included in the notes to the financial
statements have been condensed or omitted as permitted by the rules and
regulations of the Securities and Exchange Commission. The accompanying
unaudited financial statements should be read in conjunction with the financial
statements contained in the Annual Report on Form 10-K for the year ended
September 30, 1996.
2. CONTINGENCIES
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists, psychologists and 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 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, which
motion has not yet been heard or decided. 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.
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.
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Overview
The Company is one of the leading behavioral health managed care companies in
the United States, arranging for a full spectrum of behavioral healthcare
services on a nationwide basis. 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
managed behavioral healthcare services through a systematic clinical approach
with the objective of diagnosing problems promptly and designing treatment plans
to ensure that patients receive the appropriate level of care in an effective
and cost-efficient manner. The Company manages behavioral healthcare programs
for approximately 1,000 payors across all segments of the healthcare industry,
including health maintenance organization ("HMOs"), Blue Cross Blue Shield
organizations and other insurance companies, corporations and labor unions,
Federal, state and local governmental agencies, and various state Medicaid
programs.
Three Months Ended December 31, 1996 Compared to Three Months Ended December
31, 1995
Revenue. Revenue increased by $17.7 million, or 16.0%, to $128.6 million for the
three months ended December 31, 1996 from $110.9 million for the three months
ended December 31, 1995. Of this increase, $28.2 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 $3.5 million was attributable to new customers
commencing service in the current quarter. This revenue increase was partially
offset by a $14.0 million decrease in revenue as a result of the termination of
certain contracts, $12.8 million of which was due to 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 $14.6 million, or 16.5%,
to $102.9 million for the three months ended December 31, 1996 from $88.4
million for the three months ended December 31, 1995. As a percentage of
revenue, direct service costs increased from 79.7% in the prior year period to
80.0% in the current year period. The increase was due to the anticipated lower
than average direct profit margin earned on the TennCare Partners Program,
partly offset by a year over year decline in healthcare utilization in the
Company's overall business. Under the TennCare Partners Program, services under
which commenced in the fourth quarter of fiscal 1996, the Company (together with
a local Tennessee partner) provides mental health and substance abuse managed
care services to approximately 500,000 Medicaid eligibles and uninsured
individuals residing in the State of Tennessee. In light of the significance of
the contract to the Company's overall revenue base and the unusual structure of
the TennCare Partners Program, the Company expects unfavorable year over year
direct cost percentage comparisons for the remainder of fiscal 1997. Excluding
the effect of the TennCare Partners contract, however, the Company experienced a
decline in the direct service cost percentage as a result of overall lower
healthcare utilization in the current three month period as compared to the
previous year period, due to 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 was the effect of a nationwide recontracting program with
providers which began in the second quarter of fiscal 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $2.3 million, or 15.9%, to $16.6 million
for the three months ended December 31, 1996 from $14.3 million for the three
months ended December 31, 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 both the Company's national
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service center located in St. Louis, Missouri (the "National Service Center"),
and the Company's headquarters located in Park Ridge, New Jersey, which will
allow for growth beyond its current needs, and (iii) expenses related to the
planned deployment of the Company's new information systems. As a percentage of
revenue, selling, general and administrative expenses remained constant at 12.9%
for both the current and prior year periods, but declined from the third and
fourth quarters of fiscal 1996 due to the Company's efforts to contain such
expenses as well as an allocation of such expenses over a larger revenue base.
Amortization of Intangibles. Amortization of intangibles increased by $0.5
million, or 7.9%, to $6.8 million for the three months ended December 31, 1996
from $6.3 million for the three months ended December 31, 1995. The increase was
primarily due to an increase in amortization of goodwill recognized in
connection with the acquisitions of Choate Health Management, Inc. and ProPsych,
Inc., as well as to increases in the amortization of deferred contract start-up
costs related to new contracts.
Other Income (Expense). For the three months ended December 31, 1996, other
income and expense consisted of (i) interest expense of $6.2 million related to
debt incurred as a result of the merger of the Company with MDC Acquisition
Corp. (the "Merger"); and (ii) interest and other income of $0.8 million
relating primarily to investment earnings on the Company's short-term
investments and restricted cash balances. The year over year increase in
interest expense of $0.7 million was primarily attributable to the full quarter
impact of (i) the indebtedness incurred on October 6, 1995 by the Company in
connection with the Merger; and (ii) the 11 1/2% Senior Subordinated Notes due
2005 issued in November 1995, and exchanged for publicly traded Notes in March
1996 (the "Notes"), which bore interest at a higher rate than the bridge
financing facility that the Notes replaced. The year over year increase in
interest income of $0.2 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 the three
months ended December 31, 1996 based upon the Company's pre-tax loss in such
period.
Liquidity and Capital Resources
General. For the three months ended December 31, 1996, operating activities used
cash of $6.0 million, investing activities used cash of $5.4 million and
financing activities provided cash of $4.8 million, resulting in a net decrease
in cash and cash equivalents of $6.6 million. Investing activities in the
current three month period consisted principally of (i) capital expenditures of
$5.6 million related primarily to the continued development of the Company's new
information systems and expansion of the Company's National Service Center; and
(ii) payments totaling $0.9 million for funding under various joint venture
arrangements, the most significant of which was with Community Sector Systems,
Inc.
Senior Indebtedness. As of December 31, 1996, $39.0 million of revolving loans
and $6.2 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 $39.8 was available for
future borrowing.
Adjusted EBITDA. Adjusted EBITDA, a financial measure used in the Senior Credit
Facility and the indenture for the Notes (the "Indenture"), increased by $2.0
million, or 18.0%, to $13.0 million for the three months ended December 31, 1996
from $11.0 million for the three months ended December 31, 1995.
Cash in Claims Funds and Restricted Cash. As of December 31, 1996, the Company
had total cash balances (including cash equivalents) of $46.4 million, of which
$33.3 million was restricted under certain contractual, fiduciary and regulatory
requirements; moreover, of such amount, $5.6 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
December 31, 1996, the Company also held surplus cash balances, classified as
cash and cash equivalents, as required by the contracts held by the Company
relating to Medicaid programs for the States
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of Iowa and Tennessee and for a Medicaid contract in the Commonwealth of
Pennsylvania.
Availability of Cash. Historically, the Company has funded its operations
primarily with cash generated from operations and through the funding of certain
acquisitions, investments and other transactions by its former parent, Merck &
Co., Inc. The Company expects to finance its capital requirements in the future
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 flows 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists, psychologists and 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") 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, which motion has not yet
been heard or decided. 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 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
*27 Financial Data Schedule (electronic filing only).
*filed herewith
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter for which this
report is being filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The signatory hereby acknowledges and adopts the typed form of his name in the
electronic filing of this document with the Securities and Exchange Commission.
Date: February 12, 1997 Merit Behavioral Care Corporation
By: /s/ Arthur H. Halper
___________________________________
Arthur H. Halper, Executive Vice President
and Chief Financial Officer
(Principal Financial Officer,
Accounting Officer and
Duly Authorized Officer)
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