AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 11, 1996
REGISTRATION NO. 333-
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
SPECIALTY CARE NETWORK, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 8011 62-1623449
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
44 UNION BOULEVARD, STE. 600
LAKEWOOD, COLORADO 80228
(303) 716-0041
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------
KERRY R. HICKS
PRESIDENT AND CHIEF EXECUTIVE OFFICER
SPECIALTY CARE NETWORK, INC.
44 UNION BOULEVARD, STE. 600
LAKEWOOD, COLORADO 80228
(303) 716-0041
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------
Copies to:
ALAN SINGER, ESQUIRE MICHAEL D. NATHAN, ESQUIRE
MORGAN, LEWIS & BOCKIUS LLP SIMPSON THACHER & BARTLETT
2000 ONE LOGAN SQUARE 425 LEXINGTON AVENUE
PHILADELPHIA, PA 19103 NEW YORK, NY 10017
(215) 963-5000 (212) 455-2000
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same
offering. / / _______________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / / _______________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
CALCULATION OF REGISTRATION FEE
================================================================================
PROPOSED
MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED OFFERING PRICE(1) FEE
- --------------------------------------------------------------------------------
Common Stock, par value $.001 per share..... $41,034,400 $12,435
================================================================================
(1) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(o) under the Securities Act of 1933.
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION, DATED DECEMBER 11, 1996
3,280,400 Shares
[ LOGO ]
SPECIALTY CARE NETWORK, INC.
Common Stock
($.001 par value)
------------------
Of the shares of Common Stock (the 'Common Stock') of Specialty Care Network,
Inc. ('Company') offered hereby, 3,000,000 shares are being sold by the
Company and 280,400 shares are being sold by the Selling Stockholders
named under 'Principal and Selling Stockholders.' The Company
will not receive any of the proceeds from the sale of shares
by the Selling Stockholders. Prior to this offering, there
has been no public market for the Common Stock. It is
anticipated that the initial public offering
price will be between $ and $ per share. For
information relating to the factors
considered in determining the initial
public offering price, see
'Underwriting.' Application has
been made to list the Common
Stock on The Nasdaq
Stock Market's
National Market
('NNM')under
the symbol
'SCNI.'
------------------
THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE 'RISK FACTORS'
COMMENCING ON PAGE 7.
------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C> <C> <C> <C>
Underwriting Proceeds to
Price to Discounts and Proceeds to Selling
Public Commissions Company(1) Stockholders
--------------- -------------- --------------- ---------------
Per Share.................. $ $ $ $
Total(2)................... $ $ $ $
</TABLE>
(1) Before deduction of expenses payable by the Company estimated at $ .
(2) The Company has granted the Underwriters an option, exercisable for 30 days
from the date of this Prospectus, to purchase a maximum of 450,000
additional shares to cover over-allotments of shares. If the option is
exercised in full, the total Price to Public will be $ , Underwriting
Discounts and Commissions will be $ , Proceeds to Company will be
$ and Proceeds to Selling Stockholders will be $ .
------------------
The Shares are offered by the several Underwriters when delivered to and
accepted by the Underwriters and subject to their right to reject orders in
whole or in part. It is expected that the shares will be ready for delivery on
or about , 1997, against payment in immediately available funds.
CS First Boston
Equitable Securities Corporation
Lehman Brothers
The date of this Prospectus is , 1997.
<PAGE>
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
DURING THIS OFFERING, CERTAIN PERSONS AFFILIATED WITH PERSONS PARTICIPATING
IN THE DISTRIBUTION MAY ENGAGE IN TRANSACTIONS FOR THEIR OWN ACCOUNTS OR FOR THE
ACCOUNTS OF OTHERS IN THE COMMON STOCK PURSUANT TO EXEMPTIONS FROM 10B-6, 10B-7
AND 10B-8 UNDER THE SECURITIES EXCHANGE ACT OF 1934.
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the financial statements and notes thereto appearing elsewhere
in this Prospectus. Unless otherwise indicated, all information in this
Prospectus assumes: (i) no exercise of the Underwriters' over-allotment option
and (ii) no exercise of outstanding options to purchase Common Stock. Unless the
context otherwise requires, all references to the 'Company,' 'Specialty Care
Network' or 'SCN' refer to Specialty Care Network, Inc., a Delaware corporation,
and its subsidiaries. See 'Risk Factors' for a discussion of certain factors
that should be considered in connection with an investment in the Common Stock
offered hereby. This Prospectus contains forward-looking statements that
address, among other things, acquisition and expansion strategy, use of
proceeds, projected capital expenditures, liquidity, proposed specialties of
physicians with whom the Company intends to affiliate, possible third party
payor arrangements, cost reduction strategies, possible effects of changes in
government regulation and availability of insurance. These statements may be
found under 'Prospectus Summary,' 'Risk Factors,' 'Use of Proceeds,'
'Management's Discussion and Analysis of Financial Condition and Results of
Operations' and 'Business' as well as in the Prospectus generally. Actual events
or results may differ materially from those discussed in forward-looking
statements as a result of various factors, including without limitation those
discussed in 'Risk Factors' and matters set forth in the Prospectus generally.
THE COMPANY
Specialty Care Network is a physician practice management company that
focuses exclusively on musculoskeletal disease-state management. SCN's goal is
to build the leading musculoskeletal physician practice management company in
the United States. The Company's strategy consists of three components: (i)
affiliating with leading musculoskeletal practices in targeted markets
throughout the United States; (ii) assisting each of its affiliated practices in
managing and expanding its business by providing comprehensive operational
support, including proprietary clinical and financial information systems; and
(iii) developing integrated regional musculoskeletal networks around its
affiliated practices. As a first step in implementing this strategy, on November
12, 1996, the Company affiliated with a select group of five practices
encompassing 49 physicians located in Pennsylvania, New Jersey,
Georgia, Maryland and Florida. These practices were selected based on a variety
of factors, including, but not limited to, physician credentials and reputation;
competitive market position; specialty and subspecialty mix of physicians;
historical financial performance and growth potential; and willingness to
embrace SCN's corporate philosophy. The Company also manages one outpatient
surgery center and one outpatient magnetic resonance imaging ("MRI") center
owned by two of its affiliated practices.
The practices with which the Company has affiliated offer a broad spectrum
of musculoskeletal care, which is the treatment of conditions relating to bones,
joints, muscles and related connective tissues. The Company's affiliated
physicians are trained in a variety of musculoskeletal disciplines, including
general orthopaedics, joint replacement surgery, sports medicine, spinal care,
hand and upper extremity care, foot and ankle care, pediatric orthopaedics,
physiatry, trauma and adult neurology. In order to build networks of providers
which offer access to a full range of musculoskeletal care, the Company intends
to affiliate and otherwise contract with physicians trained in other
musculoskeletal subspecialties, including occupational medicine, neurosurgery,
plastic surgery, rehabilitation therapy and rheumatology.
Expenditures for musculoskeletal care in the United States are significant,
with total direct costs associated with the delivery of musculoskeletal care
exceeding $60 billion in 1988, according to the American Academy of Orthopaedic
Surgeons ('AAOS'). Of this amount, approximately $7 billion represents fees paid
for physician services.
The Company was incorporated in the State of Delaware in December 1995. The
Company's principal executive offices are located at 44 Union Boulevard,
Lakewood, Colorado 80228, and the Company's telephone number is (303) 716-0041.
3
<PAGE>
INITIAL AFFILIATED PRACTICES
On November 12, 1996, the Company, through a series of transactions (the
'Initial Affiliation Transactions'), including an asset purchase, a share
exchange and three mergers, acquired substantially all of the assets and certain
liabilities of the predecessors of the practices with which the Company has
affiliated (the 'Predecessor Practices'). In the Initial Affiliation
Transactions, the Company issued an aggregate of 7,659,115 shares of Common
Stock and paid $1,537,872 in cash to physician owners of the Predecessor
Practices. Following the Initial Affiliation Transactions, the physician owners
of the Predecessor Practices, other than Greater Chesapeake Orthopaedic
Associates, L.L.C. ('GCOA') in Baltimore, Maryland, which survived the Initial
Affiliation Transactions, formed new entities through which to practice
medicine. The new entities (together with GCOA, the 'Initial Affiliated
Practices') are Reconstructive Orthopaedic Associates II, P.C. ('ROA') in
Philadelphia, Pennsylvania; Princeton Orthopaedic Associates II, P.A. ('POA') in
Princeton, New Jersey; TOC Specialists, P.L. ('TOC') in Tallahassee, Florida and
Bainbridge, Georgia; and Vero Orthopaedics II, P.A. ('VO') in Vero Beach,
Florida.
Under the service agreements between the Company and each of the Initial
Affiliated Practices (the 'Initial Service Agreements') the Company will provide
management, administrative and development services to the Initial Affiliated
Practices. The Initial Affiliated Practices will retain, among other things,
sole responsibility for all aspects of the practice of medicine. See 'Business--
Contractual Agreements with Affiliated Practices' and 'Certain Transactions.' As
used in this Prospectus, the term 'Affiliated Practices' includes the Initial
Affiliated Practices and other practices with which the Company may affiliate in
the future.
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by:
The Company........................................... 3,000,000 shares
Selling Stockholders.................................. 280,400 shares
Total........................................... 3,280,400 shares
Common Stock to be outstanding after the offering.......... 14,044,955 shares(1)
Proposed Nasdaq National Market symbol..................... SCNI
Use of proceeds............................................ Repayment of certain indebtedness,
funding for possible future
affiliations and general corporate
and working capital purposes. See
'Use of Proceeds.'
</TABLE>
- ------------------
(1) Excludes 1,915,748 shares of Common Stock issuable upon exercise of
outstanding options to purchase Common Stock and 450,000 shares of Common
Stock issuable upon exercise of the Underwriters' over-allotment option.
4
<PAGE>
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
The following table sets forth certain unaudited pro forma financial data
for the Company giving effect to the Initial Affiliation Transactions, which
were accounted for using historical cost in accordance with Securities and
Exchange Commission Staff Accounting Bulletin No. 48 ('SAB 48'), and the Initial
Service Agreements. The pro forma statement of income data for the year ended
December 31, 1995 and the nine months ended September 30, 1996 assume that the
Company was incorporated, the Initial Affiliation Transactions had occurred and
the Initial Service Agreements were entered into on January 1, 1995.
The unaudited pro forma as adjusted financial data further include the sale
by the Company of 3,000,000 shares of Common Stock offered hereby with estimated
net proceeds of $ and the repayment of certain indebtedness as
described under 'Use of Proceeds.' The pro forma as adjusted balance sheet data
give effect to the transactions described above as if they occurred on September
30, 1996.
The unaudited pro forma financial data may not be indicative of the results
that actually would have occurred if the Initial Affiliation Transactions had
been effected, and the Initial Service Agreements had been entered into, on the
dates indicated or the results that may be obtained in the future. This data is
qualified in its entirety by, and should be read in conjunction with, the
Unaudited Pro Forma Financial Statements and Notes thereto, the financial
statements for the Company and each of the Predecessor Practices and
'Management's Discussion and Analysis of Financial Condition and Results of
Operations.'
5
<PAGE>
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA (1)(2)
<TABLE>
<S> <C> <C>
FOR THE YEAR FOR THE NINE
ENDED MONTHS ENDED
DECEMBER 31, 1995 SEPTEMBER 30, 1996
------------ ------------
STATEMENT OF INCOME DATA
- ------------------------
Revenue (3) ........................................... $ 31,493,723 $ 25,036,076
Operating expenses:
Salaries and benefits ............................... 14,214,984 10,599,417
Supplies, general and administrative expenses ....... 10,930,793 9,579,454
Depreciation and amortization ....................... 713,481 602,396
Costs to evaluate and acquire physician practices ... 94,903 71,177
------------ ------------
Income from continuing operations ..................... 5,539,562 4,183,632
Interest expense and other, net ....................... (74,306) (22,648)
------------ ------------
Income from continuing operations before income tax ... 5,465,256 4,160,984
Income tax expense .................................... (2,076,797) (1,581,174)
------------ ------------
Net income ............................................ $ 3,388,459 $ 2,579,810
------------ ------------
------------ ------------
Total weighted average number of common shares
outstanding (4) ..................................... 12,491,897 12,491,897
------------
------------
Shares offered by the Company in this offering ........ 3,000,000
------------
Pro forma as adjusted weighted average number of common
shares outstanding (5) ............................... 15,491,897
------------
------------
Income per share amount ............................... $ 0.27 $ 0.21
------------ ------------
------------ ------------
Pro forma as adjusted income per share amount ......... $ 0.17
------------
------------
PRO FORMA AS ADJUSTED BALANCE SHEET DATA (6)
- --------------------------------------------
Total assets .......................................... $
Total debt ............................................ 1,158,262
</TABLE>
- ------------------
(1) The Initial Affiliation Transactions were accounted for using historical
cost in accordance with SAB 48. Accordingly, the Company will record the net
assets acquired at the Predecessor Practices' historical cost basis.
(2) Excluded from the summary financial data above are the discontinued
operations of Vero Orthopaedics, P.A. for the year ended December 31, 1995.
(3) Revenue generally consists of service fees equal to (i) a percentage of
pre-tax earnings of the Predecessor Practices before physician compensation
and most fringe benefits and, excluding certain expenses of the Predecessor
Practices and (ii) reimbursement for operating expenses of the Predecessor
Practices to be paid by the Company. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Specialty Care
Network, Inc. -- Overview.'
(4) The computation of income per share is based upon 12,491,897 weighted
average common shares outstanding and common stock equivalents. See Note 15
to the Unaudited Pro Forma Financial Statements included elsewhere in this
Prospectus for further discussion of the weighted average number of shares.
(5) The computation of pro forma as adjusted income per share is based on the
information discussed in (4) above plus 3,000,000 shares of common stock
offered by the Company in this offering.
(6) See Selected Unaudited Pro Forma Financial Data included elsewhere in this
Prospectus for the pro forma balance sheet data as of September 30, 1996.
6
<PAGE>
RISK FACTORS
The following risk factors, as well as the other information contained in
this Prospectus, should be considered carefully before purchasing the Common
Stock offered hereby. This Prospectus contains forward-looking statements which
involve risks and uncertainties. See 'Prospectus Summary.' Actual events or
results may differ materially from those discussed in forward-looking statements
as a result of various factors, including, but not limited to, those discussed
below.
LACK OF OPERATING HISTORY; RISKS RELATED TO INTEGRATION OF ASSETS AND PERSONNEL
The Company was incorporated in December 1995 and, prior to its affiliation
with the Initial Affiliated Practices in November 1996, had no history of
operations or earnings. As a result of acquiring certain assets of the
Predecessor Practices, and entering into the Initial Service Agreements with the
Initial Affiliated Practices, the Company is now responsible for most
non-medical aspects of the operations, and manages most non-physician employees,
of the Initial Affiliated Practices. Prior to their affiliation with the
Company, the Predecessor Practices operated as separate independent entities,
and there can be no assurance that the Company will be able to integrate and
manage successfully the assets and personnel of, or provide services profitably
to, the Initial Affiliated Practices or other Affiliated Practices in the
future. In addition, there can be no assurance that the Company's affiliation
with the Initial Affiliated Practices or other Affiliated Practices will not
result in a loss of patients by any of the Affiliated Practices or other
unanticipated adverse consequences. Any of these events could have a material
adverse effect on the Company. There can be no assurance that the Company's
personnel, systems and infrastructure will be sufficient to permit effective and
profitable management of the Initial Affiliated Practices under the Initial
Service Agreements or to implement effectively the Company's strategies. See
'Business -- Strategy' and 'Management.'
RISKS ASSOCIATED WITH AFFILIATION AND EXPANSION STRATEGY
A primary element of the Company's strategy is to acquire certain assets
of, and affiliate through service agreements with, selected musculoskeletal
practices in targeted markets. The Company's strategy also involves assisting
Affiliated Practices in recruiting physicians and, to the extent permitted by
applicable law, contracting with ancillary musculoskeletal providers and
facilities, such as outpatient occupational medicine, physical therapy and
surgery centers and MRI centers. Identifying appropriate physician group
practices, individual physicians and ancillary providers and facilities and
proposing, negotiating and implementing economically attractive affiliations
with such practices, physicians and providers can be a lengthy, complex and
costly process. In addition, the Company is a party to a credit facility that
places certain limitations upon the number of affiliations the Company can enter
into in any quarter or year and the terms of any future affiliations. The
failure of the Company to identify and effect additional affiliations would have
a material adverse effect on the Company. Moreover, there can be no assurance
that future affiliations, if any, will contribute to the Company's profitability
or otherwise facilitate the successful implementation of the Company's overall
strategy. See 'Business -- Strategy.'
The Company's ability to expand is also dependent upon factors such as its
and the Affiliated Practices' ability to (i) adapt the Company's arrangements
with Affiliated Practices to comply with current or future legal requirements,
including state prohibitions on fee-splitting, corporate practice of medicine
and referrals to facilities in which physicians have a financial interest and
state anti-kickback provisions, (ii) obtain regulatory approval and certificates
of need, where necessary, and (iii) comply with licensing requirements
applicable to physicians and to facilities operated, and services offered, by
physicians. There can be no assurance that application of current laws or
changes in legal requirements will not adversely affect the Company or that the
Company and the Affiliated Practices will be able to obtain and maintain all
necessary regulatory approvals and comply with applicable licensing
requirements.
7
<PAGE>
DEPENDENCE ON INFORMATION SYSTEMS
The Company's success is largely dependent on its ability to implement new
information systems and to integrate these systems into the Initial Affiliated
Practices' existing, operational, financial and clinical information systems. In
addition to their integral role in helping the Affiliated Practices realize
operating efficiencies, such systems are critical to negotiating, pricing and
managing capitated managed care contracts. See '-- Risks Associated with Managed
Care Contracts.' The Company will need to continue to invest in, and administer,
sophisticated management information systems to support these activities. The
Company may experience unanticipated delays, complications and expenses in
implementing, integrating and operating such systems. Furthermore, such systems
may require modifications, improvements or replacements as the Company expands
or if new technologies become available. Such modifications, improvements or
replacements may require substantial expenditures and may require interruptions
in operations during periods of implementation. The failure to implement
successfully operational, financial and clinical information systems would have
a material adverse effect on the Company. See 'Business -- SCN Operations.'
DEPENDENCE ON AFFILIATED PRACTICES AND PHYSICIANS; RISK OF TERMINATION OF
SERVICE AGREEMENTS
The Company's operations are entirely dependent on its continued
affiliation through service agreements with the Initial Affiliated Practices and
on the success of the Initial Affiliated Practices. There can be no assurance
that the Initial Affiliated Practices will maintain successful practices, that
service agreements will not be terminated or that any of the key physicians in a
particular Initial Affiliated Practice will continue affiliation with such
practice. Two of the Initial Affiliated Practices, ROA and POA, are expected to
contribute approximately 30% each of the fees to be paid to the Company by all
of the Initial Affiliated Practices, based on their historical net patient
revenue and expenses. The termination of any of the Initial Service Agreements
would, and termination of service agreements with any additional Affiliated
Practices could, have a material adverse effect on the Company. For a
description of the Initial Service Agreements, including a description of their
termination provisions, see 'Business -- Contractual Agreements with Affiliated
Practices.'
Some of the Initial Affiliated Practices derive, and other Affiliated
Practices may derive, a significant portion of their revenue from a limited
number of physicians. Particularly because these physicians have not previously
entered into service arrangements similar to those embodied in the service
agreements, there can be no assurance that the Company or the Affiliated
Practices will maintain cooperative relationships with key members of a
particular Affiliated Practice. In addition, there can be no assurance that key
members of an Affiliated Practice will not retire, become disabled or otherwise
become unable or unwilling to continue practicing their profession. The loss by
an Affiliated Practice of one or more key members would have a material adverse
effect on the revenue of such Affiliated Practice and on the Company. Neither
the Company nor the Initial Affiliated Practices maintains insurance on the
lives of any affiliated physicians for the benefit of the Company. The loss of
revenue by any Affiliated Practice would have a material adverse effect on the
Company.
NEED FOR ADDITIONAL FUNDS
The Company's acquisition and expansion strategy will require substantial
capital, and the Company anticipates that it will, in the future, seek to raise
additional funds through debt financing or the issuance of equity or debt
securities. There can be no assurance that sufficient funds will be available on
terms acceptable to the Company, if at all. If equity securities are issued,
either to raise funds or in connection with future affiliations, dilution to the
Company's stockholders may result, and if additional funds are raised through
the incurrence of debt, the Company may become subject to restrictions on its
operation and finances. Such restrictions may have an adverse effect on, among
other things, the Company's ability to pursue its acquisition strategy. See
'Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources.'
8
<PAGE>
RISK OF CHANGES IN PAYMENT FOR MEDICAL SERVICES
The health care industry is experiencing a trend toward cost containment as
government and private third party payors seek to impose lower reimbursement and
utilization rates and negotiate reduced capitated payment schedules with service
providers. The federal government has implemented, in annual increments through
December 31, 1996, through the Medicare program, a resource-based relative value
scale ('RBRVS') payment methodology for health care provider services. RBRVS is
a fee schedule that, except for certain geographical and other adjustments, pays
similarly situated health care providers the same amount for the same services.
The RBRVS is adjusted each year and is subject to increases or decreases at the
discretion of Congress. To date, the implementation of RBRVS has reduced payment
rates for certain of the procedures historically provided by the Initial
Affiliated Practices. Further reductions could significantly affect the Initial
Affiliated Practices, each of which derives a significant portion of its revenue
from Medicare. RBRVS types of payment systems have also been adopted by certain
private third party payors and may become a predominant payment methodology.
Wider-spread implementation of such programs would reduce payments from private
third party payors, and could indirectly reduce revenue to the Company.
Further reductions in payments to health care providers or other changes in
reimbursement for health care services could have a material adverse effect on
the Affiliated Practices and, as a result, on the Company. These reductions
could result from changes in current reimbursement rates or from a shift in
clinical protocols to non-surgical solutions to orthopaedic conditions. There
can be no assurance that the Company will be able to offset successfully any or
all of the payment reductions that may occur.
Rates paid by private third party payors, including those that provide
Medicare supplemental insurance, are based on established health care provider
and hospital charges and are generally higher than Medicare payment rates. A
change in the patient mix of any of the Affiliated Practices that results in a
decrease in patients covered by private insurance could have a material adverse
effect on the Affiliated Practices and, as a result, on the Company.
COMPETITION
Competition for affiliation with additional musculoskeletal practices is
intense and may limit the availability of suitable practices. Several companies
with established operating histories and greater resources than the Company,
including physician practice management companies and some hospitals, clinics
and health maintenance organizations ('HMOs'), are pursuing activities similar
to those of the Company. There can be no assurance that the Company will be able
to compete effectively with such competitors, that additional competitors will
not enter the market or that such competition will not make it more difficult
and costly to acquire the assets of, and provide management services to,
musculoskeletal medical practices on terms beneficial to the Company. The
Company also believes that changes in governmental and private reimbursement
policies, among other factors, have resulted in increased competition among
providers of medical services to consumers. There can be no assurance that the
Company's Affiliated Practices will be able to compete effectively in the
markets they serve. See 'Business -- Competition.'
GOVERNMENT REGULATION
The delivery of health care, including the relationships among health care
providers such as physicians and other clinicians, is subject to extensive
federal and state regulation. The fraud and abuse provisions of the Social
Security Act prohibit the solicitation, payment, receipt or offering of any
direct or indirect remuneration in return for, or as an inducement to, the
referral of patients, items or services with respect to which payments are made
in whole or in part by Medicare or Medicaid. These laws also impose significant
penalties for false or improper billings. In addition, the Stark Self-Referral
Law imposes restrictions on physicians' referrals for designated health services
reimbursable by Medicare or Medicaid to entities with which the physicians have
financial relationships. Violations of these laws may result in substantial
civil or criminal penalties, including large civil monetary penalties and
9
<PAGE>
exclusion from participation in the Medicare and Medicaid programs. These
exclusion and penalties, if applied to the Company or its Affiliated Practices,
would have a material adverse effect on the Company.
The laws of many states, including the states in which the Initial
Affiliated Practices are located, prohibit business corporations such as the
Company from practicing medicine or exercising control over the medical
judgments or decisions of physicians and from engaging in certain financial
arrangements, such as splitting fees with physicians. In addition, a number of
states have enacted anti-kickback laws similar to the federal fraud and abuse
provisions and self-referral laws which generally restrict physicians' referrals
for designated health services if the physician owns a beneficial interest or
has a compensation arrangement with the entity to which the referral is made.
These laws and their interpretations vary from state to state and are enforced
by both the courts and regulatory authorities, each with broad discretion. The
Company believes that its operations are conducted in material compliance with
applicable laws; however, the Company has not received or applied for a legal
opinion from counsel or from any federal or state judicial or regulatory
authority to this effect, and many aspects of the Company's business operations
have not been the subject of state or federal regulatory interpretation. There
can be no assurance that a review of the Company's operations by federal or
state judicial or regulatory authorities will not result in a determination that
would have a material adverse effect on the Company or its Affiliated Practices.
There can be no assurance that the Company's service agreements will not be
challenged as constituting the unlawful corporate practice of medicine or
unlawful fee splitting arrangements, or that the enforceability of the
provisions of such agreements, including non-competition arrangements, will not
be limited. Any of these events could have a material adverse effect on the
Company.
Expansion of the operations of the Company to certain jurisdictions may
require modification of the Company's form of relationship with Affiliated
Practices, which could have an adverse effect on the Company. Furthermore, the
Company's ability to expand into, or to continue to operate within certain
jurisdictions may depend on the Company's ability to modify its operational
structure to conform to such jurisdictions' regulatory framework or to obtain
necessary approvals, licenses and permits. Any limitation on the Company's
ability to expand could have a material adverse effect on the Company. See
'Business -- Government Regulation and Supervision.'
In addition to extensive existing government health care regulation, there
are numerous initiatives on the federal and state levels for comprehensive
reforms affecting the payment for and availability of health care services.
These initiatives include reductions in Medicare and Medicaid payments, trends
in adopting managed care for Medicare and Medicaid patients and additional
prohibitions on ownership by health care providers, directly or indirectly, of
facilities to which they refer patients. Aspects of certain of these health care
proposals, if adopted, could have a material adverse effect on the Company. See
'-- Risks Associated with Affiliation and Expansion Strategy,' '-- Risk of
Changes in Payment for Medical Services' and 'Business -- Government Regulation
and Supervision.'
RISKS ASSOCIATED WITH MANAGED CARE CONTRACTS
As an increasing percentage of patients enter into health care coverage
arrangements with managed care payors, the Company believes that its success
will be, in part, dependent upon the Company's ability to negotiate contracts on
behalf of its Affiliated Practices with HMOs, employer groups and other private
third party payors. The Company believes that the Initial Affiliated Practices
were attracted to the Company, in part, due to the potential ability of the
Company to assist the Affiliated Practices in entering into managed care
contracts and to organize regional integrated musculoskeletal care networks. The
inability of the Company to enter into such arrangements in the future on behalf
of its Affiliated Practices could have a material adverse effect on the Company.
In certain instances, the Company may seek to negotiate on behalf of
regional musculoskeletal care networks consisting of the Company's Affiliated
Practices and other physicians or group practices willing to permit the Company
to negotiate on their behalf with respect to a particular third party payor. The
Company anticipates that, in the future, the payor contracts that may be entered
into on
10
<PAGE>
behalf of its Affiliated Practices and any related network physicians will
include contracts based on capitated fee arrangements. Under some of these
agreements, a health care provider agrees either to accept a predetermined
dollar amount per member per month in exchange for undertaking to provide all
covered services to patients or to provide treatment on an episode of care
basis. Such health care providers bear the risk, generally subject to certain
loss limits, that the aggregate costs of providing medical services will exceed
the premiums received. Some agreements may also contain 'shared risk' provisions
under which affiliated physicians may earn additional compensation based on
utilization control of institutional, ancillary and other services by patients,
and the Affiliated Practices may be required to bear a portion of any loss in
connection with such 'shared risk' provisions. To the extent that patients or
enrollees covered by such contracts require more frequent or, in certain
instances, more extensive care than anticipated, there could be a material
adverse effect on an Affiliated Practice and, therefore, on the Company. In the
worst case, revenue negotiated under risk-sharing or capitated contracts would
be insufficient to cover the costs of the care provided. Any such reduction or
elimination of earnings to the Affiliated Practices under such fee arrangements
could have a material adverse effect on the Company.
Increasingly, some jurisdictions are taking the position that capitated
agreements in which the provider of medical services bears the economic risk of
providing such services should be regulated by insurance laws. As a consequence,
the Company and the Affiliated Practices may have to comply with additional
requirements in some of the states in which it operates, including requirements
that it qualify as an HMO or insurance company and meet related capital and
surplus requirements, in its attempt to enter into or arrange capitated
agreements for its Affiliated Practices when those capitated arrangements
involve the assumption of risk. Compliance with such requirements could have a
material adverse effect on the Company.
Generally, there is no certainty that the Company and its Affiliated
Practices will be able to establish or maintain satisfactory relationships with
managed care and other third party payors, many of which already have existing
provider structures in place and may not be able or willing to change their
provider networks. In addition, any significant loss of revenue by the
Affiliated Practices as a result of the termination of third party payor
contracts or otherwise would have a material adverse effect on the Company.
DEPENDENCE UPON KEY PERSONNEL
The Company is dependent upon the ability and experience of its executive
officers and key personnel for the management of the Company and the
implementation of its business strategy. The Company currently has employment
contracts with its nine executive officers. Because of the difficulty in finding
adequate replacements for such personnel, the loss of the services of any such
personnel or the Company's inability in the future to attract and retain
management and other key personnel could have a material adverse effect on the
Company. The Company does not maintain significant key man insurance for any of
its executive officers. See 'Management -- Employment Agreements.'
POTENTIAL LIABILITY AND INSURANCE; LEGAL PROCEEDINGS
The provision of medical services entails an inherent risk of professional
malpractice and other similar claims. While the Initial Affiliated Practices
maintain malpractice insurance, there can be no assurance that any claim
asserted against any of the Initial Affiliated Practices or any other Affiliated
Practice will be covered by, or will not exceed the coverage limits, of
applicable insurance. A successful malpractice claim against any of the
Affiliated Practices, even if covered by insurance, could have a material
adverse effect on such Affiliated Practice and, as a result, on the Company.
The Company does not engage in the practice of medicine; however, the
Company could be implicated in such claims, and there can be no assurance that
claims, suits or complaints relating to services delivered by Affiliated
Practices (including claims with regard to services rendered by the Initial
Affiliated Practices prior to the Initial Affiliation Transactions) will not be
asserted against the Company in the future. Although the Company has attempted
to address this risk by maintaining
11
<PAGE>
insurance, there can be no assurance that any claim asserted against the Company
for professional or other liability will be covered by, or will not exceed the
coverage limits, of such insurance.
The availability and cost of professional liability insurance have been
affected by various factors, many of which are beyond the control of the
Company. There can be no assurance that the Company will be able to maintain
insurance in the future at a cost that is acceptable to the Company, or at all.
Any claim made against the Company not fully covered by insurance could have a
material adverse effect on the Company.
NO PRIOR MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to this offering, there has been no public market for the Company's
Common Stock, and there can be no assurance that an active public market for the
Common Stock will develop or continue after this offering. The initial public
offering price will be determined by negotiations among the Company and CS First
Boston Corporation, Equitable Securities Corporation and Lehman Brothers Inc.
and may not be indicative of the market price for the Common Stock after this
offering. See 'Underwriting' for factors to be considered in determining the
initial public offering price. From time to time after this offering, there may
be significant volatility in the market price of the Common Stock. Quarterly
operating results of the Company, deviations in results of operations from
estimates of securities analysts, changes in general conditions in the economy
or the health care industry or other developments affecting the Company or its
competitors could cause the market price of the Common Stock to fluctuate
substantially. The equity markets have, on occasion, experienced significant
price and volume fluctuations that have affected the market prices for many
companies' securities and that have often been unrelated to the operating
performance of these companies. Concern about the potential effects of health
care reform measures has contributed to the volatility of stock prices of
companies in health care and related industries and may similarly affect the
price of the Common Stock following this offering. Any such fluctuations that
occur following completion of this offering may adversely affect the market
price of the Common Stock.
QUARTERLY RESULTS FLUCTUATION
The Company's quarterly operating results may fluctuate significantly as
the result of the timing of affiliations and as a result of timing of
musculoskeletal procedures. Such fluctuation could adversely affect the price of
the Company's Common Stock. See '-- No Prior Market; Possible Volatility of
Stock Price.'
SHARES ELIGIBLE FOR FUTURE SALE
The market price of the Common Stock of the Company could be adversely
affected by the sale of substantial amounts of the Common Stock in the public
market following this offering. After giving effect to the shares of Common
Stock offered hereby, the Company will have outstanding 14,044,955 shares of
Common Stock. Of these shares, 3,280,400 shares (3,730,400 shares if the
Underwriters' over-allotment option is exercised in full) of Common Stock sold
in this offering will be freely tradeable without restriction under the
Securities Act of 1933, as amended (the 'Securities Act'), except for any shares
purchased by 'affiliates,' as that term is defined under the Securities Act, of
the Company. The remaining 10,764,555 shares are 'restricted securities' within
the meaning of Rule 144 promulgated under the Securities Act. Of these
restricted shares, 1,265,000 shares will be eligible for sale pursuant to Rule
144 in December 1997 and the balance of the restricted shares will be eligible
for sale at various times from January 1998 through November 1998. The
Securities and Exchange Commission (the 'Commission') has proposed reducing the
initial Rule 144 holding period to one year. There can be no assurance as to
whether or when such rule changes will be enacted. If enacted, such modification
will accelerate by one year the initial date upon which all currently
outstanding Common Stock becomes eligible for resale under Rule 144.
The Company, its officers and directors and certain other stockholders of
the Company have agreed that they will not offer, sell, contract to sell,
announce their intention to sell, pledge or generally otherwise dispose of,
directly or indirectly, or file with the Commission a registration statement
under the Securities Act relating to any additional shares of
12
<PAGE>
Common Stock or securities convertible or exchangeable or exercisable for any
shares of Common Stock, without the prior written consent of CS First Boston
Corporation for a period of 180 days after the date of this Prospectus (the
'lock-up period'), except (i) subsequent sales of Common Stock offered in this
offering, (ii) issuances of Common Stock by the Company in connection with
affiliation with practices, physicians and ancillary providers (although persons
receiving such shares would be subject to such restrictions for the remainder of
the lock-up period) or (iii) issuances of Common Stock by the Company pursuant
to the exercise of employee stock options outstanding on the date of this
Prospectus.
The holders of all shares of Common Stock outstanding on the date of this
Prospectus have certain rights to have their shares registered under the
Securities Act, although the holders of 4,210,498 of these shares, and an
additional 550,000 shares issuable upon exercise of outstanding options, have
agreed to refrain from selling their shares during the lock-up period. In
addition, the Company intends to register approximately 2,000,000 shares of
Common Stock reserved for issuance under the Company's 1996 Equity Compensation
Plan as soon as practicable after expiration of the lock-up period. The Company
also intends to register an additional 553,500 shares of Common Stock reserved
for issuance under the Company's 1996 Incentive and Non-Qualified Stock Option
Plan as soon as practicable thereafter. See 'Management' and 'Underwriting.'
CONTROL BY EXISTING STOCKHOLDERS
Following the completion of this offering, the officers and directors of
the Company and the physician owners of the Initial Affiliated Practices will
beneficially own approximately 72% of the outstanding shares of Common Stock of
the Company. Although, following this offering, no arrangements or understanding
among such persons with respect to the voting of the shares of Common Stock
beneficially owned by such persons will remain in effect, such persons may
nevertheless effectively be able to control the affairs of the Company. Each of
the Initial Affiliated Practices is represented on the Company's Board of
Directors and physician owners of the Initial Affiliated Practices constitute a
majority of the Board of Directors. See 'Principal and Selling Stockholders.'
POTENTIAL ANTI-TAKEOVER EFFECTS OF CHARTER AND BYLAWS PROVISIONS; POSSIBLE
ISSUANCES OF PREFERRED STOCK
Certain provisions of Delaware law, the Company's Amended and Restated
Certificate of Incorporation ('Certificate of Incorporation') and the Company's
Amended and Restated Bylaws ('Bylaws') could delay or impede the removal of
incumbent directors and could make it more difficult for a third party to
acquire, or could discourage a third party from attempting to acquire, control
of the Company. Such provisions could limit the price that certain investors
might be willing to pay in the future for shares of the Common Stock. In
addition, shares of preferred stock may be issued by the Board of Directors
without stockholder approval on such terms and conditions, and having such
rights, privileges and preferences, as the Board of Directors may determine. The
rights of the holders of the Common Stock will be subject to, and may be
adversely affected by, the rights of the holders of any preferred stock that may
be issued in the future. The Company has no current plans to issue any shares of
preferred stock. See 'Description of Capital Stock.'
IMMEDIATE AND SUBSTANTIAL DILUTION
The purchasers of the shares of Common Stock offered hereby will experience
immediate and substantial dilution in the net tangible book value of their
shares of Common Stock in the amount of $ per share (assuming an initial
public offering price of $ per share and after giving effect to
estimated underwriting discounts and commissions). See 'Dilution.' In the event
the Company issues additional Common Stock in the future, including shares that
may be issued in connection with future affiliations, purchasers of Common Stock
in this offering may experience further dilution in the net tangible book value
per share of the Common Stock of the Company.
13
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of 3,000,000 shares of Common
Stock in this offering, after deducting the underwriting discounts and
commissions and estimated expenses, are estimated to be approximately $____
million ($____ million if the Underwriters' over-allotment option is exercised
in full) assuming an initial public offering price of $___ per share, the
midpoint of the range indicated on the cover page of this Prospectus. The
Company will not receive any proceeds from the sale of Common Stock by the
Selling Stockholders. The Company expects to use a portion of the net proceeds
to repay all outstanding indebtedness under the Company's loan agreement with
NationsBank of Tennessee, N.A. (the 'Credit Facility'). Pursuant to the terms of
the Credit Facility, the Company may borrow up to $5.0 million for working
capital and other corporate purposes (the 'Working Capital Facility') and up to
$15.0 million to finance the acquisition of assets (the 'Aquisition Facility').
As of December 9, 1996, approximately $2.8 million was outstanding under the
Credit Facility, of which $1.1 million was borrowed under the Working Capital
Facility and $1.7 million was borrowed under the Acquisition Facility. Amounts
borrowed under the Credit Facility have been used to finance the acquisition of
assets of the Predecessor Practices and for working capital and other corporate
purposes.
The Working Capital Facility matures on October 31, 1997 and the
Acquisition Facility matures on October 31, 1998. The Company can elect to
borrow on either facility at a floating rate based on the prime rate plus an
applicable margin or at a fixed rate based on LIBOR plus an applicable margin.
At December 9, 1996, the effective interest rate for both the Acquisition and
the Working Capital Facilities was 7.34% per annum. See 'Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources.'
The balance of the net proceeds will be used to finance the acquisition of
assets of additional Affiliated Practices and for working capital and other
general corporate purposes. Although the Company has engaged in discussions with
practices with which it might affiliate, except as described under 'Business --
Initial Affiliated Practices' the Company has no definitive agreements regarding
any affiliations with additional practices. Pending such uses, the net proceeds
will be invested in United States government securities and in short-term,
interest-bearing investment grade securities.
DIVIDEND POLICY
The Company has never paid or declared any cash dividends and does not
anticipate paying any cash dividends in the foreseeable future. The Company
currently intends to retain any future earnings for use in its business. The
Credit Facility prohibits the paying of any dividends.
14
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
September 30, 1996 on a pro forma basis (i) to reflect the Initial Affiliation
Transactions and (ii) as adjusted to reflect the sale by the Company of
3,000,000 shares of Common Stock offered hereby (assuming an initial public
offering price of $ per share) and the application of the estimated net
proceeds therefrom. See 'Use of Proceeds.' This table should be read in
conjunction with the historical financial statements of the Company and the
Predecessor Practices, the Unaudited Pro Forma Financial Statements and
'Management's Discussion and Analysis of Financial Condition and Results of
Operations' appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
(UNAUDITED)
-----------------------------
PRO FORMA
PRO FORMA AS ADJUSTED
------------- --------------
<S> <C> <C>
Acquisition revolving line of credit and current portion of capital
lease obligations.................................................... $ 1,868,023 $ 190,273
=========== ===========
Capital lease obligations, less current portion........................ $ 967,989 $ 967,989
Stockholders' equity:
Preferred Stock, $0.001 par value: 2,000,000 shares authorized; no
shares issued or outstanding...................................... -- --
Common Stock, $0.001 par value: 50,000,000 shares authorized;
11,044,955 shares issued and outstanding pro forma; and 14,044,955
shares issued and outstanding pro forma as adjusted............... 11,045 14,045
Additional paid-in capital........................................... 8,298,156
Accumulated deficit.................................................. (2,285,314) (2,285,314)
----------- -----------
Total stockholders' equity............................................. 6,023,887
----------- -----------
Total capitalization................................................... $ 6,991,876 $
=========== ===========
</TABLE>
15
<PAGE>
DILUTION
The pro forma net tangible book value of the Company at September 30, 1996,
after giving effect to the Initial Affiliation Transactions as if they had
occurred on that date, was $5,836,046 or $0.53 per share. 'Pro forma net
tangible book value per share' represents the amount of pro forma total tangible
assets of the Company less pro forma total liabilities divided by the number of
shares of Common Stock outstanding. After giving effect to the sale by the
Company of the 3,000,000 shares of Common Stock offered hereby (assuming an
initial public offering price of $ per share and after deducting the
estimated underwriting discounts and commissions and estimated offering expenses
payable by the Company) and the application of the net proceeds therefrom as
discussed under 'Use of Proceeds,' the pro forma as adjusted net tangible book
value of the Company as of September 30, 1996 would have been approximately
$ , or $ per share. This represents an immediate increase in pro
forma net tangible book value of approximately $ per share to existing
stockholders and an immediate dilution of approximately $ per share to new
investors purchasing Common Stock in this offering. The following table
illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share...................................... $
Pro forma net tangible book value per share as of September 30, 1996............... 0.53
Increase per share attributable to new investors...................................
---------
Pro forma as adjusted net tangible book value per share after this offering..........
---------
Dilution per share to new investors.................................................. $ (1)
=========
</TABLE>
- ------------------
(1) Does not include the effect of the issuance of 1,915,748 shares of Common
Stock issuable upon exercise of outstanding options with a weighted average
exercise price of $4.56 per share.
The following table sets forth as of September 30, 1996 (i) the number of
shares of Common Stock outstanding and total and average per share amounts of
par value of outstanding Common Stock and additional paid-in capital immediately
after giving effect to the Initial Affiliation Transactions and (ii) the number
of shares of Common Stock purchased from the Company, the total consideration
paid and the average price per share for new investors (assuming an initial
public offering price of $ per share), before deducting underwriting discounts
and commissions and estimated offering expenses payable by the Company (no
effect is given to the sale of shares of Common Stock by the Selling
Stockholders):
<TABLE>
<CAPTION>
SHARES TOTAL
-------------------------- --------------------------- AVERAGE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- ----------- -------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders............................... 11,044,955 79% $ 8,309,201(1) % $ 0.75(1)
New investors....................................... 3,000,000 21
------------- ----- -------------- ----- -----------
Total.......................................... 14,044,955 100% $ 100% $
============= ===== ============== ===== ===========
</TABLE>
- ------------------
(1) Represents the par value of outstanding Common Stock and additional paid-in
capital immediately after giving effect to the Initial Affiliation
Transactions as of September 30, 1996. See the Unaudited Pro Forma Financial
Statements and Notes thereto of Specialty Care Network, Inc. included
elsewhere in this Prospectus.
16
<PAGE>
SELECTED UNAUDITED FINANCIAL DATA
The following table sets forth certain unaudited pro forma financial data
for the Company giving effect to the Initial Affiliation Transactions, which
were accounted for using historical cost in accordance with SAB 48, and the
Initial Service Agreements. Accordingly, the Company will record the net assets
acquired at the Predecessor Practices' historical cost basis. The pro forma
statement of income data for the year ended December 31, 1995 and the nine
months ended September 30, 1996 assume that the Company was incorporated, the
Initial Affiliation Transactions had occurred and the Initial Service Agreements
were entered into on January 1, 1995. The pro forma balance sheet data assume
that the Initial Affiliation Transactions occurred on September 30, 1996.
Prior to the Initial Affiliation Transactions, each of the Predecessor
Practices operated independently and none was under common control or
management. Accordingly, the unaudited pro forma financial data may not be
indicative of the results that actually would have occurred if these
transactions had been effected on the dates indicated or the results that may be
obtained in the future. This data is qualified in its entirety by, and should be
read in conjunction with, the Unaudited Pro Forma Financial Statements and Notes
thereto, the financial statements for the Company and each of the Predecessor
Practices and 'Management's Discussion and Analysis of Financial Condition and
Results of Operations.'
SELECTED UNAUDITED PRO FORMA FINANCIAL DATA (1)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 1995 SEPTEMBER 30, 1996
----------------- ------------------
STATEMENT OF INCOME DATA
- ------------------------
<S> <C> <C>
Revenue(2)................................................................ $31,493,723 $25,036,076
Operating expenses:
Salaries and benefits................................................... 14,214,984 10,599,417
Supplies, general and administrative expenses........................... 10,930,793 9,579,454
Depreciation and amortization........................................... 713,481 602,396
Costs to evaluate and acquire physician practices....................... 94,903 71,177
----------- ------------
Income from continuing operations......................................... 5,539,562 4,183,632
Interest expense and other, net........................................... (74,306) (22,648)
----------- -----------
Income from continuing operations before income tax....................... 5,465,256 4,160,984
Income tax expense........................................................ (2,076,797) (1,581,174)
----------- -----------
Net income................................................................ $ 3,388,459 $ 2,579,810
=========== ===========
Total weighted average number of common shares outstanding(3)............. 12,491,897 12,491,897
=========== ===========
Income per share amount................................................... $ 0.27 $ 0.21
=========== ===========
BALANCE SHEET DATA
Total assets.............................................................. $14,744,983
Total debt................................................................ 2,836,012
</TABLE>
- ------------------
(1) Excluded from the selected financial data above are the discontinued
operations of Vero Orthopaedics, P.A. for the year ended December 31, 1995.
(2) Revenue consists of service fees equal to (i) a percentage of pre-tax
earnings of the Predecessor Practices before physician compensation and most
fringe benefits and excluding certain expenses of the Predecessor Practices
and (ii) reimbursement for operating expenses of the Predecessor Practices
to be paid by the Company. See 'Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Specialty Care Network,
Inc. -- Overview.'
(3) The computation of income per share is based upon 12,491,897 weighted
average common shares outstanding and common stock equivalents. See Note 15
to the Unaudited Pro Forma Financial Statements included elsewhere in this
Prospectus for further discussion of the weighted average number of common
shares.
17
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
COMBINED PREDECESSOR PRACTICES(1)(2)(3)
The selected historical financial data for the combined Predecessor
Practices for the years ended December 31, 1993, 1994 and 1995 are derived from
each of the Predecessor Practice's respective audited financial statements, and
the financial data for the nine months ended September 30, 1995 and 1996 and as
of September 30, 1996 are derived from each of the Predecessor Practice's
respective unaudited financial statements. The combined financial data of the
Predecessor Practices does not represent financial data for the Company before
or after giving effect to the Initial Affiliation Transactions. This data is
presented solely for purposes of showing the historical financial performance of
the Predecessor Practices on an aggregate basis.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------- ----------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ------------ --------------
(UNAUDITED)
STATEMENT OF OPERATIONS DATA
- ----------------------------
<S> <C> <C> <C> <C> <C>
Net practice revenue.................. $ 34,040,248 $ 41,088,379 $ 53,684,757 $ 38,780,128 $ 44,623,616
Operating expenses:
Physician compensation.............. 15,354,867 19,523,875 27,028,657 20,341,874 20,956,807
Salaries and benefits............... 9,742,802 11,714,406 14,096,958 9,212,955 10,787,068
Supplies, general and administrative
expenses.......................... 8,476,211 9,191,433 11,290,130 8,270,421 10,647,745
Depreciation and amortization....... 430,702 426,538 689,700 484,800 685,950
------------ ------------ ------------ ------------ --------------
Income from continuing operations..... 35,666 232,127 579,312 470,078 1,546,046
Interest expense and other, net....... (156,583) (145,803) (240,812) (154,013) (209,022)
------------ ------------ ------------ ------------ --------------
Income (loss) from continuing
operations before income tax........ $ (120,917) $ 86,324 $ 338,500 $ 316,065 $ 1,337,024
============ ============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------------ ------------ ------------ --------------
(UNAUDITED)
BALANCE SHEET DATA
- ------------------
<S> <C> <C> <C> <C> <C>
Total assets.......................... $ 10,768,778 $ 12,469,832 $ 16,852,154 $ 18,387,535
Total debt............................ 2,757,597 2,677,523 4,627,420 3,511,174
</TABLE>
- ------------------
(1) The selected historical financial data above includes the operations of GCOA
from October 17, 1994 (date of inception).
(2) Excluded from the selected historical financial data above are the
discontinued operations of Vero Orthopaedics, P.A. for the years ended
December 31, 1994 and 1995.
(3) Historical net income and income tax expense have been omitted because these
amounts are not meaningful due to the different tax status of the
Predecessor Practices after the Initial Affiliated Transactions.
18
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA PREDECESSOR PRACTICES
The historical financial data presented for each of the Predecessor
Practices for the years ended December 31, 1993, 1994 and 1995 are derived from
each of the Predecessor Practice's respective audited financial statements, and
the historical financial data for the nine months ended September 30, 1995 and
1996 and as of September 30, 1996 are derived from each of the Predecessor
Practice's respective unaudited financial statements.
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------- ---------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ------------ -------------
(UNAUDITED)
STATEMENT OF INCOME DATA
- ------------------------
<S> <C> <C> <C> <C> <C>
Net practice revenue................... $ 11,902,216 $ 13,325,350 $ 17,549,907 $ 12,431,874 $14,255,838
Income from operations before income
taxes................................ 377,445 128,803 1,460,162 774,082 374,437
Pro forma income tax expense(1)........ 152,158 62,029 555,804 293,405 139,307
Pro forma net income(1)................ 225,287 66,774 904,358 480,677 235,130
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------------ ------------ ------------ -------------
(UNAUDITED)
BALANCE SHEET DATA
- ---------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets........................... $ 3,672,138 $ 3,701,073 $ 5,312,577 $ 5,334,817
Total debt............................. 700,000 550,000 570,000 155,699
</TABLE>
- ------------------
(1) Pro forma net income represents the effects of taxing the entity under
Subchapter C of the Internal Revenue Code.
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------- ---------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ------------ -------------
(UNAUDITED)
STATEMENT OF OPERATIONS DATA
- ----------------------------
<S> <C> <C> <C> <C> <C>
Net practice revenue................... $ 11,552,476 $ 13,561,339 $ 13,298,164 $ 9,842,814 $11,152,357
Income (loss) from operations before
income taxes......................... (617,719) 95,371 (334,642) (25,271) 24,876
Income tax benefit (expense)........... 194,660 (35,385) 118,242 6,608 (8,707)
Net income (loss)...................... (423,059) 59,986 (216,400) (18,663) 16,169
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------------ ------------ ------------ -------------
(UNAUDITED)
BALANCE SHEET DATA
- ------------------
<S> <C> <C> <C> <C> <C>
Total assets........................... $ 3,807,273 $ 3,654,883 $ 3,584,722 $ 4,451,636
Total debt............................. 1,636,102 1,552,502 1,412,663 1,286,040
</TABLE>
19
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------------- --------------------------
1993 1994 1995 1995 1996
----------- ----------- ------------ ----------- -------------
(UNAUDITED)
STATEMENT OF OPERATIONS DATA
- ----------------------------
<S> <C> <C> <C> <C> <C>
Net practice revenue...................... $ 8,040,293 $ 9,455,216 $ 10,420,265 $ 7,470,881 $10,053,710
Income (loss) from operations
before income taxes..................... 261,123 351,361 103,809 (167,690) 903,425
Pro forma income tax benefit
(expense)(1)............................ (104,645) (143,143) (53,908) 54,393 (357,018)
Pro forma net income (loss)(1)............ 156,478 208,218 49,901 (113,297) 546,407
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
----------- ----------- ------------ -------------
(UNAUDITED)
BALANCE SHEET DATA
- ------------------
<S> <C> <C> <C> <C> <C>
Total assets.............................. $ 2,527,530 $ 3,244,254 $ 5,481,617 $ 6,078,007
Total debt................................ -- -- 2,276,880 1,944,880
</TABLE>
- ------------------
(1) Pro forma net income (loss) represents the effects of taxing the entity
under Subchapter C of the Internal Revenue Code.
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC(1)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------ --------------------------
1994 1995 1995 1996
----------- ----------- ----------- -------------
(UNAUDITED)
STATEMENT OF OPERATIONS DATA
- ----------------------------
<S> <C> <C> <C> <C>
Net practice revenue..................................... $ 1,542,250 $ 8,207,951 $ 5,855,525 $ 6,208,360
Loss from operations before income taxes................. (286,717) (349,179) (314,296) (272,068)
Pro forma net loss(2).................................... (286,717) (349,179) (314,296) (272,068)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ SEPTEMBER 30,
1994 1995 1996
----------- ----------- -------------
(UNAUDITED)
BALANCE SHEET DATA
- ------------------
<S> <C> <C> <C> <C>
Total assets............................................. $ 1,150,472 $ 1,685,062 $ 1,676,622
Total debt............................................... -- -- --
</TABLE>
- ------------------
(1) The selected financial data above includes GCOA from the period October 17,
1994 (date of inception) through September 30, 1996.
(2) Pro forma net loss represents the effects of taxing the entity under
Subchapter C of the Internal Revenue Code; however, no income tax benefit
has been provided herein due to the absence of net operating loss carryback
availability at the entity.
20
<PAGE>
VERO ORTHOPAEDICS, P.A.(1)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------- --------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -------------
(UNAUDITED)
STATEMENT OF OPERATIONS DATA
- ----------------------------
<S> <C> <C> <C> <C> <C>
Net practice revenue........................ $ 2,545,263 $ 3,204,224 $ 4,208,470 $ 3,179,034 $ 2,953,351
Income (loss) from continuing operations
before income taxes....................... (141,766) (202,494) (541,650) 49,160 306,354
Income tax benefit (expense)................ 49,618 69,646 (64,300) (5,021) (132,025)
Net income (loss) from
continuing operations..................... (92,148) (132,848) (605,950) 44,139 174,329
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
----------- ----------- ----------- -------------
(UNAUDITED)
BALANCE SHEET DATA
- ------------------
<S> <C> <C> <C> <C> <C>
Total assets................................ $ 761,837 $ 719,150 $ 788,176 $ 846,453
Total debt.................................. 421,495 575,021 367,877 124,555
</TABLE>
- ------------------
(1) Excluded from the selected financial data above for Vero Orthopaedics, P.A.
are the discontinued operations for the years ended December 31, 1994 and
1995.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Prospectus contains forward-looking statements which involve risks and
uncertainties. See 'Prospectus Summary.' Actual events or results may differ
materially from those discussed in forward-looking statements as a result of
various factors, including, but not limited to, those discussed in 'Risk
Factors.'
GENERAL
SCN was incorporated in 1995, but did not conduct any significant
operations until November 1996, following its affiliation with the Initial
Affiliated Practices. At the time of the Initial Affiliation Transactions, the
predecessors of the Initial Affiliated Practices were established businesses
engaged in the provision of musculoskeletal care as separate independent
entities. The Initial Affiliated Practices currently conduct business as
separate entities obtaining services from the Company pursuant to the Initial
Service Agreements.
The following discussion of the unaudited pro forma results of operations
and financial position of the Company and of the combined results of operations
of the Predecessor Practices should be read in conjunction with the Unaudited
Pro Forma Financial Statements and Notes thereto and the financial statements
for the Company and each of the Predecessor Practices included elsewhere in this
Prospectus.
ACCOUNTING TREATMENT
The acquisition of the assets and assumption of certain liabilities of the
Predecessor Practices were accounted for by the Company at the transferors'
historical cost basis. The Common Stock being exchanged for those assets is
recorded by SCN at the Predecessor Practices' historical cost. Cash
consideration given in these acquisitions is treated for accounting purposes as
a dividend from SCN to the physician owners who received cash.
Future acquisitions will be accounted for by either the pooling of
interests or purchase accounting methods. To the extent future acquisitions are
accounted for by the purchase method of accounting, the Company may have to
recognize substantial amounts of goodwill.
SPECIALTY CARE NETWORK, INC.
OVERVIEW
In connection with the Initial Affiliation Transactions, the Company
acquired certain assets and liabilities of the Predecessor Practices and entered
into the Initial Service Agreements with the Initial Affiliated Practices.
Pursuant to the terms of the Initial Service Agreements, the Company, among
other things, provides facilities and management, administrative and development
services, and employs most non-medical personnel, in return for management
service fees. Such fees are payable monthly and consist of the following: (i)
service fees based on a percentage (the 'Service Fee Percentage') ranging from
20%-33% of the Adjusted Pre-Tax Income of the Initial Affiliated Practices
(defined as revenue of the Initial Affiliated Practices related to professional
services less amounts equal to certain clinic expenses of the Initial Affiliated
Practices ('Clinic Expenses,' as defined more fully in the Initial Service
Agreements), not including physician owner compensation or most benefits to
physician owners) and (ii) amounts equal to Clinic Expenses. For the first three
years following affiliation, however, the portion of the service fees described
under clause (i) is specified to be the greater of the amount payable as
described under clause (i) above or a fixed dollar amount (the 'Base Service
Fee'), which was generally calculated by applying the respective Service Fee
Percentage of Adjusted Pre-Tax Income of the Predecessor Practices for the
twelve months prior to affiliation. The aggregate annual Base Service Fee for
each of the Initial Affiliated Practices is approximately $9.5 million. In
addition, with respect to its management of certain facilities and ancillary
services
22
<PAGE>
associated with certain of the Initial Affiliated Practices, the Company
receives fees ranging from 2%-8% of net revenue.
The expenses incurred by the Company in fulfilling its obligations under
the Initial Service Agreements include the salaries, wages and benefits of
personnel (other than physician owners and certain technical medical personnel),
supplies, expenses involved in administering the clinical practices of the
Initial Affiliated Practices and general and administrative expenses, as well as
depreciation and amortization of assets acquired from the Predecessor Practices.
The Company will seek to reduce these operating costs and expenses, as a
percentage of net revenue, through purchase discounts, economies of scale and
standardization of best practices. In addition to the operating costs and
expenses discussed above, the Company has and will continue to incur personnel
and administrative expenses in connection with its corporate office, which
provides management, administrative and development services to the Initial
Affiliated Practices.
Significant factors that influence revenue of the Initial Affiliated
Practices include the number of physicians, specialty and subspecialty mix,
payor mix and associated ancillary services. The Company plans to assist the
Initial Affiliated Practices by providing management, capital and other
resources required to develop new services, to recruit additional physicians to
its Initial Affiliated Practices and to secure managed care contracts.
RESULTS OF OPERATIONS
HISTORICAL
The Company had not entered into any service agreements, and consequently
generated no revenue, prior to September 30, 1996. The Company incurred a loss
for the period from the date of its incorporation through September 30, 1996 of
approximately $2.3 million reflecting management salaries and the travel, legal
and accounting costs associated with the Initial Affiliation Transactions.
PRO FORMA
Revenue. The pro forma revenue of the Company consists almost exclusively
of amounts to be earned under the Initial Service Agreements. The revenue
included in the pro forma financial statements is that which would have been
earned based on the operating results of the Predecessor Practices for the year
ended December 31, 1995 and for the nine months ended September 30, 1996,
assuming the Initial Affiliation Transactions had occurred on January 1, 1995.
The pro forma revenue of $31.5 million and $25.0 million for the year ended
December 31, 1995 and for the nine months ended September 30, 1996,
respectively, are based on the amounts that would have been payable pursuant to
the Initial Service Agreements, which include management fees and the
reimbursable expenses of the Initial Affiliated Practices. The pro forma revenue
includes revenue that would have been derived from the management agreement
between the Tallahassee MRI center and the Company and revenue that would have
been derived from the management agreement between the Company and POA relating
to POA's ambulatory surgery center.
Operating Expenses. The total pro forma operating expenses for the year
ended December 31, 1995 and for the nine months ended September 30, 1996 reflect
the operating expenses of the Predecessor Practices which would have been
payable by SCN under the Initial Service Agreements and SCN corporate costs.
Income Taxes. Pro forma income taxes assume that the Company had operated
as a tax-paying entity, subject to an effective combined tax rate for state and
federal income taxes of 38%.
LIQUIDITY AND CAPITAL RESOURCES
SCN has financed its operations to date from the proceeds of private
placements of convertible debt and equity and bank borrowings. During 1996, the
Company received net proceeds from private placements of convertible
subordinated debt and equity in an aggregate amount of approximately $2.5
23
<PAGE>
million. SCN utilized bank borrowings of approximately $1.7 million to effect
the Initial Affiliation Transactions.
The Company has a $20 million Credit Facility, including a $15.0 million
Acquisition Facility and a $5.0 million Working Capital Facility to be used for
acquisitions and general corporate purposes. The Company's aggregate borrowings
cannot exceed an established borrowing base, which is a multiple of the
Company's trailing twelve months cash flow, subject to certain adjustments, less
existing indebtedness. The minimum rates at which the Company can borrow are the
prime rate or LIBOR plus 1.75% on the Acquisition Facility and the prime rate or
LIBOR plus 1.50% on the Working Capital Facility. At November 30, 1996, the
Company had approximately $2.8 million outstanding under the Credit Facility,
consisting of $1.7 million in Acquisition Facility debt and $1.1 million in
Working Capital Facility debt. At December 9, 1996, the Company's borrowing base
under the Credit Facility was $7.0 million, and the Company's effective rate of
interest was 7.34% for both the Acquisition and Working Capital Facilities. The
Credit Facility is secured by substantially all of the assets of the Company and
contains customary affirmative and negative covenants, including covenants
limiting the Company's ability to incur additional indebtedness and limiting the
Company's ability to, and restricting the terms upon which the Company can,
affiliate with physician practices in the future. The per annum commitment fee
on the unused portion of the Credit Facility is 0.25% on the Acquisition
Facility and 0.20% on the Working Capital Facility and increases to 0.35% on the
Acquisition Facility and 0.30% on the Working Capital Facility on January 1,
1997.
The Company plans to repay all outstanding indebtedness under the Credit
Facility with proceeds from this offering.
In connection with the Initial Affiliation Transactions, the Company has
committed to enter into loan agreements with certain physician owners of the
Predecessor Practices for loans in an aggregate amount of up to approximately
$4.3 million. These loans are available until November 12, 1998 and the amount
that each physician may borrow is limited. Pursuant to these loan agreements as
of December 9, 1996, the Company had loaned approximately $800,000 to certain
physician owners of the Initial Affiliated Practices to cover anticipated cash
flow needs of these physician owners. The loans bear interest at a floating rate
based on prime plus 1.25% and mature at the earlier of the date on which shares
of Common Stock held by the physicians, (i) are sold pursuant to a registration
statement filed with the Commission or (ii) may otherwise be sold pursuant to
Rule 144.
Pursuant to separate agreements with two of the physician owners at ROA,
the Company has agreed to support the establishment of a sports medicine center
and a knee center. The Company has agreed to negotiate in good faith with one
physician owner to develop a plan for the sports medicine center by November
1997. The specifications relating to the development of the centers, including
the extent of capital commitments by the Company, have not been determined. The
development of the centers would be subject to regulatory approvals under
current law.
In connection with the Initial Affiliation Transactions, the Company
purchased, subject to adjustment, the accounts receivable of the Predecessor
Practices. In addition, pursuant to the Initial Service Agreements, the Company
will purchase, subject to adjustment, the accounts receivable of the Initial
Affiliated Practices monthly in arrears and anticipates that it will have a
similar obligation under service agreements entered into in the future. The
Company expects to use working capital to fund its obligation to purchase,
subject to adjustment, the accounts receivable on an ongoing basis.
In connection with the Initial Affiliation Transactions, the Company will
record aggregate federal and state deferred tax liabilities of approximately
$3.9 million. These liabilities generally will become payable ratably over a
four year period commencing on the date of the consumation of the Initial
Affiliation Transactions.
The Company anticipates that capital expenditures during 1997 will relate
primarily to affiliations with additional practices, if any, and to the
expansion and replacement of medical and office
24
<PAGE>
equipment for the Initial Affiliated Practices. It is anticipated that funding
for these purposes will be derived from the proceeds of this offering, funds
borrowed under the Credit Facility and cash flow from operations. Management
believes that such sources will be sufficient to fund the Company's capital
needs for a period of twelve months following completion of this offering. In
the future, the Company will seek to raise additional funds through debt
financing or the issuance of debt or equity securities. There can be no
assurance that sufficient funds will be available on terms acceptable to the
Company, if at all.
COMBINED PREDECESSOR PRACTICES
OVERVIEW
For all periods presented with respect to the Predecessor Practices, the
combined financial statements reflect operations of these practices as if they
had been members of the same operating group, although there has not been a
prior operating relationship among these practices and they will not operate on
a combined basis in the future. The historical net practice revenue of the
Predecessor Practices consists of professional fees from medical services
provided by the physicians and medical personnel associated with such practices,
facility fees from one ambulatory surgery center and fees from one MRI center.
The operating expenses of the Predecessor Practices represent salaries and
benefits of all personnel associated with the practices, pharmaceuticals and
supplies consumed in the practice of medicine, general and administrative
expenses associated with the conduct of the business and administrative aspects
of the practices, depreciation of the fixed assets of the practices, interest
expense on debt and other miscellaneous items of income and expenses.
RESULTS OF OPERATIONS
Net Revenue. Total combined net revenue for the Predecessor Practices
increased from $34.0 million in 1993 to $41.1 million in 1994 and to $53.7
million in 1995. Net revenue reflects fees at established rates net of
contractual adjustments and provision for bad debt. The $7.1 million increase
between 1993 and 1994 was primarily attributable to (i) the addition of two
physicians at one of the Predecessor Practices and (ii) the inclusion of two
months of GCOA's financial results in the 1994 period (GCOA began operations on
October 17, 1994). The remainder of the 1994 increase was attributable to
increased revenue from surgical procedures at several of the Predecessor
Practices. The $12.6 million increase between 1994 and 1995 was primarily
attributable to (i) addition of ten physicians at the Predecessor Practices,
including the addition of five pysicians at the predecessor of ROA, (ii) a full
year of financial results reported for GCOA and (iii) additional revenue
realized by the predecessor of TOC from its MRI center.
Total net revenue increased from $38.8 million in the nine months ended
September 30, 1995 to $44.6 million for the same period in 1996. The $5.8
million increase was primarily attributable to (i) increased revenue from the
MRI center at one of the Predecessor Practices and (ii) increased revenue from
surgical procedures at several of the Predecessor Practices.
In each of the periods, total combined net revenue was also affected by an
increase in the number of surgical procedures performed by several of the
Predecessor Practices offset by a decrease in the reimbursement rate for certain
procedures, in each case when compared to the prior period.
Physician Compensation. Combined physician compensation for the
Predecessor Practices of $15.4 million, $19.5 million and $27.0 million in 1993,
1994 and 1995, respectively, and of $20.3 million and $21.0 million for the nine
months ended September 30, 1995 and 1996, respectively, includes all
compensation paid to physician owners and physician employees during the
periods. The physician owners determined the amount of such compensation.
Salaries and Benefits. Combined salaries and benefits for the Predecessor
Practices increased from $9.7 million in 1993 to $11.7 million in 1994 and to
$14.1 million in 1995, with the percentage of these expenses to total net
revenue being 28.6%, 28.5% and 26.3%, respectively. The $2.0 million increase
between 1993 and 1994 was primarily attributable to (i) the additional salaries
and benefits for
25
<PAGE>
personnel hired to support the increase in the number of physicians at the
Predecessor Practices and (ii) the salaries and benefits for personnel at GCOA,
which was formed on October 17, 1994, and additional personnel at the
predecessor of POA following its addition of another group in the Princeton
area. The $2.4 million increase between 1994 and 1995 was primarily attributable
to the same factors as those discussed above.
Salaries and benefits increased from $9.2 million in the nine months ended
September 30, 1995 to $10.8 million for the same period in 1996, with the
percentage of these expenses to total net revenue being 23.8% and 24.2%,
respectively. The $1.6 million increase was primarily attributable to increased
staffing levels to support an increased number of physicians.
Supplies, General and Administrative Expenses. Combined supplies, general
and administrative expenses for the Predecessor Practices increased from $8.5
million in 1993 to $9.2 million in 1994 and to $11.3 million in 1995, with the
percentage of these expenses to total net revenue being 24.9%, 22.4% and 21.0%,
respectively. The approximately $700,000 increase between 1993 and 1994 was
primarily attributable to (i) the additional supplies, general and
administrative expenses necessary to support the increase in the number of
physicians at the Predecessor Practices and (ii) the supplies, general and
administrative expenses at GCOA following its formation and at the predecessor
of POA following the addition of another group in the Princeton area. The $2.1
million increase between 1994 and 1995 was primarily attributable to the same
factors as those discussed above.
Supplies, general and administrative expenses for the Predecessor Practices
increased from $8.3 million in the nine months ended September 30, 1995 to $10.6
million for the same period in 1996, with the percentage of these expenses to
total revenue being 21.3% and 23.9%, respectively. The $2.3 million increase was
primarily attributable to increased expenses necessary to support an increased
number of physicians.
Depreciation and Amortization. Combined depreciation and amortization for
the Predecessor Practices decreased slightly from $430,702 in 1993 to $426,538
in 1994 and increased to $689,700 in 1995, with the percentage of these expenses
to total revenue being 1.3%, 1.0% and 1.3%, respectively. The increase between
1994 and 1995 was primarily attributable to additional depreciation expense
related to the purchase of an MRI facility by the predecessor of TOC.
Depreciation and amortization for the Predecessor Practices increased from
$484,800 in the nine months ended September 30, 1995 to $685,950 for the same
period in 1996, with the percentage of these expenses to total revenue being
1.3% and 1.5%, respectively. The increase was primarily attributable to a full
period's depreciation on the aforementioned MRI facility and depreciation
related to additional capital expenditures at the predecessor of TOC.
Inflation. Inflation has not had a material effect on the combined results
of operations of the Predecessor Practices.
26
<PAGE>
BUSINESS
GENERAL
Specialty Care Network is a physician practice management company focusing
exclusively on musculoskeletal disease-state management. Since November 12,
1996, the Company has provided comprehensive management services under long-term
agreements with five practices, encompassing 49 physicians in five states. In
addition, the Company has entered into definitive agreements to affiliate with
three single physician practices in two of its existing markets. The Company
also manages one outpatient surgery center and one outpatient MRI center owned
by two of its Initial Affiliated Practices.
The Initial Affiliated Practices offer a broad spectrum of musculoskeletal
care, which is the treatment of conditions relating to bones, joints, muscles
and related connective tissues. The Company's affiliated physicians are trained
in a variety of musculoskeletal disciplines, including general orthopaedics,
joint replacement surgery, sports medicine, spinal care, hand and upper
extremity care, foot and ankle care, pediatric orthopaedics, physiatry, trauma
and adult neurology. In order to build networks of providers which offer access
to a full range of musculoskeletal care, the Company intends to affiliate and
otherwise contract with physicians trained in other musculoskeletal
subspecialties, including occupational medicine, neurosurgery, plastic surgery,
rehabilitation therapy and rheumatology.
SCN's goal is to build the leading musculoskeletal physician practice
management company in the United States. The Company's strategy consists of
three components: (i) affiliating with leading musculoskeletal practices in
targeted markets throughout the United States; (ii) assisting each Affiliated
Practice in managing and expanding its business by providing comprehensive
operational support, including proprietary clinical and financial information
systems; and (iii) developing integrated regional musculoskeletal networks
around its Affiliated Practices. As a first step in implementing this strategy,
the Company has entered into long-term service agreements with the Initial
Affiliated Practices, a select group of practices in Philadelphia, Pennsylvania;
Princeton, New Jersey; Tallahassee, Florida; Baltimore, Maryland; and Vero
Beach, Florida. These Initial Affiliated Practices were selected based on a
variety of factors including, but not limited to, physician credentials and
reputation; competitive market position; specialty and subspecialty mix of
physicians; historical financial performance and growth potential; and
willingness to embrace SCN's corporate philosophy.
INDUSTRY BACKGROUND
PHYSICIAN PRACTICE MANAGEMENT INDUSTRY
The Health Care Financing Administration ('HCFA') estimated that national
health care spending in 1994 was approximately $940 billion, with approximately
$180 billion of such expenditures in 1994 directly attributable to physician
services and an additional $600 billion under physician direction. Moreover,
HCFA projects that national health care spending will be nearly $1.5 trillion in
2000. The growth in health care expenditures has increased the demand by
government and third party payors to control health care costs. The resulting
emphasis on cost containment, the consolidation of the health care market in
general, the increased market share of managed care companies and the transfer
of risk from payors to providers have precipitated and accelerated significant
changes in the way physicians organize themselves.
The Company believes that, among other factors, these market pressures have
caused physicians to affiliate with physician practice management companies that
provide comprehensive operational and financial support. Although several
companies provide such services to physicians across a variety of medical
specialties, including musculoskeletal care, management believes that, upon
completion of this offering, SCN will be the only publicly-traded physician
practice management company focusing exclusively on musculoskeletal care.
27
<PAGE>
MUSCULOSKELETAL MARKET OVERVIEW
Expenditures for musculoskeletal care in the United States are significant,
with total direct costs associated with the delivery of musculoskeletal care
exceeding $60 billion in 1988, according to the AAOS. Of this amount,
approximately $7 billion represents fees paid for physician services.
Furthermore, according to the AAOS, the 65-and-over age group accounts for
approximately 25% of musculoskeletal cases. Given the aging of the U.S.
population, the Company believes that demographic trends favor the growth of the
need for musculoskeletal care.
The spectrum of musculoskeletal care ranges from acute procedures, such as
spinal or hip surgery after trauma, to the treatment of chronic conditions, such
as arthritis and back pain. Musculoskeletal care is provided by a variety of
medical and surgical specialists. Although the orthopaedic surgeon represents
the primary musculoskeletal provider, musculoskeletal care is also provided by
neurosurgeons, neurologists, plastic surgeons, physiatrists, rheumatologists,
occupational medicine physicians, podiatrists and primary care physicians, as
well as rehabilitative therapists. Moreover, there are a number of
subspecialties of orthopaedics, including adult reconstructive (joint
replacement) surgery, spinal care, sports medicine, foot and ankle care, hand
and upper extremity care, pediatrics, oncology and trauma care. The American
Medical Association estimates that in 1995, there were approximately 22,000
orthopaedic surgeons, as well as approximately 5,500 physiatrists, 3,500
rheumatologists, 3,000 occupational medicine physicians, 11,400 neurologists and
4,900 neurosurgeons.
The payor mix for musculoskeletal care is diverse, with managed care
enrollees representing an increasing percentage of patients. According to data
from a 1994 AAOS survey, the largest percentage of patients is private pay
(28%), followed by managed care, including fee-for-service and capitation (21%),
Medicare (21%) and workers compensation (18%). Almost 80% of orthopaedic
surgeons indicated they received patients from managed care sources. While
private pay patients remain the largest category, the AAOS survey indicated that
the percentage of total private pay patients has declined from 39% in 1988 to
28% in 1994. Over the same period, patients from managed care sources increased
from 12% to 21%. The distribution of patients from other sources remained
relatively constant over this period.
STRATEGY
SCN's goal is to become the leading physician practice management company
focusing on musculoskeletal disease-state management. The Company's strategy
consists of three components: (i) affiliating with leading musculoskeletal
practices in targeted markets throughout the United States; (ii) assisting each
Affiliated Practice in managing and expanding its business by providing
comprehensive operational support, including the development of proprietary
clinical and financial information systems; and (iii) developing integrated
regional musculoskeletal networks around its Affiliated Practices.
AFFILIATE WITH LEADING MUSCULOSKELETAL GROUPS
As a result of the Initial Affiliation Transactions, the Company has
affiliated with five practices encompassing 49 physicians in five states. The
Company intends to acquire the assets of, and provide management services to,
additional leading musculoskeletal physician groups in targeted markets. The
Company evaluates potential acquisition candidates based on a variety of
factors, including, but not limited to, physician credentials and reputation;
competitive market position; specialty and subspecialty mix of physicians;
historical financial performance and growth potential; and willingness to
embrace SCN's corporate philosophy. The Company believes that it is an
attractive affiliation partner because of the depth and experience of the
Company's management team; the Company's physician-driven practice governance
structure; the fee structure under the Company's service agreements; and the
affiliation transaction structure, which permits physicians to become
stockholders whose interests are aligned with those of the Company.
28
<PAGE>
PROVIDE COMPREHENSIVE OPERATIONAL SUPPORT
The Company intends to provide the Affiliated Practices comprehensive
operational services designed to enable physicians to devote their full time and
effort toward their clinical practices. The Company also will seek to increase
practice revenue through physician recruitment, contracting with ancillary
musculoskeletal-related providers, enhanced managed care contracting and
improvements in billing and collection. For a discussion of the Company's
current efforts in this regard see '-- Payor Contracting.' In addition, the
Company will seek to reduce operating costs and expenses, as a percentage of net
revenue, through purchase discounts, economies of scale and standardization of
best practices.
As a key element of assisting the Affiliated Practices, the Company intends
to leverage information systems experience of its management and utilize the
Company's proprietary information systems. Kerry R. Hicks, Chief Executive
Officer of the Company, and David G. Hicks, Vice President of Management
Information Systems of the Company, have significant experience in designing and
implementing health care information systems. The Company has established
standards at the Initial Affiliated Practices for gathering clinical and
financial information such as personal patient data, physician and procedure
identifier codes, payor class and amounts charged and reimbursed. The Company
intends to develop a proprietary clinical outcomes database to enable the
Affiliated Practices to analyze clinical outcomes at the practitioner and
practice levels on a standardized basis. Information will be gathered in areas
such as incidents rates (the number of specified procedural, diagnostic and
medical events during a specified period with respect to a specified patient
population), utilization (frequency of patient care and activity relating to the
patient) and quality of care (monitoring and evaluation of patient outcomes).
This information should assist physicians in developing clinical protocols,
measuring outcomes, ensuring that standards of quality are met and determining
the most cost-effective course for treating patients. The Company intends to use
this data, together with data derived from its financial information systems, to
produce comprehensive financial and clinical reports to be used in connection
with the negotiation, structuring and pricing of managed care contracts. See '--
SCN Operations -- Management Information Systems.'
DEVELOP INTEGRATED REGIONAL MUSCULOSKELETAL NETWORKS
The Company intends in the longer term to leverage the reputation and
market share of the Affiliated Practices to develop integrated regional
musculoskeletal care networks. In order to offer patients and payors a
multi-disciplinary continuum of care and to increase patient access points in a
given market, the Company intends to develop these networks through contracts
with additional specialists in the musculoskeletal disciplines not represented
in the Affiliated Practices. The Company also intends, to the extent permitted
by applicable law, to contract with selected musculoskeletal providers and
facilities as needed in order to offer an umbrella of care, including MRI and
x-ray, outpatient occupational medicine, physical therapy and surgery centers.
The Company's objective in developing these networks is to obtain managed care
contracts for the networks and to enhance relationships with third party payors.
The Company believes patients are treated most effectively and efficiently
when various physician, institutional and ancillary providers are integrated
vertically into an organized musculoskeletal health care delivery system.
Efficiencies can be achieved by gathering, interpreting and sharing clinical
outcomes information, standardizing referral patterns and treatment protocols
within the network and coordinating patients' clinical treatment as they move
through the continuum of care toward recovery. These efficiencies result in an
increased ability to control and predict the cost of care for various patient
diagnoses. The Company believes that organized musculoskeletal physicians in a
network, with access to reliable clinical outcomes information, are able to
deliver a higher quality of care to patients. Nevertheless, the Company is
unable to predict whether and to what extent it will be able to establish
integrated musculoskeletal networks or negotiate capitated arrangements in the
future.
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<PAGE>
INITIAL AFFILIATED PRACTICES
The Company has affiliated, through the Initial Service Agreements, with
five practices. On November 12, 1996, the Company, through a series of
transactions including an asset purchase, a share exchange and three mergers,
acquired substantially all of the assets and certain liabilities of the Initial
Affiliated Practices. In the Initial Affiliation Transactions, the Company
issued an aggregate of 7,659,115 shares of Common Stock and paid $1,537,872 in
cash to physicians in the Initial Affiliated Practices. In addition, the Company
has entered into definitive agreements to affiliate with three single physician
practices in Tallahassee, Florida; Thomasville, Georgia; and Baltimore,
Maryland.
The table below sets forth certain information regarding the Initial
Affiliated Practices, all of whose physicians are board certified or board
eligible:
<TABLE>
<S> <C> <C> <C> <C>
MUSCULOSKELETAL
AFFILIATED PRACTICES LOCATION(S) PHYSICIANS SUBSPECIALTIES ANCILLARY SERVICES
- --------------------------------- --------------------- ------------- --------------------- --------------------------
Reconstructive Orthopaedics Philadelphia, PA 10 3 None
Associates II, P.C.
Princeton Orthopaedic Princeton, NJ 12 7 Outpatient Surgery,
Associates II, P.A. Physical Therapy
TOC Specialists, P.L. Tallahassee, FL 14 7 MRI
Bainbridge, GA
Greater Chesapeake Baltimore, MD 8 5 None
Orthopaedic
Associates, L.L.C.
Vero Orthopaedics II, P.A. Vero Beach, FL 5 5 None
Sebastian, FL
-----
Total 49
-----
-----
</TABLE>
RECONSTRUCTIVE ORTHOPAEDICS ASSOCIATES II, P.C.
ROA, operating under the name The Rothman Institute, was founded in
Philadelphia, Pennsylvania in 1970 and currently has nine orthopaedic surgeons
and one anesthesiologist. ROA has its own research department and has compiled
an orthopaedic database for more than 25 years.
ROA physicians (and their specialties) are Todd J. Albert, M.D. (spine
surgery); Richard A. Balderston, M.D. (spine surgery); Arthur R. Bartolozzi,
M.D. (sports medicine); Robert E. Booth, Jr., M.D. (joint replacement surgery);
Michael G. Ciccotti, M.D. (sports medicine); William J. Hozack, M.D. (joint
replacement surgery); Philip M. Mauer (anesthesiologist); Richard H. Rothman,
M.D., Ph.D. (joint replacement surgery); Peter F. Sharkey, M.D. (joint
replacement surgery); and Alexander R. Vaccaro, M.D. (spine surgery). All of
these physicians, other than Dr. Mauer, are physician owners of ROA.
Dr. Balderston serves as Clinical Professor, Vice Chairman of the
Department of Orthopaedics and Chief of Orthopaedic Surgery at Thomas Jefferson
University Hospital ('Jefferson'). Dr. Bartolozzi is a team physician for
several sports teams, including the Philadelphia Flyers hockey team and the
Philadelphia Eagles football team. Dr. Booth serves as Co-Chief of Orthopaedic
Surgery at Pennsylvania Hospital, and is Professor and Vice Chairman of
Orthopaedic Surgery at Jefferson. Dr. Rothman serves as the Chairman of the
Department of Orthopaedics at Jefferson and Co-Chairman of the Department of
Orthopaedics at Pennsylvania Hospital and is the Editor-in-Chief of the Journal
of Arthroplasty, a journal of joint replacement surgery.
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<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES II, P.A. AND PRINCETON SPORTSMEDICINE
POA was founded in 1974 in Princeton, New Jersey and currently has 10
orthopaedic surgeons, one podiatric surgeon, two physiatrists and 16 physical
therapists. POA operates three facilities, each of which has an approximately
7,000 square foot physical therapy center. One of these facilities, operating
under the name SportsMedicine Princeton, provides multi-disciplinary diagnostic
and rehabilitative care for sports-related injuries. POA also operates its own
outpatient surgery center, for which SCN provides management services for a fee.
POA physicians (and their specialties) are Jeffrey S. Abrams, M.D.
(shoulder surgery); Jon W. Ark, M.D. (hand and foot surgery); Robert N. Dunn,
M.D. (spine surgery); Richard E. Fleming, Jr., M.D. (sports medicine); Steven R.
Gecha, M.D. (sports medicine); W. Thomas Gutowski, M.D. (sports medicine);
Michael N. Jolley, M.D. (joint replacement surgery); Greg E. Lutz, M.D.
(physiatry); C. Alexander Moskwa, Jr., M.D. (sports medicine); Michael A.
Palmer, M.D. (physiatry); Harvey E. Smires, M.D. (joint replacement surgery);
David M. Smith, M.D. (general orthopaedics); and John S. Smith, DPM (podiatry).
All of these physicians, other than Drs. Ark, Lutz, Palmer and John S. Smith,
are physician owners of POA.
TOC SPECIALISTS, P.L.
TOC was founded in 1972 and currently has nine orthopaedic surgeons, two
non-surgical musculoskeletal specialists and three neurologists. In its main
facility in Tallahassee, Florida, TOC has an MRI center for which SCN provides
management services for a fee. In addition, TOC physicians also practice at a
satellite facility in Bainbridge, Georgia operating under the name Southern
Orthopedic Specialists, Inc. TOC has a non-contractual capitated arrangement
with Capital Health Plans covering approximately 75,000 lives and a capitated
contract with Health Plan Southeast covering approximately 55,000 lives.
TOC physicians (and their specialties) are Gregg A. Alexander, M.D.
(musculoskeletal medicine, disorders of the spine); D. Christian Berg, M.D.
(hand and upper extremities); Richard E. Blackburn, M.D. (adult neurology);
Donald M. Dewey, M.D., C.P.O. (foot and ankle surgery, pediatric orthopaedics);
Mark E. Fahey, M.D. (general orthopaedic surgery); Thomas C. Haney, M.D. (knee
surgery, sports medicine); William D. Henderson, Jr., M.D. (knee surgery, sports
medicine); Steve E. Jordan, M.D. (general orthopaedic surgery, sports medicine);
J. Rick Lyon, M.D. (general orthopaedic surgery); Kris D. Stowers, M.D.
(musculoskeletal and sports medicine); Robert L. Thornberry, M.D. (hip and knee
surgery, sports medicine); Billy C. Weinstein, M.D. (adult neurology); Stanley
Whitney, M.D. (adult neurology); and Charles H. Wingo, M.D. (spine surgery). All
of these physicians, other than Dr. Whitney, are physician owners of TOC.
TOC physicians have served as team physicians for a number of local high
schools and colleges. Dr. Haney serves as the team physician for the Florida
State University football team. Dr. Henderson currently serves as the president
of the Herodicus Society, a national sports medicine society, and is one of the
sports medicine physicians for the U.S. National Soccer Team. Dr. Wingo
currently serves as Chairman of the Orthopaedic Section/Surgery at the
Tallahassee Memorial Regional Medical Center.
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, L.L.C.
GCOA was founded in Baltimore, Maryland in 1994 and currently has eight
orthopaedic surgeons. The two main focus areas of GCOA are sports medicine and
foot and ankle services. The practice is located adjacent to Union Memorial
Hospital and is actively involved in the orthopaedic residency and fellowship
teaching programs at that institution, and two of its physicians are active in
such programs at the Johns Hopkins University School of Medicine ('Johns
Hopkins').
GCOA physicians (and their specialties) are Paul L. Asdourian, M.D. (spine
surgery); Frank R. Ebert, M.D. (joint replacement surgery); Leslie S. Matthews,
M.D. (sports medicine); Stuart D. Miller, M.D. (foot and ankle); Mark S.
Myerson, M.D. (foot and ankle); John B. O'Donnell, M.D. (sports
31
<PAGE>
medicine); Lew C. Schon, M.D. (foot and ankle); and Martin A. Yahiro, M.D.
(general orthopaedics). All of these physicians, other than Dr. Yahiro, are
physician owners of GCOA.
Dr. Asdourian serves as Chief of Orthopaedic Spinal Surgery at Union
Memorial Hospital and is a clinical instructor in orthopaedic surgery at Johns
Hopkins. Dr. Ebert currently serves as Assistant Chief of Orthopaedic Surgery at
Union Memorial Hospital. Dr. Matthews currently serves as Chief of Orthopaedic
Surgery at Union Memorial Hospital and is Program Director for the Orthopaedic
Surgery Residency training program. Dr. Matthews also is an Assistant Professor
of orthopaedic surgery at Johns Hopkins. Dr. Myerson serves as the director of
Foot and Ankle Services at Union Memorial Hospital. Dr. O'Donnell is assistant
director of Union Memorial Hospital's Sports Medicine Fellowship Program and is
a clinical instructor in orthopaedic surgery at Johns Hopkins. Dr. Schon serves
as Associate Director of the Foot & Ankle Fellowship program at Union Memorial
Hospital. Dr. Yahiro joined the group in July 1995. He currently serves as an
orthopaedic surgeon advisor to the federal Food and Drug Administration.
VERO ORTHOPAEDICS II, P.A.
VO was founded in Vero Beach, Florida in 1976 and currently has four
orthopaedic surgeons and one physiatrist. The practice is located near Indian
River Memorial Hospital. VO operates one satellite office in Sebastian, Florida.
VO's physicians (and their specialties) are James L. Cain, M.D. (foot and
ankle); David W. Griffin, M.D. (knee surgery); George K. Nichols, M.D. (hip
surgery); Peter G. Wernicki, M.D. (sports medicine); and Charlene Wilson, M.D.
(physiatry). All of these physicians, other than Dr. Wilson, are physician
owners of VO.
Dr. James L. Cain, founder of Vero Orthopaedics, has served as Chairman of
the Department of Orthopaedics, Chief of the Medical Staff, and as a member of
the Board of Directors of Indian River Memorial Hospital. Dr. David W. Griffin
is Director of the Joint Implant Center of the Treasure Coast at Indian River
Memorial Hospital.
SCN OPERATIONS
Upon affiliation with SCN, physician practices enter into a long-term
service agreement with the Company. Under the terms of a service agreement, the
Company generally employs most of a practice's non-physician personnel, provides
facilities for the practices and provides services in the areas of practice
management, information systems and negotiation of payor contracts, all as more
specifically described below. The governance structure provided with respect to
the service agreements facilitates close cooperation between the Company and the
practices, while ensuring that the practices maintain clinical autonomy. See '--
Contractual Agreements with Affiliated Practices.'
MANAGEMENT SERVICES
Pursuant to the terms of the Service Agreements, the Company assists the
Initial Affiliated Practices in strategic planning, preparation of operating
budgets and capital project analysis. The Company intends to coordinate group
purchasing of supplies, inventory, and insurance for the practices. In addition,
the Company will assist the Affiliated Practices in physician recruitment by
introducing physician candidates to the practices and advising the practices in
structuring employment arrangements.
The Company also provides or arranges for a variety of additional services
relating to the day-to-day non-medical operations of the practices, including
(i) management and monitoring each practice's billing levels, invoicing and
accounts receivable collection by payor type, (ii) accounting, payroll and legal
services and records and (iii) cash management and centralized disbursements.
These services are designed to reduce the amount of time physicians must
spend on administrative matters, thereby enabling the physicians to dedicate
more of their efforts toward the delivery of health care. The Company's
anticipated capital resources and assistance in preparation of budgets and
capital project analysis are intended to facilitate the establishment of
ancillary services for the practices,
32
<PAGE>
including, where appropriate, facilities. These ancillary services may include
occupational medicine, physical therapy and outpatient surgery centers and MRI
centers. Comprehensive administrative support should facilitate more effective
billings and collections and, as the Company grows, economies of scale in
effecting purchases. The Company's proprietary accounts payable system should
allow SCN to control disbursements and identify economies in purchasing.
PRACTICE SERVICES
As a result of its affiliation with the Initial Affiliated Practices, SCN
employs most of the Initial Affiliated Practices' non-physician personnel. These
non-physician personnel, along with additional personnel at the Company's
headquarters, manage the day-to-day non-medical operations of each of the
Initial Affiliated Practices, including, among other things, secretarial,
bookkeeping, scheduling and other routine services. Under the Initial Service
Agreements, the Company must provide facilities and equipment to the Initial
Affiliated Practices, and to this end, the Company entered into lease agreements
for the facilities, and purchased the assets, utilized by each of the Initial
Affiliated Practices.
MANAGEMENT INFORMATION SYSTEMS
The Company believes that a key element in the implementation of its
business strategy is the development and utilization of its proprietary
management information systems. The Company is designing its information systems
to integrate and analyze financial and clinical data, improve operating
efficiency at the practice level and enhance the ability of the Company to
negotiate managed care contracts on behalf of its Affiliated Practices.
The Company has developed proprietary financial systems that have been
installed at the Company's headquarters and at each of the Initial Affiliated
Practices. These systems include an internally developed purchase order
application and electronic interfaces between payroll, general ledger, banking,
accounts payable and accounts receivable applications. These systems permit each
Initial Affiliated Practice to separately designate purchase requirements and
transfer purchase information on a daily basis. Such information allows the
Company to monitor purchases from order to receipt, to centrally control the
disbursement of funds and to identify economics in purchasing. In addition, the
Company's systems permit the Company to capture, analyze and report centrally
financial data from the various Initial Affiliated Practice locations and
provide analysis of financial data on a fully integrated basis. In addition, the
Company's management information systems personnel is designing a proprietary
clinical outcomes database. See 'Strategy -- Provide Comprehensive Operational
Support.'
PAYOR CONTRACTING
An increasing portion of the net revenue of the Initial Affiliated
Practices is derived from managed care payors. Although rates paid by managed
care payors are generally lower than commercial rates, managed care payors can
provide access to large patient volumes. TOC derives managed care revenue from
two capitated arrangements covering a total of 130,000 enrollees.
The Company seeks to negotiate capitated contracts on behalf of the Initial
Affiliated Practices. Under capitated arrangements, providers deliver health
care services to managed care enrollees and would bear all or a portion of the
risk that the cost of such services may exceed capitated payments. Capitated
contracts involve various forms of risk sharing. Providers may accept risk only
with respect to the costs of physician services required by a patient
(professional component) or for all of the medical costs required by a patient
including professional, institutional and ancillary services (global
capitation). Managed care companies' arrangements with providers can be further
segmented into episode of care and per member per month capitation. Under
specified episode of care capitation, providers deliver care for covered
enrollees with a specified medical condition or who require a particular
treatment on a fixed fee basis per episode. Under per member per month
capitation, the providers
33
<PAGE>
receive fixed monthly fees per covered enrollee and assume the additional risk
for the incidence of medical conditions requiring procedures specified in the
contract.
Currently, the Company performs analyses of the Initial Affiliated
Practices' markets to develop managed care contracting strategies and meets with
principal payors in each of these markets to enhance and establish relationships
between the Initial Affiliated Practices and such payors. In addition, the
Company is currently in the process of negotiating a capitated, episode of care
managed care contract on behalf of one of the Initial Affiliated Practices, fee
for service contracts for physician services for several of the Initial
Affiliated Practices and a fee for service contract for the surgery center at
POA.
GOVERNANCE AND QUALITY ASSURANCE
The Company's current governance structure promotes physician participation
in the management of the Company. Currently, each of the Initial Affiliated
Practices is represented on the Company's Board of Directors, as well as on
other policy making bodies. Each Initial Affiliated Practice is represented on
the Company's Board of Directors. In addition, each Affiliated Practice has a
Joint Policy Board whose membership includes an equal number of representatives
from each of the Company and the Affiliated Practice. The Joint Policy Board
will have responsibilities that include developing long term strategic
objectives, developing practice expansion and payor contracting guidelines,
promoting practice efficiencies, recommending significant capital expenditures
and facilitating communication and information exchange between the Company and
each of the Affiliated Practices.
The Company intends to create an Outcomes Management and Standards Board
that will focus on the identification and communication of the best practices
and clinical protocols in the business and administrative areas. The Company
also intends to create a Medical Provider Board that will identify and
communicate the best practices and protocols in the medical area. Both of these
boards, which will consist solely of physicians from Affiliated Practices, will
receive managerial and information systems support from the Company.
CONTRACTUAL AGREEMENTS WITH AFFILIATED PRACTICES
The Company has entered into the Initial Service Agreements with each of
the Initial Affiliated Practices, and intends to enter into long-term service
agreements with each additional Affiliated Practice, to provide management,
administrative and development services. Under the Initial Service Agreements,
the Initial Affiliated Practices are solely responsible for all aspects of the
practice of medicine and the Company has the primary responsibility for the
business and administrative aspects of the Initial Affiliated Practices. The
Company employs most of the Initial Affiliated Practice's non-physician
personnel. Pursuant to the Initial Service Agreements, the Company provides or
arranges for various management, administrative and development services to the
Initial Affiliated Practices relating to the day-to-day non-medical operations
of the Initial Affiliated Practices.
The following summary of the Initial Service Agreements is intended to be a
general summary of the form of Initial Service Agreement. The Company expects to
enter into similar agreements with other Affiliated Practices in the future. The
actual terms of the individual Initial Service Agreements, and other service
agreements into which the Company may enter in the future, may vary in certain
respects from the description below as a result of negotiations with the
individual practices and the requirements of local regulations. Each of the
Initial Service Agreements and certain related agreements are filed as an
exhibit to the Registration Statement of which this Prospectus is a part. The
following summary is qualified in its entirety by reference to such exhibits.
Pursuant to the Initial Service Agreements, the Company, among other
things, (i) acts as the exclusive manager and administrator of non-physician
services relating to the operation of the Initial Affiliated Practices, subject
to matters for which the Initial Affiliated Practices maintain responsibility or
which referred to the Joint Policy Boards of the Initial Affiliated Practices,
(ii) bills patients, insurance companies and other third party payors and
collects, on behalf of the Initial Affiliated
34
<PAGE>
Practices, the fees for professional medical and other services rendered,
including goods and supplies sold by the Initial Affiliated Practices, (iii)
provides or arranges for, as necessary, clerical, accounting, purchasing,
payroll, legal, bookkeeping and computer services and personnel, information
management, preparation of certain tax returns, printing, postage and
duplication services and medical transcribing services, (iv) supervises and
maintains custody of substantially all files and records (medical records of the
Initial Affiliated Practices remain the property of the Initial Affiliated
Practices), (v) provides facilities for the Initial Affiliated Practices, (vi)
prepares, in consultation with the Joint Policy Boards and the Initial
Affiliated Practices, all annual and capital operating budgets, (vii) orders and
purchases inventory and supplies as reasonably requested by the Initial
Affiliated Practices, (viii) implements, in consultation with the Joint Policy
Boards and the Initial Affiliated Practices, national and local public relations
or advertising programs and (ix) provides financial and business assistance in
the negotiation, establishment, supervision and maintenance of contracts and
relationships with managed care and other similar providers and payors. Most of
the services described above are provided by employees previously employed by
the Predecessor Practices.
Under the Initial Service Agreements, the Initial Affiliated Practices
retain the responsibility for, among other things, (i) hiring and compensating
physician employees and other medical professionals, (ii) ensuring that
physicians have the required licenses, credentials, approvals and other
certifications needed to perform their duties and (iii) complying with certain
federal and state laws and regulations applicable to the practice of medicine.
In addition, the Initial Affiliated Practices maintain exclusive control of all
aspects of the practice of medicine and the delivery of medical services.
Under the Initial Service Agreements, the Company collects fees from the
Initial Affiliated Practices on a monthly basis. The fees consist of the
following: (i) service fees based on a percentage (the 'Service Fee Percentage')
ranging from 20%-33% of the Adjusted Pre-Tax Income of the Initial Affiliated
Practices (defined as revenue of the Initial Affiliated Practices related to
professional services less amounts equal to certain clinic expenses of the
Initial Affiliated Practices ('Clinic Expenses,' as defined more fully in the
Initial Service Agreements), not including physician owner compensation or most
benefits to physician owners) and (ii) amounts equal to Clinic Expenses. For the
first three years following the affiliation, however, the portion of the service
fees described under clause (i) above is specified to be the greater of the
amount payable as described under clause (i) above or a fixed dollar amount,
which was generally calculated by applying the respective Service Fee Percentage
of Adjusted Pre-Tax Income for the Predecessor Practices for the twelve months
prior to affiliation. In addition, with respect to its management of certain
facilities and ancillary services associated with certain of the Initial
Affiliated Practices, the Company receives fees ranging from 2%-8% of net
revenue.
Pursuant to the Initial Service Agreements, each Initial Affiliated
Practice agrees to sell and assign to the Company, and the Company agrees to
buy, all of the Initial Affiliated Practice's accounts receivable each month
during the existence of the Initial Service Agreement. The purchase price for
such accounts receivable will equal the face amounts of the accounts receivable
recorded each month less adjustments for contractual allowances, allowances for
doubtful accounts and other potentially uncollectable amounts based on the
Predecessor Practice's historical collection rate, as determined by the Company.
The Initial Service Agreements have initial terms of forty years, with
automatic extensions (unless specified notice is given) of additional five-year
terms. The Initial Service Agreement may be terminated by either party if the
other party (i) files a petition in bankruptcy or other similar events occur or
(ii) defaults on the performance of a material duty or obligation, which default
continues for a specified term after notice. In addition, the Company may
terminate the agreement if the Affiliated Practice's Medicare or Medicaid number
is terminated or suspended as a result of some act or omission of the Affiliated
Practice or the physicians, and the Affiliated Practice may terminate the
agreement if the Company misapplies funds or assets or violates certain laws.
Upon termination of an Initial Service Agreement by the Company for one of
the reasons set forth above, the Company has the option to require the Initial
Affiliated Practice to purchase and assume the assets and liabilities related to
the Initial Affiliated Practice at the fair market value thereof. In addition,
35
<PAGE>
upon termination of an Initial Service Agreement by the Company during the first
five years of the term, the physician owners of the Initial Affiliated Practice
are required to pay the Company or return to the Company an amount of cash or
stock of the Company equal to one-third of the total consideration received by
such physicians in connection with the Company's affiliation with the practice.
Under the Initial Service Agreements, each physician owner must give the
Company twelve months notice of an intent to retire from the Initial Affiliated
Practice. If a physician gives such notice during the first five years of the
agreement, the physician must also locate a replacement physician or physicians
acceptable to the Joint Policy Board and pay the Company any loss of service fee
payable to the Company for the first five years of the term. The agreement also
provides that no more than 20% of the physician owners at the Initial Affiliated
Practice may retire within a one year period.
The Company has entered into an agreement with one of the physician owners
of ROA, pursuant to which the Company has agreed to support the development of a
sports medicine center. If the Company and the physician have not agreed to a
plan for the development of the center by November 1997, the physician may
terminate the service agreement as it pertains to him, with three months written
notice to the Company. Upon such a termination, the physician must return to the
Company an amount equal to (i) the after-tax amount of the consideration
received by the physician in the merger transaction between ROA and the Company
less (ii) the after-tax amount of the physician's pro rata portion of service
fees paid to SCN during the term of the service agreement. In the event of such
termination, the Base Service Fee to be paid by ROA to SCN will be
proportionally reduced by the pro rata portion of the consideration paid to the
physician at the closing of the merger between SCN and ROA.
During the term of the Initial Service Agreements, the Initial Affiliated
Practices and the physician owners of the Initial Affiliated Practices agree not
to compete with the Company in providing services similar to those provided by
the Company under the Initial Service Agreements, and also agrees not to compete
with the Affiliated Practice, within a specified geographic area. In addition,
the Initial Service Agreement requires the Initial Affiliated Practice to enter
into non-competition agreements with all physicians in the Initial Affiliated
Practice, of which agreements the Company is a third-party beneficiary. After
the fifth year of the term of the Initial Service Agreement, physician owners of
the Initial Affiliated Practices may be released from the non-competition
provisions upon payment of certain amounts to the Company. Non-competition
restrictions apply to physician employees during the term of their employment
and for two years thereafter. The Initial Service Agreements generally require
the Initial Affiliated Practices to pursue enforcement of the non-competition
agreement with physicians or assign to the Company the right to pursue
enforcement.
The Initial Affiliated Practices are responsible for obtaining professional
liability and worker's compensation insurance for the physicians and other
medical employees of the Initial Affiliated Practices, as well as general
liability umbrella coverage. The Company is responsible for obtaining
professional liability and worker's compensation insurance for employees of the
Company and general liability and property insurance for the Initial Affiliated
Practices.
The Initial Service Agreements contain indemnification provisions, pursuant
to which the Company indemnifies the Initial Affiliated Practices for damages
resulting from negligent acts or omissions by the Company or its agents,
employees or shareholders. In addition, the Initial Affiliated Practices
indemnify the Company for any damages resulting from any negligent act or
omissions by any affiliated physicians, agents or employees of the Initial
Affiliated Practice, other than damages resulting from claims arising from the
performance or nonperformance of medical services. See 'Risk Factors --
Potential Liability and Insurance; Legal Proceedings.'
GOVERNMENT REGULATION AND SUPERVISION
The delivery of health care services has become one of the most highly
regulated of professional and business endeavors in the United States. Both the
federal government and the individual state governments are responsible for
overseeing the activities of individuals and businesses engaged in the delivery
of health care services. Federal law and regulations are based primarily upon
the Medicare
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<PAGE>
program and the Medicaid program, each of which is financed, at least in part,
with federal funds. State jurisdiction is based upon the state's interest in
regulating the quality of health care in the state, regardless of the source of
payment.
The Company believes its operations are in material compliance with
applicable laws. However, the laws applicable to the Company are subject to
evolving interpretations, and therefore, there can be no assurance that a review
of the Company or the Affiliated Practices by a court or law enforcement or
regulatory authority will not result in a determination that could have a
material adverse affect on the Company or the Affiliated Practices. Furthermore,
there can be no assurance that the laws applicable to the Company will not be
amended in a manner that could have a material adverse affect on the Company.
FEDERAL LAW
The federal health care laws apply in any case in which an Affiliated
Practice is providing an item or service that is reimbursable under Medicare or
Medicaid or in which the Company is claiming reimbursement from Medicare or
Medicaid on behalf of physicians with whom the Company has a service agreement.
The principal federal laws include those that prohibit the filing of false or
improper claims with the Medicare or Medicaid programs, those that prohibit
unlawful inducements for the referral of business reimbursable under Medicare or
Medicaid and those that prohibit the provision of certain services by a provider
to a patient if the patient was referred by a physician with which the provider
has certain types of financial relationships.
False and Other Improper Claims. The federal government is authorized to
impose criminal, civil and administrative penalties on any health care provider
that files a false claim for reimbursement from Medicare or Medicaid. Criminal
penalties are also available in the case of claims filed with private insurers
if the government can show that the claims constitute mail fraud or wire fraud.
While the criminal statutes are generally reserved for instances evincing an
obviously fraudulent intent, the criminal and administrative penalty statutes
are being applied by the government in an increasingly broader range of
circumstances. The government has taken the position, for example, that a
pattern of claiming reimbursement for unnecessary services violates these
statutes if the claimant should have known that the services were unnecessary.
The government has also taken the position that claiming reimbursement for
services that are substandard is a violation of these statutes if the claimant
should have known that the care was substandard.
The Company believes that its billing activities on behalf of the Initial
Affiliated Practices are in material compliance with such laws, but there can be
no assurance that the Company's activities will not be challenged or scrutinized
by governmental authorities. A determination that the Company had violated such
laws could have a material adverse impact on the Company.
Anti-Kickback Law. A federal law commonly known as the 'Anti-kickback
Amendments' prohibits the offer, solicitation, payment or receipt of anything of
value (direct or indirect, overt or covert, in cash or in kind) which is
intended to induce the referral of Medicare or Medicaid patients, or the
ordering of items or services reimbursable under those programs. The law also
prohibits remuneration that is intended to induce the recommendation of, or the
arranging for, the provision of items or services reimbursable under Medicare
and Medicaid. The law has been broadly interpreted by a number of courts to
prohibit remuneration that is offered or paid for otherwise legitimate purposes
if the circumstances show that one purpose of the arrangement is to induce
referrals. Even bona fide investment interests in a health care provider may be
questioned under the Anti-kickback Amendments if the government concludes that
the opportunity to invest was offered as an inducement for referrals. The
penalties for violations of this law include criminal sanctions and exclusion
from the federal health care program.
In part to address concerns regarding the implementation of the
Anti-kickback Amendments, the federal government in 1991 published regulations
that provide exceptions or 'safe harbors,' for certain transactions that will
not be deemed to violate the Anti-kickback Amendments. Among the safe harbors
included in the regulations were provisions relating to the sale of physician
practices, management and personal services agreements and employee
relationships. Subsequently, regulations were published offering safe harbor
protection to additional activities, including referrals within group
37
<PAGE>
practices consisting of active investors. Proposed amendments clarifying the
existing safe harbor regulations were published in 1994. If any of the proposed
regulations are ultimately adopted, they would result in substantive changes to
existing regulations. The failure of an activity to qualify under a safe harbor
provision, while potentially leading to greater regulatory scrutiny, does not
render the activity illegal.
There are several aspects of the Company's relationships with physicians to
which the anti-kickback law may be relevant. In some instances, for example, the
government may construe some of the marketing and managed care contracting
activities of the Company as arranging for the referral of patients to the
physicians with whom the Company has a Service Agreement.
Although neither the investments in the Company by physicians nor the
Initial Service Agreements between the Company and the Initial Affiliated
Practices qualify for protection under the safe harbor regulations, the Company
does not believe that these activities fall within the type of activities the
Anti-kickback Amendments were intended to prohibit. A determination that the
Company had violated the Anti-kickback Amendments would have a material adverse
effect on the Company.
The Stark Self-Referral Law. The Stark Self-Referral Law (the 'Stark Law')
prohibits a physician from referring a patient to a health care provider for
certain designated health services reimbursable by Medicare or Medicaid if the
physician has a financial relationship with that provider, including an
investment interest, a loan or debt relationship or a compensation relationship.
In addition to the conduct directly prohibited by the law, the statute also
prohibits schemes that are designed to obtain referrals indirectly that cannot
be made directly. The penalties for violating the law include (i) a refund of
any Medicare or Medicaid payments for services that resulted from an unlawful
referral, (ii) civil fines and (iii) exclusion from the Medicare and Medicaid
programs.
The Company does not currently provide any designated health service under
the Stark Law. However, because the Company will provide management services
related to those designated health services provided by physicians affiliated
with the Initial Affiliated Practices, there can be no assurance that the
Company will not be deemed the provider for those services for purposes of the
Stark Law and, accordingly, the recipient of referrals from physicians
affiliated with the Affiliated Practices. In that event, such referrals will be
permissible only if (i) the financial arrangements under the service agreements
with the Affiliated Practices meet certain exceptions in the Stark Law and (ii)
the ownership of stock in the Company by the referring physicians meets certain
investment exceptions under the Stark Law. The Company believes that the
financial arrangements under the Initial Service Agreements qualify for
applicable exceptions under the Stark Law; however, there can be no assurance
that a review by courts or regulatory authorities would not result in a contrary
determination. In addition, the Company will not meet the Stark exception
related to investment interest until the Company's stockholders' equity exceeds
$75 million.
STATE LAW
State Anti-Kickback Laws. Many states have laws that prohibit payment of
kickbacks in return for the referral of patients. Some of these laws apply only
to services reimbursable under state Medicaid programs. However, a number of
these laws apply to all health care services in the state, regardless of the
source of payment for the service. Based on court and administrative
interpretation of federal anti-kickback laws, the Company believes that these
laws prohibit payments to referral sources where a purpose for payment is for
the referral. However, the laws in most states regarding kickbacks have been
subjected to limited judicial and regulatory interpretation and therefore, no
assurances can be given that the Company's activities will be found to be in
compliance. Noncompliance with such laws could have an adverse effect upon the
Company and subject it and physicians affiliated with the Affiliated Practices
to penalties and sanctions.
State Self-Referral Laws. A number of states have enacted self-referral
laws that are similar in purpose to the Stark Law but which impose different
restrictions. Some states, for example, only prohibit referrals when the
physician's financial relationship with a health care provider is based upon an
investment interest. Other state laws apply only to a limited number of
designated health services. Some states do not prohibit referrals, but require
only that a patient be informed of the financial relationship before the
referral is made. The Company believes that its operations are in material
compliance with the self-referral law of the states in which the Initial
Affiliated Practices are located.
38
<PAGE>
Fee-Splitting Laws. Many states prohibit a physician from splitting with a
referral source the fees generated from physician services. Other states have a
broader prohibition against any splitting of a physician's fees, regardless of
whether the other party is a referral source. In most states, it is not
considered to be fee-splitting when the payment made by the physician is
reasonable reimbursement for services rendered on the physician's behalf.
The Company will be reimbursed by physicians on whose behalf the Company
provides management services. The compensation provisions of the Initial Service
Agreements have been designed to comply with applicable state laws relating to
fee-splitting. There can be no certainty, however, that, if challenged, the
Company and its Affiliated Practices will be found to be in compliance with each
state's fee-splitting laws.
Corporate Practice of Medicine. Most states prohibit corporations from
engaging in the practice of medicine. Many of these state doctrines prohibit a
business corporation from employing a physician. States differ, however, with
respect to the extent to which a licensed physician can affiliate with corporate
entities for the delivery of medical services. Some states interpret the
'practice of medicine' broadly to include activities of corporations such as the
Company that have an indirect impact on the practice of medicine, even where the
physician rendering the medical services is not an employee of the corporation
and the corporation exercises no discretion with respect to the diagnosis or
treatment of a particular patient.
The Company intends that the Initial Service Agreements avoid the exercise
of any responsibility by the Company on behalf of affiliated physicians that
could be construed as affecting the practice of medicine. Accordingly, the
Company believes that its operations do not violate applicable state laws
relating to the corporate practice of medicine. Such laws and legal doctrines
have been subjected to only limited judicial and regulatory interpretation and
there can be no assurance that, if challenged, the Company would be considered
to be in compliance with all such laws and doctrines.
Insurance Laws. Laws in all states regulate the business of insurance and
the operation of HMOs. Many states also regulate the establishment and operation
of networks of health care providers. While these laws do not generally apply to
companies that provide management services to networks of physicians, there can
be no assurance that regulatory authorities of the states in which the Company
operates would not apply these laws to require licensure of the Company's
operations as an insurer, as an HMO or as a provider network. The Company
believes that its proposed operations are in compliance with these laws in the
states in which it currently does business, but there can be no assurance that
future interpretations of insurance and health care network laws by regulatory
authorities in these states or in the states into which the Company may expand
will not require licensure or a restructuring of some or all of the Company's
operations. See 'Risk Factors -- Government Regulation.'
COMPETITION
The Company competes with many other entities to affiliate with
musculoskeletal practices. Several companies that have established operating
histories and greater resources than the Company are pursuing the acquisition of
the assets of general and specialty practices and the management of such
practices. Physician practice management companies and some hospitals, clinics
and HMOs engage in activities similar to the activities of the Company. There
can be no assurance that the Company will be able to compete effectively with
such competitors, that additional competitors will not enter the market, or that
such competition will not make it more difficult to affiliate with, and to enter
into agreements to provide management services to, practices on terms beneficial
to the Company.
Affiliated Practices will compete with local musculoskeletal care service
providers as well as some managed care organizations. The Company believes that
changes in governmental and private reimbursement policies and other factors
have resulted in increased competition among consumers for medical services. The
Company believes that the cost, accessibility and quality of services provided
are the principal factors that affect competition. There can be no assurance
that the Affiliated Practices will be able to compete effectively in the markets
that they serve. The inability of the Affiliated Practices to compete
effectively would materially adversely affect the Company.
39
<PAGE>
Further, the Affiliated Practices compete with other providers for managed
musculoskeletal care contracts. The Company believes that trends toward managed
care have resulted in increased competition for such contracts. Other practices
and management service organizations may have more experience than the Initial
Affiliated Practices and the Company in obtaining such contracts. There can be
no assurance that the Company and the Affiliated Practices will be able to
successfully acquire sufficient managed care contracts to compete effectively in
the markets they serve. The inability of the Affiliated Practices to compete
effectively for such contracts could materially adversely affect the Company.
EMPLOYEES
As of December 9, 1996, the Company has approximately 334 employees, of
whom approximately 19 are located at the Company's headquarters and 315 are
located at the Initial Affiliated Practices. The Company believes that its
relationship with its employees is good.
LEGAL PROCEEDINGS
The Company is not a party to any claims, suits or complaints relating to
services provided by the Company or the Affiliated Practices, although there can
be no assurance that such claims will not be asserted against the Company in the
future. However, the Company may become subject to certain pending claims as the
result of successor liability in connection with the assumption of certain
liabilities of the Initial Affiliated Practices; however, the Company believes
that the ultimate resolution of such claims will not have a material adverse
effect on the Company. See 'Risk Factors -- Potential Liability and Insurance,
Legal Proceedings.'
PROPERTIES
The Company has a five-year lease for its headquarters in Lakewood,
Colorado, which provides for annual lease payments of approximately $80,000. In
addition, in connection with the Initial Affiliation Transactions, the Company
has entered into the leases for the facilities utilized by each of the Initial
Affiliated Practices.
CORPORATE LIABILITY AND INSURANCE
The provision of medical services entails an inherent risk of professional
malpractice and other similar claims. However, the Company does not influence or
control the practice of medicine by physicians or have responsibility for
compliance with certain regulatory and other requirements directly applicable to
physicians and physician groups. As a result of the relationship between the
Company and the Affiliated Practices, the Company may become subject to some
medical malpractice actions under various theories, including successor
liability. There can be no assurance that claims, suits or complaints relating
to services and products provided by Affiliated Practices will not be asserted
against the Company in the future. The Company maintains insurance coverage that
it believes will be adequate both as to risks and amounts. The Company believes
that such insurance will extend to professional liability claims that may be
asserted against employees of the Company that work on site at Affiliated
Practice locations. In addition, pursuant to the Service Agreements, the Initial
Affiliated Practices are required (and the other Affiliated Practices will be
required) to maintain comprehensive professional liability insurance. The
availability and cost of such insurance has been affected by various factors,
many of which are beyond the control of the Company and Affiliated Practices.
The cost of such insurance to the Company and Affiliated Practices may have a
material adverse effect on the Company. In addition, successful malpractice or
other claims asserted against Affiliated Practices or the Company that exceed
applicable policy limits would have a material adverse effect on the Company.
40
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY PERSONNEL
The following table sets forth certain information concerning the
directors, executive officers and key personnel of the Company:
<TABLE>
<S> <C> <C>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
Richard H. Rothman, M.D., Ph.D....................... 60 Chairman of the Board of Directors
Kerry R. Hicks....................................... 37 President, Chief Executive Officer and Director
Patrick M. Jaeckle................................... 38 Executive Vice President of Finance/Development and
Director
William C. Behrens................................... 45 Executive Vice President of Practice Management and
Director
Robert E. Booth, Jr., M.D............................ 54 Director
James L. Cain, M.D................................... 57 Director
Peter H. Cheesbrough................................. 44 Director
Richard E. Fleming, Jr., M.D......................... 50 Director
Thomas C. Haney, M.D................................. 54 Director
Leslie S. Matthews, M.D.............................. 45 Director
D. Paul Davis........................................ 38 Vice President of Finance/Controller
Peter A. Fatianow.................................... 33 Vice President of Development
David G. Hicks....................................... 38 Vice President of Management Information Systems
Timothy D. O'Hare.................................... 43 Vice President, Payor Operations
Fran W. Hempstead.................................... 43 Manager, Practice Operations
M. John Neal......................................... 29 Manager, Finance and Development
Michael M. Nuzzo..................................... 26 Manager, Payor Operations
</TABLE>
RICHARD H. ROTHMAN, M.D., PH.D. has been Chairman of the Board of Directors
of the Company since December 1996. Since 1970, Dr. Rothman has been Chairman of
The Rothman Institute at Pennsylvania Hospital and since 1986, has been Chairman
of the Department of Orthopaedic Surgery at Thomas Jefferson University. Dr.
Rothman is Editor-in-Chief of The Journal of Arthroplasty, a journal regarding
joint replacement surgery. Dr. Rothman received a B.A. degree from the
University of Pennsylvania, an M.D. degree from the University of Pennsylvania
School of Medicine and a Ph.D. degree from Jefferson Medical College.
KERRY R. HICKS has served as President and Chief Executive Officer and as a
director of the Company since its inception. From 1985 to March 1996, Mr. Hicks
served as Senior Vice President of LBA Health Care Management ('LBA'), a
developer of health care and management information services. LBA provided
management consulting services (including over 150 orthopaedic projects) to over
400 medical centers to support the purchasing, planning, marketing and delivery
of health care. Mr. Hicks was principally responsible for developing LBA's
orthopaedic product line and its information systems. LBA's orthopaedic product
line established quality and cost benchmarks and developed clinical protocols
and patient care algorithms intended to enhance both the quality and
effectiveness of the delivery of orthopaedic care.
PATRICK M. JAECKLE has served as Executive Vice President of
Finance/Development and as a director of the Company since its inception. From
February 1994 to March 1996, Dr. Jaeckle served as director of health care
corporate finance at Morgan Keegan & Company, Inc., a regional investment
banking firm. Prior to February 1994, Dr. Jaeckle was a member of the health
care investment banking groups at both CS First Boston Corporation (from June
1992 to February 1994) and Smith Barney, Inc. (from May 1991 to June 1992). Dr.
Jaeckle holds an M.B.A. degree from Columbia Business School, a D.D.S. degree
from Baylor College of Dentistry and a B.A. degree from The University of Texas
at Austin.
41
<PAGE>
WILLIAM C. BEHRENS has been the Company's Executive Vice President of
Practice Management Service since he joined the Company in June 1996 and as a
director of the Company since June 1996. From June 1992 to July 1996, he served
as Chief Executive Officer and President of The Hughston Sports Medicine
Foundation, a non-profit foundation focused on furthering orthopaedic clinical
studies. From 1984 to June 1992, Mr. Behrens served as Executive Administrator
for Knoxville Orthopaedic Center in Knoxville, Tennessee. In these positions,
Mr. Behrens participated in the development of medical office buildings,
out-patient surgery centers and services as well as diagnostic centers. Mr.
Behrens received his B.S. degree from Alderson-Broaddus College and a Masters
degree in Public Health & Administration from the University of South Carolina.
ROBERT E. BOOTH, JR., M.D. has served as a director of the Company since
December 1996. Since 1977, Dr. Booth has been an orthopaedic surgeon at The
Rothman Institute at Pennsylvania Hospital and since 1990, he has been Co-Chief
of Orthopaedic Surgery at Pennsylvania Hospital. Dr. Booth received a B.A.
degree from Princeton University and an M.D. degree from the University of
Pennsylvania.
JAMES L. CAIN, M.D. has served as a director of the Company since December
1996. Since 1976, Dr. Cain has been an orthopaedic surgeon at, and the physician
manager of, Vero Orthopaedics in Vero Beach, Florida. Dr. Cain received a B.A.
degree from Emory University and an M.D. degree from the Tulane University
School of Medicine.
PETER H. CHEESBROUGH has served as a director of the Company since December
1996. Since June 1993, Mr. Cheesbrough has been the Senior Vice
President-Finance and Chief Finance Officer of Echo Bay Mines Ltd., a company
engaged in precious metals mining. From April 1988 to June 1993, he was Echo Bay
Mines' Vice President and Controller. Mr. Cheesbrough is a Fellow of the
Institute of Chartered Accountants of England and Wales and also a chartered
accountant in Canada.
RICHARD E. FLEMING, JR., M.D. has served as a director of the Company since
December 1996. Since 1979, Dr. Fleming has been an orthopaedic surgeon at
Princeton Orthopaedic Associates, P.A. Dr. Fleming received a B.A. degree from
Princeton University and an M.D. degree from Columbia University College of
Physicians and Surgeons.
THOMAS C. HANEY, M.D. has served as a director of the Company since
December 1996. Since 1973, Dr. Haney has been an orthopaedic surgeon at
Tallahassee Orthopedic Clinic, Inc. Dr. Haney received a B.A. degree from
Florida State University and an M.D. degree from Emory University School of
Medicine.
LESLIE S. MATTHEWS, M.D. has served as a director of the Company since
December 1996. Since October 1994, Dr. Matthews has been an orthopaedic surgeon
at Greater Chesapeake Orthopaedic Associates, LLC and since 1990, has been the
Chief of Orthopaedic Surgery at Union Memorial Hospital. From July 1982 to
October 1994, Dr. Matthews was in private practice. Dr. Matthews received a B.A.
degree from Johns Hopkins University and an M.D. degree from the Baylor College
of Medicine.
D. PAUL DAVIS has served as Vice President of Finance/Controller of the
Company since March 1996. From January 1993 to March 1996, Mr. Davis served as
Vice President of Finance for Surgical Partners of America, Inc. From April 1987
to January 1993, he served as Chief Financial Officer for Anesthesia Service
Medical Group, Inc. Mr. Davis received a B.S. degree in Accounting from the
University of Utah. He is a certified public accountant.
PETER A. FATIANOW has been Vice President of Development of the Company
since March 1996. From July 1994 to February 1996, Mr. Fatianow worked at Morgan
Keegan & Company, Inc., most recently as an Associate Vice President in health
care corporate finance. From July 1992 to July 1994, Mr. Fatianow was a member
of the health care investment banking group at CS First Boston Corporation in
New York. Mr. Fatianow received a B.S. degree in Business Management with an
emphasis in Finance from Brigham Young University.
42
<PAGE>
DAVID G. HICKS has served as Vice President of Management Information
Systems of the Company since March 1996. From November 1994 to March 1996, Mr.
Hicks worked as Manager of Information Technology for the Association of
Operating Room Nurses, responsible for information technology maintenance and
development. From February 1993 to November 1994, he served as Manager of
Information Systems Administration for Coors Brewing Company, and from January
1982 to February 1993, Mr. Hicks served as Manager of Internal Systems for
Martin Marietta Data Systems. Mr. Hicks received a B.S. degree in Management
Information Systems from Colorado State University.
TIMOTHY D. O'HARE joined the Company as Vice President of Payor Operations
in August 1996. From May 1994 to July 1996, Mr. O'Hare served as Executive
Director of Kaiser Foundation HealthPlan of North Carolina, where his
responsibilities included the negotiation of capitated and incentive contracts
with hospitals, physician hospital organizations and physician group practices.
From April 1987 to May 1994, Mr. O'Hare served as Vice President/Executive
Director of CIGNA Health Care of North Carolina. From March 1986 to April 1987,
Mr. O'Hare served as Vice President of Operations for a Preferred Health
Network. Mr. O'Hare received a B.S. degree from Virginia Polytechnic Institute
and State University and a Masters degree in Health Administration from Virginia
Commonwealth University.
FRAN W. HEMPSTEAD has served as Manager of Practice Operations since
joining the Company in July 1996. Ms. Hempstead has over 16 years experience in
the operations aspects of an orthopaedic practice. From September 1988 to April
1996, Ms. Hempstead was employed in various capacities by The Hughston Clinic
P.C., an orthopaedic practice in Columbus, Georgia including as Chief Operating
Officer from June 1994 to April 1996 and as the Director of Operations from June
1992 to May 1994. She is currently on the Board of the Orthopaedic Practice
Assembly of the Medical Group Management Association ('MGMA'). Ms. Hempstead
received a B.A. degree in Business Administration from the University of
Georgia.
M. JOHN NEAL has served as Manager of Finance and Development of the
Company since March 1996. From July 1994 to March 1996, Mr. Neal worked as an
investment banking associate with Morgan Keegan & Company, Inc. Previously, Mr.
Neal served two years as a financial analyst for Service Merchandise, Inc. Prior
to joining Service Merchandise, Inc., Mr. Neal received a B.S. in Finance and an
M.B.A. in Economics and Finance from the University of Tennessee at Knoxville.
MICHAEL M. NUZZO has been Manager of Payor Operations of the Company since
July 1996. From June 1992 to July 1996, Mr. Nuzzo worked as an associate with
Medimetrix Group, Inc., a health care consulting company. Prior to joining
Medimetrix, Mr. Nuzzo received a B.A. degree from Kenyon College.
Drs. Cain, Fleming, Haney, Matthews and Rothman were elected to the Board
of Directors pursuant to the terms of a Stockholders Agreement among the holders
of the Company's outstanding Common Stock. Dr. Booth was elected to the Board of
Directors pursuant to an agreement between the Company and Dr. Booth. The
provisions of the agreements relating to election of these persons to the Board
of Directors will not be in effect following completion of this offering.
Kerry R. Hicks and David G. Hicks are brothers.
DIRECTOR COMPENSATION AND COMMITTEES
The directors do not currently receive compensation for their service on
the board of directors or any committee thereof but are reimbursed for their
out-of-pocket expenses for serving on the board of directors. However, under the
Company's 1996 Equity Compensation Plan, non-employee directors are eligible to
receive option grants, and, in December 1996, each non-employee director other
than Mr. Cheesbrough was granted an option to purchase 10,000 shares of Common
Stock at an exercise price of $6.00 per share and Mr. Cheesbrough was granted an
option to purchase 20,000 shares of Common Stock at an exercise price of $6.00
per share. The options vest in three substantially equal increments on the
first, second and third anniversary of the date of grant. See 'Stock Plans.'
The Board of Directors intends to establish a Compensation Committee and an
Audit Committee, each of which will be comprised of two independent directors.
It is anticipated that the Compensation
43
<PAGE>
Committee and the Audit Committee will be comprised of Mr. Cheesbrough and a
second independent director to be elected by the Board of Directors. The Board
of Directors plans to elect the second independent director within 90 days after
listing the Common Stock on the Nasdaq National Market. The Compensation
Committee will determine compensation for executive officers of the Company, and
administer the Company's stock option plans. The Audit Committee will recommend
the appointment of the Company's independent public accountants and will review
the scope and results of audits and internal accounting controls.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During its current and last completed fiscal years, the Company did not
have a Compensation Committee of the Board of Directors. The compensation of the
Company's executive officers has been determined by Kerry R. Hicks and Patrick
M. Jaeckle, the Company's President and Executive Vice President of
Finance/Development, respectively, through December 1996. Options were granted
in December 1996 and cash annual incentive awards were approved in December
1996. Within 90 days following the completion of this offering, the Board of
Directors intends to establish a Compensation Committee that will determine
compensation for the Company's executive officers and administer the Company's
stock option plans.
EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth certain
information concerning the compensation paid by the Company to the Chief
Executive Officer of the Company during the fiscal year ending December 31,
1995. No executive officer of the Company earned salary and bonus exceeding
$100,000 for services rendered during the fiscal year ended December 31, 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<S> <C> <C> <C>
ANNUAL COMPENSATION
----------------------------
NAME AND PRINCIPAL POSITION SALARY ($) BONUS ($) ALL OTHER COMPENSATION
- ------------------------------------------------ ------------- ------------- ---------------------------
Kerry R. Hicks
President and Chief Executive Officer......... $ 0 $ 0 $ 0
</TABLE>
Pursuant to employment agreements with the Company, the salary rates of
each of Kerry R. Hicks, Patrick M. Jaeckle and William C. Behrens for 1996 is
$187,500 and of each of D. Paul Davis, Peter A. Fatianow and David G. Hicks is
$108,000. Messrs. Kerry R. Hicks, Jaeckle, Behrens, Davis, Fatianow and David G.
Hicks are referred to herein as the 'Named Executive Officers.' All of the Named
Executive Officers are eligible to receive bonuses and such other compensation
as determined by the Board of Directors and salary increases as set forth in
their respective agreements and in December 1996, the Board of Directors
approved annual incentive awards to Messrs. Kerry R. Hicks, Jaeckle, Behrens,
Davis, Fatianow and David G. Hicks, of $140,625, $140,625, $185,938, $64,125,
$67,500 and $64,125, respectively. See 'Management -- Employment Agreements.'
Option Grants. No Named Executive Officer received an option grant during
the fiscal year ended December 31, 1995.
The following table sets forth certain information regarding stock options
granted from January 1, 1996 through December 4, 1996 to the Named Executive
Officers. The Company has not granted any stock options to the Named Executive
Officers since December 4, 1996.
44
<PAGE>
OPTION GRANTS IN CURRENT FISCAL YEAR
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
- -------------------------------------------------------------------------------------- ANNUAL RATES OF
NUMBER OF PERCENT OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(2)
OPTIONS EMPLOYEES IN PRICE EXPIRATION --------------------
NAME GRANTED (#) FISCAL YEAR PER SHARE(1) DATE 5% 10%
- ---------------------------- ------------- ------------- ------------- ----------- --------- ---------
Kerry R. Hicks.............. 75,000 6.0% $ 6.00 12/4/2006 $ 283,003 $ 717,184
Patrick M. Jaeckle.......... 75,000 6.0% $ 6.00 12/4/2006 $ 283,003 $ 717,184
William C. Behrens.......... 500,000 40.1% $ 1.00 3/22/2006 $ 314,448 $ 796,871
45,825 3.7% $ 6.00 12/4/2006 $ 172,915 $ 438,200
D. Paul Davis............... 30,000 2.4% $ 6.00 12/4/2006 $ 113,201 $ 286,874
Peter A. Fatianow........... 30,000 2.4% $ 6.00 12/4/2006 $ 113,201 $ 286,874
David G. Hicks.............. 30,000 2.4% $ 6.00 12/4/2006 $ 113,201 $ 286,874
</TABLE>
- ------------------
(1) The exercise price per share is equal to the fair market value of the Common
Stock on the date of grant, as determined by the Company's Board of
Directors.
(2) Based on the exercise price per share on the date of grant.
The following table sets forth certain information regarding stock options
held as of December 4, 1996 by the Named Executive Officers. None of the Named
Executive Officers exercised stock options during the current fiscal year.
DECEMBER 4, 1996 OPTION VALUES
<TABLE>
<S> <C> <C> <C> <C>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FISCAL YEAR END (#) AT FISCAL YEAR-END($)(1)
------------------------------- --------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------- ----------------- ------------ ----------------- -------------
Kerry R. Hicks....................... 0 75,000 0 $ 300,000
Patrick M. Jaeckle................... 0 75,000 0 300,000
William C. Behrens................... 0 545,825 0 4,683,300
D. Paul Davis........................ 0 30,000 0 120,000
Peter A. Fatianow.................... 0 30,000 0 120,000
David G. Hicks....................... 0 30,000 0 120,000
</TABLE>
- ------------------
(1) There was no public trading market for the Common Stock as of December 4,
1996. Accordingly, these values have been calculated on the basis of an
assumed initial public offering price of $ per share (which is the
assumed per share price to the public in this offering), minus the
applicable per share exercise price.
1996 EQUITY COMPENSATION PLAN
The Company's 1996 Equity Compensation Plan (the 'Plan') provides for
grants of stock options ('Options') to selected employees, officers, directors,
consultants and advisers of the Company. By encouraging stock ownership, the
Company seeks to attract, retain and motivate such persons and to encourage them
to devote their best efforts to the business and financial success of the
Company.
The Plan authorizes up to 2,000,000 shares of the Company's Common Stock
(subject to adjustment in certain circumstances) for issuance pursuant to the
terms of the Plan. If Options expire or are terminated for any reason without
being exercised, the shares of Common Stock subject to such Options again will
be available for purposes of the Plan.
The Plan may be administered by the Board of Directors (the 'Board') or by
a committee of the Board (references to the 'Committee' refers to the committee,
if one is appointed, and otherwise to
45
<PAGE>
the Board). Grants under the Plan may consist of (i) options intended to qualify
as incentive stock options ('ISOs') within the meaning of section 422 of the
Internal Revenue Code of 1986, as amended (the 'Code') or (ii) 'non-qualified
stock options' that are not intended so to qualify ('NQSOs'). Options may be
granted to any employee (including officers and directors) of the Company,
members of the Board who are not employees, and consultants and advisers who
perform services to the Company or any of its subsidiaries ('Key Advisers').
'Key Advisers' include personnel of medical practices that have entered into and
remain subject to management agreements with the Company or any of its
subsidiaries. During any calendar year, no grantee may receive Options for more
than 500,000 shares of the Company's Common Stock.
The option price of any ISO granted under the Plan will not be less than
the fair market value of the underlying shares of Common Stock on the date of
grant. The option price of a NQSO will be determined by the Committee, in its
sole discretion, and may be greater than, equal to or less than the fair market
value of the underlying shares of Common Stock on the date of grant. The
Committee will determine the term of each Option, provided that the exercise
period may not exceed ten years from the date of grant. The option price of an
ISO granted to a person who owns more than 10% of the total combined voting
power of all classes of stock of the Company must be at least equal to 110% of
the fair market value of Common Stock on the date of grant, and the ISO's term
may not exceed five years. A grantee may pay the option price (i) in cash, (ii)
by delivering shares of Common Stock already owned by the grantee and having a
fair market value on the date of exercise equal to the option price, or (iii) by
such other method as the Committee may approve. The Committee may impose on
Options such vesting and other conditions as the Committee deems appropriate.
Options may be exercised while the grantee is an employee, Key Adviser or member
of the Board or within a specified period after termination of the grantee's
employment or services.
In the event of a change of control (as defined in the Plan), all
outstanding Options will become fully exercisable, unless the Committee
determines otherwise. Except as provided below, unless the Committee determines
otherwise, in the event of a merger where the Company is not the surviving
corporation, all outstanding Options will be assumed by or replaced with
comparable options by the surviving corporation. The Committee may require that
grantees surrender their outstanding Options in the event of a change of control
and receive a payment in cash or Common Stock equal to the amount by which the
fair market value of the shares of Common Stock subject to the Options exceeds
the exercise price of the Options.
All options issued under the Plan will be granted subject to any applicable
federal, state and local withholding requirements; the Company can deduct from
wages paid to the grantee any such taxes required to be withheld with respect to
the options. If the Company so permits, a grantee may choose to satisfy the
Company's income tax withholding obligation with respect to an option by having
shares withheld up to an amount that does not exceed the grantee's maximum
marginal tax rate for federal, local and state taxes.
The Board may amend or terminate the Plan at any time; provided that, if
the Common Stock becomes publicly traded, the Board may not make any amendment
that requires stockholder approval pursuant to Section 162(m) of the Code
without stockholder approval. As of December 4, 1996, options to purchase
1,362,248 shares of Common Stock were outstanding under the Plan. The Plan will
terminate on October 14, 2006, unless terminated earlier by the Board or
extended by the Board with approval of the stockholders.
1996 INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN
The Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock
Option Plan (the 'Incentive Plan') provides incentives to attract and retain
directors, officers, advisors, consultants and key employees. As of December 1,
1996, options to purchase 553,500 shares of Common Stock were outstanding under
the Incentive Plan. No additional option grants will be made under the Incentive
Plan.
46
<PAGE>
EMPLOYMENT AGREEMENTS
The Company has employment agreements with each of Kerry R. Hicks and
Patrick M. Jaeckle dated as of April 1, 1996 and an employment agreement with
William Behrens dated as of March 11, 1996. Each agreement has an initial term
of five years and is renewable automatically for one year periods unless
terminated by one of the parties. The agreements provide for an annual salary
rate to each officer of $187,500 for 1996, $215,000 for 1997 and $250,000 for
1998, with cost of living increases for the years following the third year. In
addition, the agreements provide for annual incentive compensation to each
officer equal to up to 100% of his base salary based on performance targets
established by the Board of Directors, and on December 4, 1996, the Board of
Directors approved annual incentive compensation awards to Messrs. Hicks,
Jaeckle and Behrens of $140,625, $140,625 and $85,938, respectively. In the
event that the officer is terminated without cause and there has been no change
of control of the Company, the Company will pay such officer his base salary for
the remaining term of the agreement and any earned but unpaid salary and
incentive compensation. In the event the officer is terminated with cause,
regardless of whether there has been a change of control of the Company, the
Company will pay such officer his base salary for 60 days following such
termination. If the officer is terminated without cause upon a change of control
of the Company, he is entitled to receive a lump sum payment upon such
termination equal to 300% of his base salary plus 300% of his annual incentive
compensation for the prior year. Each agreement contains certain confidentiality
and non-competition covenants.
The Company has employment agreements with David G. Hicks and Peter A.
Fatianow dated as of March 1, 1996 and an agreement with D. Paul Davis dated as
of February 22, 1996. Each agreement has an initial term of five years and is
renewable automatically for one year periods unless terminated by one of the
parties. The agreements provide for an annual salary rate to each officer of
$108,000 for 1996, $125,000 for 1997 and $144,000 for 1998, with cost of living
increases for the years following the third year. In addition, the agreements
provide for annual incentive compensation to each officer equal to up to 75% of
his base salary based on performance targets established by the Board of
Directors and on December 4, 1996, the Board of Directors approved annual
incentive compensation awards to Messrs. Hicks, Fatianow and Davis of $64,125,
$67,500 and $64,125, respectively. In the event that the officer is terminated
without cause and there has been no change of control of the Company, the
Company will pay such officer his base salary for the remaining term of the
agreement and any earned but unpaid salary and incentive compensation. In the
event the officer is terminated with cause, regardless of whether there has been
a change of control of the Company, the Company will pay such officer his base
salary for 60 days following such termination. If the officer is terminated
without cause upon a change of control of the Company, he is entitled to receive
a lump sum payment upon such termination equal to 300% of his base salary plus
300% of his annual incentive compensation for the prior year. Each agreement
contains certain confidentiality and non-competition covenants.
47
<PAGE>
CERTAIN TRANSACTIONS
Following the Company's incorporation in December 1995, the following
individuals purchased shares of Common Stock, at a price of $.001 per share: Mr.
Kerry Hicks purchased 500,000 shares; Patrick M. Jaeckle purchased 500,000
shares; D. Paul Davis purchased 50,000 shares; Peter A. Fatianow purchased
50,000 shares; David G. Hicks purchased 50,000 shares; and M. John Neal
purchased 30,000 shares.
In addition, since January 15, 1996, various executive officers, directors
and principal stockholders have participated in the Company's debt and equity
financings. These financings have included the following.
From January 1, 1996 through July 1, 1996, the Company sold 5% convertible
debentures in the aggregate principal amount of $1,870,000. On November 12,
1996, the convertible debentures, along with the accrued interest thereon, were
converted into 1,920,272 shares of Common Stock at a rate of one share of Common
Stock for each $1.00 of indebtedness. The securities were issued to certain
executive officers of the Company as follows: Kerry R. Hicks and Patrick M.
Jaeckle each converted $200,000 of convertible debentures and $5,418 in accrued
interest into 205,418 shares of Common Stock, William C. Behrens converted
$75,000 of convertible debentures and $1,645 in accrued interest into 76,645
shares of Common Stock, David G. Hicks converted $60,000 of convertible
debentures and $2,281 in accrued interest into 62,281 shares of Common Stock,
Peter A. Fatianow converted $35,000 in convertible debentures and $1,236 of
accrued interest into 36,236 shares of Common Stock, D. Paul Davis converted
$35,000 of convertible debentures and $899 in accrued interest into 35,899
shares of Common Stock and M. John Neal converted $26,000 of convertible
debentures and $972 in accrued interest into 26,972 shares of Common Stock. In
addition, securities were issued to certain non-employee directors of the
Company as follows: Richard H. Rothman, M.D., Ph.D. and Richard Balderson, M.D.
each converted $233,333 of convertible debentures and $7,085 in accrued interest
into 240,418 shares of Common Stock and Richard E. Booth, Jr., M.D. converted
$83,333 of convertible debentures and $3,483 in accrued interest into 86,816
shares of Common Stock.
On October 1, 1996, the Company sold to GCOA 5% convertible debentures in
the aggregate principal amount of $300,000. On November 12, 1996, the
convertible debentures, along with the accrued interest thereon of $1,707, was
converted into 100,569 shares of Common Stock at a rate of one share of Common
Stock for each $3.00 in indebtedness. Leslie S. Matthews, M.D., a director of
the Company, is a physician owner of GCOA.
On November 4, 1996, the Company sold to TOC 100,000 shares of Common Stock
for an aggregate purchase price of $300,000. Thomas C. Haney, M.D., a director
of the Company, is a physician owner of TOC.
On November 12, 1996, pursuant to the Initial Affiliation Transactions, the
Company entered into agreements with each of the Predecessor Practices pursuant
to which the Company merged with or acquired stock or certain assets of the
Predecessor Practices. The Company also assumed certain liabilities of the
Predecessor Practices, including obligations under acquired contracts (including
facilities leases and vendor or supplier contracts). In connection with the
Initial Affiliation Transactions, the Company issued shares of Common Stock to
the physician owners of the Initial Affiliated Practices.
The Company entered into an Asset Exchange Agreement with GCOA and the
individual physicians who are owners of GCOA, including Leslie S. Matthews,
M.D., a director of the Company. Pursuant to the terms of the agreement, the
Company purchased certain assets of GCOA and assumed certain liabilities
relating to those assets. In exchange for the purchased assets, the Company
issued 1,568,922 shares, valued at $6 per share of its Common Stock, including
280,721 shares to Dr. Matthews.
The Company entered into a Stock Exchange Agreement with the individual
physicians who are members of POA, including Richard E. Fleming, Jr., M.D., a
director of the Company. Pursuant to the terms of the agreement, the Company
purchased all of the outstanding shares of the predecessor of
48
<PAGE>
POA, in exchange for 1,196,793 shares valued at $6 per share of Common Stock of
the Company, including 163,548 shares issued to Dr. Fleming.
The Company entered into a Merger Agreement with a predecessor of ROA whose
physicians included Richard H. Rothman, M.D., Ph.D., the Chairman of the Board
of Directors of the Company and Robert E. Booth, Jr., M.D., a director of the
Company, pursuant to which the predecessor of ROA merged with and into Company,
with the Company surviving the Merger. Pursuant to the terms of the agreement,
the outstanding shares of Common Stock of the predecessor of ROA were converted
into 3,169,379 shares of Common Stock valued at $6 per share and $1,388,000 in
cash was paid to two former shareholders of the predecessor of ROA. In addition,
$149,872 was paid off by the Company in satisfaction of outstanding indebtedness
of the predecessor of ROA. The Company issued 462,484 shares of Common Stock and
approximately $694,000 in cash to Dr. Rothman, and 462,484 shares of Common
Stock and approximately $694,000 in cash to Dr. Booth.
The Company entered into a Merger Agreement with a predecessor of TOC,
pursuant to which the predecessor of TOC merged with and into Company, with the
Company surviving the Merger. Pursuant to the terms of the agreement, each
outstanding share of Common Stock of the predecessor of TOC was converted into
1,032.02 shares of Common Stock, with the result that the Company issued an
aggregate of 1,072,414 shares, valued at $6 per share, to the former
shareholders of the predecessor of TOC, including 103,202 shares to Thomas C.
Haney, M.D., a director of the Company.
The Company entered into a Merger Agreement with a predecessor of Vero,
pursuant to which Vero merged with and into Company, with the Company surviving
the Merger. Pursuant to the terms of the agreement, each outstanding share of
Common Stock of the predecessor of Vero was converted into 6,516.07 shares of
Common Stock, with the result that the Company issued an aggregate of 651,607
shares, valued at $6 per share, to the former shareholders of the predecessor of
Vero. In addition, pursuant to the terms of the agreement, one shareholder of
the predecessor of Vero was granted an option to purchase 80,000 shares of
Common Stock at an exercise price of $6 per share. In connection with the
transaction, James L. Cain, M.D., a director of the Company received 103,410
shares of Common Stock. For a description of registration rights that apply to
Shares of Common Stock held by certain directors, officers and 5% stockholders,
see 'Shares Eligible for Future Sale.'
In connection with the Initial Affiliation Transactions, the Company has
committed to enter into loan agreements with certain physician owners of the
Predecessor Practices for loans in an aggregate amount of up to approximately
$4.3 million. These loans are available until November 12, 1998 and the amount
that each physician may borrow is limited.
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of December 4, 1996, as
adjusted to reflect the sale of the shares offered pursuant to this Prospectus,
by (i) each Selling Stockholder, (ii) each person known to the Company to own
beneficially more than 5% of the Company's Common Stock (including their
address), (iii) each Named Executive Officer of the Company, (iv) each director
of the Company and (v) all directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR OWNED SUBSEQUENT
TO OFFERING(1) SHARES TO OFFERING(1)
------------------------ BEING ------------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- --------------------------------------------------------- ----------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Richard H. Rothman, M.D., Ph.D. (2)...................... 496,902 4.5% 496,902 3.5%
Kerry R. Hicks (3)(4).................................... 645,418 5.8 645,418 4.6
Patrick M. Jaeckle (3)(5)................................ 605,418 5.5 605,418 4.3
William C. Behrens (3)(6)................................ 576,645 5.0 576,645 4.0
Robert E. Booth, Jr., M.D................................ 549,300 5.0 549,300 3.9
James L. Cain, M.D....................................... 132,721 1.2 132,721 *
Peter H. Cheesbrough..................................... 0 * 0 *
Richard E. Fleming, Jr., M.D. (7)........................ 158,454 1.4 158,454 1.1
Thomas C. Haney, M.D..................................... 110,549 1.0 110,549 *
Leslie S. Matthews, M.D.................................. 295,088 2.7 295,088 2.1
D. Paul Davis............................................ 85,899 * 85,899 *
Peter A. Fatianow (8).................................... 71,236 * 71,236 *
David G. Hicks (9)....................................... 102,281 * 102,281 *
Richard Balderston, M.D. (10)............................ 818,524 7.4 818,524 5.8
Jeffrey S. Abrams, M.D. (11)............................. 165,579 1.5 24,000 141,579 1.0
Gregg A. Alexander, M.D. (12)............................ 28,174 * 3,600 24,574 *
D. Christian Berg, M.D. (12)............................. 110,548 1.0 15,500 95,048 *
Richard E. Blackburn, M.D. (12).......................... 59,689 * 4,700 54,989 *
Donald M. Dewey, M.D. (12)............................... 110,548 1.0 10,300 100,248 *
Robert N. Dunn, M.D. (11)................................ 153,359 1.4 24,000 129,354 *
Mark E. Fahey, M.D. (12)................................. 110,548 1.0 8,300 102,248 *
Steven R. Gecha, M.D. (11)............................... 165,588 1.5 24,000 141,588 1.0
W. Thomas Gutowski, M.D. (11)(13)........................ 153,359 1.4 24,000 129,359 *
William D. Henderson, M.D. (12).......................... 57,691 * 7,600 50,091 *
William J. Hozack, M.D. (14)............................. 340,062 3.1 51,000 289,062 2.1
Michael N. Jolley, M.D. (11)............................. 165,588 1.5 24,000 141,588 1.0
Steve E. Jordan, M.D. (12)............................... 110,548 1.0 10,300 100,248 *
C. Alexander Moskwa, Jr., M.D. (11)...................... 165,579 1.5 24,000 141,579 1.0
Harvey E. Smires, M.D. (11).............................. 165,588 1.5 24,000 141,588 1.0
Kris D. Stowers, M.D. (12)............................... 32,351 * 1,100 31,251 *
All directors and executive officers as a group
(16 persons) (15)....................................... 3,941,974 34.0 3,941,974 27.0
</TABLE>
- ------------------
* Less than one percent.
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<PAGE>
(1) Applicable percentage of ownership is based on 11,044,955 shares of Common
Stock outstanding as of December 4, 1996 and 14,044,955 shares of Common
Stock outstanding upon consummation of this offering. Beneficial ownership
is determined in accordance with the rules of the Commission and includes
voting or investment power with respect to securities. Shares of Common
Stock issuable upon the exercise of stock options currently exercisable or
convertible, or exercisable or convertible within 60 days of December 4,
1996 are deemed outstanding and to be beneficially owned by the person
holding such option for purposes of computing such person's percentage
ownership, but are not deemed outstanding for the purpose of computing the
percentage ownership of any other person. Except for shares held jointly
with a person's spouse or subject to applicable community property laws, or
as indicated in the footnotes to this table, each stockholder identified in
the table possesses sole voting and investment power with respect to all
shares of Common Stock shown as beneficially owned by such stockholder.
(2) Does not include 200,000 shares of Common Stock held in the Richard H.
Rothman 1996 'SCN' Annuity Trust dated November 26, 1996 and 3,000 shares
of Common Stock held by each of the U/I/T of Richard H. Rothman dated
September 5, 1995 f/b/o Daniel Sheerr Kapp and the U/I/T of Richard H.
Rothman dated September 5, 1995 f/b/o Samuel Rothman Kapp, with respect to
which Dr. Rothman disclaims beneficial ownership. Dr. Rothman's business
address is 800 Spruce Street, Philadelphia, Pennsylvania 19107.
(3) Messrs. Hicks, Jaeckle and Behren's business address is 44 Union Boulevard,
Suite 600, Lakewood, Colorado 80228.
(4) Includes 60,000 shares of Common Stock held in the Linda Wratten Trust,
20,000 shares of Common Stock in each of the Frank Nemick III Trust, the
William Nemick Trust and the Jeanette Baysinger Trust and 10,000 shares of
Common Stock in each of the Frank Nemick, Jr. Trust and the Julie Nemick
Trust. Does not include 60,000 shares of Common Stock held by The Hicks
Family Irrevocable Trust, for which shares Mr. Hicks disclaims beneficial
ownership.
(5) Does not include 100,000 shares of Common Stock held by The Patrick M.
Jaeckle Family Irrevocable Children's Trust, for which shares Mr. Jaeckle
disclaims beneficial ownership.
(6) Includes options to purchase 500,000 shares of Common Stock that become
exercisable upon completion of this offering.
(7) Includes 20,382 shares and 5,095 shares of Common Stock held by the Fleming
Charitable Remainder Unitrust and the Fleming Family Foundation,
respectively. Does not include 2,547 shares of Common Stock held by each of
the Irrevocable Trust FBO M. Fleming and the Irrevocable Trust FBO A.
Fleming, respectively, for which Dr. Fleming disclaims beneficial
ownership.
(8) Does not include 15,000 shares of Common Stock held by the Fatianow Family
Irrevocable Children's Trust, for which shares Mr. Fatianow disclaims
beneficial ownership.
(9) Does not include 10,000 shares of Common Stock held by The David G. Hicks
Irrevocable Children's Trust, for which shares Mr. Hicks disclaims
beneficial ownership.
(10) Dr. Balderston's business address is 800 Spruce Street, Philadelphia,
Pennsylvania 19107.
(11) Drs. Abrams, Dunn, Gecha, Gutowski, Jolley, Moskwa and Smires are each
physician owners of POA, one of the Initial Affiliated Practices.
(12) Drs. Alexander, Berg, Blackburn, Dewey, Fahey, Henderson, Jordan and
Stowers are each physician owners of TOC, one of the Initial Affiliated
Practices.
(13) Does not include 4,076 shares of Common Stock held by each of the Andrew
Gutowski 1995 Irrevocable Trust, Christina Gutowski 1995 Irrevocable Trust
and Alexandra Gutowski 1995 Irrevocable Trust, for which Dr. Gutowski
disclaims beneficial ownership.
(14) Dr. Hozack is a physician owner of the predecessor of ROA, one of the
Initial Affiliated Practices.
(15) Includes options to purchase 550,000 shares of Common Stock that become
exercisable upon completion of this offering.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares
of Common Stock, $.001 par value per share, and 2,000,000 shares of Preferred
Stock, $.001 par value per share (the 'Preferred Stock'). As of December 1,
1996, there were 11,044,955 shares of Common Stock outstanding. No shares of
Preferred Stock are currently outstanding.
COMMON STOCK
The holders of Common Stock are entitled to one vote per share on each
matter to be decided by the stockholders and do not have cumulative voting
rights. Accordingly, the holders of a majority of Common Stock entitled to vote
in any election of directors may elect all of the directors standing for
election. The holders of Common Stock have no preemptive, redemption or
conversion rights. The holders of the Common Stock will be entitled to receive
ratably such dividends, if any, as the Board of Directors may declare from time
to time out of funds legally available for such purpose. In the event of
liquidation, dissolution or winding up of the affairs of the Company, after
payment or provision for payment of all of the Company's debts and obligations
and any preferential distributions to holders of Preferred Stock, if any, the
holders of the Common Stock will be entitled to share ratably in the Company's
remaining assets. All outstanding shares of Common Stock are, and the Common
Stock offered hereby will be, validly issued, fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors is authorized, without further action by the
stockholders, to provide for the issuance of shares of Preferred Stock as a
class without series or in one or more series, to establish the number of shares
in each class or series and to fix the designation, powers, preferences and
rights of each such class or series and the qualifications, limitations or
restrictions thereof. Because the Board of Directors has the power to establish
the preferences and rights of each class or series of Preferred Stock, the Board
of Directors may afford the holders of any class or series of Preferred Stock
preferences, powers and rights, voting or otherwise, senior to the rights of
holders of Common Stock. The issuance of Preferred Stock could have the effect
of delaying or preventing a change in control of the Company. As of the date of
this Prospectus, the Company has not authorized the issuance of any Preferred
Stock and there are no plans, agreements or understandings for the issuance of
any shares of Preferred Stock.
CERTAIN PROVISIONS OF DELAWARE LAW AND THE COMPANY'S CERTIFICATE OF
INCORPORATION AND BYLAWS
The Company is subject to the provisions of Section 203 of the General
Corporation Law of the State of Delaware (the 'GCL'). Section 203 prohibits a
publicly held Delaware corporation from engaging in a 'business combination'
with an 'interested stockholder' for a period of three years after the date of
the transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. A 'business
combination' includes a merger, asset sale or other transaction resulting in a
financial benefit to the interested stockholder. Subject to certain exceptions,
an 'interested stockholder' is a person who, together with affiliates and
associates, owns, or within three years prior to the proposed business
combination has owned, 15% or more of the corporation's voting stock.
The Company's Certificate of Incorporation provides that liability of
directors of the Company is eliminated to the fullest extent permitted under
Section 102(b)(7) of the GCL. As a result, no director of the Company will be
liable to the Company or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability: (i) for any breach of the
director's duty of loyalty to the Company or its stockholders; (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (iii) for any willful or negligent payment of an unlawful
dividend, stock purchase or redemption; or (iv) for any transaction from which
the director derived an
52
<PAGE>
improper personal benefit. The Company's Bylaws generally provide that the
Company shall indemnify its directors, employees and other agents to the fullest
extent provided by Delaware law.
In addition, the Company's Certificate of Incorporation requires the vote
of 66 2/3 percent of the outstanding voting securities to effect certain
actions, including a sale of substantially all of the assets of the Company,
certain mergers and consolidations, and dissolution and liquidation of the
Company unless such actions have been approved by a majority of the directors.
The 'supermajority' voting rights could have the effect of making it more
difficult for a third party to acquire, or discouraging a third party from
seeking to acquire, control of the Company.
The Bylaws of the Company provide that stockholders must follow an advance
notification procedure for certain stockholder nominations of candidates for the
Board of Directors and for certain other stockholder business to be conducted at
an annual meeting. These provisions could, under certain circumstances, operate
to delay, defer or prevent a change in control of the Company.
SHARES ELIGIBLE FOR FUTURE SALE
The market price of the Common Stock of the Company could be adversely
affected by the sale of substantial amounts of the Common Stock in the public
market following this offering. After giving effect to the shares of Common
Stock offered hereby, the Company will have outstanding 14,044,955 shares of
Common Stock. Of these shares, the 3,280,400 shares (3,730,400 shares if the
Underwriters' over-allotment option is exercised in full) of Common Stock sold
in this offering will be freely tradeable without restriction under the
Securities Act, except for any shares purchased by 'affiliates,' as that term is
defined under the Securities Act, of the Company. The remaining 10,764,555
shares are 'restricted securities' within the meaning of Rule 144 promulgated
under the Securities Act. Of these restricted shares, 1,265,000 shares will be
eligible for the sale pursuant to Rule 144 in December 1997 and the balance of
the restricted shares will be eligible for sale at various times from January
1998 through November 1998. The Securities and Exchange Commission (the
'Commission') has proposed reducing the initial Rule 144 holding period to one
year. There can be no assurance as to whether or when such rule changes will be
enacted. If enacted, such modification will accelerate by one year the initial
date upon which all currently outstanding Common Stock becomes eligible for
resale under Rule 144.
The Company, its officers and directors and certain other stockholders of
the Company have agreed that they will not offer, sell, contract to sell,
announce their intention to sell, pledge or generally otherwise dispose of,
directly or indirectly, or file with Commission a registration statement under
the Securities Act relating to any additional any shares of Common Stock or
securities convertible or exchangeable or exercisable for any shares of Common
Stock without the prior written consent of CS First Boston Corporation for a
period of 180 days after the date of this Prospectus (the 'lock-up period'),
except (i) subsequent sales of Common Stock offered in this offering, (ii)
issuances of Common Stock by the Company in connection with affiliation with
practices, physicians and ancillary providers (although persons receiving such
shares would be subject to such restrictions for the remainder of the lock-up
period) or (iii) issuances of Common Stock by the Company pursuant to the
exercise of employee stock options outstanding on the date of this Prospectus.
The holders of all shares of Common Stock outstanding on the date of this
Prospectus have certain rights to have their shares registered under the
Securities Act, although the holders of _____________ of these shares have
agreed to refrain from selling their shares during the lock-up period. In
addition, the Company intends to register approximately 2,000,000 shares of
Common Stock reserved for issuance under the Company's 1996 Equity Compensation
Plan as soon as practicable after expiration of the lock-up period. The Company
intends to register an additional 553,500 shares of Common Stock reserved for
issuance under the Company's 1996 Incentive and Non-Qualified Stock Option Plan
as soon as practicable thereafter. See 'Management' and 'Underwriting.'
53
<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated , 1997 (the 'Underwriting Agreement'), the
Underwriters named below (the 'Underwriters'), for whom CS First Boston
Corporation, Equitable Securities Corporation and Lehman Brothers Inc. are
acting as representatives (the 'Representatives') have severally but not jointly
agreed to purchase from the Company and the Selling Stockholders the following
respective numbers of shares of Common Stock:
NUMBER OF
UNDERWRITER SHARES
----------- ---------
CS First Boston Corporation............................
Equitable Securities Corporation.......................
Lehman Brothers Inc....................................
-----------
Total.................................................. 3,280,400
-----------
-----------
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will be obligated to purchase all of the shares of Common Stock
offered hereby (other than those shares covered by the over-allotment option
described below), if any are purchased. The Underwriting Agreement provides
that, in the event of a default by an Underwriter, in certain circumstances the
purchase commitments of the non-defaulting Underwriter may be increased or the
Underwriting Agreement may be terminated.
The Company has granted to the Underwriters an option, expiring on the
close of business on the 30th day after the date of this Prospectus, to purchase
up to 450,000 additional shares at the initial public offering price less the
underwriting discounts and commissions, all as set forth on the cover page of
this Prospectus. Such option may be exercised only to cover over-allotments in
the sale of the shares of Common Stock. To the extent such option is exercised,
each Underwriter will become obligated, subject to certain conditions, to
purchase approximately the same percentage of the additional shares of Common
Stock as it was obligated to purchase pursuant to the Underwriting Agreement.
Prior to this Offering, there has been no public market for the Common
Stock. The initial price to the public for the shares of Common Stock will be
determined by negotiation among the Company and the Representatives and will be
based on, among other things, the Company's financial and operating history and
condition, its prospects and the prospects for its industry in general, the
management of the Company and the market prices for the securities of companies
in businesses similar to that of the Company.
The Company has been advised by the Representatives that the Underwriters
propose to offer the shares offered hereby to the public initially at the public
offering price set forth on the cover page of this Prospectus and to certain
dealers at such price less a concession of $_____ per share, and the
Underwriters and such dealers may allow a discount of $______ per share on sales
to certain other dealers. After the initial public offering, the public offering
price and concession and discount to dealers may be changed by the
Representatives.
The Representatives have informed the Company that they do not expect
discretionary sales by the Underwriters to exceed 5% of the Shares being offered
hereby.
The Company, its officers and directors and certain other stockholders of
the Company have agreed that they will not offer, sell, contract to sell,
announce their intention to sell, pledge or otherwise dispose of, directly or
indirectly, or file with the Commission a registration statement under the
Securities Act relating to any additional shares of Common Stock or securities
convertible into or exchangeable or exercisable for any shares of Common Stock
without the
54
<PAGE>
prior written consent of CS First Boston Corporation for a period of 180 days
from the date of this Prospectus except (i) subsequent sales of Common Stock
offered in this offering, (ii) issuances of Common Stock by the Company issued
in connection with affiliation with Acquired Practices or (iii) issuances of
Common Stock by the Company pursuant to the exercise of employee stock options
outstanding on the date of this Prospectus.
At the request of the Company the Underwriters are reserving up to
shares of Common Stock ( % of the shares to be offered) for sale to
employees, directors and friends of the Company. The number of shares available
for sale to the general public in this offering will be reduced to the extent
such persons purchase such reserved shares. Shares purchased by employees,
directors and friends of the Company will be at the public offering price as set
forth on the cover page of this Prospectus. Any reserved shares not so purchased
will be offered by the Underwriters to the general public in this offering.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including civil liabilities under the
Securities Act, or contribute to payments which the Underwriters may be required
to make in respect thereof.
Application has been made to list the shares of Common Stock on the Nasdaq
National Market under the symbol 'SCNI.'
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the Common Stock in Canada is being made only on a
private placement basis exempt from the requirement that the Company prepare and
file a prospectus with the securities regulatory authorities in each province
where trades of Common Stock are effected. Accordingly, any resale of the Common
Stock in Canada must be made in accordance with applicable securities laws which
will vary depending on the relevant jurisdiction, and which may require resales
to be made in accordance with available statutory exemptions or pursuant to a
discretionary exemption granted by the applicable Canadian securities regulatory
authority. Purchasers are advised to seek legal advice prior to any resale of
the Common Stock.
REPRESENTATIONS OF PURCHASERS
Each purchaser of Common Stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company and the dealer from whom
such purchase confirmation is received that (i) such purchaser is entitled under
applicable provincial securities laws to purchase such Common Stock without the
benefit of a prospectus qualified under such securities laws, (ii) where
required by law, that such purchaser is purchasing as principal and not as agent
and (iii) such purchaser has reviewed the text above under 'Resale
Restrictions.'
RIGHT OF ACTION AND ENFORCEMENT
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
section 32 of the Regulations under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available, including
common law rights of action for damages or rescission or rights of action under
the civil liability provisions of the U.S. federal securities laws.
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be possible
for Ontario purchasers to effect service of process within Canada upon the
issuer or such persons. All or a substantial portion of the assets of the issuer
and such persons may be located outside of Canada and, as a result, it may not
be possible to satisfy a judgment against the issuer or such persons in Canada
or to enforce a judgment obtained in Canadian courts against the issuer or such
persons outside of Canada.
55
<PAGE>
NOTICE TO BRITISH COLUMBIA RESIDENTS
A purchaser of Common Stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any such
Common Stock acquired by such purchaser pursuant to this offering. Such report
must be in the form attached to British Columbia Securities Commission Blank
Order BOR #95/17, a copy of which may be obtained from the Company. Only one
such report must be filed in respect of Common Stock acquired on the same date
and under the same prospectus exemption.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Certain
health care regulatory matters will be passed upon for the Company by Baker,
Donelson, Bearman & Caldwell, Memphis, Tennessee. Certain legal matters in
connection with this offering will be passed upon for the Underwriters by
Simpson Thacher & Bartlett (a partnership which includes professional
corporations), New York, New York.
EXPERTS
The financial statements of Specialty Care Network, Inc., Greater
Chesapeake Orthopaedic Associates, LLC, Princeton Orthopaedic Associates, P.A.,
Reconstructive Orthopaedic Associates, Inc., Tallahassee Orthopedic Clinic, Inc.
and Vero Orthopaedics, P.A., appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, to the
extent indicated in their reports thereon also appearing elsewhere herein and in
the Registration Statement. Such financial statements have been included herein
in reliance upon such reports given upon the authority of such firm as experts
in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act (the 'Registration Statement') with respect to the
shares of Common Stock offered hereby. This Prospectus, which constitutes a part
of the Registration Statement, does not contain all of the information set forth
in the Registration Statement, including the exhibits and schedules thereto. For
further information with respect to the Company and the shares of Common Stock,
reference is made to the Registration Statement. Statements contained in this
Prospectus as to the contents of any contract or other document are not
necessarily complete and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. The
Registration Statement, including the exhibits and schedules thereto, may be
inspected without charge at the principal office of the Commission at Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and the Commission's
Regional Offices at Seven World Trade Center, Suite 1300, New York, New York
10048, and Northwest Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661, and copies may be obtained at prescribed rates from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549. In addition, the registration statement and certain
other filings made with the Commission through its Electronic Data Gathering
Analysis and Retrieval ('EDGAR') system are publicly available through the
Commission's site on the Internet's World Wide Web, located at
http://www.sec.gov. The Registration Statement, including all exhibits thereto
and amendments thereof, has been filed with the Commission through EDGAR.
56
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
PAGE
----------
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF SPECIALTY CARE NETWORK, INC.:
Basis of Presentation.......................................................... F-2
Unaudited Pro Forma Balance Sheet at September 30, 1996........................ F-3
Unaudited Pro Forma Statements of Income for the year ended
December 31, 1995 and for the nine months ended September 30, 1996.......... F-4 - F-5
Notes to Unaudited Pro Forma Financial Statements.............................. F-6
SPECIALTY CARE NETWORK, INC.:
Report of Independent Auditors................................................. F-12
Balance Sheet.................................................................. F-13
Statement of Operations........................................................ F-14
Statement of Stockholders' Deficiency.......................................... F-15
Statement of Cash Flows........................................................ F-16
Notes to Financial Statements.................................................. F-17
RECONSTRUCTIVE ORTHOPAEDICS ASSOCIATES, INC.:
Report of Independent Auditors................................................. F-24
Balance Sheets................................................................. F-25
Statements of Income........................................................... F-26
Statements of Stockholders' Equity............................................. F-27
Statements of Cash Flows....................................................... F-28
Notes to Financial Statements.................................................. F-29
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.:
Report of Independent Auditors................................................. F-33
Balance Sheets................................................................. F-34
Statements of Operations....................................................... F-35
Statements of Stockholders' Equity............................................. F-36
Statements of Cash Flows....................................................... F-37
Notes to Financial Statements.................................................. F-38
TALLAHASSEE ORTHOPEDIC CLINIC, INC.:
Report of Independent Auditors................................................. F-43
Balance Sheets................................................................. F-44
Statements of Income........................................................... F-45
Statements of Stockholders' Equity............................................. F-46
Statements of Cash Flows....................................................... F-47
Notes to Financial Statements.................................................. F-48
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC:
Report of Independent Auditors................................................. F-53
Balance Sheets................................................................. F-54
Statements of Operations....................................................... F-55
Statements of Members' Equity.................................................. F-56
Statements of Cash Flows....................................................... F-57
Notes to Financial Statements.................................................. F-58
VERO ORTHOPAEDICS, P.A.:
Report of Independent Auditors................................................. F-63
Balance Sheets................................................................. F-64
Statements of Operations....................................................... F-65
Statements of Stockholders' Equity............................................. F-66
Statements of Cash Flows....................................................... F-67
Notes to Financial Statements.................................................. F-68
</TABLE>
F-1
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS
OF SPECIALTY CARE NETWORK, INC.
BASIS OF PRESENTATION
The following unaudited pro forma financial statements give effect to the
acquisition by Specialty Care Network, Inc. (the 'Company'), a Delaware
corporation, of substantially all of the net assets of the Predecessor
Practices, in exchange for shares of the Company's Common Stock, cash and the
assumption of certain liabilities, and the effects of the provisions of the
Initial Services Agreement between the Company and each of Initial Affiliated
Practices.
Reconstructive Orthopaedic Associates, Inc.
Princeton Orthopaedic Associates, P.A.
Tallahassee Orthopedic Clinic, Inc.
Greater Chesapeake Orthopaedic Associates, LLC
Vero Orthopaedics, P.A.
The unaudited pro forma financial statements have been prepared by the
Company based upon the historical financial statements of Specialty Care
Network, Inc. and the Predecessor Practices included elsewhere in this
prospectus, and certain preliminary estimates and assumptions deemed appropriate
by management of the Company. These pro forma financial statements may not be
indicative of actual results as if the transaction had occurred on the dates
indicated or which may be realized in the future. Neither expected benefits nor
cost reductions anticipated by the Predecessor Practices following consummation
of the Initial Affiliation Transactions have been reflected in such pro forma
financial statements; however, additional estimated future corporate overhead
and direct costs of the Company have been reflected in the pro forma financial
statements. The pro forma balance sheet as of September 30, 1996 gives effect to
the Initial Affiliation Transactions as if such transactions had occurred on
September 30, 1996. The pro forma statements of income for the nine months ended
September 30, 1996 and the year ended December 31, 1995 assume the Initial
Affiliation Transactions were completed on January 1, 1995 and exclude the
discontinued operations of Vero Orthopaedics, P.A. for the year ended December
31, 1995.
The pro forma financial statements should be read in conjunction with the
historical financial statements of the Company and the individual Predecessor
Practices, including the related notes thereto, and 'Management's Discussion and
Analysis of Financial Condition and Results of Operations' that appear elsewhere
in this prospectus.
F-2
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
PRO FORMA BALANCE SHEET
SEPTEMBER 30, 1996
<TABLE>
<S> <C> <C> <C> <C>
SPECIALTY PRO FORMA
CARE PRO FORMA ADJUSTMENT
NETWORK, INC. ADJUSTMENTS LEGEND PRO FORMA
------------- ------------ ------------- ------------
ASSETS
Current Assets:
Cash ............................................. $ 132,105 $ 600,000 (3) $ 732,105
Accounts receivable, net ......................... -- 10,119,180 (2) 10,119,180
Inventories ...................................... -- 80,324 (2) 80,324
Due from related parties ......................... -- 605,538 (2) 605,538
Prepaid expenses ................................. 270,272 99,529 (2) 369,801
------------ ------------ ------------
Total current assets ............................... 402,377 11,504,571 11,906,948
Furniture, fixtures and equipment, net ............. 251,560 2,320,187 (2) 2,571,747
Intangible assets .................................. 25,457 139,800 (1) 187,841
22,584 (2)
Other assets ....................................... 51,733 26,714 (2) 78,447
------------ ------------ ------------
Total assets ....................................... $ 731,127 $ 14,013,856 $ 14,744,983
------------ ------------ ------------
------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................................. $ 92,332 $ 376,483 (2) $ 468,815
Accrued compensation and benefits ................ 496,939 257,622 (2) 754,561
Revolving line of credit ......................... -- 1,677,750 (1) 1,677,750
Current portion of capital lease obligations ..... -- 190,273 (2) 190,273
Convertible debentures ........................... 1,870,000 (1,870,000) (3) --
Deferred tax liability ........................... -- 251,635 (2) 1,637,094
1,385,459 (4)
Other accrued expenses ........................... 555,905 (39,254) (3) 764,651
248,000 (5)
------------ ------------ ------------
Total current liabilities .......................... 3,015,176 2,477,968 5,493,144
Deferred tax liability ............................. 124,776 (2) 2,259,963
-- 2,135,187 (4)
Capital lease obligations, less current portion .... -- 967,989 (2) 967,989
------------ ------------ ------------
Total liabilities .................................. 3,015,176 5,705,920 8,721,096
Stockholders' equity (deficit)
Common stock ..................................... 1,265 9,780 (3) 11,045
Additional paid-in capital (owners' equity) ...... -- (1,537,950) (1) 8,298,156
(9,780) (3)
11,105,278 (2)
1,870,000 (3)
39,254 (3)
600,000 (3)
(3,520,646) (4)
(248,000) (5)
Accumulated deficit .............................. (2,285,314) -- (2,285,314)
------------ ------------ ------------
Total stockholders' equity (deficit) ............... (2,284,049) 8,307,936 6,023,887
------------ ------------ ------------
Total liabilities and stockholders' equity (deficit) $ 731,127 $ 14,013,856 $ 14,744,983
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying notes to unaudited pro forma financial statements.
F-3
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
PRO FORMA STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1995
<TABLE>
<S> <C> <C> <C> <C>
SPECIALTY PRO FORMA
CARE PRO FORMA ADJUSTMENT
NETWORK, INC. ADJUSTMENTS LEGEND PRO FORMA
------------- ------------ --------------- ------------
Revenue................................................. $ -- $ 31,493,723 (8) $ 31,493,723
Operating expenses:
Salaries and benefits................................. -- 11,366,021 (6) 14,214,984
2,848,963 (9)
Supplies, general and administrative expenses......... -- 9,968,982 (6) 10,930,793
961,811 (10)
Depreciation and amortization......................... -- 554,434 (6) 713,481
159,047 (11)
Costs to evaluate and acquire physician practices..... -- 94,903 (12) 94,903
------------- ------------ ------------
Income from continuing operations....................... -- 5,539,562 5,539,562
Interest expense and other, net......................... -- (74,306) (6) (74,306)
------------- ------------ ------------
Income from continuing operations before
income tax............................................ -- 5,465,256 5,465,256
Income tax expense...................................... -- (2,076,797) (14) (2,076,797)
------------- ------------ ------------
Net income.............................................. $ -- $ 3,388,459 $ 3,388,459
------------- ------------ ------------
------------- ------------ ------------
Net income per share.................................... $ 0.27
Weighted average common shares outstanding and common
stock equivalents..................................... 12,491,897
</TABLE>
See accompanying notes to unaudited pro forma financial statements.
F-4
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
PRO FORMA STATEMENT OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<S> <C> <C> <C> <C>
SPECIALTY PRO FORMA
CARE PRO FORMA ADJUSTMENT
NETWORK, INC. ADJUSTMENTS LEGEND PRO FORMA
------------- ------------ --------------- ------------
Revenue....................................................... $ -- $ 25,036,076 (8) $ 25,036,076
Operating expenses:
Salaries and benefits....................................... 1,223,923 8,556,147 (7) 10,599,417
819,347 (9)
Supplies, general and administrative expenses............... 480,905 8,858,096 (7) 9,579,454
240,453 (10)
Depreciation and amortization............................... 37,482 483,111 (7) 602,396
81,803 (11)
Costs to evaluate and acquire physician practices........... 509,656 (438,479) (12) 71,177
------------- ------------ ------------
Income (loss) from operations................................. (2,251,966) 6,435,598 4,183,632
Interest expense and other, net............................... (33,348) (28,554) (7) (22,648)
39,254 (13)
------------- ------------ ------------
Income (loss) from operations before income tax............... (2,285,314) 6,446,298 4,160,984
Income tax expense............................................ -- (1,581,174) (14) (1,581,174)
------------- ------------ ------------
Net income (loss)............................................. $(2,285,314) $ 4,865,124 $ 2,579,810
------------- ------------ ------------
------------- ------------ ------------
Net income per share.......................................... $ 0.21
Weighted average common shares outstanding and common stock
equivalents................................................. 12,491,897
</TABLE>
See accompanying notes to unaudited pro forma financial statements.
F-5
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
NOTES TO PRO FORMA
FINANCIAL STATEMENTS
PRO FORMA BALANCE SHEET ADJUSTMENTS
1. Reflects the distributions to certain owners of Reconstructive Orthopaedic
Associates, Inc. of $1,537,950 in connection with the Initial Affiliation
Transactions and the application of SAB 48. These payments are accounted for
as dividends to such owners of Reconstructive Orthopaedic Associates, Inc.
The cash necessary to effectuate these dividend payments was primarily
provided by a bank pursuant to a new $20 million Revolving Loan and Security
Agreement established between the Company and the bank on November 1, 1996.
Accordingly, this accounting treatment results in (i) a $1,537,950 reduction
in additional paid-in capital, (ii) an increase in the revolving line of
credit of $1,677,750, and (iii) an increase of intangible assets for deferred
debt issuance costs of $139,800. The pro forma financial statements do not
reflect an adjustment for interest expense on the revolving line of credit
because management expects that the outstanding principal will be fully
repaid with the proceeds from the initial public offering of the Company's
common stock and, accordingly, there is no continuing effect for a period of
at least twelve months after the Initial Affiliation Transactions.
2. Historical assets and liabilities to be included in the pro forma balance
sheet pursuant to the terms and conditions of the underlying acquisition
agreements executed with the Predecessor Practices are summarized on the
following page.
F-6
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
NOTES TO PRO FORMA
FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
RECONSTRUCTIVE PRINCETON TALLAHASSEE GREATER
ORTHOPAEDIC ORTHOPAEDIC ORTHOPEDIC CHESAPEAKE
ASSOCIATES, ASSOCIATES, CLINIC, ORTHOPAEDIC
INC. P.A. INC. ASSOCIATES, LLC
------------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents...................................... $ 831,472 $ 632,059 $ 647,863 $ 448,196
Accounts receivable, net....................................... 3,905,093 2,338,764 2,611,574 1,136,958
Inventories.................................................... 19,100 -- 68,224 --
Due from related parties....................................... -- 465,924 815,341 --
Prepaid expenses............................................... -- 80,006 180,677 49,892
----------- ---------- ---------- -----------
Total current assets............................................. 4,755,665 3,516,753 4,323,679 1,635,046
Furniture, fixtures and equipment, net........................... 563,048 934,883 1,744,788 18,992
Intangible assets................................................ -- -- -- 22,584
Other assets..................................................... 16,104 -- 9,540 --
----------- ---------- ---------- -----------
Total assets..................................................... $ 5,334,817 $4,451,636 $6,078,007 $ 1,676,622
=========== ========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings.......................................... $ -- $ -- $ 400,000 $ --
Current portion of long-term notes payable..................... 66,000 70,000 409,708 --
Current portion of capital lease obligations................... -- 107,489 49,976 --
Accounts payable............................................... 119,338 439,629 113,613 30,287
Accrued compensation and
benefits..................................................... 160,949 1,588,076 211,551 1,431,935
Accrued profit sharing
contribution................................................. 285,750 300,000 427,072 --
Income taxes payable........................................... -- -- -- --
Deferred tax liability......................................... -- 251,635 -- --
Due to related parties......................................... 168,356 165,377 201,173 122,932
Other accrued expenses......................................... -- -- 7,304 --
----------- ---------- ---------- -----------
Total current liabilities........................................ 800,393 2,922,206 1,820,397 1,585,154
Deferred tax liability........................................... -- -- -- --
Notes payable, less current portion.............................. 89,699 339,428 896,077 --
Capital lease obligations, less current portion.................. -- 769,123 189,119 --
----------- ---------- ---------- -----------
Total liabilities................................................ 890,092 4,030,757 2,905,593 1,585,154
Total owners' equity............................................. 4,444,725 420,879 3,172,414 91,468
----------- ---------- ---------- -----------
Total liabilities and owners' equity............................. $ 5,334,817 $4,451,636 $6,078,007 $ 1,676,622
=========== ========== ========== ===========
<CAPTION>
COMBINED EXCLUDED
VERO PREDECESSOR ASSETS
ORTHOPAEDICS, PRACTICE AND PRO FORMA
P.A. TOTALS LIABILITES ADJUSTMENT
------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents...................................... $ 135,228 $ 2,694,818 $(2,694,818) $ --
Accounts receivable, net....................................... 564,425 10,556,814 (437,634) 10,119,180
Inventories.................................................... -- 87,324 (7,000) 80,324
Due from related parties....................................... 40,692 1,321,957 (716,419) 605,538
Prepaid expenses............................................... 32,367 342,942 (243,413) 99,529
---------- ----------- ----------- -----------
Total current assets............................................. 772,712 15,003,855 (4,099,284) 10,904,571
Furniture, fixtures and equipment, net........................... 72,671 3,334,382 (1,014,195) 2,320,187
Intangible assets................................................ -- 22,584 -- 22,584
Other assets..................................................... 1,070 26,714 -- 26,714
---------- ----------- ----------- -----------
Total assets..................................................... $ 846,453 $18,387,535 $(5,113,479) $13,274,056
========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings.......................................... $ -- $ 400,000 $ (400,000) $ --
Current portion of long-term notes payable..................... 82,000 627,708 (627,708) --
Current portion of capital lease obligations................... 32,808 190,273 -- 190,273
Accounts payable............................................... 13,245 716,112 (339,629) 376,483
Accrued compensation and
benefits..................................................... 40,676 3,433,187 (3,175,565) 257,622
Accrued profit sharing
contribution................................................. -- 1,012,822 (1,012,822) --
Income taxes payable........................................... 107,994 107,994 (107,994) --
Deferred tax liability......................................... -- 251,635 -- 251,635
Due to related parties......................................... -- 657,838 (657,838) --
Other accrued expenses......................................... -- 7,304 (7,304) --
---------- ----------- ----------- -----------
Total current liabilities........................................ 276,723 7,404,873 (6,328,860) 1,076,013
Deferred tax liability........................................... 124,776 124,776 -- 124,776
Notes payable, less current portion.............................. -- 1,325,204 (1,325,204) --
Capital lease obligations, less current portion.................. 9,747 967,989 -- 967,989
---------- ----------- ----------- -----------
Total liabilities................................................ 411,246 9,822,842 (7,654,064) 2,168,778
Total owners' equity............................................. 435,207 8,564,693 2,540,585 11,105,278
---------- ----------- ----------- -----------
Total liabilities and owners' equity............................. $ 846,453 $18,387,535 $(5,113,479) $13,274,056
========== =========== =========== ===========
</TABLE>
F-7
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
NOTES TO PRO FORMA
FINANCIAL STATEMENTS -- (CONTINUED)
3. Pursuant to equity transactions executed as part of, or contemporaneously
with, the Initial Affiliation Transactions, 11,044,955 shares of the
Company's $0.001 par value Common Stock became outstanding immediately
thereafter, inclusive of the conversion of all of the outstanding convertible
debentures into Common Stock. Accordingly, the pro forma financial statements
reflect (i) a reclassification of $9,780 from additional paid-in capital to
Common Stock, (ii) a $1,870,000 reclassification from convertible debentures
to additional paid-in capital, (iii) a $39,254 reclassification from accrued
expenses to additional paid-in capital, and (iv) increases of $600,000 in
cash and additional paid-in capital for the issuance of Common Stock to one
of the Predecessor Practices subsequent to September 30, 1996 and the
issuance/conversion of an incremental $300,000 in convertible debentures to
another one of the Predecessor Practices, also in the period subsequent to
September 30, 1996.
4. Reflects the resulting deferred income taxes in accordance with Statement of
Accounting Standards No. 109, Accounting for Income Taxes, for the Internal
Revenue Code Section 481 net federal and state deferred tax liabilities to be
assumed by the Company based on the underlying cash basis net assets of the
Predecessor Practices. This pro forma adjustment results in (i) a $1,385,459
increase in the short-term deferred tax liability, (ii) a $2,135,187 increase
in the long-term deferred tax liability, and (iii) a corresponding $3,520,646
reduction in additional paid-in capital. A full valuation allowance remains
on the net deferred tax asset of the Company because, notwithstanding the pro
forma statements of income included herein, there can be no objective
measurement of the Company's ability to generate sufficient future taxable
income of the appropriate nature and character to provide reasonable
assurance that the net deferred tax asset will be recoverable in a timely
fashion.
5. Reflects the incremental costs necessary to effectuate the acquisition of the
Predecessor Practices, resulting in an increase of $248,000 in accrued
expenses and a corresponding reduction in additional paid-in capital.
6. For purposes of deriving the pro forma financial statements of the Company
based on the terms and conditions of the underlying long-term service
agreements with the Initial Affiliated Practices, the following adjustments
have been made to the Predecessor Practices' combined historical financial
information for the year ended December 31, 1995 for pro forma purposes.
F-8
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
NOTES TO PRO FORMA
FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
RECONSTRUCTIVE PRINCETON GREATER
ORTHOPAEDIC ORTHOPAEDIC TALLAHASSEE CHESAPEAKE VERO
ASSOCIATES, ASSOCIATES, ORTHOPEDIC ORTHOPAEDIC ORTHOPAEDICS,
INC. P.A. CLINIC, INC. ASSOCIATES, LLC P.A.
------------- ------------ ------------ --------------- -------------
<S> <C> <C> <C> <C> <C>
Net practice revenue........................... $17,549,907 $ 13,298,164 $ 10,420,265 $ 8,207,951 $ 4,208,470
Operating expenses:
Physician compensation....................... 9,288,516 4,968,251 3,473,978 6,432,601 2,865,311
Salaries and benefits........................ 3,874,636 4,057,086 4,028,185 1,113,570 1,023,481
Supplies, general and administrative
expenses................................... 2,792,588 4,235,715 2,471,876 1,003,915 786,036
Depreciation and amortization................ 133,450 258,497 224,054 12,338 61,361
----------- ------------ ------------ ------------- -----------
Total operating expenses....................... 16,089,190 13,519,549 10,198,093 8,562,424 4,736,189
----------- ------------ ------------ ------------- -----------
Income (loss) from operations.................. 1,460,717 (221,385) 222,172 (354,473) (527,719)
Interest expense, net.......................... (555) (113,257) (118,363) -- (20,391)
Other income (expense) net..................... 5,294 6,460
----------- ------------ ------------ ------------- -----------
Income (loss) from continuing operations before
income taxes................................. 1,460,162 (334,642) 103,809 (349,179) (541,650)
Income tax benefit (expense)................... -- 118,242 -- -- (64,300)
----------- ------------ ------------ ------------- -----------
Net income (loss) from continuing operations... $ 1,460,162 $ (216,400) $ 103,809 $ (349,179) $ (605,950)
=========== ============ ============ ============= ===========
<CAPTION>
PREDECESSOR
PRACTICE ADJUSTMENT PRO FORMA
TOTALS ADJUSTMENT LEGEND ADJUSTMENT
------------ ------------ --------------- ------------
<S> <C> <C> <C> <C>
Net practice revenue........................... $ 53,684,757 $(53,684,757) (a) $ --
Operating expenses:
Physician compensation....................... 27,028,657 (27,028,657) (b) --
Salaries and benefits........................ 14,096,958 (2,730,937) (c) 11,366,021
Supplies, general and administrative
expenses................................... 11,290,130 (1,321,148) (d) 9,968,982
Depreciation and amortization................ 689,700 (135,266) (e) 554,434
------------ ------------ ------------
Total operating expenses....................... 53,105,445 (31,216,008) 21,889,437
------------ ------------ ------------
Income (loss) from operations.................. 579,312 (22,468,749) (21,889,437)
Interest expense, net.......................... (252,566) 166,506 (f) (86,060)
Other income (expense) net..................... 11,754 -- 11,754
------------ ------------ ------------
Income (loss) from continuing operations before
income taxes................................. 338,500 (22,302,243) (21,963,743)
Income tax benefit (expense)................... 53,942 (53,942) (g) --
------------ ------------ ------------
Net income (loss) from continuing operations... $ 392,442 $(22,356,185) $(21,963,743)
============ ============ =============== ============
</TABLE>
<TABLE>
<S> <C>
(a) Reflects the following adjustments to net practice revenue:
(i) Elimination of net practice revenue from recurring business
segments........................................................... ($53,018,325)
(ii) Reduction for nonrecurring business segments...................... (666,432)
------------
(53,684,757)
(b) Reflects the following adjustment to physician compensation:
(i) Elimination of all physician compensation.......................... ($27,028,657)
(c) Reflects the following adjustments to salaries and benefits:
(i) Elimination of physician owner fringe benefit expenses............. ($ 2,697,549)
(ii) Incremental employee benefit plan costs........................... 61,413
(iii) Reduction for nonrecurring business segments...................... (94,801)
-----------
(2,730,937)
(d) Reflects the following adjustments to supplies, general and
administrative expenses:
(i) Reduction for nonrecurring business segments....................... $ (208,150)
(ii) Elimination of nonclinical expenses assumed by shareholder
physicians........................................................ (1,112,998)
-----------
(1,321,148)
(e) Reflects the following adjustment to depreciation and amortization:
(i) Reduction for nonrecurring business segments....................... $ (135,266)
(f) Reflects the following adjustments to interest expense related to:
(i) Elimination of debt assumed by shareholder physicians.............. $ 81,076
(ii) Elimination of debt related to nonrecurring business segments..... 85,430
-----------
166,506
(g) Reflects the following adjustment to the provision for income taxes:
(i) Elimination of income tax benefit retained by Predecessor
Practices.......................................................... $ (53,942)
</TABLE>
F-9
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
NOTES TO PRO FORMA
FINANCIAL STATEMENTS -- (CONTINUED)
7. For purposes of deriving the pro forma financial statements of the Company
based on the terms and conditions of the underlying long-term service
agreements with the Initial Affiliated Practices, the following adjustments
have been made to the Predecessor Practices' combined unaudited historical
financial information for the nine months ended September 30, 1996 for pro
forma purposes.
<TABLE>
<CAPTION>
RECONSTRUCTIVE PRINCETON GREATER
ORTHOPAEDIC ORTHOPAEDIC TALLAHASSEE CHESAPEAKE VERO PREDECESSOR
ASSOCIATES, ASSOCIATES, ORTHOPEDIC ORTHOPAEDIC ORTHOPAEDICS, PRACTICE
INC. P.A. CLINIC, INC. ASSOCIATES, LLC P.A. TOTALS
------------- ------------ ------------ --------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Net practice revenue..................... $14,255,838 $ 11,152,357 $ 10,053,710 $ 6,208,360 $ 2,953,351 $ 44,623,616
Operating expenses:
Physician compensation................. 8,051,782 4,084,772 3,052,624 4,580,750 1,186,879 20,956,807
Salaries and benefits.................. 2,205,990 3,350,844 3,453,082 948,270 828,882 10,787,068
Supplies, general and administrative
expenses............................. 3,512,248 3,464,665 2,133,338 965,778 571,716 10,647,745
Depreciation and amortization.......... 98,972 137,054 394,337 12,205 43,382 685,950
----------- ------------ ------------ ------------- ----------- ------------
Total operating expenses................. 13,868,992 11,037,335 9,033,381 6,507,003 2,630,859 43,077,570
----------- ------------ ------------ ------------- ----------- ------------
Income (loss) from operations............ 386,846 115,022 1,020,329 (298,643) 322,492 1,546,046
Interest expense, net.................... (12,409) (90,146) (116,904) -- (21,460) (240,919)
Other income, net........................ -- -- -- 26,575 5,322 31,897
----------- ------------ ------------ ------------- ----------- ------------
Income (loss) from operations before
income taxes........................... 374,437 24,876 903,425 (272,068) 306,354 1,337,024
Income tax expense....................... -- (8,707) -- -- (132,025) (140,732)
----------- ------------ ------------ ------------- ----------- ------------
Net income (loss)........................ $ 374,437 $ 16,169 $ 903,425 $ (272,068) $ 174,329 $ 1,196,292
=========== ============ ============ ============= =========== ============
<CAPTION>
ADJUSTMENT PRO FORMA
ADJUSTMENTS LEGEND ADJUSTMENT
------------ --------------- ------------
Net practice revenue..................... $(44,623,616) (a) $ --
Operating expenses:
Physician compensation................. (20,956,807) (b) --
Salaries and benefits.................. (2,230,921) (c) 8,556,147
Supplies, general and administrative
expenses............................. (1,789,649) (d) 8,858,096
Depreciation and amortization.......... (202,839) (e) 483,111
------------ ------------
Total operating expenses................. (25,180,216) 17,897,354
------------ ------------
Income (loss) from operations............ (19,443,400) (17,897,354)
Interest expense, net.................... 180,468 (f) (60,451)
Other income, net........................ -- 31,897
------------ ------------
Income (loss) from operations before
income taxes........................... (19,262,932) (17,925,908)
Income tax expense....................... 140,732 (g) --
------------ ------------
Net income (loss)........................ $(19,122,200) $(17,925,908)
============ ============
</TABLE>
<TABLE>
<S> <C>
(a) Reflects the following adjustments to net practice revenue:
(i) Elimination of net practice revenue from recurring business
segments........................................................... ($42,605,438)
(ii) Reduction for nonrecurring business segments...................... (2,018,178)
------------
(44,623,616)
(b) Reflects the following adjustment to physician compensation:
(i) Elimination of all physician compensation.......................... ($20,956,807)
(c) Reflects the following adjustment to salaries and benefits:
(i) Elimination of physician owner fringe benefit expenses............. $(2,082,904)
(ii) Incremental employee benefit plan costs........................... (41,360)
(iii) Reduction for nonrecurring business segments...................... (106,657)
------------
(2,230,921)
(d) Reflects the following adjustments to supplies, general and
administrative expenses:
(i) Reduction for nonrecurring business segments....................... $ (610,287)
(ii) Elimination of Predecessor Practices' costs to effectuate the
Initial Affiliation Transactions.................................. (174,612)
(iii) Elimination of nonclinical expenses assumed by shareholder
physicians........................................................ (1,004,750)
------------
(1,789,649)
(e) Reflects the following adjustment to depreciation and amortization:
(i) Reduction for nonrecurring business segments....................... $ (202,839)
(f) Reflects the following adjustments to interest expense related to:
(i) Elimination of debt assumed by shareholder physicians.............. $ 86,917
(ii) Elimination of debt related to nonrecurring business segments..... 93,551
------------
180,468
(g) Reflects the following adjustment to the provision for income taxes:
(i) Elimination of income tax expense retained by Predecessor
Practices.......................................................... $ 140,732
</TABLE>
F-10
<PAGE>
UNAUDITED PRO FORMA FINANCIAL STATEMENTS OF
SPECIALTY CARE NETWORK, INC.
NOTES TO PRO FORMA
FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED SEPT. 30,
1995 1996
--------------- ---------------
<S> <C> <C>
8. Reflects the following adjustments to revenue:
(i) Recognition of service fee revenue based on long-term management
service agreements................................................... $ 9,516,759 $ 7,137,569
(ii) Reimbursement of clinic operating expenses ......................... 21,976,964 17,898,507
----------- -----------
31,493,723 25,036,076
9. Reflects the following adjustments to salaries and benefits:
(i) Corporate office and officer compensation............................ $ 2,492,063 $ 799,128
(ii) Corporate office and officer fringe benefit expenses................ 356,900 20,219
----------- -----------
2,848,963 819,347
10. Reflects the following adjustment to supplies, general and administrative
expenses:
(i) Annualized corporate supplies, general and administrative expenses... $ 961,811 $ 240,453
11. Reflects the following adjustment to depreciation and amortization:
(i) Annualized corporate overhead charges................................ $ 159,047 $ 81,803
12. Reflects the following adjustment to costs to evaluate and acquire
practices:
(i) Addition (elimination) of costs to evaluate and acquire physician
practices............................................................ $ 94,903 $ (438,479)
13. Reflects the following adjustment to interest expense related to:
(i) Elimination of convertible debentures................................ $ -- $ 39,254
14. Reflects the following adjustment to the provision for income taxes:
(i) Provide for an expected combined federal and state effective income
tax rate of 38%...................................................... $(2,076,797) $(1,581,174)
</TABLE>
15. The computation of pro forma income per share is based upon 12,491,897
weighted average common shares outstanding and common stock equivalents,
calculated by using the treasury stock method and an assumed initial public
offering price of $____ per share and includes (i) 7,659,115 shares
distributed to the shareholders of the Predecessor Practices, (ii) 1,517,905
weighted average common shares outstanding during the period ended September
30, 1996 and the year ended December 31, 1995, (iii) 100,000 shares issued
to TOC subsequent to September 30, 1996, (iv) 2,020,841 shares converted
from debt and accrued interest into common stock by debenture holders, (v)
1,040,249 common stock equivalents attributable to stock options outstanding
at December 4, 1996, and (vi) 153,787 common stock equivalents arising from
cash paid to certain owners of the predecessor of ROA in lieu of common
shares that otherwise would have been issued as part of the Initial
Affiliated Transactions.
F-11
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Specialty Care Network, Inc.
We have audited the accompanying balance sheet of Specialty Care Network, Inc.
(the 'Company') as of September 30, 1996, and the related statements of
operations, stockholders' deficiency, and cash flows for the period from
December 22, 1995 (date of incorporation) through September 30, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides 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 Specialty Care Network, Inc. at
September 30, 1996, and the results of its operations and its cash flows for the
period from December 22, 1995 (date of incorporation) through September 30, 1996
in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------
Ernst & Young LLP
Denver, Colorado
November 12, 1996
F-12
<PAGE>
SPECIALTY CARE NETWORK, INC.
BALANCE SHEET
SEPTEMBER 30, 1996
<TABLE>
<S> <C>
ASSETS
Cash ............................................................................. $ 132,105
Prepaid offering and other assets ................................................ 270,272
-----------
Total current assets ............................................................. 402,377
Property and equipment, net of accumulated depreciation .......................... 251,560
Intangible assets, net of accumulated amortization of $4,127 ..................... 25,457
Other assets ..................................................................... 51,733
-----------
Total assets ..................................................................... $ 731,127
-----------
-----------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Accounts payable ................................................................. $ 92,332
Accrued payroll, incentive compensation and related expenses ..................... 496,939
Accrued expenses ................................................................. 555,905
Convertible debentures ........................................................... 1,870,000
-----------
Total current liabilities ........................................................ 3,015,176
Commitments
Stockholders' deficiency:
Preferred stock, $0.001 par value, 2,000,000 shares authorized,
no shares issued or outstanding .......................................... --
Common stock, $0.001 par value, 50,000,000 nontransferable shares authorized,
1,265,000 shares issued and outstanding .................................. 1,265
Accumulated deficit ......................................................... (2,285,314)
-----------
Total stockholders' deficiency ................................................... (2,284,049)
-----------
Total liabilities and stockholders' deficiency ................................... $ 731,127
-----------
-----------
</TABLE>
See accompanying notes.
F-13
<PAGE>
SPECIALTY CARE NETWORK, INC.
STATEMENT OF OPERATIONS
PERIOD FROM DECEMBER 22, 1995
(DATE OF INCORPORATION) THROUGH SEPTEMBER 30, 1996
Interest income ............................................ $ 5,906
Costs and expenses:
Salaries, wages and incentive compensation ............... 1,069,919
Fringe benefits and payroll taxes ........................ 154,004
Costs to evaluate and acquire physician practices ........ 509,656
Depreciation and amortization ............................ 37,482
Other general and administrative expenses ................ 480,905
Interest expense on convertible debentures ............... 39,254
-----------
2,291,220
-----------
Net loss ................................................... $(2,285,314)
-----------
-----------
See accompanying notes.
F-14
<PAGE>
SPECIALTY CARE NETWORK, INC.
STATEMENT OF STOCKHOLDERS' DEFICIENCY
PERIOD FROM DECEMBER 22, 1995
(DATE OF INCORPORATION) THROUGH SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
$0.001 PAR VALUE $0.001 PAR VALUE
---------------------- ------------------------ ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
--------- ----------- ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 22, 1995............... -- $ -- -- $ -- $ -- $ --
Shares issued pursuant to a private
placement................................ -- -- 1,690,000 1,690 -- 1,690
Purchase and retirement of common stock in
connection with a severance agreement.... -- -- (425,000) (425) -- (425)
Net loss................................... -- -- -- -- (2,285,314) (2,285,314)
--------- ----------- ----------- ----------- ------------ ------------
Balance at September 30, 1996.............. -- $ -- 1,265,000 $ 1,265 $ (2,285,314) $ (2,284,049)
--------- ----------- ----------- ----------- ------------ ------------
--------- ----------- ----------- ----------- ------------ ------------
</TABLE>
See accompanying notes.
F-15
<PAGE>
SPECIALTY CARE NETWORK, INC.
STATEMENT OF CASH FLOWS
PERIOD FROM DECEMBER 22, 1995
(DATE OF INCORPORATION) THROUGH SEPTEMBER 30, 1996
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net loss .................................................................. $(2,285,314)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................... 37,482
Changes in operating assets and liabilities:
Prepaid expenses and other assets .................................... (71,863)
Accounts payable ..................................................... 92,332
Accrued payroll, incentive compensation and related expenses ......... 496,939
Accrued expenses ..................................................... 555,905
-----------
Net cash used in operating activities ..................................... (1,174,519)
INVESTING ACTIVITIES
Purchases of property and equipment ....................................... (284,915)
Increases in intangible assets ............................................ (29,584)
-----------
Net cash used in investing activities ..................................... (314,499)
FINANCING ACTIVITIES
Proceeds from convertible debentures (Note 4) ............................. 1,870,000
Capital contributions, net ................................................ 1,265
Prepaid offering costs .................................................... (250,142)
-----------
Net cash provided by financing activities ................................. 1,621,123
-----------
Net increase in cash ...................................................... 132,105
Cash at beginning of period ............................................... --
-----------
Cash at end of period ..................................................... $ 132,105
-----------
-----------
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid ............................................................. $ --
-----------
-----------
Income taxes paid ......................................................... $ --
-----------
-----------
</TABLE>
See accompanying notes.
F-16
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
1. DESCRIPTION OF BUSINESS
Specialty Care Network, Inc. (the 'Company'), which was incorporated on
December 22, 1995, is a national physician practice management company focusing
exclusively on musculoskeletal disease-state management. Commencing on or about
November 12, 1996, the Company began providing comprehensive management services
under long-term management service agreements with five physician practices in
various states and managing an outpatient surgery center in Princeton, New
Jersey.
The accompanying financial statements reflect the Company's activity during
its start-up and organizational phase. See Note 8 for further discussion of the
Company's activities subsequent to September 30, 1996.
2. 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 amounts reported in the financial statements and
footnotes. Although these estimates are based on management's knowledge of
current events and actions they may undertake in the future, actual results
could differ from those estimates.
Financial Instruments
The carrying amounts of financial instruments as reported in the
accompanying balance sheet approximate their fair value.
Prepaid Offering Costs
Prepaid offering costs of $250,142, which primarily relate to legal and
accounting services, will be used to reduce the expected proceeds from the
Company's initial public offering of its common stock. If the initial public
offering is unsuccessful, the costs will be charged to the statement of
operations in that future period.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the three to five year estimated useful lives of
the underlying assets. Costs of repairs and maintenance are expensed as
incurred.
F-17
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Intangible Assets
Intangible assets, which are stated at cost, consist of organization costs
($29,854) that are being amortized over a three-year period.
Income Taxes
The Company provides for income taxes pursuant to the liability method as
prescribed in Statement of Financial Accounting Standards No. 109, Accounting
for Income Taxes. The liability method requires recognition of deferred income
taxes based on temporary differences between the financial reporting and income
tax bases of assets and liabilities, using currently enacted income tax rates
and regulations.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
Deferred tax assets:
Net operating loss carryforwards, expiring in 2011.......... $ 693,196
Deferred compensation....................................... 154,435
Vacation pay................................................ 8,669
------------
856,300
------------
Deferred tax liability:
Property and equipment...................................... (4,952)
------------
Valuation allowance........................................... (851,348)
------------
Net deferred tax asset........................................ $ --
------------
------------
A full valuation allowance has been recognized by the Company because there
can be no objective measurement of the Company's ability to generate sufficient
future taxable income of the appropriate nature and character to provide
reasonable assurance that the net deferred tax asset will be recoverable in a
timely fashion.
Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements under
the provisions of Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ('APB No. 25'). In 1995, Financial Accounting
Standards Board Statement No. 123, Accounting for Stock-Based Compensation
('FASB No. 123'), was issued, whereby companies may elect to account for stock-
based compensation using a fair value based method or continue measuring
compensation expense using the intrinsic value method prescribed in APB No. 25.
FASB No. 123 requires that companies electing to continue to use the intrinsic
value method make pro forma disclosure of net income and net income per share as
if the fair value based method of accounting had been applied.
The pro forma effects of adopting FASB No. 123's fair value based method
for the period ended September 30, 1996 were not materially different than from
the corresponding APB No. 25 intrinsic value methodology because the weighted
average grant-date fair value of options granted during the period was
negligible. However, the effects of applying FASB No. 123 during 1996 are not
likely to be representative of the effects on pro forma net income for future
years because the vesting of options will cause additional incremental expense
to be recognized in future periods.
F-18
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Computer equipment............................................. $ 160,327
Furniture and fixtures......................................... 116,197
Other.......................................................... 8,391
-----------
284,915
Accumulated depreciation....................................... 33,355
-----------
Net property and equipment..................................... $ 251,560
-----------
-----------
4. CONVERTIBLE DEBENTURES
The Company raised $1.87 million of short-term unsecured convertible debt
pursuant to two private placements during the period ended September 30, 1996.
The proceeds thereof have been utilized to fund the Company's start-up and
organizational phase until such time as certain physician practices were
acquired on or about November 12, 1996 (see Note 8).
Contemporaneous with the acquisitions of the founding physician practices,
the holders of the debentures converted the unpaid principal amount plus any
accrued interest thereon (calculated at 5.0%), into the Company's common stock
at the conversion ratio of $1.00 of debenture principal and accrued interest for
one share of common stock. The following table summarizes the September 30, 1996
financial position of the debenture holders:
<TABLE>
<CAPTION>
ACCRUED
PRINCIPAL INTEREST TOTAL
------------- --------- -------------
<S> <C> <C> <C>
Stockholders of the Company.................................. $ 640,000 $ 14,406 $ 654,406
Founding physician practices and related stockholders........ 1,230,000 24,848 1,254,848
------------- --------- -------------
$ 1,870,000 $ 39,254 $ 1,909,254
------------- --------- -------------
------------- --------- -------------
</TABLE>
Subsequent to September 30, 1996, the Company issued an additional $300,000
of convertible debentures to one of the founding practices on substantially the
same terms as described above, except that the conversion ratio was $3.00 of
debenture principal and accrued interest for one share of common stock.
Concurrent with its acquisition by the Company, the founding practice executed
its right to convert the debentures and accrued interest thereon into the
Company's common stock.
5. COMMON STOCK
At September 30, 1996, 1,180,000 and 85,000 shares of outstanding
nontransferable common stock are held by current employees and former employees,
respectively. Pursuant to certain common stock subscription agreements and a
related Stockholders Agreement, executed by the Company and its employees, the
1,180,000 shares vest, based upon continued employment with the Company, as
follows:
December 31, 1996.............................................. 393,333
December 31, 1997.............................................. 393,333
December 31, 1998.............................................. 393,334
-----------
1,180,000
-----------
-----------
Certain events, including an initial public offering of the Company's
common stock, provide for the immediate and full vesting of the aforementioned
employee owned shares. However, prior to vesting, the holders retain voting
rights with respect to such shares. Of the 85,000 shares attributable to
F-19
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. COMMON STOCK -- (CONTINUED)
former employees, 75,000 will fully vest solely upon the consummation of an
initial public offering and the remaining 10,000 shares are fully vested as of
September 30, 1996.
Subsequent to September 30, 1996, the Company issued an additional 100,000
shares of nontransferable common stock to one of the founding practices (see
Note 8) at $3.00 per share.
6. STOCK OPTION PLANS
On March 22, 1996, the Company adopted the 1996 Incentive and Non-Qualified
Stock Option Plan (the 'Plan') pursuant to which nontransferable options to
purchase up to 5,000,000 shares of common stock of the Company may be granted to
eligible directors, officers, advisors, consultants and key employees in order
to provide incentive for such personnel to serve the Company and have a greater
interest in its overall success. The Plan will terminate no later than December
31, 2005, after which no additional stock options will be granted thereunder.
Pursuant to the Plan, the exercise price for incentive stock options shall not
be less than the fair market value of each share at the date of the grant. The
option period shall not exceed ten years. Options, which are generally
contingent on continued employment with the Company, may be exercised only in
accordance with a vesting schedule established by the Company's Board of
Directors; however, all options under the Plan will become fully vested upon an
initial public offering of the Company's common stock. As of September 30, 1996,
4,446,500 shares of the Company's common stock were available for future grants
under the Plan. Only 3,500 of the options which are outstanding under the Plan
at September 30, 1996 were exercisable at such date, and no options were
forfeited or expired during the period then ended.
<TABLE>
<CAPTION>
SHARES
OPTION UNDER
PRICE OPTION
--------- ---------
<S> <C> <C>
Outstanding at September 30 1996, which generally vest
ratably on March 22, 1997, 1998 and 1999 and expire on
March 22, 2006.............................................. $1.00 553,500
</TABLE>
On October 15, 1996, the Company's Board of Directors approved the 1996
Equity Compensation Plan (the 'Equity Plan'), which provides for the granting of
options to purchase up to two million shares of the Company's common stock. Both
incentive stock options and nonqualified stock options may be issued under the
provisions of the Equity Plan. Employees of the Company and any future
subsidiaries, members of the Board of Directors and certain key advisors are
eligible to participate in this plan, which shall terminate no later than
October 14, 2006. The granting and vesting of the options under the Equity Plan
are provided by the Company's Board of Directors. Subsequent to October 15,
1996, the Company's Board of Directors approved grants under the Equity Plan
exercisable for approximately 1,362,000 of common shares at an exercise price of
$6.00 per share.
F-20
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS
The Company is obligated under operating lease agreements for an office and
certain equipment. Future minimum payments under noncancelable operating leases
with lease terms in excess of one year are summarized as follows for the years
ending September 30:
1997.......................................................... $ 84,072
1998.......................................................... 85,416
1999.......................................................... 86,040
2000.......................................................... 86,988
2001.......................................................... 43,830
--------
$386,346
--------
--------
Rent expense for the period ended September 30, 1996 under all operating
leases was approximately $62,100.
The Company has entered into certain employment agreements that provide key
executives and employees with minimum base pay, annual incentive awards and
other fringe benefits. The Company expenses all costs related thereto in the
period that the service is rendered by the employee. In the event of death,
disability, termination with or without cause, voluntary employee termination,
change in ownership of the Company, etc., the Company may be partially or wholly
relieved of its financial obligations to such individuals. However, under
certain circumstances, a change in control of the Company may provide
significant and immediate enhanced compensation to the employees possessing
employment contracts. At September 30, 1996, the Company was contractually
obligated for the following base pay compensation amounts (summarized by fiscal
year ending September 30):
1997........................................................... $ 1,273,167
1998........................................................... 1,458,604
1999........................................................... 1,551,000
2000........................................................... 1,551,000
2001........................................................... 840,417
-------------
$ 6,674,188
-------------
-------------
As required by one of its vendors, the Company established a $50,000
irrevocable letter of credit in favor of such vendor, which expires on February
3, 1997. The letter of credit will generally continue to exist beyond the
expiration date as long as the Company continues to maintain its relationship
with such vendor. The letter of credit is secured by a $50,000 savings account,
which is included in other long-term assets in the accompanying financial
statements.
8. SUBSEQUENT EVENTS
As noted in the accompanying financial statements, the Company expended
approximately $510,000 during the period ended September 30, 1996 in order to
evaluate the acquisition of substantially all the assets, liabilities and
business of certain physician practices. The following table
F-21
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. SUBSEQUENT EVENTS -- (CONTINUED)
summarizes certain financial information (unaudited) related to the acquisitions
of the five founding physician practices on or about November 12, 1996:
<TABLE>
<CAPTION>
NET REVENUE COMMON
FOR THE NINE STOCK
TOTAL ASSETS MONTHS CONSIDERATION CASH
AT ENDED PAID CONSIDERATION
SEPTEMBER 30 SEPTEMBER 30 BY THE PAID BY THE
1996 1996 (1) COMPANY COMPANY
------------ ------------- ------------- -------------
(SHARES)
<S> <C> <C> <C> <C>
Reconstructive Orthopaedic Associates, Inc.......... $5,334,817 $14,255,838 3,169,379 $1,537,872
Princeton Orthopaedic Associates, P.A............... 4,451,636 11,152,357 1,196,793 --
Tallahassee Orthopedic Clinic, Inc.................. 6,078,007 10,053,710 1,072,414 --
Greater Chesapeake Orthopaedic Associates, LLC...... 1,676,622 6,208,360 1,568,922 --
Vero Orthopaedics, P.A.............................. 846,453 2,953,351 651,607(2) --
</TABLE>
- ------------------
(1) Net revenue represents practice revenue primarily generated through
physician services.
(2) Excludes stock options to purchase an additional 50,000 shares of the
Company's common stock at $6.00 per share.
On November 1, 1996, the Company entered into a $20 million Revolving Loan
and Security Agreement with a bank, which provided certain amounts necessary to
effectuate the aforementioned acquisition transactions. At November 12, 1996,
the outstanding amount thereunder was approximately $1.7 million, and such
amount is secured by a first collateral interest on substantially all of the
assets owned by the Company or thereafter acquired. Additionally,
contemporaneous with the acquisitions of the founding physician practices, the
Company extended lines of credit to the former stockholders of certain founding
practices aggregating approximately $4.3 million. Such lines of credit will
generally remain in existence through November 12, 1998. Advances thereunder,
which aggregated $800,000 subsequent to September 30, 1996, bear interest at the
prime lending rate plus 1.25% and will be collateralized by the Company's common
stock owned by the individual physician.
Concurrent with the acquisitions, the affiliated physician groups
simultaneously entered into long-term management service agreements with the
Company. The Company, under the terms of the management service agreements,
employs most of the groups' non-physician/non-technical personnel and receives a
service fee.
Pursuant to the terms of the management service agreements, the Company
will assist the founding practices with strategic planning, preparation of
operating budgets and capital project analysis. The Company intends to
coordinate group purchasing of supplies, inventories and insurance for the
practices. In addition, the Company will assist the founding practices with
physician recruitment by introducing physician candidates to the practices and
advising the practices in structuring employment arrangements. The Company will
also provide or arrange for a variety of additional services relating to the
day-to-day non-medical operations of the practices, including (i) management and
monitoring each practice's billing levels, invoicing and accounts receivable
collection by payor type, (ii) accounting, payroll and legal services and
records and (iii) cash management and centralized disbursements.
Furthermore, the Company will, among other things, (i) act as the exclusive
manager and administrator of non-physician services relating to the operation of
the founding practices, subject to matters reserved to the founding practices or
referred to a Joint Policy Board, (ii) bill patients, insurance companies and
other third party payors and collect, on behalf of the
F-22
<PAGE>
SPECIALTY CARE NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. SUBSEQUENT EVENTS -- (CONTINUED)
founding practices, the fees for professional medical and other services
rendered, including goods and supplies sold, by the founding practices, (iii)
provide, as necessary, clerical, accounting, purchasing, payroll, legal,
bookkeeping and computer services and personnel, information management,
preparation of certain tax returns, printing, postage and duplication services
and medical transcribing services, (iv) supervise and maintain custody of
substantially all files and records, (v) provide facilities for the founding
practices, (vi) prepare, in consultation with a Joint Policy Board and the
founding practices, all annual and capital operating budgets, (vii) order and
purchase inventories and supplies as reasonably requested by the founding
practices, (viii) implement, in consultation with a Joint Policy Board and the
founding practices, national and local public relations or advertising programs
and (ix) provide financial and business assistance in the negotiation,
establishment, supervision and maintenance of contracts and relationships with
managed care and other similar providers and payors.
Under the management service agreements, the respective founding practice
retains the responsibility for, among other things, (i) hiring and compensating
physician employees and other medical professionals, (ii) ensuring that
physicians have the required licenses, credentials, approvals and other
certifications needed to perform their duties and (iii) complying with certain
federal and state laws and regulations applicable to the practice of medicine.
In addition, the founding practices will be exclusively in control of all
aspects of the practice of medicine and the delivery of medical services.
The management service agreements are for initial terms of forty years,
with automatic extensions (unless specified notice is given) of five years. The
management service agreements may be terminated by either party if the other
party (i) files a petition in bankruptcy or other similar events occur, or (ii)
defaults on the performance of a material duty or obligation, which default
continues for a specified term after notice.
The founding practices are responsible for obtaining professional liability
insurance for the employees of the founding practice and the Company is
responsible for obtaining general liability and property insurance for the
founding practices.
Upon termination of a management service agreement by the Company, the
physician practice has the option to purchase and assume, and the Company has
the option to require the physician practice to purchase and assume, the related
assets and liabilities at the fair market value thereof, except in certain
circumstances where the physician practice or the Company, as applicable, is in
breach of the underlying agreement.
F-23
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Reconstructive Orthopaedic Associates, Inc.
We have audited the accompanying balance sheets of Reconstructive Orthopaedic
Associates, Inc. as of December 31, 1994 and 1995, and the related statements of
income, stockholders' equity and cash flows for each of the three years in the
period ended December 31, l995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Reconstructive Orthopaedic
Associates, Inc. as of December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Denver, Colorado
July 12, 1996
F-24
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
---------------------------- -------------
1994 1995 1996
------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 234,883 $ 246,203 $ 831,472
Accounts receivable, net.......................................... 2,623,768 4,288,456 3,905,093
Inventories....................................................... 25,200 19,100 19,100
Due from related parties.......................................... 57,716 -- --
Prepaid expenses.................................................. 247,152 122,793 --
------------- ------------- -------------
Total current assets................................................ 3,188,719 4,676,552 4,755,665
Furniture, fixtures and equipment, net.............................. 510,077 617,053 563,048
Other assets........................................................ 2,277 18,972 16,104
------------- ------------- -------------
Total assets........................................................ $ 3,701,073 $ 5,312,577 $ 5,334,817
============= ============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings............................................. $ 550,000 $ 570,000 $ --
Current portion of long-term debt................................. -- -- 66,000
Accounts payable.................................................. 151,316 271,333 119,338
Accrued compensation and benefits................................. 117,995 81,924 160,949
Accrued profit sharing contribution............................... 160,398 245,819 285,750
Due to related parties............................................ -- -- 168,356
Other accrued expenses............................................ 888 2,863 --
------------- ------------- -------------
Total current liabilities........................................... 980,597 1,171,939 800,393
Long-term debt, less current portion................................ -- -- 89,699
------------- ------------- -------------
Total liabilities................................................... 980,597 1,171,939 890,092
Commitments
Stockholders' equity:
Common stock, $1 par value:
Authorized and outstanding shares -- 1,000..................... 1,000 1,000 1,000
Retained earnings.............................................. 2,744,489 4,164,651 4,539,088
Treasury stock................................................. (25,013) (25,013) (25,013)
Less note receivable from stockholder.......................... -- -- (70,350)
------------- ------------- -------------
Total stockholders' equity.......................................... 2,720,476 4,140,638 4,444,725
------------- ------------- -------------
Total liabilities and stockholders' equity.......................... $ 3,701,073 $ 5,312,577 $ 5,334,817
============= ============= =============
</TABLE>
See accompanying notes.
F-25
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
---------------------------------------- --------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue................................ $ 11,902,216 $ 13,325,350 $ 17,549,907 $ 12,431,874 $ 14,255,838
Operating expenses:
Physician compensation................... 6,741,664 7,711,380 9,288,516 7,546,155 8,051,782
Salaries and benefits.................... 2,623,412 3,288,766 3,874,636 1,916,237 2,205,990
Supplies, general and administrative
expenses............................... 2,022,581 2,066,795 2,792,588 2,108,595 3,512,248
Depreciation............................. 126,889 124,304 133,450 84,869 98,972
------------ ------------ ------------ ------------ ------------
Total operating expenses................... 11,514,546 13,191,245 16,089,190 11,655,856 13,868,992
------------ ------------ ------------ ------------ ------------
Income from operations..................... 387,670 134,105 1,460,717 776,018 386,846
Interest expense........................... (10,225) (5,302) (555) (1,936) (12,409)
------------ ------------ ------------ ------------ ------------
Net income................................. $ 377,445 $ 128,803 $ 1,460,162 $ 774,082 $ 374,437
============ ============ ============ ============ ============
</TABLE>
See accompanying notes.
F-26
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NOTE
NUMBER RECEIVABLE
OF COMMON RETAINED TREASURY FROM
SHARES STOCK EARNINGS STOCK STOCKHOLDER TOTAL
--------- --------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992................. 1,000 $ 1,000 $ 2,318,241 $ (25,013) $ -- $ 2,294,228
Net income............................... -- -- 377,445 -- -- 377,445
--------- --------- ----------- --------- --------- -----------
Balance, December 31, 1993................. 1,000 1,000 2,695,686 (25,013) -- 2,671,673
Net income............................... -- -- 128,803 -- -- 128,803
Dividends paid........................... -- -- (80,000) -- -- (80,000)
--------- --------- ----------- --------- --------- -----------
Balance, December 31, 1994................. 1,000 1,000 2,744,489 (25,013) -- 2,720,476
Net income............................... -- -- 1,460,162 -- -- 1,460,162
Dividends paid........................... -- -- (40,000) -- -- (40,000)
--------- --------- ----------- --------- --------- -----------
Balance, December 31, 1995................. 1,000 1,000 4,164,651 (25,013) -- 4,140,638
Net income (unaudited)................... -- -- 374,437 -- -- 374,437
Purchase of treasury stock (unaudited)... (660) -- -- (141,700) -- (141,700)
Sale of treasury stock (unaudited)....... 660 -- -- 141,700 (70,350) 71,350
--------- --------- ----------- --------- --------- -----------
Balance, September 30, 1996 (unaudited).... 1,000 $ 1,000 $ 4,539,088 $ (25,013) $ (70,350) $ 4,444,725
========= ========= =========== ========= ========= ===========
</TABLE>
See accompanying notes.
F-27
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
--------------------------------- ----------------------
1993 1994 1995 1995 1996
--------- --------- ----------- ----------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income......................................... $ 377,445 $ 128,803 $ 1,460,162 $ 774,082 $ 374,437
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation................................... 126,889 124,304 133,450 84,869 98,972
Changes in assets and liabilities:
Accounts receivable.......................... (161,437) (167,932) (1,664,688) (900,289) 383,363
Inventories.................................. -- -- 6,100 -- --
Due from related parties..................... (39,629) 92,356 57,716 (580,214) --
Prepaid expenses............................. (112,300) (71,379) 124,359 176,117 122,793
Other assets................................. 6,927 (409) (16,695) (142,588) 2,868
Accounts payable............................. 9,900 14,321 120,017 90,228 (151,995)
Accrued compensation and benefits............ 6,684 32,695 (36,071) 42,692 79,025
Other accrued expenses....................... 11,697 (14,307) 1,975 34,766 (2,863)
Due to related parties....................... -- -- -- 58,885 26,656
Accrued profit sharing contribution.......... 30,225 97,423 85,421 19,602 39,931
Accrued bonuses.............................. -- -- -- 2,581,783 --
--------- --------- ----------- ----------- ---------
Net cash provided by operating activities.......... 256,401 235,875 271,746 2,239,933 973,187
INVESTING ACTIVITIES
Sale of investments................................ 75,000 69,631 -- -- --
Purchases of furniture, fixtures and equipment..... (216,383) (39,061) (240,426) (240,862) (44,967)
--------- --------- ----------- ----------- ---------
Net cash provided by (used in) investing
activities....................................... (141,383) 30,570 (240,426) (240,862) (44,967)
FINANCING ACTIVITIES
Proceeds from short-term borrowings................ -- -- 570,000 -- --
Repayment of short-term borrowings................. -- -- (550,000) (550,000) (570,000)
Proceeds from long-term debt....................... -- -- -- -- 200,000
Principal payments on long-term debt............... (47,000) (150,000) -- -- (44,301)
Proceeds from sale of treasury stock............... -- -- -- -- 71,350
Dividends paid..................................... -- (80,000) (40,000) -- --
--------- --------- ----------- ----------- ---------
Net cash used in financing activities.............. (47,000) (230,000) (20,000) (550,000) (342,951)
--------- --------- ----------- ----------- ---------
Net increase in cash and cash equivalents.......... 68,018 36,445 11,320 1,449,071 585,269
Cash and cash equivalents at beginning of year..... 130,420 198,438 234,883 234,883 246,203
--------- --------- ----------- ----------- ---------
Cash and cash equivalents at end of year........... $ 198,438 $ 234,883 $ 246,203 $ 1,683,954 $ 831,472
========= ========= =========== =========== =========
Supplemental noncash operating and financing
activities:
Acquisition of treasury stock for payable to
related parties.............................. $ -- $ -- $ -- $ -- $ 141,700
Sale of treasury stock for note receivable from
stockholder.................................. $ -- $ -- $ -- $ -- $ 70,350
</TABLE>
See accompanying notes.
F-28
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
(INFORMATION PERTAINING TO THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND 1996 AND SUBSEQUENT TO SEPTEMBER 30, 1996 IS UNAUDITED)
1. DESCRIPTION OF THE BUSINESS
Reconstructive Orthopaedic Associates, Inc. (the Company) is an orthopaedic
physician practice which services the surrounding communities of Philadelphia,
Pennsylvania. The Company is organized as a corporation under the laws of the
state of Pennsylvania.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Net revenue is recorded as services are rendered at established rates net
of provision for bad debts, charity and contractual adjustments. Contractual
adjustments arise due to the terms of certain reimbursement and managed care
contracts. Such adjustments represent the difference between charges at
established rates and estimated amounts to be reimbursed to the Company and are
recognized when the services are rendered. Any differences between estimated
contractual adjustments and actual final settlements under reimbursement
contracts are recognized when the final settlements are made.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with original maturities of
three months or less.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost. Depreciation is
determined using the straight-line method over the estimated useful lives of the
assets. The estimated useful lives used are as follows:
Computer equipment and automobiles............................. 5 years
Furniture, fixtures and equipment.............................. 7 years
Leasehold improvements......................................... 15 years
Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts
receivable and certain current liabilities. The carrying amounts reported in the
balance sheets for these items approximate fair value.
Estimated Medical Professional Liability Claims
The Company is insured for medical professional liability claims through an
occurrence-based commercial insurance policy.
Income Taxes
The Company is a Subchapter S corporation under the Internal Revenue Code,
and, accordingly, is not taxed as a separate entity. The Company's taxable
income or loss is allocated to each stockholder and recognized as taxable income
on their individual tax returns.
F-29
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
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 at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
Newly Issued Accounting Standard
The Company has considered the impact of Statement of Financial Accounting
Standards No. 121, 'Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of,' and does not believe that adoption of this
pronouncement would have a significant impact on the Company's financial
statements.
3. ACCOUNTS RECEIVABLE AND NET REVENUE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------
1994 1995
--------- -----------
<S> <C> <C>
Gross patient accounts receivable........................... $6,433,550 $10,952,124
Less allowance for contractual adjustments and
uncollectibles............................................ 3,809,782 6,663,668
---------- -----------
$2,623,768 $ 4,288,456
========== ===========
</TABLE>
Net revenue consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------
1993 1994 1995
---------- ----------- -----------
<S> <C> <C> <C>
Gross patient revenue........................................... $23,996,688 $29,666,524 $39,767,311
Less contractual adjustments and uncollectibles................. 12,094,472 16,341,174 22,217,404
----------- ----------- -----------
$11,902,216 $13,325,350 $17,549,907
=========== =========== ===========
</TABLE>
Concentration of credit risk related to accounts receivable is limited by
the diversity and number of providers, patients and payors.
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment, net consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------
1994 1995
---------- ----------
<S> <C> <C>
Furniture and fixtures........................................ $ 410,185 $ 475,394
Equipment..................................................... 289,715 463,757
Automobiles................................................... 171,432 171,432
Leasehold improvements........................................ 441,294 442,519
---------- ----------
1,312,626 1,553,102
Less accumulated depreciation................................. 802,549 936,049
---------- ----------
Furniture, fixtures and equipment, net........................ $ 510,077 $ 617,053
========== ==========
</TABLE>
F-30
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. LINE OF CREDIT
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1994 1995
-------- --------
<S> <C> <C>
Line of credit with a bank, due on demand, plus interest at
8.50%........................................................... $550,000 $570,000
======== ========
</TABLE>
The Company has a $700,000 line of credit with Mellon Bank, of which
$150,000 and $130,000 was available at December 31, 1994 and 1995, respectively.
Borrowings under the line of credit bear an interest rate equal to 8.50%.
Accounts receivable collateralize the line of credit with the bank.
6. EMPLOYEE BENEFIT PLANS
The Company has a profit sharing plan that covers substantially all of its
employees. Eligible employees may contribute up to 15% of their compensation.
The Company contributes a discretionary amount which is allocated proportionally
based upon the salaries of participating employees. The profit sharing plan
expense was $178,225, $263,898 and $247,894 for the years ended December 31,
1993, 1994 and 1995, respectively.
7. RELATED PARTY TRANSACTIONS
The Company advanced money to certain stockholders in exchange for notes
receivable. As of December 31, 1994, the outstanding balance was $57,716.
8. OPERATING LEASES
The Company leases its office facilities on an annual basis. Rent expense
for the years ended December 31, 1993, 1994 and 1995 totaled $121,259, $126,090
and $121,139, respectively.
9. SUBSEQUENT EVENT
Subsequent to year end, the Company reorganized by repurchasing a portion
of the outstanding common stock from the two existing stockholders and selling
additional common stock to several additional physicians. This transaction had
no effect on the total number of shares outstanding.
Effective November 12, 1996, the Company entered into a tax-free merger
(the Merger) with Specialty Care Network, Inc. (SCN) in a reorganization,
whereby the stockholders of the Company agreed to exchange their outstanding
common stock for 3,169,379 shares of common stock of SCN and $1,537,872 in cash.
In connection with the Merger, SCN will provide administrative services and
manage the non-medical operations of the Company and enter into a long-term
service agreement with the physician stockholders of the Company, pursuant to
which the physicians will continue to provide medical services through a new
entity. In addition, certain of the Company's physician stockholders have
purchased $550,000 of convertible debentures of SCN that are convertible into
common stock of SCN at $1 a share.
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet as of September 30, 1996 and the statements of income,
stockholders' equity and cash flows for the nine months ended September 30, 1995
and 1996 (interim financial statements) have been prepared by management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments necessary for a fair presentation of the
interim results.
F-31
<PAGE>
RECONSTRUCTIVE ORTHOPAEDIC ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
10. UNAUDITED INTERIM FINANCIAL INFORMATION -- (CONTINUED)
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the nine months ended September 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
11. PRO FORMA TAX INFORMATION (UNAUDITED)
As discussed elsewhere in these footnotes, the Company operates under
Subchapter S of the Internal Revenue Code and is not subject to corporate
federal or state income taxes. In connection with the merger with Specialty Care
Network, Inc. (See Note 9), the Subchapter S election was terminated. As a
result, the Company will be subject to federal and state corporate income taxes
subsequent to the termination of the Subchapter S status. The Company had net
operating income for income tax purposes of $413,474, $168,556 and $1,510,336
for the years ended December 31, 1993, 1994 and 1995, respectively. The
corresponding net operating income for income tax purposes for the nine months
ended September 30, 1995 and 1996 were $797,297 and $378,552, respectively. Had
the Company filed federal and state income tax returns as a regular Subchapter C
corporation, the income tax expense under the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, would have
been as follows:
Year ended December 31, 1993........................................ $152,158
Year ended December 31, 1994........................................ 62,029
Year ended December 31, 1995........................................ 555,804
Nine months ended September 30, 1995................................ 293,405
Nine months ended September 30, 1996................................ 139,307
The effect of recognizing the deferred taxes will be included in income
from continuing operations. If the termination of the Subchapter S corporation
status had occurred at September 30, 1996, the net deferred tax liability would
have been approximately $1,280,142.
F-32
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Princeton Orthopaedic Associates, P.A.
We have audited the accompanying balance sheets of Princeton Orthopaedic
Associates, P.A. as of December 31, 1994 and 1995, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, l995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Princeton Orthopaedic
Associates, P.A. as of December 31, 1994 and 1995, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------
Ernst & Young LLP
Denver, Colorado
August 28, 1996
F-33
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
---------------------------- -------------
1994 1995 1996
------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents...................................... $ 63,242 $ 117,277 $ 632,059
Accounts receivable, net....................................... 1,826,429 1,954,380 2,338,764
Prepaid expenses............................................... 360,960 320,025 80,006
Due from related parties....................................... 2,700 49,866 465,924
------------- ------------- -------------
Total current assets............................................. 2,253,331 2,441,548 3,516,753
Furniture, fixtures and equipment, net........................... 1,401,552 1,143,174 934,883
------------- ------------- -------------
Total assets..................................................... $ 3,654,883 $ 3,584,722 $ 4,451,636
============= ============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term note payable...................... $ 70,000 $ 70,000 $ 70,000
Current portion of capital lease obligations................... 69,839 100,038 107,489
Deferred tax liability......................................... 361,170 242,928 251,635
Accounts payable............................................... 102,002 101,810 439,629
Accrued compensation and benefits.............................. 647,377 911,033 1,588,076
Accrued profit sharing contribution 293,529 432,100 300,000
Due to related parties......................................... 17,340 37,924 165,377
Other accrued expenses......................................... 59,853 41,554 --
------------- ------------- -------------
Total current liabilities........................................ 1,621,110 1,937,387 2,922,206
Long-term note payable, less current portion..................... 461,928 391,928 339,428
Capital lease obligations, less current portion.................. 950,735 850,697 769,123
------------- ------------- -------------
Total liabilities................................................ 3,033,773 3,180,012 4,030,757
Commitments
Stockholders' equity:
Common stock, no par value:
Authorized, issued and outstanding
shares--900........................................... -- -- --
Additional paid-in capital............................... 17,308 17,308 17,308
Retained earnings........................................ 853,802 637,402 653,571
Treasury stock........................................... (250,000) (250,000) (250,000)
------------- ------------- -------------
Total stockholders' equity....................................... 621,110 404,710 420,879
------------- ------------- -------------
Total liabilities and stockholders' equity....................... $ 3,654,883 $ 3,584,722 $ 4,451,636
============= ============= =============
</TABLE>
See accompanying notes.
F-34
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
---------------------------------------- -------------------------
1993 1994 1995 1995 1996
------------ ------------ ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue................................. $ 11,552,476 $ 13,561,339 $ 13,298,164 $ 9,842,814 $ 11,152,357
Operating expenses:
Physician compensation.................... 4,273,893 5,194,385 4,968,251 3,854,871 4,084,772
Salaries and benefits..................... 3,904,184 4,099,459 4,057,086 2,758,435 3,350,844
Supplies, general and administrative
expenses................................ 3,623,877 3,837,396 4,235,715 2,937,658 3,464,665
Depreciation and amortization............. 246,815 218,440 258,497 193,872 137,054
------------ ------------ ------------ ----------- ------------
Total operating expenses.................... 12,048,769 13,349,680 13,519,549 9,744,836 11,037,335
------------ ------------ ------------ ----------- ------------
Income (loss) from operations............... (496,293) 211,659 (221,385) 97,978 115,022
Interest expense, net....................... (121,426) (116,288) (113,257) (123,249) (90,146)
------------ ------------ ------------ ----------- ------------
Income (loss) before income taxes........... (617,719) 95,371 (334,642) (25,271) 24,876
Income tax benefit (expense)................ 194,660 (35,385) 118,242 6,608 (8,707)
------------ ------------ ------------ ----------- ------------
Net income (loss)........................... $ (423,059) $ 59,986 $ (216,400) $ (18,663) $ 16,169
============ ============ ============ =========== ============
</TABLE>
See accompanying notes.
F-35
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
NUMBER OF COMMON PAID-IN RETAINED TREASURY
SHARES STOCK CAPITAL EARNINGS STOCK TOTAL
----------- ----------- ----------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992................ 900 $ -- $ 17,308 $ 1,216,875 $ (250,000) $ 984,183
Net loss................................ -- -- -- (423,059) -- (423,059)
----------- ----------- ----------- ----------- ---------- ---------
Balance, December 31, 1993................ 900 -- 17,308 793,816 (250,000) 561,124
Net income.............................. -- -- -- 59,986 -- 59,986
----------- ----------- ----------- ----------- ---------- ---------
Balance, December 31, 1994................ 900 -- 17,308 853,802 (250,000) 621,110
Net loss................................ -- -- -- (216,400) -- (216,400)
----------- ----------- ----------- ----------- ---------- ---------
Balance, December 31, 1995................ 900 -- 17,308 637,402 (250,000) 404,710
Net income (unaudited).................. -- -- -- 16,169 -- 16,169
----------- ----------- ----------- ----------- ---------- ---------
Balance, September 30, 1996............... --
(unaudited)............................. 900 $ -- $ 17,308 $ 653,571 $ (250,000) $ 420,879
=========== =========== =========== =========== ========== =========
</TABLE>
See accompanying notes.
F-36
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
---------------------------------- -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ----------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss).................................... $ (423,059) $ 59,986 $ (216,400) $ (18,663) $ 16,169
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 246,815 218,440 258,497 193,872 137,054
Deferred income tax provision.................... (194,660) 35,385 (118,242) (6,608) 8,707
Changes in assets and liabilities:
Accounts receivable, net....................... 305,886 (245,447) (127,951) (33,928) (384,384)
Due from related parties....................... 7,500 (2,700) (47,166) (103,224) (416,058)
Prepaid expenses............................... (19,219) (10,165) 40,935 270,720 240,019
Due to related parties......................... 29,722 (12,382) 20,584 (17,340) 127,453
Accounts payable............................... (6,332) 48,334 (192) 35,104 337,819
Accrued compensation and benefits.............. 422,642 (217,099) 263,656 811,292 677,043
Accrued profit sharing contribution............ 24,500 (30,971) 138,571 30,471 (132,100)
Other accrued expenses......................... 1,896 47,957 (18,299) (59,853) (41,554)
---------- ---------- ---------- ----------- ----------
Net cash provided by (used in) operating
activities......................................... 395,691 (108,662) 193,993 1,101,843 570,168
INVESTING ACTIVITIES
(Purchases) sales of furniture, fixtures and
equipment, net..................................... (72,073) 7,608 (119) 71,103 71,237
---------- ---------- ---------- ----------- ----------
Net cash provided by (used in) investing
activities......................................... (72,073) 7,608 (119) 71,103 71,237
FINANCING ACTIVITIES
Principal payments on long-term debt and capital
lease obligations.................................. (113,098) (83,600) (139,839) (104,246) (126,623)
---------- ---------- ---------- ----------- ----------
Net cash used in financing activities................ (113,098) (83,600) (139,839) (104,246) (126,623)
---------- ---------- ---------- ----------- ----------
Net increase (decrease) in cash and cash
equivalents........................................ 210,520 (184,654) 54,035 1,068,670 514,782
Cash and cash equivalents at beginning of year....... 37,376 247,896 63,242 63,242 117,277
---------- ---------- ---------- ----------- ----------
Cash and cash equivalents at end of year............. $ 247,896 $ 63,242 $ 117,277 $ 1,131,912 $ 632,059
========== ========== ========== =========== ==========
Supplemental noncash investing activities:
Acquisition of furniture, fixtures and equipment
under capital lease.............................. $ 730,720 $ -- $ -- $ -- $ --
</TABLE>
See accompanying notes.
F-37
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
(INFORMATION PERTAINING TO THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND 1996 AND SUBSEQUENT TO SEPTEMBER 30, 1996 IS UNAUDITED)
1. DESCRIPTION OF BUSINESS
Princeton Orthopaedic Associates, P.A. (the Company) is an orthopaedic
physician practice which services the surrounding communities of Princeton, New
Jersey and effective January 1, 1996, operates an outpatient surgery center. The
Company is organized as a professional corporation under the laws of the state
of New Jersey.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Net revenue is recorded as services are rendered at established rates net
of provision for bad debts, charity, and contractual adjustments. Contractual
adjustments arise due to the terms of certain reimbursement and managed care
contracts. Such adjustments represent the difference between charges at
established rates and estimated amounts to be reimbursed to the Company and are
recognized when the services are rendered. Any differences between estimated
contractual adjustments and actual final settlements under reimbursement
contracts are recognized when the final settlements are made.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of
three months or less.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost, less accumulated
depreciation, and are depreciated using the straight-line method over the
estimated useful lives of the assets. The estimated useful lives are as follows:
Furniture, fixtures and equipment............................ 5-7 years
Leasehold improvements....................................... 15 years
Estimated Medical Professional Liability Claims
The Company is insured for medical professional liability claims through a
retrospectively rated occurrence-based commercial insurance policy.
Income Taxes
Deferred tax liabilities or assets (net of a valuation allowance) are
provided in the financial statements by applying the provisions of applicable
tax laws to measure the deferred tax consequences of temporary differences that
will result in net taxable or deductible amounts in future years as a result of
events recognized in the financial statements in the current or preceding years.
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 at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
F-38
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts
receivable, certain current liabilities and long-term debt. The carrying amounts
reported in the balance sheets for these items approximate fair value.
Newly Issued Accounting Standard
The Company has considered the impact of Statement of Financial Accounting
Standards No. 121, 'Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of,' and does not believe that adoption of this
pronouncement would have a significant impact on the Company's financial
statements.
3. ACCOUNTS RECEIVABLE AND NET REVENUE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------
1994 1995
------------- -------------
<S> <C> <C>
Gross patient accounts receivable..................................... $ 3,168,395 $ 4,011,580
Less allowances for contractual adjustments and uncollectibles........ 1,341,966 2,057,200
------------- -------------
$ 1,826,429 $ 1,954,380
============= =============
</TABLE>
Net revenue consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1993 1994 1995
-------------- -------------- --------------
<S> <C> <C> <C>
Gross patient revenue................................ $ 12,836,084 $ 15,954,516 $ 15,643,395
Less contractual adjustments and uncollectibles...... 1,283,608 2,393,177 2,345,231
-------------- -------------- --------------
$ 11,552,476 $ 13,561,339 $ 13,298,164
============== ============== ==============
</TABLE>
Concentration of credit risk related to accounts receivable is limited by
the diversity and number of providers, patients and payors.
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------
1994 1995
------------- -------------
<S> <C> <C>
Purchased and leased furniture, fixtures and equipment................ $ 2,046,840 $ 2,046,959
Leasehold improvements................................................ 516,268 516,268
------------- -------------
2,563,108 2,563,227
Less accumulated depreciation and amortization........................ 1,161,556 1,420,053
------------- -------------
$ 1,401,552 $ 1,143,174
============= =============
</TABLE>
F-39
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. NOTE PAYABLE
Note payable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1994 1995
----------- -----------
<S> <C> <C>
Note payable, due in monthly installments of $5,833 plus interest at 8.5%,
collateralized by certain equipment..................................... $ 531,928 $ 461,928
Less current portion...................................................... 70,000 70,000
----------- -----------
$ 461,928 $ 391,928
=========== ===========
</TABLE>
At December 31, 1995, the aggregate maturities of the note payable are as
follows: 1996--$70,000; 1997--$70,000; 1998--$70,000; 1999--$251,928.
Interest expense approximates interest paid.
6. BENEFIT PLANS
The Company has a 401(k) plan and a defined contribution pension plan
covering all full-time employees with one year or more of service. Prior to
1994, the Company maintained a profit sharing plan. Effective in 1994, the
Company terminated the profit sharing plan and adopted the 401(k) plan.
Contributions under the 401(k) plan are determined annually by the Board of
Directors. The pension plan contribution is mandatory and is based upon a fixed
percentage of an employee's annual salary. The retirement plan expenses were
$423,500, $549,592 and $444,992 for the years ended December 31, 1993, 1994 and
1995, respectively.
7. INCOME TAXES
Significant components of the Company's deferred tax liabilities and assets
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1994 1995
----------- -----------
<S> <C> <C>
Deferred tax liabilities:
Capitalized lease............................................... $ -- $ 12,052
Cash-to-accrual adjustment...................................... 485,423 469,967
----------- -----------
Total deferred tax liabilities............................... 485,423 482,019
----------- -----------
Deferred tax assets:
Capitalized leases.............................................. 12,395 --
Net operating loss carryforward................................. 15,837 99,507
Depreciation and amortization................................... 96,021 139,584
----------- -----------
Total deferred tax assets.................................... 124,253 239,091
Valuation allowance for deferred tax assets....................... -- --
----------- -----------
Net deferred tax assets........................................... 124,253 239,091
----------- -----------
Net deferred tax liabilities...................................... $ 361,170 $ 242,928
=========== ===========
</TABLE>
The (provision for) benefit from income taxes is comprised of the
following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------
1993 1994 1995
----------- ---------- -----------
<S> <C> <C> <C>
Current.............................................. $ -- $ -- $ --
Deferred............................................. 194,660 (35,385) 118,242
----------- ---------- -----------
Total................................................ $ 194,660 $ (35,385) $ 118,242
=========== ========== ===========
</TABLE>
F-40
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. INCOME TAXES -- (CONTINUED)
At December 31, 1995, the Company has aggregate net operating loss
carryforwards of $284,308 for federal tax reporting purposes, which expire
through 2010, if not utilized.
The difference between the actual income tax provision and the tax
provision computed by applying the statutory Federal income tax rate to earnings
before taxes is attributable to the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------
1994 1995
--------- ------------
<S> <C> <C>
Expected provision for (benefit from) federal income taxes at
statutory rate of 35%........................................... $ 33,380 $ (117,125)
Other, net........................................................ 2,005 (1,117)
--------- ------------
Income tax (benefit) expense...................................... $ 35,385 $ (118,242)
========= ============
</TABLE>
8. LEASES
The Company leases certain equipment under capitalized leases. The cost of
such equipment at both December 31, 1994 and 1995 was $985,158. Accumulated
amortization was $238,714 and $345,349 at December 31, 1994 and 1995,
respectively.
The Company also leases office and clinic space under noncancelable lease
arrangements. Future minimum payments under capital and noncancelable operating
leases are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------------- --------------
<S> <C> <C>
1996........................................................ $ 187,200 $ 1,203,430
1997........................................................ 187,200 1,203,430
1998........................................................ 187,200 1,203,430
1999........................................................ 187,200 1,203,430
2000........................................................ 187,200 1,203,430
Thereafter.................................................. 374,400 9,589,883
------------- --------------
Total minimum lease payments................................ 1,310,400 $ 15,607,033
==============
Less amount representing interest........................... (359,665)
-------------
Present value of net minimum lease payments................. 950,735
Less current portion........................................ 100,038
-------------
Long-term portion........................................... $ 850,697
=============
</TABLE>
The Company leases office space from various partnerships whose partners
are officers and shareholders of the Company. Rent expense, substantially all to
related parties, for the years ended December 31, 1993, 1994 and 1995 totaled
$978,873, $1,055,884 and $1,295,037, respectively.
9. SUBSEQUENT EVENTS
In January 1996, the Company entered into additional equipment leases. The
aggregate payments on these leases are as follows: 1996--$55,643; 1997--$63,758;
1998--$73,522; 1999--$90,166; 2000--$76,635; thereafter--$235,299.
Effective November 12, 1996, the stockholders of the Company entered into a
tax-free exchange (the Exchange) with Specialty Care Network Inc. (SCN) in a
reorganization, whereby the stockholders of the Company agreed to exchange their
outstanding common stock for 1,196,793 shares of common stock of SCN. In
connection with the Exchange, SCN will provide administrative services and
manage the non-medical operations of the Company and enter into a long-term
service agreement with the
F-41
<PAGE>
PRINCETON ORTHOPAEDIC ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
9. SUBSEQUENT EVENTS -- (CONTINUED)
physician stockholders of the Company, pursuant to which the physicians will
continue to provide medical services through a new entity. In addition, certain
of the Company's physician stockholders have purchased $310,000 of convertible
debentures of SCN that are convertible into common stock of SCN at $1 a share.
Before this exchange net assets of the outpatient surgery center of
approximately $577,000 were distributed to the shareholders
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet at September 30, 1996 and the statements of operations,
stockholders' equity and cash flows for the nine months ended September 30, 1995
and 1996 (interim financial statements) have been prepared by management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the nine months ended September 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-42
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Tallahassee Orthopedic Clinic, Inc.
We have audited the accompanying balance sheets of Tallahassee Orthopedic
Clinic, Inc. as of December 31, 1994 and 1995, and the related statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, l995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Tallahassee Orthopedic Clinic,
Inc. as of December 31, 1994 and 1995, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
-------------------------------------
Ernst & Young LLP
Denver, Colorado
October 15, 1996
F-43
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
------------------------ ------------
1994 1995 1996
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 133,122 $ 74,803 $ 647,863
Accounts receivable, net.......................................... 2,391,173 2,248,046 2,611,574
Inventories....................................................... 22,210 55,720 68,224
Prepaid expenses and other current assets......................... 62,858 93,902 180,677
Due from related parties.......................................... 354,254 952,862 815,341
----------- ----------- -----------
Total current assets................................................ 2,963,617 3,425,333 4,323,679
Furniture, fixtures and equipment, net.............................. 142,042 2,044,174 1,744,788
Other assets........................................................ 138,595 12,110 9,540
----------- ----------- -----------
Total assets........................................................ $ 3,244,254 $ 5,481,617 $ 6,078,007
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable...................................................... $ -- $ 400,000 $ 400,000
Current portion of long-term debt................................. -- 389,218 409,708
Current portion of capital lease obligations...................... -- 52,797 49,976
Accounts payable.................................................. 142,006 261,030 113,613
Accrued compensation and benefits................................. 237,851 228,954 211,551
Accrued profit sharing contribution............................... 338,354 415,444 427,072
Accrued interest expense.......................................... -- 13,915 7,304
Due to related parties............................................ 207,851 27,718 201,173
----------- ----------- -----------
Total current liabilities........................................... 926,062 1,789,076 1,820,397
Long-term debt, less current portion................................ -- 1,211,857 896,077
Capital lease obligations, less current portion..................... -- 223,008 189,119
----------- ----------- -----------
Total liabilities................................................... 926,062 3,223,941 2,905,593
Commitments
Stockholders' equity:
Common stock, $1 par value:
Authorized 5,000 shares, issued and outstanding shares --
900 in 1994 and 1,100 in 1995............................ 900 1,100 1,100
Additional paid-in capital.................................. 157,221 202,473 213,786
Retained earnings........................................... 2,160,071 2,263,880 3,167,305
Treasury stock.............................................. -- (209,777) (209,777)
----------- ----------- -----------
Total stockholders' equity........................................ 2,318,192 2,257,676 3,172,414
----------- ----------- -----------
Total liabilities and stockholders' equity........................ $ 3,244,254 $ 5,481,617 $ 6,078,007
=========== =========== ===========
</TABLE>
See accompanying notes.
F-44
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
----------------------------------- -----------------------
1993 1994 1995 1995 1996
---------- ---------- ----------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue............................ $8,040,293 $9,455,216 $10,420,265 $7,470,881 $10,053,710
Operating expenses:
Physician compensation............... 2,910,131 3,562,535 3,473,978 2,597,561 3,052,624
Salaries and benefits................ 2,700,058 3,194,994 4,028,185 2,993,544 3,453,082
Supplies, general and administrative
expenses.......................... 2,146,522 2,308,263 2,471,876 1,847,229 2,133,338
Depreciation and amortization........ 22,459 38,063 224,054 168,041 394,337
---------- ---------- ----------- ---------- -----------
Total operating expenses............... 7,779,170 9,103,855 10,198,093 7,606,375 9,033,381
---------- ---------- ----------- ---------- -----------
Income (loss) from operations.......... 261,123 351,361 222,172 (135,494) 1,020,329
Interest expense....................... -- -- (118,363) (32,116) (116,904)
---------- ---------- ----------- ---------- -----------
Net income (loss)...................... $ 261,123 $ 351,361 $ 103,809 $ (167,610) $ 903,425
========== ========== =========== ========== ===========
</TABLE>
See accompanying notes.
F-45
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NUMBER ADDITIONAL
OF COMMON PAID-IN RETAINED TREASURY
SHARES STOCK CAPITAL EARNINGS STOCK TOTAL
--------- --------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992................. 600 $ 600 $ 89,343 $ 1,547,587 $ -- $ 1,637,530
Net income............................... -- -- -- 261,123 -- 261,123
Stock issued............................. 200 200 -- -- -- 200
-------- -------- ---------- ----------- ---------- -----------
Balance, December 31, 1993................. 800 800 89,343 1,808,710 -- 1,898,853
Net income............................... -- -- -- 351,361 -- 351,361
Stock issued............................. 100 100 -- -- -- 100
Additional contributed capital........... -- -- 67,878 -- -- 67,878
-------- -------- ---------- ----------- ---------- -----------
Balance, December 31, 1994................. 900 900 157,221 2,160,071 -- 2,318,192
Net income............................... -- -- 103,809 -- 103,809
Stock issued............................. 200 200 -- -- -- 200
Additional contributed capital........... -- -- 45,252 -- -- 45,252
Treasury stock purchased................. -- -- -- -- (209,777) (209,777)
-------- -------- ---------- ----------- ---------- -----------
Balance, December 31, 1995................. 1,100 1,100 202,473 2,263,880 (209,777) 2,257,676
Net income (unaudited)................... -- -- -- 903,425 -- 903,425
Additional contributed capital
(unaudited)............................ -- -- 11,313 -- -- 11,313
-------- -------- ---------- ----------- ---------- -----------
Balance, September 30, 1996 (unaudited).... 1,100 $ 1,100 $ 213,786 $ 3,167,305 $ (209,777) $ 3,172,414
======== ======== ========= =========== ========== ===========
</TABLE>
See accompanying notes.
F-46
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
--------------------------------- ---------------------
1993 1994 1995 1995 1996
---------- --------- ---------- ---------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)......................................... $ 261,123 $ 351,361 $ 103,809 $ (167,610) $ 903,425
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 22,459 38,063 224,054 168,041 394,337
Changes in assets and liabilities:
Accounts receivable, net.............................. (48,024) (321,378) 143,127 136,811 (363,528)
Inventories........................................... (4,487) (6,385) (33,510) (25,133) (12,504)
Prepaid expenses and other current assets............. 57,040 (34,948) (31,044) (30,109) (86,775)
Due from related parties.............................. (294,163) (22,366) (598,608) (419,070) 137,521
Other assets.......................................... -- (138,595) 126,485 125,295 2,570
Accounts payable...................................... 29,125 58,441 119,024 49,525 (147,417)
Accrued compensation and benefits..................... 7,914 79,692 (8,897) 99,735 (17,403)
Accrued profit sharing contribution................... (83,103) 56,151 77,090 (12,095) 11,628
Accrued interest expense.............................. -- -- 13,915 -- (6,611)
Due to related parties................................ (48,000) 103,101 (180,133) (175,231) 173,455
---------- --------- ---------- ---------- ---------
Net cash provided by (used in) operating activities....... (100,116) 163,137 (44,688) (249,841) 988,698
INVESTING ACTIVITIES
Purchases of furniture, fixtures and equipment............ (34,420) (118,730) (1,830,466) (1,759,209) (94,951)
---------- --------- ---------- ---------- ---------
Net cash used in investing activities..................... (34,420) (118,730) (1,830,466) (1,759,209) (94,951)
FINANCING ACTIVITIES
Proceeds from long-term debt.............................. -- -- 1,500,000 1,500,000 --
Proceeds from note payable................................ -- -- 400,000 400,000 --
Principal payments on long-term debt and capital lease
obligations............................................. -- -- (128,617) (14,311) (332,000)
Additional stock and contributed capital.................. 200 67,978 45,452 45,452 11,313
---------- --------- ---------- ---------- ---------
Net cash provided by (used in) financing activities....... 200 67,978 1,816,835 1,931,141 (320,687)
---------- --------- ---------- ---------- ---------
Net increase (decrease) in cash and cash equivalents...... (134,336) 112,385 (58,319) (77,909) 573,060
Cash and cash equivalents at beginning of year............ 155,073 20,737 133,122 133,122 74,803
---------- --------- ---------- ---------- ---------
Cash and cash equivalents at end of year.................. $ 20,737 $ 133,122 $ 74,803 $ 55,213 $ 647,863
========== ========= ========== ========== =========
Supplemental noncash investing and financing activities:
Acquisition of furniture, fixtures and equipment under
capital lease obligations............................. $ -- $ -- $ 295,720 $ 150,059 $ --
Purchase of treasury stock for long-term debt........... $ -- $ -- $ 209,777 $ 209,777 $ --
</TABLE>
See accompanying notes.
F-47
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
(INFORMATION PERTAINING TO THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 AND
SUBSEQUENT TO SEPTEMBER 30, 1996 IS UNAUDITED)
1. DESCRIPTION OF THE BUSINESS
Tallahassee Orthopedic Clinic, Inc. is an orthopedic physician practice
which services the surrounding communities in northern Florida, southern Georgia
and southern Alabama. The Company is organized as a professional corporation
under the laws of the state of Florida.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Net revenue is recorded as services are rendered at established rates net
of provision for bad debts, charity, and contractual adjustments. Contractual
adjustments arise due to the terms of certain reimbursement and managed care
contracts. Such adjustments represent the difference between charges at
established rates and estimated amounts to be reimbursed to the Company and are
recognized when the services are rendered. Any differences between estimated
contractual adjustments and actual final settlements under reimbursement
contracts are recognized when the final settlements are made.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of
three months or less.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost, less accumulated
depreciation, and are depreciated using the straight-line method over the
estimated useful lives of the assets, ranging from five to seven years.
Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts
receivable, certain current liabilities and long-term debt. The carrying amounts
reported in the balance sheets for these items approximate fair value.
Estimated Medical Professional Liability Claims
The Company is insured for medical professional liability claims through a
retrospectively rated claims-made commercial insurance policy.
Income Taxes
The Company is a Subchapter S corporation under the Internal Revenue Code,
and, accordingly, is not taxed as a separate entity. The Company's taxable
income or loss is allocated to each stockholder and recognized as taxable income
on their individual tax returns.
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 at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
F-48
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Newly Issued Accounting Standard
The Company has considered the impact of Statement of Financial Accounting
Standards No. 121, 'Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of,' and does not believe that adoption of this
pronouncement would have a significant impact on the Company's financial
statements.
3. ACCOUNTS RECEIVABLE AND NET REVENUE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------
1994 1995
---------- ----------
<S> <C> <C>
Gross patient accounts receivable............................. $4,899,975 $4,893,690
Less allowances for contractual adjustments and
uncollectibles.............................................. 2,508,802 2,645,644
---------- ----------
$2,391,173 $2,248,046
========== ==========
</TABLE>
Net revenue consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------
1993 1994 1995
----------- ----------- -----------
<S> <C> <C> <C>
Gross patient revenue................................ $12,909,244 $16,252,825 $18,394,960
Less contractual adjustments and uncollectibles...... 4,868,951 6,797,609 7,974,695
----------- ----------- -----------
$ 8,040,293 $ 9,455,216 $10,420,265
=========== =========== ===========
</TABLE>
Concentration of credit risk related to accounts receivable is limited by
the diversity and number of providers, patients and payors.
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1994 1995
-------- ----------
<S> <C> <C>
Furniture and fixtures.......................................... $ 79,417 $ 149,728
Equipment....................................................... 337,250 2,340,706
Computer software............................................... 48,003 100,522
-------- ----------
464,670 2,590,956
Less accumulated depreciation and amortization.................. 322,628 546,782
-------- ----------
$142,042 $2,044,174
======== ==========
</TABLE>
F-49
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. NOTE PAYABLE AND LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1994 1995
-------- ----------
<S> <C> <C>
Note payable to a bank, due in monthly installments of $38,768
including interest at .5% plus the First Union National Bank's
prime rate, maturing in May 1999.............................. $ -- $1,391,298
Note payable to former shareholder, due in monthly installments
of $6,250 including interest at 8.5%, maturing in June 1999... -- 209,777
-------- ----------
-- 1,601,075
Less current portion............................................ -- 389,218
-------- ----------
$ -- $1,211,857
======== ==========
</TABLE>
At December 31, 1995, the aggregate maturities of long-term debt are as
follows: 1996-$389,218; 1997-$445,573; 1998-$489,111; 1999-$277,173.
The proceeds from the First Union National Bank note, along with additional
contributed capital in 1995 and 1994 from all physician shareholders, was used
to purchase a Magnetic Resonance Imaging unit.
In September 1995, the Company borrowed $400,000 in the form of a note from
Barnett Bank of Tallahassee. Principal was due in one payment when the note
matured on September 8, 1996. This payment was not made by the Company. Barnett
Bank extended the note to December 8, 1996. Interest is payable quarterly
beginning December 1995 at an interest rate equal to .25% plus the bank's prime
rate. Borrowings are collateralized by the assets of the Company.
Interest paid for the year ended December 31, 1995 was $104,448.
6. EMPLOYEE BENEFIT PLANS
The Company has a profit sharing plan that covers all employees that have
completed a year of service and have attained the age of 21. The Company
contributes a discretionary amount which is allocated proportionately based upon
the salaries of participating employees. The profit sharing plan expense was
$312,248, $344,456 and $429,682 for the years ended December 31, 1993, 1994 and
1995, respectively.
7. RELATED PARTY TRANSACTIONS
Due from related parties consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1994 1995
-------- --------
<S> <C> <C>
Officer salary advances........................................... $ 89,046 $203,160
Due from Tallahassee Orthopedic Center, L.C....................... 195,208 688,702
Due from Haney, Henderson et al Rental Partnership................ 70,000 61,000
-------- --------
$354,254 $952,862
======== ========
</TABLE>
F-50
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. RELATED PARTY TRANSACTIONS -- (CONTINUED)
Due to related parties consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1994 1995
------- --------
<S> <C> <C>
Due to TOC Imaging, Inc........................................... $ 57,122 $18,968
Consulting fees payable........................................... 60,750 8,750
Advances from officers............................................ 89,979 --
-------- -------
$207,851 $27,718
======== =======
</TABLE>
The Company leases its primary facility from Tallahassee Orthopedic Center,
L.C. which is controlled by the shareholders. Rent expense resulting from this
lease for the years ended December 1, 1993, 1994 and 1995 was $451,831, $520,626
and $579,765, respectively.
8. LEASES
The Company leases certain equipment under capitalized leases. The cost and
net book value of such equipment at December 31, 1995 was $295,720.
The Company also leases office and clinic space under noncancelable lease
arrangements. Future minimum payments under capital and noncancelable operating
leases are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
1996............................................................ $ 75,779 $ 322,253
1997............................................................ 69,972 590,394
1998............................................................ 69,972 590,394
1999............................................................ 69,972 590,394
2000............................................................ 55,333 567,844
Thereafter...................................................... -- 5,360,883
-------- ----------
Total minimum lease payments.................................... 341,028 $8,022,162
==========
Less amount representing interest............................... (65,223)
--------
Present value of net minimum lease payments..................... 275,805
Less current portion............................................ 52,797
--------
Long-term portion............................................... $223,008
========
</TABLE>
The Company leases its office facilities on an annual basis. Rent expense,
substantially all to related parties, for the years ended December 31, 1993,
1994 and 1995 totaled $560,779, $521,894 and $630,715, respectively.
9. SUBSEQUENT EVENT
Effective November 12, 1996, the Company entered into a tax-free merger
(the Merger) with Specialty Care Network, Inc. (SCN) in a reorganization,
whereby the stockholders of the Company agreed to exchange their outstanding
common stock for 1,072,414 shares of common stock of SCN. In connection with the
Merger, SCN will provide administrative services and manage the non-medical
operations of the Company and enter into a long-term service agreement with the
physician stockholders of the Company, pursuant to which the physicians will
continue to provide medical
F-51
<PAGE>
TALLAHASSEE ORTHOPEDIC CLINIC, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
9. SUBSEQUENT EVENT -- (CONTINUED)
services through a new entity. In addition, certain of the Company's physician
stockholders have purchased $300,000 of convertible debentures of SCN at $3 a
share.
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet at September 30, 1996 and the statements of income,
stockholders' equity and cash flows for the nine months ended September 30, 1995
and 1996 (interim financial statements) have been prepared by management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the nine months ended September 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
11. PRO FORMA TAX INFORMATION (UNAUDITED)
As discussed elsewhere in these footnotes, the Company operates under
Subchapter S of the Internal Revenue Code and is not subject to corporate
federal or state income taxes. In connection with the merger with Specialty Care
Network, Inc. (see Note 9), the Subchapter S election was terminated. As a
result, the Company will be subject to federal and state corporate income taxes
subsequent to the termination of the Subchapter S status. The Company had net
operating income for income tax purposes of $270,890, $370,548 and $139,549 for
the years ended December 31, 1993, 1994 and 1995, respectively. The
corresponding net operating income (loss) for income tax purposes for the nine
months ended September 30, 1995 and 1996 was $(140,805) and $924,198,
respectively. Had the Company filed federal and state income tax returns as a
regular Subchapter C corporation, the income tax expense (benefit) under the
provisions of Statement of Financial Accounting Standards No. 109, Accounting
for Income Taxes, would have been as follows:
Year ended December 31, 1993............................. $104,645
Year ended December 31, 1994............................. 143,143
Year ended December 31, 1995............................. 53,908
Nine months ended September 30, 1995..................... (54,393)
Nine months ended September 30, 1996..................... 357,018
At the date of termination of the Subchapter S corporation status, the
Company will be required to provide deferred taxes for the cumulative temporary
differences between financial reporting and tax reporting bases of assets and
liabilities. Such deferred taxes will be based on the cumulative temporary
differences at the date of termination of the Subchapter S corporation status.
The effect of recognizing the deferred taxes will be included in income
from continuing operations. If the termination of the Subchapter S corporation
status had occurred at September 30, 1996, the net deferred tax liability would
have been approximately $1,045,422.
F-52
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Greater Chesapeake Orthopaedic Associates, LLC
We have audited the accompanying balance sheets of Greater Chesapeake
Orthopaedic Associates, LLC as of December 31, 1994 and 1995, and the related
statements of operations, members' equity, and cash flows for the period October
17, 1994 (inception) through December 31, 1994 and the year ended December 31,
1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Greater Chesapeake Orthopaedic
Associates, LLC as of December 31, 1994 and 1995, and the results of its
operations and its cash flows for the period October 17, 1994 (inception)
through December 31, 1994 and the year ended December 31, 1995, in conformity
with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
-------------------------------
Ernst & Young LLP
Denver, Colorado
October 11, 1996
F-53
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
1994 1995 1996
------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 12,025 $ 150,217 $ 448,196
Accounts receivable, net............................... 1,056,949 1,257,081 1,136,958
Prepaid expenses....................................... 45,920 229,424 49,892
------------- ------------- -------------
Total current assets 1,114,894 1,636,722 1,635,046
Furniture, fixtures and equipment, net................... -- 20,187 18,992
Intangibles, net......................................... 35,578 28,153 22,584
------------- ------------- -------------
Total assets............................................. $ 1,150,472 $ 1,685,062 $ 1,676,622
============= ============= =============
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 20,224 $ 19,340 $ 30,287
Accrued compensation and benefits...................... 982,391 1,313,971 1,431,935
Due to related parties................................. 66,359 72,682 122,932
------------- ------------- -------------
Total current liabilities................................ 1,068,974 1,405,993 1,585,154
Commitments
Members' equity.......................................... 81,498 279,069 91,468
------------- ------------- -------------
Total liabilities and members' equity.................... $ 1,150,472 $ 1,685,062 $ 1,676,622
============= ============= =============
</TABLE>
See accompanying notes.
F-54
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
OCTOBER 17,
1994
(INCEPTION)
THROUGH YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1994 1995 1995 1996
------------- ------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net revenue........................................ $ 1,542,250 $ 8,207,951 $ 5,855,525 $ 6,208,360
Operating expenses:
Physician compensation........................... 1,387,789 6,432,601 4,567,310 4,580,750
Salaries and benefits............................ 200,941 1,113,570 838,811 948,270
Supplies, general and administrative expenses.... 238,485 1,003,915 773,756 965,778
Depreciation and amortization.................... 1,547 12,338 8,127 12,205
------------- ------------- -------------- --------------
Total operating expenses........................... 1,828,762 8,562,424 6,188,004 6,507,003
Loss from operations............................... (286,512) (354,473) (332,479) (298,643)
Interest income (expense), net..................... 205 5,294 18,183 26,575
------------- ------------- -------------- --------------
Net loss........................................... $ (286,717) $ (349,179) $ (314,296) $ (272,068)
============= ============= ============== ==============
</TABLE>
See accompanying notes.
F-55
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
STATEMENTS OF MEMBERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED TOTAL
MEMBER EARNINGS MEMBERS'
CONTRIBUTIONS (DEFICIT) EQUITY
------------ ------------- -------------
<S> <C> <C> <C>
Balance, October 17, 1994................................. $ -- $ -- $ --
Contributions from members.............................. 368,215 -- 368,215
Net loss................................................ -- (286,717) (286,717)
------------ ------------- -------------
Balance, December 31, 1994................................ 368,215 (286,717) 81,498
Contributions from members.............................. 546,750 -- 546,750
Net loss................................................ -- (349,179) (349,179)
------------ ------------- -------------
Balance, December 31, 1995................................ 914,965 (635,896) 279,069
Contributions from members
(unaudited).......................................... 84,467 -- 84,467
Net loss (unaudited).................................... -- (272,068) (272,068)
------------ ------------- -------------
Balance, September 30, 1996
(unaudited)............................................. $ 999,432 $ (907,964) $ 91,468
========== ============= =============
</TABLE>
See accompanying notes.
F-56
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
OCTOBER 17,
1994
(INCEPTION)
THROUGH YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1994 1995 1995 1996
--------------- ------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................... $ (286,717) $ (349,179) $ (314,296) $ (272,068)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................ 1,547 12,338 8,127 12,205
Changes in assets and liabilities:
Accounts receivable, net.................. (1,056,949) (200,132) (150,247) 120,123
Other assets.............................. (83,045) (183,504) 672 179,532
Accounts payable.......................... 20,224 (884) (4,195) 10,947
Due to related parties.................... 66,359 6,323 14,906 50,250
Accrued compensation and benefits......... 982,391 331,580 263,346 117,964
--------------- ------------- -------------- --------------
Net cash used in operating activities............. (356,190) (383,458) (181,687) 218,953
INVESTING ACTIVITIES
Purchases of furniture, fixtures and equipment.... -- (25,100) (17,590) (5,441)
--------------- ------------- -------------- --------------
Net cash used in investing activities............. -- (25,100) (17,590) (5,441)
FINANCING ACTIVITIES
Contributions from members........................ 368,215 546,750 356,560 84,467
--------------- ------------- -------------- --------------
Net cash provided by financing activities......... 368,215 546,750 356,560 84,467
--------------- ------------- -------------- --------------
Net increase in cash and cash equivalents......... 12,025 138,192 157,283 297,979
Cash and cash equivalents at beginning of year.... -- 12,025 12,025 150,217
--------------- ------------- -------------- --------------
Cash and cash equivalents at end of year.......... $ 12,025 $ 150,217 $ 169,308 $ 448,196
=============== ============= ============== ==============
</TABLE>
See accompanying notes.
F-57
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A Maryland Limited Liability Company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
(INFORMATION PERTAINING TO THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND 1996 AND SUBSEQUENT TO SEPTEMBER 30, 1996 IS UNAUDITED)
1. DESCRIPTION OF THE BUSINESS
Greater Chesapeake Orthopaedic Associates, LLC (the Company) is an
orthopaedic physician practice which services the surrounding communities of
Baltimore, Maryland. The Company was formed on October 17, 1994, by a group of
eight physicians (the founding members) who desired to form a limited liability
company under the laws of the state of Maryland.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Limited Liability Company (LLC)
An LLC is an unincorporated association of two or more persons, whose
members have limited personal liability for the obligations or debts of the
entity. For federal income tax purposes, the entity is classified as a
partnership.
Under the Company's operating agreement, the Company is dissolved upon the
death, insanity, withdrawal, bankruptcy or expulsion of a member, or the
occurrence of any other event which terminates the continued membership of a
member in the Company (a Dissolution Event), unless a majority of the remaining
members, including in any event, all of the remaining founding members, consent
to the continuation of the business of the Company within 90 days of the
Dissolution Event. Notwithstanding the above, the Company will terminate on
October 17, 2044.
Revenue Recognition
Net revenue is recorded as services are rendered at established rates net
of provision for bad debts, charity, and contractual adjustments. Contractual
adjustments arise due to the terms of certain reimbursement and managed care
contracts. Such adjustments represent the difference between charges at
established rates and estimated amounts to be reimbursed to the Company and are
recognized when the services are rendered. Any differences between estimated
contractual adjustments and actual final settlements under reimbursement
contracts are recognized when the final settlements are made.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of
three months or less.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost, less accumulated
depreciation, and are depreciated using the straight-line method over the
estimated useful lives of the assets, ranging from five to seven years.
F-58
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Intangible Assets
Intangible assets consist of organization costs, and are amortized using
the straight-line method over five years.
Estimated Medical Professional Liability Claims
The Company is insured for medical professional liability claims through a
retrospectively rated claims-made commercial insurance policy.
Physician Compensation
As the Company's Operating Agreement does not separate amounts to be paid
to the member physician owners between member distributions and physician
compensation, all payments to physicians have been classified as physician
compensation.
Income Taxes
No provision for income taxes has been provided since the members report
their distributive shares of income and deductions of the LLC in their personal
capacities, pursuant to election under Subchapter K of the Internal Revenue
Code.
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 at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts
receivable and certain current liabilities. The carrying amounts reported in the
balance sheets for these items approximate fair value.
Newly Issued Accounting Standard
The Company has considered the impact of Statement of Financial Accounting
Standards No. 121, 'Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of,' and does not believe that adoption of this
pronouncement would have a significant impact on the Company's financial
statements.
F-59
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. ACCOUNTS RECEIVABLE AND NET REVENUE
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31
1994 1995
------------- -------------
<S> <C> <C>
Gross patient accounts receivable............................. $ 2,264,890 $ 3,833,238
Less allowances for contractual adjustments and
uncollectibles.............................................. 1,207,941 2,576,157
------------- -------------
$ 1,056,949 $ 1,257,081
============= =============
</TABLE>
Net revenue consists of the following:
<TABLE>
<CAPTION>
OCTOBER 17,
1994
(INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, DECEMBER 31,
1994 1995
------------- --------------
<S> <C> <C>
Gross patient revenue....................................... $ 3,408,509 $ 19,735,533
Less contractual adjustments and uncollectibles............. 1,866,259 11,527,582
------------- --------------
$ 1,542,250 $ 8,207,951
============= ==============
</TABLE>
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31
1994 1995
--------- ---------
<S> <C> <C>
Furniture, fixtures and equipment.................................... $ -- $ 25,100
Less accumulated depreciation and amortization....................... $ -- 4,913
--------- ---------
$ -- $ 20,187
========= =========
</TABLE>
5. LINE OF CREDIT
In November 1995, the Company entered into a $250,000 line of credit with
NationsBank, N.A., all of which was available at December 31, 1995. Any amounts
outstanding under the line of credit mature December 21, 1996. Borrowings under
the line of credit bear an interest rate equal to .75% plus the NationsBank,
N.A. prime rate, published periodically; and borrowings are collateralized by
the assets of the Company.
6. RELATED PARTY TRANSACTIONS
The Company rents the clinic facility and certain equipment from University
Property Management and Associates, LLC (UPM&A). Seven of the eight physician
owners of the Company are the owners of UPM&A. Facility and equipment rent
expense owed to UPM&A was $89,031 and $427,150 for the period October 17, 1994
(inception) through December 31, 1994 and the year ended December 31, 1995,
respectively.
F-60
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. LEASES
The Company leases its clinic facility from UPM&A under a noncancelable
operating lease arrangement. Future minimum payments under noncancelable
operating leases are as follows:
OPERATING
LEASES
----------
1996........................................................... $ 382,959
1997........................................................... 382,959
1998........................................................... 422,260
1999........................................................... 417,431
2000 and thereafter............................................ 3,741,730
----------
Total minimum lease payments................................... $5,347,339
==========
8. SUBSEQUENT EVENT
Effective November 12, 1996, the Company entered into an Asset Exchange
Agreement (the Agreement) with Specialty Care Network Inc. (SCN), whereby the
Company agreed to exchange certain of its assets and liabilities, in exchange
for 1,568,922 shares of common stock of SCN. In connection with the Agreement,
SCN will provide administrative services and manage the non-medical operations
of the Company and enter into a long-term service agreement with the physician
members of the Company, pursuant to which the physicians will continue to
provide medical services.
9. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet at September 30, 1996 and the statements of operations,
member's equity and cash flows for the nine months ended September 30, 1995 and
1996 (interim financial statements) have been prepared by management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the nine months ended September 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
10. PRO FORMA TAX INFORMATION (UNAUDITED)
As discussed elsewhere in these footnotes, the Company is classified as a
partnership for federal income tax purposes and is not subject to corporate
federal or state income taxes. In connection with the Agreement with Specialty
Care Network, Inc. (see Note 8) the Company will be subject to federal and state
corporate income taxes. The Company had net operating loss for income tax
purposes of $286,717 and $347,826 for the period October 17, 1994 (inception)
through December 31, 1994 and the year ended December 31, 1995, respectively.
The corresponding net operating loss for income tax purposes for the nine months
ended September 30, 1995 and 1996 was $314,296 and $533,839, respectively. Had
the Company filed federal and state income tax returns as a regular Subchapter C
corporation, the income tax benefit under the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, would have
been as follows:
F-61
<PAGE>
GREATER CHESAPEAKE ORTHOPAEDIC ASSOCIATES, LLC
(A MARYLAND LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
10. PRO FORMA TAX INFORMATION (UNAUDITED)--(CONTINUED)
Period October 17, 1994 (inception) through December 31, 1994......... $109,669
Year ended December 31, 1995.......................................... 133,043
Nine months ended September 30, 1995.................................. 120,218
Nine months ended September 30, 1996.................................. 204,193
The effect of recognizing the deferred taxes will be included in income
from continuing operations. If the Agreement had been entered into at September
30, 1996, the net deferred tax liability would have been approximately $438,133.
F-62
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Vero Orthopaedics, P.A.
We have audited the accompanying balance sheets of Vero Orthopaedics, P.A. as of
December 31, 1994 and 1995, and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, l995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Vero Orthopaedics, P.A. as of
December 31, 1994 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1995, in conformity
with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------
Ernst & Young LLP
Denver, Colorado
August 20, 1996
F-63
<PAGE>
VERO ORTHOPAEDICS, P.A.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
--------------------------- ------------
1994 1995 1996
------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ...................... $ 65,907 $ 11,464 $ 135,228
Accounts receivable, net ....................... 435,065 592,157 564,425
Due from related parties ....................... 56,108 67,432 40,692
Prepaid expenses ............................... -- -- 32,367
----------- --------- ---------
Total current assets ............................. 557,080 671,053 772,712
Furniture, fixtures and equipment, net ........... 161,106 116,053 72,671
Net assets of discontinued operations ............ 743,395 -- --
Other assets ..................................... 964 1,070 1,070
----------- --------- ---------
Total assets ..................................... $ 1,462,545 $ 788,176 $ 846,453
----------- --------- ---------
----------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term notes payable ..... $ 172,879 $ 203,514 $ 82,000
Current portion of capital lease obligations ... 62,388 62,388 32,808
Accounts payable ............................... -- -- 13,245
Income tax payable ............................. -- -- 107,994
Accrued compensation and benefits .............. 155,860 62,210 40,676
----------- --------- ---------
Total current liabilities ........................ 391,127 328,112 276,723
Deferred tax liability ........................... 71 100,745 124,776
Notes payable, less current portion .............. 265,412 81,899 --
Capital lease obligations, less current portion .. 74,342 20,076 9,747
----------- --------- ---------
Total liabilities ................................ 730,952 530,832 411,246
Commitments
Stockholders' equity:
Common stock, $1 par value:
Authorized, issued and outstanding shares -- 100 100 100 100
Additional paid-in capital ..................... 683,950 683,950 683,950
Retained earnings (deficit) .................... 65,664 (417,268) (242,939)
Less note receivable from stockholder .......... (18,121) (9,438) (5,904)
----------- --------- ---------
Total stockholders' equity ..................... 731,593 257,344 435,207
----------- --------- ---------
Total liabilities and stockholders' equity ....... $ 1,462,545 $ 788,176 $ 846,453
----------- --------- ---------
----------- --------- ---------
</TABLE>
See accompanying notes.
F-64
<PAGE>
VERO ORTHOPAEDICS, P.A.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
1993 1994 1995 1995 1996
-------------- -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue...................... $ 2,545,263 $ 3,204,224 $ 4,208,470 $ 3,179,034 $ 2,953,351
Operating expenses:
Physician compensation......... 1,429,179 1,667,786 2,865,311 1,775,977 1,186,879
Salaries and benefits.......... 515,148 930,246 1,023,481 705,928 828,882
Supplies, general and
administrative expenses..... 683,231 740,494 786,036 603,183 571,716
Depreciation and
amortization................ 34,539 44,184 61,361 29,891 43,382
-------------- -------------- -------------- -------------- --------------
Total operating expenses......... 2,662,097 3,382,710 4,736,189 3,114,979 2,630,859
-------------- -------------- -------------- -------------- --------------
(116,834) (178,486) (527,719) 64,055 322,492
Interest expense, net............ (24,932) (23,779) (20,391) (15,738) (21,460)
Other income (expense), net...... -- (229) 6,460 843 5,322
-------------- -------------- -------------- -------------- --------------
Income (loss) from continuing
operations before income
taxes.......................... (141,766) (202,494) (541,650) 49,160 306,354
Income tax benefit (expense)..... 49,618 69,646 (64,300) (5,021) (132,025)
-------------- -------------- -------------- -------------- --------------
Income (loss) from continuing
operations..................... (92,148) (132,848) (605,950) 44,139 174,329
Discontinued operations:
Income from operations (net of
income tax expense of
$10,500 and $30,874 for the
years ended December 31,
1994 and 1995, respectively
and $27,590 for the nine
months ended September 30,
1995)....................... -- 20,289 111,724 97,821 --
Gain on sale of investment in
discontinued operations (net
of income tax expense of
$5,500)..................... -- -- 11,294 -- --
-------------- -------------- -------------- -------------- --------------
Net income (loss)................ $ (92,148) $ (112,559) $ (482,932) $ 141,960 $ 174,329
-------------- -------------- -------------- -------------- --------------
-------------- -------------- -------------- -------------- --------------
</TABLE>
See accompanying notes.
F-65
<PAGE>
VERO ORTHOPAEDICS, P.A.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NOTE
ADDITIONAL RECEIVABLE
NUMBER OF COMMON PAID-IN RETAINED FROM
SHARES STOCK CAPITAL EARNINGS STOCKHOLDER TOTAL
----------- ----------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992............ 100 $ 100 $ -- $ 270,371 $ -- $ 270,471
Additional contributed capital...... -- -- 30,000 -- -- 30,000
Net loss............................ -- -- -- (92,148) -- (92,148)
----- ----------- ----------- ------------ ------------ ------------
Balance, December 31, 1993............ 100 100 30,000 178,223 -- 208,323
Additional contributed capital...... -- -- 653,950 -- (18,121) 635,829
Net loss............................ -- -- -- (112,559) -- (112,559)
----- ----------- ----------- ------------ ------------ ------------
Balance, December 31, 1994............ 100 100 683,950 65,664 (18,121) 731,593
Note payments....................... -- -- -- -- 8,683 8,683
Net loss............................ -- -- -- (482,932) -- (482,932)
----- ----------- ----------- ------------ ------------ ------------
Balance, December 31, 1995............ 100 100 683,950 (417,268) (9,438) 257,344
Note payments (unaudited)........... -- -- -- -- 3,534 3,534
Net income (unaudited).............. -- -- -- 174,329 -- 174,329
----- ----------- ----------- ------------ ------------ ------------
Balance, September 30, 1996
(unaudited)......................... 100 $ 100 $ 683,950 $ (242,939) $ (5,904) $ 435,207
----- ----------- ----------- ------------ ------------ ------------
----- ----------- ----------- ------------ ------------ ------------
</TABLE>
See accompanying notes.
F-66
<PAGE>
VERO ORTHOPAEDICS, P.A.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31 SEPTEMBER 30
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss............................................ $ (92,148) $ (112,559) $ (482,932) $ 141,960 $ 174,329
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Gain on sale of investment in discontinued
operations.................................... -- -- (16,794) -- --
Depreciation and amortization................... 34,539 44,184 61,361 29,891 43,382
Deferred income tax provision................... (49,618) (59,146) 100,674 100,140 24,031
Changes in assets and liabilities:
Accounts receivable, net...................... 242,170 193,258 (157,092) (54,059) 27,732
Due from related parties...................... 2,308 16,272 (11,324) 1,083 26,740
Prepaid expenses.............................. -- -- -- -- (32,367)
Other assets.................................. (4,549) 3,584 (106) (106) --
Accounts payable.............................. -- -- -- -- 13,245
Accrued compensation and benefits............. (33,110) 83,057 (93,650) (166) (21,534)
Income taxes payable.......................... -- -- -- -- 107,994
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) operating
activities........................................ 99,592 168,650 (599,863) 218,743 363,552
INVESTING ACTIVITIES
Purchases of furniture, fixtures and equipment...... (13,672) -- -- -- --
Net change in investment in discontinued operations
prior to sale..................................... -- -- (6,219) 5,391 --
Proceeds from sale of investment in discontinued
operations........................................ -- -- 750,100 -- --
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) investing
activities........................................ (13,672) -- 743,881 5,391 --
FINANCING ACTIVITIES
Principal payments on long-term debt and capital
lease obligations................................. (103,671) (143,019) (207,144) (164,599) (243,321)
Additional contributed capital...................... 30,000 -- 8,683 -- 3,533
---------- ---------- ---------- ---------- ----------
Net cash used in financing activities............... (73,671) (143,019) (198,461) (164,599) (239,788)
---------- ---------- ---------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents....................................... 12,249 25,631 (54,443) 59,535 123,764
Cash and cash equivalents at beginning of year...... 28,027 40,276 65,907 65,907 11,464
---------- ---------- ---------- ---------- ----------
Cash and cash equivalents at end of year............ $ 40,276 $ 65,907 $ 11,464 $ 125,442 $ 135,228
---------- ---------- ---------- ---------- ----------
Supplemental noncash investing and financing
activities:
Acquisition of furniture, fixtures and equipment
under capital lease........................... $ 237,339 $ -- $ -- $ -- $ --
Purchase of ownership interest for notes
payable....................................... $ -- $ 319,235 $ -- $ -- $ --
</TABLE>
See accompanying notes.
F-67
<PAGE>
VERO ORTHOPAEDICS, P.A.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
(INFORMATION PERTAINING TO THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 AND
SUBSEQUENT TO SEPTEMBER 30, 1996 IS UNAUDITED)
1. DESCRIPTION OF THE BUSINESS
Vero Orthopaedics, P.A. (the Company) is an orthopaedic physician practice
which services the surrounding communities of Vero Beach and Sebastian, Florida.
The Company is organized as a professional corporation under the laws of the
state of Florida.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Net revenue is recorded as services are rendered at established rates net
of provision for bad debts, charity, and contractual adjustments. During the
years ended December 31, 1993, 1994 and 1995, the Company received approximately
75% of its net revenue from Medicare and Medicaid reimbursement programs which
reimburse orthopaedic services on a prospective payment system. Contractual
adjustments arise due to the terms of certain reimbursement and managed care
contracts. Such adjustments represent the difference between charges at
established rates and estimated amounts to be reimbursed to the Company and are
recognized when the services are rendered. Any differences between estimated
contractual adjustments and actual final settlements under reimbursement
contracts are recognized when the final settlements are made.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of
three months or less.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost, less accumulated
depreciation, and are depreciated using the straight-line method over the
estimated useful lives of the assets, ranging from five to seven years.
Estimated Medical Professional Liability Claims
The Company is insured for medical professional liability claims through a
retrospectively rated claims-made commercial insurance policy.
Income Taxes
Deferred tax liabilities or assets (net of a valuation allowance) are
provided in the financial statements by applying the provisions of applicable
tax laws to measure the deferred tax consequences of temporary differences that
will result in net taxable or deductible amounts in future years as a result of
events recognized in the financial statements in the current or preceding years.
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 at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
F-68
<PAGE>
VERO ORTHOPAEDICS, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts
receivable, certain current liabilities and long-term notes payable. The
carrying amounts reported in the balance sheets for these items approximate fair
value.
Newly Issued Accounting Standard
The Company has considered the impact of Statement of Financial Accounting
Standards No. 121, 'Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of,' and does not believe that adoption of this
pronouncement would have a significant impact on the Company's financial
statements.
3. ACCOUNTS RECEIVABLE AND NET REVENUE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1994 1995
----------- -----------
<S> <C> <C>
Gross patient accounts receivable................................. $ 714,155 $ 877,346
Less allowances for contractual adjustments and uncollectibles.... 279,090 285,189
----------- -----------
$ 435,065 $ 592,157
----------- -----------
----------- -----------
</TABLE>
Net revenue consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------------
1993 1994 1995
------------- ------------- -------------
<S> <C> <C> <C>
Gross patient revenue.................................... $ 3,249,198 $ 3,884,516 $ 5,146,178
Less contractual adjustments and
uncollectibles......................................... 703,935 680,292 937,708
------------- ------------- -------------
$ 2,545,263 $ 3,204,224 $ 4,208,470
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1994 1995
----------- -----------
<S> <C> <C>
Furniture, fixtures and equipment................................. $ 332,533 $ 332,533
Less accumulated depreciation and amortization.................... 171,427 216,480
----------- -----------
$ 161,106 $ 116,053
----------- -----------
----------- -----------
</TABLE>
F-69
<PAGE>
VERO ORTHOPAEDICS, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. NOTES PAYABLE
Notes payable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------
1994 1995
----------- -----------
<S> <C> <C>
Notes payable to a bank, due in monthly installments of $6,208
plus interest at .5% plus the Barnett Banks, Inc. prime rate,
maturing in 1997................................................ $ 161,403 $ 86,910
Notes payable to individual, due in monthly installments of $5,700
including interest at 6%, maturing in 1997...................... 143,628 82,174
Notes payable to individual, due in monthly installments of
$4,000, including interest at 6%, maturing in 1997.............. 133,260 96,329
Line of credit.................................................... -- 20,000
----------- -----------
438,291 285,413
Less current portion.............................................. 172,879 203,514
----------- -----------
$ 265,412 $ 81,899
----------- -----------
----------- -----------
</TABLE>
At December 31, 1995, the aggregate maturities of long-term debt are as
follows: 1996 -- $203,514; 1997 -- $81,899.
The Company has a $100,000 line of credit with Barnett Banks, Inc., of
which $80,000 was available at December 31, 1995, that matures December 21,
1996. Borrowings under the line of credit bear an interest rate equal to .5%
plus the Barnett Banks, Inc. prime rate, published periodically, and borrowings
are collateralized by the assets of the Company. Accounts receivable
collateralize the notes payable to the bank.
Interest expense approximates interest paid.
6. BENEFIT PLANS
The Company has a profit sharing plan for its employees. Employees are
eligible to participate if they have completed more than one thousand hours of
service with the Company in a given year and are over the age of eighteen. The
Company contributes a discretionary amount which is allocated proportionally
based upon the salaries of participating employees. The retirement plan expense
was approximately $179,000, $165,000 and $127,000 for the years ended December
31, 1993, 1994 and 1995, respectively.
F-70
<PAGE>
VERO ORTHOPAEDICS, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. INCOME TAXES
Significant components of the Company's deferred tax liabilities and assets
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1994 1995
------- --------
<S> <C> <C>
Deferred tax liabilities:
Capitalized lease................................................ $30,622 $ 46,770
Cash-to-accrual adjustment....................................... 11,813 105,112
------- --------
Total deferred tax liabilities................................ 42,435 151,882
------- --------
Deferred tax assets:
Net operating loss carryforward.................................. 10,018 4,779
Depreciation and amortization.................................... 32,346 46,358
------- --------
Total deferred tax assets..................................... 42,364 51,137
Valuation allowance for deferred tax assets........................ -- --
------- --------
Net deferred tax assets............................................ 42,364 51,137
------- --------
Net deferred tax liabilities....................................... $ 71 $100,745
------- --------
------- --------
</TABLE>
The (provision for) benefit from income taxes is comprised of the
following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1993 1994 1995
--------- --------- ------------
<S> <C> <C> <C>
Current.......................................................... $ -- $ -- $ --
Deferred......................................................... 49,618 59,146 (100,674)
--------- --------- ------------
Total............................................................ $ 49,618 $ 59,146 $ (100,674)
--------- --------- ------------
--------- --------- ------------
</TABLE>
At December 31, 1995, the Company has aggregate net operating loss
carryforwards of $13,653 for federal tax reporting purposes, which expire
beginning 2007 through 2008, if not utilized.
The difference between the actual income tax provision and the tax
provision computed by applying the statutory Federal income tax rate to earnings
before taxes is attributable to the following:
<TABLE>
YEAR ENDED DECEMBER 31
------------------------
1994 1995
---------- ------------
<S> <C> <C>
Expected benefit from federal income taxes at statutory rate of
35%............................................................ $ (70,873) $ (189,578)
Divestitures..................................................... -- 227,330
Other, net....................................................... 1,227 26,548
---------- ------------
Income tax (benefit) expense..................................... $ (69,646) $ 64,300
---------- ------------
---------- ------------
</TABLE>
8. RELATED PARTY TRANSACTIONS
The Company rents the clinic office space and certain equipment from 1260
Associates, L.C. (1260 Corp.). The shareholders of the Company are stockholders
of 1260 Corp. Facility and equipment rent paid to 1260 Corp. was $141,098,
$150,168 and $150,168 for the years ended December 31, 1993, 1994 and 1995,
respectively.
The Company advances money to certain affiliates (1260 Corp. and the
individual stockholders) in exchange for notes receivable. As of December 31,
1993, 1994 and 1995, the amounts receivable are $66,317, $53,495, and $60,753,
respectively, from 1260 Corp. and $6,063, $2,613 and $5,996, respectively, from
the individual stockholders.
On October 1, 1994, the Company financed for a new physician stockholder
the purchase of one-fourth of the issued shares of the Company's stock from
existing stockholders for a note totaling
F-71
<PAGE>
VERO ORTHOPAEDICS, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. RELATED PARTY TRANSACTIONS -- (CONTINUED)
$18,121. Principal and interest payments are due monthly until maturity at
October 20, 1996. The note bears 6% interest. The purchase of these issued
shares from existing stockholders has been reflected as an increase in
additional paid-in capital and the note receivable has been classified as a
reduction of stockholders' equity.
9. LEASES
The Company leases certain equipment under capitalized leases. The cost of
such equipment at both December 31, 1994 and 1995 was $237,339. Accumulated
amortization was $90,673 and $124,578 at December 31, 1994 and 1995,
respectively.
The Company also leases its clinic facility from 1260 Corp. under a
noncancelable operating lease arrangement. Future minimum payments under capital
and noncancelable operating leases are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996............................................................... $62,388 $ 95,040
1997............................................................... 16,448 7,920
1998............................................................... 7,260 --
1999............................................................... 1,815 --
------- --------
Total minimum lease payments....................................... 87,911 $102,960
--------
--------
Less amount representing interest.................................. 5,447
-------
Present value of net minimum lease payments........................ 82,464
Less current portion............................................... 62,388
-------
Long-term portion.................................................. $20,076
-------
-------
</TABLE>
Rent expense for the years ended December 31, 1993, 1994 and 1995 totaled
$92,880, $95,040 and $95,040, respectively.
10. DISCONTINUED OPERATIONS
On December 27, 1995, the Company completed the sale of the net assets and
operations of Vero Physical Therapy (PT) to HealthSouth of Treasure Coast, Inc.
for $750,100. This sale was accounted for as discontinued operations and,
accordingly, the operations and assets sold related to this discontinued
business have been segregated in the accompanying financial statements. Revenues
from the PT operations, originally acquired by the Company in 1994, were
approximately $229,000 and $900,000 for the years ended December 31, 1994 and
1995, respectively. Net assets of discontinued operations are composed primarily
of accounts receivable and goodwill.
11. SUBSEQUENT EVENT
Effective November 12, 1996, the Company entered into a tax-free merger
(the Merger) with Specialty Care Network, Inc. (SCN) in a reorganization,
whereby the stockholders of the Company agreed to exchange their outstanding
common stock for approximately 651,607 shares of common stock of SCN. In
connection with the Merger, SCN will provide administrative services and manage
the non-medical operations of the Company and enter into a long-term service
agreement with the physician stockholders of the Company, pursuant to which the
physicians will continue to provide medical services through a new entity. In
addition, certain of the Company's physician stockholders have purchased
$115,000 of convertible debentures of SCN that are convertible into common stock
of SCN of $1 a share.
F-72
<PAGE>
VERO ORTHOPAEDICS, P.A.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
12. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet at September 30, 1996 and the statements of operations,
stockholders' equity and cash flows for the nine months ended September 30, 1995
and 1996 (interim financial statements) have been prepared by management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the nine months ended September 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-73
<PAGE>
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY TO ANY OF
THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF
THE COMPANY SINCE SUCH DATE.
------------------
TABLE OF CONTENTS
PAGE
--------
Prospectus Summary.............................. 3
Risk Factors.................................... 7
Use of Proceeds................................. 14
Dividend Policy................................. 14
Capitalization.................................. 15
Dilution........................................ 16
Selected Unaudited Financial Data............... 17
Management's Discussion and
Analysis of Financial Condition and
Results of Operations......................... 22
Business........................................ 27
Management...................................... 41
Certain Transactions............................ 48
Principal and Selling Stockholders.............. 50
Description of Capital Stock.................... 52
Shares Eligible for Future Sale................. 53
Underwriting.................................... 54
Notice to Canadian Residents.................... 55
Legal Matters................................... 56
Experts......................................... 56
Additional Information.......................... 56
Index to Financial Statements................... F-1
UNTIL , 1997 (25 DAYS AFTER THE COMMENCEMENT OF THE
OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
[ LOGO ]
3,280,400 Shares
Common Stock
($.001 par value)
PROSPECTUS
CS First Boston
Equitable Securities Corporation
Lehman Brothers
- --------------------------------------------------------------------------------
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Lakewood, Colorado, on December 10,
1996.
SPECIALTY CARE NETWORK, INC.
By: /s/ Kerry R. Hicks
----------------------------------
Kerry R. Hicks
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE
APPEARS BELOW IN SO SIGNING ALSO MAKES, CONSTITUTES AND APPOINTS KERRY R. HICKS,
PATRICK M. JAECKLE AND WILLIAM C. BEHRENS, AND EACH OF THEM, HIS TRUE AND LAWFUL
ATTORNEYS-IN-FACT AND AGENTS, WITH FULL POWER OF SUBSTITUTION AND
RESUBSTITUTION, FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN ANY AND ALL
CAPACITIES, TO EXECUTE AND CAUSE TO BE FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION ANY AND ALL AMENDMENTS AND POST-EFFECTIVE AMENDMENTS TO THIS
REGISTRATION STATEMENT AND A RELATED REGISTRATION STATEMENT THAT IS TO BE
EFFECTIVE UPON FILING PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT OF 1933,
AND IN EACH CASE TO FILE THE SAME, WITH ALL EXHIBITS THERETO AND OTHER DOCUMENTS
IN CONNECTION THEREWITH, AND HEREBY RATIFIES AND CONFIRMS ALL THAT SAID
ATTORNEYS-IN-FACT AND AGENTS OR THEIR SUBSTITUTE OR SUBSTITUTES MAY DO OR CAUSE
TO BE DONE BY VIRTUE HEREOF.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Richard H. Rothman, M.D., Ph.D. Chairman of the Board of December 10, 1996
- ----------------------------------------- Directors
Richard H. Rothman, M.D., Ph.D.
/s/ Kerry R. Hicks Principal Executive Officer December 10, 1996
- ----------------------------------------- and Director
Kerry R. Hicks
/s/ Patrick M. Jaeckle Principal Financial Officer December 10, 1996
- ----------------------------------------- and Director
Patrick M. Jaeckle
/s/ D. Paul Davis Principal Accounting Officer December 10, 1996
- -----------------------------------------
D. Paul Davis
/s/ Robert E. Booth, Jr., M.D. Director December 10, 1996
- -----------------------------------------
Robert E. Booth, Jr., M.D.
/s/ James L. Cain, M.D. Director December 10, 1996
- -----------------------------------------
James L. Cain, M.D.
/s/ Peter H. Cheesbrough Director December 10, 1996
- -----------------------------------------
Peter H. Cheesbrough
/s/ Richard E. Fleming, Jr., M.D. Director December 10, 1996
- -----------------------------------------
Richard E. Fleming, Jr., M.D.
/s/ Thomas C. Haney, M.D. Director December 10, 1996
- -----------------------------------------
Thomas C. Haney, M.D.
/s/ Leslie S. Matthews, M.D. Director December 10, 1996
- -----------------------------------------
Leslie S. Matthews, M.D.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ William C. Behrens Director December 10, 1996
- -----------------------------------------
Wiliam C. Behrens
</TABLE>
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table set forth fees payable to the Securities and Exchange
Commission, National Association of Securities Dealers, Inc. and The Nasdaq
Stock Market and other expenses expected to be incurred in connection with the
issuance and distribution of the securities being registered. All the fees and
expenses will be paid by the Company.
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee......................................... $12,435
National Association of Securities Dealers, Inc. Filing Fee................................. 4,604
The Nasdaq Stock Market Listing Fee......................................................... 50,000
Printing Expenses........................................................................... *
Legal Fees and Expenses..................................................................... *
Accounting Fees and Expenses................................................................ *
Blue Sky Qualification Fees and Expenses (including counsel fees)........................... *
Transfer Agent Fees and Expenses............................................................ *
Miscellaneous Expenses...................................................................... *
---------
Total.................................................................................. *
---------
---------
</TABLE>
- ------------------
*Estimates
14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 102(b)(7) of the Delaware General Corporation Law (the 'DGCL')
permits a corporation, in its certificate of incorporation, to limit or
eliminate, subject to certain statutory limitations, the liability of directors
to the corporation or its stockholders for monetary damages for breaches of
fiduciary duty, except for liability (a) for any breach of the director's duty
of loyalty to the corporation or its stockholders, (b) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation of
law, (c) under Section 174 of the DGCL, or (d) for any transaction from which
the director derived an improper personal benefit. Article 7 of the registrant's
Certificate of Incorporation provides that the personal liability of directors
of the registrant is eliminated to the fullest extent permitted by Section
102(b)(7) of the DGCL.
Under Section 145 of the DGCL, a corporation has the power to indemnify
directors and officers under certain prescribed circumstances and subject to
certain limitations against certain costs and expenses, including attorney's
fees actually and reasonably incurred in connection with any action, suit or
proceeding, whether civil, criminal, administrative or investigative, to which
any of them is a party by reason of being a director or officer of the
corporation if it is determined that the director or officer acted in accordance
with the applicable standard of conduct set forth in such statutory provision.
Article 6 of the registrant's Bylaws provides that the registrant will indemnify
any person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding by reasons of the
fact that he is or was a director, officer, employee or agent of the registrant,
or is or was serving at the request of the registrant as a director, officer,
employee or agent of another entity, against certain liabilities, costs and
expenses. Article 6 further permits the agent of the registrant, or is or was
serving at the request of the registrant as a director, officer, employee or
agent of another entity, against any liability asserted against such person and
incurred by such person in any such capacity or arising out of his status as
such, whether or not the registrant would have the power to indemnify such
person against such liability under the DGCL.
II-1
<PAGE>
15. RECENT SALES OF UNREGISTERED SECURITIES
Since December 22, 1995, the date the Company was incorporated, the Company
has issued and sold the following unregistered securities:
1. On December 25, 1995, the Company issued 1,265,000 shares of Common
Stock to privateinvestors for an aggregate price of $1,265 or $.001 per share.
In addition, on December 22, 1995, 500,000 Shares of Common Stock were issued to
an employee of the Company of which 425,000 shares were returned to the Company
in connection with the termination of such employee's employment with the
Company.
2. From January 15, 1996 through July 1, 1996, the Company issued
$1,869,999 of convertible debentures to private investors for an aggregate price
of $1,870,000. The convertible debentures bore interest at 5% per annum and were
converted at a rate of one share of Common Stock for each $1.00 of indebtedness
into 1,920,222 shares of Common Stock on November 12, 1996.
3. On October 1, 1996, the Company issued Debentures to a private investor
for an aggregate price of $300,000. The convertible debentures bore interest a
5% per annum and were converted at a rate of one share of common stock for each
$3.00 of indebtedness, into 100,569 shares of Common Stock on November 12, 1996.
4. On November 4, 1996, the Company issued 100,000 shares of Common Stock
to a private investor for an aggregate price of $300,000.
The Company believes that the transactions described above were exempt from
registration under Section 4(2) of the Act because the subject securities were
sold to a limited group of persons, each of whom was believed to have been a
sophisticated investor or had a pre-existing business or personal relationship
with the Company or its management and was purchasing for investment without a
view to further distribution. Restrictive legends were placed on stock
certificates evidencing the shares and/or agreements relating to the right to
purchase such shares described above.
16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits. The following exhibits are filed as part of this registration
statement.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
--------- -----------
<S> <C>
1* Form of Underwriting Agreement
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
5* Opinion of Morgan, Lewis & Bockius LLP regarding legality of securities being registered
10.1* Specialty Care Network, Inc. 1996 Equity Compensation Plan
10.2* Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock Option Plan
10.3* Employment Agreement dated as of April 1, 1996 by and between Specialty Care Network, Inc. and Kerry
R. Hicks
10.4* Employment Agreement dated as of April 1, 1996 by and between Specialty Care Network, Inc. and
Patrick M. Jaeckle
10.5* Employment Agreement dated as of March 11, 1996 by and between Specialty Care Network, Inc. and
William Behrens
10.6* Employment Agreement dated as of February 22, 1996 by and between Specialty Care Network, Inc. and
Paul Davis
</TABLE>
II-2
<PAGE>
<TABLE>
<S> <C>
10.7* Employment Agreement dated as of March 1, 1996 by and between Specialty Care Network, Inc. and Peter
A. Fatianow
10.8* Employment Agreement dated as of March 1, 1996 by and between Specialty Care Network, Inc. and David
Hicks
10.9* Merger Agreement dated November 12, 1996 by and among Specialty Care Network, Inc. and Reconstructive
Orthopaedic Assocs., Inc.
10.10* Service Agreement dated as of November 12, 1996 by and between Specialty Care Network, Inc.,
Reconstructive Orthopaedic Associates II, P.C. and Richard H. Rothman, M.D., Robert E. Booth, Jr., M.D.,
Richard Balderston, M.D., Arthur R. Bartolozzi, M.D., William J. Hozack, M.D., Michael G. Ciccotti, M.D.,
Todd J. Albert, M.D., Alexander R. Vaccaro, M.D. and Peter F. Sharkey, M.D.
10.11* Letter agreement dated October 29, 1996 by and between Arthur R. Bartolozzi, M.D. and Specialty Care
Network, Inc.
10.12* Letter agreement dated October 29, 1996 by and between Robert E. Booth, Jr., M.D. and Specialty Care
Network, Inc.
10.13* Letter agreement dated November 11, 1996 by and between Richard H. Rothman, M.D. and Specialty Care
Network, Inc.
10.14* Stock Exchange Agreement dated October 21, 1996 by and among Specialty Care Network, Inc. and Michael
N. Jolley, M.D., Harvey E. Smires, M.D., Robert N. Dunn, M.D., Jeffrey S. Abrams, M.D., Richard E.
Fleming, Jr., M.D., W. Thomas Gutowski, M.D., Steven R. Gecha, M.D., C. Alexander Moskwa, Jr., M.D.
and David M. Smith, M.D.
10.15* Service Agreement dated as of November 1, 1996, by and between Specialty Care Network, Inc., SCN of
Princeton, Inc., Princeton Orthopedic Associates II, P.A. and Michael N. Jolley, M.D., Harvey E.
Smires, M.D., Robert N. Dunn, M.D., Jeffrey S. Abrams, M.D., Richard E. Fleming, Jr., M.D., W. Thomas
Gutowski, M.D., Steven R. Gecha, M.D., C. Alexander Moskwa, Jr., M.D. and David M. Smith, M.D.
10.16* Merger Agreement dated November 12, 1996 by and among Specialty Care Network, Inc. and TOC Services,
Inc.
10.17* Service Agreement dated as of November 12, 1996 by and between TOC Specialists, P.L., (d/b/a
Tallahassee Orthopedic Clinic) TOC Services, Inc. (f/k/a Tallahassee Orthopedic Clinic, P.A.) and
Greg A. Alexander, M.D., David C. Berg, M.D., Richard E. Blackburn, M.D., Donald Dewey, M.D., Mark E.
Fahey, M.D., Tom C. Haney, M.D., William D. Henderson, Jr., M.D., Steve E. Jordan, M.D., J. Rick
Lyon, M.D., Kris D. Stowers, M.D., Robert L. Thornberry, M.D., Billy C. Weinstein, M.D. and Charles
H. Wingo, M.D.
10.18* Asset Exchange Agreement dated as of November 12, 1996 by and among Specialty Care Network, Inc.,
Greater Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller, M.D., Leslie S. Matthews, M.D.,
Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Mark S. Myerson, M.D., John B. O'Donnell, M.D. and Lew
C. Schon, M.D.
10.19* Service Agreement dated as of November 12, 1996 by and between Speciality Care Network, Inc., Greater
Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller, M.D., Leslie S. Matthews, M.D., Paul L.
Asdourian, M.D., Frank R. Ebert, M.D., Mark S. Myerson, M.D., John B. O'Donnell, M.D. and Lew C.
Schon, M.D.
10.20* Merger Agreement dated November 12, 1996 by and among Specialty Care Network, Inc. and Vero
Orthopaedic, Inc.
</TABLE>
II-3
<PAGE>
<TABLE>
<S> <C>
10.21* Service Agreement dated as of November 12, 1996 by and between Specialty Care Network, Inc., Vero
Orthopaedics II, P.A. and James L. Cain, M.D., David W. Griffin, M.D., George K. Nichols, M.D., Peter
G. Wernicki, M.D. and Charlene Wilson, M.D.
11* Statement re: computation of per share earnings
23.1 Consent of Ernst & Young LLP
23.2* Consent of Morgan, Lewis & Bockius LLP (included in its opinion filed as Exhibit 5 hereto)
24 Powers of Attorney (included as part of the signature page hereof)
27 Financial Data Schedule
</TABLE>
- ------------------
* To be filed by amendment.
(b) Financial Statement Schedules
None.
17. UNDERTAKINGS.
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the registrant's Articles of Incorporation, its Bylaws,
the Underwriting Agreement, or otherwise, the registrant has been advised that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -------------
<S> <C>
1* Form of Underwriting Agreement
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
5* Opinion of Morgan, Lewis & Bockius LLP regarding legality of securities being registered
10.1* Specialty Care Network, Inc. 1996 Equity Compensation Plan
10.2* Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock Option Plan
10.3* Employment Agreement dated as of April 1, 1996 by and between Specialty Care Network, Inc. and Kerry R.
Hicks
10.4* Employment Agreement dated as of April 1, 1996 by and between Specialty Care Network, Inc. and Patrick
M. Jaeckle
10.5* Employment Agreement dated as of March 11, 1996 by and between Specialty Care Network, Inc. and William
Behrens
10.6* Employment Agreement dated as of February 22, 1996 by and between Specialty Care Network, Inc. and Paul
Davis
10.7* Employment Agreement dated as of March 1, 1996 by and between Specialty Care Network, Inc. and Peter A.
Fatianow
10.8* Employment Agreement dated as of March 1, 1996 by and between Specialty Care Network, Inc. and David
Hicks
10.9* Merger Agreement dated November 12, 1996 by and among Specialty Care Network, Inc. and Reconstructive
Orthopaedic Assocs., Inc.
10.10* Service Agreement dated as of November 12, 1996 by and between Specialty Care Network, Inc.,
Reconstructive Orthopaedic Associates II, P.C. and Richard H. Rothman, M.D., Robert E. Booth, Jr., M.D.,
Richard Balderston, M.D., Arthur R. Bartolozzi, M.D., William J. Hozack, M.D., Michael G. Ciccotti,
M.D., Todd J. Albert, M.D., Alexander R. Vaccaro, M.D. and Peter F. Sharkey, M.D.
10.11* Letter Agreement dated October 29, 1996 by and between Arthur R. Bartolozzi, M.D. and Specialty Care
Network, Inc.
10.12* Letter Agreement dated October 29, 1996 by and between Robert E. Booth, Jr., M.D. and Specialty Care
Network, Inc.
10.13* Letter Agreement dated November 11, 1996 by and between Richard H. Rothman, M.D. and Specialty Care
Network, Inc.
10.14* Stock Exchange Agreement dated October 21, 1996 by and among Specialty Care Network, Inc. and Michael N.
Jolley, M.D., Harvey E. Smires, M.D., Robert N. Dunn, M.D., Jeffrey S. Abrams, M.D., Richard E. Fleming,
Jr., M.D., W. Thomas Gutowski, M.D., Steven R. Gecha, M.D., C. Alexander Moskwa, Jr., M.D. and David M.
Smith, M.D.
10.15* Service Agreement dated as of November 1, 1996, by and between Specialty Care Network, Inc., SCN of
Princeton, Inc., Princeton Orthopedic Associates II, P.A. and Michael N. Jolley, M.D., Harvey E. Smires,
M.D., Robert N. Dunn, M.D., Jeffrey S. Abrams, M.D., Richard E. Fleming, Jr., M.D., W. Thomas Gutowski,
M.D., Steven R. Gecha, M.D., C. Alexander Moskwa, Jr., M.D. and David M. Smith, M.D.
10.16* Merger Agreement dated November 12, 1996 by and among Specialty Care Network, Inc. and TOC Services,
Inc.
</TABLE>
<PAGE>
<TABLE>
<S> <C>
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
10.17* Service Agreement dated as of November 12, 1996 by and between TOC Specialists, P.L., (d/b/a Tallahassee
Orthopedic Clinic) TOC Services, Inc. (f/k/a Tallahassee Orthopedic Clinic, P.A.) and Greg A. Alexander,
M.D., David C. Berg, M.D., Richard E. Blackburn, M.D., Donald Dewey, M.D., Mark E. Fahey, M.D., Tom C.
Haney, M.D., William D. Henderson, Jr., M.D., Steve E. Jordan, M.D., J. Rick Lyon, M.D., Kris D. Stowers,
M.D., Robert L. Thornberry, M.D., Billy C. Weinstein, M.D. and Charles H. Wingo, M.D.
10.18* Asset Exchange Agreement dated as of November 12, 1996 by and among Specialty Care Network, Inc.,
Greater Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller, M.D., Leslie S. Matthews, M.D.,
Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Mark S. Myerson, M.D., John B. O'Donnell, M.D. and Lew C.
Schon, M.D.
10.19* Service Agreement dated as of November 12, 1996 by and between Speciality Care Network, Inc., Greater
Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller, M.D., Leslie S. Matthews, M.D., Paul L.
Asdourian, M.D., Frank R. Ebert, M.D., Mark S. Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon,
M.D.
10.20* Merger Agreement dated November 12, 1996 by and among Specialty Care Network, Inc. and Vero Orthopaedic,
Inc.
10.21* Service Agreement dated as of November 12, 1996 by and between Specialty Care Network, Inc., Vero
Orthopaedics II, P.A. and James L. Cain, M.D., David W. Griffin, M.D., George K. Nichols, M.D., Peter G.
Wernicki, M.D. and Charlene Wilson, M.D.
11* Statement re: computation of per share earnings
23.1 Consent of Ernst & Young LLP
23.2* Consent of Morgan, Lewis & Bockius LLP (included in its opinion filed as Exhibit 5 hereto)
24 Powers of Attorney (included as part of the signature page hereof)
27 Financial Data Schedule
- ----------------
* To be filed by amendment.
</TABLE>
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to the
use of our reports dated November 12, 1996 (Specialty Care Network, Inc.),
July 12, 1996 (Reconstructive Orthopaedic Associates, Inc.), August 28, 1996
(Princeton Orthopaedic Associates, P.A.), October 15, 1996 (Tallahassee
Orthopedic Clinic, Inc.), October 11, 1996 (Greater Chesapeake Orthopaedic
Associates, LLC) and August 20, 1996 (Vero Orthopaedics, P.A.) in the
Registration Statement (Form S-1) and related Prospectus of Specialty Care
Network, Inc. dated December 11, 1996.
/s/ Ernst & Young LLP
ERNST & YOUNG LLP
Denver, Colorado
December 10, 1996
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