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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ..................... TO .....................
COMMISSION FILE NUMBER 0-
................................................
BMJ MEDICAL MANAGEMENT, INC.
(EXACT NAME OF THE REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 65-067609
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4800 NORTH FEDERAL HIGHWAY
SUITE 101E
BOCA RATON, FLORIDA 33431
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (561) 391-1311
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, $.001 par value Nasdaq National Market
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __ No X
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____________
The aggregate market value of the registrant's Common Stock, par value
$.001 per share, held by non-affiliates of the registrant, based upon the
closing price at March 16, 1998 was approximately $121,532,714. For purposes of
this disclosure, shares of Common Stock held by persons who hold more than 5% of
the outstanding shares of Common Stock and shares held by officers and directors
of the registrant have been excluded because such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily conclusive
for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE.
None
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BMJ MEDICAL MANAGEMENT, INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
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PART I
Item 1. BUSINESS....................................................................................... 1
Item 2. PROPERTIES..................................................................................... 24
Item 3. LEGAL PROCEEDINGS.............................................................................. 24
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 24
PART II
Item 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED
STOCKHOLDERS MATTERS......................................................................... 25
Item 6. SELECTED FINANCIAL INFORMATION................................................................. 25
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 25
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................................... 31
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................... 32
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........... 58
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................. 58
Item 11. EXECUTIVE COMPENSATION......................................................................... 60
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................. 62
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................. 63
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K..................................................................................... 66
SIGNATURES..................................................................................... 73
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FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED IN THIS REPORT, INCLUDING STATEMENTS REGARDING
THE ANTICIPATED DEVELOPMENT AND EXPANSION OF THE COMPANY'S BUSINESS, THE INTENT,
BELIEF OR CURRENT EXPECTATIONS OF THE COMPANY, ITS DIRECTORS OR ITS OFFICERS,
PRIMARILY WITH RESPECT TO THE FUTURE OPERATING PERFORMANCE OF THE COMPANY AND
OTHER STATEMENTS CONTAINED HEREIN REGARDING MATTERS THAT ARE NOT HISTORICAL
FACTS ARE 'FORWARD-LOOKING' STATEMENTS. BECAUSE SUCH STATEMENTS INCLUDE RISKS
AND UNCERTAINTIES, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR
IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, THE POTENTIAL
INABILITY TO AFFILIATE WITH PHYSICIAN PRACTICES, THE POTENTIAL TERMINATION OF
CONTRACTUAL RELATIONSHIPS, THE POTENTIAL INABILITY OF THE COMPANY TO ESTABLISH
ANCILLARY SERVICE FACILITIES, FLUCTUATIONS IN THE VOLUME OF PROCEDURES PERFORMED
BY THE PRACTICES' PHYSICIANS, CHANGES IN THE REIMBURSEMENT RATES FOR THOSE
SERVICES, UNCERTAINTY ABOUT THE ABILITY TO COLLECT THE APPROPRIATE FEES FOR
SERVICES PROVIDED OR ORDERED BY THE PRACTICES' PHYSICIANS.
PART I
ITEM 1. BUSINESS
GENERAL
BMJ Medical Management, Inc. (together with its subsidiaries, the 'Company'
or 'BMJ') is principally a physician practice management company (a 'PPM') that
provides management services to physician practices that focus on
musculoskeletal care, which involves the medical and surgical treatment of
conditions relating to bones, muscles, joints and related connective tissues.
The broad spectrum of musculoskeletal care offered by the physician practices
ranges from acute procedures, such as spine or other complex surgeries, to the
treatment of chronic conditions, such as arthritis and back pain. The management
services provided by the Company include physician practice and network
development, marketing, payor contracting and financial, administrative and
clinical information management. As of December 31, 1997, the Company had
affiliated (the 'Affiliation Transactions') by entering into management services
agreements (the 'Management Services Agreements') with 25 practices (the
'Existing Practices' and, together with other practices with which the Company
may affiliate in the future, the 'Practices') comprising 117 physicians
practicing in Arizona, California, Florida, Pennsylvania, New Jersey and Texas
and owned and operated one Independent Physician Association (the 'IPA') which
provides services to enrollees of health care plans and other specified patient
populations pursuant to agreements with health care plans (the 'IPA Provider
Agents') with 42 physicians in Arizona.
AFFILIATION TRANSACTIONS
In July 1996, the Company affiliated with its first Practice, Lehigh Valley
Bone, Muscle and Joint Group, LLC ('LVBMJ'), comprising five physicians. In
November 1996, the Company affiliated with South Texas Spinal Clinc, P.A.
('STSC') and Southern California Orthopedic Institute Medical Group ('SCOI'),
resulting in the addition of a total of 29 physicians located in Texas and
California. The Company affiliated with Lauderdale Orthopedic Surgeons ('LOS')
and Tri-City Orthopedic Surgery Medical Group, Inc. ('Tri-City') in April 1997,
Fishman & Stashak, M.D.'s, P.A. (d/b/a Gold Coast Orthopaedics) ('Gold Coast')
in June 1997 and Sun Valley Orthopedic Surgeons ('Sun Valley') in July 1997,
resulting in the addition of a total of 23 physicians. In October 1997, the
Company affiliated with Broward Institute of Orthopedic Specialties, P.A.
('BIOS') and Orthopedic Surgery Associates, P.A. ('OSA'), resulting in the
addition of a total of 15 physicians. In addition to the foregoing Affiliation
Transactions, the Company has affiliated with 17 other Practices comprising 45
additional physicians.
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The Company has divided the United States into the eastern, central and
western regions. Set forth below is a description of the Affiliation
Transactions that the Company had entered into in each region as of December 31,
1997.
Eastern Region
Effective July 1, 1996, the Company entered into a Management Services
Agreement with LVBMJ in Bethlehem, Pennsylvania. Under the terms of the initial
Management Services Agreement between LVBMJ and the Company, the Company
received a fee equal to 50% of the net collected revenues of LVBMJ and became
responsible for all the clinic overhead expenses (medical support services).
Effective July 1, 1997, the Company and LVBMJ entered into an amended and
restated Management Services Agreement, (the 'LVBMJ Management Services
Agreement'). Under the terms of the LVBMJ Management Services Agreement, the
Company is entitled to receive a fee equal to 10% of net collections received
for professional services by the Practice net of refunds paid ('Collections')
plus reimbursement of clinic overhead expenses and 66 2/3% of the cost savings
the Company is able to achieve through its purchasing power. As consideration to
LVBMJ for entering into the LVBMJ Management Services Agreement, the Company
issued an aggregate of 370,023 shares of Common Stock, options to purchase an
aggregate of 21,429 shares of Common Stock and additional consideration of
$320,000 to the physician owners of LVBMJ. The Company may be required to issue
more shares of Common Stock to the Practice in 1998 based on the Practice's
actual Collections for the twelve month period ended March 1998.
Effective April 1, 1997, the Company entered into a Management Services
Agreement (the 'LOS Management Services Agreement') with LOS located in Ft.
Lauderdale, Florida. As consideration to LOS for entering into the agreement,
the Company issued an aggregate of 329,259 shares of its Common Stock and paid
additional consideration of $512,514 to the LOS physicians. Under the terms of
the LOS Management Services Agreement, the Company is entitled to receive a fee
equal to (i) the aggregate of (A) 20% of net operating income (as defined in the
LOS Management Services Agreement) of the Practice plus reimbursement of
clinical overhead expenses, plus (B) 66 2/3% of the cost savings the Company is
able to achieve through its purchasing power. Notwithstanding the foregoing,
during the first seven years of the term of the LOS Management Services
Agreement, the Company is entitled to receive a guaranteed minimum annual
management fee of $400,000. The Company also purchased certain assets from LOS,
including the assumption of two leases, for an aggregate purchase price of
$2,250,000 (subject to adjustment based upon the Company's actual collection of
the purchased accounts receivable).
Effective June 1, 1997, the Company entered into a Management Services
Agreement (the 'Gold Coast Management Services Agreement') with Gold Coast
located in West Palm Beach, Florida, pursuant to which the Company issued
179,010 shares of Common Stock to the physician owners of Gold Coast. The
Company may be required to issue more shares of Common Stock to the Practice in
1998 based on the Practice's actual Collections for the twelve month period
ended August 1998. Under the terms of the Gold Coast Management Services
Agreement, the Company is entitled to receive a fee equal to the aggregate of
(i) 15% of the Collections of the Practice plus reimbursement of clinic overhead
expenses, plus (ii) 66 2/3% of the cost savings the Company is able to achieve
through its purchasing power. Notwithstanding the foregoing, during the first
six years of the term of the Gold Coast Management Services Agreement, the
Company is entitled to receive a guaranteed minimum annual management fee of
$500,000. In connection with the Gold Coast Affiliation Transaction, the Company
also entered into an Asset Purchase Agreement, effective as of June 1, 1997,
pursuant to which the Company purchased certain assets (including accounts
receivable) from Gold Coast for an aggregate purchase price of $2,976,577.
Effective August 1, 1997, the Company entered into a Management Services
Agreement (the 'BOS Management Services Agreement') with Broward Orthopedic
Specialists, Inc. ('BOS') located in Ft. Lauderdale, Florida, pursuant to which
the Company issued 446,977 shares of Common Stock to the physician owners of
BOS. The Company may be required to issue more shares of Common Stock to the
Practice in 1998 based on the Practice's actual Collections for the twelve month
period ended July 1998. Under the terms of the BOS Management Services
Agreement, the Company is entitled to receive a fee equal to the aggregate of
(i) 15% of the Collections of the Practice plus reimbursement of clinic overhead
expenses, plus (ii) 66 2/3% of the cost savings the Company is able to achieve
through its purchasing power. Notwithstanding the foregoing, during the
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first four years of the term of the BOS Management Services Agreement, the
Company is entitled to receive a guaranteed minimum annual management fee of
$810,000. In connection with the BOS Affiliation Transaction, the Company also
entered into Asset Purchase Agreements, effective as of August 1, 1997, pursuant
to which the Company purchased certain assets (including accounts receivable)
from BOS and the physician owners of BOS for an aggregate purchase price of
$4,222,498.
Effective August 1, 1997, the Company entered into a Management Services
Agreement (the 'PM&R Management Services Agreement') with Physical Medicine and
Rehabilitation Associates, Inc. ('PM&R'), located in Delray Beach, Florida,
pursuant to which the Company issued 90,659 shares of Common Stock to the
physician owners of PM&R. Under the terms of the PM&R Management Services
Agreement, the Company is entitled to receive a fee equal to the aggregate of
(i) 10% of the Collections of the Practice plus reimbursement of clinic overhead
expenses, plus (ii) 66 2/3% of the cost savings the Company is able to achieve
through its purchasing power. Notwithstanding the foregoing, during the first
five years of the term of the PM&R Management Services Agreement, the Company is
entitled to receive a guaranteed minimum annual management fee of $136,000. In
connection with the PM&R Affiliation Transaction, the Company also entered into
an Asset Purchase Agreement, effective as of August 1, 1997, pursuant to which
the Company purchased certain assets (including accounts receivable) from PM&R
for an aggregate purchase price of $830,166.
In October 1997, the Company entered into a Management Services Agreement
(the 'OSA Management Services Agreement') with OSA located in Boca Raton,
Florida, pursuant to which the Company issued 44,364 shares of Common Stock to
the physician owners of OSA. The Company may be required to issue more shares of
Common Stock to OSA in 1998 and 1999 based on the Practice's actual Collections
for the twelve months ended August 1998 and August 1999. Under the terms of the
OSA Management Services Agreement, the Company is entitled to receive a fee
equal to the aggregate of (i) 12.5% of the Collections of the Practice plus
reimbursement of clinic overhead expenses, plus (ii) 66 2/3% of the cost savings
the Company is able to achieve through its purchasing power. Notwithstanding the
foregoing, during the first four years of the term of the OSA Management
Services Agreement, the Company is entitled to receive a guaranteed minimum
annual management fee of $799,000. In connection with the OSA Affiliation
Transaction, the Company also entered into an Asset Purchase Agreement,
effective as of September 1, 1997, pursuant to which the Company purchased
certain assets (including accounts receivable) from OSA for an aggregate
purchase price of $6,773,951 and issued 177,455 shares of Common Stock to the
physician owners of OSA.
In October 1997, the Company entered into a Management Services Agreement
(the 'BIOS Management Services Agreement') with BIOS located in Hollywood,
Florida. As consideration to BIOS for entering into the agreement, the Company
issued an aggregate of 182,312 shares of its Common Stock and paid additional
consideration of $24,000 to the BIOS physicians. The Company may be required to
issue more shares of Common Stock to BIOS in 1998 based on BIOS's actual
Collections for the twelve month period ended August 1998. Under the terms of
the BIOS Management Services Agreement, the Company is entitled to receive a fee
equal to the aggregate of (i) 15% of net operating income (as defined in the
BIOS Management Services Agreement) of the Practice plus reimbursement of
clinical overhead expenses, plus (ii) 66 2/3% of the cost savings the Company is
able to achieve through its purchasing power. The Company also purchased certain
assets from BIOS for an aggregate purchase price of $2,761,563.
In October 1997, the Company entered into a Management Services Agreement
(the 'LOAS Management Services Agreement') with Lighthouse Orthopedic
Associates, P.A. ('LOAS') located in Lighthouse Point, Florida. As consideration
to LOAS for entering into the agreement, the Company issued an aggregate of
37,837 shares of its Common Stock to the LOAS physicians. The Company may be
required to issue more shares of Common Stock to the Practice in 1998 based on
the Practice's actual Collections for the twelve month period ended August 1998.
Under the terms of the LOAS Management Services Agreement, the Company is
entitled to receive a fee equal to the aggregate of (i) 12.5% of the Collections
of the Practice plus reimbursement of clinic overhead expenses, plus (ii)
66 2/3% of the cost savings the Company is able to achieve through its
purchasing power. Notwithstanding the foregoing, during the first four years of
the term of the LOAS Management Services Agreement, the Company is entitled to
receive a guaranteed minimum annual management fee of $535,000. In connection
with the LOAS Affiliation Transaction, the Company also entered into Asset
Purchase Agreements, effective as of September 1, 1997, pursuant to which the
Company purchased certain assets (including accounts receivable) from each of
LOAS, certain affiliates of LOAS and each of the physicians of LOAS, for an
aggregate
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purchase price of $3,899,930 and issued an aggregate of 156,383 shares of Common
Stock to the physician owners of LOAS.
In October 1997, the Company acquired all of the issued and outstanding
shares of common stock of Valley Sports Surgeons, Inc., a physician practice
management company located in Allentown, Pennsylvania ('VSI'), in exchange for
an aggregate of 359,464 shares of Common Stock. Pursuant to the terms of a
Management Services Agreement (the 'Valley Management Services Agreement'), VSI
currently manages Valley Sports & Arthritis Surgeons, P.C., an orthopedic
medical practice also located in Allentown, Pennsylvania ('VSAS'). The Company
is entitled to receive a fee equal to the aggregate of (i) 10% of the
Collections of the Practice plus reimbursement of clinic overhead expenses, plus
(ii) 66 2/3% of the cost savings the Company is able to achieve through its
purchasing power. Notwithstanding the foregoing, during the first five years of
the term of the Valley Management Services Agreement, the Company is entitled to
receive a guaranteed minimum annual management fee of $416,500. Prior to the
acquisition of the capital stock of VSI, the Company purchased substantially all
of the assets of VSAS used in connection with its medical practice (including
certain accounts receivable) for an aggregate purchase price of $897,727.
Effective November 1, 1997, the Company entered into a Management Services
Agreement (the 'New Jersey Management Services Agreement') with New Jersey
Orthopedic Associates, P.A., a New Jersey professional association ('NJOA'),
located in Freehold, New Jersey, pursuant to which the Company issued 67,859
shares of Common Stock and paid additional consideration of $411,680 to the
physician owners of NJOA. Under the terms of the New Jersey Management Services
Agreement, the Company is entitled to receive a fee equal to the aggregate of
(i) 10% of the Collections of the Practice plus reimbursement of clinic overhead
expenses, plus (ii) 66 2/3% of the cost savings the Company is able to achieve
through its purchasing power. Notwithstanding the foregoing, during the first
five years of the term of the New Jersey Management Services Agreement, the
Company is entitled to receive a guaranteed minimum annual management fee of
$240,840. In connection with the NJOA Affiliation Transaction, the Company
entered into an Asset Purchase Agreement, effective November 1, 1997, pursuant
to which the Company purchased certain assets from Orthopedic Associates of New
Jersey, an affiliate of NJOA, for a purchase price of $75,000. Additionally,
NJOA and the Company entered into a Stockholders Noncompetition Agreement and
the Company paid consideration of $954,194 to the physician owners of NJOA.
Other Eastern Region Affiliations
Effective July 1, 1997, the Company entered into a Management Services
Agreement with Kramer & Maehrer, LLC, located in Bethlehem, Pennsylvania. In
order to enhance the Company's presence in the Ft. Lauderdale market, the
Company entered into Management Services Agreements with Jeffrey Beitler, M.D.,
P.A., located in Aventura, Florida, and Michael Abrahams, M.D., P.A., located in
Plantation, Florida, effective as of September 1, 1997 and August 1, 1997,
respectively. Under the terms of these Management Services Agreements, the
Company is entitled to receive a fee equal to the aggregate of (i) 10% (15% in
the case of Dr. Abrahams) of the Collections of the Practice plus reimbursement
of clinic overhead expenses, plus (ii) 66 2/3% of the cost savings the Company
is able to achieve through its purchasing power.
Central Region
The Company's initial Affiliation Transaction in the central region was
with STSC. The Company entered into a Management Services Agreement with STSC,
located in San Antonio, Texas, effective as of November 1, 1996, pursuant to
which the Company issued 768,929 shares of Common Stock and deferred
consideration of $915,835. Pursuant to the STSC Management Services Agreement,
the Company is entitled to receive a management fee equal to an aggregate of (i)
11 1/2% of Collections of the Practice (less certain lease payments) plus
reimbursement of clinic overhead expenses, plus (ii) 66 2/3% of the cost savings
the Company is able to achieve through its purchasing power. The Company also
entered into an asset purchase agreement with STSC, pursuant to which the
Company agreed to purchase certain assets (including accounts receivable) and
assume certain liabilities for a purchase price of (i) $1,703,826 (subject to
adjustment based upon the Company's actual collection of the purchased accounts
receivable), plus (ii) a future payment of $446,327.
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Other Central Region Affiliations
Effective July 1, 1997, the Company entered into a Management Services
Agreement with Eradio Arrendondo, M.D., P.A., located in San Antonio, Texas.
Western Region
Effective November 1, 1996, the Company entered into a Management Services
Agreement (the 'SCOI Management Services Agreement') with SCOI, located in Van
Nuys, California, and, in connection therewith, the Company issued 2,857,140
shares of Common Stock to the physician owners and certain key employees of
SCOI. Under the SCOI Management Services Agreement, the Company is entitled to
receive a fee equal to the aggregate of (i) 10% of the Collections of the
Practice (if certain conditions are met) less certain equipment lease payments
plus reimbursement of clinic overhead expenses, plus (ii) 66 2/3% of the cost
savings the Company is able to achieve through its purchasing power.
Simultaneously with the execution and delivery of the SCOI Management Services
Agreement and pursuant to an Asset Purchase Agreement, the Company acquired
certain assets (including the outstanding accounts receivable), and assumed
certain liabilities, of SCOI for an aggregate purchase price of $5,930,897
(which included $4,448,000 of value of accounts receivable purchased).
In a subsequent transaction with the Center for Orthopedic Surgery, Inc.
('COSI'), an outpatient surgery center in Van Nuys, California owned by the SCOI
physicians, the Company issued 392,857 shares of Common Stock to the physician
owners of COSI as consideration for the execution of the Management Services
Agreement entered into between COSI and the Company (the 'COSI Management
Services Agreement').
The SCOI and COSI Management Services Agreements provided for the
recalculation of the number of shares issued to the physicians in connection
with the SCOI and COSI Affiliation Transactions, and such recalculations were
completed in November 1997. As a result of such recalculation provisions, the
Company issued approximately 887,000 additional shares of Common Stock to the
SCOI physicians which resulted in an increase in general and administrative
expense of approximately $13.5 million in the fourth quarter of 1997.
To expand its network in the western region, effective April 1, 1997, the
Company entered into a Management Services Agreement (the 'Tri-City Management
Services Agreement') with Tri-City, located in Oceanside, California, pursuant
to which the Company issued 287,659 shares of Common Stock and paid $202,900 to
the physician owners of Tri-City. Under the terms of the Tri-City Management
Services Agreement, the Company is entitled to receive a fee equal to the
aggregate of (i) 10% of Collections of the Practice (less certain lease
payments) plus reimbursement of clinic overhead expenses, plus (ii) 66 2/3% of
the cost savings the Company is able to achieve through its purchasing power. In
connection with the Tri-City Affiliation Transaction, the Company also entered
into three Asset Purchase Agreements with Tri-City or affiliates thereof, all
effective as of April 1, 1997, pursuant to which the Company purchased certain
assets (including accounts receivable) from such parties for an aggregate
purchase price of $745,300 ($519,000 of which is subject to adjustment, based
upon the Company's actual collection of the purchased accounts receivable).
Effective July 1, 1997, the Company entered into a Management Services
Agreement (the 'Sun Valley Management Services Agreement') with Sun Valley
Orthopedic Surgeons, an Arizona general partnership ('Sun Valley'), located in
Sun City, Arizona, pursuant to which the Company issued 112,719 shares of Common
Stock to the physician owners of Sun Valley. The Sun Valley Management Services
Agreement requires the Company to pay additional cash consideration to the
physician owners of Sun Valley if the current market value of the Company's
Common Stock is not at least equal to a specified price on the first anniversary
of such agreement. Under the terms of the Sun Valley Management Services
Agreement, the Company is entitled to receive a fee equal to the aggregate of
(i) 10% of the Collections of the Practice plus reimbursement of clinic overhead
expenses, plus (ii) 66 2/3% of the cost savings the Company is able to achieve
through its purchasing power. In connection with the Sun Valley Affiliation
Transaction, the Company also entered into an Asset Purchase Agreement,
effective as of July 1, 1997, pursuant to which the Company purchased certain
assets (including accounts receivable) from Sun Valley for an aggregate purchase
price of $355,750.
Effective July 1, 1997, the Company entered into a Management Services
Agreement (the 'Stockdale Management Services Agreement') with Stockdale
Podiatry Group, Inc. ('Stockdale'), located in Bakersfield, California, pursuant
to which the Company issued 88,846 shares of Common Stock and paid additional
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consideration of $300,435 to the physician owners of Stockdale. Under the terms
of the Stockdale Management Services Agreement, the Company is entitled to
receive a fee equal to the aggregate of (i) 10% of the Collections of the
Practice plus reimbursement of clinic overhead expenses, plus (ii) 66 2/3% of
the cost savings the Company is able to achieve through its purchasing power. In
connection with the Stockdale Affiliation Transaction, the Company also entered
into an Asset Purchase Agreement, effective as of August 1, 1997, pursuant to
which the Company purchased certain assets (including accounts receivable) from
Stockdale for an aggregate purchase price of $516,065.
Other Western Region Affiliations
Effective June 1, 1997 in order to enhance the Company's presence in the
Los Angeles market area, the Company entered into separate Management Services
Agreements with H. Leon Brooks, M.D. and Clive Segil, M.D., both located in Los
Angeles, California. In addition, effective July 1, 1997, in order to establish
a presence in the Lake Tahoe area, the Company entered into separate Management
Services Agreements with R.C. Watson, M.D., Inc., Swanson Orthopedic Medical
Corporation and Lake Tahoe Sports Medicine Center, all located in South Lake
Tahoe, California. In addition, effective July 1, 1997, the Company entered into
a Management Services Agreement with Robert O. Wilson, M.D. located in Sun City,
Arizona. Effective August 1, 1997 the Company entered into a Management Services
Agreement with John Zimmerman, M.D. located in Bakersfield, California. Under
the terms of each of these Management Services Agreements, the Company is
entitled to receive a fee equal to the aggregate of (ii) 10% of the Collections
of the Practice plus reimbursement of clinic overhead expenses, plus (ii)
66 2/3% of the cost savings the Company is able to achieve through its
purchasing power.
In October 1997, the Company acquired its IPA, Orthopedic Management
Network, Inc., an Arizona corporation, in exchange for $63,000 in cash, the
assumption of $1,010,306 in accounts payable and accrued liabilities and the
issuance of 20,370 shares of Common Stock.
STRATEGY
The Company's goal is to develop the leading musculoskeletal network in
each of its markets by aligning the Company's interests with those of the
Practices' physicians. Key components of the Company's strategy are:
Expand Into New Markets. The Company intends to expand into targeted new
markets by establishing relationships and affiliations with the most qualified
practices in such markets. The Company targets markets that have a large enough
population to support a viable musculoskeletal physician network. The Company
generally seeks to affiliate initially with platform practices in new markets.
Platform practices generally consist of at least five physicians who have the
demonstrated ability to grow in their market. Potential affiliation candidates
are evaluated on a variety of factors, including, but not limited to, physician
credentials and reputation, the practice's competitive market position,
specialty and subspecialty mix of physicians, historical financial performance,
growth potential, the local demographics potential and potential for development
of ancillary musculoskeletal facilities (the 'Ancillary Service Facilities').
Continue to Develop Existing Markets. The Company strengthens its market
positions by (i) providing uniform financial reporting systems to the Practices;
(ii) implementing uniform practice management systems to facilitate the
collection of financial and clinical data; (iii) investing in new clinical
equipment such as EMGs and bone densitometers; (iv) increasing the number of
physicians and diversifying the subspecialties in a Practice; (v) developing
satellite offices to accommodate increased patient flow; (vi) committing capital
to develop or acquire Ancillary Service Facilities; and (vii) expanding revenues
through additional payor contracting and focused marketing on a regional basis.
The Company believes these services will enable the physicians to devote more
time to the practice of medicine and the strategic development of their
practice, thereby increasing revenues and creating greater efficiencies in the
operation of each Practice.
Introduce Ancillary Service Facilities. Ancillary Service Facilities will
provide such services as ambulatory surgery, physical therapy and magnetic
resonance imaging ('MRI') services. Once the Practices or a network in a
particular market have achieved a significant local presence, the Company plans
to introduce Ancillary Service Facilities by assisting the Practices in
developing such facilities. The first Ancillary Service Facility was opened in
late 1997 (an MRI unit in San Antonio, Texas) and additional Ancillary Service
Facilities are planned to be
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opened in 1998 in other markets. In addition, the Company currently manages one
physician-owned ambulatory surgery center which was under development by the
physicians prior to their involvement with the Company and for which the Company
receives a 10% management fee.
Develop Disease Management and Clinical Information System. Following the
implementation of a uniform practice management system, the Company has a
two-step strategy for creating a disease management and clinical information
system. The Company is in the process of developing standard procedures 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's goal is to establish a non-patient identifiable
information database across all Practices pursuant to which efficiencies may be
achieved by gathering, interpreting and sharing clinical information,
standardizing referral patterns and treatment protocols within a physician
network and coordinating the needs of the patient population in any geographic
market. Utilization of the database is expected to result in an increased
ability to control and predict the cost of care for various patient diagnoses.
The Company believes that its network of musculoskeletal physicians with access
to reliable clinical outcome information will make the Company more attractive
to payors because the Company will be able to demonstrate cost-effective quality
care.
BMJ OPERATIONS
Existing Practices. Since commencing operations in January 1996, through
December 31, 1997, the Company had affiliated with 25 Existing Practices,
comprising 117 physicians, in Arizona, California, Florida, Pennsylvania, New
Jersey and Texas, and purchased and operated one IPA, comprising 42 physicians,
in Phoenix, Arizona. Approximately 83% of the physicians at the managed
Practices are orthopedic surgeons.
Regional Business Model. While health care has become an increasingly
significant national issue, it is still delivered on a local level. Therefore,
in order to execute its growth and operating strategies, the Company has divided
the United States into the eastern, central and western regions. The Company
believes that its regional business model benefits both the Company and the
Practices. Local management teams allow the Company to better understand the
specific characteristics of a region, such as the demographics, the payor mix,
the competitive landscape and the managed care environment, thus enabling the
Company to be more effective in marketing to patients and negotiating with third
party payors and suppliers. In addition, the regional management team is able to
develop and maintain long-term relationships with both the Practices' physicians
and local entities such as hospitals, managed care networks, suppliers and
non-musculoskeletal physician groups. The Company believes that due to its
regional business model, it is better equipped to develop relationships with
such local entities than PPMs with centralized business models.
Regional vice presidents are responsible for management teams that
supervise the development of each market within a region and coordinate market
expansion initiatives and integration of administrative services within the
region. The regional team provides management and network services related to
the following: (i) integration and transition; (ii) physician services including
cost containment and operating efficiencies; (iii) ancillary services
development and management; (iv) physician recruitment and professional
development; (v) workers' compensation; and (vi) payor contracting.
Affiliation Structure. The Company believes its affiliation model aligns
the interests of the Company and the Practices' physicians by (i) providing
equity ownership in the Company to the physicians; (ii) assuring that the
physicians and the Company share in the profits from the Ancillary Service
Facilities and Practice cost savings; (iii) focusing on revenue enhancement; and
(iv) reducing the amount of time the physicians must spend on administrative
matters, thereby enabling them to dedicate more of their efforts to the delivery
of health care services. Additionally, each Practice retains professional
autonomy and control over its medical practice through continued ownership and
participation in Practice governance.
The total consideration generally paid to a Practice's physicians, once the
Practice has agreed to affiliate with the Company, is based on a multiple of the
Company's management fee plus the fair market value of the Practice's assets,
including furniture, fixtures and equipment and, subject to legal limitations
regarding Medicare and Medicaid receivables, the estimated net realizable value
of its accounts receivable. The multiple of the Company's management fee is
determined by reference to a number of factors, including the geographic
location of the Practice, the size and specialty mix of the Practice, the
Practice's competitive market position, the
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Practice's historical financial performance and the potential for the
development of Ancillary Service Facilities. The total consideration paid by the
Company generally consists of Common Stock, cash and the assumption of certain
liabilities (principally notes payable to financial institutions secured by
receivables of the Practice, which notes are repaid at the time the Affiliation
Transaction is consummated). In exchange for this consideration, the Practice
enters into a 40-year Management Services Agreement with the Company.
The revenue to the Company from a Practice is typically based on a
specified percentage (typically 10% to 15%) of the Practice's revenues (rather
than on a percentage of the net operating income of the Practice) plus
reimbursement of the Practice's overhead expenses and two-thirds of the cost
savings the Company is able to achieve through its purchasing power. In
addition, the Company will be responsible for arranging the funding of Ancillary
Service Facilities when appropriate and will, subject to applicable laws, share
appropriately in the profits from such facilities.
Upon affiliating with a Practice, the Company assumes the management of
substantially all aspects of the Practice's operations other than the provision
of medical services. Pursuant to the Management Services Agreements, the Company
assists the Practices in the preparation of operating budgets and capital
project analyses, the coordination of group purchases of medical supplies and
insurance and the introduction of physician candidates. The Company provides the
full range of administrative services required for a Practice's day-to-day
non-medical operations, including management and monitoring of the Practice's
billing and collection, accounting, payroll, legal services, recordkeeping, cash
flow activity, physician recruiting, payor contracting and marketing.
Comprehensive administrative support should facilitate more effective billing
and collections, and, as the Company grows, economies of scale in effecting
purchases. In addition, the Company plans to integrate the Practices' management
information systems into a single system that will expand the financial and
clinical reporting capabilities of each of the Practices and facilitate the
analysis of data collected.
The Company believes that through its affiliation with Practices across
multiple markets it can achieve benefits in the aggregate purchasing of products
and services for the Practices. The Company believes that, in particular, it can
assist the Practices in reducing its purchasing expenses such as insurance,
medical equipment and clinical and administrative supplies. Pursuant to the
Management Services Agreements, the Company receives two-thirds of any such cost
savings.
Financial and Practice Management Systems. To date, the Company has
implemented an interconnected financial accounting system in the Practices. This
system allows the Company to analyze the financial aspects of the Practices from
a centralized location and ensure uniformity with respect to financial
classifications at the Practice level.
The Company receives daily cash receipts related to the collection of
patient accounts receivable and revenues. The Company utilizes these funds to
pay the clinic overhead expenses (medical support services) as they are incurred
and pays to the Practice a physician draw based upon a predetermined percentage
of estimated net collected revenue. Annually, the cash actually collected and
paid as physician draw, medical support services or management fee is reconciled
with the Practice and any over/under payments are settled.
The Company believes that the implementation of a uniform practice
management system will enable it to monitor the operations of the Practices in a
cost-effective manner, enhance utilization of the Practices, develop practice
protocols and provide the Company with a competitive advantage in negotiating
contracts with third party payors. The Company is currently reviewing various
practice management software programs and expects to select and implement such a
program within 6 to 18 months.
The Company believes that the implementation of the practice management
system, together with the integrated financial accounting system, will enable it
to gather data that will be the foundation for a disease management and clinical
information system. The Company intends to capture, retain and use such
information in accordance with applicable legal and ethical requirements
regarding the confidentiality of medical records. The Company further believes
that such a system will facilitate the collection of clinical information such
as type of injuries reported, patient characteristics and diagnoses of injuries,
that will improve provider and patient access to resources and technology,
facilitate quantitative analysis of outcome quality and cost and eventually
allow for the development of curative and palliative regimens based on such
information. The Company intends to obtain the informed, written consent of each
patient for whom information will be included in the database.
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Staffing and Facilities. The Company employs most of the Practices'
non-professional personnel. These non-professional personnel, along with
additional personnel at the Company's headquarters, manage the day-to-day
non-medical operations of each of the Practices, including, among other things,
secretarial, bookkeeping, scheduling and other routine services. Under the
Management Services Agreements, the Company must generally provide facilities
and equipment to the Practices and, to this end, the Company assumes the
Practice's existing leases for the facilities and equipment and purchases the
assets, or a leasehold interest in the assets, utilized by the Practice.
DEVELOPMENT OF ANCILLARY SERVICE FACILITIES
Within each market, the Company plans to establish Ancillary Service
Facilities including, ambulatory surgery centers, physical therapy facilities
and MRI centers and mobile units. In order to establish such facilities, the
Company has designated professionals within each market to locate sites,
identify acquisition opportunities and otherwise arrange for the provision of
the ancillary services. Additionally, the Company's regional management teams
are responsible for marketing the Ancillary Service Facilities to payors and
referral sources and staffing, operating and financial management of the
facilities.
PAYOR MIX OF EXISTING PRACTICES
The Company's Practices derive revenue from a broad mix of third party
payors. This payor mix is a result of a number of underlying trends in the
patient base of musculoskeletal specialists. A significant portion of
reimbursement to physicians in musculoskeletal practices is derived from
workers' compensation insurance programs, which generally pay higher
reimbursements per procedure than health insurance payors and are generally not
subject to co-payments and deductibles. The Company believes that reimbursement
from workers' compensation payors will continue to represent a substantial
portion of practice revenues because of broader definitions of work-related
injuries, the shift of medical costs from health insurance payors to workers'
compensation payors, aging of the work force, and the requirement that employers
pay the total cost of medical treatment for work-related injuries.
The following table sets forth the payor mix of the Existing Practices for
the year ended December 31, 1997:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997
------------
<S> <C>
Workers' compensation........................................................... 23%
Medicare(1)..................................................................... 13%
Private payors and managed care(2).............................................. 64%
</TABLE>
- ------------------
(1) Includes 2% attributable to Medicaid.
(2) Includes managed care, substantially all of which is on a fee-for-service
basis.
Workers' Compensation. Workers' compensation is a state-mandated,
comprehensive insurance program that requires employers to fund medical
expenses, lost wages and other costs resulting from work-related injuries and
illnesses. Provider reimbursement methods vary on a state-by-state basis. A
majority of states have adopted fee schedules pursuant to which all health care
providers are uniformly reimbursed. The fee schedules are set by each state and
generally prescribe the maximum amounts that may be reimbursed for a designated
procedure. In most states without fee schedules, health care providers are
reimbursed based on usual, customary and reasonable fees charged in the state in
which the services are provided. In Florida (a state in which the Company does
business), state law mandates that all workers' compensation services be
provided under a managed care arrangement approved by Florida's Agency for
Healthcare Administration.
Medicare. The federal government has implemented, through the Medicare
program, the 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 subject to annual
increases or decreases at the discretion of Congress or the Federal Health Care
Financing Administration ('HCFA'). To date, the implementation of RBRVS has
reduced payment rates for certain of the procedures historically provided by the
Existing Practices.
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Furthermore, it is expected that HCFA will be required by law to recalibrate the
practice expense component of the RBRVS over the next four years in a way that
will have positive effects on payments to primary care providers, but will
decrease payments for most services provided by specialists, including many
services provided by the Existing Practices.
Managed Care Payors. An increasing portion of the net revenue of the
Existing Practices is derived from managed care payors which make payments under
discounted fee-for-service and capitation arrangements. Although rates paid by
managed care payors are generally lower than commercial indemnity rates, managed
care payors can provide access to large patient volumes. To date, the Company
has not entered into any contracts on behalf of the Managed Practices with
managed care payors; however, the Company intends to seek to negotiate both
discounted fee-for-service and capitated contracts on behalf of the Practices.
Discounted fee-for-service contracts involve negotiated rates for specified
procedures and services. Under capitated arrangements, providers deliver health
care services to managed care enrollees and typically bear all or a portion of
the risk that the cost of such services may exceed capitated payments.
Private Payors. Rates paid by private third party payors are based on
established health care provider and hospital charges and are generally higher
than Medicare payment rates. Recently, RBRVS types of payment systems have been
adopted by certain private third party payors and may become a predominant
payment methodology. Wider implementation of such programs would reduce payments
from private third party payors, and could indirectly reduce revenue to the
Company.
CONTRACTUAL AGREEMENTS WITH THE PRACTICES
The Company has entered into Management Services Agreements and, in most
cases, Asset Purchase Agreements, Restricted Stock Agreements and Stockholder
Noncompetition Agreements (collectively, the 'Affiliation Agreements'), with
each of the Existing Practices, and intends to enter into Affiliation Agreements
with each additional Practice, to provide management, administrative and
development services. The following summary of the Affiliation Agreements is
intended to be a general summary of the form of the Affiliation Agreements. The
actual terms of the individual Affiliation 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.
Management Services Agreement. Under the Management Services Agreement, the
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 Practices. Pursuant to the Management Services Agreements, the
Company provides or arranges for various management, administrative and
development services relating to the day-to-day non-medical operations of the
Practices. Pursuant to the Management Services Agreements, the Company acts as
the exclusive manager and administrator of non-medical services relating to the
operation of the Practices. Subject to matters for which the Practices maintain
responsibility or which are governed by the Operations Committee (as defined
herein) of the Practices, the Company (i) bills patients, insurance companies
and other third party payors and collects, on behalf of the Practices, the fees
for medical and other services rendered, including goods and supplies sold by
the Practices; (ii) provides or arranges for, as necessary, clerical,
accounting, purchasing, payroll, legal, bookkeeping and computer services,
personnel, information management, preparation of certain tax returns, printing,
postage and duplication services and medical transcribing services; (iii)
supervises and maintains custody of substantially all files and records (medical
records of the Practices remain the property of the Practices); (iv) provides
facilities and equipment for the Practices; (v) prepares, in consultation with
the Operations Committee and the Practices, all operating and capital
expenditure budgets; (vi) orders and purchases inventory and medical supplies as
reasonably requested by the Practices; (vii) implements, in consultation with
the Operations Committee and the Practices, national and local public relations
or advertising programs; (viii) 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; (ix)
recruits physician employees and other medical professionals on behalf of the
Practices; and (x) ensures that all medical and technical personnel have the
licenses, credentials, approvals and other certifications needed to perform
their respective duties.
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<PAGE>
Under the Management Services Agreements, the Practices retain the
responsibility for, among other things, providing professional services to
patients in compliance with the ethical standards, laws and regulations to which
they are subject. In addition, the Practices maintain exclusive control of all
aspects of the practice of medicine and the delivery of medical services.
The revenue to the Company from a Practice is typically based on a
specified percentage (typically 10-15%) of the Practice's revenues (rather than
on a percentage of the net operating income of the Practice) plus reimbursement
of the Practice's overhead expenses and two-thirds of cost savings that the
Company is able to achieve through its purchasing power. The Management Services
Agreements provide that each Practice will retain an amount equal to net
collections less the management fee earned by the Company, which includes the
authorized operating costs incurred. If the amount of such costs incurred and
paid by the Company exceeds the amount authorized, approval to reimburse the
Company for such excess must come from the Operations Committee. In addition,
the Company will be responsible for arranging the funding of Ancillary Service
Facilities when appropriate and will, subject to applicable laws, share
appropriately in the profits from such facilities.
Each Management Services Agreement has an initial term of 40 years, with
automatic extensions (unless at least six months' notice is given) of additional
five-year terms. The Management Services Agreement may be terminated by either
party if the other party (a) files a petition in bankruptcy or other similar
events occur, or (b) defaults in any material respect in the performance of any
duty or obligation under the Management Services Agreement, which default is not
cured within a specified period after receipt of notice thereof or (c) any of
the representations and warranties made by such party in the Management Services
Agreement is materially untrue or misleading and such party fails to correct
such matter after receipt of written notice thereof. The Company also has the
right to terminate the Management Services Agreement in the event that the
Practice is excluded from participation in the Medicaid or Medicare program for
any reason. Either party may also terminate the Management Services Agreement if
such party determines that the structure of the Management Services Agreement
violates any state or federal laws or regulations existing at such time and that
an amendment to the Management Services Agreement will be unable to correct such
defect.
Upon termination of the Management Services Agreement, neither party is
obligated to the other party except as set forth below. In the event of such
termination, the Company is required to complete, within four months after the
termination date, the annual settlement of the respective obligations of the
Company and Practice for the period prior to the termination date. Furthermore,
following any such termination, the Company must sell to the Practice all of the
Company's interest in the assets that are located in the offices of the Practice
and used in connection with the medical practice. The purchase price for all of
such assets will be agreed upon by the parties; however, if an agreement is not
reached, the purchase price will be determined by an independent appraisal.
Under the Management Services Agreement, the Company is typically entitled to
receive all of the revenues collected by the Practice during the 90-day period
following termination of the agreement.
The Company has entered into a Management Services Agreement with STSC that
permits STSC and the individual physicians to rescind the Affiliation
Transaction on November 1, 2003. Management Services Agreements for seven other
Existing Practices comprising 29 physicians contain provisions that permit such
Existing Practices to rescind their Affiliation Transactions on their respective
seventh anniversaries.
Under the Management Services Agreement, the Practice agrees generally not
to, at any time prior to the second anniversary of the termination of the
Management Services Agreement, compete with the Company by providing services to
other medical groups similar to those provided by the Company under the
Management Services Agreement or by entering into a management relationship with
another provider of non-professional management services that provides such
services to multiple physician groups. The Company and the Practice agree not to
disclose to third parties any confidential information relating to the other
party.
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<PAGE>
Asset Purchase Agreement. Subject to the terms and conditions of an asset
purchase agreement (the 'Asset Purchase Agreement'), the Company typically
purchases from the Practice all of those assets used by the Practice in the
operation of the medical practice, including medical equipment, furniture, trade
fixtures, office equipment, supplies, and, subject to legal limitations
regarding Medicare and Medicaid receivables, outstanding accounts receivable.
Pursuant to an assignment and assumption agreement entered into as a condition
to the Asset Purchase Agreement, the Company also acquires a leasehold interest
in certain assets leased by the Practice, including offices and equipment. The
Company also assumes certain liabilities related to any leased equipment and
leased offices. The purchase price paid by the Company under the Asset Purchase
Agreement is customarily determined by the parties after an appraisal of the
assets being acquired. Under the Asset Purchase Agreement, the Practice agrees
to indemnify the Company for any losses resulting from the operation of such
medical practice prior to the effectiveness of the affiliation of such Practice
with the Company.
Restricted Stock Agreement. The Company issues Common Stock to the
physician owners of the Practice as partial consideration for affiliating with
the Company. Such Common Stock is issued pursuant to the terms and conditions
set forth in a restricted stock agreement (the 'Restricted Stock Agreement'),
which terms generally include annual vesting of 25% of the Common Stock each
year in a four year period, a right of first refusal for the Company in the
event the physician decides to sell such Common Stock and the authority of the
Company's Board of Directors to prevent a physician's sale of such Common Stock
to a competitor of the Company. The Restricted Stock Agreement further provides
that the shares of Common Stock issued by the Company to the physicians remain
issued and outstanding regardless of whether such physicians remain with the
Practice, but the rights of the individual physicians to such shares (as opposed
to the right of the Practice) will vest equally over four years, with the
Practice retaining the right to utilize unvested shares to recruit new
physicians. Upon termination of the Management Services Agreement, the Company
has the right to repurchase all or any part of the Common Stock issued in the
Affiliation Transaction. If the Company elects to repurchase unvested shares,
the price per share is the original value of such Common Stock as set forth in
the Restricted Stock Agreement. If the Company elects to purchase vested shares,
the price per share is the then fair market value of the Common Stock. The
Company may also issue Common Stock to employed physicians and other key
personnel of the Practice pursuant to a Restricted Stock Agreement containing
substantially similar terms. The Company expects to enter into amendments to the
Restricted Stock Agreements to eliminate the vesting provisions.
Stockholder Noncompetition Agreement. Under a non-competition agreement
(the 'Stockholder Non-competition Agreement'), each physician owner and employed
physician of the Practice agrees not to (i) compete directly or indirectly with
the Practice in the provision of medical services or with the Company in the
provision of practice management services for a period of two years after
termination of his affiliation with the Practice and within a 25 mile radius of
any of the Practice's offices; or (ii) disclose any confidential information of
the Company or the Practice. Each physician further agrees to indemnify the
Company and the Practice for any damages they may suffer as a result of the
physician's failure to abide by the foregoing covenants. There can be no
assurance as to the enforceability of the Stockholder Noncompetition Agreements.
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 both general and specialty practices and the management of such
practices. Other PPMs and some hospitals, clinics, health maintenance
organizations ('HMOs') and provider networks engage in 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 to
affiliate with, and to enter into agreements to provide management services to,
medical practices on terms beneficial to the Company.
The Practices and the IPA 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 for consumers of 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 Practices or the IPA will be able to compete effectively in the
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<PAGE>
markets that they serve. The inability of the Practices or the IPA to compete
effectively would have a material adverse effect on the Company.
Further, the Practices and the IPA compete with other providers for
musculoskeletal managed 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
Practices, the IPA and the Company in obtaining such contracts. There can be no
assurance that the Company and the Practices will be able to successfully obtain
sufficient managed care contracts to compete effectively in the markets they
serve. The inability of the Practices to compete effectively for and obtain such
contracts could materially adversely affect the Company.
GOVERNMENT REGULATION AND SUPERVISION
The delivery of health care services is regulated at both the federal and
state level. The laws applicable to the Company are subject to evolving
interpretations, and therefore there can be no assurance that a review of the
Company's operations by federal or state judicial or regulatory authorities
would not result in a determination that the Company, the IPA or one of the
Practices has violated one or more provisions of federal or state law. Any such
determination could have a material adverse effect on the Company.
Federal Law
Among the significant federal laws that apply to the Company's activities
are those that prohibit: (a) the filing of false or improper claims with a
federally funded health program; (b) unlawful inducements for the referral of
business reimbursable under most federally funded health programs; (c) fraud in
regard to payment or service in any health program; and (d) the billing for the
provision of certain Medicare or Medicaid covered items or services where such
items or services were provided based upon a referral to the providing entity by
a physician who has, or whose immediate family member has, a financial
relationship with that entity that does not fall within an applicable exception.
False and Other Improper Claims. Under numerous federal laws, including
the Federal False Claims Act (the 'False Claims Act'), 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 a federally funded
health program (such as Medicare or Medicaid). The False Claims Act provides for
a civil penalty of not less than $5,000 and not more than $10,000 per false
claim and between two to three times the amount of damages depending on the
facts and circumstances. The Medicare civil monetary penalty is now ten thousand
dollars ($10,000) per false item or service claimed. Recently enacted federal
legislation also imposes federal criminal penalties on persons who file false or
fraudulent claims with private insurers. While the criminal statutes are
generally reserved for instances of fraud, the civil and administrative penalty
statutes are being applied by the government in an increasingly broad range of
circumstances. Civil sanctions may be imposed if the claimant knew or should
have known that billing was improper. The government also has taken the position
that claiming reimbursement for services that are substandard is a violation of
these false claims statutes if the claimant knew or should have known that the
care was substandard or rendered under improper circumstances. Private persons
may bring civil actions to enforce the False Claims Act. Under certain lower
court decisions, claims derived from a violation of the Anti-Kickback Statute
(as defined herein) or the federal Self-Referral Law (also known as the 'Stark
Law') have been deemed to be, or may under certain circumstances be construed to
be, false claims.
The Stark Self-Referral Law. The Stark Law prohibits a physician from
referring a patient for certain designated health services reimbursable by
Medicare to an entity with which the physician (or the physician's immediate
family member) has a financial relationship, whether through ownership, debt or
compensation arrangements. In addition, a state cannot receive federal financial
participation payment under the Medicaid program for designated health services
furnished to an individual on the basis of a physician referral that would
result in a denial of payments under the Medicare program if Medicare covered
the services to the same extent and under the same terms and conditions as under
the state Medicaid plan. Designated health services means clinical laboratory
services, physical therapy services, occupational therapy services, radiology
(including magnetic resonance imaging, computerized axial tomography scans and
ultrasound services), radiation therapy services and supplies, durable medical
equipment and supplies, parenteral and enteral nutrients, equipment, and
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<PAGE>
supplies, prosthetics, orthotics, and prosthetic devices, home health services
and supplies, outpatient prescription drugs, and inpatient and outpatient
hospital services. Referrals for services other than designated health services
and the furnishing of physicians' services that do not involve any designated
health services are not subject to the Stark Law. The term 'referral' under the
Stark Law means more than merely recommending a vendor for designated health
services to a patient; referrals are defined to include the request or
establishment of a plan of care by a physician which includes the provision of
designated health services. Consequently, the ordering of designated health
services within a physician's medical group can constitute a referral within the
meaning of the Stark Law.
Further, unless an exception is met, both the health care entity that
furnishes the services and the physician who makes the referral are prohibited
from billing Medicare for services rendered to Medicare beneficiaries in
violation of the Stark Law. The Stark Law is a civil statute which does not
include criminal penalties. Violations of the Stark Law could result in
significant civil sanctions, including denial of payment, refunds of amounts
collected in violation of the statute and civil money penalties of up to fifteen
thousand dollars ($15,000) for each bill or claim for a service a person knows
or should know is a service for which payment may not be made. The Stark Law
also includes civil money penalties of up to one hundred thousand dollars
($100,000) for each arrangement or scheme which the physician or entity knows or
should know has a principal purpose of assuring referrals which, if directly
made, would violate the Stark Law proscription. Both penalty provisions also
provide for exclusion from the Medicare programs. The Stark Law also prohibits
federal financial participation in any payment by a state for services where
such payment would be prohibited by the Stark Law if rendered to a Medicare
beneficiary. The Stark Law also requires each entity that receives Medicare or
Medicaid payments for designated health services to report to HCFA (for
Medicare) or the state Medicaid agency all financial relationships with
referring physicians, with penalties of $10,000 per day for failing to report
such information appropriately, and requires group practices to provide an
attestation. Implementation of these reporting and attestation requirements has
been deferred pending adoption of regulations related to such requirements.
The Company currently does not directly provide any designated health
services as that term currently is defined under the Stark Law; however, one or
more of the Practices may provide designated health services within their
offices. Because the Company provides management services and managed care
contracting services to the Practices for a fee, there can be no assurance that
the Company will not be deemed to be providing designated health services within
each Practice. If the Company is held to be the provider of such designated
health services within each Practice, the Stark Law will require that the
arrangements between the Company and the physicians in each Practice that
provide designated health services be structured to meet a Stark Law exception.
Under this scenario, the physicians' ability to order designated health services
within the Practices and the ability of the Practices to bill Medicare or
Medicaid for such designated health services will be permissible only if the
financial arrangements under the Management Services Agreements or IPA Provider
Agreements entered into by the Company and the Practices meet certain exceptions
set forth in the Stark Law. The Company believes that the financial arrangements
under the Management Services Agreements or IPA Provider Agreements qualify for
applicable exceptions under the Stark Law; however, there can be no assurance
that a review by the courts or regulatory authorities would not result in a
contrary determination. Also, to the extent that the Company in the future owns,
manages or operates Ancillary Service Facilities that provide designated health
services, the Stark Law may require the arrangements for the Company's
acquisition of certain non-clinical assets of the Practices and its Management
Services Agreements or IPA Provider Agreements with each Practice to be
structured to meet Stark Law exceptions in order for the physicians within each
Practice to refer Medicare patients to the Ancillary Service Facilities for
designated health services.
It is also possible that, as a result of the Company's Management Services
Agreements and IPA Provider Agreements with the Practices, the physicians in the
Practices will be deemed to have indirect financial interests in Practices by
virtue of the physicians' ownership interests in the Company. Under such
interpretation of the Stark Law, the physicians' ability to order and bill for
designated health services provided within the Practices and the ability of the
Practices to bill Medicare or Medicaid for such designated health services will
be permissible only if an exception under the Stark Law is applicable. The
current Stark Law exception related to physicians' ownership interests in
entities to which they refer patients may be relevant to the physicians' ability
to make referrals for designated health services to any Ancillary Service
Facilities owned or managed by the
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Company in the future. The Company will not be in a position to meet that
exception related to investment interests until the Company's stockholders'
equity exceeds $75 million.
The Stark Law also governs the physicians' ability to refer patients for
designated health services within the Practices in light of the physicians'
ongoing compensation and ownership arrangements with such Practices. An
exception for in-office ancillary services requires that the Practices meet
certain structural and operational requirements on an ongoing basis in order to
bill for in-office ancillary designated health services rendered by employed or
contracted physicians.
A key feature of the in-office ancillary services exception is the Stark
Laws definition of a 'group practice.' On January 9, 1998, HCFA published
proposed regulations which, among other things, focus on the definition of
'group practice.' In the proposed regulations, among other things, HCFA has
provided or clarified that (i) a referral of a designated health service within
the group practice is a Stark-covered referral; (ii) generally, a group practice
must be a single legal entity, although professional corporations wholly-owned
by a single physician may own an interest in the entity; (iii) independent
contractors to the group practice are not group members, and therefore cannot
provide supervision services if application of the in-office ancillary services
exception is sought; (iv) the supervising group member generally must be in the
office suite; (v) distribution of income and allocation of expenses within the
group practice must be in accordance with methods that are determined prior to
the time the group practice has earned the income or incurred the costs and must
indicate that the group practice is a unified business, that is, the methods
must reflect centralized decision making, pooling of expenses and revenues, and
a distribution system that is not based on each satellite office operating as if
it were a separate enterprise; (vi) a group member's compensation cannot be
directly related to revenues generated by his or her own referrals, even if he
or she personally provided or supervised the referred service (although the
referring physician can share in overall profits related to such services);
(vii) the allocation of profits by sub-group is prohibited; (viii) the 'same
building' in which the unrelated service and the ancillary service must be
provided to comply with the requirements for application of the in-office
ancillary service exception excludes trailers and multiple addresses, or
buildings connected by tunnels or walkways; (ix) the group practice may have
more than one centralized facility for the provision of the group practice's
designated health services; (x) profits distribution within the group practice
cannot be based on reduced referrals (incentive plan payments); and (xi) with
regard to the requirement that a group physician provide to the group practice
substantially the full range of services that he or she routinely provides, only
the services provided in the discrete specialty area of services that the
physician provides for the group practice need be considered, even though the
physician might provide services in another area for another group practice on
different days. Although the proposed regulations do not yet have the effect of
law, they provide guidance as to HCFA's interpretation of the Stark Law.
Therefore, the Company will be reviewing the new guidance provided by the
proposed regulations with the Practices to determine if any changes in the
Practices' operations may be appropriate. The Company cannot assure that the
Practices will implement such changes, if appropriate, or will implement them
correctly, or that the proposed regulations will not be interpreted to prohibit
relationships that the Company and the Practices believe comply with the Stark
Law, or that the final regulations or future regulations, statutory amendments,
or interpretations thereof, will not further modify requirements for compliance
with the Stark Law.
In the recently enacted 1997 Budget Bill, Congress directed the Secretary
of the U.S. Department of Health and Human Services ('HHS') effective on or
about November 3, 1997, to issue advisory opinions as to whether a referral
relating to designated health services (other than clinical laboratory services)
is prohibited under the Stark Law. Regulations implementing the advisory opinion
process were adopted on January 9, 1998. An advisory opinion issued by the
Secretary will be binding as to the Secretary and the party or parties
requesting the opinion. The Company has no present intention to seek an advisory
opinion from HHS, HCFA or any other governmental authority regarding its current
operations, arrangements with physicians or the referral activities of
physicians in the Practices.
Federal Anti-Kickback Statute. A federal law commonly known as the
'Anti-Kickback Statute' 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 business for which payment may be made under a
federal health care program. A 'federal health care program' is any plan or
program that provides health benefits, whether directly, through insurance, or
otherwise, which is funded directly, in whole or in part, by the United States
Government (e.g., Medicare, Medicaid, and CHAMPUS). Excluded from the definition
of federal health care program is the Federal
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Employee Health Benefits Program. The type of remuneration covered by the
Anti-Kickback Statute is very broad. It includes not only kickbacks, bribes and
rebates, but also proscribes any such remuneration, whether made directly or
indirectly, overtly or covertly, in cash or in kind. Moreover, prohibited
conduct includes not only remuneration intended to induce referrals, but also
remuneration intended to induce the purchasing, leasing, arranging or ordering
of any goods, facilities, services, or items paid for by a federal health care
program. The Anti-Kickback Statute has been interpreted broadly by a number of
courts to prohibit remuneration that is offered or paid for otherwise legitimate
purposes if one purpose of the payment is to induce referrals. Even bona fide
investment interests in a health care provider may be questioned under the
Anti-Kickback Statute if the government concludes that the opportunity to invest
was offered as an inducement for referrals.
In part to address concerns regarding the implementation of the
Anti-Kickback Statute, in 1991 the federal government published regulations that
provide exceptions or 'safe harbors' for certain transactions that are deemed
not to violate the Anti-Kickback Statute. Among the safe harbors included in the
regulations are transactions involving the sale of physician practices,
management and personal services agreements and employee relationships. Congress
recently added a significant new statutory exception related to 'remuneration
between an organization and an individual or entity' if the organization is a
Medicare risk contracting organization or if the remuneration is provided
pursuant to a written agreement that places the individual or entity at
substantial financial risk for the cost or utilization of services. Regulations
implementing the foregoing statute have not yet been adopted, but are expected
to be enacted soon. The failure of an activity to qualify under a safe harbor
provision, while potentially leading to greater regulatory scrutiny, does not
render the activity automatically illegal under the Anti-Kickback Statute.
Conduct falling outside the safe harbors will be judged by government regulators
on a case-by-case basis based on the specific facts and circumstances.
Each offense under the Anti-Kickback Statute is classified as a felony and
is punishable by a criminal fine of up to twenty-five thousand dollars ($25,000)
and/or imprisonment of up to five (5) years; a civil money penalty of fifty
thousand dollars ($50,000) for each violation and/or civil damages of not more
than three times the total amount of remuneration offered, paid, solicited or
received may be imposed without regard to whether any portion of such
remuneration was for a lawful purpose. Both the offeror and the recipient of the
illegal remuneration are potentially liable. In addition, violators are subject
to civil exclusion from participation in the federal health care programs,
regardless of whether they also have been convicted under the criminal penalty
provisions or have been found liable under the civil monetary penalty provisions
of the Anti-Kickback Statute. Also, there is a risk that, in a civil lawsuit to
enforce a contract that contains a structure in violation of the Anti-Kickback
Statute, a court might conclude that the contract is unenforceable as against
public policy.
There are several aspects of the Company's relationships with the
physicians and the Practices to which the Anti-Kickback Statute may be relevant.
In some instances, for example, the government may construe some of the
Company's marketing and managed care contracting activities as arranging for the
referral of patients to the physicians with whom the Company has a Management
Services Agreement or IPA Provider Agreement. Further, any referral of patients
between physicians within the Practices and between the Practices could be
construed as a referral to which the Anti-Kickback Statute applies. Although
neither the investments in the Company by physicians nor the Management Services
Agreements or the IPA Provider Agreements between the Company and the Practices
qualify for protection under the statutory exception or the safe harbor
regulations described above, the Company does not believe that these activities
fall within the type of activities the Anti-Kickback Statute were intended to
prohibit. The Company also does not believe that referral activities within the
Practices violate the Anti-Kickback Statute. A determination that the Company
has violated the Anti-Kickback Statute would have a material adverse effect on
the Company.
As a component of the recently enacted HIPAA, Congress directed the
Secretary of the U.S. Department of Health and Human Services to issue advisory
opinions regarding compliance with the Anti-Kickback Statute. The advisory
opinion mechanism is authorized for a trial period, beginning six months after
the date of enactment, August 21, 1996. Advisory opinions are available
concerning what constitutes prohibited remuneration within the meaning of the
Anti-Kickback Statute, whether an arrangement satisfies the statutory exceptions
to the Anti-Kickback Statute, whether an arrangement meets a safe harbor, what
constitutes an illegal inducement to reduce or limit services to individuals
entitled to benefits covered by the Anti-Kickback Statute, and whether an
activity constitutes grounds for the imposition of a civil or criminal penalty
under the applicable exclusion, civil money penalty and criminal provisions.
Advisory opinions, however, will not assess fair market value for any goods,
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services or property or determine whether an individual is a bona fide employee
within the meaning of the Internal Revenue Code. The statutory language makes
clear that advisory opinions are available for both proposed and existing
arrangements. The failure of a party to seek an advisory opinion, however, may
not be introduced into evidence to prove that the party intended to violate the
Anti-Kickback Statute. The Company has not sought, and has no present intention
to seek an advisory opinion regarding any aspect of its current operations or
arrangements with physicians.
PIP Regulations. HCFA has issued final regulations (the 'PIP regulations')
covering the use of physician incentive plans ('PIPs') by HMOs and other managed
care contractors and subcontractors that contract to arrange for services to
Medicare or Medicaid beneficiaries ('Organizations'), potentially including the
Company. Any Organization that contracts with a physician group that places the
individual physician members of the group at substantial financial risk for the
provision of services that the group does not directly provide (e.g., a primary
care group takes risk but subcontracts with a specialty group to provide certain
services), must satisfy certain disclosure, survey and stop-loss requirements.
Under the PIP regulations, payments of any kind, direct or indirect, to induce
providers to reduce or limit covered or medically necessary services are
prohibited ('Prohibited Payments'). Further, where there are no Prohibited
Payments, but there is risk sharing among participating providers related to
utilization of services by their patients, the regulations contain three groups
of requirements: (i) requirements for physician incentive plans that place
physicians at 'substantial financial risk'; (ii) disclosure requirements for all
Organizations with PIPs; and (iii) requirements related to subcontracting
arrangements. In the case of substantial financial risk (defined in the
regulations according to several methods, but essentially risk in excess of 25%
of the maximum payments anticipated under a plan with less than 25,000 covered
lives), Organizations must conduct enrollee surveys and ensure that all
providers have specified stop-loss protection. The violation of the requirements
of the PIP regulations may result in a variety of sanctions, including
suspension of enrollment of new Medicaid or Medicare members, or a civil
monetary penalty of $25,000 for each determination of noncompliance. In
addition, because of the increasing public concerns regarding PIPs, the PIP
regulations may become the model for the industry as a whole. Although the
Company currently has no contracts that require compliance with the PIP
regulations, the new regulations, by limiting the amount of risk that may be
imposed upon physicians in certain arrangements, could affect the ability of the
Company to meaningfully reduce the costs of providing services.
Antitrust. Because the Practices that affiliate with the Company remain
separate legal entities, they may be deemed competitors subject to a range of
antitrust laws that prohibit anti-competitive conduct, including price fixing,
concerted refusals to deal and divisions of markets. In particular, the
antitrust laws have been interpreted by the Federal Trade Commission ('FTC') and
the United States Department of Justice ('DOJ') to prohibit joint negotiation by
competitors of price terms in the absence of financial risk that is shared among
the competitors, other financial integration or substantial clinical integration
among the competitors. The Company intends to comply with such state and federal
laws as may affect its development of, and contracting for, integrated health
care delivery networks (and in particular its IPA) and will utilize the DOJ and
FTC approved 'messenger model'--which avoids joint price negotiations--for those
agreements that do not involve sufficient financial or clinical integration.
Nevertheless, there can be no assurance that a review of the Company's business
by courts or regulatory authorities will not result in a determination that
could adversely affect the operation of the Company and the Practices.
State Law
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 on referrals than the Stark Law. These various state self-referral
laws have different requirements. 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 or, alternatively, to all health
care services furnished by a provider. Some states do not prohibit referrals at
all, but require only that a patient be informed of the financial relationship
before the referral is made.
The following provides a brief review of the self-referral laws in each of
the states in which the Company does business:
Arizona law requires that physicians, when making referrals to an entity
they own that is not part of their group practice, disclose to patients (i) that
the physician has a direct financial interest in the separate diagnostic or
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treatment agency or non-routine goods or services that such patient is being
prescribed, and (ii) that the prescribed treatment, goods or services are
available on a competitive basis from other agencies.
California's principal self-referral law applies to all payors and provides
that it is unlawful to refer a person for certain defined categories of services
(including laboratory, physical therapy, physical rehabilitation and diagnostic
imaging) to an entity in which or with which the referring person has a
financial interest (broadly defined). Several exceptions apply, including an
exception for group practices and for referrals to certain publicly traded
entities. Any financial interest by a physician in a health related facility
providing the listed services must be disclosed to the state as a condition of
licensure. The California self-referral statute also requires all physicians to
make disclosure to patients in the event of any referral to a service in which
the physician or his or her family has a significant beneficial interest (even
if such service is not one of the covered services affected by the self-referral
prohibition). In the context of a group practice, the patient disclosure
requirement may be met by providing a written disclosure to each patient or
posting a notice in a common area. Disclosure to the state of physician referral
interests is also a condition of payment under the California Medi-Cal
(Medicaid) program. California also has a separate self-referral law with
respect to care that is covered under workers' compensation insurance, although
the scope of the prohibition, the list of covered services, and the exceptions
provided are virtually identical to those contained in the state's all-payor
self-referral law summarized above.
Florida's Patient Self-Referral Act of 1992 prohibits health care
providers, including physicians, from referring a patient for the provision of
designated health care services, and in some circumstances any health care
services, to an entity in which the health care provider has an investment
interest, unless an exception, such as for referrals within a group practice,
applies.
New Jersey statutes and regulations contain a general prohibition against
self-referrals of a patient to any 'health care service' in which the
practitioner or his or her immediate family has a significant beneficial
interest. This self-referral prohibition is, however, subject to certain
exceptions, including an exception for referrals to a referring physician's own
'medical office' for services billed directly by and in the name of the
referring physician. In general, the Company is aware that significant portions
of New Jersey regulations addressing the issues of self-referral, anti-kickback,
fee splitting and corporate practice of medicine are currently in the process of
being developed and revised by appropriate agencies for possible publication as
proposed rules.
In Pennsylvania, there is no comprehensive self-referral prohibition,
although Pennsylvania does require disclosure to patients where a financial
interest exists in the entity or with the person to which a referral is made.
For providers treating Medicaid patients, Pennsylvania Medicaid regulations
contain a limited self-referral ban, prohibiting, without exceptions, referrals
to an independent laboratory, pharmacy, radiology or ancillary medical service
in which the referring practitioner has an ownership interest. Finally,
Pennsylvania's workers' compensation statute also prohibits the referral of
workers' compensation patients from a provider to a person or an entity with
which the provider has a financial relationship. The Pennsylvania's workers'
compensation self-referral law applies all of the exceptions, including the
group practice exception, applicable under the federal Stark Law.
Texas law does not have a specific self-referral law.
Failure to comply with the foregoing laws may result in loss of licensure,
which would be imposed against the physicians in the Practices, or other civil
or criminal penalties, which may be imposed against the physicians in the
Practices, or against the Company in its capacity as billing agent for the
physicians (pursuant to the Management Services Agreements) or in the event the
Company becomes or is deemed to be a provider of health care services subject to
the various self-referral laws, or if the Company becomes or is deemed to be in
a position to make or influence referrals to the Practices. In addition, any
determination that any Management Services Agreement violates any of the
foregoing laws may result in such agreement being unenforceable. Additional
risks under state self-referral laws could arise, however, to the extent that
the Company or the Practices undertake to own, manage or operate any Ancillary
Service Facilities to which the physicians within the Practices may wish to
refer patients.
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. Some state laws governing workers'
compensation and other insurance also include an anti-kickback prohibition.
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The following provides a brief review of the anti-kickback laws of the
states in which the Company does business:
In Arizona, the state's Professions and Occupations statute declares it
unprofessional conduct for a physician to divide fees for professional services
with another health care provider or health care institution. Arizona's Medicaid
statute also includes a broad general anti-kickback proscription.
California has a general, all-payor anti-kickback statute which prohibits
the offer or acceptance of any compensation by a licensed provider as
compensation or inducement for referring patients, clients or customers.
Significantly, however, this statute also provides that payments for services
other than the referral of patients based on a percentage of gross revenue (or
other similar type of contractual arrangement) is not unlawful if the
consideration is commensurate with the value of the services furnished.
Prohibitions against receiving remuneration for patient referrals also exist
elsewhere in the California statutes, including the state Medicaid statute, the
workers' compensation statute, and the insurance code.
Florida's patient brokering law prohibits any person, including health care
providers, from offering or paying, soliciting or receiving, any commission,
bonus, rebate, kickback, or bribe, or from engaging in any split-fee
arrangement, in return for referring patients. Exceptions include payment
arrangements that are not prohibited by the federal Anti-Kickback law, and
financial arrangements within a group practice. Florida law contains a number of
similar anti-kickback prohibitions. For example, Florida law governing medical
practice provides that licensed physicians are subject to disciplinary action
for these kinds of activities, and Florida's Medicaid statute prohibits similar
activities, but as applied to items and services reimbursed by Medicaid.
New Jersey's professional licensure statutes and regulations prohibit
payment and the receipt of payments for referrals of patients and for
recommending purchasing or prescribing any medical product or other device or
appliance. In addition, under New Jersey's Medicaid statute, criminal penalties
are imposed for any provider or other person who solicits, offers or receives
any kickback, rebate or bribe in connection with the furnishing of Medicaid
items or services. In general, the Company is aware that significant portions of
New Jersey regulations addressing the issues of self-referral, anti-kickback,
fee splitting, and corporate practice of medicine are currently in the process
of being developed and revised by appropriate agencies for possible publication
as proposed rules.
In Pennsylvania, the criminal code provides a general anti-kickback
prohibition, which defines the crime of insurance fraud to include a health care
provider's giving of anything of value in consideration of a referral with
respect to services subject to insurance benefits or claims. Substantially
similar anti-kickback prohibitions are also contained in Pennsylvania's statute
and regulations dealing with providers who participate in the Pennsylvania
Medicaid program or who are paid under the state's workers' compensation
program.
Texas anti-kickback law applies to remuneration or compensation for
referrals made between a licensed provider and an unlicensed person or entity,
but it permits any activity that complies with the federal anti-Kickback Statute
or any regulations promulgated thereunder. In addition, the medical practice
standards in Texas prohibit physicians from paying any person for soliciting or
securing referrals.
Failure to comply with the foregoing laws may result in loss of licensure,
which would be imposed against the physicians in the Practices, or other civil
or criminal penalties, which may be imposed against the physicians in the
Practices, or against the Company in its capacity as billing agent for the
physicians (pursuant to the Management Services Agreements) or in the event the
Company becomes or is deemed to be a provider of health care services subject to
the various anti-kickback laws, or if the Company becomes or is deemed to be in
a position to make or influence referrals to the Practices. In addition, any
determination that any Management Services Agreement violates any of the
foregoing laws may result in such Agreement being unenforceable. 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 a material adverse effect upon the Company and subject it and
the Practices' physicians to penalties and sanctions.
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 division of a physician's fees, regardless of
whether the other party is a referral source. Some states have laws that
specifically address payments for services rendered to physicians based on a
percentage of revenues from the physician's practice.
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The following provides a brief review of the fee-splitting laws in each of
the states where the Company does business:
Arizona does not explicitly prohibit the sharing of fees between physicians
and non-professionals (e.g., a management company). However, as noted above,
Arizona does declare it unprofessional conduct for a physician to divide fees
for professional services with another health care provider or health care
institution in return for a patient referral.
As noted above in the discussion of California's anti-kickback provisions,
California explicitly permits payment for services (other than the referral of
patients) based on a 'percentage of gross revenue or similar type of contractual
arrangement,' provided that the consideration is commensurate with the value of
the services furnished. However, even if a contractual arrangement does not
involve unlawful fee splitting, the arrangement nonetheless could be deemed to
constitute an arrangement involving payment for referrals under the state anti-
kickback laws.
On November 3, 1997, the State of Florida Board of Medicine ruled that
percentage-based management services fees violate Florida's prohibition on fee
splitting by licensed professionals. The Company has included such percentage
fees in all of its Management Services Agreements with physicians in Florida.
Thus, no assurance can be given that the Company's Management Services
Agreements based on such percentage fees will be enforceable. To avoid this
risk, the Company will seek to restructure such agreements in Florida to comply
with the order, but such modifications, or the failure to obtain agreement on
such modifications, could have a material adverse effect on the Company.
New Jersey does not explicitly prohibit the sharing of fees between
physicians and nonprofessionals, but such fee sharing may be a factor in the
determination as to whether New Jersey's corporate practice of medicine doctrine
has been violated. In general, the Company is aware that significant portions of
New Jersey regulations addressing the issues of self-referral, anti-kickback,
fee splitting, and corporate practice of medicine are currently in the process
of being developed and revised by appropriate agencies for possible publication
as proposed rules.
Pennsylvania does not explicitly prohibit the sharing of fees between
physicians and nonprofessionals, but such fee sharing may be a factor in the
determination as to whether Pennsylvania's corporate practice of medicine
doctrine has been violated.
In Texas, judicial interpretation of the state's corporate practice of
medicine doctrine in Texas has suggested that payments of a percentage of
profits from a physician's medical practice to a management company is a factor
indicative of the corporate practice of medicine.
The Company is reimbursed by physicians in the Practices on whose behalf
the Company provides management services. There can be no certainty that, if
challenged, the Company and the Practices will be found to be in compliance with
each state's fee-splitting (or related corporate practice) laws. Failure to
comply with the foregoing laws may result in loss of licensure, which would be
imposed against the physicians in the Practices, or other civil or criminal
penalties, which may be imposed against the physicians in the Practices, or
against the Company in its capacity as agent for the physicians (pursuant to the
Management Services Agreements) or in the event the Company becomes or is deemed
to be a provider of health care services subject to the various fee-splitting
laws, or if the Company becomes or is deemed to be in a position to make or
influence referrals to the Practices. A determination in any state that the
Company is engaged in any unlawful fee-splitting arrangement could render any
Management Services Agreement or IPA Provider Agreement between the Company and
a Practice located in such state unenforceable or subject to modification in a
manner materially adverse to the Company.
Corporate Practice of Medicine. The laws of many states prohibit business
corporations, including the Company, from employing physicians, exercising
control over the medical judgments or decisions of physicians and from engaging
in certain financial arrangements, such as fee-splitting with physicians. These
laws and their interpretations vary from state to state and are enforced by both
the courts and regulatory authorities, each with broad discretion. 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.
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The following provides a brief review of the corporate practice of medicine
doctrine as applied in each of the states in which the Company does business:
Although Arizona case law dated 1967 suggests a long-standing proscription
against the practice of medicine by corporate entities, there are no reported
cases or Arizona Attorney General opinions of this proscription in recent years.
In addition, Arizona's professional corporation statute permits up to forty-nine
percent (49%) ownership of professional medical corporations by non-physicians.
The prohibition on the corporate practice of medicine in California is
reflected both in statute and in case law. In California, a management contract
can be interpreted as unlawfully violating the prohibition on the corporate
practice of medicine if it concedes too much power to the management company.
Examples of such power would be the ability of the management company to select
office sites, require payment to the management company of a substantial
percentage of the practice's gross income, require adherence to design
specifications for practice offices, require approval of goods and supplies used
by the practice, or other matters which singly or in combination may interfere
with the ability of the physician to exercise independent professional judgment.
The Company also is aware that the California Medical Association has developed
guidelines for physicians on the extent to which a management company can
exercise decision-making over a physician practice.
The Florida Board of Medicine has ruled that Florida law does not prohibit
licensed physicians from engaging in the practice of medicine as employees of
business entities, such as business corporations or limited liability companies,
as long as the physicians maintain control over medical decision-making.
New Jersey regulations specify permitted practice forms for physicians and
provide examples of relationships a medical practice may enter into with
non-professional entities for space, equipment and management services. These
regulations require that the physicians retain control of the professional
medical aspects of the practice, as well as control over fee schedules and
certain other functions. In general, the Company is aware that significant
portions of New Jersey regulations addressing the issues of self-referral,
anti-kickback, fee splitting, and corporate practice of medicine are currently
in the process of being developed and revised by appropriate agencies for
possible publication as proposed rules.
Pennsylvania's corporate practice of medicine doctrine permits only
licensed professionals and entities owned solely by such professionals to
practice medicine, not business corporations or similar entities. Although there
are no regulations or case law regarding management services agreements with
professionals, the Company believes Pennsylvania will require the professionals
to maintain control of their practices.
Texas' physician licensure statute contains a broad prohibition against the
'aiding or abetting, directly or indirectly,' of the corporate practice of
medicine. Further, judicial interpretation in Texas of the state's corporate
practice doctrine has suggested that payments of a percentage of profits from a
physician's medical practice to a management company is a factor indicative of
the corporate practice of medicine.
The Company's practice management structure, which the Company believes is
consistent with standard practices for PPMs, uses an operations committee (the
'Operations Committee') of six members, three of whom are designated by each of
the Company and the Practice. Among other things, the Operations Committee
approves a budget, medical group costs, costs and expenses that exceed the
budget, the acquisition and replacement of equipment and the integration of new
technologies. In addition, the Company's explicit approval is required for
implementation or acquisition of new technologies or medical equipment if the
costs of such equipment or technology exceeds 5% of the management fee. Company
approval is also required for all new offices and new ancillary services. If a
new medical office is not profitable, the Company may, in its sole discretion,
close the new office. Finally, a change in control of the Practice requires the
consent of the Company (not to be unreasonably withheld). While these provisions
in the Company's Management Services Agreements are designed to give the Company
control over certain business transactions by the Practices, which explicitly
retain their professional independence, the Management Services Agreements give
the Company either control over or require the agreement of the Company and the
Practices with respect to certain matters that might be viewed as indicia of the
corporate practice of medicine. While the Company is not given any control over
clinical care decisions, its control or substantial influence over other
decisions may be deemed to be great enough to constitute the corporate practice
of medicine.
The Company's intent is not to exercise any responsibility on behalf of the
Practices' physicians that interferes with the physicians' independent patient
care and professional judgments. However, as noted, the laws
21
<PAGE>
and legal doctrines relating to the corporate practice of medicine 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. A determination in any state that
the Company is engaged in the corporate practice of medicine could render any
Management Services Agreement or IPA Provider Agreement between the Company and
a Practice located in such state unenforceable or subject to modification in a
manner materially adverse to the Company.
The Company hires certain ancillary health personnel (nurses and
technicians) and leases their services back to the Practices in a manner that it
believes accords with applicable Medicare billing requirements. The Company's
ability to hire such ancillary personnel is subject to various state
regulations. The Company believes that its structure in this area is common
among PPMs. Should such state corporate practice laws be interpreted to prohibit
such hiring by the Company, the Company will be required to revise its
relationship with such ancillary personnel, and the relationship of the
ancillary personnel to the Practice would also have to be modified. Such
modification in the forgoing relationships could have a material adverse effect
on the Company.
Texas Staff Leasing Law. In Texas, it is unlawful to provide 'staff
leasing services' without a license issued by the State (the 'Staff Leasing
Law'). The Texas Staff Leasing Law requires any person offering such services to
obtain a license from the Texas Department of Licensing and Regulation. The
Company leases certain non-physician personnel to STSC as part of the management
services provided by the Company to STSC. The Company was notified on December
2, 1997 that a fine of $20,000 has been recommended to be assessed against it as
a result of its operations in violation of the Staff Leasing Law between April
1, 1997 and November 30, 1997. The fine was subsequently reduced to $5,000 and
on February 19, 1998, the Company was issued the required license by the State
of Texas.
Licensure and Certificate of Need Laws. Certain of the ancillary services
that the Company anticipates providing or managing on behalf of the Practices
are now or may in the future be subject to licensure or certificate of need laws
in various states. There can be no assurance that the Company or the Practices
will be able to obtain such licenses or certificates of need approval to the
extent required for the particular ancillary service. Failure to obtain such
licenses or certificates of need could have a material adverse effect on the
Company.
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, they have
been construed in some states to apply to such companies and 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.
The National Association of Insurance Commissioners ('NAIC') in 1995
endorsed a policy proposing the state regulation of risk assumption by
physicians. The policy proposes prohibiting physicians from entering into
capitated payment or other risk sharing contracts except through HMOs or
insurance companies. Several states have adopted regulations implementing the
NAIC policy in some form. In states where such regulations have been adopted,
practices are precluded from entering into capitated contracts directly with
employers, individuals and benefit plans unless they qualify to do business as
HMOs or insurance companies. The Existing Practices currently provide services
under very few capitated payment contracts. The Company intends to limit the
number of capitated payments or other risk-sharing arrangements into which it
enters on its own behalf or on behalf of the Practices. The Company expects to
make such arrangements only with HMOs or insurance companies. In addition, in
December 1996, the NAIC issued a white paper entitled 'Regulation of Health Risk
Bearing Entities,' which sets forth issues to be considered by state insurance
regulators when considering new regulations, and encourages that a uniform body
of regulation be adopted by the states. Certain states have enacted statutes or
adopted regulations affecting risk assumption in the health care industry. In
some states, including California, these statutes and regulations subject any
physician or physician network engaged in risk-based contracting, even if
through HMOs and insurance companies, to applicable insurance laws and
regulations,
22
<PAGE>
which may include, among other things, laws and regulations providing for
minimum capital requirements and other safety and soundness requirements. The
Company believes that additional regulation at the state level will be
forthcoming in response to the NAIC initiatives.
The IPA that is owned by the Company operates as a specialty physician
network in Arizona, and contracts directly or indirectly with licensed HMOs or
insurance companies to arrange for the provision of specialty orthopedic
physician services on behalf of enrollees of the HMOs or insurance companies. In
return, the IPA accepts a fee from the relevant payor, which fee the IPA passes
along to the participating physician provider, less the IPA's fee (generally
13%) to compensate the IPA for its services. The two IPA Payor Agreements
currently in place with the IPA involve 'capitation' fees--a fixed per month per
enrollee fee for all designated orthopedic services. Arizona law does not permit
a provider network to enter into such agreement directly with enrollees, unions,
employers or other patient group on behalf of their members or employees, as
applicable; the direct acceptance of risk by such a network, under Arizona law,
would constitute the 'business of insurance' subject to licensure and regulation
by the Arizona Department of Insurance. However, where the capitation or other
risk-based payment is accepted by a provider network as a 'downstream' risk from
a licensed HMO or insurance company, the Arizona Department of Insurance has
indicated that such risk contracting would not subject the Company to licensure
or regulation by the Department. However, there can be no assurance that the
laws governing the business of insurance in Arizona will not be revised or
interpreted in a manner that would prohibit operation of the IPA under either
the IPA Payor Agreements or the IPA Provider Agreements, and in such event, the
Company would be required to modify or terminate its relationships with payors
or providers in Arizona. Such modification or termination could have a material
adverse effect on the Company.
FEDERAL AND STATE INITIATIVES
Fraud and Abuse. In the recently enacted 1997 Budget Bill and HIPAA,
Congress has responded to perceived fraud and abuse in the Medicare and Medicaid
programs. This legislation has fortified the government's enforcement authority
with increased resources and greater civil and criminal penalties for offenses.
It is anticipated that there will be further restrictive legislative and
regulatory measures to reduce fraud, waste and abuse in the Medicare and
Medicaid programs. There can be no assurance that any such legislation will not
have a material impact on the Company.
Health Care Reform. As a result of the continued escalation of health care
costs and the inability of many individuals to obtain insurance, numerous
proposals have been or may be introduced in Congress and state legislatures
relating to health care reform. There can be no assurance as to the ultimate
content, timing or effect of any health care reform legislation, nor is it
possible at this time to estimate the impact of potential legislation, which may
be material, on the Company.
Confidentiality of Patient Records. The confidentiality of patient records
and the circumstances under which such records may be released is subject to
substantial regulation under state and federal laws and regulations. To protect
patient confidentiality, data entries to the Company's databases delete any
patient identifiers, including name, address, hospital and physician. Further,
the Company obtains the informed, written consent of the patient to use or
disclose patient information where the Company believes that such consent is
necessary or appropriate. The Company believes that its procedures comply with
the laws and regulations regarding the collection of patient data in
substantially all jurisdictions, but regulations governing patient
confidentiality rights are evolving rapidly and are often difficult to apply.
Additional legislation governing the dissemination of medical record information
has been proposed at both the state and federal level. Furthermore, the Health
Insurance Portability and Accountability Act of 1996 requires the Secretary of
Health and Human Services to recommend legislation or promulgate regulations
governing privacy standards for individually identifiable health information and
creates a federal criminal offense for knowing disclosure or misuse of such
information. These statutes and regulations may require holders of such
information to implement security measures that may be of substantial cost to
the Company. There can be no assurance that changes to state or federal laws
would not materially restrict the ability of the Company to obtain patient
information originating from records.
23
<PAGE>
EMPLOYEES
As of December 31, 1997, the Company had approximately 845 employees, of
whom 26 are located at the Company's headquarters, seven are located in the
regional offices and 812 are located at the Existing Practices. The Company
believes that its relations with its employees are satisfactory.
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 Practices, the Company may become subject to some medical
malpractice actions under various theories. There can be no assurance that
claims, suits or complaints relating to services and products provided by the
Practices will not be asserted against the Company in the future. The Company
maintains medical professional liability insurance and general liability
insurance and believes that such insurance will extend to professional liability
claims that may be asserted against employees of the Company that work on-site
at Practice locations. In addition, pursuant to the Management Services
Agreements, the Practices are 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 the Practices. The cost of such insurance to the Company and the Practices
may have a material adverse effect on the Company. In addition, successful
malpractice or other claims asserted against the Practices or the Company that
exceed applicable policy limits would have a material adverse effect on the
Company.
ITEM 2. PROPERTIES
The Company has a five-year lease for its headquarters in Boca Raton,
Florida, which provides for annual lease payments of approximately $63,000. In
addition, in connection with the Affiliation Transactions, the Company assumed
leases for the facilities utilized by the respective Existing Practices for
aggregate annual lease payments of approximately $2.0 million as of December 31,
1997.
ITEM 3. LEGAL PROCEEDINGS
On August 15, 1997, an action entitled John Finlay v. Bone, Muscle & Joint,
Inc., was filed. In this action, which is currently pending in the United States
District Court for the Southern District of Texas, plaintiff has asserted claims
for breach of contract arising out of an alleged employment agreement and
alleged non-qualified stock option agreement between plaintiff and the Company.
Plaintiff's complaint seeks compensatory damages of approximately $135,000
pursuant to the alleged employment agreement as well as 16,071 shares of the
Company's Common Stock pursuant to the alleged non-qualified stock option
agreement. The Company believes that each of plaintiff's claims is without
merit, and it intends to defend against the action vigorously.
On September 3, 1997, an action entitled Robert P. Lehmann, M.D., et al. v.
Bone, Muscle & Joint, Inc., et al., was filed. In this action, which is
currently pending in the United States District Court for the Southern District
of Texas, plaintiffs have asserted claims for breach of contract, common law
fraud and promissory estoppel arising out of an alleged restricted stock
purchase agreement between plaintiffs and the Company. Plaintiffs' amended
complaint seeks unspecified compensatory and exemplary damages as well as
specific performance for delivery of 117,860 shares of the Company's Common
Stock. The Company believes that each of the plaintiffs' claims is without
merit, and it intends to defend against the action vigorously.
The Company is subject to legal proceedings in the ordinary course of its
business. The Company does not believe that any such legal proceedings will have
a material adverse effect on the Company, although there can be no assurance to
this effect. In addition, 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 Practices; nevertheless, the Company believes that
the ultimate resolution of such additional claims will not have a material
adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
24
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDERS MATTERS
The Company's Common Stock has traded on the Nasdaq National Market since
the Company's initial public offering (the 'Offering') on February 4, 1998. As
of March 16, 1998, there were approximately 200 holders of record of the Common
Stock. The Company has never paid or declared dividends on the Common Stock and
does not anticipate paying any dividends on the Common Stock in the foreseeable
future. Under certain loan agreements, the Company is prohibited from declaring
or paying any cash dividend or making distributions on any class of stock,
except pursuant to an employee repurchase plan or with the consent of its
lenders.
ITEM 6. SELECTED FINANCIAL INFORMATION
The following selected financial data with respect to the Company's
statements of operations for the years ended December 31, 1996 and 1997 and the
balance sheet data at December 31, 1996 and 1997 have been derived from the
consolidated financial statements of the Company which have been audited by
Ernst & Young LLP, independent certified public accountants.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------------
1996 1997
-------- ---------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C>
OPERATING DATA:
Practice revenues, net.............................................................. $ 6,029 $ 64,676
Less: amounts retained by physician groups.......................................... (2,912) (27,703)
-------- ---------
Management fee revenue.............................................................. $ 3,117 $ 36,973
-------- ---------
-------- ---------
Loss before income taxes............................................................ $ (1,742) $ (31,573)
Income taxes........................................................................ -- --
-------- ---------
Net loss............................................................................ $ (1,742) $ (31,573)
-------- ---------
-------- ---------
Net loss per common share........................................................... $ (1.67) $ (4.97)
-------- ---------
-------- ---------
Weighted average number of common shares outstanding--basic and diluted............. 1,043 6,351
-------- ---------
-------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
------- --------
(IN THOUSANDS, EXCEPT
OTHER OPERATING DATA)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................................................. $ 1,439 $ 2,849
Working capital....................................................................... 1,819 12,317
Total assets.......................................................................... 25,332 84,153
Short term debt expected to be refinanced............................................. -- 14,693
Long-term debt and capital lease obligation, less current portion..................... 59 20,452
Total stockholders' equity............................................................ 19,381 34,088
OTHER OPERATING DATA:
Number of practices................................................................... 3 25
Number of physicians.................................................................. 34 117
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the results of operations and financial
condition of the Company should be read in conjunction with the financial
statements and notes thereto of the Company included elsewhere in this Form
10-K. This Form 10-K contains forward-looking statements. Discussions containing
such forward-looking statements may be found in the material set forth below and
under 'Business,' as well as in this Form 10-K generally. Any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties. Actual events or results may differ materially from
those discussed in the forward-looking statements as a result of various factors
set forth in this Form 10-K generally.
25
<PAGE>
OVERVIEW
The Company is principally a PPM that provides management services to the
Practices and the COSI ambulatory surgery center and also operates an IPA. The
Company focuses on musculoskeletal care, which involves the medical and surgical
treatment of conditions relating to bones, muscles, joints and related
connective tissues. The broad spectrum of musculoskeletal care offered by the
Practices ranges from acute procedures, such as spine or other complex
surgeries, to the treatment of chronic conditions, such as arthritis and back
pain. As of December 31, 1997, the Company had affiliated with 25 existing
Practices comprising 117 physicians practicing in Arizona, California, Florida,
Pennsylvania, New Jersey and Texas by entering into Management Services
Agreements. The Company was incorporated in Delaware in January 1996 and
affiliated with its first Practice in July 1996. At December 31, 1996, the
Company had entered into Management Services Agreements with three Practices
comprising 34 physicians at that time and 37 physicians as of December 31, 1997.
During the year ended December 31, 1997, the Company entered into additional
Management Services Agreements with 22 Practices, comprising 80 physicians and
acquired the IPA with 42 physicians in Arizona.
Generally, the total consideration paid to a Practice's physicians, once
the Practice has agreed to affiliate with the Company, is based on a multiple of
the Company's management fee plus the fair market value of the Practice's
furniture, fixtures and equipment and, subject to legal limitations regarding
Medicare and Medicaid receivables, the estimated net realizable value of its
outstanding accounts receivable. The consideration paid by the Company generally
consists of the Company's Common Stock, cash and the assumption of certain
liabilities (principally notes payable to financial institutions secured by
receivables of the Practice, which notes are repaid at the time the transaction
is consummated). In exchange for this consideration, the Practice enters into a
40-year Management Services Agreement with the Company.
Practice revenues, net represents the gross revenues of the affiliated
Practices, the IPA, and the COSI ambulatory surgery center reported at the
estimated realizable amounts from patients, third party payors and others for
services rendered, net of contractual and other adjustments. Contractual
adjustments typically result from the differences between the Practices'
established rates for services and the amounts paid by government sponsored
health care programs and other insurers. The Company estimates that
approximately 15% and 13% of practice revenues, net were received under
government sponsored health care programs (principally, the Medicare and
Medicaid programs) during the years ended December 31, 1996 and 1997,
respectively. The Practices have numerous agreements with managed care and other
organizations to provide physician services based on negotiated fee schedules.
Laws and regulations governing Medicare and Medicaid programs are complex
and subject to interpretation. The Company believes that it is in compliance
with all applicable laws and regulations and is not aware of any pending or
threatened investigations involving allegations of potential wrongdoing. While
no such regulatory inquiries have been made, compliance with such laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory actions including fines, penalties and exclusion
from the Medicare and Medicaid programs. Management fee revenue primarily
represents practice revenues, net less amounts retained by the Practices
(consisting of amounts retained by the Practices, principally compensation and
fees paid to physicians and other health care providers) which are paid to the
physicians pursuant to the Management Services Agreements. Under each Management
Services Agreement, the Company assumes responsibility for the management of the
non-medical operations of the Practice, employs substantially all of the
non-professional personnel utilized by the Practice and may provide the Practice
with the facilities and equipment used in its medical practice. The Company's
management fee revenue consists of four components: (i) a percentage of the
Practices' net collected revenues (generally ranging from 10% to 15%), plus (ii)
100% of the non-physician affiliated practice expenses (generally expected to
range from 45% to 55% of the Practices' net collected revenue), plus (iii)
66 2/3% of the cost savings the Company is able to achieve through its
purchasing power (generally related to medical malpractice insurance, property
and liability insurance, group benefits and certain major medical supplies) plus
(iv) a percentage of the profits from new ancillary services at the Practices.
The portion of the management fee revenue that represents a percentage of net
collected revenue is dependent upon the Practices' revenues which must be billed
and collected.
The Company's operating expenses consist primarily of the expenses incurred
in fulfilling its obligations under the Management Services Agreements. These
expenses include medical support services (principally clinic overhead expenses
that would have been incurred by the Practices, including non-professional
employee salaries,
26
<PAGE>
employee benefits, medical supplies, malpractice insurance premiums, building
and equipment rental and other expenses related to clinic operations) and
general and administrative expenses (personnel and administrative expenses in
connection with maintaining a corporate office function that provides
management, contracting, administrative, marketing and development services to
the Practices).
As the Company develops, acquires and operates additional Ancillary Service
Facilities such as ambulatory surgery centers, MRI diagnostic imaging centers
and rehabilitative therapy units, the mix and relationship of revenues and
operating expenses will differ from historical trends through December 31, 1997.
It is expected in the future that the revenues from these activities will become
a separate component of consolidated revenues in addition to management fee
revenue. It is also expected that the costs and expenses involved in the direct
operation of these facilities will be included in medical support services. The
impact of these activities on the mix of revenues and expenses cannot be
determined at this time.
The Company's future revenues and profitability are largely dependent upon
its ability to continue to affiliate with new Practices and develop Ancillary
Service Facilities. As a result of the Company's rapid growth, costs and
expenses exceeded management fee revenue due to the start-up nature of the
Company. The level of these costs and expenses are expected to continue to
increase as affiliations with additional Practices are achieved and the Company
adds to its management infrastructure.
The Company intends to change its fiscal year from a calendar year to March
31 commencing after April 1, 1998.
RESULTS OF OPERATIONS
The following table sets forth the percentages of the Practices' revenue
represented by certain items reflected in the Company's consolidated statements
of operations. As a result of the Company's limited period of existence and
affiliation with the Practices, the Company does not believe that comparisons
between periods and percentage relationships within the periods set forth below
are meaningful.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1997
----------------- -----------------
<S> <C> <C>
Practice revenues, net..................................................... 100.0% 100.0%
Less: amounts retained by physician groups................................. (48.3) (42.8)
----------------- -----------------
Management fee revenue..................................................... 51.7 57.2
Operating expenses and other expenses:
Medical support services................................................. 47.2 48.3
General and administrative............................................... 21.2 41.3
Depreciation and amortization............................................ 12.2 12.5
Interest expense......................................................... -- 3.9
----------------- -----------------
Total expenses........................................................ 80.6 106.0
----------------- -----------------
Net loss................................................................... (28.9)% (48.8)%
----------------- -----------------
----------------- -----------------
</TABLE>
Practice revenues, net. For the year ended December 31, 1996, practice
revenues, net was $6.0 million, arising from its initial affiliation transaction
on July 1, 1996 and two additional affiliation transactions on November 1, 1996
('the 1996 Affiliations'). For the year ended December 31, 1997, practice
revenue, net was $64.7 million, an increase of $58.7 million over 1996,
resulting from the Company's affiliation with 22 additional Practices comprising
80 physicians at various dates from April 1 through November 1, 1997. Also, in
October 1997, the Company acquired the IPA in a transaction accounted for as a
purchase.
Amounts retained by physician groups. Amounts retained by physician groups
for the year ended December 31, 1996 was $2.9 million, consisting of
compensation and fees paid to physicians and other health care providers by the
Practices pursuant to Management Services Agreements entered into on July 1,
1996 and November 1, 1996. For the year ended December 31, 1997, amounts
retained by physician groups was $27.7 million, an increase of $24.8 million
over 1996, resulting from the Company's affiliation with the additional 22
Practices pursuant to Management Services Agreements executed in 1997.
Management fee revenue. Management fee revenue for the year ended December
31, 1996 was $3.1 million as a result of the factors set forth above. For the
year ended December 31, 1997, management fee revenue was $37.0 million, an
increase of $33.9 million over 1996, as a result of the factors set forth above.
27
<PAGE>
Medical support services. Medical support services, principally clinic
overhead expenses, was $2.8 million for the year ended December 31, 1996,
resulting from the 1996 Affiliations. For the year ended December 31, 1997,
medical support services was $31.2 million, an increase of $28.4 million over
1996, reflecting the effect of the 22 additional Management Services Agreements
executed in 1997.
General and administrative. General and administrative expenses for the
year ended December 31, 1996 was $1.3 million, reflecting the expenses incurred
in establishing a corporate office. These expenses consisted of labor costs,
group benefits, accounting, legal, rent and other expenses, substantially all of
which were incurred after July 1, 1996 (the date of the first Affiliation
Transaction). For the year ended December 31, 1997, general and administrative
expenses were $26.7 million, an increase of $25.4 million over 1996.
Approximately $4.9 million of the increase related to the Company's increased
development of corporate infrastructure to support the additional Affiliation
Transactions as well as the acquisition of the IPA in October 1997. The
remainder of the increase resulted primarily from equity-based and other
compensation expense related to physicians and employees and the expensing of
certain start-up costs. Approximately $13.5 million of the equity-based
compensation expense related to the recalculation provisions contained in the
SCOI and COSI Management Services Agreements and approximately $6.3 million of
the compensation expense related to employees, primarily related to the
acceleration of the vesting of options granted to certain employees. See Notes 3
and 7 in the Notes to Consolidated Financial Statements. The Company also
adopted the provisions of the Statement of Position 'Reporting on the Costs of
Start-Up Activities' which was promulgated in February 1998 and, accordingly,
included as expense in 1997 $140,000 of costs associated with the organization
of the Company that were previously capitalized. The Company also expects to
incur an additional amount of such costs in the three months ended March 31,
1998 (approximately $1 million) which it will record as expense. The Company
also expects to incur approximately $400,000 of additional equity-based
compensation expense in the quarter ending March 31, 1998 relating to the
issuance of options to certain employees and physicians.
While the Company expects that general and administrative expenses will
continue to increase as more Practices affiliate with the Company and the
Company continues to build its infrastructure, it also expects them to decline
as a percentage of both practice revenues, net and management fee revenue.
Depreciation and amortization. Depreciation and amortization for the year
ended December 31, 1996 was $737,000, substantially all of which was incurred
after July 1, 1996. The depreciation expense relates to acquired furniture,
fixtures and equipment and the amortization expense relates to Management
Services Agreements. For the year ended December 31, 1997, depreciation and
amortization was $8.1 million, an increase of $7.4 million over 1996, reflecting
the additional Affiliation Transactions entered into during 1997. The intangible
assets related to the Management Services Agreements are being amortized over
four years as a result of the vesting provisions contained in the Restricted
Stock Agreements relating to Common Stock which was issued by the Company to
physicians in connection with the Affiliation Transactions. The Company expects
to enter into amendments to the Restricted Stock Agreements to eliminate the
vesting provisions related to these shares of Common Stock. At the time the
amendments are executed, the Company expects to revise the estimated useful
lives of its Restricted Stock Agreements and amortize the remaining balances of
the Management Services Agreements over periods ranging from 7 to 25 years.
Consequently, the amortization expense related to the 25 Practices will decrease
in the future; however, the Company expects that depreciation and amortization
expense levels will continue to increase as additional Practices affiliate with
the Company. The depreciation and amortization expense, based on amortization
periods ranging from 7 to 25 years, is expected to remain relatively constant as
a percentage of both practice revenue and management fee revenue. Although the
Company's net unamortized balance of intangible assets acquired ($46.9 million
at December 31, 1997) is not considered to be impaired at December 31, 1997, any
future determination that a significant impairment has occurred would require
the write-off of the impaired portion of unamortized intangible assets, which
could have a material adverse effect on the Company's results of operations.
Interest expense. Interest expense for the year ended December 31, 1997 was
$2.6 million, resulting from borrowings related to the Affiliation Transactions.
The Company expects to continue to incur interest expense primarily as a result
of borrowings primarily related to anticipated future affiliations. In February
and March 1998, the Company completed the sale of 4,600,000 shares of common
stock in the Offering (including shares issued pursuant to the exercise of the
underwriters' overallotment option), raising $32.2 million in proceeds. In
connection with the repayment and prepayment of certain of its indebtedness with
the proceeds of the Offering
28
<PAGE>
and the expected conversion of the Convertible Debentures (as defined), the
Company expects to incur approximately $1.5 million of prepayment penalties,
success fees and other charges in early 1998.
Net loss. The net loss for the year ended December 31, 1996 was $1.7
million, or $1.67 per share of Common Stock, as a result of the factors set
forth above. The net loss for the year ended December 31, 1997 was $31.6
million, or $4.97 per share of Common Stock as a result of the factors set forth
above.
On March 12, 1998, the Company issued a press release in which the Company
reported a loss per share for the fiscal years ended December 31, 1996 and
December 31, 1997 of $.84 and $4.30, respectively. Subsequent to this
announcement, the Company was advised that, as a result of the most recent
interpretation of Staff Accounting Bulletin No. 98 by the staff of the
Securities and Exchange Commission (which was issued on February 3, 1998),
substantially all nominal issuances of common stock options and warrants prior
to December 31, 1997 should be excluded in the computation of loss per share.
Accordingly, the loss per share reported in the Company's consolidated financial
statements for the periods ended December 31, 1996 and December 31, 1997 differs
from that reported in its press release of March 12, 1998.
Impact of Year 2000. The Year 2000 issue is the result of computer programs
being written using two digits rather than four to define the applicable year.
Any computer programs that have time-sensitive software may recognize a date
using '00' as the year 1900 rather than the year 2000. This could result in
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions in a timely manner. As
part of the Company's organization and development, the software purchased and
installed to date, as well as the software under evaluation for future purchase
and installation, is Year 2000 compliant. The Company is in the process of
initiating formal communication with all of the significant payors and
third-party insurers of its affiliated practices to determine the extent to
which the interface systems are vulnerable to those third parties' failure to
remediate their own Year 2000 issues. There is no guarantee that the systems of
other companies on which the Company's systems rely or interface will be timely
converted and would not have an adverse effect on the Company's operations or
cash flows.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996 and December 31, 1997, the Company had $1.8 million
and $12.3 million, respectively, in working capital and $1.4 million and $2.8
million, respectively, in cash and cash equivalents. The Company's principal
sources of liquidity as of December 31, 1996 and December 31, 1997 consisted of
cash and cash equivalents and net accounts receivable of $1.4 million and $5.8
million, and $2.8 million and $23.2 million, respectively.
The Company has financed its Affiliation Transactions, capital expenditures
and working capital needs since its inception through a combination of (i)
private placements of capital stock; (ii) borrowings from institutional lenders;
(iii) short-term borrowings from stockholders; and (iv) issuance of promissory
notes to certain physicians.
For the years ended December 31, 1996 and 1997, cash used in operations was
$1.0 million and $4.2 million, respectively, an increase of $3.2 million,
resulting primarily from net operating losses adjusted for non-cash expenses.
Cash used in investing activities for the years ended December 31, 1996 and
1997 was $4.6 million and $28.4 million, respectively, an increase of $23.8
million, relating primarily to Affiliation Transactions resulting in increases
in intangible assets, accounts receivable and furniture, fixtures and equipment.
Additionally, the Company utilized $3.1 million of cash for deferred offering
costs.
Cash provided by financing activities for the years ended December 31, 1996
and 1997 was $7.1 million and $33.9 million, an increase of $26.8 million
respectively. For the year ended December 31, 1996, substantially all of the
cash provided resulted from proceeds from the issuance by the Company of two
series of preferred stock. For the year ended December 31, 1997, cash provided
by financing activities resulted primarily from $28.5 million in net borrowings
including $5.4 million from stockholders and $5.2 million in proceeds from the
issuance of three series of preferred stock.
29
<PAGE>
Beginning in March 1997, the Company entered into a series of credit
agreements (the 'HCFP Loan Agreements') with Health Care Financial Partners
('HCFP'), secured by the accounts receivable acquired from its affiliated
Practices. The Company may borrow up to an aggregate of $19.5 million under the
HCFP Loan Agreements, subject to a borrowing base of 85% of eligible accounts
receivable. Borrowings under the HCFP Loan Agreements and term loans bear
interest at the prime rate plus 1.75% per annum (10.25% at December 31, 1997)
until December 31, 1997 and at the prime rate thereafter and mature at various
dates ranging from March 1999 to December 1999. The HCFP Loan Agreements and
term loans require the Company to maintain a prescribed level of tangible net
worth and interest coverage, place limitations on indebtedness, liens, and
investments and prohibit the payment of dividends. At December 31, 1997, $6.1
million was outstanding under these agreements, the maximum allowable under the
borrowing base restriction. Subsequent to December 31, 1997, the Company entered
into additional HCFP Loan Agreements totaling $3.5 million, subject to a
borrowing base limitation of 85% of eligible accounts receivable.
On June 30, 1997, the Company entered into an additional HCFP Loan
Agreement secured by a lien on substantially all of the assets of the Company.
The Company may borrow up to $3.3 million under such agreement for practice
affiliations. Borrowings under such agreement bear interest at the prime rate
plus 3.5%. Interest only was payable through December 31, 1997, at which time
the loan converted to a term loan repayable in 36 monthly installments. In
addition, in connection with such agreement, the Company issued warrants to HCFP
to purchase 28,570 shares of the Company's Common Stock. The warrants contain
put rights which give the holder the right to receive payment, based on a
minimum put price of $14 per share, for the value of such warrants at January
15, 1998. Under this agreement, $1.5 million of the Company's obligations are
guaranteed by the Company's President and other stockholders, and in connection
therewith, the Company issued warrants to purchase an aggregate of 9,525 shares
of the Company's Common Stock.
In August 1997 and November 1997, the Company borrowed approximately $6.0
million of subordinated debt (the 'Comdisco Loan') under a Subordinated Loan and
Security Agreement (the 'Comdisco Loan Agreement') between the Company and
Comdisco, Inc. ('Comdisco') and approximately $1.5 million of subordinated debt
(the 'Cedar Loan') under a Subordinated Loan and Security Agreement (the 'Cedar
Loan Agreement') between the Company and Cedar Equities, LLC ('Cedar') to fund
Affiliation Transactions. The Comdisco Loan and the Cedar Loan each have three
year terms, bear interest at 14% per annum and are secured by a second lien on
all of the Company's tangible and intangible personal property. In connection
with these loans the Company issued warrants to purchase 166,667 and 41,667
shares of Series E Preferred Stock to Comdisco and Cedar, respectively.
On September 9, 1997, the Company issued $4.0 million principal amount of
its 6% subordinated convertible debentures due August 2000 (the 'Convertible
Debentures') to fund Affiliation Transactions. The Convertible Debentures are
convertible into Common Stock. The Convertible Debentures were purchased by the
Company's President and certain stockholders. The Company expects that the
Convertible Debentures will be converted in early 1998.
On October 14, 1997, the Company obtained short-term financing in the form
of a secured term note for $2.5 million payable to HCFP Funding to fund
Affiliation Transactions, secured by a lien on substantially all of the assets
of the Company. The loan bears interest at the prime rate plus 3.5% (12% at
December 31, 1997). Interest only was payable through December 31, 1997 and the
entire principal sum is due and payable on January 1, 1999. In connection with
this loan agreement, the Company will pay HCFP Funding a fee in the amount of
$300,000 on the maturity date.
On October 15, 1997, the Company obtained short-term bridge financing in
the aggregate amount of $3.4 million from certain stockholders, including its
President and Chief Executive Officer, to fund Affiliation Transactions. In
connection with these loans, the Company issued warrants to such stockholders to
purchase an aggregate of 48,215 shares of Common Stock at an exercise price of
$0.01 per share. Outstanding loans bear interest at the prime rate plus 3.5%
(12% at December 31, 1997). The principal and accrued interest on such loans are
due and payable on January 1, 1999.
During October and November 1997, in connection with several Affiliation
Transactions, the Company issued Notes in the aggregate amount of approximately
$12.6 million to affiliating physicians (the 'Physician
30
<PAGE>
Notes'). Approximately $1.9 million of the Physician Notes was repaid on January
2, 1998. The remaining Physician Notes were repaid in February and March 1998.
In December 1997, the Company entered into commitments totaling $2.8
million for construction of two ambulatory surgery centers.
On January 2, 1998, the Company obtained short-term financing in the form
of a demand note from Dr. Nagpal in the amount of $1.0 million to repay certain
of the Physician Notes. In connection with this loan, the Company issued
warrants to Dr. Nagpal to purchase 14,286 shares of Common Stock at an exercise
price of $0.01 per share. The demand note bears interest at 8% per annum.
On September 16, 1997, the Company filed a registration statement relating
to the Offering with the Securities and Exchange Commission. This registration
statement became effective on February 4, 1998 and the Company issued 4,000,000
shares of Common Stock to the public at a price of $7.00 per share. Net proceeds
after underwriting discount and expenses of the Offering were $23.7 million. The
Offering was completed on February 9, 1998. On March 4, 1998, the underwriters
exercised their overallotment option and the Company issued an additional
600,000 shares of Common Stock and received additional net proceeds of $3.9
million.
A portion of the proceeds of the Offering were used to repay the following
borrowings:
<TABLE>
<S> <C>
Physician Notes...................................................... $ 9,608,000
Subordinated debt.................................................... 7,332,000
Secured term note.................................................... 2,500,000
Short-term bridge notes.............................................. 3,375,000
-----------
$22,815,000
-----------
-----------
</TABLE>
The remaining proceeds will be used for general corporate purposes. The
Company's affiliation and expansion programs will require substantial capital
resources. In addition, the operations and expansion of the existing Practices,
including the addition of Ancillary Service Facilities, and the IPA will require
ongoing capital expenditures. The financing of future affiliations and business
expansion is anticipated to be provided by a combination of borrowings and cash
flows from operations. The Company believes that the combination of these
sources will be sufficient to meet its currently anticipated operating and
capital expenditure requirements and working capital needs through 1998. In
order to meet its affiliation and expansion goals as well as its long-term
liquidity needs, the Company expects to incur, from time to time, additional
short-term and long-term indebtedness and to issue additional debt and equity
securities, the availability and terms of which will depend upon market and
other conditions; and thus, no assurance can be given that such financing
sources will be available on terms acceptable to the Company.
REIMBURSEMENT RATES
The health care industry is experiencing a trend toward cost containment as
payors seek to improve lower reimbursement and utilization rates with providers.
Further reductions in payments to health care providers or other changes in
reimbursement for health care services could adversely affect the Practices with
which the Company is affiliated and adversely affect the Company's results of
operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
31
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<S> <C>
Report of Independent Certified Public Accountants............................................. 33
Consolidated Balance Sheets at December 31, 1996 and December 31, 1997......................... 34
Consolidated Statements of Operations for the Years Ended December 31, 1996 and December 31,
1997......................................................................................... 35
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996 and
December 31, 1997............................................................................ 36
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996 and December 31,
1997......................................................................................... 37
Notes to Consolidated Financial Statements..................................................... 38
</TABLE>
32
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
BMJ Medical Management, Inc.
We have audited the accompanying consolidated balance sheets of BMJ Medical
Management, Inc. and subsidiaries (the Company) as of December 31, 1996 and
1997, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the years then ended. 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of BMJ
Medical Management, Inc. and subsidiaries at December 31, 1996 and 1997, and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with generally accepted accounting principles.
ERNST & YOUNG, LLP
West Palm Beach, Florida
March 13, 1998
33
<PAGE>
BMJ MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 1,439,000 $ 2,849,000
Accounts receivable, net......................................................... 5,817,000 23,222,000
Prepaid expenses and other current assets........................................ 29,000 157,000
Due from physician groups, net................................................... 426,000 721,000
----------- -----------
Total current assets.......................................................... 7,711,000 26,949,000
Furniture, fixtures and equipment, net............................................. 2,142,000 5,372,000
Management services agreements and other intangible assets, net of accumulated
amortization of $663,000 at December 31, 1996 and $8,023,000 at December 31,
1997............................................................................. 15,447,000 46,878,000
Other assets....................................................................... 32,000 4,954,000
----------- -----------
Total assets.................................................................. $25,332,000 $84,153,000
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................. $ 149,000 $ 2,079,000
Accrued expenses................................................................. 366,000 4,050,000
Interest payable................................................................. -- 640,000
Accrued salaries and benefits.................................................... 383,000 2,474,000
Due to physician groups, net..................................................... 4,936,000 --
Shareholder notes payable........................................................ 40,000 991,000
Current portion of long-term debt and capital lease obligations.................. 18,000 4,398,000
----------- -----------
Total current liabilities..................................................... 5,892,000 14,632,000
Long-term debt and capital lease obligations, less current portion................. 59,000 20,452,000
Short term debt expected to be refinanced.......................................... -- 14,693,000
Minority Interest.................................................................. -- 288,000
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock...................................................... 30,000 42,000
Common stock, $0.001 par value--15,000,000 shares authorized, 4,786,782 shares
issued and outstanding at December 31, 1996; 25,000,000 shares authorized,
9,179,289 shares issued and outstanding at December 31, 1997.................. 5,000 9,000
Additional paid-in capital....................................................... 21,088,000 67,352,000
Accumulated deficit.............................................................. (1,742,000) (33,315,000)
----------- -----------
Total stockholders' equity......................................................... 19,381,000 34,088,000
----------- -----------
Total liabilities and stockholders' equity......................................... $25,332,000 $84,153,000
----------- -----------
----------- -----------
</TABLE>
See accompanying notes.
34
<PAGE>
BMJ MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1997
----------- ------------
<S> <C> <C>
Practice revenues, net............................................................. $ 6,029,000 $ 64,676,000
Less: amounts retained by physician groups......................................... (2,912,000) (27,703,000)
----------- ------------
Management fee revenue............................................................. 3,117,000 36,973,000
Operating expenses:
Medical support services......................................................... 2,844,000 31,215,000
General and administrative....................................................... 1,278,000 26,712,000
Depreciation and amortization.................................................... 737,000 8,068,000
----------- ------------
Total operating expenses........................................................... 4,859,000 65,995,000
----------- ------------
Operating loss..................................................................... (1,742,000) (29,022,000)
Other expenses:
Interest expense................................................................. -- 2,551,000
----------- ------------
Net loss........................................................................... $(1,742,000) $(31,573,000)
----------- ------------
----------- ------------
Net loss per share--basic and diluted.............................................. $ (1.67) $ (4.97)
----------- ------------
----------- ------------
Weighted average number of common shares outstanding--basic and diluted............ 1,043,000 6,351,000
----------- ------------
----------- ------------
</TABLE>
See accompanying notes.
35
<PAGE>
BMJ MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C SERIES D SERIES E
NUMBER OF PREFERRED PREFERRED PREFERRED PREFERRED PREFERRED
SHARES STOCK STOCK STOCK STOCK STOCK
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at inception (January 16,
1996).................................. $ -- $ -- $ -- $ -- $ --
Initial issuance of convertible
preferred stock........................ 3,000,000 10,000 20,000 -- -- --
Issuance of common stock................ 839,285 -- -- -- -- --
Issuance of common stock in connection
with practice affiliation agreements... 3,947,497 -- -- -- -- --
Net loss................................ -- -- -- -- --
--------- --------- --------- --------- ---------
Balance at December 31, 1996............ 10,000 20,000 -- -- --
Issuance of convertible preferred
stock.................................. 1,184,740 -- -- 3,000 2,000 7,000
Issuance of common stock in connection
with practice affiliation agreements... 4,315,712 -- -- -- -- --
Issuance of common stock in exchange for
services............................... 69,643 -- -- -- -- --
Issuance of options to purchase common
stock.................................. -- -- -- -- --
Issuance of stock purchase warrants for
258,332 shares of common stock......... -- -- -- -- --
Exercise of stock options............... 7,143
Net loss................................ -- -- -- -- --
--------- --------- --------- --------- ---------
Balance at December 31, 1997............ $10,000 $20,000 $ 3,000 $ 2,000 $ 7,000
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
<CAPTION>
ADDITIONAL
COMMON PAID-IN ACCUMULATED
STOCK CAPITAL DEFICIT TOTAL
------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Balance at inception (January 16,
1996).................................. $ -- $ -- $ --
Initial issuance of convertible
preferred stock........................ -- 6,970,000 -- 7,000,000
Issuance of common stock................ 1,000 11,000 -- 12,000
Issuance of common stock in connection
with practice affiliation agreements... 4,000 14,107,000 -- 14,111,000
Net loss................................ -- -- (1,742,000 ) (1,742,000)
------- ----------- ------------ -----------
Balance at December 31, 1996............ 5,000 21,088,000 (1,742,000 ) 19,381,000
Issuance of convertible preferred
stock.................................. -- 6,237,000 -- 6,249,000
Issuance of common stock in connection
with practice affiliation agreements... 4,000 33,490,000 -- 33,494,000
Issuance of common stock in exchange for
services............................... -- 292,000 -- 292,000
Issuance of options to purchase common
stock.................................. -- 4,665,000 -- 4,665,000
Issuance of stock purchase warrants for
258,332 shares of common stock......... -- 1,580,000 -- 1,580,000
Exercise of stock options...............
Net loss................................ -- -- (31,573,000 ) (31,573,000)
------- ----------- ------------ -----------
Balance at December 31, 1997............ $9,000 $67,352,000 $(33,315,000) $34,088,000
------- ----------- ------------ -----------
------- ----------- ------------ -----------
</TABLE>
See accompanying notes.
36
<PAGE>
BMJ MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1997
------------ ------------
<S> <C> <C>
Operating activities:
Net loss................................... $ (1,742,000) $(31,573,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation............................ 74,000 676,000
Amortization of management services
agreements and deferred financing
costs.................................. 663,000 8,084,000
Interest expense converted to preferred
stock.................................. -- 34,000
Equity-based compensation expense....... -- 17,567,000
Changes in operating assets and
liabilities:
Accounts receivable..................... (449,000) (4,700,000)
Due from physician groups............... (426,000) (3,062,000)
Prepaid expenses and other current
assets................................. 2,000 177,000
Accounts payable........................ 149,000 1,930,000
Accrued expenses........................ 366,000 3,684,000
Accrued salaries and benefits........... 383,000 2,383,000
Accrued interest........................ -- 640,000
------------ ------------
Net cash used in operating activities........ (980,000) (4,160,000)
Investing activities:
Purchases of furniture, fixtures and
equipment............................... (697,000) (969,000)
Payments for management services
agreements.............................. (206,000) (10,123,000)
Payments for deferred offering costs....... -- (3,186,000)
Cash used for acquisition of non-cash
assets of affiliated practices.......... (3,707,000) (13,230,000)
Payments for deposits and other assets..... (22,000) (848,000)
------------ ------------
Net cash used in investing activities...... (4,632,000) (28,356,000)
Financing activities:
Proceeds from issuance of preferred
stock................................... 7,000,000 5,164,000
Proceeds from debt issuance................ -- 41,664,000
Payments on stockholder notes payable...... -- (130,000)
Proceeds from issuance of stockholder notes
payable................................. 40,000 5,507,000
Proceeds from issuance of common stock..... 11,000 --
Payments on borrowings..................... -- (18,567,000)
Minority interest.......................... -- 288,000
------------ ------------
Net cash provided by financing activities.... 7,051,000 33,926,000
------------ ------------
Net increase in cash and cash equivalents.... 1,439,000 1,410,000
Cash and cash equivalents at beginning of
period..................................... -- 1,439,000
------------ ------------
Cash and cash equivalents at end of period... $ 1,439,000 $ 2,849,000
------------ ------------
------------ ------------
</TABLE>
See accompanying notes.
37
<PAGE>
BMJ MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
BMJ Medical Management, Inc. and its subsidiaries (the Company), are
engaged in managing physician groups focusing exclusively on musculoskeletal
disease management, including ancillary services such as ambulatory surgery
centers, magnetic resonance imaging and rehabilitative therapy. The Company also
operates an Independent Physician Association (IPA) that negotiates and
administers payor contracts for the delivery of healthcare services. The Company
manages physician groups under long-term management services agreements
(Management Services Agreements) with affiliated physician groups located in
various states. The Company may also acquire certain assets under Asset Purchase
Agreements, primarily accounts receivable and furniture, fixtures and equipment
from these groups. The cost of these assets is determined based on their
appraised or net realizable value. BMJ Medical Management, Inc. was incorporated
in Delaware in January 1996.
Under the Management Services Agreements, the Company provides a full range
of administrative services required for a physician group's day-to-day
nonmedical operations and employs substantially all of the nonmedical personnel
utilized by the group. The nonclinical services provided include, but are not
limited to, practice administration, practice support, data processing, business
office management including billing and collecting, marketing, accounting, the
provision of office space and equipment and the arrangement of group purchasing
discounts for medical and nonmedical supplies and services. The Company may also
assist the physician group in the recruitment of additional physicians and
negotiates managed care contracts which must be approved by the group.
The terms of the Management Services Agreements are 40 years and
automatically renew for successive 5-year periods thereafter unless terminated
by one of the parties. As compensation for services provided by the Company, the
Company generally receives a percentage of the group's net collected revenues,
reimbursement of all nonmedical expenses of the practice incurred by the Company
in supporting the group, 66 2/3% of the cost savings the Company is able to
achieve through its purchasing power and a percentage of the profits from new
ancillary services.
The laws of many states, including some of the states in which the Company
presently has Management Services Agreements, prohibit business corporations
from practicing medicine or exercising control over the medical judgments or
decisions of physicians and from engaging in certain financial arrangements with
physicians. The Company intends that, pursuant to the Management Services
Agreements, it will not exercise any responsibility 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.
On December 23, 1997, the Board of Directors approved a five-for-seven
reverse stock split of the Company's common stock. All common share and per
share data presented herein give effect to such reverse stock split. Concurrent
with the consummation of the Company's initial public offering (IPO), which
occurred February 9, 1998, the Company's certificate of incorporation was
amended to increase the Company's authorized common stock from 25,000,000 shares
to 35,000,000 shares. Additionally, the Company intends to change its fiscal
year end from December 31 to March 31, effective in 1998.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Company does not consolidate the operating results and accounts of the
physician groups since it does not own or control the groups it manages. The
Company believes that the Management Services Agreements provide it with the
preponderance of the net profits of the medical services furnished by the
groups. Consequently, the Company presents physician groups' revenues, net, less
amounts retained by the physician groups as management fee revenue in the
accompanying consolidated financial statements ('display method').
On November 20, 1997, the Emerging Issues Task Force (EITF) of the
Financial Accounting Standards Board reached a consensus concerning certain
matters relating to the physician practice management industry
38
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
with respect to the requirements which must be met to consolidate a managed
professional corporation and the accounting for business combinations involving
professional corporations. In accordance with the EITF's guidance, the Company
will discontinue use of the display method to report revenues from management
contracts in financial statements for periods ending after December 15, 1998.
Thus, after December 15, 1998, fees from management contracts will be reported
as a single line item in the Company's consolidated financial statements.
The consolidated financial statements include the accounts of BMJ Medical
Management, Inc. and its subsidiaries as well as those entities controlled by
the Company. The minority interest held by third parties is separately stated.
In consolidation, all significant intercompany balances and transactions have
been eliminated.
Reclassification
Certain amounts presented in the consolidated statements of operations for
prior periods have been reclassified for comparative purposes.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. The Company's actual results in subsequent periods may differ
from the estimates and assumptions used in the preparation of the accompanying
consolidated financial statements.
Practice Revenues, Net
Practice revenues, net, represent the gross revenues earned from patients
by the physician groups and one ambulatory surgery center, net of contractual
and other adjustments and uncollectible amounts. Contractual adjustments
typically result from differences between the physician groups' established
rates for services and the amounts paid by government sponsored health care
programs and other insurers.
There are no material claims, disputes, or other unsettled matters that
exist to management's knowledge concerning third-party reimbursements. In
addition, management believes there are no retroactive adjustments that would be
material to the financial statements. The Company estimates that approximately
15% and 13% of practice revenues, net, were received under government sponsored
health care programs (principally, the Medicare and Medicaid programs) during
the years ended December 31, 1996 and 1997, respectively. The physician groups
have numerous agreements with managed care and other organizations to provide
physician services based on negotiated fee schedules.
Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. The Company believes that it is in
compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigations involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and Medicaid programs.
Management Fee Revenue
Management fee revenue represents practice and ambulatory surgery center
net revenues less amounts retained by the physician groups.
The Company's management fee revenue is comprised of four components: (i)
percentage of the physician groups' net collected revenues (generally ranging
from 10%-15%), plus (ii) 100% of the non-physician affiliated practice expenses
(generally expected to range from 45%-55% of the physician groups' net collected
revenue), plus (iii) 66 2/3% of the cost savings the Company is able to achieve
through its purchasing power (generally related to medical malpractice
insurance, property and liability insurance, group benefits and certain major
medical supplies) plus (iv) a percentage of the profits from new ancillary
services of the practices. The portion of
39
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
the management fee revenue that represents a percentage of net collected
revenues is dependent upon the physician groups' revenues which must be billed
and collected.
Management fee revenue included in the accompanying consolidated statements
of operations is comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------------
1996 1997
---------- -----------
<S> <C> <C>
Component based upon percentage of physician groups' net collected
revenues................................................................. $1,079,000 $ 6,105,000
Reimbursement of non-physician affiliated practice expenses................ 2,038,000 30,868,000
---------- -----------
Management fee revenue..................................................... $3,117,000 $36,973,000
---------- -----------
---------- -----------
</TABLE>
For the year ended December 31, 1996, three affiliated practices; Southern
California Orthopedic Institute Medical Group (SCOI), South Texas Spinal Clinic,
P.A. (STSC) and Lehigh Valley Bone, Muscle and Joint Group, LLC (LVBMJ)
comprised approximately 52%, 23%, and 25%, respectively, of management fee
revenue. For the year ended December 31, 1997, SCOI comprised approximately 29%
of management fee revenue. No other affiliated practices individually comprised
10% or more of management fee revenue.
Operating Expenses
Medical support services represent costs incurred by the Company relative
to the operations of the physician groups including non-physician personnel
salaries and benefits, medical supplies, malpractice insurance premiums,
building and equipment rental expense, general and administrative expenses,
supplies, maintenance and repairs, insurance, utilities and other indirect
expenses.
General and administrative expenses primarily represent the salaries of
corporate headquarters personnel, rent, travel, and other administrative
expenses. Additionally, for the year ended December 31, 1997, approximately
$13.5 million of non-cash equity based compensation related to the affiliations
with SCOI and the Center for Orthopedic Surgery Inc. (COSI) was included in
general and administrative expenses.
Cash and Cash Equivalents
Cash in excess of daily requirements invested in short-term investments
with maturities of three months or less is considered to be cash equivalents for
financial statement purposes. Deposits in banks may exceed the amount of
insurance provided on such deposits. The Company performs reviews of the credit
worthiness of its depository banks. The Company has not experienced any losses
on its deposits of cash.
Accounts Receivable
Accounts receivable principally represent receivables related to the
medical groups for medical services provided by the physician groups. Risk of
collection is borne by the physician groups and any amounts advanced by the
Company for accounts receivable that are uncollected are reimbursed to the
Company by the physician groups.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are carried at cost less accumulated
depreciation. Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets which primarily range from three to seven
years. Routine maintenance and repairs which do not extend the life of the
assets are charged to expense as incurred and major renovations or improvements
are capitalized.
Management Services Agreements
Management Services Agreements include consideration (cash, common stock or
other consideration) paid to the physician groups for entering into Management
Services Agreements, legal and accounting fees and other similar transaction
costs. The Management Services Agreements are for a term of 40 years and eight
agreements
40
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
are subject to rescission by the respective physician group on the seventh
anniversary. Under the terms of the related Restricted Stock Agreements, if a
physician leaves the practice within four years the common stock issued is
returned to the applicable practice. Therefore, the Company amortizes the costs
of entering into Management Services Agreements over four years. The Company
intends to amend its Restricted Stock Agreements during the first quarter of
1998 to eliminate the four-year vesting provisions. As a result, the Company
will adjust the amortization of the Management Services Agreements to the new
useful lives of the agreements which will range from 7 to 25 years. Had these
revisions and the related Affiliation Transactions and Management Service
Agreements been reflected as of January 1, 1996 and January 1, 1997 in the
accompanying financial statements as of January 1, 1996 and January 1, 1997,
amortization expense would have decreased by approximately $491,000 and
$6,551,000 for the years ended December 31, 1996 and 1997, respectively. Shares
issued to physician practices that are subject to performance criteria are
accounted for as compensation.
The Company periodically reviews its intangible assets to assess
recoverability and a charge will be recognized in the consolidated statement of
operations if a permanent impairment is determined to have occurred.
Recoverability of intangibles is determined based on undiscounted future
operating cash flows from the related business unit or activity. The amount of
impairment, if any, would be measured based on discounted future operating cash
flows using a discount rate reflecting the Company's average cost of funds. The
assessment of the recoverability of intangible assets will be affected if
estimated future operating cash flows are not achieved. The Company does not
believe that any impairment has occurred at December 31, 1996 or December 31,
1997.
Due from Physician Groups, net
Due from physician groups, net at December 31, 1996 consists of
non-interest bearing short-term advances due to the Company. The amount due to
physician groups at December 31, 1996, represents the net of (i) cash
consideration related to the Management Services Agreements that is payable by
the Company, without interest, at the earlier of the consummation of the IPO or
the one year anniversary of the execution of the Management Services Agreements;
(ii) amounts due to the physician groups related to the ongoing monthly
purchases of accounts receivable and (iii) amounts due from the physician groups
relating to the monthly management fees and reimbursement to the Company for
monthly medical support service costs. Amounts due from physician groups, net at
December 31, 1997, represents the net of (i) amounts due to the physician groups
related to the ongoing monthly purchases of accounts receivable and (ii) amounts
due from the physician groups relating to the monthly management fees and
reimbursement to the Company for monthly medical support service costs.
Accounting for Stock Based Compensation
In 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ('SFAS') No. 123, Accounting for Stock Based
Compensation. SFAS No.123 allows either adoption of a fair value method of
accounting for stock-based compensation plans or a continuation of accounting
under Accounting Principles Board (APB) Opinion No. 25 Accounting for Stock
Issued to Employees and related interpretations with supplemental disclosures.
The Company has chosen to account for all employee stock-based compensation
arrangements in accordance with APB Opinion No. 25 with related disclosures
under SFAS No. 123, which requires pro forma net income and earnings per share
disclosures as well as various other disclosures not required under APB No. 25
for companies adhering to APB No. 25. As a result, the Company recognized
compensation expense for stock options granted to employees with an exercise
price below the fair value of the shares on the date of grant.
Under the Company's stock option plans, the Company may also grant stock
options for a fixed number of shares to independent consultants and contractors
typically with an exercise price equal to the fair value of the shares on the
date of grant. The Company accounts for these stock option grants using the fair
value method of SFAS No. 123. The fair value for these options is estimated at
the date of grant using a stock option pricing model and recognized as
compensation cost.
41
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Loss Per Common Share
In February 1997, SFAS No. 128, Earnings Per Share, was issued. SFAS No.
128, which applies to entities with publicly held common stock, simplifies the
standards for computing earnings per share previously required in APB Opinion
No. 15, Earnings Per Share, and makes them comparable to international earnings
per share standards. SFAS No. 128 is effective for financial statements issued
for periods ending after December 15, 1997, including interim periods; earlier
adoption is not permitted.
On February 3, 1998, due to the issuance of SFAS No. 128, the SEC revised
its Staff Accounting Bulletin ('SAB') relative to the treatment of common shares
and common equivalent shares issued at prices below the estimated public
offering price during the 12 months immediately preceding the date of the
initial filing of the registration statement. The revised SAB recognizes only
nominal issuances of common shares and common equivalent shares as outstanding
for all periods presented. The Company has not issued any nominal shares during
the periods presented in the consolidated statements of operations. All earnings
per share amounts for all periods have been presented, and where necessary,
restated to conform to the SFAS No. 128 requirements.
Basic net loss per share, is calculated using the weighted average number
of common shares outstanding during the respective periods. Potentially dilutive
securities are not included in the computation of net loss per share in 1997 and
1996 as their effective is antidilutive.
Financial Instruments
The carrying amount of financial instruments including cash and cash
equivalents, accounts receivable, and accounts payable approximate fair value as
of December 31, 1996 and 1997 due to the short maturity of the instruments and
reserves for potential losses, as applicable. The carrying amounts of the
Company's borrowings approximate their fair value due to the recent issuance of
such borrowings which represent current market value.
3. PRACTICE AFFILIATIONS
Effective July 1, 1996, the Company entered into an affiliation transaction
with LVBMJ, under which the Company would receive as a management fee 50% of the
net collected revenues of LVBMJ and would be responsible for all the clinic
overhead expenses (medical support services). In connection with this
transaction, on July 1, 1996, the Company issued 321,429 shares of common stock
recorded at $1.26 per share. This agreement was amended on July 1, 1997. Under
the terms of the Amended and Restated Management Services Agreement between
LVBMJ and the Company, effective July 1, 1997 (the LVBMJ Management Services
Agreement), the Company paid $320,000 in cash, issued an additional 48,594
shares of common stock (effective July 1, 1997) recorded at $7.56 per share
representing total stock consideration of $772,367 in connection with this
transaction. Effective July 1, 1997, the Company and LVBMJ amended and restated
their agreement to adjust the management fee to 10% of net collected revenues
plus reimbursement of clinic overhead expenses. The aggregate consideration of
$1,106,916, including transaction costs of $14,549, has been allocated as
follows: furniture, fixtures and equipment-$50,000, and Management Services
Agreement--$1,056,916. The LVBMJ Management Services Agreement provides that the
Company may be required to issue more shares of common stock as additional
consideration during 1998. The total number of shares to be issued will depend
on actual collections of the practice during the twelve month period ended March
1998. The value of any subsequently issued shares will increase the cost of the
LVBMJ Management Services Agreement.
On November 22, 1996, the Company entered into an Asset Purchase Agreement
with SCOI, a California general partnership, in exchange for $5,930,897 in cash
and a Management Services Agreement, effective November 1, 1996 (SCOI Management
Services Agreement), in exchange for the issuance of 2,857,140 shares of common
stock recorded at $3.78 per share, representing consideration of $10,800,000.
The SCOI Management Services Agreement calls for management fees to be
earned by the Company equal to 3 1/3% of the net collected revenues until
certain conditions are met at which time the management fee will increase to
6 2/3% of net collected revenues. At the time of filing of a preliminary
prospectus for the initial public offering of the Company's common stock with
the SEC that becomes effective within 90 days, the management fee will increase
to 10% of the net collected revenues. For the period from November 1, 1996
through September 30, 1997, the Company recognized management fees under the
SCOI Management Services
42
<PAGE>
3. PRACTICE AFFILIATIONS--(CONTINUED)
Agreement of 3 1/3% of net collected revenues and 6 2/3% of net collected
revenues for the three months ended December 31, 1997. The number of shares
issued in connection with this transaction which exceed 2,142,857, were subject
to recalculation effective November 1, 1997 and were permanently issued on
December 31, 1997. On April 1, 1997, the Company entered into a Management
Services Agreement with COSI, owned by the SCOI physicians, in exchange for
392,857 shares of common stock recorded at $3.78 per share, representing
consideration of $1,485,000. The number of shares issued in connection with this
transaction were also subject to recalculation during the fourth quarter of
1997. The aggregate consideration of $18,336,999, including transaction costs of
$121,102, has been allocated as follows: net accounts receivable--$4,448,000,
furniture, fixtures and equipment--$1,441,920, supplies--$30,897,
deposits--$10,080 and Management Services Agreements--$12,406,102. In accordance
with the recalculation provisions, the Company issued additional shares of
common stock to the SCOI physicians for both the SCOI and COSI recalculation in
the fourth quarter of 1997. These shares and 714,286 of the original 2,857,140
shares issued in November 1996 in connection with the SCOI transaction represent
consideration based upon performance and have been accounted for as non-cash
equity-based compensation expense. Accordingly, the Company recorded a charge to
earnings of $13.5 million in the fourth quarter of 1997, which is included in
general and administrative expenses in the consolidated statement of operations
for the year ended December 31, 1997.
On December 23, 1996, the Company entered into an Asset Purchase Agreement
and a Management Services Agreement, effective November 1, 1996, (STSC
Management Services Agreement) with STSC in exchange for the issuance of 768,929
shares of common stock recorded at $3.78 per share, representing consideration
of $2,906,553 and cash of $3,065,990. The aggregate consideration of $6,014,009,
including transaction costs of $41,466 has been allocated as follows: net
accounts receivable--$1,703,826, furniture, fixtures and equipment--$425,000,
supplies--$21,328 and Management Services Agreement--$3,863,855.
Effective April 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (Tri-City Management Services
Agreement) with Tri-City Orthopedic Surgery Medical Group, Inc., a California
corporation (Tri-City), and two of its affiliates in exchange for $948,200 in
cash, the issuance of 287,659 shares of common stock recorded at $3.78 per
share, representing consideration of $1,087,352. The aggregate consideration of
$2,088,861, including transaction costs of $53,309, has been allocated as
follows: net accounts receivable--$519,000, furniture, fixtures and
equipment--$167,590, Management Services Agreement--$1,402,271.
Effective April 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (LOS Management Services
Agreement) with Lauderdale Orthopaedic Surgeons, a Florida partnership, in
exchange for $2,698,359 in cash and the issuance of 329,259 shares of common
stock recorded at $3.78 per share, representing consideration of $1,244,598. The
aggregate consideration of $4,154,824, including transaction costs of $211,867,
has been allocated as follows: accounts receivable--$2,000,000, furniture,
fixtures and equipment--$103,915 Management Services Agreement--$2,050,909.
Effective June 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (GCO Management Services
Agreement) with Fishman and Stashak, M.D.'s, P.A. (GCO), a Florida professional
association, (d/b/a Gold Coast Orthopedics), Clive Segil, M.D. (Segil), a
California professional corporation, and H. Leon Brooks, M.D. (Brooks), a
California professional corporation, in exchange for an aggregate amount of
$3,769,172 in cash, the issuance of 281,789 shares of common stock recorded at
$6.93 per share, representing consideration of $1,952,796. The aggregate
consideration of $6,092,016, including transaction costs of $370,048, has been
allocated as follows: accounts receivable--$1,759,000, furniture, fixtures and
equipment--$194,150, supplies--$3,650 and Management Services
Agreement--$4,135,216. The GCO agreement provides that the Company may be
required to issue more shares of common stock as additional consideration during
1998. The total number of shares to be issued will depend on actual collections
of the practice for the twelve month period ended August 1998. The value of any
subsequently issued shares will be allocated to the Management Service
Agreements.
Effective July 1, 1997, the Company entered into three separate Asset
Purchase Agreements and Management Services Agreements with Swanson Orthopedic
Medical Corporation, a professional corporation, Randy C. Watson, M.D., a
professional corporation and Lake Tahoe Sports Medicine Center, a medical
43
<PAGE>
3. PRACTICE AFFILIATIONS--(CONTINUED)
corporation, all located in South Lake Tahoe, California, in exchange for an
aggregate amount of $986,000 in cash and the issuance of 107,648 shares of
common stock recorded at $7.56 per share, representing consideration of
$813,824. The aggregate consideration of $2,064,780, including transaction costs
of $264,956, has been allocated as follows: accounts receivable--$726,000,
furniture, fixtures and equipment--$67,200, supplies-$10,000, and Management
Services Agreement--$1,261,580.
Effective July 1, 1997, the Company entered into two separate Asset
Purchase Agreements and Management Services Agreements with Sun Valley
Orthopaedic Surgeons, an Arizona general partnership (Sun Valley) and Robert O.
Wilson, M.D., P.C., an Arizona professional corporation, both located in Sun
City, Arizona, in exchange for an aggregate amount of $616,125 in cash and the
issuance of 141,332 shares of common stock recorded at $7.56 per share,
representing consideration of $1,068,471. Sun Valley has the right to receive
additional consideration if the fair market value of the Company's common stock,
as determined on July 1, 1998, is less than $9.10. The additional consideration
would be determined by multiplying the per share dollar amount below $9.10 by
36,318 shares and would be payable in full in cash no later than July 31, 1998.
The aggregate consideration of $2,075,553, including transaction costs of
$121,478, has been allocated as follows: accounts receivable--$457,000,
furniture, fixtures and equipment--$67,500, supplies--$7,000, deposits--$4,564,
and Management Services Agreement--$1,539,489 (including the additional
consideration of $269,479).
Effective July 1, 1997, the Company entered into two separate Asset
Purchase Agreements and Management Services Agreements with Stockdale Podiatry
Group, Inc., a California professional corporation, and John C. Zimmerman,
D.P.M., both located in Bakersfield, California, in exchange for an aggregate
amount of $1,032,842 in cash, a contractual obligation to pay John C. Zimmerman,
M.D. $78,858 in cash at a future specified date and the issuance of 121,066
shares of common stock recorded at $7.56 per share, representing consideration
of $915,263. The aggregate consideration of $2,111,337, including transaction
costs of $84,374, has been allocated as follows: accounts receivable--$637,200,
furniture, fixtures and equipment--$85,207, supplies--$10,000, and Management
Services Agreement--$1,378,930.
Effective July 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (Kramer Management Services
Agreement) with Kramer & Maehrer, L.L.C., a Pennsylvania limited liability
company, in exchange for $45,981 in cash and the issuance of 51,857 shares of
common stock recorded at $7.56 per share, representing consideration of
$392,040. The aggregate consideration of $441,047, including transaction costs
of $3,026, has been allocated as follows: furniture, fixtures and
equipment--$45,981, Management Services Agreement--$395,066.
Effective July 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (SAB Management Services
Agreement) with San Antonio Bone and Joint Clinic, P.A., a Texas professional
association, in exchange for an aggregate amount of $288,978 in cash and the
issuance of 27,306 shares of common stock recorded at $7.56 per share,
representing consideration of $206,437. The aggregate consideration of $557,236,
including transaction costs of $61,821, has been allocated as follows: accounts
receivable--$92,289, furniture, fixtures and equipment--$175,801,
supplies--$649, and Management Services Agreement--$288,497.
Effective August 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (P M & R Management Services
Agreement) with Physical Medicine and Rehabilitation Associates, Inc., a Florida
corporation, in exchange for $830,166 in cash and the issuance of 90,659 shares
of common stock recorded at $7.56 per share, representing consideration of
$685,384. The aggregate consideration of $1,651,063, including transaction costs
of $135,513, has been allocated as follows: accounts receivable-- $465,000,
furniture, fixtures and equipment--$165,000, deposits--$5,166, and Management
Services Agreement--$1,015,897.
Effective August 1, 1997, the Company entered into separate Asset Purchase
Agreements with Broward Orthopaedic Specialists, Inc., a Florida corporation
(Broward), Terence Matthews, M.D. P.A., Wylie Scott, M.D. P.A. and Mitchell S.
Seavey, M.D. and a Management Services Agreement with Broward (Broward
Management Services Agreement), in exchange for $3,938,996 in cash, a promissory
note issued to Dr. Seavey for $283,502 and the issuance of 446,977 shares of
common stock recorded at $7.56 per share, representing consideration of
$3,379,147. The aggregate consideration of $8,015,174, including transaction
costs of $413,529, has been
44
<PAGE>
3. PRACTICE AFFILIATIONS--(CONTINUED)
allocated as follows: accounts receivable--$1,685,000, furniture, fixtures and
equipment--$420,000 and Management Services Agreement--$5,910,174. The Broward
Management Services Agreement provides that the Company may be required to issue
more shares of common stock as additional consideration during 1998. The total
number of shares to be issued will depend on actual collections of the practice
for the twelve month period ended July 1998. The value of any subsequently
issued shares will increase the cost of the Broward Management Services
Agreement.
Effective August 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (Abrahams Management Services
Agreement) with Michael A. Abrahams, M.D. P.A., a Florida professional
association, in exchange for $620,004 in cash and the issuance of 68,131 shares
of common stock recorded at $7.56 per share, representing consideration of
$515,074. The aggregate consideration of $1,181,694, including transaction costs
of $46,616, has been allocated as follows: accounts receivable-- $285,000,
furniture, fixtures and equipment--$47,500, and Management Services
Agreement--$849,194.
Effective September 1, 1997, the Company entered into an Asset Purchase
Agreement and a Management Services Agreement (Beitler Management Services
Agreement) with Jeffrey Beitler, M.D. P.A., a Florida professional corporation,
in exchange for $275,000 in cash and the issuance of 26,066 shares of common
stock recorded at $8.40 per share, representing consideration of $218,952. The
aggregate consideration of $513,952, including transaction costs of $20,000, has
been allocated as follows: accounts receivable--$200,000, furniture, fixtures
and equipment--$35,000, and Management Services Agreement--$278,952.
In October 1997, the Company entered into an Asset Purchase Agreement and a
Management Services Agreement (OSA Management Services Agreement) with
Orthopaedic Surgery Associates, P.A., a Florida professional corporation (OSA)
in exchange for $4,396,250 in cash, issuance of a promissory note for
$2,377,701, bearing interest at 8.5%, annually and the issuance of 221,819
shares of common stock recorded at $8.40 per share, representing consideration
of $1,863,276. The aggregate consideration of $9,149,979, including transaction
costs of $512,752, has been allocated as follows: accounts
receivable--$2,000,000, furniture, fixtures and equipment--$500,000, and
Management Services Agreement--$6,649,979. The OSA Management Services Agreement
provides that the Company may be required to issue more shares of common stock
as additional consideration during 1998 and 1999. The total number of shares to
be issued will depend on actual collections of the practice for a the twelve
month periods ended August 1998 and 1999. The value of any subsequently issued
shares will increase the cost of the OSA Management Services Agreement.
In October 1997, the Company entered into an Asset Purchase Agreement and a
Management Services Agreement (LOM Management Services Agreement) with
Lighthouse Orthopaedic Management Group, Inc (LOM), a Florida corporation, in
exchange for the issuance of promissory notes for $3,899,930, bearing interest
at 8.5% annually and the issuance of 194,220 shares of common stock recorded at
$8.40 per share, representing consideration of $1,631,448. The aggregate
consideration of $5,808,421, including transaction costs of $277,043, has been
allocated as follows: accounts receivable--$1,300,000 furniture, fixtures, and
equipment--$250,000, and Management Services Agreement--$4,258,421. The LOM
Management Services Agreement provides that the Company may be required to issue
more shares of common stock as additional consideration during 1998. The total
number of shares to be issued will depend on actual collections of the practice
for the twelve month period ended August 1998. The value of any subsequently
issued shares will increase the cost of the LOM Management Services Agreement.
In October 1997, the Company entered into an Asset Purchase Agreement and a
Management Services Agreement (BIOS Management Services Agreement) with Broward
Institute of Orthopaedic Specialties, P.A., a Florida professional association
(BIOS), in exchange for $119,311 in cash, the issuance of promissory notes for
$3,466,252, bearing interest at 8% annually, and the issuance of 182,312 shares
of common stock recorded at $8.40 per share, representing consideration of
$1,531,422. The aggregate consideration of $5,076,985, including transaction
costs of $24,000, has been allocated as follows: advances--$800,000, furniture,
fixtures, and equipment--$281,197, supplies--$61,189, deposits--$37,966 and
Management Services Agreement-- $3,896,633. The BIOS Management Services
Agreement provides that the Company may be required to issue more shares of
common stock as additional consideration during 1998. The total number of shares
to be issued
45
<PAGE>
3. PRACTICE AFFILIATIONS--(CONTINUED)
will depend on actual collections of the practice for the twelve month period
ended August 1998. The value of any subsequently issued shares will increase the
cost of the BIOS Management Services Agreement.
In October 1997, the Company entered into a Management Services Agreement
(Valley Management Services Agreement) with Valley Sports & Arthritis Surgeons,
P. C., a Pennsylvania professional corporation (Valley), in exchange for a
promissory note of $897,727, bearing interest at 8.5% annually and the issuance
of 359,464 shares of common stock recorded at $8.40 per share, representing
consideration of $3,019,501. The aggregate consideration of $3,917,228 has been
allocated as follows: accounts receivable--$630,000, furniture, fixtures, and
equipment--$120,833, supplies--$35,000, and Management Services
Agreement--$3,131,395.
In October 1997, the Company acquired Orthopaedic Management Network, Inc.,
an Arizona corporation, in exchange for $63,000 in cash, the assumption of
$1,010,306 accounts payable and accrued liabilities and the issuance of 20,370
shares of common stock recorded at $8.40 per share, representing consideration
of $171,108. The aggregate purchase price of $1,244,414 has been allocated to
certain assets and liabilities including goodwill--$665,845.
Effective November 1, 1997, the Company entered into a Management Services
Agreement with New Jersey Orthopedic Associates, P.A., a New Jersey professional
association. Additionally, the Company entered into an Asset Purchase Agreement
with Orthopedic Associates of New Jersey, a New Jersey professional association.
The aggregate consideration consisted of $1,029,194 in cash, issuance of a
promissory note for $411,680, bearing interest at 8.0%, and the issuance of
67,859 shares of common stock recorded at $8.40 per share, representing
consideration of $570,012. The aggregate consideration of $2,010,886 has been
allocated as follows: furniture, fixtures and equipment--$75,000, and Management
Services Agreement--$1,935,886.
The Management Services Agreements are subject to termination in the event
of (i) bankruptcy of the Company or the medical practice; (ii) default in any
material respect in the performance of either parties' obligations under the
Management Services Agreement; (iii) representations and warranties made by
either party are untrue or misleading in any material respect; (iv) the medical
practice is excluded from the Medicare or Medicaid programs; or (v) either party
determines that the structure of the Management Services Agreement violates any
state or federal laws or regulations existing at such time and that an amendment
to the Management Services Agreement will be unable to correct such defect. Upon
termination of the Management Services Agreement, the transaction will be
unwound with the assets (other than accounts receivable) acquired by the Company
being returned to the physician group and the purchase price paid, therefore,
being returned to the Company.
The STSC Management Services Agreement permits STSC and individual
physicians to rescind the Affiliation Transaction on November 1, 2003. In the
event of a rescission of the transaction, the transaction will be unwound, with
the assets (other than the accounts receivable) acquired by the Company being
returned to STSC, and the purchase price paid therefore being returned to the
Company. In addition, the physician owners and the employed physicians, if any,
who received common stock of the Company in connection with the transaction will
be required to return 50% of such capital stock to the Company. In addition, the
Management Services Agreements for seven other practices comprising 29
physicians contain provisions that permit the practices to rescind their
Affiliation Transaction on their respective seventh anniversaries. The cost to
enter into the Management Services Agreements and acquire the assets, including
transaction costs, was as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
Cost of acquiring the Management Services Agreements..................... $16,110,000 $54,233,000
Accounts receivable...................................................... 6,152,000 18,907,000
Furniture, fixtures and equipment........................................ 1,867,000 4,719,000
Advances................................................................. -- 800,000
Other.................................................................... 62,000 237,000
----------- -----------
Total.................................................................... $24,191,000 $78,896,000
----------- -----------
----------- -----------
</TABLE>
46
<PAGE>
4. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
---------- ----------
<S> <C> <C>
Office, computer, and telephone equipment......................... $ 999,000 $3,162,000
Medical equipment................................................. 659,000 1,717,000
Furniture and fixtures............................................ 558,000 1,121,000
Construction-in-progress, ambulatory surgery centers.............. -- 122,000
Less: accumulated depreciation.................................... 74,000 750,000
---------- ----------
Furniture, fixtures and equipment, net............................ $2,142,000 $5,372,000
---------- ----------
---------- ----------
</TABLE>
5. LEASES
The Company, as part of the MSA, is obligated under certain lease
agreements for offices and certain equipment which have terms ranging from three
to ten years and are considered reimbursable to the Company under the terms of
the MSA. In some circumstances, these lease arrangements are with entities owned
or controlled by physician stockholders. Future minimum payments under
noncancelable leases with lease terms in excess of one year at December 31,
1997, are summarized as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
-----------
<S> <C>
1998........................................................................... $ 2,005,000
1999........................................................................... 1,730,000
2000........................................................................... 1,410,000
2001........................................................................... 1,270,000
2002........................................................................... 784,000
Thereafter..................................................................... 4,858,000
-----------
Total minimum lease obligations................................................ $12,057,000
-----------
-----------
</TABLE>
Rent expense for the years ended December 31, 1996 and 1997 under all
operating leases was approximately $602,000 and $1,926,000 respectively.
The Company has assumed leases between the affiliated medical practices and
entities controlled by equity owners in the related practices. Amounts charged
to expense for these leases were $193,000 and $1,226,000 for the years ended
December 31, 1996 and 1997, respectively. The commitments under these leases are
included above.
On August 1, 1997, in connection with a $5,000,000 loan (see Note 9) the
Company entered into an agreement (the Master Lease Agreement) with a lender
pursuant to which the lender agreed to purchase and lease certain equipment to
the Company on the terms and conditions contained in the Master Lease Agreement.
No transactions have occurred with respect to the Master Lease Agreement. In
connection with the Master Lease Agreement, the Company issued to the lender a
warrant to purchase up to 5,000 shares of the Company's Series E Preferred Stock
at a price per share equal to $6.00. This warrant is exercisable for a period of
7 years or 3 years from the effective date of the IPO, whichever is longer. The
fair value per share for this warrant based on the Black-Scholes valuation
method is $4.29 using the assumptions described in Note 6 and the actual life of
the warrant. In November 1997, the Master Lease Agreement was increased to
$1,500,000 and an additional 10,000 warrants were issued for the purchase of
Series E Preferred Stock at a price per share equal to $6.00. The fair value per
share for this warrant based on the Black-Scholes valuation method is $4.29
using the assumptions described in Note 6 and the actual life of the warrant.
6. STOCK OPTION PLAN
On May 6, 1996, and subsequently amended on May 30 and December 31, 1997,
the Company's Board of Directors approved the 1996 Stock Option Plan (the Option
Plan), which provides for the granting of options to purchase up to 2,000,000
shares of the Company's common stock. Both incentive stock options and
nonqualified stock options may be issued under the provisions of the Option
Plan. Employees of the Company and any future subsidiaries, members of the Board
of Directors, independent consultants and contractors and the physicians
employed by the medical groups with which the Company is affiliated through the
MSAs are eligible to participate in the Option Plan, which will terminate no
later than May 6, 2006. The granting and vesting of
47
<PAGE>
6. STOCK OPTION PLAN--(CONTINUED)
options under the Option Plan are authorized by the Company's Board of Directors
or a committee of the Board of Directors. Under the terms of the Option Plan,
incentive stock options vest pro rata over four years, except for options
covering 10,715 shares which vested at the completion of the IPO, have an
exercise price of $0.49 per share, and expire ten years from the date of grant.
None of the incentive stock options were exercisable as of December 31, 1996.
During 1997, the Company granted stock options to employees at exercise prices
ranging from $0.01 to $4.90 per share. In accordance with the provisions of the
option plan, the options vest over a four year period. During August and
December 1997, the Company modified the vesting terms of all the options such
that these options vested immediately. Total compensation expense related to the
granting of options and acceleration of the vesting, for the year ended December
31, 1997, based on a fair value ranging from $3.78 to $8.40 per share, amounted
to $4,665,000. Pro forma information regarding net income and earnings per share
has been determined as if the Company had accounted for its employee stock
options under the fair value method of SFAS No. 123. The fair value for these
options was estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions for 1996 and 1997:
risk-free interest rate of 6%; dividend yield of 0%; volatility factor of the
expected market price of the Company's common stock of .68; and a
weighted-average expected option life of four years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Information regarding these option plans is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
<S> <C> <C>
Options outstanding at inception............................................. -- $ --
Granted................................................................... 110,715 0.27
Exercised................................................................. -- --
Canceled.................................................................. -- --
---------
Options outstanding at December 31, 1996..................................... 110,715 0.27
Granted................................................................... 1,139,830 1.48
Exercised................................................................. (7,143) 0.01
Canceled.................................................................. (96,429) 0.55
--------- --------
Options outstanding at December 31, 1997.................................. 1,146,973 $ 1.44
--------- --------
--------- --------
Exercisable at December 31, 1996............................................. --
---------
---------
Exercisable at December 31, 1997............................................. 1,146,973
---------
---------
Reserved for future option grants at December 31, 1997....................... 853,027
--------
--------
Weighted average fair value of options granted during 1996................... $ 2.20
--------
--------
Weighted average fair value of options granted during 1997................... $ 4.76
--------
--------
</TABLE>
48
<PAGE>
6. STOCK OPTION PLAN--(CONTINUED)
The following table sets forth information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED
NUMBER OUTSTANDING REMAINING AVERAGE NUMBER EXERCISABLE
RANGE OF AS OF CONTRACTUAL EXERCISE AS OF
EXERCISE PRICES DECEMBER 31, 1997 LIFE PRICE DECEMBER 31, 1997
- -------------------------------------- ------------------ ----------- -------- ------------------
<S> <C> <C> <C> <C>
$0.01................................. 110,715 8.6 $ 0.01 110,715
$0.35-$0.84........................... 773,572 9.3 $ 0.63 773,572
$2.35-$4.90........................... 262,686 9.8 $ 4.58 262,686
------------------ ------------------
$0.01-$4.90........................... 1,146,973 9.4 $ 1.86 1,146,973
------------------ ------------------
------------------ ------------------
</TABLE>
The pro forma effects of adopting SFAS No. 123's fair value based method
for the year ended December 31, 1996 was not materially different from the
corresponding APB Opinion No. 25 intrinsic value methodology because the options
granted in 1996 were primarily issued near year end and the fair value of the
Company's stock, was $3.78 as of December 31, 1996. Accordingly, pro forma
stock-based compensation in 1996 is substantially less than would result from a
full year's compensation expense amortization and a higher valuation of the
common stock. The effects of applying SFAS No. 123 during 1996 and the year
ended December 31, 1997 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. The Company's
pro forma information for the year ended December 31, 1997 follows:
<TABLE>
<S> <C>
Pro forma net loss............................................................ $(32,030,000)
------------
------------
Pro forma net loss per share.................................................. $ (5.04)
------------
------------
</TABLE>
Additionally, the FASB has added to its agenda a project regarding certain
APB No. 25 issues, including such things as incorporating the SFAS No. 123 grant
date definition into APB No. 25, re-addressing the criteria under broad-based
plans qualifying for noncompensatory accounting and defining what constitutes
employees. The resolution of these issues could result in modification in the
Company's accounting for stock-based compensation arrangements.
Shares of common stock reserved for future issuance at December 31, 1997 is
as follows:
<TABLE>
<S> <C>
Options.......................................................................... 1,146,972
Convertible preferred stock...................................................... 2,989,100
Warrants......................................................................... 258,332
Convertible debentures........................................................... 396,825
---------
4,791,229
---------
---------
</TABLE>
49
<PAGE>
7. STOCKHOLDERS' EQUITY
Stockholders' equity consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1997
------------ ------------
<S> <C> <C>
Convertible preferred stock--Series A, $0.01 par value--
999,999 shares authorized, issued and outstanding............ $ 10,000 $ 10,000
Convertible preferred stock--Series B, $0.01 par value--
2,000,001 shares authorized, issued and outstanding.......... 20,000 20,000
Convertible preferred stock--Series C, $0.01 par value--
254,999 shares authorized, issued and outstanding............ -- 3,000
Convertible preferred stock--Series D, $0.01 par value--
189,000 shares authorized, 188,072 shares issued and
outstanding.................................................. -- 2,000
Convertible preferred stock--Series E, $0.01 par value--
1,300,025 shares authorized, 741,669 shares issued and
outstanding.................................................. -- 7,000
Convertible preferred stock--Series A-1, B-1, D-1 and E-1,
$0.01 par value--4,489,025 shares authorized; none issued and
outstanding.................................................. -- --
Common stock, $0.001 par value--15,000,000 shares authorized;
4,786,782 shares issued and outstanding at December 31, 1996;
25,000,000 shares authorized; 9,179,289 shares issued and
outstanding at December 31, 1997............................. 5,000 9,000
Additional paid-in capital..................................... 21,088,000 67,352,000
Accumulated deficit............................................ (1,742,000) (33,315,000)
------------ ------------
$ 19,381,000 $ 34,088,000
------------ ------------
------------ ------------
</TABLE>
On May 6, 1996, the Company issued 839,285 shares of $.001 par value common
stock for cash consideration of $0.014 per share, which resulted in proceeds to
the Company of approximately $12,000.
On May 6, 1996, the Company issued 999,999 shares of Series A convertible
preferred stock with a par value of $0.01 for $1.00 per share, which resulted in
proceeds to the Company of $999,999. On November 12, 1996, the Company issued
2,000,001 shares of Series B convertible preferred stock with a par value of
$0.01 for $3.00 per share, which resulted in proceeds to the Company of
$6,000,003.
On January 29, 1997 and March 12, 1997, the Company raised approximately
$765,000 in connection with the issuance of an aggregate of 254,999 shares of
Series C convertible preferred stock, with a par value of $0.01 per share.
On June 19, 1997, the Company issued 188,072 shares of Series D convertible
preferred stock with a par value of $0.01 for $5.50 per share as repayment of a
$1,000,000 loan plus accrued interest that had been made to the Company by
certain stockholders on January 14, 1997. In connection with the original loan,
the stockholders received warrants to purchase 23,810 shares of the Company's
common stock at a price of $4.20 per share, exercisable through January 14,
2002, resulting in deferred financing costs of approximately $2,400 based on the
Black-Scholes valuation method. The unamortized portion of this amount was
charged to interest expense when the loan was converted.
On June 19, July 31 and August 18, 1997, the Company issued an aggregate of
741,669 shares of Series E convertible preferred stock with a par value of $0.01
for $6.00 per share in exchange for $4,450,000.
50
<PAGE>
7. STOCKHOLDERS' EQUITY--(CONTINUED)
All classes of convertible preferred stock have the right to share in any
dividends declared and paid or set aside for the common stock of the Company,
pro rata, in accordance with the number of shares of common stock into which
such shares of preferred stock are then convertible; liquidation preference of
the original issuance price per share; and voting rights equal to the number of
shares of common stock into which the preferred stock is then convertible. All
classes of preferred shares are convertible into common shares at a ratio of 7:5
and were automatically converted upon the occurrence of the IPO. Upon the
automatic conversion, the holders of the convertible preferred stock were not
entitled to payment of any accrued but unpaid dividends. As more fully described
in Note 9, certain of the Company's debt agreements prohibit the Company from
declaring or paying dividends.
The Company is a party to a stockholders agreement dated as of November 22,
1996 (the Stockholders Agreement), with its President, certain stockholders and
the SCOI physicians. Under the Stockholders Agreement, the stockholders agreed
to vote their shares to appoint to the Company's board of directors certain
designees of such stockholders. The stockholders (other than the SCOI
physicians) also have the right of first refusal with respect to issuances of
the Company's capital stock or securities convertible into capital stock and are
subject to various restrictions on transfers of the Company's securities. Under
the terms of the Stockholders Agreement, 500,000 shares of the common stock that
the Company's President acquired for cash on May 6, 1996, are subject to vesting
over a 40-month period subject to acceleration in certain circumstances. In the
event of the termination of the President's employment with the Company for any
reason, the Company has the right to repurchase from the President all of the
shares of unvested stock at a purchase price equal to $0.01 per share. The
Stockholders Agreement terminated at the completion of the IPO.
On September 16, 1997, the Company filed a registration statement relating
to its common stock with the Securities and Exchange Commission. This
registration statement became effective on February 4, 1998 and the Company
issued 4,000,000 shares of common stock to the public at a price of $7.00 per
share. Net proceeds after underwriting discount and expenses of the offering
were $23,700,000. The offering was completed on February 9, 1998. On March 4,
1998, the underwriters exercised their overallotment option and the Company
issued an additional 600,000 shares of common stock and received net proceeds of
$3,906,000. Concurrent with this offering, the Company's certificate of
incorporation was amended to increase the Company's authorized common stock from
25,000,000 shares to 35,000,000 shares.
8. INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, Accounting for
Income Taxes. Deferred income tax assets and liabilities are determined based
upon differences between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Deferred income taxes
reflect the net tax effects of temporary differences
51
<PAGE>
8. INCOME TAXES--(CONTINUED)
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's net deferred tax assets are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1996 1997
----------------------- -----------------------
<S> <C> <C>
Deferred tax assets:
Amortization of intangible assets............................. $ 188,000 $ 6,000,000
Accrued expenses.............................................. 174,000 278,000
Stock option deduction for books.............................. -- 1,802,000
NOL carry-forward............................................. 319,000 3,719,000
------------ -----------------------
Deferred tax assets........................................... 681,000 11,799,000
Less valuation allowance...................................... (670,000) (11,558,000)
------------ -----------------------
Total deferred tax assets..................................... 11,000 241,000
Deferred tax liabilities:
Depreciation.................................................. (11,000) (241,000)
------------ -----------------------
Total deferred tax liabilities.................................. (11,000) (241,000)
------------ -----------------------
Total net deferred taxes........................................ $ 0 $ 0
------------ -----------------------
------------ -----------------------
</TABLE>
SFAS No. 109 requires a valuation allowance to reduce the deferred tax
assets reported if, based on the weight of the evidence, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
After consideration of all the evidence, both positive and negative, management
has determined that a $670,000 and $11,558,000 valuation allowance at December
31, 1996 and 1997, respectively, is necessary to reduce the deferred tax assets
to the amount that will more than likely not be realized. The change in the
valuation allowance for the current period is $10,888,000. On November 11, 1996,
the Company had an ownership change as defined by Internal Revenue code section
382 (Section 382) which caused the utilization of the net operating loss and tax
credits, at that time, to be limited to approximately $415,000 per year relating
to approximately $690,000 of the net operating losses at December 31, 1996. At
December 31, 1996 and 1997, the Company has available net operating loss
carryforwards of $826,000 and $9,631,000, which expire in the years 2011 through
2012. As a result of the completion of the Company's initial public offering in
February, 1998, the Company may have incurred a change in ownership as defined
by Section 382. Although the effects of this change have not yet been
determined, the utilization of the net operating loss carryforwards at December
31, 1997 will more than likely be limited.
The reconciliation of income tax computed at the U.S. federal statutory
rate to income tax expense is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1996 1997
----------------------- -----------------------
<S> <C> <C>
Tax at U.S. statutory rate....................................... (34.0%) (34.0%)
State taxes, net of federal benefit.............................. (4.6%) (4.1%)
Non-deductible items............................................. 0.2% 3.6%
Change in valuation allowance.................................... 38.4% 34.5%
------- -------
0.0% 0.0%
------- -------
------- -------
</TABLE>
52
<PAGE>
9. BORROWINGS
Borrowings consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1996 1997
-------------- ---------------
<S> <C> <C>
Borrowing under senior revolving lines of credit.......................... $ -- $ 6,113,000
Senior secured term note, payable in monthly installments of $90,000
through December 31, 2000, plus interest at prime plus 3.5% (12% at
December 31, 1997)...................................................... -- 3,250,000
Secured term note due January 1, 1999, plus interest at prime plus 3.5%
(12% at December 31, 1997).............................................. -- 2,500,000
Subordinated debt, payable in monthly installments of $257,000 through
December 31, 2000, including interest at 14% until January 1, 1998,
increasing to 15% thereafter............................................ -- 7,332,000
Subordinated convertible debentures, due August 31, 2000, plus interest,
payable semiannually at 6%.............................................. -- 4,000,000
Promissory notes to physician due at various dates ranging from, January
2, 1998 to January 31, 1999, plus interest at rates ranging from 6%
to 11%.................................................................. -- 12,909,000
Shareholder notes payable................................................. 40,000 4,366,000
Obligation under capital lease............................................ 77,000 64,000
--------- ------------
117,000 40,534,000
Less current portion...................................................... 58,000 5,389,000
----------- -----------
$ 59,000 $ 35,145,000
----------- -----------
----------- -----------
</TABLE>
In January 1997, the Company obtained short-term loans in the aggregate
amount of $999,999 from certain stockholders, including its President. In
connection with such loans, the Company issued warrants to such stockholders to
purchase an aggregate of 23,810 shares of Common Stock at an exercise price of
$4.20 per share which are immediately exercisable for a period of five years.
The fair value of the warrants based on the Black-Scholes valuation method is
$2.30 per share using the assumptions described in Note 6 and the actual life of
the warrant. In June 1997, such loans and related accrued interest were
converted into 188,072 shares of Series D Preferred Stock. Also, in January
1997, the Company issued two promissory notes to the Company's President
totaling $867,000. The notes plus accrued interest were converted to a single
note in the amount of $991,000 which bears interest at a rate of prime plus 3.5%
and is due on demand.
From March 1997 to December 31, 1997, the Company entered into a series of
credit agreements with its senior lender secured by the accounts receivable
acquired from each of the affiliated physician groups. The Company may borrow up
to an aggregate limit of $19,500,000, subject to a borrowing base of 85% of
eligible accounts receivable. Outstanding loans bear interest at the prime rate
plus 1.75% (10.25% at December 31, 1997) until December 31, 1997 and at the
prime rate thereafter and mature at various dates ranging from March 1999 to
December 1999. The credit agreements and term loans with its senior lender
require the Company to maintain a prescribed level of tangible net worth and
interest coverage and place limitations on indebtedness, liens and investments,
and prohibit the payment of dividends. At December 31, 1997, the Company was in
compliance with all financial covenants. At December 31, 1997, $6,113,000 was
outstanding under these agreements, the maximum allowable under the borrowing
base restriction.
Subsequent to December 31, 1997, the Company entered into additional credit
agreements with the Company's senior lender, totaling $3.5 million, subject to a
borrowing base limitation of 85% of eligible accounts receivable.
On June 30, 1997, the Company obtained a senior credit facility to fund
practice affiliations with its senior lender secured by a lien on substantially
all of the assets of the Company. The Company may borrow up to $3,250,000 for
practice affiliations, of which $3,250,000 is outstanding as of December 31,
1997. The loan bears interest at the prime rate plus 3.5% (12% at December 31,
1997). Interest only is payable through December 31, 1997, at which time the
loan converts to a term loan repayable in 36 monthly installments. The credit
facility contains various covenants including the right of the lender to declare
the loan due and payable upon the
53
<PAGE>
9. BORROWINGS--(CONTINUED)
occurrence of a material adverse change in the financial condition or business
prospects of the Company. In addition, in September 1997, the Company issued the
senior lender a warrant to purchase 28,570 shares of the Company's common stock
for nominal cash consideration. The warrant contains put rights which give the
holders the right to receive payment, based on a minimum put price of $14 per
share, for the value of the stock warrant at the earlier of the effective date
of the IPO or January 15, 1998. The warrant is exercisable for 10 years. Under
this facility, $1,500,000 of the Company's obligations are guaranteed by the
Company's President and other stockholders, and in connection therewith the
Company issued warrants to purchase an aggregate of 9,525 shares of common stock
for nominal cash consideration which are exercisable for a period of five years.
The fair value of the warrant based on the Black-Scholes valuation method is
$8.39 per share using the assumptions described in Note 6 and the actual life of
the warrants.
On August 1, 1997 and August 22, 1997, the Company entered into
subordinated loan agreements, with two different lenders, in the principal
amounts of $5,000,000 (the $5 million loan) and $1,500,000 (the $1.5 million
loan). The loans are secured by liens on all of the Company's tangible and
intangible personal property. The loans mature on December 31, 2000, however,
within 45 days subsequent to the effective date of the IPO, the Company is
obligated to prepay the loans in full. These loans and the liens granted to the
respective lenders are subordinated in all respects to the current and future
indebtedness of the Company under the senior credit facility described above.
The loans initially bear interest at 14% per annum, provided, however, that if
an initial public offering of the Company's capital stock is not consummated on
or prior to December 31, 1997, the loans will, commencing January 1, 1998, bear
interest at 15% per annum.
In connection with the $5 million and $1.5 million loans the Company issued
warrants to purchase up to 125,000 and 37,500 shares, respectively, of the
Company's Series E Preferred Stock at a price per share equal to $6.00. As the
IPO was not effective by December 31, 1997, the warrants increased to 133,333
and 40,000, respectively. These warrants are immediately exercisable for a
period of 10 years or 5 years, respectively, from the effective date of the IPO
whichever is earlier. The fair value per warrant based on the Black-Scholes
valuation method is $3.77 per share using the assumptions described in Note 6
and the actual life of the warrant. In addition, pursuant to stock purchase
agreements dated as of July 31, 1997 and August 18, 1997, the Company issued
166,667 and 41,667 shares, respectively, of Series E Preferred Stock to the
lenders for an aggregate purchase price of $1,250,000.
The $1.5 million loan is convertible into shares of preferred stock of the
Company at the option of the lender after the Company completes a sale and
issuance of any shares of its preferred stock in connection with an equity
financing at any time after a payment default under the loan agreement. The
conversion price will be equal to the purchase price per share paid by the
purchasers in such equity financings.
On September 9, 1997, the Company issued and sold $4,000,000 in aggregate
principal amount of its subordinated convertible debentures due August 31, 2000
(the 'Debentures') pursuant to the Convertible Debenture Purchase Agreement,
dated as of September 9, 1997 (the 'Debenture Purchase Agreement'). The
Debentures were purchased by the Company's President, certain stockholders and
certain of the Company's underwriters. Pursuant to the terms of the Debenture
Purchase Agreement, the Debentures are subordinated in right of payment to all
indebtedness of the Company under the loans described above. The Debentures bear
interest at 6% per annum and are payable semi-annually. The unpaid principal
amount of the Debentures is due on August 31, 2000.
Except in very limited instances, the Company may not prepay the Debentures
prior to September 9, 1999. The Debentures are subject to prepayment at the
option of the holders of the Debentures upon the consummation of (i) a sale of
all or substantially all of the assets of the Company; (ii) a sale or transfer
of all or a majority of the outstanding common stock of the Company in any one
transaction or series of related transactions: or (iii) a merger or
consolidation of the Company with or into another entity. The Debentures are
convertible at any time at the option of the holders thereof into shares of
common stock at an initial conversion price equal to $10.08 per share subject to
reduction in the event that the Company sells its common stock for a price less
than $10.08 per share. Accordingly, in conjunction with the Company's IPO more
fully described in Note 7, the conversion price was reduced to $7 per share.
Pursuant to the terms of the Debenture Purchase Agreement, the holders of the
Debentures have rights of first offer on future issuances of capital stock of
the Company or other securities
54
<PAGE>
9. BORROWINGS--(CONTINUED)
convertible into capital stock of the Company (except with respect to a public
offering of shares of the Company's common stock). The Debenture Purchase
Agreement places limitations on indebtedness and liens and prohibits the payment
of dividends.
On October 14, 1997, the Company obtained short-term financing in the form
of a secured term note from its senior lender, to fund practice affiliations in
an aggregate amount of $2,500,000. The note is secured by a lien on
substantially all of the assets of the Company. Outstanding loans bear interest
at the prime rate plus 3.5% (12% at December 31, 1997). Interest only is payable
through December 31, 1997 and the entire principal amount is due and payable on
January 1, 1999. In connection with this loan agreement, the Company will pay to
the lender a fee in the amount of $300,000 on the maturity date.
On October 15, 1997, the Company obtained short-term bridge financing in
the aggregate amount of $3,375,000 from certain stockholders, including its
President, to fund practice affiliations. In connection with these loans, the
Company issued warrants to such stockholders to purchase an aggregate of 48,215
shares of Common Stock at an exercise price of $0.01 per share which are
immediately exercisable for a period of 5 years. The fair value per warrant
based on the Black-Scholes valuation method is $8.39 per share using the
assumptions described in Note 6 and the actual life of the warrant. Outstanding
loans bear interest at the prime rate plus 3.5%. (12% at December 31, 1997). The
principal amounts and accrued interest were repaid in February 1998.
During October and November 1997, in connection with several practice
affiliations, the Company issued promissory notes that in the aggregate total
$12,625,000 (Physician Notes). These outstanding promissory notes bear interest
ranging from 6% to 11%. Substantially all of these promissory notes are due and
payable either on the date of the Company's completion of the IPO or at various
maturity dates ranging from January 2, 1998 to March 31, 1998.
On November 14, 1997, the Company entered into an additional subordinated
loan agreement in the principal amount of $1,000,000 (the $1 million loan) with
the lender of the $5 million loan. The $1 million loan is due on December 1,
2000 and contains the same terms as the $5 million loan. A warrant to purchase
26,667 shares of the Company's Series E Preferred Stock was issued to the
lender. The warrant is immediately exercisable, at an exercise price of $.01 per
share, for a period of five years. The fair value of the warrant based on the
Black-Scholes valuation method is $8.39 per share using the assumptions
described in Note 6 and the actual life of the warrant.
On October 15, 1997, the Company issued to its President a warrant to
purchase 23,214 shares of common stock at an exercise price of $.01 per share.
The warrant is exercisable for a period of five years. The fair value of the
warrant based on the Black-Scholes valuation method is $8.39 per share using the
assumptions described in Note 6 and the actual life of the warrant.
On January 2, 1998, the Company obtained short-term financing in the form
of a demand note from its President in the amount of $1.0 million to repay
certain of the Physician Notes. In connection with this loan, the Company issued
a warrant to the President to purchase 14,286 shares of common stock at an
exercise price of $0.01 per share. The demand note bears interest at 8% per
annum. The fair value of the warrants based on the Black-Scholes valuation
method is $8.39 per share using the assumptions described in Note 6 and the
actual life of the warrant. The warrant is immediately exercisable for a period
of 5 years.
Included in other assets in the accompanying consolidated balance sheet as
of December 31, 1997 is deferred financing costs related to warrants issued in
connection with certain borrowings. Such costs are being amortized over the
applicable life of the related debt.
Under the terms of all the credit agreements and credit facilities with the
senior lender, the subordinated loan agreements and the subordinated convertible
debentures, the Company is prohibited from declaring or paying any cash dividend
or making any distribution on any class of stock, except pursuant to an employee
repurchase plan or with the consent of the lender.
55
<PAGE>
9. BORROWINGS--(CONTINUED)
On February 9, 1998, the Company completed the IPO (see Note 7), the
proceeds of which were used to repay the following borrowings:
<TABLE>
<S> <C>
Promissory notes to physicians............................. $ 9,608,000
Subordinated debt.......................................... 7,332,000
Secured term note.......................................... 2,500,000
Short-term bridge notes.................................... 3,375,000
-----------
$22,815,000
-----------
</TABLE>
Accordingly, this indebtedness has been classified as long-term in the
accompanying financial statements and the Company expects to incur charges
associated with the repayment and early extinguishment of debt of approximately
$1,000,000 in the quarter ending March 31, 1998. The aggregate principal
maturities of long-term debt remaining for the next five years after giving
effect to the above disclosed repayments are as follows: 1998, $5,389,000; 1999,
$7,211,000; 2000, $5,098,000; 2001, $15,000; 2002, $6,000.
10. COMMITMENTS AND CONTINGENCIES
The Company has an employment agreement dated as of May 6, 1996, as
amended, with its President (the Employment Agreement). Base compensation under
the Employment Agreement is $300,000 per year, subject to increase by the Board
of Directors. In addition, the Board of Directors may award an annual bonus to
the President in an amount of up to 30% of his base salary based on the
attainment of certain benchmarks. The Company may terminate the President's
employment at any time and for any reason; provided that, if his employment is
terminated without cause (as defined in such agreement) or as a result of his
becoming permanently disabled, the Company must pay the President a severance
amount determined in accordance with a formula contained in the agreement.
The Company is a defendant in an action entitled John Finlay v. Bone,
Muscle & Joint, Inc., which is currently pending in the United States District
Court for the Southern District of Texas. The action asserts claims for breach
of contract arising out of an alleged employment agreement and alleged
non-qualified stock option agreement. The action seeks compensatory damages
pursuant to the alleged employment agreement as well as specific performance for
the delivery of 16,071 shares of the Company's common stock. The Company
believes that the ultimate resolution of this matter will not have a material
impact on the Company's financial position, results of operations or cash flows.
The Company is a defendant in an action entitled Robert P. Lehmann, M.D. et
al. v. Bone, Muscle & Joint, Inc., et al. which has been filed in the United
States District Court for the Southern District of Texas. The action asserts
claims for breach of contract, common law fraud and promissory estoppel arising
from an alleged restricted stock purchase agreement. The action seeks
compensatory and exemplary damages as well as specific performance for the
delivery of 117,860 shares of the common stock. The Company believes that the
ultimate resolution of this matter will not have a material impact on the
Company's financial position, results of operations or cash flows.
The Company and its affiliated physician practices are insured with respect
to medical malpractice risks on either an occurrence-rate or a claims-made
basis. Management is not aware of any claims against it or its affiliated
physicians which might have a material impact on the Company's financial
position or results of operations. Management of the company intends to renew
the existing claims-made policies annually and expects to be able to obtain such
coverage. When coverage is not renewed, management intends to purchase an
extended reporting period endorsement to provide professional liability coverage
for losses incurred prior to, but reported subsequent to, the termination of the
claims-made policies.
The Company is subject to legal proceedings in the ordinary course of its
business including certain claims resulting from the result of successor
liability in connection with the assumption of certain liabilities of the
physician practices. The Company does not believe that any of such legal
proceedings, after consideration of professional and other liability insurance
and amounts provided in the accompanying consolidated balance sheet as of
December 31, 1997, will have a material adverse effect on the Company's
financial position, results of operations or cash flows.
56
<PAGE>
10. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
In December 1997, the Company had commitments totaling $2.75 million for
construction of two ambulatory surgery centers.
11. RETIREMENT PLAN
The Company has a qualified contributory savings plan as allowed under
Section 401(k) of the Internal Revenue Code which was implemented in October
1997. The plan permits participant contributions, subject to certain
limitations, and requires a minimum contribution from the Company based on the
participants' contribution. The Company made no contributions to the plan during
the year ended December 31, 1997.
12. SUPPLEMENTAL CASH FLOW INFORMATION
Significant non-cash financing and investing activities for the year ended
December 31, 1996, are summarized as follows:
o The value of stock issued upon execution of Management Services
Agreements was $14,111,000.
o Non-cash transactions from practice affiliations including accounts
receivable, Management Services Agreements and due to/from
physicians amounted to $4,905,000.
o Equipment acquired under capital lease obligations amounted to
$77,000.
o Interest paid amounted to $9,000.
Significant non-cash financing and investing activities for the year ended
December 31, 1997, are summarized as follows:
o The value of stock issued upon execution of Management Services
Agreements was $23,292,000.
o Notes issued upon execution of Management Services Agreements was
$8,109,000.
o Non-cash transactions from practice affiliations including accounts
receivable, Management Services Agreements and due to/from
physicians amounted to $4,885,000.
o Short-term loans converted to preferred stock amounted to
$1,000,000.
o Deferred financing costs related to the issuance of warrants
amounted to $1,580,000.
o Common stock issued in payment of accrued salaries amounted to
$292,000.
o Interest paid amounted to $583,000.
57
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the directors
and executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------------ --- ------------------------------------------------
<S> <C> <C>
Naresh Nagpal, M.D.............................. 48 President, Chief Executive Officer and Director
David H. Fater.................................. 51 Executive Vice President, Chief Financial
Officer and Director
David K. Ellwanger.............................. 40 Senior Vice President of Operations
Sheldon Lutz.................................... 54 Senior Vice President of Corporate Development
Neil F. Luria................................... 30 General Counsel
Georges Daou(2)................................. 36 Director
Stewart G. Eidelson, M.D........................ 47 Director
James M. Fox, M.D.(1)........................... 55 Director
Ann H. Lamont(1)................................ 41 Director
Donald J. Lothrop(2)............................ 38 Director
</TABLE>
- ------------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
The Company's Board of Directors is classified into three classes which
consist of, as nearly as practicable, an equal number of directors. The members
of each class serve staggered three-year terms. Messrs. Eidelson and Fox are
Class I directors, Mr. Fater and Ms. Lamont are Class II directors and Messrs.
Nagpal, Daou and Lothrop are Class III directors. Nominees for director will be
divided among the three classes upon their election or appointment. The terms of
Class I, Class II and Class III directors expire at the annual meeting of
stockholders to be held in 1999, 2000 and 2001, respectively.
Naresh Nagpal, M.D. became President and Chief Executive Officer and a
director in March 1996. From September 1993 to August 1996, Dr. Nagpal served on
the board of directors of InPhyNet Medical Management Inc. ('IMMI'), a PPM. From
September 1993 to August 1995, Dr. Nagpal was the Senior Executive Vice
President and Chief Operating Officer of IMMI. From January 1985 to August 1993,
Dr. Nagpal was President of Acute Care Specialists, Inc. and its related
companies which are PPMs that provide services to several hospitals and
physicians. Dr. Nagpal was the Chairman of the Department of Emergency Medicine
at Barberton Citizens Hospital in Barberton, Ohio from January to June of 1992
and Chairman of the Department of Emergency Medicine at Audobon Regional Medical
Center in Louisville, Kentucky from July to December of 1992.
David H. Fater became Executive Vice President and Chief Financial Officer
in February 1997 and a director in April 1997. From June 1995 to January 1997,
Mr. Fater was the Executive Vice President and Chief Financial Officer of
Community Care of America, Inc. From January 1993 to April 1995, Mr. Fater was
the Executive Vice President and Chief Financial Officer of Coastal Physician
Group, Inc. Prior to that, Mr. Fater was a partner at Ernst & Young, LLP.
David 'Deke' K. Ellwanger became Senior Vice President of Operations in
July 1997. From July 1994 to July 1997, Mr. Ellwanger was the Vice President of
Managed Care for MedPartners/InPhyNet Medical Management Inc. From August 1985
to June 1994, Mr. Ellwanger worked for Aetna Health Plans/PARTNERS National
Health Plans managing various HMO's and HMO acquisitions.
58
<PAGE>
Sheldon Lutz became Senior Vice President of Corporate Development in
November 1997. From February 1992 until 1997, Mr. Lutz was the Vice President of
Development for Columbia/HCA Healthcare Corporation responsible for acquisitions
and joint ventures and development of a marketwide joint venture model.
Neil F. Luria became General Counsel in February 1998. From September 1992
to February 1998, Mr. Luria was an attorney with Jones Day Reavis & Pogue.
Georges Daou became a director in September 1997. Mr. Daou is a founder of
DAOU Systems, Inc. and has served as Chairman of the Board and Chief Executive
Officer of such company since 1987. Mr. Daou sits on the boards of various
healthcare and community organizations, including the College of Healthcare
Management Executives and the Healthcare Information Managers Association.
Stewart G. Eidelson, M.D. became a director in October 1997. Dr. Eidelson
is a shareholder of, and since 1990 has been an orthopedic surgeon at, OSA.
James M. Fox, M.D. became a director in November 1996. Dr. Fox was a
founding partner of, and since 1992 has been an orthopedic surgeon at, SCOI.
Ann H. Lamont became a director in May 1996. Ms. Lamont is a managing
member of each of the general partner of Oak Investment Partners VI, Limited
Partnership ('Oak Partners') and Oak VI Affiliates Fund, Limited Partnership
('Oak VI'). Since September 1983, Ms. Lamont has been a general partner or
managing member of the general partner of four other venture capital
partnerships affiliated with Oak Partners and Oak VI. Ms. Lamont currently
serves as a director on the board of ViroPharma, Incorporated.
Donald J. Lothrop became a director in May 1996. Since July 1994, Mr.
Lothrop has been a General Partner of Delphi Ventures, a privately held venture
capital firm. From January 1991 to July 1994, Mr. Lothrop was a Partner at
Marquette Venture Partners, Inc., a privately held venture capital partnership.
Mr. Lothrop currently serves as a director on the boards of Accordant Health
Services, Inc., Affiliated Research Centers, Inc., EXOGEN, Inc., Kelson
Physician Partners, Inc., Pacific Dental Benefits, Presidium Inc. and PriCare,
Inc.
NATIONAL PHYSICIAN ADVISORY BOARD
The Company has established a National Physician Advisory Board (the
'Advisory Board') which provides oversight of certain matters including
responsibility for all patient care and clinical issues. The Advisory Board also
has responsibility for providing guidance to the Company regarding the
development of its disease management system and protocols as well as all
professional issues. The Advisory Board consists of seven musculoskeletal
physicians from various parts of the country, including physicians who are not
affiliated with the Company.
The initial six members of the Advisory Board are:
<TABLE>
<CAPTION>
PHYSICIAN PRACTICE
- ------------------------------------------------------------------------- --------
<S> <C>
James Esch, M.D.......................................................... Tri-City
Lanny Johnson, M.D....................................................... Retired
Gilbert R. Meadows, M.D.................................................. STSC
Ranjan Sachdev, M.D...................................................... LVBMJ
Martin Silverstein, M.D.................................................. LOS
Donald Wiss, M.D......................................................... SCOI
</TABLE>
DIRECTOR COMPENSATION AND COMMITTEES
The non-employee directors currently receive $10,000 annual compensation
for their service on the Board of Directors, $2,000 for each meeting attended in
person and $1,000 for each meeting attended telephonically and are reimbursed
for their out-of-pocket expenses. Under the Company's Option Plan, non-employee
directors are eligible to receive option grants.
The Board of Directors currently includes a Compensation Committee composed
of two directors, Ms. Lamont and Dr. Fox, and an Audit Committee composed of two
directors, Messrs. Daou and Lothrop. The Compensation Committee determines
compensation for executive officers of the Company and administers the
59
<PAGE>
Company's Option Plan. The Audit Committee reviews the scope and results of
audits and internal accounting controls and all other tasks performed by the
independent public accountants of the Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to the establishment of the Compensation Committee in February 1997,
the Board of Directors determined the compensation payable to the Company's
executive officers. Stock options have been granted to employees of the Company
and, at the end of fiscal 1996, the Board of Directors approved an incentive
bonus for Dr. Nagpal.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the
compensation paid by the Company to the President and Chief Executive Officer of
the Company during the fiscal year ended December 31, 1996 (the only executive
officer of the Company during such year) and to the President and Chief
Executive Officer and the Executive Vice President and Chief Financial Officer
of the Company during the fiscal year ended December 31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
COMPENSATION
ANNUAL COMPENSATION AWARDS
--------------------------------- ------------
OTHER SECURITIES ALL
FISCAL ANNUAL UNDERLYING OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS/SARS COMPENSATION
- ---------------------------------------- ------ ------- ------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Naresh Nagpal, M.D...................... 1996 225,000 67,500 -- -- --
President and Chief Executive Officer 1997 300,000 90,000 -- -- --
David H. Fater.......................... 1997 194,615 50,000 -- -- --
Executive Vice President and Chief
Financial Officer
</TABLE>
OPTION GRANTS
There were no options granted to the President and Chief Executive Officer
during the fiscal years ended December 31, 1996 and 1997, and options to
purchase 100,000 shares of Common Stock were granted to the Executive Vice
President and Chief Financial Officer during the fiscal year ended December 31,
1997.
STOCK OPTION PLAN
In order to attract and motivate employees, consultants and directors to
use their best efforts on behalf of the Company, the Company may, pursuant to
its Option Plan, grant to its employees, consultants, and directors options to
purchase an aggregate of 2,000,000 shares of Common Stock (subject to adjustment
in certain circumstances). If any options expire or are canceled or terminated
without being exercised, the Company may, in accordance with the terms of the
Option Plan, grant additional options with respect to those shares of Common
Stock underlying the unexercised portion of such expired, canceled or terminated
options.
The Option Plan may be administered by the Board of Directors or by a
committee of the Board of the Directors (the 'Committee,' and references to the
Committee shall mean the Board of Directors, if a committee is not appointed).
Grants of Common Stock may consist of (i) options intended to qualify as
incentive stock options ('ISOs') or (ii) nonqualified stock options that are not
intended so to qualify ('NSOs'). Except as set forth below, the term of any such
option is ten years. Options may be granted to any employees (including officers
and directors) of the Company, members of the Board of Directors who are not
employees, and consultants and advisers who perform services to the Company or
any of its subsidiaries.
60
<PAGE>
The option price of any ISO granted under the Option Plan will not be less
than the fair market value of the underlying shares of Common Stock on the date
of grant; provided that the 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, in such case, the ISO's term may not exceed five
years. The option price of an NSO 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; provided
that, subsequent to the initial public offering of the Company's Common Stock,
the price of the underlying shares may not be less than fair market value. A
grantee may pay the option price (i) in cash, (ii) by delivering shares of
Common Stock already owned by the grantee or vested options held by the grantee,
which, in either case, have a fair market value on the date of exercise equal to
the option price or (iii) by any combination of (i) and (ii) above. With respect
to any options, the Committee may impose such vesting and other conditions as
the Committee may deem appropriate, all of which terms and conditions must be
set forth in an option agreement between the Company and the grantee. Options
may be exercised by the grantee at any time during his employment or retention
by the Company or any subsidiary thereof and within a specified period after
termination of the grantee's employment or retention.
In the event of a change of control (as defined in the Option Plan), all
grantees will be afforded an opportunity to exercise the portion of their
respective options that are then vested and exercisable. Thereafter, any
unexercised and any unvested portion of all outstanding options will be
automatically terminated.
All options issued under the Option Plan will be granted subject to any
applicable federal, state and local withholding requirements. At the time of
exercise, the grantee must remit to the Company an amount sufficient to satisfy
the total amount of any such taxes required to be withheld by the Company with
respect to such exercised options.
The Board of Directors may amend or terminate the Option Plan at any time;
provided that, under certain circumstances the approval of the stockholders of
the Company may be required. As of December 31, 1997, the Company has granted
options under the Option Plan to purchase an aggregate of 1,250,545 shares of
Common Stock, of which 7,143 have been exercised, 96,429 have been canceled and
94,642 were issued to physicians. The Option Plan will terminate on May 6, 2006,
unless earlier terminated by the Board of Directors or extended by the Board of
Directors with the approval of the stockholders.
EMPLOYMENT AGREEMENT
The Company has entered into an employment agreement dated as of May 6,
1996, as amended, with Dr. Nagpal (the 'Nagpal Employment Agreement'). Base
compensation under the Nagpal Employment Agreement is $300,000 per year, subject
to increase by the Board of Directors. In addition, the Board of Directors may
award an annual bonus to Dr. Nagpal in an amount of up to 30% of his base salary
based on the attainment of certain benchmarks. The Company may terminate Dr.
Nagpal's employment at any time and for any reason; provided that, if his
employment is terminated without cause (as defined in such agreement) or as a
result of his becoming permanently disabled, the Company must pay Dr. Nagpal a
severance amount determined in accordance with a formula contained in the
agreement.
Under the Nagpal Employment Agreement, Dr. Nagpal is prohibited from
directly or indirectly competing with the Company during the term of his
employment with the Company and for an additional year thereafter or as long as
the Company is making severance payments to him. However, there can be no
assurance as to the enforceability of such Agreement. The restraint on
competition by Dr. Nagpal is geographically limited to any state in the United
States in which the Company or any of its subsidiaries conducts business or
specifically plans to conduct business at the time of the termination of his
employment with the Company. Under the terms of the Nagpal Employment Agreement,
Dr. Nagpal acknowledges that any proprietary information (as defined in such
agreement) that he may develop is the sole property of the Company and agrees
not to disclose to, or use for the benefit of, any person or entity (other than
the Company) any of such proprietary information whether or not developed by
him.
61
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of February 4, 1998
regarding the beneficial ownership of the Common Stock of the Company with
respect to (i) each person known by the Company to own beneficially more than 5%
of the outstanding shares of Common Stock; (ii) each of the Company's directors;
and (iii) all directors and officers as a group. Unless otherwise indicated, the
address for each stockholder is c/o BMJ Medical Management, Inc., 4800 North
Federal Highway, Suite 101E, Boca Raton, Florida 33431.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED(1)
----------------------------------------------------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT
- ------------------------------------------------------ ------------------------------ ------------------------------
<S> <C> <C>
Delphi Ventures III, L.P.(2).......................... 1,367,079 8.41%
3000 Sand Hill Road, Building One, Suite 135,
Menlo Park, California 94025
Oak Investment Partners VI, L.P.(3)................... 1,367,079 8.41
One Gorham Island
Westport, Connecticut 06880
Naresh Nagpal, M.D.(4)................................ 1,824,369 11.12
David H. Fater(5)..................................... 100,000 *
Georges Daou(6)....................................... 17,855 *
Stewart G. Eidelson, M.D.(7).......................... 10,020 *
James M. Fox, M.D.(8)................................. 469,002 2.82
Ann H. Lamont(3)(9)................................... 1,367,079 8.41
Donald J. Lothrop(2)(10).............................. 1,367,079 8.41
All officers and directors as a group (7
persons)(11)........................................ 5,155,404 30.77
</TABLE>
- ------------------------
* Less than one percent.
(1) Applicable percentage of ownership is based on 16,163,133 shares of Common
Stock outstanding as of February 4, 1998. Beneficial ownership is determined
in accordance with the rules of the Commission and includes voting and
investment power with respect to securities. Securities subject to options
or warrants currently exercisable or exercisable within 60 days of February
4, 1998 are deemed outstanding for purposes of computing the percentage
ownership of the person holding such options or warrants, but are not deemed
outstanding for purposes 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) Includes (i) 1,895 shares of Common Stock owned by Delphi BioInvestments,
(ii) warrants to purchase 24,945 shares of Common Stock owned by the
stockholder and warrants to purchase 450 shares of Common Stock owned by
Delphi BioInvestments and (iii) 71,429 shares of Common Stock issuable upon
conversion of Convertible Debentures held by the stockholder.
(3) Includes (i) 2,445 shares of Common Stock owned by Oak VI, (ii) warrants to
purchase 24,820 shares of Common Stock owned by the stockholder and warrants
to purchase 580 shares of Common Stock owned by Oak VI and (iii) 71,429
shares of Common Stock issuable upon conversion of Convertible Debentures
held by the stockholder.
(4) Includes (i) 107,145 shares of Common Stock reserved for issuance upon
exercise of presently exercisable stock options, (ii) warrants to purchase
62,895 shares of Common Stock and (iii) 71,429 shares of Common Stock
issuable upon conversion of Convertible Debentures held by the stockholder.
Dr. Nagpal's shares are held in two trusts for his children, the Prianker
Nagpal Family Trust and the Zubin Nagpal Family Trust. Dr. Nagpal is the
grantor of each trust and Dr. Nagpal's wife is the sole trustee of each
trust.
(5) Consists of 100,000 shares of Common Stock reserved for issuance upon
exercise of presently exercisable options.
(6) Consists of 17,855 shares of Common Stock reserved for issuance upon
exercise of presently exercisable options.
62
<PAGE>
(7) Consists of 10,020 shares of Common Stock issued pursuant to a Management
Services Agreement.
(8) Includes warrants to purchase 5,355 shares of Common Stock and presently
exercisable options to purchase 35,714 shares of Common Stock owned by the
stockholder.
(9) Ms. Lamont, a director of the Company, is a managing member of each of the
general partner of Oak Investment and Oak VI. As such, Ms. Lamont may be
deemed to have an indirect pecuniary interest (within the meaning of Rule
16a-1 under the Exchange Act), in an indeterminate portion of the shares
beneficially owned by Oak Investment and Oak VI. All of the shares indicated
as owned by Ms. Lamont are owned beneficially by Oak Investment and Oak VI
and are included because of the affiliation of Ms. Lamont with each of the
partnerships. Ms. Lamont disclaims beneficial ownership of these shares to
the extent permitted under Rule 13d-3 under the Exchange Act.
(10) Mr. Lothrop, a director of the Company, is a General Partner of Delphi
Ventures. As such, Mr. Lothrop may be deemed to have an indirect pecuniary
interest (within the meaning of Rule 16a-1 under the Exchange Act), in an
indeterminate portion of the shares beneficially owned by Delphi Ventures
and Delphi BioInvestments. All of the shares indicated as owned by Mr.
Lothrop are owned beneficially by Delphi Ventures and Delphi BioInvestments
and are included because of the affiliation of Mr. Lothrop with each of the
partnerships. Mr. Lothrop disclaims beneficial ownership of these shares to
the extent permitted under Rule 13d-3 under the Exchange Act.
(11) Includes beneficial ownership of an aggregate of 2,734,158 shares of Common
Stock and warrants to purchase Common Stock attributable to the affiliation
of Ms. Lamont and Mr. Lothrop with the entities described in footnotes (9)
and (10) above.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with its initial capitalization, the Company sold shares of
Common Stock and Series A Convertible Preferred Stock (the 'Series A Preferred
Stock') to each of the following persons and entities at a per share purchase
price of $0.014 and $1.00, respectively: (a) Oak Partners purchased 104,700 and
325,733 shares of Common Stock and Series A Preferred Stock, respectively; (b)
Oak VI purchased 2,445 and 7,600 shares of Common Stock and Series A Preferred
Stock, respectively; (c) Delphi Ventures purchased 105,250 and 327,438 shares of
Common Stock and Series A Preferred Stock, respectively; (d) Delphi
BioInvestments III, L.P. ('Delphi BioInvestments') purchased 1,895 and 5,895
shares of Common Stock and Series A Preferred Stock, respectively; (e) Dr.
Nagpal purchased 607,145 and 333,333 shares of Common Stock and Series A
Preferred Stock, respectively and (f) Scheer & Co. purchased 17,855 shares of
Common Stock. Upon consummation of the Company's Offering, each outstanding
share of Series A Preferred Stock automatically converted into .7143 shares of
Common Stock.
During the period beginning November 1996 and ending in March 1997, the
Company raised additional working capital funds by issuing additional shares of
preferred stock. On November 12, 1996, the Company issued an aggregate of
2,000,001 shares of Series B Convertible Preferred Stock, $0.01 par value (the
'Series B Preferred Stock'), to the following persons and entities in the
following amounts: Oak Partners, 651,467 shares; Oak VI, 15,200 shares; Delphi
Ventures, 654,877 shares; Delphi BioInvestments, 11,790 shares; and Dr. Nagpal,
666,667 shares. The investors paid an aggregate purchase price of $6,000,003 for
the Series B Preferred Stock. Upon consummation of the Offering, each
outstanding share of Series B Preferred Stock automatically converted into .7143
shares of Common Stock. An additional $764,997 was raised by the Company from
the issuance of an aggregate of 254,999 shares of Series C Convertible Preferred
Stock, $0.01 par value (the 'Series C Preferred Stock'), on January 22, 1997 and
March 12, 1997 to certain of the SCOI physicians (including Dr. Fox, one of the
Company's directors), key employees and legal counsel of SCOI, an employee of
the Company, CGJR Health Care Private Equities, L.P., CGJR II, L.P. and CGJR/MF
III, L.P. Upon consummation of the Offering, each outstanding share of Series C
Preferred Stock automatically converted into .7143 shares of Common Stock. On
January 14, 1997, the Company obtained short-term loans in the aggregate amount
of $999,999 from Delphi Ventures, Delphi BioInvestments, Oak Partners, Oak VI
and Dr. Nagpal. In connection with such loans, the Company issued warrants to
the lenders to purchase an aggregate of 23,810 shares of Common Stock, which
warrants may be exercised at any time, in whole or in part, prior to January 14,
2002 at an exercise price of $4.20 per share. The Company borrowed an additional
$866,667 (of which $130,000 has been repaid) from Dr. Nagpal
63
<PAGE>
on January 10, 1997 and January 14, 1997. Each of the foregoing loans bears
interest at 14% per annum. On June 19, 1997, pursuant to a letter agreement, the
Company issued an aggregate of 188,072 shares of Series D Convertible Preferred
Stock, $0.01 par value (the 'Series D Preferred Stock'), to Oak VI, Oak
Partners, Delphi Ventures, Delphi BioInvestments, and Dr. Nagpal in exchange for
the cancellation of promissory notes in the aggregate principal amount of
$999,999, plus accrued interest, previously issued by the Company to secure
loans made by such investors to the Company. Upon consummation of the Offering,
each outstanding share of Series D Preferred Stock automatically converted into
.7143 shares of Common Stock.
On June 19, 1997, pursuant to a letter agreement, the Company issued an
aggregate of 533,335 shares of Series E Convertible Preferred Stock, $0.01 par
value (the 'Series E Preferred Stock'), to Oak VI, Oak Partners, Delphi
Ventures, Delphi BioInvestments, Dr. Nagpal, CGJR Health Care, CGJR II, and
CGJR/MF. The investors paid an aggregate purchase price of $3,200,010 for the
Series E Preferred Stock. Upon consummation of the Offering, each outstanding
share of Series E Preferred Stock automatically converted into .7143 shares of
Common Stock.
From March 1997 to November 1997, the Company entered into the HCFP Loan
Agreements with HCFP Funding. Each of the HCFP Loan Agreements is in the nature
of a revolving line of credit, with each such loan to be made against a
borrowing base equal to 85% of the qualified accounts receivable generated by
the subject Practice. Each HCFP Loan had an initial term of two years, subject
to renewals of one-year periods upon the mutual agreement of the parties, and
bears interest at the Base Rate (defined as 1.75% above the prime rate
designated by Fleet National Bank of Connecticut, N.A.), subject to increase
upon the occurrence of an event of default. In addition, upon the occurrence and
during the continuance of an event of default, the Company is prohibited from
declaring or paying cash dividends on its Common Stock. As security for
repayment of the HCFP Loans, the Company granted HCFP Funding a first priority
lien and security interest in its accounts receivable.
On June 30, 1997, the Company issued a secured term note in the aggregate
principal amount of $3,250,000 to HCFP Funding (the 'June HCFP Note'), which
bears interest at the Base Rate (defined as the prime rate designated by Fleet
National Bank of Connecticut plus 3.5%) (the 'Fleet Base Rate'), subject to
increase upon the occurrence of an event of default, with interest payable on
the last business day of each month for the first six months commencing July 31,
1997 through December 31, 1997. Commencing on January 31, 1998, the Company is
required to make 36 equal monthly installments of principal, plus accrued
interest at the Base Rate. The June HCFP Note is secured by a lien on
substantially all of the assets of the Company and $1.5 million of the Company's
obligations under the June HCFP Note are guaranteed by Dr. Nagpal, Delphi
Ventures III, L.P., Delphi BioInvestments III, L.P., Oak Investment Partners VI,
L.P. and Oak VI Affiliates Fund, L.P. In connection with such guarantees, the
Company issued warrants to purchase an aggregate of 9,525 shares of Common Stock
to such guarantors. In connection with the HCFP Note, the Company issued
warrants to purchase 28,570 shares (subject to increase) of Common Stock to HCFP
Funding at an exercise price of $0.01 per share. The warrants contain put rights
which give the holder the right to receive payment, based on a minimum put price
of $14.00 per share, for the value of such warrants at January 15, 1998.
Pursuant to a Stock Purchase Agreement dated as of July 31, 1997, the
Company issued 166,667 shares of Series E Preferred Stock to HIS Ventures, LLC
for an aggregate purchase price of $1,000,000. Upon the consummation of the
Offering, each outstanding share of Series E Preferred Stock automatically
converted into .7143 shares of Common Stock.
On August 1, 1997, the Company entered into the Comdisco Loan Agreement
pursuant to which Comdisco made the Comdisco Loan to the Company in the
principal amount of $5,000,000. The Comdisco Loan Agreement was subsequently
amended on November 14, 1997, to increase the amount of the Comdisco Loan to an
aggregate of $6,000,000. To secure its obligations to Comdisco under the
Comdisco Loan Agreement, the Company granted to Comdisco a secured lien on all
of the Company's tangible and intangible personal property. The Comdisco Loan
and the liens granted to Comdisco (the 'Comdisco Liens') are subordinated in all
respects to the current and future indebtedness of the Company owing to HCFP
Funding. The Comdisco Liens rank pari passu with the liens granted to Cedar. The
Comdisco Loan initially bears interest at 15% per annum. The Comdisco Loan may
be prepaid, in whole or in part, at any time, by the Company without penalty or
premium. Within 45 days of the effective date of the Offering, the Company is
obligated to prepay the Comdisco Loan in full. The Comdisco Loan matures
December 31, 2000. The Comdisco Loan Agreement prohibits the Company
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from making or declaring any cash dividends or making any distributions of any
class of capital stock of the Company, except pursuant to an employee repurchase
plan or with the consent of Comdisco. Further, in connection with the Comdisco
Loan, the Company issued to Comdisco warrants to purchase up to 150,000 shares
of the Company's Series E Preferred Stock at a price per share equal to $6.00;
provided, however, that because an initial public offering of the Company's
capital stock was not consummated on or prior to December 31, 1997, the number
of shares of Series E Preferred Stock issuable upon exercise of the warrant
increased to 160,000. Upon the completion of the Offering, such warrant became
exercisable for 114,286 shares of Common Stock. In addition, pursuant to a Stock
Purchase Agreement dated as of August 18, 1997, the Company issued 41,667 shares
of Series E Preferred Stock to Comdisco for an aggregate purchase price of
$250,000. Upon the consummation of the Offering, each outstanding share of
Series E Preferred Stock automatically converted into .7143 shares of Common
Stock.
On August 1, 1997, the Company entered into an agreement (the 'Master Lease
Agreement') with Comdisco pursuant to which Comdisco agreed to purchase and
lease certain equipment to the Company on the terms and conditions contained in
the Master Lease Agreement. In connection with the Master Lease Agreement, the
Company issued to Comdisco a warrant to purchase up to 5,000 shares of the
Company's Series E Preferred Stock at a price per share equal to $6.00. In
November 1997, the Master Lease Agreement was increased and an additional 10,000
warrants were issued for the purchase of Series E Preferred Stock at a price per
share equal to $6.00. Upon the completion of the Offering, such warrants became
exercisable for 10,714 shares of Common Stock.
On August 22, 1997, the Company entered into the Cedar Loan Agreement with
Galtney Corporate Services, Inc. which subsequently assigned to Cedar the loan
in the principal amount of $1,500,000. To secure its obligations under the Cedar
Loan Agreement, the Company granted to Cedar a secured lien on all of the
Company's tangible and intangible personal property. The Cedar Loan and the
liens granted to Cedar ('Cedar Liens') are subordinated in all respects to the
current and future indebtedness of the Company owing to HCFP Funding. The Cedar
Liens rank pari passu with the liens granted to Comdisco. The Cedar Loan bears
interest at 15% per annum. The Cedar Loan may be prepaid, in whole or in part,
at any time, by the Company without penalty or premium. Within 45 days of the
effective date of the Offering of the capital stock of the Company, the Company
is obligated to prepay the Cedar Loan in full. The Cedar Loan matures December
31, 2000. The Cedar Loan Agreement prohibits the Company from making or
declaring any cash dividends or making any distributions of any class of capital
stock of the Company, except pursuant to an employee dividends repurchase plan
or with the consent of Cedar. Pursuant to the terms of the Cedar Loan Agreement,
the outstanding amount of the Cedar Loan is convertible into shares of Preferred
Stock of the Company at the option of Cedar after the Company completes a sale
and issuance of any shares of its Preferred Stock in connection with an equity
financing (an 'Equity Financing') at any time after the earlier to occur of (i)
a payment default under the Cedar Loan Agreement or (ii) the failure of the
Company to consummate an initial public offering of its capital stock prior to
December 31, 1997. Further, in connection with the Cedar Loan, the Company
issued to Cedar a warrant to purchase up to 37,500 shares of the Company's
Series E Preferred Stock at a price per share equal to $6.00; provided, however,
that because an initial public offering of the Company's capital stock was not
consummated on or prior to December 31, 1997, the number of shares of Series E
Preferred Stock issuable upon exercise of the warrant increased to 40,000. Upon
the completion of the Offering, such warrant became exercisable for 28,571
shares of Common Stock.
On September 9, 1997, the Company issued and sold $4,000,000 in aggregate
principal amount of the Convertible Debentures pursuant to the Debenture
Purchase Agreement. The Convertible Debentures were purchased by Dr. Nagpal,
Delphi Ventures, Delphi BioInvestments, Oak Partners, Oak VI and Health Care
Services-BMJ, LLC and H&Q Serv*is Ventures, L.P., affiliates of Hambrecht &
Quist, LLC. Pursuant to the terms of the Debenture Purchase Agreement, the
Convertible Debentures are subordinated in right of payment to all indebtedness
owing by the Company to HCFP Funding, the Comdisco Loan and the Galtney Loan.
The Convertible Debentures bear interest at 6% per annum and are payable
semi-annually. The unpaid principal amount of the Convertible Debentures is due
on August 31, 2000.
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Except in very limited instances, the Company may not prepay the
Convertible Debentures prior to September 9, 1999. The Convertible Debentures
are subject to prepayment at the option of the holders of the Convertible
Debentures upon the consummation of (i) a sale of all or substantially all of
the assets of the Company; (ii) a sale or transfer of all or a majority of the
outstanding Common Stock of the Company in any one transaction or series of
related transactions; or (iii) a merger or consolidation of the Company with or
into another entity. The Convertible Debentures are convertible at any time at
the option of the holders thereof into shares of Common Stock at a conversion
price equal to $10.08 per share. Pursuant to the terms of the Debenture Purchase
Agreement, the holders of the Convertible Debentures have rights of first offer
on future issuances of capital stock of the Company or other securities
convertible into capital stock of the Company. The Debenture Purchase Agreement
places limitations on indebtedness and liens and prohibits the payment of
dividends. The Company expects the Convertible Debentures to be converted in
early 1998.
On October 14, 1997, the Company issued a secured term note in the
principal amount of $2,500,000 to HCFP Funding (the 'October HCFP Note'), which
bears interest at the Fleet Base Rate, subject to increase upon the occurrence
of an event of default, with interest payable on the last business day of each
quarter through December 31, 1998. The entire principal sum is due and payable
on January 1, 1999. Pursuant to the terms of the October HCFP Note, the Company
is also obligated to pay a fee in the amount of $300,000 to HCFP Funding on the
maturity date. The October HCFP Note is secured by a lien on substantially all
of the assets of the Company.
On October 15, 1997, the Company issued promissory notes (the 'October
Notes') in the aggregate principal amount of $3,375,000 to Dr. Nagpal, Delphi
Ventures, Delphi BioInvestments, Oak Partners, Oak IV and Dr. Fox (collectively,
the 'October Note Holders'). The October Notes bear interest at the Fleet Base
Rate, subject to increase upon the occurrence of an event of default. The entire
principal sum is due and payable on January 1, 1999. In connection with the
October Notes, the Company issued warrants to purchase 48,215 shares of Common
Stock to the October Note Holders. The warrants may be exercised at any time, in
whole or in part, at an exercise price of $0.01 per share and expire on October
15, 2002. The warrants contain customary antidilution provisions.
On November 21, 1997, the Company issued warrants to purchase 23,214 shares
of Common Stock to Dr. Nagpal at an exercise price of $0.01 per share.
On January 2, 1998, the Company obtained short-term financing in the form
of a demand note from Dr. Nagpal in the amount of $1.0 million to repay certain
of the Physician Notes. In connection with this loan, the Company issued
warrants to Dr. Nagpal to purchase 14,286 shares of Common Stock at an exercise
price of $0.01 per share. The demand note bears interest at 8% per annum.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-K:
1. Financial Statements:
A list of the Consolidated Financial Statements, related notes and Report
of Independent Certified Public Accountants is set forth in Item 8 of this
report on Form 10-K.
2. Financial Statement Schedules:
All schedules are omitted because they are inapplicable or the requested
information is shown in the Consolidated Financial Statements or related notes.
3. Index to Exhibits:
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<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
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<S> <C> <C>
3.1 -- Amended and Restated Certificate of Incorporation of the Registrant.
3.2 -- By-laws of the Registrant. Incorporated by reference to Exhibit 3.2 to BMJ's Registration Statement
on Form S-1 (File No. 333-35759).
4.1 -- Bone, Muscle and Joint, Inc. 1996 Stock Option Plan. Incorporated by reference to Exhibit 4.1 to
BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.1 -- Stock Purchase Agreement dated as of May 6, 1996 among the Company, Dr. Nagpal, Oak VI, Oak Partners,
Delphi Ventures and Delphi BioInvestments. Incorporated by reference to Exhibit 10.1 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.2 -- Stock Purchase Agreement dated November 12, 1996 among the Company, Dr. Nagpal, Oak VI, Oak Partners,
Delphi Ventures, and Delphi BioInvestments. Incorporated by reference to Exhibit 10.2 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.3 -- Stock Purchase Agreement dated January 29, 1997 among the Company, certain physicians affiliated with
SCOI, Glenn Cozen and the Saphier and Heller Law Corporation Retirement Trust. Incorporated by
reference to Exhibit 10.3 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.4 -- Stock Purchase Agreement dated March 12, 1997, among the Company, Andrea Seratte, CGJR Health Care,
CGJR II and CGJR/MF. Incorporated by reference to Exhibit 10.4 to BMJ's Registration Statement on
Form S-1 (File No. 333-35759).
10.5 -- Stock Purchase Agreement dated June 19, 1997, among the Company, Dr. Nagpal, Oak VI, Oak Partners,
Delphi Ventures, Delphi BioInvestments, CGJR Health Care, CGJR II and CGJR/MF. Incorporated by
reference to Exhibit 10.5 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.6 -- Stock Purchase Agreement dated July 31, 1997, between the Company and HIS Ventures, LLC. Incorporated
by reference to Exhibit 10.6 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.7 -- Stock Purchase Agreement dated August 18, 1997, between the Company and Comdisco. Incorporated by
reference to Exhibit 10.7 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.8 -- Second Term Note dated June 30, 1997, issued by the Company to HCFP Funding. Incorporated by
reference to Exhibit 10.8 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.9 -- Form of Loan and Security Agreement dated March 28, 1997, between the Company and HCFP Funding.
Incorporated by reference to Exhibit 10.9 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.10 -- Subordinated Loan and Security Agreement dated as of August 1, 1997, as amended, between the Company
and Comdisco. Incorporated by reference to Exhibit 10.10 to BMJ's Registration Statement on Form S-1
(File No. 333-35759).
10.11 -- Master Lease Agreement dated August 1, 1997 between Comdisco and the Company. Incorporated by
reference to Exhibit 10.11 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.12 -- Subordinated Loan and Security Agreement dated as of August 22, 1997 between the Company and Galtney.
Incorporated by reference to Exhibit 10.12 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.13 -- Convertible Debenture Purchase Agreement dated as of September 9, 1997 among the Company, Dr. Nagpal,
Delphi Ventures, Delphi BioInvestments, Oak VI, Oak Partners, Health Care Services--BMJ, LLC and HGQ
Serv*is Ventures, L.P. Incorporated by reference to Exhibit 10.13 to BMJ's Registration Statement on
Form S-1 (File No. 333-35759).
</TABLE>
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<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
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<S> <C> <C>
10.14 -- 8% Promissory Note in the aggregate principal amount of $700,000 issued by the Company and payable to
the order of Dr. Nagpal, dated January 10, 1997. Incorporated by reference to Exhibit 10.14 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.15 -- 8% Promissory Note in the aggregate principal amount of $167,000 issued by the Company and payable to
the order of Dr. Nagpal, dated January 10, 1997. Incorporated by reference to Exhibit 10.15 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.16 -- Second Amended and Restated Stockholders Agreement, dated as of November 22, 1996, among the Company,
Dr. Nagpal, Delphi Ventures, Delphi BioInvestments, Oak Partners, Oak VI, Scheer and the stockholders
named therein. Incorporated by reference to Exhibit 10.16 to BMJ's Registration Statement on Form S-1
(File No. 333-35759).
10.17 -- Employment Agreement between the Company and Dr. Nagpal, dated May 6, 1996. Incorporated by reference
to Exhibit 10.17 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.18 -- Amended and Restated Management Services Agreement, effective as of July 1, 1997, among the Company,
LVBMJ and certain physicians affiliated with LVBMJ. Incorporated by reference to Exhibit 10.18 to
BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.19 -- Asset Purchase Agreement, effective as of July 1, 1997, between the Company and OAB. Incorporated by
reference to Exhibit 10.19 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.20 -- Amended and Restated Restricted Stock Agreement, dated as of September 9, 1997, among the Company,
LVBMJ and certain physicians affiliated with LVBMJ. Incorporated by reference to Exhibit 10.20 to
BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.21 -- Management Services Agreement, effective as of November 1, 1996, as amended, between the Company and
STSC. Incorporated by reference to Exhibit 10.21 to BMJ's Registration Statement on Form S-1 (File
No. 333-35759).
10.22 -- Asset Purchase Agreement, dated as of November 1, 1996, between the Company and STSC. Incorporated by
reference to Exhibit 10.22 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.23 -- Restricted Stock Agreement, dated as of December 23, 1996, between the Company, STSC and certain
physicians affiliated with STSC. Incorporated by reference to Exhibit 10.23 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.24 -- Stockholder Non-Competition Agreement, dated as of December 23, 1996, among the Company, STSC and the
STSC physicians. Incorporated by reference to Exhibit 10.24 to BMJ's Registration Statement on Form
S-1 (File No. 333-35759).
10.25 -- Management Services Agreement, effective as of April 1, 1997, as amended, among the Company, Tri-City
and the indemnifying persons identified therein. Incorporated by reference to Exhibit 10.25 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.26 -- Asset Purchase Agreement, dated as of April 1, 1997, between the Company and Tri-City. Incorporated
by reference to Exhibit 10.26 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.27 -- Restricted Stock Agreement, dated as of April 1, 1997, as amended, among the Company, Tri-City and
certain physicians affiliated with Tri-City. Incorporated by reference to Exhibit 10.27 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.28 -- Stockholder Non-Competition Agreement, dated as of April 1, 1997, among the Company, Tri-City and
certain physicians affiliated with Tri-City. Incorporated by reference to Exhibit 10.28 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759). Incorporated by reference to Exhibit
</TABLE>
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<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
10.29 -- to BMJ's Registration Statement on Form S-1 (File No. 333-35759). 10.29 Management Services
Agreement, effective as of November 1, 1996, as amended, between the Company and SCOI. Incorporated
by reference to Exhibit 10.29 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.30 -- Asset Purchase Agreement, effective as of November 1, 1996, between the Company and SCOI.
Incorporated by reference to Exhibit 10.30 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.31 -- Restricted Stock Agreement, effective as of November 1, 1996, as amended, among the Company, SCOI,
certain physicians affiliated with SCOI, Delphi Ventures, Delphi BioInvestments, Oak VI and Oak
Partners. Incorporated by reference to Exhibit 10.31 to BMJ's Registration Statement on Form S-1
(File No. 333-35759).
10.32 -- Stockholder Non-Competition Agreement, effective November 1, 1996, among the Company, SCOI and
certain physicians affiliated with SCOI. Incorporated by reference to Exhibit 10.32 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.33 -- Management Services Agreement, effective April 1, 1997, as amended, among the Company, LOS and
certain physicians affiliated with LOS. Incorporated by reference to Exhibit 10.33 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.34 -- Asset Purchase Agreement, effective as of April 1, 1997, between the Company and LOS. Incorporated by
reference to Exhibit 10.34 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.35 -- Restricted Stock Agreement, dated as of May 6, 1997, as amended, among the Company, LOS and certain
physicians affiliated with LOS. Incorporated by reference to Exhibit 10.35 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.36 -- Stockholder Non-Competition Agreement effective as of April 1, 1997, among the Company, LOS and
certain physicians affiliated with LOS. Incorporated by reference to Exhibit 10.36 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.37 -- Management Services Agreement, effective as of July 1, 1997, as amended, among the Company, Sun
Valley and the indemnifying persons thereto. Incorporated by reference to Exhibit 10.37 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.38 -- Asset Purchase Agreement, effective as of July 1, 1997, between the Company and Sun Valley.
Incorporated by reference to Exhibit 10.38 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.39 -- Restricted Stock Agreement, dated as of July 1, 1997, among the Company, Sun Valley and certain
physicians affiliated with Sun Valley. Incorporated by reference to Exhibit 10.39 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.40 -- Stockholder Non-Competition Agreement, dated as of July 1, 1997, among the Company, Sun Valley and
certain physicians affiliated with Sun Valley. Incorporated by reference to Exhibit 10.40 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.41 -- Management Services Agreement, effective as of June 1, 1997, as amended, among the Company, Gold
Coast and the physicians affiliated with Gold Coast. Incorporated by reference to Exhibit 10.41 to
BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.42 -- Asset Purchase Agreement, effective as of June 1, 1997, as amended, between the Company and Gold
Coast. Incorporated by reference to Exhibit 10.42 to BMJ's Registration Statement on Form S-1 (File
No. 333-35759).
10.43 -- Restricted Stock Agreement, effective June 1, 1997, as amended, among the Company and certain
physicians affiliated with Gold Coast. Incorporated by reference to Exhibit 10.43 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
</TABLE>
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<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
10.44 -- Stockholder Non-Competition Agreement, dated August 8, 1997, among the Company and certain physicians
affiliated with Gold Coast. Incorporated by reference to Exhibit 10.44 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.45 -- Amendatory Agreement dated as of July 3, 1997, between the Company and Gold Coast. Incorporated by
reference to Exhibit 10.45 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.46 -- Note Purchase Agreement dated as of October 15, 1997, among the Company, Dr. Nagpal, Dr. Fox, Delphi
Ventures, Delphi Bio Investments, Oak Partners and Oak VI. Incorporated by reference to Exhibit 10.46
to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.47 -- Management Services Agreement, effective as of September 1, 1997, between the Company and OSA.
Incorporated by reference to Exhibit 10.47 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.48 -- Asset Purchase Agreement, effective as of September 1, 1997, between the Company and OSA.
Incorporated by reference to Exhibit 10.48 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.49 -- Restricted Stock Agreement, dated as of October 16, 1997, among the Company, OSA and certain
physicians affiliated with OSA. Incorporated by reference to Exhibit 10.49 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.50 -- Stockholder Non-Competition Agreement dated as of October 16, 1997, among the Company and certain
physicians affiliated with OSA. Incorporated by reference to Exhibit 10.50 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.51 -- Management Services Agreement, effective as of September 1, 1997, as amended, between the Company and
BIOS. Incorporated by reference to Exhibit 10.51 to BMJ's Registration Statement on Form S-1 (File
No. 333-35759).
10.52 -- Asset Purchase Agreement, effective as of September 1, 1997, between the Company and BIOS.
Incorporated by reference to Exhibit 10.52 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.53 -- Restricted Stock Agreement dated as of October 31, 1997, among the Company, BIOS and certain
physicians affiliated with BIOS. Incorporated by reference to Exhibit 10.53 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.54 -- Stockholder Non-Competition Agreement dated as of October 31, 1997, among the Company and certain
physicians affiliated with BIOS. Incorporated by reference to Exhibit 10.54 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.55 -- Management Services Agreement effective as of September 1, 1997, between the Company and LOAS.
Incorporated by reference to Exhibit 10.55 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.56 -- Asset Purchase Agreements effective as of September 1, 1997, between the Company and certain
affiliates of LOAS. Incorporated by reference to Exhibit 10.56 to BMJ's Registration Statement on
Form S-1 (File No. 333-35759).
10.57 -- Restricted Stock Agreement dated as of October 28, 1997, among the Company, LOAS and certain
physicians affiliated with LOAS. Incorporated by reference to Exhibit 10.57 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.58 -- Form of Amended and Restated Practice Management Services Agreement dated as of September 26, 1997,
among the Company and certain physicians affiliated with Orthopedic Management Network, Inc.
Incorporated by reference to Exhibit 10.58 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
</TABLE>
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EXHIBIT
NUMBER DESCRIPTION
- ------ -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
10.59 -- Restricted Stock Agreement dated as of September 26, 1997, among the Company and certain physicians
affiliated with Orthopedic Management Network, Inc. Incorporated by reference to Exhibit 10.59 to
BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.60 -- Agreement and Plan of Reorganization and Merger dated as of October 6, 1997, among the Company, OMNI
Acquisition Corporation, Orthopedic Management Network, Inc. and the shareholders' representative
named therein. Incorporated by reference to Exhibit 10.60 to BMJ's Registration Statement on Form S-1
(File No. 333-35759).
10.61 -- Tri-Party Agreement dated as of December 31, 1996, between the Company and SCOI. Incorporated by
reference to Exhibit 10.61 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.62 -- Management Services Agreement effective as of September 1, 1997, among the Company, VSI and VSAS.
Incorporated by reference to Exhibit 10.62 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.63 -- Asset Purchase Agreement effective as of October 3, 1997, between the Company and VSI. Incorporated
by reference to Exhibit 10.63 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.64 -- Restricted Stock Agreement dated as of October 3, 1997, among the Company, VSI and certain affiliated
with VSI. Incorporated by reference to Exhibit 10.64 to BMJ's Registration Statement on Form S-1
(File No. 333-35759).
10.65 -- Stockholder Non-Competition Agreement dated as of October 3, 1997, among the Company and certain
physicians affiliated with VSAS. Incorporated by reference to Exhibit 10.65 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
10.66 -- Stock Purchase Agreement dated as of August 3, 1997, among the Company, VSI and the stockholders
listed therein. Incorporated by reference to Exhibit 10.66 to BMJ's Registration Statement on Form
S-1 (File No. 333-35759).
10.67 -- Registration Rights Agreement dated as of August 1, 1997, among the Company, Comdisco and Galtney.
Incorporated by reference to Exhibit 10.67 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.68 -- Registration Rights Agreement dated as of September 9, 1997, among the Company, Health Care
Services-BMJ, LLC and H&Q Serv*is Ventures L.P. Incorporated by reference to Exhibit 10.68 to BMJ's
Registration Statement on Form S-1 (File No. 333-35759).
10.69 -- Registration Rights Agreement dated as of September 15, 1997, between the Company and Healthcare
Financial Partners, Inc. Incorporated by reference to Exhibit 10.69 to BMJ's Registration Statement
on Form S-1 (File No. 333-35759).
10.70 -- Third Amended and Restate Registration Rights Agreement dated as of September 30, 1997, among the
Company, Dr. Nagpal, Delphi Ventures III, L.P., Delphi Bioinvestments III, L.P., Oak Investment
Partners VI, Limited Partnership, Oak VI Affiliated Fund, Limited Partnership, L.P., CGJR Health Care
Services Private Equities, L.P., CGJR II, L.P., CGJR/MF III, L.P. and HIS Ventures, LLC. Incorporated
by reference to Exhibit 10.70 to BMJ's Registration Statement on Form S-1 (File No. 333-35759).
10.71 -- Management Services Agreement effective as of November 1, 1997, between the Company and NJOA.
Incorporated by reference to Exhibit 10.71 to BMJ's Registration Statement on Form S-1 (File No.
333-35759).
10.72 -- Asset Purchase Agreement effective November 1, 1997, between the Company and Orthopedic Associates of
New Jersey, an affiliate of NJOA. Incorporated by reference to Exhibit 10.72 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
</TABLE>
71
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
10.73 -- Restricted Stock Agreement dated as of November 26, 1997, between the Company and certain physicians
affiliated with NJOA. Incorporated by reference to Exhibit 10.73 to BMJ's Registration Statement on
Form S-1 (File No. 333-35759).
10.74 -- Stockholder Non-Competition Agreement dated as of November 26, 1997, among the Company and certain
physicians affiliated with NJOA. Incorporated by reference to Exhibit 10.74 to BMJ's Registration
Statement on Form S-1 (File No. 333-35759).
21 -- List of Subsidiaries. Incorporated by reference to Exhibit 21 to BMJ's Registration Statement on Form
S-1 (File No. 333-3579).
27 -- Financial Data Schedule.
</TABLE>
72
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
BMJ MEDICAL MANAGEMENT, INC.
March 31, 1998 By: /s/ NARESH NAGPAL
-----------------------------------
Naresh Nagpal
President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED ON THE 31ST DAY OF MARCH, 1998, BY THE FOLLOWING PERSONS
ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE TITLE
- ------------------------------------------ -------------------------------------------
<S> <C>
/s/ NARESH NAGPAL, M.D. President, Chief Executive Officer and
- ------------------------------------------ Director (Principal Executive Officer)
Naresh Nagpal, M.D.
/s/ DAVID H. FATER Executive Vice President, Chief
- ------------------------------------------ Financial Officer and Director (Principal
David H. Fater Financial and Accounting Officer)
/s/ GEORGES DAOU Director
- ------------------------------------------
Georges Daou
/s/ STEWART G. EIDELSON, M.D. Director
- ------------------------------------------
Stewart G. Eidelson, M.D.
/s/ ANN H. LAMONT Director
- ------------------------------------------
Ann H. Lamont
/s/ DONALD J. LOTHROP Director
- ------------------------------------------
Donald J. Lothrop
/s/ JAMES M. FOX, M.D. Director
- ------------------------------------------
James M. Fox, M.D.
</TABLE>
73
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF BMJ MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,849,000
<SECURITIES> 0
<RECEIVABLES> 44,287,000
<ALLOWANCES> 21,065,000
<INVENTORY> 0
<CURRENT-ASSETS> 26,949,000
<PP&E> 6,122,000
<DEPRECIATION> 750,000
<TOTAL-ASSETS> 84,153,000
<CURRENT-LIABILITIES> 14,632,000
<BONDS> 0
0
42,000
<COMMON> 9,000
<OTHER-SE> 34,088,000
<TOTAL-LIABILITY-AND-EQUITY> 84,153,000
<SALES> 0
<TOTAL-REVENUES> 36,973,000
<CGS> 0
<TOTAL-COSTS> 65,995,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,551,000
<INCOME-PRETAX> (31,573,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (31,573,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (31,573,000)
<EPS-PRIMARY> (4.97)
<EPS-DILUTED> (4.97)
</TABLE>
