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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO ________________
COMMISSION FILE NO. 1-6639
MAGELLAN HEALTH SERVICES, INC.
(Exact name of Registrant as specified in its charter)
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DELAWARE 58-1076937
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(State or other jurisdiction of (I.R.S. Employer
Identification
incorporation or organization) No.)
3414 PEACHTREE ROAD, N.E.
SUITE 1400
ATLANTA, GEORGIA 30326
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(Address of principal executive
offices) (Zip Code)
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Registrant's telephone number, including area code: (404) 841-9200
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
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NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED
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Common Stock ($0.25 par value) New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at November 30, 1998 was approximately $264 million.
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes / / No / /
The number of shares of the Registrant's Common Stock outstanding as of
November 30, 1998 was 31,612,554.
DOCUMENTS INCORPORATED BY REFERENCE: The Registrant's Definitive Proxy
Materials on Schedule 14A relating to its Annual Meeting of Stockholders on
February 11, 1999 are incorporated by reference into Part III as set forth
herein.
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MAGELLAN HEALTH SERVICES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
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PART I PAGE
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ITEM 1. Business................................................................... 2
ITEM 2. Properties................................................................. 37
ITEM 3. Legal Proceedings.......................................................... 38
ITEM 4. Submission of Matters to a Vote of Security Holders........................ 40
PART II
ITEM 5. Market Price for Registrant's Common Equity and Related Stockholder
Matters.................................................................... 41
ITEM 6. Selected Financial Data.................................................... 41
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................. 43
ITEM 8. Financial Statements and Supplementary Data................................ 57
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................. 57
PART III
ITEM 10. Directors and Executive Officers of the Registrant......................... 58
ITEM 11. Executive Compensation..................................................... 58
ITEM 12. Security Ownership of Certain Beneficial Owners and Management............. 58
ITEM 13. Certain Relationships and Related Transactions............................. 58
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............ 58
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PART I
ITEM 1. BUSINESS
Magellan Health Services, Inc. (the "Company"), which was incorporated in
1969 under the laws of the State of Delaware, is an international healthcare
company. The Company operates through five principal segments engaging in (i)
the behavioral managed healthcare business, (ii) the human services business,
(iii) the specialty managed healthcare business, (iv) the healthcare franchising
business and (v) the healthcare provider business. The Company's executive
offices are located at Suite 1400, 3414 Peachtree Road, N.E., Atlanta, Georgia
30326, and its telephone number at that location is (404) 841-9200.
RECENT DEVELOPMENTS
THE MERIT ACQUISITION. On February 12, 1998, the Company consummated the
acquisition of Merit Behavioral Care Corporation ("Merit") for cash
consideration of approximately $448.9 million plus the repayment of Merit's
debt. Merit manages behavioral healthcare programs across all segments of the
healthcare industry, including health maintenance organizations ("HMO's"), Blue
Cross/Blue Shield organizations and other insurance companies, corporations and
labor unions, federal, state and local governmental agencies and various state
Medicaid programs. On September 12, 1997, Merit completed the acquisition of CMG
Health, Inc. ("CMG"). CMG is a national managed behavioral healthcare company.
Merit paid approximately $48.7 million in cash and issued approximately 739,000
shares of Merit common stock as consideration for CMG. The former owners of CMG
may be entitled to additional consideration, depending on CMG's future
performance. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Outlook--Liquidity and Capital Resources."
HUMAN AFFAIRS INTERNATIONAL, INCORPORATED ACQUISITION. On December 4, 1997,
the Company consummated the purchase of Human Affairs International,
Incorporated ("HAI"), formerly a unit of Aetna/ U.S. Healthcare ("Aetna"), for
approximately $122.1 million, which the Company funded from cash on hand. HAI
manages behavioral healthcare programs primarily through employee assistance
programs ("EAPs") and other behavioral managed healthcare plans. The Company may
be required to make additional contingent payments of up to $60.0 million
annually to Aetna over the five year period subsequent to closing. The amount
and timing of the payments will be contingent upon net increases in the number
of HAI's covered lives in specified products. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Outlook--Liquidity
and Capital Resources."
ALLIED HEALTH GROUP, INC. ACQUISITION. On December 5, 1997, the Company
purchased the assets of Allied Health Group, Inc. and certain of its affiliates
("Allied"). Allied provides specialty managed care products, including
risk-based products and administrative services to a variety of insurance
companies and other customers, including Prudential, CIGNA and NYLCare. Allied
has over 80 physician networks across the eastern United States. Allied's
networks include physicians specializing in cardiology, oncology and diabetes.
The Company paid approximately $70.0 million for Allied, of which $50.0 million
was paid to the seller at closing with the remaining $20.0 million placed in
escrow. The Company may be required to make additional contingent payments to
the former owners of Allied depending on Allied's future performance. On
November 25, 1998, the Company and the former owners of Allied amended the
Allied purchase agreement, which resulted in the repayment of a portion of the
initial escrowed amount to the Company and the reduction of potential future
contingent payments to the former owners of Allied. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--
Outlook--Liquidity and Capital Resources."
GREEN SPRING MINORITY STOCK CONVERSION. The minority stockholders of Green
Spring Health Services, Inc. ("Green Spring") converted their interests in Green
Spring into an aggregate of 2,831,516 shares of Company Common Stock during
January 1998. Such conversion is referred to as the "Green
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Spring Minority Stockholder Conversion." As a result of the Green Spring
Minority Stockholder Conversion, the Company owns 100% of Green Spring.
HUMAN SERVICES ACQUISITIONS. During fiscal 1998, the Company acquired seven
businesses in its human services segment for an aggregate purchase price of
approximately $57.0 million (collectively, the "Human Services Acquisitions").
The Human Services Acquisitions provide various residential and day services for
individuals with acquired brain injuries and for individuals with mental
retardation and developmental disabilities.
CBHS TRANSACTIONS. On March 3, 1998, the Company and certain of its wholly
owned subsidiaries entered into definitive agreements with Crescent Operating,
Inc. ("COI") and Charter Behavioral Health Systems, LLC ("CBHS") pursuant to
which the Company would have, among other things, sold the Company's franchise
operations, certain domestic provider operations and certain other assets and
operations. On August 19, 1998, the Company announced that it had terminated
discussions with COI for the sale of its interest in CBHS. Furthermore, the
Company exercised certain of its limited management rights pursuant to the
Master Franchise Agreement (as defined) and, with CBHS's board support, made
operational and management changes at CBHS. The Company has since restored all
management rights to the CBHS board. See "Cautionary Statements--Subordination
of Franchise Fees." The Company will continue to seek opportunities to divest
its ownership interest in CBHS at a later date.
THE TRANSACTIONS. On February 12, 1998, in connection with the consummation
of the Merit acquisition, the Company consummated certain related transactions
(together with the Merit acquisition, collectively, the "Transactions"), as
follows: (i) the Company terminated its existing credit agreement (the "Magellan
Existing Credit Agreement"); (ii) the Company repaid all loans outstanding
pursuant to and terminated Merit's existing credit agreement (the "Merit
Existing Credit Agreement") (the Magellan Existing Credit Agreement and the
Merit Existing Credit Agreement are hereinafter referred to as the "Existing
Credit Agreements"); (iii) the Company consummated a tender offer for its
11 1/4% Series A Senior Subordinated Notes due 2004 (the "Magellan Outstanding
Notes"); (iv) Merit consummated a tender offer for its 11 1/2% Senior
Subordinated Notes due 2005 (the "Merit Outstanding Notes") (the Magellan
Outstanding Notes and the Merit Outstanding Notes are hereinafter referred to
collectively as the "Outstanding Notes" and such tender offers are hereinafter
referred to collectively as the "Debt Tender Offers"); (v) the Company entered
into a new senior secured bank credit agreement (the "New Credit Agreement"),
providing for a revolving credit facility (the "Revolving Facility") and a term
loan facility (the "Term Loan Facility") which provides for borrowings of up to
$700 million; and (vi) the Company issued the 9% Series A Senior Subordinated
Notes due 2008 (the "Notes") pursuant to an indenture which governs the Notes
("Indenture").
The following table sets forth the sources and uses of funds for the
Transactions (in millions):
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SOURCES:
Cash and cash equivalents......................................... $ 59.3
New Credit Agreement:
Revolving Facility(1)........................................... 20.0
Term Loan Facility.............................................. 550.0
The Notes......................................................... 625.0
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Total sources................................................. $ 1,254.3
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USES:
Direct Cash Merger Consideration.................................. $ 448.9
Repayment of Merit Existing Credit Agreement(2)................... 196.4
Purchase of Magellan Outstanding Notes(3)......................... 432.1
Purchase of Merit Outstanding Notes(4)............................ 121.6
Transaction costs(5).............................................. 55.3
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Total uses.................................................... $ 1,254.3
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(1) The Revolving Facility provides for borrowings of up to $150.0
million. As of September 30, 1998, the Company had approximately $92.5
million available for borrowing pursuant to the Revolving Facility,
excluding approximately $17.5 million of availability reserved for
certain letters of credit.
(2) Includes principal amount of $193.6 million and accrued interest of
$2.7 million.
(3) Includes principal amount of $375.0 million, tender premium of $43.4
million and accrued interest of $13.7 million.
(4) Includes principal amount of $100.0 million, tender premium of $18.9
million and accrued interest of $2.8 million.
(5) Transaction costs include, among other things, costs paid at closing
associated with the Debt Tender Offers, the Notes offering, the Merit
acquisition and the New Credit Agreement.
HISTORY
During the late 1980's and the early to mid 1990's, the healthcare provider
business began a rapid consolidation. The consolidation of the healthcare
provider business was necessitated by the need of hospitals to reduce costs
through economies of scale as a result of pressure on reimbursement rates and
average length of hospital stay by third-party payors. At the time, the Company
had a presence in both the psychiatric hospital industry and the general
hospital industry.
In fiscal 1993, the Company decided to focus solely on the psychiatric
hospital industry and to attempt to acquire additional behavioral healthcare
businesses. Accordingly, the Company sold its general hospitals and related
assets in fiscal 1993 for $338 million with the net proceeds used to reduce
long-term debt. In 1994, the Company acquired 40 psychiatric hospitals
("Acquired Hospitals") for approximately $171 million. The purchase of the
Acquired Hospitals included the refinancing of most of the Company's then
outstanding long-term debt, including the issuance of the Magellan Outstanding
Notes.
The Company has historically derived the majority of its revenue and
earnings from providing healthcare services in an inpatient setting. Payments
from third-party payors are the principal source of revenue for most healthcare
providers. In the early 1990's, many third-party payors sought to control the
cost of providing care to their patients by instituting managed care programs or
seeking the assistance of managed care companies. Providers participating in
managed care programs agree to provide services to patients for a discount from
established rates, which generally results in pricing concessions by the
providers and lower margins. Additionally, managed care programs generally
encourage alternatives to inpatient treatment settings and reduce utilization of
inpatient services. Third-party payors established managed care programs or
engaged managed care companies in many areas of healthcare, including behavioral
healthcare. The Company, which, until June 1997, was the largest operator of
psychiatric hospitals in the United States, was adversely affected by the
adoption of managed care programs as the principal cost control measure of the
third party payors.
Prior to the first quarter of fiscal 1996, the Company was not a provider of
behavioral managed care services. During the first quarter of fiscal 1996, the
Company acquired a 61% ownership interest in Green Spring, a managed care
company specializing in mental health and substance abuse/dependence services.
At that time, the Company intended to become a fully integrated behavioral
healthcare provider by combining the behavioral managed healthcare products
offered by Green Spring with the direct treatment services offered by the
Company's psychiatric hospitals. The Company believed that an entity that
participated in both the managed care and provider segments of the behavioral
healthcare industry could more efficiently provide and manage behavioral
healthcare for insured populations than an entity that was solely a managed care
company. The Company also believed that earnings from its behavorial managed
care business would offset, in part, the negative impact on the financial
performance of its psychiatric hospitals caused by managed care. Green Spring
was the Company's first significant involvement in behavioral managed
healthcare.
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Subsequent to the Company's acquisition of Green Spring, the growth of the
behavioral managed healthcare industry accelerated. Under the Company's majority
ownership, Green Spring increased its base of covered lives from 12.0 million as
of the end of calendar year 1995 to 21.1 million as of the end of calendar 1997,
a compound annual growth rate of over 32%. While growth in the industry was
accelerating, the behavioral managed healthcare industry also began to
consolidate. The Company concluded that this consolidation presented an
opportunity for the Company to increase its participation in the behavioral
managed healthcare industry, which the Company believed offered growth and
earnings prospects superior to those of the psychiatric hospital industry.
Therefore, the Company decided to sell its domestic psychiatric facilities to
obtain capital for expansion in the behavioral managed healthcare business.
The Company took a significant step toward implementing this strategy during
the third quarter of fiscal 1997, when it sold substantially all of its domestic
acute-care psychiatric hospitals and residential treatment facilities
(collectively, the "Psychiatric Hospital Facilities") to Crescent Real Estate
Equities Limited Partnership ("Crescent") for $417.2 million in cash (before
costs of approximately $16.0 million) and certain other consideration.
Simultaneously with the sale of the Psychiatric Hospital Facilities, the Company
and COI, an affiliate of Cresent, formed CBHS to conduct the operations of the
Psychiatric Hospital Facilities and certain other facilities transfered to CBHS
by the Company. The Company retained a 50% ownership of CBHS; the other 50% of
the equity of CBHS is owned by COI.
In related transactions, (i) Crescent leased the Psychiatric Hospital
Facilities to CBHS and (ii) the Company entered into a master franchise
agreement (the "Master Franchise Agreement") with CBHS and a franchise agreement
with each of the Psychiatric Hospital Facilities and other facilities operated
by CBHS (collectively, the "Franchise Agreements"). The Company's sale of the
Psychiatric Hospital Facilities and the related transactions described above are
referred to as the "Crescent Transactions." Pursuant to the Franchise
Agreements, the Company franchises the "CHARTER" System of behavioral healthcare
to each of the Psychiatric Hospital Facilities and the other facilities operated
by CBHS. In exchange, CBHS agreed to pay the Company, pursuant to the Master
Franchise Agreement, annual franchise fees (the "Franchise Fees") of
approximately $78.3 million. However, CBHS's obligation to pay the Franchise
Fees is subordinate to its obligation to pay rent for the Psychiatric Hospital
Facilities to Crescent.
The sale of the Psychiatric Hospital Facilities provided the Company with
approximately $200 million of net cash proceeds, after debt repayment, for use
in implementing its business strategy of expanding its managed care operations.
The Company used the proceeds to finance the acquisitions of HAI and Allied in
December 1997. The Company further implemented its business strategy through the
Merit acquisition. The Company undertook this transformation because it believed
that the behavioral managed healthcare industry offers growth and earnings
prospects superior to those available to the psychiatric hospital industry
because, among other things, third party payors for healthcare services are
continuing to seek to control the cost of providing care to their patients by
instituting managed care programs or seeking the assistance of managed care
companies. Furthermore, government payors are continuing to reduce reimbursement
rates or coverage in an effort to control costs.
INDUSTRY
OVERVIEW
Behavioral healthcare costs have increased significantly in the United
States in recent years. According to industry sources, direct medical costs of
behavioral health problems, combined with the indirect costs, such as lost
productivity due to mental illness and alcohol and drug abuse, were estimated at
more than $300.0 billion in 1990, the latest year for which statistics are
available. In addition, according to industry sources, in 1994 (the most recent
year for which such information was available), direct behavioral healthcare
services treatment costs amounted to approximately $81.0 billion, or
approximately 8% of total healthcare industry spending. These direct costs have
grown, in part, as society has begun to recognize and address behavioral health
concerns and employers have realized that rehabilitation of employees suffering
from substance abuse and relatively mild mental health problems can reduce
losses due to absenteeism and decreased productivity.
In response to these escalating costs, behavioral managed healthcare
companies such as Green Spring, HAI and Merit have been formed. These companies
focus on care management techniques with
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the goal of arranging for the provision of an appropriate level of care in a
cost-efficient and effective manner by improving early access to care and
assuring an effective match between the patient and the behavioral healthcare
provider's specialty. As the growth of behavioral managed healthcare has
increased, there has been a significant decrease in occupancy rates and average
lengths of stay for inpatient psychiatric facilities and an increase in
outpatient treatment and alternative care services.
According to an industry trade publication entitled "Managed Behavioral
Health Market Share in the United States 1997-1998" published by Open Minds,
Gettysburg, Pennsylvania (hereinafter referred to as "OPEN MINDS"), as of
January 1997, approximately 149.0 million beneficiaries were covered by some
form of behavioral managed healthcare plan and an additional 19.5 million
beneficiaries were enrolled in internally-managed behavioral healthcare programs
within HMOs. The number of covered beneficiaries has grown from approximately
86.0 million beneficiaries in 1993 to approximately 149.0 million in 1997,
representing an approximate 15% compound annual growth rate since 1993. In
addition, according to OPEN MINDS, beneficiaries covered under risk-based
programs are growing even more rapidly, from approximately 13.6 million as of
January 1993 to approximately 38.9 million as of January 1997, representing a
compound annual growth rate of over 30%. OPEN MINDS estimates that the revenues
of behavioral managed healthcare companies totaled approximately $3.5 billion in
1996.
OPEN MINDS divides the managed behavioral healthcare industry as of January
1997 into the following categories of care, based on services provided, extent
of care management and level of risk assumption:
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BENEFICIARIES PERCENT
CATEGORY OF CARE (IN MILLIONS) OF TOTAL
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Utilization Review/Care Management Programs.............................................. 39.2 26.3%
Risk-Based Network Products.............................................................. 38.9 26.1
Non-Risk-Based Network Products.......................................................... 31.9 21.4
EAPs..................................................................................... 28.3 19.0
Integrated Programs...................................................................... 10.7 7.2
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Total............................................................................ 149.0 100.0%
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Management believes the current trends in the behavioral healthcare industry
include increased utilization of risk-based network managed care products and
the integration of EAPs with such managed care products. Management believes
that these trends have developed in response to the attempt by payors to reduce
rapidly escalating behavioral healthcare costs and to limit their risk
associated with such costs while continuing to provide access to high quality
care. According to OPEN MINDS, risk-based network products, integrated programs
and EAPs are the most rapidly growing segments of the behavioral managed
healthcare industry.
UTILIZATION REVIEW/CARE MANAGEMENT PRODUCTS. Under utilization review/care
management products, a managed behavioral healthcare company manages and often
arranges for treatment, but does not maintain a network of providers or assume
any of the responsibility for the cost of providing treatment services. The
Company categorizes its products within this segment of the managed behavioral
healthcare industry (as it is defined by OPEN MINDS) as administrative services
only ("ASO") products. The Company does not expect this segment of the industry
to experience significant growth, given the growth of risk-based products.
NON-RISK-BASED NETWORK PRODUCTS. Under non-risk-based network products, the
behavioral managed healthcare company provides a full array of managed care
services, including selecting, credentialing and managing a network of providers
(such as psychiatrists, psychologists, social workers and hospitals), and
performs utilization review, claims administration and care management
functions. The third-party payor remains responsible for the cost of providing
the treatment services rendered. The Company categorizes its products within
this segment of the behavioral managed healthcare industry (as it is defined by
OPEN MINDS) as ASO products.
RISK-BASED NETWORK PRODUCTS. Under risk-based network products, the
behavioral managed healthcare company assumes all or a portion of the
responsibility for the cost of providing a full or specified range of behavioral
healthcare treatment services. Most of these programs have payment
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arrangements in which the managed care company agrees to provide services in
exchange for a fixed fee per member per month that varies depending on the
profile of the beneficiary population or otherwise shares the responsibility for
providing all or some portion of the treatment services at a specific cost per
person. Under these products, the behavioral managed healthcare company not only
approves and monitors a course of treatment, but also arranges and pays for the
provision of patient care (either through its third-party network providers or
staff providers or some combination of network and staff providers). Therefore,
the behavioral managed healthcare company must be proficient in contracting
with, credentialing and managing a network of specialized providers and
facilities that covers the complete continuum of care. The behavioral managed
healthcare company must also ensure that the appropriate level of care is
delivered in the appropriate setting. Given the ability of payors of behavioral
healthcare benefits to reduce their risk with respect to the cost of treatment
services through risk-based network products while continuing to provide access
to high quality care, this market segment has grown rapidly in recent years. In
addition to the expected growth in total beneficiaries covered under behavioral
managed healthcare products, this shift of beneficiaries into risk-based network
products should further contribute to revenue growth for the behavioral managed
healthcare industry because such contracts generate significantly higher revenue
than ASO contracts. The higher revenue is intended to compensate the behavioral
managed healthcare company for bearing the financial responsibility for the cost
of delivering care. The Company's risk-based products are risk-based network
products as defined by OPEN MINDS.
EMPLOYEE ASSISTANCE PROGRAMS. An EAP is a worksite-based program designed
to assist in the early identification and resolution of productivity problems
associated with behavioral conditions or other personal concerns of employees
and their dependants. Under an EAP, staff or network providers or other
affiliated clinicians provide assessment and referral services to employee
beneficiaries and their dependants. These services consist of evaluating a
patient's needs and, if indicated, providing limited counseling and/or
identifying an appropriate provider, treatment facility or other resource for
more intensive treatment services. The EAP industry developed largely out of
employers' efforts to combat alcoholism and substance abuse problems afflicting
workers. A 1990 industry survey estimated the total costs of this dependency at
approximately $98.6 billion per year. Many businesses have implemented
alcoholism and drug abuse treatment programs in the workplace, and in some cases
have expanded those services to cover a wider spectrum of personal problems
experienced by workers and their families. As a result, EAP products now
typically include consultation services, evaluation and referral services,
employee education and outreach services. The Company believes that federal and
state "drug-free workplace" measures and Federal Occupational Health and Safety
Act requirements, taken together with the growing public perception of increased
violence in the workplace, have prompted many companies to implement EAPs.
Although EAPs originated as a support tool to assist managers in dealing with
troubled employees, payors increasingly regard EAPs as an important component in
the continuum of behavioral healthcare services.
INTEGRATED EAP/MANAGED BEHAVIORAL HEALTHCARE PRODUCTS. EAPs are utilized in
a preventive role and in facilitating early intervention and brief treatment of
behavioral healthcare problems before more extensive treatment is required.
Consequently, EAPs often are marketed and sold in tandem with managed behavioral
healthcare programs through "integrated" product offerings. Integrated products
offer employers comprehensive management and treatment of all aspects of
behavioral healthcare. In an effort to both reduce costs and increase
accessibility and ease of treatment, employers are increasingly attempting to
consolidate EAP and behavioral managed healthcare services into a single
product. Although integrated EAP/managed behavioral healthcare products are
currently only a small component of the overall industry, the Company expects
this market segment to grow.
AREAS OF GROWTH
Management believes that the growth of the behavioral managed healthcare
industry will continue, as payors of behavioral healthcare benefits attempt to
reduce the costs of behavioral healthcare while maintaining high quality care.
Management also believes that a number of opportunities exist in the behavioral
managed healthcare industry for continued growth, primarily for risk-based
products. The following paragraphs discuss factors contributing to the growth of
risk-based products and the increase in the number of covered lives in certain
markets.
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RISK-BASED PRODUCTS. According to OPEN MINDS, industry enrollment in
risk-based products has grown from approximately 13.6 million covered lives in
1993 to approximately 38.9 million covered lives in 1997, a compound annual
growth rate of over 30%. Despite this growth, only approximately 26% of total
managed behavioral healthcare covered lives were enrolled in risk-based products
in 1997. The Company believes that the market for risk-based products has grown
and will continue to grow as payors attempt to reduce their responsibility for
the cost of providing behavioral healthcare while ensuring an appropriate level
of access to care. Risk-based products can generate significantly greater
revenue per covered life than other non-risk product types. According to the
OPEN MINDS survey, risk-based products account for approximately two-thirds of
total managed behavioral healthcare industry revenue, but, as stated above,
accounted for only approximately 26% of total covered lives in 1997. During
fiscal 1998, risk-based products accounted for approximately 76% of the
Company's behavorial managed healthcare revenue and represented approximately
30% of covered lives as of September 30, 1998. See "Cautionary
Statements--Risk-Based Products."
MEDICAID. Medicaid is a joint state and federal program to provide
healthcare benefits to approximately 33.0 million low income individuals,
including welfare recipients. According to the Health Care Financing
Administration of the United States Department of Health and Human Services
("HCFA"), federal and state Medicaid spending increased from $69.0 billion in
1990 to an estimated $160.0 billion in 1996, at an average annual rate almost
twice as fast as the annual increase in overall healthcare spending.
Furthermore, according to HCFA, from 1991 to 1996 the number of Medicaid
beneficiaries covered under full managed contracts grew at a compound annual
rate of approximately 40% per year. The Company expects that the Balanced Budget
Act of 1997 (the "Budget Act") will slow the growth of Medicaid spending by
accelerating the trend of state Medicaid programs toward shifting beneficiaries
into managed care programs in order to control rising costs.
Despite the recent increase in managed care enrollment of Medicaid
beneficiaries, Medicaid managed care enrollment as a percentage of all Medicaid
beneficiaries remains small. As of June 1996, according to the National
Institute for Health Care Management, only approximately 35% of all Medicaid
beneficiaries were enrolled in some form of managed care program, and less than
7% were enrolled in risk-based programs. The Company expects the number of
Medicaid recipients enrolled in managed behavioral healthcare programs to
increase through two avenues: (i) subcontracts with HMOs and (ii) direct
contracts with state agencies. As HMOs increase their penetration of the
Medicaid market, the Company expects that many HMOs will continue to (or begin
to) subcontract with behavioral managed healthcare companies to provide services
for Medicaid beneficiaries. State agencies have also begun to contract directly
with behavioral managed healthcare companies to provide behavioral healthcare
services to their Medicaid beneficiaries. Iowa, Massachusetts, Nebraska,
Maryland, Pennsylvania, Tennessee and Montana have decided to "carve out"
behavioral healthcare from their overall Medicaid managed care programs and have
contracted or are expected to contract directly with behavioral managed
healthcare companies to provide such services. The Company expects that the
Budget Act will accelerate the trend of states contracting directly with
behavioral managed healthcare companies. During fiscal 1998, Medicaid programs
accounted for approximately 23% of the Company's behavorial managed healthcare
revenue and represented approximately 6% of covered lives as of September 30,
1998. Substantially all of the Company's Medicaid Contracts are risk-based. See
"Cautionary Statements--Dependence on Government Spending for Managed
Healthcare; Possible Impact of Healthcare Reform" and "--Risk-Based Products"
and "Business--Regulation--Budget Act."
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COMPANY OVERVIEW
GENERAL
According to enrollment data reported in OPEN MINDS, the Company is the
nation's largest provider of behavioral managed healthcare services. As of
September 30, 1998, the Company had approximately 61.6 million covered lives
under behavioral managed healthcare contracts and manages behavioral healthcare
programs for over 3,000 customers. Through its current network of over 35,000
providers and nearly 5,000 treatment facilities, the Company manages behavioral
healthcare programs for HMOs, Blue Cross/Blue Shield organizations and other
insurance companies, corporations, federal, state and local governmental
agencies, labor unions and various state Medicaid programs. The Company believes
it has the largest and most comprehensive behavioral healthcare provider network
in the United States. In addition to the Company's behavioral managed healthcare
segment, the Company offers specialty managed care products related to the
management of certain chronic medical conditions. The Company also offers a
broad continuum of human services to approximately 3,350 individuals who receive
healthcare benefits funded by state and local governmental agencies through
National Mentor, Inc., its wholly-owned human services provider. Furthermore,
the Company franchises the "CHARTER" System of behavioral healthcare to the
Psychiatric Hospital Facilities and other facilities operated by CBHS, an entity
in which the Company owns a 50% equity interest.
The Company's professional care managers coordinate and manage the delivery
of behavioral healthcare treatment services through the Company's network of
providers, which includes psychiatrists, psychologists, licensed clinical social
workers, marriage and family therapists and licensed clinical professional
counselors. The treatment services provided by the Company's behavioral provider
network include outpatient programs (such as counseling and therapy),
intermediate care programs (such as sub-acute emergency care, intensive
outpatient programs and partial hospitalization services), inpatient treatment
services and alternative care services (such as residential treatment, home and
community-based programs and rehabilitative and support services). The Company
provides these services through: (i) risk-based products, (ii) EAPs, (iii) ASO
products and (iv) products that combine features of some or all of these
products. Under risk-based products, the Company arranges for the provision of a
full range of behavioral healthcare services for beneficiaries of its customers'
healthcare benefit plans through fee arrangements under which the Company
assumes all or a portion of the responsibility for the cost of providing such
services in exchange for a fixed per member per month fee. Under EAPs, the
Company provides assessment services to employees and dependents of its
customers, and if required, referral services to the appropriate behavioral
healthcare service provider. Under ASO products, the Company provides services
such as utilization review, claims administration and provider network
management. The Company does not assume the responsibility for the cost of
providing healthcare services pursuant to its ASO products.
The Company conducts operations in five business segments: (i) behavioral
managed healthcare, (ii) human services, (iii) specialty managed healthcare,
(iv) healthcare franchising and (v) healthcare provider. The following describes
the Company's five business segments:
BEHAVIORAL MANAGED CARE. The behavioral managed healthcare segment is the
Company's primary operating segment. The Company's behavioral managed care
subsidiaries include Green Spring, HAI, and Merit. The following is a
description of each of these subsidiaries prior to the Company's integration of
its behavioral managed care businesses:
Green Spring was one of the largest companies in the behavioral managed
healthcare industry and was the largest behavioral managed healthcare provider
to the Blue Cross/Blue Shield networks. Green Spring's client base included Blue
Cross/Blue Shield plans, major HMOs and preferred provider organizations
("PPOs"), state employee programs, Fortune 1000 corporations, labor unions and a
growing number of state Medicaid programs.
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Merit was one of the leading behavioral managed healthcare providers in the
nation. Merit managed behavioral healthcare programs for clients across all
segments of the healthcare industry, particularly in the corporate and HMO
segment. Merit was also a leading provider to Blue Cross/Blue Shield
organizations and other insurance companies, corporations and labor unions,
federal, state and local governmental agencies and various state Medicaid
programs.
HAI was one of the first and was one of the largest providers of EAP
products. HAI had providers in all 50 states and serves many of the nation's
largest companies, including Aetna, Exxon, JP Morgan, MCI, Northwest Airlines
and Sears.
The behavioral managed healthcare operations are now organized around three
customer segments, as follows: (i) the Health Plan Division, focusing on the
needs of health insurance plans and HMO's and their members; (ii) the Workplace
Division, focusing on self-insured employers and labor unions and their
employees and dependants; and (iii) the Public Sector Division, focusing on the
needs of public purchasers of behavioral healthcare services and their
constituents.
HUMAN SERVICES. The Company's human services business provided specialty
home-based behavioral healthcare services through Mentor to approximately 3,350
individuals in 105 programs in 20 states as of September 30, 1998. Mentor was
founded in 1983 and was acquired by the Company in January 1995. Mentor's
services include specialty home-based behavioral healthcare services, which
feature individualized home and community-based health and human services
delivered in highly structured and professionally monitored family environments
or "mentor" homes. The mentor homes serve clients with chronic behavioral
disorders and disabilities requiring long-term care, including children and
adolescents with behavioral problems, individuals with mental retardation or
developmental disabilities, and individuals with neurological impairment or
other medical and behavioral frailties. As a result of the Human Services
Acquisitions, Mentor also provides various residential and day services for
individuals with acquired brain injuries and for individuals with mental
retardation and developmental disabilities.
SPECIALTY MANAGED HEALTHCARE. The Company's specialty managed healthcare
business provides specialty risk-based products and administrative services to a
variety of insurance companies and other customers, including Prudential, CIGNA
and NYLCare. Allied has over 80 physician networks across the eastern United
States. Allied's networks include physicians specializing in cardiology,
oncology and diabetes. The specialty managed healthcare operations focus on the
needs of health plans to manage their specialty care networks and disease
management programs in areas such as diabetes, asthma, oncology and cardiology.
HEALTHCARE FRANCHISING. The Company's wholly-owned subsidiary Charter
Advantage, LLC ("Charter Advantage") franchises the "CHARTER" System of
behavioral healthcare to the Psychiatric Hospital Facilities and other
facilities operated by CBHS. See "Business--Charter Advantage."
HEALTHCARE PROVIDER. The Company's provider operations include the
ownership and operation of two psychiatric hospitals in London, England (a
45-bed hospital and a 78-bed hospital) and a 69-bed psychiatric hospital in
Nyon, Switzerland (collectively, the "European Facilities"). The Company's
provider operations also include its interest in six hospital-based joint
ventures ("Joint Ventures"). The Company's joint venture partner in four of the
Joint Ventures is Columbia/HCA Healthcare Corporation. Although the Company is
the managing member of each Joint Venture, it has delegated its management
responsibilities to CBHS. The Company pays CBHS a fee for managing the Joint
Ventures equal to the Company's share of the earnings of the Joint Ventures. The
Company's provider operations also include a Puerto Rican provider management
business.
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BUSINESS STRATEGY
INCREASE ENROLLMENT IN BEHAVIORAL MANAGED HEALTHCARE PRODUCTS. The Company
believes it has an opportunity to increase covered lives in all its behavioral
managed healthcare products. The Company believes its market presence will
further enhance its ability to increase ASO and EAP covered lives with large
corporate, HMO and insurance customers. The Company further believes that it has
an opportunity to increase revenues, earnings and cash flows from operations by
increasing lives covered by its risk-based products. The Company is the
industry's leading provider of risk-based products, according to data reported
by OPEN MINDS, and believes that it may benefit from the continuing shift to
risk-based products. According to OPEN MINDS, industry enrollment in risk-based
products has grown from approximately 13.6 million in 1993 to approximately 38.9
million in 1997, representing a compound annual growth rate of over 30%. Despite
this growth, only approximately 26% of total behavioral managed healthcare
enrollees were in risk-based products in 1997. The Company believes that the
market for risk-based products has grown and will continue to grow as payors
attempt to reduce their cost of providing behavioral healthcare while ensuring a
high quality of care and an appropriate level of access to care. The Company
believes enrollment in its risk-based products will increase through growth in
new covered lives and through the transition of covered lives in ASO and EAP
products to higher revenue risk-based products. There are certain risks
associated with increased enrollment in risk-based products. See "Cautionary
Statements--Risk-Based Products."
ACHIEVE SIGNIFICANT INTEGRATION EFFICIENCIES. The Company believes that the
HAI and Merit acquisitions have created opportunities for the Company to achieve
significant cost savings. Management believes that cost saving opportunities
will result from leveraging fixed overhead over a larger revenue base and an
increased number of covered lives and from reducing duplicative corporate and
regional selling, general and administrative expenses. As a result, the Company
expects to achieve approximately $60.0 million of costs savings on an annual
basis by September 30, 1999. Such cost savings are measured relative to the
combined operating expenses of Green Spring, HAI and Merit prior to the Merit
acquisition. There can be no assurance that the Company will be able to
integrate its operations according to its plan. See "Cautionary
Statements--Integration of Operations."
PURSUE ADDITIONAL SPECIALTY MANAGED HEALTHCARE OPPORTUNITIES. The Company
believes that significant demand exists for specialty managed healthcare
products related to the management of certain chronic conditions. The Company
believes its large number of covered lives, information systems infrastructure
and experience in managing behavioral healthcare programs position the Company
to provide customers with specialty managed healthcare products. As a first
major step in implementing this strategy, the Company acquired Allied, a
provider of specialty managed care products for cardiology, oncology and
diabetes patients, on December 5, 1997. See "Recent Developments--Allied
Acquisition." The Company's highly leveraged financial position may prevent it
from acquiring additional specialty managed healthcare providers. See
"Cautionary Statements--Substantial Leverage and Debt Service Obligations."
EXPANSION OF HUMAN SERVICES GEOGRAPHIC COVERAGE AND PRODUCT MIX. The human
services industry is a very fragmented, $100 billion industry that continues to
be consolidated by a few competitors. The Company believes it has an opportunity
to increase its geographic coverage and leverage its human services product
offerings on a nationwide basis. The Human Services Acquisitions diversified the
product mix and increased the geographic market penetration of the human
services segment. Mentor plans to launch national brain injury rehabilitation
product lines and expand its product offerings in California as a result of the
Human Services Acquisitions.
EXIT FROM THE HEALTHCARE FRANCHISING AND HEALTHCARE PROVIDER
OPERATIONS. The Company will continue its efforts to sell its three European
hospitals, its 50% interest in CBHS, Charter Advantage and other provider
operations in an effort to reduce the Company's long-term debt and improve
liquidity. The
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Company is currently involved in negotiations to sell some or all of the
previously mentioned businesses. There can be no assurance that the Company will
be able to sell any of these businesses.
BEHAVIORAL MANAGED HEALTHCARE PRODUCTS AND SERVICES
GENERAL. The following table sets forth the approximate number of covered
lives as of September 30, 1998 and revenue for fiscal 1998 for the types of
behavioral managed healthcare programs offered by the Company:
<TABLE>
<CAPTION>
PROGRAMS COVERED LIVES PERCENT REVENUE PERCENT
- ----------------------------------------------------------------- ----------------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
(IN MILLIONS, EXCEPT PERCENTAGES)
Risk-Based Products.............................................. 18.6 30.2% $ 786.1 75.7%
EAP, ASO and other products...................................... 43.0 69.8 252.9 24.3
--- ----- ---------- -----
Total........................................................ 61.6 100.0% $ 1,039.0 100.0%
--- ----- ---------- -----
--- ----- ---------- -----
</TABLE>
The number of the Company's covered lives fluctuates based on the number of the
Company's customer contracts and as employee, HMO and insurance company
subscriber and government program enrollee populations change from time to time.
On a pro forma basis including HAI and Merit, the number of lives covered by the
Company's managed healthcare products at September 30, 1996 and 1997 would have
been 45.7 million and 51.7 million, respectively.
RISK-BASED PRODUCTS. Under the Company's risk-based products, the Company
typically arranges for the provision of a full range of outpatient, intermediate
and inpatient treatment services to beneficiaries of its customers' healthcare
benefit plans, primarily through arrangements in which the Company assumes all
or a portion of the responsibility for the cost of providing such services in
exchange for a per member per month fee. The Company's experience with
risk-based contracts (including the experience of Green Spring, HAI and Merit)
covering a large number of lives has given it a broad base of data from which to
analyze utilization rates. The Company believes that this broad database permits
it to estimate utilization trends and costs more accurately than many of its
competitors, which allows it to bid effectively. The Company believes that its
experience has also allowed it to develop effective measures for controlling the
cost of providing a unit of care to its covered lives. Among other cost control
measures, the Company has developed or acquired clinical protocols, which permit
the Company to assist its network providers to administer effective treatment in
a cost efficient manner, and claims management technology, which permits the
Company to reduce the cost of processing claims. The Company's care managers are
an essential element in its provision of cost-effective care. Except in
emergencies, treatment is required to be authorized by a Company care manager.
Care managers, in consultation with treating professionals, and using the
Company's clinical protocols, authorize an appropriate level and intensity of
services that can be delivered in a cost-efficient manner.
EMPLOYEE ASSISTANCE PROGRAMS. The Company's EAP products typically provide
assessment and referral services to employees and dependents of the Company's
customers in an effort to assist in the early identification and resolution of
productivity problems associated with the employees who are impaired by
behavioral conditions or other personal concerns. For many EAP customers, the
Company also provides limited outpatient therapy (typically limited to eight or
fewer sessions) to patients requiring such services. For these services, the
Company typically is paid a fixed fee per member per month; however, the Company
is usually not responsible for the cost of providing care beyond these services.
If further services are necessary beyond limited outpatient therapy, the Company
will refer the beneficiary to an appropriate provider or treatment facility.
INTEGRATED PRODUCTS. Under its integrated products, the Company typically
establishes an EAP to function as the "front end" of a managed care program that
provides a full range of services, including more intensive treatment services
not covered by the EAP. The Company typically manages the EAP and accepts all or
some of the responsibility for the cost of any additional treatment required
upon referral out
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<PAGE>
of the EAP, thus integrating the two products and using both the Company's care
management and clinical care techniques to manage the provision of care.
ASO PRODUCTS. Under its ASO products, the Company provides services ranging
from utilization review and claims administration to the arrangement for and
management of a full range of patient treatment services, but does not assume
any of the responsibility for the cost of providing treatment services. Services
include member assistance, management reporting and claims processing in
addition to utilization review and care management.
BEHAVIORAL MANAGED HEALTHCARE CUSTOMERS
GENERAL. The following table sets forth the approximate number of covered
lives as of September 30, 1998 and revenue for fiscal 1998 in each of the
Company's market segments described below:
<TABLE>
<CAPTION>
MARKET COVERED LIVES PERCENT REVENUE PERCENT
- ----------------------------------------------------------------- ----------------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
(IN MILLIONS, EXCEPT PERCENTAGES)
Workplace (Corporations and Labor Unions)........................ 19.7 32.0% $ 141.6 13.6%
Health Plans..................................................... 31.0 50.3 633.4 61.0
Public Sector.................................................... 7.8 12.7 240.3 23.1
Other............................................................ 3.1 5.0 23.7 2.3
--- ----- ---------- -----
Total........................................................ 61.6 100.0% $ 1,039.0 100.0%
--- ----- ---------- -----
--- ----- ---------- -----
</TABLE>
CORPORATIONS AND LABOR UNIONS. Corporations and, to a lesser extent, labor
unions, account for a large number of the Company's contracts to provide
behavioral managed healthcare services and, in particular, EAP and integrated
EAP/managed care services. The Company has structured a variety of fee
arrangements with corporate customers to cover all or a portion of the
responsibility of the cost of providing treatment services. In addition, the
Company operates a number of programs for corporate customers on an ASO basis.
Management believes the corporate market is an area of potential growth for the
Company, as corporations are anticipated to increase their utilization of
behavioral managed healthcare services. In an effort to increase penetration of
the corporate market, the Company intends to build upon Merit's experience in
managing programs for large corporate customers (such as IBM, Federal Express
and AT&T) and to market integrated programs to Merit's existing EAP customers
and other prospective corporate clients.
HEALTH PLANS. The Company is a leader in the HMO market, providing
behavioral managed healthcare services to HMO beneficiaries. HMO contracts are
full, limited or shared risk contracts in which the Company generally accepts a
fixed fee per member per month from the HMO in exchange for providing a full or
specified range of behavioral healthcare services for a specific portion of the
HMO's beneficiaries. Although certain large HMOs provide their own behavioral
managed healthcare services, many HMOs "carve out" behavioral healthcare from
their general healthcare services and subcontract such services to behavioral
managed healthcare companies such as the Company. The Company anticipates that
its business with HMOs will continue to grow. The Company is also the nation's
leading provider of behavioral managed healthcare services to Blue Cross/Blue
Shield organizations, serving 28 Blue Cross/Blue Shield organizations as of
September 30, 1998.
HAI has contracts with its former owner, Aetna, pursuant to which HAI
provides behavioral managed healthcare products to Aetna, including focused
psychiatric review (a type of utilization review product), risk-based HMO
products, administrative services for Aetna's "Managed Choice" product and
provider network management services.
PUBLIC SECTOR. The Company provides behavioral managed healthcare services
to Medicaid recipients through both direct contracts with state and local
governmental agencies and through subcontracts with HMOs focused on Medicaid
beneficiary populations. In addition to the Medicaid population,
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other public entitlement programs, such as Medicare and state insurance programs
for the uninsured, offer the Company areas of potential future growth. The
Company expects that governmental agencies will continue to implement a
significant number of managed care Medicaid programs through contracts with HMOs
and that many HMOs will subcontract with behavioral managed healthcare
organizations, such as the Company, for behavioral healthcare services. The
Company also expects that other states will continue the trend of "carving-out"
behavioral healthcare services from their general healthcare benefit plans and
contracting directly with behavioral managed healthcare companies such as the
Company. See "Industry--Areas of Growth," "Cautionary Statements--Dependence on
Government Spending for Managed Healthcare; Possible Impact of Healthcare
Reform" and "--Regulation--Other Proposed Legislation." The Company also
provides EAPs and other managed care products for employees and their dependents
who are beneficiaries of federal, state and local governmental agencies'
healthcare benefit plans. Governmental agencies' healthcare benefit plans have
historically contracted for managed behavioral healthcare services as part of
their general healthcare contracts with HMOs or indemnity insurers. In turn,
HMOs or indemnity insurers have either provided managed behavioral healthcare
services directly or subcontracted such services to managed behavioral
healthcare companies such as the Company. The Company currently provides
services to a number of government employees either directly pursuant to a
contract with the government agency or as a subcontractor to HMOs. More
recently, governmental agencies have begun to contract directly with managed
behavioral healthcare companies to provide these services. In addition, the
Company currently manages contracts for CHAMPUS beneficiaries and is actively
pursuing new contracts and subcontracts under the CHAMPUS program. In this
market, the Company often bids for such contracts together with HMOs to provide
the behavioral healthcare services portion of the overall CHAMPUS healthcare
contract.
BEHAVIORAL MANAGED HEALTHCARE CONTRACTS
The Company's contracts with customers typically have terms of one to three
years, and in certain cases contain renewal provisions (at the customer's
option) for successive terms of between one and two years (unless terminated
earlier). Substantially all of these contracts are immediately terminable with
cause and many are terminable without cause by the customer or the Company
either upon the giving of requisite notice and the passage of a specified period
of time (typically between 60 and 180 days) or upon the occurrence of other
specified events. In addition, the Company's contracts with federal, state and
local governmental agencies, under both direct contract and subcontract
arrangements with HMOs, generally are conditioned on legislative appropriations.
These contracts, notwithstanding terms to the contrary, generally can be
terminated or modified by the customer if such appropriations are not made. See
"Cautionary Statements--Risk Based Programs" and "--Reliance on Customer
Contracts."
The specific terms of the Company's contracts are determined by whether the
contracts are for risk-based, EAP, integrated or ASO products. Risk-based and
EAP contracts provide for payment of a fixed per member per month fee to the
Company. The customer remits this fee to the Company monthly. With respect to
ASO products, the Company is generally paid on a per member per month basis. The
Company bills its customer for such services on a monthly basis. The Company's
billing arrangements for integrated products vary on a case by case basis.
BEHAVIORAL MANAGED HEALTHCARE NETWORK
The Company's behavioral managed healthcare and EAP treatment services are
provided by a network of third-party providers. The number and type of providers
in a particular area depend upon customer preference, site, geographic
concentration and demographic make-up of the beneficiary population in that
area. Network providers include a variety of specialized behavioral healthcare
personnel, such as psychiatrists, psychologists, licensed clinical social
workers, substance abuse counselors and other professionals.
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<PAGE>
As of September 30, 1998, the Company had contractual arrangements covering
over 35,000 individual third-party network providers. The Company's network
providers are independent contractors located throughout the local areas in
which the Company's customer's beneficiary population resides. Network providers
work out of their own offices, although the Company's personnel are available to
assist them with consultation and other needs. Network providers include both
individual practitioners, as well as individuals who are members of group
practices or other licensed centers or programs. Network providers typically
execute standard contracts with the Company for which they are typically paid by
the Company on a fee-for-service basis. In some cases, network providers are
paid on a "case rate" basis, whereby the provider is paid a set rate for an
entire course of treatment, or through other risk sharing arrangements. A
network provider's contract with the Company typically has a one-year term, with
automatic renewal at the Company's option for successive one-year terms, and
generally may be terminated without cause by the Company or the provider upon 30
to 90 days notice.
As of September 30, 1998, the Company's behavorial managed healthcare
network included contractual arrangements with approximately 5,000 third-party
treatment facilities, including inpatient psychiatric and substance abuse
hospitals, intensive outpatient facilities, partial hospitalization facilities,
community health centers and other community-based facilities, rehabilitative
and support facilities, and other intermediate care and alternative care
facilities or programs. This variety of facilities enables the Company to offer
patients a full continuum of care and to refer patients to the most appropriate
facility or program within that continuum. Typically, the Company contracts with
facilities on a per diem or fee-for-service basis and, in some cases, on a "case
rate" or capitated basis. The contracts between the Company and inpatient and
other facilities typically are for one year terms and, in some cases, are
automatically renewable at the Company's option. Facility contracts are usually
terminable by the Company or the facility owner upon 30 to 120 days notice. The
Psychiatric Hospital Facilities and other facilities operated by CBHS are
members of the Company's hospital provider network on the same terms as are
generally applicable to unaffiliated third-party treatment facilities.
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<PAGE>
COMPETITION
Each segment of the Company's business is highly competitive. With respect
to its managed care businesses, the Company competes with large insurance
companies, HMOs, PPOs, third-party administrators ("TPAs"), independent
practitioner associations ("IPAs"), multi-disciplinary medical groups and other
managed care companies. Many of the Company's competitors are significantly
larger and have greater financial, marketing and other resources than the
Company, and some of the Company's competitors provide a broader range of
services. The Company may also encounter substantial competition in the future
from new market entrants. Many of the Company's customers that are managed care
companies may, in the future, seek to provide behavioral managed healthcare and
EAP services to their employees or subscribers directly, rather than by
contracting with the Company for such services. Because of competition, the
Company does not expect to be able to rely on price increases to achieve revenue
growth and expects to continue experiencing pressure on direct operating
margins. See "Cautionary Statements--Highly Competitive Industry."
The Company's human services operations compete with various for profit and
not-for-profit entities, including, but not limited to: (i) behavioral managed
healthcare companies that have started managing human services for governmental
agencies; (ii) home health care organizations; (iii) proprietary nursing home
companies; and (iv) proprietary human services companies. The Company believes
that the most significant factors in a customer's selection of services include
price, quality of services and outcomes. The pricing aspect of such services is
especially important to attract public sector agencies looking to outsource
public services to the private sector as demand for quality services escalates
while budgeted dollars for healthcare services are reduced. The Company's
management believes that it competes effectively with respect to these factors.
The Company believes it benefits from the competitive strengths described
below:
INDUSTRY LEADERSHIP. The Company is the largest provider of behavioral
managed healthcare services in the United States, according to enrollment data
reported in OPEN MINDS. The Company believes, based on data reported in OPEN
MINDS, that it also now has the number one market position in each of the major
product markets in which it competes. The Company believes its position will
enhance its ability to: (i) provide a consistent level of high quality service
on a nationwide basis; (ii) enter into agreements with behavioral healthcare
providers that allow it to control healthcare costs for its customers; and (iii)
market its behavioral managed care products to large corporate, HMO and
insurance customers, which, the Company believes, increasingly prefer to be
serviced by a single-source provider on a national basis. See "Cautionary
Statements--Highly Competitive Industry" and "--Reliance on Customer Contracts"
for a discussion of the risks associated with the highly competitive nature of
the behavioral managed healthcare industry and the Company's reliance on
contracts with payors of behavioral healthcare benefits, respectively.
BROAD PRODUCT OFFERING AND NATIONWIDE PROVIDER NETWORK. The Company offers
behavioral managed care products that can be designed to meet specific customer
needs, including risk-based and partial risk-based products, integrated EAPs,
stand-alone EAPs and ASO products. The Company's provider network encompasses
over 35,000 providers and nearly 5,000 treatment facilities in all 50 states.
The Company believes that the combination of its product offerings and its
provider network allows the Company to meet its customers needs for behavioral
managed healthcare on a nationwide basis, and positions the Company to capture
incremental revenue opportunities resulting from the continued growth of the
behavioral managed healthcare industry and the continued migration of its
customers from ASO and EAP products to higher revenue risk-based products. See
"Cautionary Statements--Risk-Based Products" for a discussion of the risks
associated with risk-based products, which are the Company's primary source of
revenue.
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BROAD BASE OF CUSTOMER RELATIONSHIPS. The Company believes that the breadth
of its customer relationships are attributable to the Company's broad product
offerings, nationwide provider network, commitment to quality care and ability
to manage behavioral healthcare costs effectively. The Company's customers
include: (i) Blue Cross/Blue Shield organizations; (ii) national HMOs and other
large insurers, such as Aetna/US Healthcare, Humana and Prudential; (iii) large
corporations, such as IBM, Federal Express and AT&T; (iv) state and local
governmental agencies through commercial, Medicaid and other programs; and (v)
the federal government through contracts pursuant to the Civilian Health and
Medical Program of the Uniformed Services ("CHAMPUS") and with the U.S. Postal
Service. This broad base of customer relationships provides the Company with
stable and diverse sources of revenue, earnings and cash flows and an
established base from which to continue to increase covered lives and revenue.
See "Cautionary Statements--Reliance on Customer Contracts" for a discussion of
the risks associated with the Company's reliance on certain contracts with
payors of behavioral healthcare benefits.
PROVEN RISK MANAGEMENT EXPERIENCE. The Company had approximately 18.6
million covered lives under risk-based contracts at September 30, 1998, making
it the nation's industry leader in at-risk behavioral managed healthcare
products, based on data reported in OPEN MINDS. The Company's experience with
risk-based products covering a large number of lives has given it a broad base
of data from which to analyze utilization rates. The Company believes that this
broad database permits it to estimate utilization trends and costs more
accurately than many of its competitors, which allows it to bid effectively. The
Company believes that its experience has also allowed it to develop effective
measures for controlling the cost of providing a unit of care to its covered
lives. Among other cost control measures, the Company has developed or acquired
clinical protocols, which permit the Company to assist its network providers to
administer effective treatment in a cost efficient manner, and claims management
technology, which permits the Company to reduce the cost of processing claims.
As the Company continues to integrate HAI and Merit into its behavioral managed
healthcare operations, it will be able to select from the best practices of its
subsidiaries to further enhance its utilization and cost control methodologies.
See "Cautionary Statements--Integration of Operations" for a discussion of the
risks associated with integrating the Company's recently acquired businesses,
including the managed care operations it acquired in fiscal 1998, with its
existing operations.
The competitive environment affecting the Company's healthcare franchising
and healthcare provider operations are discussed elsewhere. See "Charter
Advantage--Competition."
INSURANCE
The Company maintains a general and professional liability insurance policy
with an unaffiliated insurer. The policy is written on an "occurrence" basis,
subject to a $250,000 deductible per occurrence and an aggregate deductible of
$1.0 million for a three-year policy period ending June 2001.
REGULATION
GENERAL. The behavioral managed healthcare industry and the provision of
behavioral healthcare services are subject to extensive and evolving state and
federal regulation. The Company is subject to certain state laws and
regulations, including those governing: (i) the licensing of insurance
companies, HMOs, PPOs, TPAs and companies engaged in utilization review and (ii)
the licensing of healthcare professionals, including restrictions on business
corporations from practicing, controlling or exercising excessive influence over
behavioral healthcare services through the direct employment of psychiatrists
or, in a few states, psychologists and other behavioral healthcare
professionals. These laws and regulations vary considerably among states and the
Company may be subject to different types of laws and regulations depending on
the specific regulatory approach adopted by each state to regulate the managed
care business and the provision of behavioral healthcare treatment services. In
addition, the Company is subject to certain federal laws as a result of the role
the Company assumes in connection
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with managing its customers' employee benefit plans. The regulatory scheme
generally applicable to the Company's managed care operations is described in
this section. The Company's managed care operations are also indirectly affected
by regulations applicable to the operations of behavioral healthcare clinics and
facilities. See "Charter Advantage--Regulation."
The Company believes its operations are structured to comply with applicable
laws and regulations in all material respects and that it has received, or is in
the process of applying for, all licenses and approvals that are material to the
operation of its business. However, regulation of the managed healthcare
industry is evolving, with new legislative enactments and regulatory initiatives
at the state and federal levels being implemented on a regular basis.
Consequently, it is possible that a court or regulatory agency may take a
position under existing or future laws or regulations, or as a result of a
change in the interpretation thereof, that such laws or regulations apply to the
Company in a different manner than the Company believes such laws or regulations
apply. Moreover, any such position may require significant alterations to the
Company's business operations in order to comply with such laws or regulations,
or interpretations thereof. Expansion of the Company's business to cover
additional geographic areas, to serve different types of customers, to provide
new services or to commence new operations could also subject the Company to
additional licensure requirements and/or regulation.
LICENSURE. Certain regulatory agencies having jurisdiction over the Company
possess discretionary powers when issuing or renewing licenses or granting
approval of proposed actions such as mergers, a change in ownership, transfer or
assignment of licenses and certain intracorporate transactions. One or multiple
agencies may require as a condition of such licensure or approval that the
Company cease or modify certain of its operations in order to comply with
applicable regulatory requirements or policies. In addition, the time necessary
to obtain licensure or approval varies from state to state, and difficulties in
obtaining a necessary license or approval may result in delays in the Company's
plans to expand operations in a particular state and, in some cases, lost
business opportunities. Compliance activities, mandated changes in the Company's
operations, delays in the expansion of the Company's business or lost business
opportunities as a result of regulatory requirements or policies could have a
material adverse effect on the Company.
INSURANCE, HMO AND PPO ACTIVITIES. To the extent that the Company operates
or is deemed to operate in one or more states as an insurance company, HMO, PPO
or similar entity, it may be required to comply with certain laws and
regulations that, among other things, may require the Company to maintain
certain types of assets and minimum levels of deposits, capital, surplus,
reserves or net worth. In many states, entities that assume risk under contracts
with licensed insurance companies or HMOs have not been considered by state
regulators to be conducting an insurance or HMO business. As a result, the
Company has not sought licensure as either an insurer or HMO in certain states.
The National Association of Insurance Commissioners (the "NAIC") has undertaken
a comprehensive review of the regulatory status of entities arranging for the
provision of healthcare services through a network of providers that, like the
Company, may assume risk for the cost and quality of healthcare services, but
that are not currently licensed as an HMO or similar entity. As a result of this
review, the NAIC developed a "health organizations risk-based capital" formula,
designed specifically for managed care organizations, that establishes a minimum
amount of capital necessary for a managed care organization to support its
overall operations, allowing consideration for the organization's size and risk
profile. The NAIC initiative also may result in the adoption of a model NAIC
regulation in the area of health plan standards, which could be adopted by
individual states in whole or in part, and could result in the Company being
required to meet additional or new standards in connection with its existing
operations. Individual states have also recently adopted their own regulatory
initiatives that subject entities such as the Company to regulation under state
insurance laws. This includes, but is not limited to, requiring licensure as an
insurance company or HMO and requiring adherence to specific financial solvency
standards. State insurance laws and regulations may limit the ability of the
Company to pay dividends, make certain investments and repay certain
indebtedness. Licensure as an insurance company, HMO or
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similar entity could also subject the Company to regulations governing reporting
and disclosure, mandated benefits, and other traditional insurance regulatory
requirements. PPO regulations to which the Company may be subject may require
the Company to register with a state authority and provide information
concerning its operations, particularly relating to provider and payor
contracting. Based on the information presently available to it, the Company
does not believe that the imposition of requirements related to maintaining
certain types of assets, prescribed levels of deposits, capital, surplus,
reserves or net worth, or complying with other regulatory requirements
applicable to its insurance company, HMO, PPO or similar operations, would have
a material adverse effect on the Company. Notwithstanding the foregoing, the
imposition of such requirements could increase the Company's cost of doing
business and could delay the Company's conduct or expansion of its business in
some areas. The licensure process under state insurance laws can be lengthy and,
unless the applicable state regulatory agency allows the Company to continue to
operate while the licensure process is ongoing, the Company could experience a
material adverse effect on its operating results and financial condition while
its licensure application is pending. In addition, failure by the Company to
obtain and maintain required licenses typically also constitutes an event of
default under the Company's contracts with its customers. The loss of business
from one or more of the Company's major customers as a result of such an event
of default or otherwise could have a material adverse effect on the Company.
UTILIZATION REVIEW AND THIRD-PARTY ADMINISTRATOR ACTIVITIES. Numerous
states in which the Company does business have adopted, or are expected to
adopt, regulations governing entities engaging in utilization review and TPA
activities. Utilization review regulations typically impose requirements with
respect to the qualifications of personnel reviewing proposed treatment,
timeliness and notice of the review of proposed treatment, and other matters.
TPA regulations typically impose requirements regarding claims processing and
payments and the handling of customer funds. Utilization review and TPA
regulations may increase the Company's cost of doing business in the event that
compliance requires the Company to retain additional personnel to meet the
regulatory requirements and to take other required actions and make necessary
filings. Although compliance with utilization review regulations has not had a
material adverse effect on the Company, there can be no assurance that specific
regulations adopted in the future would not have such a result, particularly
since the nature, scope and specific requirements of such provisions vary
considerably among states that have adopted regulations of this type.
There is a trend among states to require licensure or certification of
entities performing utilization review or TPA activities; however, certain
federal courts have held that such licensure requirements are preempted by
ERISA. ERISA preempts state laws that mandate employee benefit structures or
their administration, as well as those that provide alternative enforcement
mechanisms. The Company believes that its TPA activities performed for its
self-insured employee benefit plan customers are exempt from otherwise
applicable state licensing or registration requirements based upon federal
preemption under ERISA and has relied on this general principle in determining
not to seek licensure for certain of its activities in many states. Existing
case law is not uniform on the applicability of ERISA preemption with respect to
state regulation of utilization review or TPA activities. There can be no
assurance that additional licensure will not be required with respect to
utilization review or TPA activities in certain states.
"ANY WILLING PROVIDER" LAWS. Several states in which the Company does
business have adopted, or are expected to adopt, "any willing provider" laws.
Such laws typically impose upon insurance companies, PPOs, HMOs or other types
of third-party payors an obligation to contract with, or pay for the services
of, any healthcare provider willing to meet the terms of the payor's contracts
with similar providers. Compliance with any willing provider laws could increase
the Company's costs of assembling and administering provider networks and could,
therefore, have a material adverse effect on its operations.
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LICENSING OF HEALTHCARE PROFESSIONALS. The provision of behavioral
healthcare treatment services by psychiatrists, psychologists and other
providers is subject to state regulation with respect to the licensing of
healthcare professionals. The Company believes that the healthcare professionals
who provide behavioral healthcare treatment on behalf of or under contracts with
the Company are in compliance with the applicable state licensing requirements
and current interpretations thereof; however, there can be no assurance that
changes in such state licensing requirements or interpretations thereof will not
adversely affect the Company's existing operations or limit expansion. With
respect to the Company's crisis intervention program, additional licensure of
clinicians who provide telephonic assessment or stabilization services to
individuals who are calling from out-of-state may be required if such assessment
or stabilization services are deemed by regulatory agencies to be treatment
provided in the state of such individual's residence. The Company believes that
any such additional licensure could be obtained; however, there can be no
assurance that such licensing requirements will not adversely affect the
Company's existing operations or limit expansion.
PROHIBITION ON FEE SPLITTING AND CORPORATE PRACTICE OF PROFESSIONS. The
laws of some states limit the ability of a business corporation to directly
provide, control or exercise excessive influence over behavioral healthcare
services through the direct employment of psychiatrists, psychologists, or other
behavioral healthcare professionals. In addition, the laws of some states
prohibit psychiatrists, psychologists, or other healthcare professionals from
splitting fees with other persons or entities. These laws and their
interpretations vary from state to state and enforcement by the courts and
regulatory authorities may vary from state to state and may change over time.
The Company believes that its operations as currently conducted are in material
compliance with the applicable laws, however, there can be no assurance that the
Company's existing operations and its contractual arrangements with
psychiatrists, psychologists and other healthcare professionals will not be
successfully challenged under state laws prohibiting fee splitting or the
practice of a profession by an unlicensed entity, or that the enforceability of
such contractual arrangements will not be limited. The Company believes that it
could, if necessary, restructure its operations to comply with changes in the
interpretation or enforcement of such laws and regulations, and that such
restructuring would not have a material adverse effect on its operations.
DIRECT CONTRACTING WITH LICENSED INSURERS. Regulators in several states in
which the Company does business have adopted policies that require HMOs or, in
some instances, insurance companies, to contract directly with licensed
healthcare providers, entities or provider groups, such as IPAs, for the
provision of treatment services, rather than with unlicensed intermediary
companies. In such states, the Company's customary model of contracting directly
with its customers may need to be modified so that, for example, the IPAs
(rather than the Company) contract directly with the HMO or insurance company,
as appropriate, for the provision of treatment services. The Company intends to
work with a number of these HMO customers to restructure existing contractual
arrangements, upon contract renewal or in renegotiations, so that the entity
which contracts with the HMO directly is an IPA. The Company does not expect
this method of contracting to have a material adverse effect on its operations.
OTHER REGULATION OF HEALTHCARE PROVIDERS. The Company's business is
affected indirectly by regulations imposed upon healthcare providers.
Regulations imposed upon healthcare providers include provisions relating to the
conduct of, and ethical considerations involved in, the practice of psychiatry,
psychology, social work and related behavioral healthcare professions and, in
certain cases, the common law duty to warn others of danger or to prevent
patient self-injury. Confidentiality and patient privacy requirements are
particularly strict in the field of behavioral healthcare services, and
additional legislative initiatives relating to confidentiality are expected. The
Health Insurance Portability and Accountability Act of 1996 ("HIPAA") included a
provision that prohibits the wrongful disclosure of certain "individually
identifiable health information." HIPAA requires the Secretary of the Department
to adopt standards relating to the transmission of such health information by
healthcare providers and healthcare plans. Although the Company believes that
such regulations do not at present materially impair the Company's
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operations, there can be no assurance that such indirect regulation will not
have a material adverse effect on the Company in the future.
REGULATION OF CUSTOMERS. Regulations imposed upon the Company's customers
include, among other things, benefits mandated by statute, exclusions from
coverages prohibited by statute, procedures governing the payment and processing
of claims, record keeping and reporting requirements, requirements for and
payment rates applicable to coverage of Medicaid and Medicare beneficiaries,
provider contracting and enrollee rights, and confidentiality requirements.
Although the Company believes that such regulations do not at present materially
impair the Company's operations, there can be no assurance that such indirect
regulation will not have a material adverse effect on the Company in the future.
ERISA. Certain of the Company's services are subject to the provisions of
ERISA. ERISA governs certain aspects of the relationship between
employer-sponsored healthcare benefit plans and certain providers of services to
such plans through a series of complex laws and regulations that are subject to
periodic interpretation by the Internal Revenue Service and the Department of
Labor. In some circumstances, and under certain customer contracts, the Company
may be expressly named as a "fiduciary" under ERISA, or be deemed to have
assumed duties that make it an ERISA fiduciary, and thus be required to carry
out its operations in a manner that complies with ERISA requirements in all
material respects. Although the Company believes that it is in material
compliance with the applicable ERISA requirements and that such compliance does
not currently have a material adverse effect on the Company's operations, there
can be no assurance that continuing ERISA compliance efforts or any future
changes to the applicable ERISA requirements will not have a material adverse
effect on the Company.
OTHER PROPOSED LEGISLATION. In the last five years, legislation has
periodically been introduced at the state and federal level providing for new
regulatory programs and materially revising existing regulatory programs. Any
such legislation, if enacted, could materially adversely affect the Company's
business, financial condition or results of operations. Such legislation could
include both federal and state bills affecting the Medicaid programs which may
be pending in or recently passed by state legislatures and which are not yet
available for review and analysis. Such legislation could also include proposals
for national health insurance and other forms of federal regulation of health
insurance and healthcare delivery. It is not possible at this time to predict
whether any such legislation will be adopted at the federal or state level, or
the nature, scope or applicability to the Company's business of any such
legislation, or when any particular legislation might be implemented. No
assurance can be given that any such federal or state legislation will not have
a material adverse effect on the Company.
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CAUTIONARY STATEMENTS--THE COMPANY.
This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Although
the Company believes that its plans, intentions and expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
such plans, intentions or expectations will be achieved. Important factors that
could cause actual results to differ materially from the Company's
forward-looking statements are set forth below and elsewhere in this Form 10-K.
All forward-looking statements attributable to the Company or persons acting on
behalf of the Company are expressly qualified in their entirety by the
cautionary statements set forth below. Additional cautionary statements
regarding the Company's healthcare franchising operations business are set forth
below elsewhere herein. See "--Charter Advantage-- Cautionary Statements--CBHS."
SUBSTANTIAL LEVERAGE AND DEBT SERVICE OBLIGATIONS The Company is currently
highly leveraged, with indebtedness that is substantial in relation to its
stockholders' equity. As of September 30, 1998, the Company's aggregate
outstanding indebtedness was approximately $1.2 billion and the Company's
stockholders' equity was approximately $187.6 million as of the same date. The
New Credit Agreement and the Indenture permit the Company to incur or guarantee
certain additional indebtedness, subject to certain limitations.
The Company's high degree of leverage could have important consequences to
the Company, including, but not limited to, the following: (i) the Company's
ability to obtain additional financing for working capital, capital
expenditures, acquisitions, general corporate purposes or other purposes may be
impaired in the future; (ii) a substantial portion of the Company's cash flows
from operations must be dedicated to the payment of principal and interest on
its indebtedness; (iii) the Company is substantially more leveraged than certain
of its competitors, which might place the Company at a competitive disadvantage;
(iv) the Company may be hindered in its ability to adjust rapidly to changing
market conditions; and (v) the Company's high degree of leverage could make it
more vulnerable in the event of a downturn in general economic conditions or its
business or in the event of adverse changes in the regulatory environment
applicable to the Company.
The Company's ability to repay or to refinance its indebtedness and to pay
interest on its indebtedness will depend on its financial and operating
performance, which, in turn, is subject to prevailing economic and competitive
conditions and to certain financial, business and other factors, many of which
are beyond the Company's control. These factors could include operating
difficulties, increased operating costs, the actions of competitors, regulatory
developments and delays in implementing strategic projects. The Company's
ability to meet its debt service and other obligations may depend in significant
part on the extent to which the Company can successfully implement its business
strategy. There can be no assurance that the Company will be able to implement
its strategy fully or that the anticipated results of its strategy will be
realized. See "Business--Business Strategy."
If the Company's cash flows and capital resources are insufficient to fund
its debt service obligations, the Company may be forced to reduce or delay
capital expenditures, sell assets or seek to obtain additional equity capital or
to restructure its debt. There can be no assurance that the Company's cash flows
and capital resources will be sufficient for payment of principal of and
interest on its indebtedness in the future, or that any such alternative
measures would be successful or would permit the Company to meet its scheduled
debt service obligations.
In addition, because the Company's obligations under the New Credit
Agreement bear interest at floating rates, an increase in interest rates could
adversely affect, among other things, the Company's ability to meet its debt
service obligations.
RESTRICTIVE FINANCING COVENANTS The New Credit Agreement and the Indenture
contain a number of covenants that restrict the operations of the Company and
its subsidiaries. In addition, the New Credit
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Agreement requires the Company to comply with specified financial ratios and
tests, including a minimum interest coverage ratio, a maximum leverage ratio, a
minimum net worth test, a maximum senior debt ratio and a minimum "EBITDA" (as
defined in the New Credit Agreement). There can be no assurance that the Company
will be able to comply with such covenants, ratios and tests in the future. The
Company's ability to comply with such covenants, ratios and tests may be
affected by events beyond its control, including prevailing economic, financial
and industry conditions. The breach of any such covenants, ratios or tests could
result in a default under the New Credit Agreement that would permit the lenders
thereunder to declare all amounts outstanding thereunder to be immediately due
and payable, together with accrued and unpaid interest, and to prevent the
Company from paying principal, premium, interest or other amounts due on any or
all of the Notes until the default is cured or all Senior Indebtedness is paid
or satisfied in full. Furthermore, the commitments of the lenders under the New
Credit Agreement to make further extensions of credit thereunder could be
terminated. If the Company were unable to repay all amounts accelerated, the
lenders could proceed against the Subsidiary Guarantors and the collateral
securing the Company's and the Subsidiary Guarantors' obligations pursuant to
the New Credit Agreement. If the indebtedness outstanding pursuant to the New
Credit Agreement were to be accelerated, there can be no assurance that the
assets of the Company would be sufficient to repay such indebtedness and the
other indebtedness of the Company. The value of the Common Stock would be
adversely affected if the Company were unable to repay such indebtedness.
RISK-BASED PRODUCTS Revenues under risk-based contracts are the primary
source of the Company's revenue from its behavioral managed healthcare business.
Such revenues accounted for approximately 52% of the Company's total revenue and
approximately 76% of its behavioral managed healthcare revenue in fiscal 1998.
Under a risk-based contract, the Company assumes all or a portion of the
responsibility for the cost of providing a full or specified range of behavioral
healthcare treatment services to a specified beneficiary population in exchange,
generally, for a fixed fee per member per month. In order for such contracts to
be profitable, the Company must accurately estimate the rate of service
utilization by beneficiaries enrolled in programs managed by the Company and
control the unit cost of such services. If the aggregate cost of behavioral
healthcare treatment services provided to a given beneficiary population in a
given period exceeds the aggregate of the per member per month fees received by
the Company with respect to the beneficiary population in such period, the
Company will incur a loss with respect to such beneficiary population during
such period. Furthermore, the Company may be required to pay during any period
amounts with respect to behavioral healthcare treatment services provided to a
given beneficiary population that exceed per member per month fees received with
respect to such beneficiary population during the same period. There can be no
assurance that the Company's assumptions as to service utilization rates and
costs will accurately and adequately reflect actual utilization rates and costs,
nor can there be any assurance that increases in behavioral healthcare costs or
higher-than-anticipated utilization rates, significant aspects of which are
outside the Company's control, will not cause expenses associated with such
contracts to exceed the Company's revenue for such contracts. In addition, there
can be no assurance that adjustments will not be required to the estimates,
particularly those regarding cost of care, made in reporting historical
financial results. See Note 1 to the audited historical consolidated financial
statements of the Company included herein. The Company will attempt to increase
membership in its risk-based products. If the Company is successful in this
regard, the Company's exposure to potential losses from its risk-based products
will also be increased. Furthermore, certain of such contracts and certain state
regulations limit the profits that may be earned by the Company on risk-based
business and may require refunds if the loss experience is more favorable than
that originally anticipated. Such contracts and regulations may also require the
Company or certain of its subsidiaries to reserve a specified amount of cash as
financial assurance that it can meet its obligations under such contracts. As of
September 30, 1998, the Company had restricted cash reserves of $89.2 million
pursuant to such contracts and regulations. Such amounts will not be available
to the Company for general corporate purposes. Furthermore, certain state
regulations restrict the ability of subsidiaries that offer risk-based products
to pay dividends to the Company. Certain state
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regulations relating to the licensing of insurance companies may also adversely
affect the Company's risk-based business. See "--Regulation." Although
experience varies on a contract-by-contract basis, historically, the Company's
risk-based contracts have been profitable. However, the degree of profitability
varies significantly from contract to contract. For example, the Company's
Medicaid contracts with governmental entities tend to have direct profit margins
that are lower than the Company's other contracts. The most significant factor
affecting the profitability of risk-based contracts is the ability to control
direct service costs. The Company believes that it will be in a better position
to control direct service costs as a result of the HAI, and Merit acquisitions.
RELIANCE ON CUSTOMER CONTRACTS Approximately 69% of the Company's revenue
in fiscal 1998 was derived from contracts with payors of behavioral healthcare
benefits. The Company's behavioral managed healthcare contracts typically have
terms of one to three years, and in certain cases contain renewal provisions
providing for successive terms of between one and two years (unless terminated
earlier). Substantially all of these contracts are immediately terminable with
cause and many, including some of the Company's most significant contracts, are
terminable without cause by the customer upon the provision of requisite notice
and the passage of a specified period of time (typically between 60 and 180
days), or upon the occurrence of certain other specified events. The Company's
ten largest behavioral managed healthcare customers accounted for approximately
55% of the Company's behavioral managed healthcare revenue for fiscal 1998. The
Company's contract with the State of Tennessee to manage the behavioral
healthcare benefits for the State's TennCare program represented approximately
15% of the Company's behavioral managed care revenue and approximately 10% of
the Company's consolidated revenue in fiscal 1998. There can be no assurance
that such contracts will be extended or successfully renegotiated or that the
terms of any new contracts will be comparable to those of existing contracts.
Loss of all of these contracts or customers would, and loss of any one of these
customers could, have a material adverse effect on the Company. In addition,
price competition in bidding for contracts can significantly affect the
financial terms of any new or renegotiated contract. The Company's customers may
reevaluate their contractual arrangements with the Company as a result of the
consummation of the Transactions.
DEPENDENCE ON GOVERNMENT SPENDING FOR MANAGED HEALTHCARE; POSSIBLE IMPACT OF
HEALTHCARE REFORM A significant portion of the Company's managed care revenue
is derived, directly or indirectly, from federal, state and local governmental
agencies, including state Medicaid programs. Reimbursement rates vary from state
to state, are subject to periodic negotiation and may limit the Company's
ability to maintain or increase rates. The Company is unable to predict the
impact on the Company's operations of future regulations or legislation
affecting Medicaid or Medicare programs, or the healthcare industry in general,
and there can be no assurance that future regulations or legislation will not
have a material adverse effect on the Company. Moreover, any reduction in
government spending for such programs could also have a material adverse effect
on the Company. In addition, the Company's contracts with federal, state and
local governmental agencies, under both direct contract and subcontract
arrangements, generally are conditioned upon financial appropriations by one or
more governmental agencies, especially with respect to state Medicaid programs.
These contracts generally can be terminated or modified by the customer if such
appropriations are not made. Finally, some of the Company's contracts with
federal, state and local governmental agencies, under both direct contract and
subcontract arrangements, require the Company to perform additional services if
federal, state or local laws or regulations imposed after the contract is signed
so require, in exchange for additional compensation to be negotiated by the
parties in good faith. Government and other third-party payors are generally
seeking to impose lower reimbursement rates and to renegotiate reduced contract
rates with service providers in a trend toward cost control. See
"Industry--Areas of Growth" and "Business-- Business Strategy."
In August 1997, Congress enacted the Budget Act. The Medicare-related
provisions of the Budget Act are designed to reduce Medicare expenditures over
the next five years by $115 billion, compared to
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projected Medicare expenditures before adoption of the Budget Act. The
Congressional Budget Office projected in July 1997 that $43.8 billion of the
reductions would come from reduced payments to hospitals, $21.8 billion from
increased enrollment in managed care plans and $11.7 billion from reduced
payments to physicians and ambulatory care providers. The five-year savings in
projected Medicare payments to physicians and hospitals would be achieved under
the Budget Act by reduced fee-for-service reimbursement and by changes in
managed care programs designed to increase enrollment of Medicare beneficiaries
in managed care plans. The increase in Medicare enrollment in managed care plans
would be achieved in part by allowing provider-sponsored organizations and
preferred provider organizations to compete with Medicare HMOs for Medicare
enrollees.
The Medicaid-related provisions of the Budget Act are designed to achieve
net federal Medicaid savings of $14.6 billion over the next five years and $56.4
billion over the next ten years. The Budget Act achieves federal Medicaid
savings in three areas. First, two-thirds of the savings over the next ten years
are attributable to limitations on federal matching payments to states for
reimbursements to "disproportionate share" hospitals. The next largest source of
federal savings is a provision allowing states to shift the cost of Medicaid
deductibles and coinsurance requirements for low-income Medicaid beneficiaries
from their Medicaid programs to physicians and other providers. Most of the
remaining savings derive from the repeal of the "Boren Amendment" and other
minimum payment guarantees for hospitals, nursing homes and community health
centers that serve Medicaid patients. These changes may have an adverse effect
on the Company if they result in reduced payment levels for providers of managed
behavioral healthcare services.
Prior to adoption of the Budget Act, the states were prohibited from
requiring Medicaid recipients to enroll in managed care products that covered
only Medicaid recipients. The Medicaid laws required that the states enroll
Medicaid recipients in products that also covered a specific number of
commercial enrollees. This requirement of the Medicaid laws was intended to
limit the ability of the states to reduce coverage levels for Medicaid
recipients below those offered to commercial enrollees. Under prior law, the
Secretary of the United States Department of Health and Human Services (the
"Department") could waive the prohibition. The Medicaid-related provisions of
the Budget Act give states broad flexibility to require most Medicaid recipients
to enroll in managed care products that only cover Medicaid recipients, without
obtaining a waiver from the Secretary of the Department that was required under
prior law. The Budget Act also allows states to limit the number of managed care
organizations with which the state will contract to deliver care to Medicaid
beneficiaries. These changes could have a positive impact on the Company's
business, if they result in increased enrollment of Medicaid beneficiaries in
managed care organizations and increased Medicaid spending on managed care.
However, these changes also may have an adverse effect on the Company if a
number of states decide to limit the number of managed care organizations with
which they will contract and to select the organization solely on the basis of
the cost of care, which could result in increased cost competition for state
contracts.
The Company cannot predict the effect of the Budget Act, or other healthcare
reform measures that may be adopted by Congress or state legislatures, on its
managed care operations and no assurance can be given that either the Budget Act
or other healthcare reform measures will not have an adverse effect on the
Company.
REGULATION The managed healthcare industry and the provision of behavioral
healthcare services are subject to extensive and evolving state and federal
regulation. The Company is subject to certain state laws and regulations,
including those governing: (i) the licensing of insurance companies, HMOs, PPOs,
TPAs and companies engaged in utilization review and (ii) the licensing of
healthcare professionals, including restrictions on business corporations from
practicing, controlling or exercising excessive influence over behavioral
healthcare services through the direct employment of psychiatrists or, in a few
states, psychologists and other behavioral healthcare professionals. In
addition, the Company is subject to certain federal laws as a result of the role
the Company assumes in connection with managing its customers' employee benefit
plans. The Company's managed care operations are also indirectly
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affected by regulations applicable to the establishment and operation of
behavioral healthcare clinics and facilities.
In many states, entities that assume risk under contracts with licensed
insurance companies or HMOs have not been considered by state regulators to be
conducting an insurance or HMO business. As a result, the Company has not sought
licensure as either an insurer or HMO in certain states. Regulators in some
states, however, have determined that risk assuming activity by entities that
are not themselves providers of care is an activity that requires some form of
licensure. There can be no assurance that other states in which the Company
operates will not adopt a similar view, thus requiring the Company to obtain
additional licenses. Such additional licensure might require the Company to
maintain minimum levels of deposits, net worth, capital, surplus or reserves, or
limit the Company's ability to pay dividends, make investments or repay
indebtedness. The imposition of these additional licensure requirements could
increase the Company's cost of doing business or delay the Company's conduct or
expansion of its business.
Regulators may impose operational restrictions on entities granted licenses
to operate as insurance companies or HMOs. For example, the California
Department of Corporations ("DOC") imposed certain restrictions on the Company
in connection with its issuance of an approval of the Company's acquisition of
HAI, including restrictions on the ability of the California subsidiaries of HAI
to fund the Company's operations in other states and on the ability of the
Company to make certain operational changes with respect to HAI's California
subsidiaries. The DOC imposed substantially identical restrictions on the
Company in connection with the Company's acquisition of Merit. The Company does
not believe such restrictions will materially impact its integration plan.
In addition, utilization review and TPA activities conducted by the Company
are regulated by many states, which states impose requirements upon the Company
that increase its business costs. The Company believes that its TPA activities
performed for its self-insured employee benefit plan customers are exempt from
otherwise applicable state licensing or registration requirements based upon
federal preemption under the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), and has relied on this general principle in determining not
to seek licensure for certain of its activities in many states. Existing case
law is not uniform on the applicability of ERISA preemption with respect to
state regulation of utilization review or TPA activities. There can be no
assurance that additional licensure will not be required with respect to
utilization review or TPA activities in certain states. See "Business--
Regulation--Insurance, HMO, and PPO Activities" and "--Utilization Review and
Third-Party Administrator Activities."
State regulatory agencies responsible for the administration and enforcement
of the laws and regulations to which the Company's operations are subject have
broad discretionary powers. A regulatory agency or a court in a state in which
the Company operates could take a position under existing or future laws or
regulations, or change its interpretation or enforcement practices with respect
thereto, that such laws or regulations apply to the Company differently than the
Company believes such laws and regulations apply or should be enforced. The
resultant compliance with, or revocation of, or failure to obtain, required
licenses and governmental approvals could result in significant alteration to
the Company's business operations, delays in the expansion of the Company's
business and lost business opportunities, any of which, under certain
circumstances, could have a material adverse effect on the Company. See
"Business--Regulation--General," "--Licensure," "--Insurance, HMO and PPO
Activities" and "--Utilization Review and Third-Party Administrator Activities."
The laws of some states limit the ability of a business corporation to
directly provide, control or exercise excessive influence over behavioral
healthcare services through the direct employment of psychiatrists,
psychologists, or other behavioral healthcare professionals. In addition, the
laws of some states prohibit psychiatrists, psychologists, or other healthcare
professionals from splitting fees with other persons or entities. These laws and
their interpretations vary from state to state and enforcement
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by the courts and regulatory authorities may vary from state to state and may
change over time. The Company believes that its operations as currently
conducted are in material compliance with the applicable laws, however there can
be no assurance that the Company's existing operations and its contractual
arrangements with psychiatrists, psychologists and other healthcare
professionals will not be successfully challenged under state laws prohibiting
fee splitting or the practice of a profession by an unlicensed entity, or that
the enforceability of such contractual arrangements will not be limited. The
Company believes that it could, if necessary, restructure its operations to
comply with changes in the interpretation or enforcement of such laws and
regulations, and that such restructuring would not have a material adverse
effect on its operations.
Several states in which the Company does business have adopted, or are
expected to adopt, "any willing provider" laws. Such laws typically impose upon
insurance companies, PPOs, HMOs or other types of third-party payors an
obligation to contract with, or pay for the services of, any healthcare provider
willing to meet the terms of the payor's contracts with similar providers.
Compliance with any willing provider laws could increase the Company's costs of
assembling and administering provider networks and could, therefore, have a
material adverse effect on its operations.
The Company's managed care operations are also generally affected by
regulations applicable to the operations of healthcare clinics and facilities.
See "Charter Advantage--Regulation."
INTEGRATION OF OPERATIONS As a result of the Company's acquisition of Merit
and HAI, the Company is the largest provider of managed behavioral healthcare
services in the United States, according to the enrollment data reported in OPEN
MINDS. The Company's ability to operate its acquired behavioral managed
healthcare businesses successfully depends on how well and how quickly it
integrates the acquired businesses with its existing operations. The Company
expects to achieve approximately $60.0 million of cost savings on an annual
basis by September 30, 1999. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." However, as the Company
implements the integration process, it may need to implement enhanced
operational, financial and information systems and may require additional
employees and management, operational and financial resources. There can be no
assurance that the Company will be able to implement and maintain such
operational, financial and information systems successfully or successfully
obtain, integrate and utilize the required employees and management, operational
and financial resources to achieve the successful integration of the acquired
businesses with its existing operations. Failure to implement such systems
successfully and to use such resources effectively could have a material adverse
effect on the Company. Furthermore, implementing such operational, financial and
information systems or obtaining such employees and management could reduce the
cost savings the Company expects to achieve. See "Business-- Business Strategy."
HIGHLY COMPETITIVE INDUSTRY The industry in which the Company conducts its
managed care businesses is highly competitive. The Company competes with large
insurance companies, HMOs, PPOs, TPAs, provider groups and other managed care
companies. Many of the Company's competitors are significantly larger and have
greater financial, marketing and other resources than the Company, and some of
the Company's competitors provide a broader range of services. The Company may
also encounter substantial competition in the future from new market entrants.
Many of the Company's customers that are managed care companies may, in the
future, seek to provide behavioral managed healthcare services to their
employees or subscribers directly, rather than contracting with the Company for
such services. See "Business--Competition."
RISKS RELATED TO AMORTIZATION OF INTANGIBLE ASSETS The Company's total
assets at September 30, 1998 reflect intangible assets of approximately $1.16
billion. At September 30, 1998, net intangible assets were 60.4% of total assets
and 616.9% of total stockholders' equity. Intangible assets include goodwill of
approximately $992.4 million, which is amortized over 25 to 40 years, and other
identifiable intangible assets (primarily customer lists, provider networks and
treatment protocols) of approximately
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$165.2 million that are amortized over 4 to 30 years. The amortization periods
used by the Company may differ from those used by other registrants. In
addition, the Company may be required to shorten the amortization period for
intangible assets in future periods based on the prospects of acquired
companies. There can be no assurance that the value of such assets will ever be
realized by the Company. The Company evaluates, on a regular basis, whether
events and circumstances have occurred that indicate that all or a portion of
the carrying value of intangible assets may no longer be recoverable, in which
case a charge to earnings for impairment losses could become necessary. Any
determination requiring the write-off of a significant portion of unamortized
intangible assets would adversely affect the Company's results of operations. A
write-off of intangible assets could become necessary if the anticipated
undiscounted cash flows of an acquired company do not support the carrying value
of long-lived assets, including intangible assets. At present, no evidence
exists that would indicate impairment losses may be necessary in future periods.
SUBORDINATION OF FRANCHISE FEES The Company owns a 50% equity interest in
CBHS, from which it receives the Franchise Fees. The Franchise Fees have in the
past represented a significant portion of the Company's earnings and cash flows.
The Franchise Fees payable to the Company by CBHS are subordinated in right of
payment to the $41.7 million initial annual base rent and 5% minimum escalator
rent due to Crescent. The Company is required to provide certain services to
CBHS under the Master Franchise Agreement whether or not CBHS pays the Franchise
Fees. However, the Company has no obligation to contribute additional capital or
make advances to CBHS. See "Charter Advantage -- Franchise Operations." If CBHS
encounters a decline in earnings or financial difficulties, such amounts due
from CBHS to Crescent will be paid before any Franchise Fees are paid. The
remainder of CBHS's available cash will then be applied in such order of
priority as CBHS may determine, to all other operating expenses of CBHS,
including the current and accumulated Franchise Fees. The Company will be
entitled to pursue all available remedies for breach of the Master Franchise
Agreement, except that the Company does not have the right to take any action
that could reasonably be expected to force CBHS into bankruptcy or receivership.
As a result of the Crescent Transactions, the Company no longer controls the
operations of the Psychiatric Hospital Facilities and other facilities operated
by CBHS. Accordingly, factors that the Company does not control will likely
influence the amount of Franchise Fees that the Company will realize in the
future.
Based on operational projections prepared by CBHS management for the fiscal
year ended September 30, 1999, and on CBHS' results of operations through
September 30, 1998, the Company believes that CBHS will be unable to pay the
full amount of the Franchise Fees it is contractually obligated to pay the
Company during fiscal 1999. CBHS paid $40.6 million of Franchise Fees to the
Company during fiscal 1998. The Company estimates that CBHS will be able to pay
$0 to $15.0 million of Franchise Fees in fiscal 1999. Based on the amount of
unpaid Franchise Fees ($38 million as of September 30, 1998), the Company
exercised its limited management rights available to it under the Master
Franchise Agreement and, with CBHS's Board Support, made operational and
management changes aimed at improving profitability and cash flows at CBHS. The
Company has since restored all management rights to the CBHS Board. See "Charter
Advantage--Franchise Operations."
The Company's relationship with CBHS and the business of CBHS are described
elsewhere herein. Such information is relevant to an understanding of the
factors having a bearing on the Company's receipt of Franchise Fees from CBHS.
PROFESSIONAL LIABILITY; INSURANCE The management and administration of the
delivery of behavioral managed healthcare services, like other healthcare
services, entail significant risks of liability. The Company is regularly
subject to lawsuits alleging malpractice and related legal theories, some of
which involve situations in which participants in the Company's programs have
committed suicide. The Company is also subject to claims of professional
liability for alleged negligence in performing utilization
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review activities, as well as for acts and omissions of independent contractors
participating in the Company's third-party provider networks. The Company is
subject to claims for the costs of services denied. There can be no assurance
that the Company's procedures for limiting liability have been or will be
effective, or that one or more lawsuits will not have a material adverse effect
on the Company in the future.
The Company carries professional liability insurance, subject to certain
deductibles. There can be no assurance that such insurance will be sufficient to
cover any judgments, settlements or costs relating to present or future claims,
suits or complaints or that, upon expiration thereof, sufficient insurance will
be available on favorable terms, if at all. If the Company is unable to secure
adequate insurance in the future, or if the insurance carried by the Company is
not sufficient to cover any judgments, settlements or costs relating to any
present or future actions or claims, there can be no assurance that the Company
will not be subject to a liability that could have a material adverse effect on
the Company. See "Business-Insurance."
The Company has certain liabilities relating to the self-insurance program
it maintained with respect to its provider business prior to the Crescent
Transactions. See Note 13 to the Company's audited historical consolidated
financial statements included elsewhere herein.
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CHARTER ADVANTAGE
OVERVIEW
On June 17, 1997, the Company consummated the Crescent Transactions,
pursuant to which, among other things, it sold the Psychiatric Hospital
Facilities to Crescent. In addition, the Company and COI, an affiliate of
Crescent, formed a joint venture known as CBHS to operate the Psychiatric
Hospital Facilities and certain other facilities transferred by the Company to
CBHS. The Company and COI each own 50% of the equity interest of CBHS. The
Company obtained its equity interest by contributing approximately $5 million of
net assets, including five leased psychiatric hospitals, to CBHS. In fiscal
1997, subsequent to the initial capitalization of CBHS, the Company and COI each
contributed an additional $17.5 million to the capital of CBHS. The Company has
no obligation to make additional contributions to the capital of CBHS. The
Company accounts for its 50% investment in CBHS under the equity method of
accounting. In connection with the Crescent Transactions, the Company received
approximately $417.2 million in cash (before costs of approximately $16.0
million) and warrants for the purchase of 2.5% of COI's common stock,
exercisable over 12 years. The Company also issued 1,283,311 warrants to
purchase shares of the Company's Common Stock to each of Crescent and COI at an
exercise price of $30 per share. In related agreements, Crescent and CBHS
entered into the facilities lease described below and the Company, CBHS and the
Psychiatric Hospital Facilities and other facilities transferred by the Company
to CBHS entered into the franchise agreements described below. Following the
consummation of the Crescent Transactions, the Company formed a new business
unit, "Charter Advantage," to franchise the "CHARTER" system of behavioral
healthcare to operators of behavioral healthcare facilities. Currently, its
primary customer is CBHS.
The following discussion of Charter Advantage's operations, CBHS and the
psychiatric hospital industry in general is relevant to an assessment of the
factors having a bearing on CBHS's ability to pay Franchise Fees to the Company,
the value of the Company's interest in the equity of CBHS and the future
business prospects of CBHS.
FRANCHISE OPERATIONS
FRANCHISE AGREEMENTS. Charter Advantage franchises the "CHARTER" System of
behavioral healthcare to the Psychiatric Hospital Facilities and other
facilities operated by CBHS. Each facility has entered into a separate Franchise
Agreement with Charter Advantage. Each franchisee is granted the right to engage
in the business of providing behavioral healthcare utilizing the "CHARTER"
System in a defined territory. Each franchisee is authorized to conduct a
"Hospital/RTC Based Behavioral Healthcare Business," which is defined as the
business of the operation of an acute care psychiatric hospital, part of an
acute care general hospital operating an acute care psychiatric unit, a
behavioral healthcare residential treatment center, a part of a facility
operating a behavioral healthcare residential treatment center, or other similar
facility providing 24-hour behavioral healthcare and the delivery of behavioral
healthcare from such facility or other affiliated facilities; such behavioral
healthcare to include inpatient hospitalization, partial hospitalization
programs, outpatient therapy, intensive outpatient therapy, residential
treatment, ambulatory detoxification, behavioral modification programs and
related services. The "CHARTER" System is a system for the operation of
Hospital/RTC Based Behavioral Healthcare Businesses under the "CHARTER" names
and marks, and includes the right to use computer software, treatment programs
and procedures, quality standards, quality assessment methods, performance
improvement and monitoring programs, as well as advertising and marketing
assistance, promotional materials, consultation and other matters relating to
the operation of Hospital/RTC Based Behavioral Healthcare Businesses.
The rights granted under each franchise agreement relate solely to a defined
territory. The rights are non-exclusive except that Charter Advantage may not
grant a franchise for, or itself operate, a facility located within a
franchisee's territory using the "CHARTER" System. Charter Advantage, however,
may
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grant franchises or licenses to individual physicians, psychologists or other
mental healthcare professionals, to operate businesses for the delivery of
behavioral healthcare utilizing the "CHARTER" System at facilities in the
franchisee's territory other than at an in-patient facility. Charter Advantage
also reserves the right to grant franchises to others to operate behavioral
healthcare businesses utilizing the "CHARTER" System other than in the
franchisee's territory and to otherwise use and grant to others the right to use
the "CHARTER" name or any other name for other businesses. In addition, Charter
Advantage reserves the right to: (i) provide behavioral healthcare services
incidental to the managed behavioral healthcare businesses or any other business
the principal purpose of which is not the operation of a Hospital/RTC Based
Behavioral Healthcare Business and (ii) pursuant to contracts with federal,
state and local governmental agencies, provide health and human services,
including behavioral healthcare services, to the mentally retarded, the
developmental disabled, the elderly, persons under the control or supervision of
criminal/juvenile systems and other designated populations.
During the term of each franchise agreement, Charter Advantage provides
franchisees with: (i) advertising and marketing assistance, including
consultation, access to media buying programs and access to broadcast and other
advertising materials produced by Charter Advantage; (ii) risk management
services, including risk financial planning, loss control and claims management;
(iii) outcomes monitoring; (iv) national and regional contracting services; and
(v) consultation by telephone or at Charter Advantage's offices with respect to
matters relating to the franchisee's business in which Charter Advantage has
expertise, including reimbursement, government relations, clinical strategies,
regulatory matters, strategic planning and business development.
FRANCHISE FEES; SUBORDINATION. The Company and CBHS are parties to a Master
Franchise Agreement pursuant to which CBHS pays the Company annual Franchise
Fees for granting the right to utilize the "CHARTER" System to the facilities
operated by CBHS. CBHS is obligated under the Master Franchise Agreement for
annual Franchise Fees equal to the greater of (i) $78.3 million, subject to
increases for inflation, and (ii) $78.3 million, plus 3% of CBHS's gross
revenues over $1 billion and not in excess of $1.2 billion and 5% of CBHS' gross
revenues over $1.2 billion. The Company, CBHS and Crescent have entered into a
Subordination Agreement pursuant to which the Franchise Fees are subordinated to
base rent and minimum escalator rent under the Facilities Lease between Crescent
and CBHS with respect to the facilities operated by CBHS.
Based on operational projections prepared by CBHS management for the fiscal
year ended September 30, 1999, and on CBHS' results of operations through
September 30, 1998, the Company believes that CBHS will be unable to pay the
full amount of the Franchise Fees it is contractually obligated to pay the
Company during fiscal 1999. CBHS paid $40.6 million of Franchise Fees to the
Company during fiscal 1998. The Company estimates that CBHS will be able to pay
$0 to $15.0 million of Franchise Fees in fiscal 1999. If the aggregate amount of
Franchise Fees not paid exceeds $6.0 million, but is less than $18.0 million,
the Company has the right to prohibit CBHS from paying any incentive
compensation to CBHS's management and may prohibit the vesting of any equity in
CBHS to which management of CBHS may be entitled during the period when
Franchise Fees remain unpaid. If the aggregate amount of Franchise Fees not paid
exceeds $18.0 million, but is less than $24.0 million, the Company has the right
to prohibit any salary increases for key personnel of CBHS, to prohibit any
additional hiring by CBHS and to prohibit CBHS from making any hospital
acquisitions or entering into any hospital joint ventures directly or indirectly
during such period. If the aggregate amount of Franchise Fees not paid exceeds
$24.0 million, the Company may require CBHS to reduce by 5% the expenses
approved in its current budget, to seek approval of expenditures, including
capital and operating expenditures, on a monthly basis, and to transfer control
and management of CBHS and the Psychiatric Hospital Facilities to the Company.
Notwithstanding the foregoing, the Company does not have the right to take any
action, in connection with the exercise of remedies against CBHS, that could
reasonably be expected to force CBHS into bankruptcy or receivership, or similar
proceedings, with respect to any dispute that may arise among the parties with
respect to payment or nonpayment of the Franchise Fees.
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Based on the amount of unpaid Franchise Fees ($38 million as of September 30,
1998), the Company exercised certain of the limited management rights available
to it under the Master Franchise Agreement and, with CBHS' Board support, made
operational and management changes aimed at improving profitability and cash
flows at CBHS. The Company has since restored all management rights to the CBHS
Board.
The initial term of the Facilities Lease is twelve years. CBHS has the right
to renew the lease for four additional terms of five years each. The base rent
for the first year of the initial term was $41.7 million, which increases each
year during the initial term by five percent compounded annually.
Notwithstanding the foregoing, when accrued and unpaid Franchise Fees,
including interest thereon, if any, equal or exceed $15.0 million, then CBHS's
available cash is thereafter first applied to base rent and minimum escalator
rent, under the Facilities Lease. The remainder of CBHS's available cash may
then be applied in such order of priority as CBHS may determine, in the
reasonable discretion of its Board of Directors (half the members of which are
appointed by the Company), to all other operating expenses of CBHS, including,
without limitation, the current and accumulated Franchise Fees, and any other
operating expenses.
CBHS
OVERVIEW. CBHS is the nation's largest operator of acute-care psychiatric
hospitals and other behavioral care treatment facilities. CBHS's psychiatric
hospitals are located in well-populated urban and suburban locations in 32
states. Most of CBHS's hospitals offer a full continuum of behavioral care in
their service area. The continuum includes inpatient hospitalization, partial
hospitalization, intensive outpatient services and, in some markets, residential
treatment services.
CBHS's hospitals provide structured and intensive treatment programs for
mental health and alcohol and drug dependency disorders in children, adolescents
and adults. The specialization of programs enables the clinical staff to provide
care that is specific to the patient's needs and facilitates monitoring of the
patient's progress. A typical treatment program at a CBHS facility integrates
physicians and other patient-care professionals with structured activities,
providing patients with testing, adjunctive therapies (occupational,
recreational and other), group therapy, individual therapy and educational
programs. A treatment program includes one or more of the types of treatment
settings provided by CBHS's continuum of care. For those patients who do not
have a personal psychiatrist or other specialist, the hospital refers the
patient to a member of its medical staff.
A significant portion of hospital admissions are provided by referrals from
former patients, local marketplace advertising, managed care organizations and
physicians. Professional relationships are an important aspect of the ongoing
business of a behavioral care facility. Management believes the quality of
CBHS's treatment programs, staff employees and physical facilities are important
factors in maintaining good professional relationships.
CBHS's hospitals work closely with mental health professionals,
non-psychiatric physicians, emergency rooms and community agencies that come in
contact with individuals who may need treatment for mental illness or substance
abuse. A portion of the Company's marketing efforts is directed at increasing
general awareness of mental health and addictive disease and the services
offered by the Company's franchisees.
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INDUSTRY TRENDS. CBHS's hospitals have been adversely affected by factors
influencing the entire psychiatric hospital industry. Such factors include: (i)
the imposition of more stringent length of stay and admission criteria and other
cost containment measures by payors; (ii) the failure of reimbursement rate
increases from certain payors that reimburse on a per diem or other discounted
basis to offset increases in the cost of providing services; (iii) an increase
in the percentage of business that CBHS derives from payors that reimburse on
per diem or other discounted basis; (iv) a trend toward higher deductibles and
co-insurance for individual patients; (v) a trend toward limited employee
behavioral health benefits, such as reductions in annual and lifetime limits on
behavioral health coverage; and (vi) pricing pressure related to an increasing
rate of claims denials by third party payors. In response to these conditions,
the Company believes that CBHS will (i) strengthen controls to minimize costs
and capital expenditures; (ii) review its portfolio of hospitals and sell, close
or lease hospitals or consolidate operations in certain locations; (iii) develop
strategies to increase outpatient services and partial hospitalization programs
to meet the demands of the marketplace; (iv) implement programs to contest third
party denials relating to valid pre-certified treatment and admissions; and (v)
renegotiate contracts with managed care organizations at increased rates.
SOURCES OF REVENUE. Payments are made to CBHS by patients, by insurance
companies and self-insured employers, by the federal and state governments under
Medicare, Medicaid, CHAMPUS and other programs and by HMOs, PPOs and other
managed care programs. Amounts received from most payors are less than the
hospital's established charges.
COMPETITION. Each of CBHS's hospitals competes with other hospitals, some
of which are larger and have greater financial resources. Some competing
hospitals are owned and operated by governmental agencies, others by nonprofit
organizations supported by endowments and charitable contributions and others by
proprietary hospital corporations. The hospitals frequently draw patients from
areas outside their immediate locale and, therefore, CBHS's hospitals may, in
certain markets, compete with both local and distant hospitals. In addition,
CBHS's hospitals compete not only with other psychiatric hospitals, but also
with psychiatric units in general hospitals, and outpatient services provided by
CBHS compete with private practicing mental health professionals, publicly
funded mental health centers and partial hospitalization and other intensive
outpatient services programs and facilities. The competitive position of a
hospital is, to a significant degree, dependent upon the number and quality of
physicians who practice at the hospital and who are members of its medical
staff. The Company believes that CBHS competes effectively with respect to the
aforementioned factors. However, there can be no assurance that CBHS will be
able to compete successfully in the provider business in the future.
Competition among hospitals and other healthcare providers for patients has
intensified in recent years. During this period, hospital occupancy rates for
inpatient behavioral care patients in the United States have declined as a
result of cost containment pressures, changing technology, changes in
reimbursement, changes in practice patterns from inpatient to outpatient
treatment and other factors. In recent years, the competitive position of
hospitals has been affected by the ability of such hospitals to obtain contracts
with PPO's, HMO's and other managed care programs to provide inpatient and other
services. Such contracts normally involve a discount from the hospital's
established charges, but provide a base of patient referrals. These contracts
also frequently provide for pre-admission certification and for concurrent
length of stay reviews. The importance of obtaining contracts with HMO's, PPO's
and other managed care companies varies from market to market, depending on the
individual market strength of the managed care companies. In certain states,
certificate of need laws place limitations on CBHS's and its competitors'
ability to build new hospitals and to expand existing hospitals and services.
CAUTIONARY STATEMENTS--CBHS
The following factors are relevant to an understanding of the risks
associated with CBHS's business and the ability of CBHS to pay Franchise Fees to
the Company.
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POTENTIAL REDUCTIONS IN REIMBURSEMENT BY THIRD-PARTY PAYORS AND CHANGES IN
HOSPITAL PAYOR MIX. CBHS's hospitals have been adversely affected by certain
factors influencing the entire psychiatric hospital industry. See"--Industry
Trends" Any of these factors may result in reductions in the amounts that CBHS's
hospitals can expect to collect per patient day for services provided or the
number of equivalent patient days.
Changes in the mix of CBHS's patients among the private-pay, Medicare and
Medicaid categories, and among different types of private-pay sources, could
significantly affect the profitability of CBHS's hospital operations. Moreover,
there can be no assurance that payments under governmental and private
third-party payor programs will remain at levels comparable to present levels or
will, in the future, be sufficient to cover the costs of providing care to
patients covered by such programs.
GOVERNMENTAL BUDGETARY CONSTRAINTS AND HEALTHCARE REFORM. In the 1995 and
1996 sessions of the United States Congress, the focus of healthcare legislation
was on budgetary and related funding mechanism issues. Both the Congress and the
Clinton Administration have made proposals to reduce the rate of increase in
projected Medicare and Medicaid expenditures and to change funding mechanisms
and other aspects of both programs. The Budget Act, which was signed into law by
President Clinton in August 1997, reduces federal spending by an estimated $140
billion. The majority of the spending reduction will come from Medicare cuts of
$115.0 billion. The Congressional Budget Office projected in July 1997 that
$43.8 billion of the reductions would come from reduced payments to hospitals,
$21.8 billion from increased enrollment in managed care plans and $11.7 billion
from reduced payments to physicians and ambulatory care providers. The five-year
savings in projected Medicare payments to physicians and hospitals would be
achieved under the Budget Act by reduced fee-for-service reimbursement and by
changes in managed care programs designed to increase enrollment of Medicare
beneficiaries in managed care plans. The increase in Medicare enrollment in
managed care plans would be achieved in part by allowing provider-sponsored
organizations and preferred provider organizations to compete with Medicare HMOs
for Medicare enrollees.
The Medicaid-related provisions of the Budget Act are designed to achieve
net federal Medicaid savings of $14.6 billion over the next five years and $56.4
billion over the next ten years. The Budget Act achieves Federal Medicaid
savings in three areas. First, two-thirds of the savings over the next ten years
are attributable to limitations on federal matching payments to states for
reimbursements to "disproportionate share" hospitals. The next largest source of
federal savings is a provision allowing states to shift the cost of Medicaid
deductibles and coinsurance requirements for low-income Medicaid beneficiaries
from their Medicaid programs to physicians and other providers. Most of the
remaining savings derive from the repeal of the "Boren Amendment" and other
minimum payment guarantees for hospitals, nursing homes and community health
centers that service Medicaid patients.
CBHS management estimates that the Budget Act will reduce the amount of
revenue and earnings that CBHS will receive for the treatment of Medicare and
Medicaid patients. CBHS management estimates that such reductions approximated
$10.0 million in fiscal 1998, and due to the phase in effects of the bill, will
approximate $15.0 million in subsequent fiscal years.
A number of states in which CBHS has operations have either adopted or are
considering the adoption of healthcare reform proposals of general applicability
or Medicaid reform proposals. Where adopted, these state reform laws have often
not yet been fully implemented. The Company cannot predict the effect of these
state healthcare reform proposals on CBHS's operations. The Company cannot
predict the effect of other healthcare reform measures that may be adopted by
Congress on the operations of CBHS and no assurance can be given that other
federal healthcare reform measures will not have an adverse effect on CBHS.
DEPENDENCE ON HEALTHCARE PROFESSIONALS. Physicians traditionally have been
the source of a significant portion of the patients treated at CBHS's hospitals.
Therefore, the success of CBHS's hospitals is dependent in part on the number
and quality of the physicians on the medical staffs of the
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hospitals and their admission practices. A small number of physicians account
for a significant portion of patient admissions at some of CBHS's hospitals.
There can be no assurance that CBHS can retain its current physicians on staff
or that additional physician relationships will be developed in the future.
Furthermore, hospital physicians generally are not employees of CBHS and, in
general, CBHS does not have contractual arrangements with hospital physicians
restricting the ability of such physicians to practice elsewhere.
POTENTIAL GENERAL AND PROFESSIONAL LIABILITY. In recent years, physicians,
hospitals, and other healthcare professionals and providers have become subject
to an increasing number of lawsuits alleging medical malpractice and related
legal theories. Many of these lawsuits involve large claims and substantial
defense costs. CBHS maintains a general and hospital professional liability
insurance policy with an unaffiliated insurer. In addition, CBHS' hospitals
require all physicians on each hospital's medical staff to maintain professional
liability coverage. Management believes that its coverage limits are adequate,
however, there can be no assurance that a future claim or claims will not exceed
the limits of these existing insurance policies or that a loss or losses for
which insurance is unavailable will not have a material adverse effect on CBHS.
GOVERNMENT REGULATION. The operation of psychiatric hospitals and other
behavioral healthcare facilities and the provision of behavioral healthcare
services are subject to extensive federal, state and local laws and regulations.
These laws and regulations provide for periodic inspections or other reviews by
state agencies, the Department and CHAMPUS to determine compliance with their
respective standards of medical care, staffing, equipment and cleanliness
necessary for continued licensing or participation in the Medicare, Medicaid or
CHAMPUS programs. The admission and treatment of patients at psychiatric
hospitals is also subject to substantial state regulation relating to
involuntary admissions, confidentiality of patient medical information,
patients' rights and federal regulation relating to confidentiality of medical
records of substance abuse patients. CBHS is also subject to state certificate
of need laws that regulate the construction of new hospitals and the expansion
of existing hospital facilities and services.
CBHS also is subject to federal and state laws that govern financial and
other arrangements between healthcare providers. Such laws include the illegal
remuneration provisions of the Social Security Act (the "Anti-Kickback Statute")
and the physician self-referral provisions of the Omnibus Budget Reconciliation
Act of 1993 ("Stark II") and state illegal remuneration and self-referral
statutes and regulations that prohibit payments in exchange for referrals and
referrals by physicians or other healthcare providers to persons or entities
with which the physician or other healthcare provider has a financial
relationship.
The Medicare and Medicaid Patient and Program Protection Act of 1987
expanded the authority of the Department to exclude from participation in the
Medicare and Medicaid programs those individuals and entities that engage in
defined prohibited activities. The Department's exclusion authority was recently
expanded under HIPAA and the Budget Act, which added additional grounds for
exclusion, established minimum exclusion periods for certain offenses and
expanded the scope of the exclusion to include all federal health care programs.
The Department also has the authority to impose civil monetary penalties for
certain prohibited activities. HIPAA increased the amount of authorized
penalties from $2,000 per item or service claimed to $10,000 per item or service
claimed, and increased the assessment to which a person may be subject in lieu
of damages from two times the amount claimed for each item or service to three
times the amount claimed. Both HIPAA and the Budget Act expanded the
Department's authority to impose civil monetary penalties by adding additional
activities for which civil monetary penalties may be imposed.
35
<PAGE>
Provisions contained in HIPAA and the Budget Act also created new criminal
healthcare fraud offenses that are applicable to both government programs and
private health insurance plans and added new programs and increased funding for
fraud and abuse detection and prevention.
CHAMPUS regulations also authorize the exclusion of providers from the
CHAMPUS program, if the provider has committed fraud or engaged in certain
"abusive practices," which are defined broadly to include, among other things,
the provision of medically unnecessary services, the provision of care of
inferior quality and the failure to maintain adequate medical or financial
records.
State regulatory agencies responsible for the administration and enforcement
of the laws and regulations to which CBHS' operations are subject have broad
discretionary powers. A regulatory agency or a court in a state in which CBHS
operates could take a position under existing or future laws or regulations, or
change its interpretation or enforcement practices with respect thereto, that
such laws or regulations apply to CBHS differently than CBHS believes such laws
and regulations apply or should be enforced. The resultant compliance with, or
revocation of, or failure to obtain, required licences and governmental
approvals could result in significant alteration to CBHS' business operations,
delays in the expansion of CBHS' business and lost business opportunities, any
of which, under certain circumstances, could have a material adverse effect on
CBHS.
INTELLECTUAL PROPERTY The Company owns certain intellectual property which
is important to its franchise operation. The Company has registered as
trademarks both the "CHARTER" name and "800-CHARTER." The Company also owns the
"Charter System," which is a system for the operation of businesses specializing
in the delivery of behavioral healthcare under the "CHARTER" names and marks.
The Charter System includes treatment programs and procedures, quality
standards, quality assessment methods, performance improvement and monitoring
programs, advertising and marketing assistance, promotional materials,
consultation and other matters related to the operation of businesses
specializing in the delivery of behavioral healthcare.
EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------------- --- ------------------------------------------------------------------
<S> <C> <C>
Henry T. Harbin M.D.................... 51 President, Chief Executive Officer and Director
Craig L. McKnight...................... 47 Executive Vice President and Chief Financial Officer
John J. Wider, Jr...................... 51 President and Chief Operating Officer of Magellan Behavorial
Health
Clarissa C. Marques, Ph.D.............. 46 Executive Vice President of Clinical and Quality Management
Gregory T. Torres...................... 48 President and Chief Executive Officer of Mentor
</TABLE>
HENRY T. HARBIN, M.D. became President, Chief Executive Officer and a
Director of the Company on March 18, 1998. Dr. Harbin served as President and
Chief Executive Officer of Green Spring from 1994 to 1998. Dr. Harbin served as
Executive Vice President of the Company from 1995 until becoming President and
Chief Executive Officer of the Company. Dr. Harbin served as Executive Vice
President and Chief Clinical Officer of Green Spring during 1993 and 1994.
CRAIG L. MCKNIGHT became Executive Vice President and Chief Financial
Officer of the Company in October 1995. From March 1995 through September 1995,
he served as Executive Vice President-- Office of the President and Chairman.
Mr. McKnight practiced public accounting with Coopers & Lybrand L.L.P. from 1985
through 1995. Coopers & Lybrand L.L.P. is an international accounting firm that
provides accounting and auditing services, tax services and consulting services.
As an audit partner at Coopers & Lybrand L.L.P., from 1985 to 1995, Mr. McKnight
had responsibility for a wide range of hospital and managed care engagements, as
well as assisting clients with formulating financing options,
36
<PAGE>
financial restructurings and the purchase and sale of health plans and
facilities. Mr. McKnight is also a director of OrthAlliance, Inc.
JOHN J. WIDER, JR. has served as President and Chief Operating Officer of
Magellan Behavorial Health ("MBH") since March 1998. Mr. Wider served as
Executive Vice President and Chief Operating Officer of Green Spring from 1997
to 1998. Mr. Wider was President and General Manager for Cigna Healthcare
Corporation's ("Cigna") Mid-Atlantic region from 1996 to 1997. Mr. Wider served
as Area Operations Officer for Cigna during 1995 and 1996 and as Vice President
of Sales of Cigna's Midwest region from 1993 to 1995.
CLARISSA C. MARQUES, PH.D. has served as Executive Vice President of
Clinical and Quality Management since March 1998. Dr. Marques served as
Executive Vice President and Chief Clinical Officer of Green Spring during 1997
and 1998. Dr. Marques served as Senior Vice President of Green Spring from 1992
to 1997.
GREGORY T. TORRES is President and Chief Executive Officer of Mentor,
positions he has held since 1996. Mr. Torres served as Senior Vice President for
Public Affairs of Mentor from 1992 until 1996.
EMPLOYEES OF THE REGISTRANT
At September 30, 1998, the Company had approximately 11,600 full-time and
part-time employees, which excludes CBHS. The Company believes it has
satisfactory relations with its employees.
INTERNATIONAL OPERATIONS
The Company owns and operates two psychiatric hospitals in London, England
(a 45-bed hospital and a 78-bed hospital) and a 69-bed psychiatric hospital in
Nyon, Switzerland. The Company's international hospital operations are not
material to the Company's overall operations.
ITEM 2. PROPERTIES
GENERAL. The Company's principal executive offices are located in Atlanta,
Georgia; the lease for the Company's headquarters expires in 1999.
BEHAVORIAL MANAGED CARE BUSINESS. MBH leases its 190 offices with terms
expiring between 1998 and 2008. MBH's headquarters are leased and are located in
Columbia, Maryland. The lease for MBH Headquarters expires in 2004.
HUMAN SERVICES BUSINESS. Mentor leases its 174 offices with terms expiring
between 1998 and 2005. Mentor's headquarters are leased and are located in
Boston, Massachusetts with the lease expiring in 2002.
SPECIALITY MANAGED CARE BUSINESS. Allied and CMR lease their 11 offices with
terms expiring between 1999 and 2004.
HEALTHCARE FRANCHISING AND HEALTHCARE PROVIDER BUSINESS. The Company has an
ownership interest in six hospital-based Joint Ventures that operate or manage
10 behavioral healthcare facilities ("JV Hospitals"). The Joint Ventures own six
of the JV Hospitals and lease two of the JV Hospitals from the respective Joint
Venture owners. The remaining two JV Hospitals are owned by the respective Joint
Venture owners.
The Company owns two behavioral healthcare facilities in the United Kingdom
and one in Switzerland. One of the United Kingdom facilities is subject to a
land-lease that expires in 2069.
37
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The management and administration of the delivery of behavioral managed
healthcare services, and the direct provision of behavioral health treatment
services, entail significant risks of liability. In recent years, the Company
and its respective network providers have been subject to a number of actions
and claims alleging malpractice, professional negligence and other related legal
theories. Many of these actions and claims seek substantial damages and
therefore require the defendant to incur significant fees and costs related to
their defense.
From time to time, the Company is subject to various actions and claims
arising from the acts or omissions of its employees, network providers or other
parties. In the normal course of business, the Company receives reports relating
to suicides and other serious incidents involving patients enrolled in its
programs. Such incidents may give rise to malpractice, professional negligence
and other related actions and claims against the Company or its employees and
network providers. As the number of lives covered by the Company and such other
entities grows, the number of providers under contract increases and the nature
and scope of services provided by them in their respective managed care and EAP
businesses expands, actions and claims against such entities (and, in turn,
possible legal liability) predicated on malpractice, professional negligence or
other related legal theories can be expected to increase. See "Cautionary
Statements--Professional Liability; Insurance."
To the extent customers of the Company are entitled to indemnification under
their contracts with the relevant entity relating to liabilities they incur
arising from the operation of the relevant entity's programs, such
indemnification may not be covered under the relevant entity's insurance
policies. In addition, to the extent that certain actions and claims seek
punitive and compensatory damages arising from alleged intentional misconduct by
the Company, such damages, if awarded, may not be covered, in whole or in part,
by the relevant entity's insurance policies. In the ordinary course of business,
such entities are also subject to actions and claims with respect to their
respective employees, network providers and suppliers of services. The Company
does not believe that any pending action against it will have a material adverse
effect on the Company. To date, claims and actions against the Company alleging
professional negligence have not resulted in material liabilities; however,
there can be no assurance that pending or future actions or claims for
professional liability (including any judgments, settlements or costs associated
therewith) will not have a material adverse effect on the Company. See
"--Insurance" and "Risk Factors--Professional Liability; Insurance."
From time to time, the Company receives notifications from and engages in
discussions with various governmental agencies concerning its respective
businesses and operations. As a result of these contacts with regulators, the
Company in many instances implements changes to its operations, revises its
filings with such agencies and/or seeks additional licenses to conduct its
business. In recent years, in response to governmental agency inquiries or
discussions with regulators, the Company has determined to seek licensure as a
single service HMO, TPA or utilization review agent in one or more
jurisdictions.
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists, psychologists and clinical social workers
brought an action under the federal antitrust laws in the United States District
Court for the Southern District of New York against nine behavioral health
managed care organizations, including Merit, CMG, Green Spring and HAI
(collectively, the "Defendants"), entitled Edward M. Stephens, Jose A.
Yaryura-Tobias, Judith Green, Ph.D., Fugen Neziroglu Ph.D., Ona Robinson, Ph.D.,
Laurie A. Baum, C.S.W., Agnes Wohl, C.S.W., and The On-Step Institute For Mental
Health Research Inc., individually and on behalf of all others similarly
situated v. CMG Health, FHC Options, Inc., Foundation Health PsychCare Services,
Inc., Green Spring Health Services, Inc., Human Affairs International, Inc.,
Merit Behavioral Care Corp., MCC Behavioral Care Inc., United Behavioral
Systems, Inc., and Value Behavioral Health, Inc., 96 Civ. 7798 (KMW) (the
"Stephens Case"). The
38
<PAGE>
complaint alleges that the Defendants violated Section 1 of the Sherman Act by
engaging in a conspiracy to fix the prices at which the Defendants purchase
services from mental healthcare providers such as the plaintiffs. The complaint
further alleges that the Defendants engaged in a group boycott to exclude mental
healthcare providers from the Defendants' networks in order to further the goals
of the alleged conspiracy. The complaint also challenges the propriety of the
Defendants' capitation arrangements with their respective customers, although it
is unclear from the complaint whether the plaintiffs allege that the Defendants
unlawfully conspired to enter into capitation arrangements with their respective
customers. The complaint seeks treble damages against the Defendants in an
unspecified amount and a permanent injunction prohibiting the Defendants from
engaging in the alleged conduct which forms the basis of the complaint, plus
costs and attorneys' fees. On May 12, 1998, the District Court granted the
Defendants' motion to dismiss the complaint with prejudice. On May 27, 1998, the
plaintiffs filed a notice of appeal of the District Court's dismissal of their
complaint with the United States Second Circuit Court of Appeals. On November
16, 1998, the Second Circuit court issued a Summary Order affirming the District
Court's decision. The plaintiffs have not filed a petition for rehearing, and
the time allotted for doing so has expired. The plaintiffs have 90 days from the
date of judgment to file a petition for certiorari with the United States
Supreme Court. The plaintiffs have not indicated whether they will file such a
petition. If no petition is filed, or if a filed petition is denied, this matter
will have been concluded. The Company does not believe this matter will have a
material adverse affect on its financial position or results of operations.
On May 26, 1998, the counsel representing the plaintiffs in the Stephens
Case filed an action in the United States District Court for the District of New
Jersey on behalf of a group of thirteen plaintiffs who also purport to represent
an uncertified class of psychiatrists, psychologists and clinical social
workers. This complaint alleges substantially the same violations of federal
antitrust laws by the same nine managed behavioral healthcare organizations that
are the defendants in the Stephens Case. This claim is entitled Russell M.
Holstein, Ph.D., Barbara I. Holstein, Ed.D., Tijen B. Eron, Ph.D., Roger Swift,
C.S.W., Chuck Stannard, C.S.W., R. Anthony Moore, M.D., Maria T. Lymberis, M.D.,
the American Association of Private Practice Psychiatrists, Inc., the Black
Psychiatrists of America, Inc. and the New Jersey Society for Clinical Social
Work, Inc., individually and on behalf of their members and all others similarly
situated, v. Green Spring Health Services, Inc., Human Affairs International,
Inc., Merit Behavioral Care Corp., CMG Health, Inc., Options Healthcare, Inc.,
Value Behavioral Health, Inc., United Behavioral Health, Inc., Foundation Health
Systems, Inc., and MCC Behavioral Care, Inc. The Defendants believe the factual
and legal issues involved in this case are substantially similar to those
involved in the Stephens Case. The Defendants intend to vigorously defend
themselves in this matter. On August 28, 1998, the Defendants filed a joint
motion requesting that the case be: (1) transferred to the Southern District of
New York; (2) alternatively, that all proceedings be stayed pending the Second
Circuit's determination of the Stephens appeal, given the res judicata effect of
the Stephens dismissal; and (3) if the Court proceeds with the case, that the
complaint be dismissed for failure to state a claim for substantially the same
reasons as in Stephens. The plaintiffs have opposed this motion, which was
argued on November 23, 1998. At the conclusion of the November 23 hearing, the
court ruled that the case should be transferred to the Southern District of New
York. The Defendants' motion to dismiss was deemed withdrawn without prejudice
to its resubmission in the Southern District. The plaintiffs have stated that
they intend to appeal the courts transfer order to the United States District
Court for the District of New Jersey. The Company does not believe this matter
will have a material adverse affect on its financial position or results of
operations.
The healthcare industry is subject to numerous laws and regulations. The
subjects of such laws and regulations include, but are not limited to, matters
such as licensure, accreditation, government healthcare program participation
requirements, reimbursement for patient services, and Medicare and Medicaid
fraud and abuse. Recently, government activity has increased with respect to
investigations and/or allegations concerning possible violations of fraud and
abuse and false claims statutes and/or regulations by healthcare providers.
Entities that are found to have violated these laws and regulations may be
39
<PAGE>
excluded from participating in government healthcare programs, subjected to
fines or penalties or required to repay amounts received from the government for
previously billed patient services. The Office of the Inspector General of the
Department of Health and Human Services and the United States Department of
Justice and certain other governmental agencies are currently conducting
inquiries and/ or investigations regarding the compliance by the Company and
certain of its subsidiaries and the compliance by CBHS and certain of its
subsidiaries with such laws and regulations. Certain of the inquiries relate to
the operations and business practices of the Psychiatric Hospital Facilities
prior to the consummation of the Crescent Transactions. In addition, the Company
is also subject to or party to litigation, claims and civil suits relating to
its operations and business practices. In the opinion of management, the Company
has recorded reserves that are adequate to cover litigation, claims or
assessments that have been or may be asserted against the Company arising out of
such litigation, civil suits and governmental inquiries. Furthermore, management
believes that the resolution of such litigation, civil suits and governmental
inquiries will not have a material adverse effect on the Company's financial
position or results of operations; however, there can be no assurance in this
regard.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
40
<PAGE>
PART II
ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company has one class of Common Stock, $0.25 par value per share, which
was listed for trading on the American Stock Exchange through December 30, 1996
(ticker symbol "MGL"), and on the New York Stock Exchange, effective December
31, 1996. As of November 30, 1998, there were 9,428 holders of record of the
Company's Common Stock. The following table sets forth the high and low sales
prices of the Company's Common Stock from October 1, 1996 through the fiscal
year ended September 30, 1998 as reported by the American Stock Exchange
(through December 30, 1996) and the New York Stock Exchange (since December 31,
1996):
<TABLE>
<CAPTION>
COMMON STOCK SALES
PRICES
--------------------
CALENDAR YEAR HIGH LOW
--------------------------- --------- ---------
<S> <C> <C>
1996
Fourth Quarter......................................................... 22 5/8 17 1/2
1997
First Quarter.......................................................... 26 20 5/8
Second Quarter......................................................... 29 1/2 24 1/2
Third Quarter.......................................................... 33 3/4 29 9/16
Fourth Quarter......................................................... 31 3/4 20 9/16
1998
First Quarter.......................................................... 26 18 5/8
Second Quarter......................................................... 28 7/16 24
Third Quarter.......................................................... 26 9 5/8
</TABLE>
The Company did not declare any cash dividends during fiscal 1997 or 1998.
As of November 30, 1998, the Company was prohibited from paying dividends on its
Common Stock under the terms of the New Credit Agreement.
Pursuant to the Green Spring Minority Stockholder Conversion, the Company
issued the following number of shares of Common Stock to the following minority
stockholders of Green Spring in exchange for their interests in Green Spring:
<TABLE>
<CAPTION>
<S> <C>
Blue Cross/Blue Shield of New Jersey 889,456
Health Services Corporation 163,148
Independence Blue Cross 889,456
Regence Blue Shield 889,456
</TABLE>
The sale of such Common Stock to the minority stockholders of Green Spring
was made pursuant to the exemption from registration under the Securities Act of
1933, as amended (the "Securities Act"), contained in Section 3(a)(10) of the
Securities Act. As a result of the Green Spring Minority Stockholder Conversion,
the Company owns 100% of Green Spring.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical consolidated financial
information of the Company for each of the five years in the period ended
September 30, 1998. The summary of operations and balance sheet data for the
five years ended and as of September 30, 1998, presented below, have been
derived from, and should be read in conjunction with, the Company's audited
consolidated financial
41
<PAGE>
statements and the notes thereto. The selected financial data set forth below
should be read in conjunction with the Company's consolidated financial
statements and the notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere herein.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------
1994 1995 1996 1997 1998
--------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net revenue............................................. $ 904,646 $1,151,736 $1,345,279 $1,210,696 $1,512,454
Salaries, cost of care and other operating expenses..... 661,436 863,598 1,064,445 978,513 1,294,481
Bad debt expense........................................ 70,623 92,022 81,470 46,211 4,977
Equity in loss of CBHS.................................. -- -- -- 8,122 31,878
Depreciation and amortization........................... 28,354 38,087 48,924 44,861 54,885
Amortization of reorganization value in excess of
amounts allocable to identifiable assets.............. 31,200 26,000 -- -- --
Interest, net........................................... 39,394 55,237 48,017 45,377 75,375
ESOP expense............................................ 49,197 73,527 -- -- --
Stock option expense (credit)........................... 10,614 (467) 914 4,292 (5,623)
Managed Care integration costs.......................... -- -- -- -- 16,962
Loss on Crescent Transactions........................... -- -- -- 59,868 --
Unusual items, net...................................... 71,287 57,437 37,271 357 458
Income (loss) before income taxes, minority interest and
extraordinary items................................... (57,459) (53,705) 64,238 23,095 39,061
Provision for (benefit from) income taxes............... (10,504) (11,082) 25,695 9,238 20,033
Income (loss) before minority interest and extraordinary
items................................................. (46,955) (42,623) 38,543 13,857 19,028
Minority interest....................................... 48 340 6,160 9,102 5,296
Income (loss) before extraordinary items................ (47,003) (42,963) 32,383 4,755 13,732
Extraordinary items-losses on early extinguishments or
discharge of debt..................................... (12,616) -- -- (5,253) (33,015)
Net income (loss)....................................... $ (59,619) $ (42,963) $ 32,383 $ (498) $ (19,283)
INCOME (LOSS) PER COMMON SHARE--BASIC:
Income (loss) before extraordinary items................ $ (1.78) $ (1.54) $ 1.04 $ 0.17 $ 0.45
Loss from extraordinary items........................... (0.48) -- -- (0.18) (1.07)
Net Income (loss)....................................... $ (2.26) $ (1.54) $ 1.04 $ (0.02) $ (0.63)
INCOME (LOSS) PER COMMON SHARE--DILUTED:
Income (loss) before extraordinary items................ $ (1.78) $ (1.54) $ 1.02 $ 0.16 $ 0.44
Loss from extraordinary items........................... (0.48) -- -- (0.18) (1.06)
Net income (loss)....................................... $ (2.26) $ (1.54) $ 1.02 $ (0.02) $ (0.62)
BALANCE SHEET DATA (END OF PERIOD):
Current assets.......................................... $ 324,627 $ 305,575 $ 338,150 $ 507,038 $ 399,724
Current liabilities..................................... 215,048 214,162 274,316 219,376 454,766
Property and equipment, net............................. 494,345 488,767 495,390 109,214 177,169
Total assets............................................ 961,480 983,558 1,140,137 895,620 1,916,290
Total debt and capital lease obligations................ 536,129 541,569 572,058 395,294 1,225,646
Stockholders' equity.................................... 56,221 88,560 121,817 158,250 187,635
</TABLE>
42
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
SEPTEMBER 30, 1998
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company historically derived the majority of its revenue from providing
behavioral healthcare services in an inpatient setting prior to the consummation
of the Crescent Transactions on June 17, 1997. Payments from third-party payors
are the principal source of revenue for most behavioral healthcare providers. In
the early 1990's, many third party payors sought to control the cost of
providing care to their patients by instituting managed care programs or seeking
the assistance of managed care companies. Providers participating in managed
care programs agree to provide services to patients for a discount from
established rates, which generally results in pricing concessions by the
providers and lower margins. Additionally, managed care programs generally
encourage alternatives to inpatient treatment settings and reduce utilization of
inpatient services. As a result, third-party payors established managed care
programs or engaged managed care companies in many areas of healthcare,
including behavioral healthcare. The Company, which until the consummation of
the Crescent Transactions on June 17, 1997, was the largest operator of
psychiatric hospitals in the United States, was adversely affected by the
adoption of managed care programs by the third-party payors.
Prior to the first quarter of fiscal 1996, the Company was not a provider of
behavioral managed healthcare services. During the first quarter of fiscal 1996,
the Company acquired a 61% ownership interest in Green Spring. At that time, the
Company intended to become a fully integrated behavioral healthcare provider by
combining the behavorial manged healthcare products offered by Green Spring with
the direct treatment services offered by the Company's psychiatric hospitals.
The Company believed that an entity that participated in both the managed care
and the provider segments of the behavioral healthcare industry could more
efficiently provide and manage behavioral healthcare for insured populations
than an entity that was solely a managed care company. The Company also believed
that earnings from its behavioral managed care business would offset, in part,
the negative impact on the financial performance of its psychiatric hospitals
caused by managed care. Green Spring was the Company's first significant
involvement in behavioral managed healthcare. During the first quarter of fiscal
1998, pursuant to the Green Spring Minority Stockholder Conversion, the minority
stockholders of Green Spring converted their interests in Green Spring into an
aggregate of 2,831,516 shares of Magellan Common Stock.
Subsequent to the Company's acquisition of Green Spring, the growth of the
behavioral managed healthcare industry accelerated. Under the Company's majority
ownership, Green Spring increased its base of covered lives from 12.0 million as
of the end of calendar year 1995 to 21.1 million as of the end of calendar year
1997, a compound annual growth rate of over 32%. While growth in the industry
was accelerating, the behavioral managed healthcare industry also began to
consolidate. The Company concluded that this consolidation presented an
opportunity for the Company to increase its participation in the behavioral
managed healthcare industry, which the Company believed offered growth and
earnings prospects superior to those of the psychiatric hospital industry.
Therefore, the Company decided to sell its domestic psychiatric facilities to
obtain capital for expansion in the behavioral managed healthcare business.
On June 17, 1997, the Company sold the Psychiatric Hospital Facilities,
which comprised substantially all of its domestic acute care psychiatric
hospitals and residential treatment facilities, to Crescent for $417.2 million
in cash (before costs of approximately $16.0 million) and certain other
consideration. The sale of the Psychiatric Hospital Facilities provided the
Company with approximately $200 million of net cash proceeds, after debt
repayment, for use in implementing its business strategy to increase its
participation in the managed healthcare industry. The Company used the net cash
proceeds of approximately $200 million to finance the acquisitions of HAI and
Allied in December 1997.
43
<PAGE>
The Company further implemented its business strategy through the Merit
acquisition. See "Business--Recent Developments--The Merit Acquisition".
RESULTS OF OPERATIONS
The following tables summarize, for the periods indicated, operating results
by business segment (in thousands).
<TABLE>
<CAPTION>
BEHAVIORAL HUMAN SPECIALTY HEALTHCARE HEALTHCARE CORPORATE
1996 MANAGED CARE SERVICES MANAGED CARE FRANCHISING PROVIDER OVERHEAD CONSOLIDATED
- ---------------------------- -------------- --------- --------------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenue................. $ 230,755 $ 69,813 $ -- $ -- $1,044,711 $ -- $ 1,345,279
-------------- --------- ------- ------------ ----------- ----------- -------------
Salaries, cost of care and
other operating expenses.. 203,860 59,670 -- -- 766,129 34,786 1,064,445
Bad debt expense............ 1,306 233 -- -- 79,931 -- 81,470
Equity in loss of CBHS...... -- -- -- -- -- -- --
-------------- --------- ------- ------------ ----------- ----------- -------------
205,166 59,903 -- -- 846,060 34,786 1,415,915
-------------- --------- ------- ------------ ----------- ----------- -------------
Segment profit
(loss)(1)................. $ 25,589 $ 9,910 $ -- $ -- $ 198,651 $ (34,786) $ 199,364
-------------- --------- ------- ------------ ----------- ----------- -------------
-------------- --------- ------- ------------ ----------- ----------- -------------
</TABLE>
<TABLE>
<CAPTION>
BEHAVIORAL HUMAN SPECIALTY HEALTHCARE HEALTHCARE CORPORATE
1997 MANAGED CARE SERVICES MANAGED CARE FRANCHISING PROVIDER OVERHEAD CONSOLIDATED
- ------------------------ -------------- ----------- --------------- ------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenue............. $ 369,974 $ 88,331 $ -- $ 22,739 $ 729,652 $ -- $ 1,210,696
-------------- ----------- ------- ------------- ----------- ----------- -------------
Salaries, cost of care
and other operating
expenses.............. 332,877 77,648 2,303 3,653 536,454 25,578 978,513
Bad debt expense........ 78 (12) -- -- 46,145 -- 46,211
Equity in loss of
CBHS.................. -- -- -- 8,122 -- -- 8,122
-------------- ----------- ------- ------------- ----------- ----------- -------------
332,955 77,636 2,303 11,775 582,599 25,578 1,032,846
-------------- ----------- ------- ------------- ----------- ----------- -------------
Segment profit
(loss)(1)............. $ 37,019 $ 10,695 $ (2,303) $ 10,964 $ 147,053 $ (25,578) $ 177,850
-------------- ----------- ------- ------------- ----------- ----------- -------------
-------------- ----------- ------- ------------- ----------- ----------- -------------
</TABLE>
<TABLE>
<CAPTION>
BEHAVIORAL HUMAN SPECIALTY HEALTHCARE HEALTHCARE CORPORATE
1998 MANAGED CARE SERVICES MANAGED CARE FRANCHISING PROVIDER OVERHEAD CONSOLIDATED
- ------------------------ -------------- --------- -------------- ------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenue............. $1,039,038 $ 141,032 $ 143,503 $ 55,625 $ 133,256 $ -- $ 1,512,454
-------------- --------- -------------- ------------- ----------- ----------- -------------
Salaries, cost of care
and other operating
expenses.............. 900,478 124,752 140,375 9,071 104,055 15,750 1,294,481
Bad debt expense........ 1,368 787 -- -- 2,822 -- 4,977
Equity in loss of
CBHS.................. -- -- -- 31,878 -- -- 31,878
-------------- --------- -------------- ------------- ----------- ----------- -------------
901,846 125,539 140,375 40,949 106,877 15,750 1,331,336
-------------- --------- -------------- ------------- ----------- ----------- -------------
Segment profit
(loss)(1)............. $ 137,192 $ 15,493 $ 3,128 $ 14,676 $ 26,379 $ (15,750) $ 181,118
-------------- --------- -------------- ------------- ----------- ----------- -------------
-------------- --------- -------------- ------------- ----------- ----------- -------------
</TABLE>
(1) Segment profit is the measure of profitability used by management to assess
the operating performance of each business segment. See Note 15, "Business
Segment Information", to the Company's audited consolidated financial
statements appearing elsewhere herein.
FISCAL 1997 COMPARED TO FISCAL 1998
BEHAVIORAL MANAGED CARE. Revenue increased 180.8% or $669.0 million, to
$1,039.0 million for fiscal 1998 from $370.0 million in fiscal 1997. Salaries,
cost of care and other operating expenses increased 170.5%, or $567.6 million,
to $900.5 million for fiscal 1998 from $332.9 million in fiscal 1997. The
increases resulted primarily from the acquisitions of HAI and Merit in fiscal
1998 and internal growth at Green Spring. The revenues and salaries, cost of
care and other operating expenses of HAI and Merit, in the aggregate, were
$559.8 million and $480.6 million, respectively, for fiscal 1998. Behavioral
managed care revenues and segment profit increased as a result of the award of
several new contracts in fiscal 1997 and 1998 and significant improvements in
negotiated rates and terms of the TennCare contract in fiscal 1998. Bad debt
expense was not significant in fiscal 1997 or 1998.
44
<PAGE>
HUMAN SERVICES. Revenue increased 59.7%, or $52.7 million, to $141.0
million for fiscal 1998 from $88.3 million in fiscal 1997. Salaries, cost of
care and other operating expenses increased 60.7%, or $47.2 million, to $124.8
million in fiscal 1998 from $77.6 million in fiscal 1997. The increases were
attributable to the seven Human Services' Acquisitions consummated in fiscal
1998 and internal growth. Placements in Mentor homes increased 19.6% in fiscal
1998 to 3,350 by September 30, 1998. Bad debt expense was not significant in
fiscal 1997 or 1998.
SPECIALTY MANAGED CARE. Revenue was $143.5 million in fiscal 1998 compared
to $0 in fiscal 1997. Salaries, cost of care and other operating expenses were
$140.4 million in fiscal 1998 compared to $2.3 million in fiscal 1997. The
increase in revenues and salaries, cost of care and other operating expenses
were primarily related to the Allied acquisition. Allied's revenues and
salaries, cost of care and other operating expenses were $142.3 million and
$135.4 million, respectively, for fiscal 1998. Fiscal 1997 salaries, cost of
care and other operating expenses represent start-up costs for CMR, the
Company's initial involvement in the specialty managed care business.
HEALTHCARE FRANCHISING. Revenue increased 144.6%, or $32.9 million, to
$55.6 million in fiscal 1998 from $22.7 million in fiscal 1997. Salaries and
other operating expenses increased 148.3%, or $5.4 million, to $9.1 million in
fiscal 1998 from $3.7 million in fiscal 1997. Equity in loss of CBHS increased
$23.8 million to $31.9 million in fiscal 1998. The increases resulted primarily
from the effect of the consummation of the Crescent Transactions on June 17,
1997, resulting in only 106 days of franchise operations and CBHS operations in
fiscal 1997, offset by declining operating performance at CBHS during the
comparable period in fiscal 1998. See "--Impact of Crescent Transactions on
Results of Operations." Also, see Note 4, "Investment in CBHS," to the Company's
audited consolidated financial statements set forth elsewhere herein.
HEALTHCARE PROVIDER. Revenue decreased 81.7%, or $596.4 million, to $133.3
million in fiscal 1998 from $729.7 million in fiscal 1997. Salaries, cost of
care and other operating expenses decreased 80.6%, or $432.4 million, to $104.1
million in fiscal 1998 from $536.5 million in fiscal 1997. Bad debt expense
decreased $43.3 million to $2.8 million in fiscal 1998 from $46.1 million in
fiscal 1997. The decreases resulted primarily from the effect of the
consummation of the Crescent Transactions on June 17, 1997, following which
revenue, salaries and other operating expenses and bad debt expense from the
Psychiatric Hospital Facilities and other facilities transferred to CBHS were no
longer reflected in the Company's financial statements. During fiscal 1997 and
1998, the Company recorded revenue of $27.4 million and $7.0 million,
respectively, for settlements and adjustments related to reimbursement issues
("Cost Report Settlements") with respect to psychiatric hospitals owned or
formerly owned by the Company. During fiscal 1997 and 1998, the Company recorded
reductions of expenses of $7.5 million and $4.1 million, respectively, as a
result of updated actuarial estimates related to malpractice claim reserves.
These reductions resulted primarily from updates to actuarial assumptions
regarding the Company's expected losses for more recent policy years. These
revisions are based on changes in expected values of ultimate losses resulting
from the Company's claim experience, and increased reliance on such claim
experience. While management and its actuaries believe that the present reserve
is reasonable, ultimate settlement of losses may vary from the amount recorded
and result in additional fluctuations in income in future periods. The fourth
quarter of fiscal 1997 included increases to income before income taxes and
minority interest of approximately $6.4 million for revenue and bad debt
adjustments related to accounts receivable retained by the Company that were
generated by the hospitals operated by CBHS. Such adjustments reflected a change
in estimates of contractual allowances and allowance for doubtful accounts of
such receivables based on the collection activity subsequent to the completion
of the Crescent Transactions.
CORPORATE OVERHEAD. Salaries and other operating expenses attributable to
the Company's corporate headquarters' decreased 38.4%, or $9.8 million, due
primarily to the transfer of personnel and overhead to CBHS and the healthcare
franchising segment as a result of the Crescent Transactions.
45
<PAGE>
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
22.3%, or $10.0 million, to $54.9 million in fiscal 1998 from $44.9 million
fiscal 1997. The increase was primarily attributable to increases in
depreciation and amortization resulting from the HAI, Allied and Merit
acquisitions of $26.8 million, in the aggregate, during 1998, offset by the
effect of the consummation of the Crescent Transactions, whereby the Psychiatric
Hospital Facilities were sold to Crescent.
INTEREST, NET. Interest expense, net, increased 66.1% or $30.0 million to
$75.4 million in fiscal 1998 from $45.4 million in fiscal 1997. The increase was
primarily the result of interest expense incurred on borrowings used to fund the
Merit acquisition and related transactions offset by lower interest expense due
to lower average borrowings and higher interest income due to temporary
investments of the cash received in the Crescent Transactions through December
5, 1997.
OTHER ITEMS. Stock option expense for fiscal 1998 decreased $9.9 million
compared to fiscal 1997 primarily due to fluctuations in the market price of the
Company's common stock.
The Company recorded Managed Care integration costs of $17.0 million for
fiscal 1998. See Note 11, "Managed Care Integration Plan and Costs," to the
Company's audited consolidated financial statements set forth elsewhere herein.
The Company recorded unusual items, net, of $0.4 million, during fiscal
1997, which consisted of a $5.4 million pre-tax gain on the sale of previously
closed psychiatric hospitals offset by a $4.2 million charge for the closure of
three psychiatric hospitals and one general hospital and a $1.6 million charge
related to the termination of an agreement to sell the Company's European
Hospitals. The Company recorded unusual items, net, of $0.5 million, during
fiscal 1998, for a $3.5 million charge related to the termination of an
agreement to sell CBHS offset by the net gain on the sale of hospitals of $3.0
million that were previously closed.
The Company's effective income tax rate increased to 51.3% for fiscal 1998
compared to 40% in fiscal 1997. The increase was primarily attributable to
non-deductible goodwill amortization of approximately $11.0 million resulting
from the Merit acquisition in fiscal 1998.
Minority interest decreased $3.8 million during fiscal 1998, compared to
fiscal 1997. The decrease was primarily attributable to the Green Spring
Minority Stockholder Conversion in January 1998 offset by Green Spring's net
income growth in fiscal 1998 through January 1998.
The Company recorded extraordinary losses on early extinguishment of debt,
net of tax, of $5.3 million and $33.0 million during fiscal 1997 and 1998,
respectively, related primarily to the termination of its then existing credit
agreements in fiscal 1997 and 1998 and the extinguishment of the Magellan
Outstanding Notes in fiscal 1998. See Note 7, "Long-Term Debt, Capital Lease
Obligations and Operating Leases," to the Company's audited consolidated
financial statements set forth elsewhere herein.
FISCAL 1996 COMPARED TO FISCAL 1997.
BEHAVIORAL MANAGED CARE. Revenue increased 60.3%, or $139.2 million, to
$370.0 million in fiscal 1997 from $230.8 million in fiscal 1996. Salaries, cost
of care and other operating expenses increased 63.3%, or $129.0 million, to
$332.9 million in fiscal 1997 from $203.9 million in fiscal 1996. The increases
resulted primarily from the inclusion of a full year of Green Spring operations
in fiscal 1997 results and internal growth. Revenue and segment profit increased
as a result of the award of several new contracts in the fourth quarter of
fiscal 1996 and fiscal 1997, resulting in a 22% increase in covered lives to
16.6 million by September 30, 1997. Bad debt expense was not significant in
fiscal 1996 or 1997.
HUMAN SERVICES. Revenue increased 26.5%, or $18.5 million, to $88.3 million
in fiscal 1997 from $69.8 million in fiscal 1996. Salaries, cost of care and
other operating expenses increased 30.1%, or $17.9 million, to $77.6 million in
fiscal 1997 from $59.7 million in fiscal 1996. The increases were primarily
attributable to internal growth. Placements in Mentor homes increased 23% to
2,800 by September 30, 1997, while operating costs reflected program start-up
costs and overhead investments necessary to maintain internal growth. Bad debt
expense was not significant in fiscal 1996 or 1997.
46
<PAGE>
SPECIALTY MANAGED CARE. Fiscal 1997 salaries, cost of care and other
operating expenses represent start-up costs for CMR, the Company's initial
involvement in the specialty managed care business.
HEALTHCARE FRANCHISING. Revenue was $22.7 million for fiscal 1997. Salaries
and other operating expenses were $3.7 million in fiscal 1997. Equity in loss of
CBHS was $8.1 million in fiscal 1997. Operations for fiscal 1997 began with the
consummation of the Crescent Transactions.
HEALTHCARE PROVIDER. Revenue decreased 30.2%, or $315.1 million, to $729.7
million in fiscal 1997 from $1,044.7 million in fiscal 1996. Salaries, and other
operating expenses decreased 30.0%, or $229.7 million, to $536.5 million in
fiscal 1997 from $766.1 million in fiscal 1996. Bad debt expense decreased
42.3%, or $33.9 million, to $46.1 million in fiscal 1997 from $80.0 million in
fiscal 1996. The decrease resulted primarily from: (i) the effect of the
consummation of the Crescent Transactions on June 17, 1997, following which
revenue, salaries and other operating expenses and bad debt expense from the
Psychiatric Hospital Facilities and other facilities transferred to CBHS was no
longer recorded as part of the Company's revenue; (ii) the closure of hospitals
in fiscal 1996 and 1997; and (iii) reduced equivalent patient days at the
Company's operating hospitals as a result of reduced average length of stay.
During fiscal 1996 and 1997, the Company recorded revenue of $28.3 million and
$27.4 million, respectively, for Cost Report Settlements with respect to
Psychiatric Hospital Facilities owned or formerly owned by the Company. The Cost
Report Settlements related primarily to certain reimbursement issues associated
with the Company's financial reorganization in fiscal 1992 and the early
extinguishment of long-term debt in fiscal 1994. During fiscal 1996 and 1997,
the Company recorded reductions of expenses of approximately $15.3 million and
$7.5 million, respectively, as a result of updated actuarial estimates related
to malpractice claim reserves. These reductions resulted primarily from updates
to actuarial assumptions regarding the Company's expected losses for more recent
policy years. These revisions are based on changes in expected values of
ultimate losses resulting from the Company's claim experience, and increased
reliance on such claim experience.
CORPORATE OVERHEAD. Salaries and other operating expenses attributable to
the Company's headquarters decreased 26.5%, or $9.2 million, due primarily to
the transfer of personnel and overhead to CBHS and the healthcare franchising
business as a result of the Crescent Transactions.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
8.3%, or $4.1 million to $44.9 million in fiscal 1997 from $48.9 million in
fiscal 1996. The decrease was primarily attributable to the effect of the
consummation of the Crescent Transactions, whereby the Psychiatric Hospital
Facilities were sold to Crescent, offset by increases in depreciation and
amortization resulting from the Green Spring acquisition.
INTEREST, NET. Interest, net, decreased 5.5%, or $2.6 million to $45.4
million in fiscal 1997 from $48.0 million in fiscal 1996. The decrease was
primarily the result of lower interest expense due to lower average borrowings
and higher interest income due to temporary investments of the cash received in
the Crescent Transactions. Fiscal 1996 included approximately $5.0 million of
interest income related to income tax refunds from the State of California for
the Company's income tax returns for fiscal 1982 through 1989.
OTHER ITEMS. Stock option expense for fiscal 1997 increased $3.4 million
from fiscal 1996 primarily due to fluctuations in the market price of the
Company's Common Stock.
The Company recorded a loss on the Crescent Transactions of approximately
$59.9 million during fiscal 1997. See Note 3, "Crescent Transactions," to the
Company's audited consolidated financial statements set forth herein.
During fiscal 1996, the Company recorded unusual items of $37.3 million.
Included in the unusual charges was the resolution of a billing dispute in
August 1996 between the Company and a group of insurance carriers that arose in
fiscal 1996 related to matters originating in the 1980's. As part of the
settlement of these claims, certain related payor matters and associated legal
fees, the Company
47
<PAGE>
recorded a charge of approximately $30.0 million. The Company is paying the
insurance settlement in twelve installments over a three-year period. The
Company's remaining obligation to make the settlement payments in fiscal 1999 is
supported by a cash collateralized letter of credit. Other unusual items
included: (i) charges of approximately $4.1 million during fiscal 1996 related
to the closure of psychiatric hospitals; (ii) a charge of approximately $1.2
million related to impairment losses; and (iii) charges of approximately $2.0
million related to severance costs for personnel reductions.
Minority interest increased $2.9 million during fiscal 1997 compared to
fiscal 1996. The increase was primarily due to: (i) the Company acquiring a
controlling interest in Green Spring in December 1995; (ii) Green Spring's
internal growth subsequent to the acquisition date; and (iii) increased net
income from hospital-based joint ventures.
IMPACT OF CRESCENT TRANSACTIONS ON RESULTS OF OPERATIONS.
The Company owns a 50% equity interest in CBHS, from which it receives the
Franchise Fees. The Franchise Fees potentially represent a significant portion
of the Company's earnings and cash flows.
Based on operational projections prepared by CBHS management for the fiscal
year ended September 30,1999, and based on CBHS's results of operations through
September 30,1998, the Company believes that CBHS will be unable to pay the full
amount of the Franchise Fees it is contractually obligated to pay the Company
during fiscal 1999. CBHS paid $40.6 million of Franchise Fees to the Company
during fiscal 1998. The Company estimates that CBHS will be able to pay $0 to
$15.0 million of Franchise Fees in fiscal 1999. The Company expects to reflect
Franchise Fee revenue in its statements of operations for future periods which
is lower in amount than that specified in the Master Franchise Agreement if CBHS
does not generate sufficient cash flows to allow for payment of future Franchise
Fees. Based on the amount of unpaid Franchise Fees ($38 million as of September
30, 1998) the Company exercised the limited management rights available to it
under the Master Franchise Agreement and, with CBHS's board support, assisted in
making operational and management changes at CBHS aimed at improving
profitability and cash flows. The Company has since restored all management
rights to the CBHS board. See "Business--Charter Advantage"
IMPACT OF THE MERIT ACQUISITION ON RESULTS OF OPERATIONS.
As of September 30, 1998, the Company had approximately 61.6 million covered
lives under behavioral managed healthcare contracts. The Company believes it has
the number one market position in each of the major product markets in which it
competes, according to enrollment data reported in OPEN MINDS. The Company
believes that the Merit acquisition creates opportunities for the Company to
achieve significant cost savings in its behavioral managed healthcare business.
Management believes that cost saving opportunities will result from leveraging
fixed overhead over a larger revenue base and an increased number of covered
lives and from reducing duplicative corporate and regional selling, general and
administrative expenses. As a result, the Company expects to achieve
approximately $60.0 million of cost savings in its behavioral managed healthcare
business on an annual basis by September 30, 1999. Such cost savings are
measured relative to the combined operating expenses of Green Spring, HAI and
Merit prior to the Merit acquisition. The Company spent approximately $13.0
million during fiscal 1998 and expects to spend $10.0 million to $15.0 million
during fiscal 1999 in connection with achieving such cost savings.
The Company expects to record additional managed care integration costs
during future periods to the extent the integration of Green Spring, HAI and
Merit results in additional facility closures at HAI and Green Spring and for
integration costs incurred that benefit future periods. The full implementation
of the integration plan is expected to be completed by fiscal 2000.
48
<PAGE>
BEHAVIORAL MANAGED HEALTHCARE RESULTS OF OPERATIONS.
The Company's behavioral managed healthcare segment results of operations
are subject to significant fluctuations on a quarterly basis. These potential
earnings fluctuations may result from: (i) changes in utilization levels by
enrolled members of the Company's risk-based contracts; (ii) performance-based
contractual adjustments to revenue, reflecting utilization results or other
performance measures; (iii) retroactive contractual adjustments under commercial
contracts and CHAMPUS contracts ("CHAMPUS Adjustments"); (iv) retrospective
membership adjustments and (v) timing of implementation of new contracts and
enrollment changes.
HISTORICAL LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. The Company's net cash provided by (used in)
operating activities was $101.9 million, $73.6 million and $(4.2) million for
fiscal 1996, 1997 and 1998 respectively. The decrease in cash provided by
operating activities in fiscal 1998 compared to fiscal 1997 was primarily the
result of: (i) higher interest payments ($54.4 million and $95.2 million in
fiscal 1997 and 1998, respectively,) as a result of the Merit acquisition; (ii)
reduced cash flows from the provider business, net of Franchise Fees received
and (iii) the funding of liabilities related to the Merit acquisition. The
decrease in net cash provided by operating activities in fiscal 1997 compared to
fiscal 1996 was primarily the result of: (i) higher income tax payments ($9.3
million and $18.4 million in fiscal 1996 and fiscal 1997, respectively; (ii)
$5.0 million of interest income related to income tax refunds from the State of
California in fiscal 1996; (iii) higher insurance settlement payments ($24.6
million in fiscal 1996 and $28.5 million in fiscal 1997); and (iv) reduced cash
flows from the provider business, net of franchise fees received.
INVESTING ACTIVITIES. The Company acquired a 61% ownership interest in
Green Spring during the first quarter of fiscal 1996. The consideration paid for
Green Spring and related acquisition costs resulted in the use of cash of
approximately $87.2 million compared to approximately $50.9 million for
acquisitions and investments in businesses, including CBHS, during fiscal 1997.
The Crescent Transactions resulted in net proceeds of $374.2 million, during
fiscal 1997 and 1998, consisting of $393.7 million related to the sale of
property and equipment to Crescent and CBHS less $19.5 million in costs and
construction obligations.
The Company made $20.0 million of cash capital contributions to CBHS during
fiscal 1997. The Company is not obligated to make any additional capital
contributions or advances to CBHS.
The Company utilized $1.0 billion in funds, net of cash acquired, for
acquisitions and investments in businesses, including the Allied, HAI, Merit and
Human Services Acquisitions during fiscal 1998.
FINANCING ACTIVITIES. The Company borrowed approximately $104.8 million,
$203.6 million and $1.2 billion during fiscal 1996, 1997 and 1998, respectively.
The fiscal 1996 borrowings primarily funded the Green Spring acquisition and
$35.0 million of treasury stock purchases. The fiscal 1997 borrowings primarily
funded the repayment of variable rate secured notes and other long-term debt
(including the refinancing of a previous revolving credit agreement),
acquisitions and working capital needs. The fiscal 1998 borrowings primarily
funded the Merit acquisition and related long-term debt refinancing.
The Company repaid approximately $85.8 million, $390.3 million and $438.6
million of debt and capital lease obligations during fiscal 1996, 1997 and 1998,
respectively. The fiscal 1997 repayments related primarily to a previous
revolving credit agreement and repaying other indebtedness as a result of the
Crescent Transactions. The fiscal 1998 repayments related primarily to the
extinguishment of the Magellan Outstanding Notes as part of the Merit
acquisition.
On January 25, 1996, the Company sold 4.0 million shares of Common Stock
along with the Rainwater-Magellan Warrant pursuant to a private placement. The
Rainwater-Magellan Warrant, which expires in January, 2000, entitles the holders
to purchase 2.0 million shares of Common Stock at a per share price of $26.15,
subject to adjustment for certain dilutive events, and provides registration
rights
49
<PAGE>
for the shares of Common Stock underlying the warrant. The warrant became
exercisable on January 25, 1997. The Company received proceeds of approximately
$68.6 million, net of issuance costs, from the Private Placement. Approximately
$68.0 million of the proceeds were used to repay outstanding borrowings related
to the Green Spring acquisition.
The Company issued approximately 2.6 million warrants to Crescent and COI
for $25.0 million in cash as part of the Crescent Transactions during fiscal
1997.
On September 27, 1996, the Company repurchased approximately 4.0 million
shares of Common Stock for approximately $73.5 million, including transaction
costs, pursuant to a "Dutch Auction" self-tender offer to its stockholders. On
November 1, 1996, the Company announced that its board of directors had approved
the repurchase of an additional 3.0 million shares of Common Stock from time to
time subject to the terms of the Company's then current credit agreements.
During fiscal 1998, the Company repurchased approximately 0.7 million shares of
its Common Stock for approximately $14.4 million.
As of September 30, 1998, the Company had approximately $92.5 million of
availability under the Revolving Facility of the New Credit Agreement, excluding
approximately $17.5 million of availability reserved for certain letters of
credit. The Company was in compliance with all debt covenants as of September
30, 1998.
OUTLOOK-LIQUIDITY AND CAPITAL RESOURCES
The interest payments on the Notes and interest and principal payments on
indebtedness outstanding pursuant to the New Credit Agreement represent
significant liquidity requirements for the Company. Borrowings under the New
Credit Agreement will bear interest at floating rates and will require interest
payments on varying dates depending on the interest rate option selected by the
Company. Borrowings pursuant to the New Credit Agreement include $550 million
under the Term Loan Facility and up to $150 million under the Revolving
Facility. Commencing in the second quarter of fiscal 1999, the Company will be
required to make principal payments with respect to the Term Loan Facility. The
Company will be required to repay the principal amount of borrowings outstanding
under the Term Loan Facility provided for in the New Credit Agreement and the
principal amount of the Notes in the years and amounts set forth in the
following table:
<TABLE>
<CAPTION>
FISCAL YEAR PRINCIPAL AMOUNT
- ------------- -----------------
<S> <C>
1999 $ 19.8
2000 32.4
2001 38.9
2002 49.4
2003 92.0
2004 156.5
2005 131.8
2006 29.2
2007 --
2008 625.0
</TABLE>
50
<PAGE>
In addition, any amounts outstanding under the Revolving Credit Facility of
the New Credit Agreement mature in February 2004.
The Company has finalized its plans for the integration of the businesses of
Green Spring, HAI and Merit. The Company expects to achieve approximately $60.0
million of cost savings on an annual basis by September 30, 1999. Such cost
savings are measured relative to the combined operating expenses of Green
Spring, HAI and Merit prior to the Merit acquisition. The Company spent
approximately $13.0 million during fiscal 1998 in connection with achieving such
cost savings, including expenses related to reducing duplicative personnel in
its managed care organizations, contractual terminations for eliminating excess
real estate (primarily locations under operating leases) and other related
costs. The Company expects to spend another $10.0 million to $15.0 million in
fiscal 1999 related to achieving such cost savings.
POTENTIAL PURCHASE PRICE ADJUSTMENTS. During December 1997, the Company
purchased HAI and Allied for approximately $122.1 million and $70.0 million,
respectively, excluding transaction costs. In addition, the Company incurred the
obligation to make contingent payments to the former owners of HAI and Allied.
With respect to HAI, the Company may be required to make additional contingent
payments of up to $60.0 million annually to Aetna over the five-year period
subsequent to closing. The Company is obligated to make contingent payments
under two separate calculations as follows: In respect of each Contract Year (as
defined), the Company may be required to pay to Aetna the "Tranche 1 Payments"
(as defined) and the "Tranche 2 Payments" (as defined). "Contract Year" means
each of the twelve-month periods ending on the last day of December in 1998,
1999, 2000, 2001, and 2002.
Upon the expiration of each Contract Year, the Tranche 1 Payment shall vest
with respect to such Contract Year in an amount equal to the product of (i) the
Tranche 1 Cumulative Incremental Members (as defined) for such Contract Year and
(ii) the Tranche 1 Multiplier (as defined) for such Contract Year. The vested
amount of Tranche 1 Payment shall be zero with respect to any Contract Year in
which the Tranche 1 Cumulative Incremental Members is a negative number.
Furthermore, in the event that the number of Tranche 1 Cumulative Incremental
Members with respect to any Contract Year is a negative number due to a decrease
in the number of Trance 1 Cumulative Incremental Members for such Contract Year
(as compared to the immediately preceding Contract Year), Aetna will forfeit the
right to receive a certain portion (which may be none or all) of the vested and
unpaid amounts of the Tranche 1 Payment relating to preceding Contract Years.
"Tranche 1 Cumulative Incremental Members" means, with respect to any
Contract Year, (i) the number of Equivalent Members (as defined) serviced by the
Company during such Contract Year for Tranche 1 Members, minus (ii) (A) for each
Contract Year other than the initial Contract Year, the number of Equivalent
Members serviced by the Company for Tranche 1 Members during the immediately
preceding Contract Year or (B) for the initial Contract Year, the number of
Tranche 1 Members as of September 30, 1997, subject to certain upward
adjustments. There were 3,761,253 Tranche 1 Members for the initial Contract
Year, prior to such upward adjustments. "Tranche 1 Members" are members of
managed behavioral healthcare plans for whom the Company provides services in
any of specified categories of products or services. "Equivalent Members" for
any Contract Year equals the aggregate Member Months for which the Company
provides services to a designated category or categories of members during the
applicable Contract Year divided by 12. "Member Months" means, for each member,
the number of months for which the Company provides services and is compensated.
The "Tranche 1 Multiplier" is $80, $50, $40, $25, and $20 for the Contract Years
1998,1999, 2000, 2001, and 2002, respectively.
For each Contract Year, the Company is obligated to pay to Aetna the lesser
of (i) the vested portion of the Tranche 1 Payment for such Contract Year and
the vested and unpaid amount relating to prior Contract Years as of the end of
the immediately preceding Contract Year and (ii) $25.0 million. To the extent
that the vested and unpaid portion of the Tranche 1 Payment exceeds $25.0
million, the Tranche 1
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<PAGE>
Payment remitted to Aetna shall be deemed to have been paid first from any
vested but unpaid amounts from previous Contract Years in order from the
earliest Contract Year for which vested amounts remain unpaid to the most recent
Contract Year at the time of such calculation. Except with respect to the
Contract Year ending in 2002, any vested but unpaid portion of the Tranche 1
Payment shall be available for payment to Aetna in future Contract Years,
subject to certain exceptions. All vested but unpaid amounts of Tranche 1
Payments shall expire following the payment of the Tranche 1 Payment in respect
to the Contract Year ending in 2002, subject to certain exceptions. In no event
shall the aggregate Tranche 1 Payments to Aetna exceed $125.0 million.
Upon the expiration of each Contract Year, the Tranche 2 payment shall be an
amount equal to the lesser of: (a) (i) the product of (A) the Tranche 2
Cumulative Members (as defined) for such Contract Year and (B) the Tranche 2
Multiplier (as defined) applicable to such number of Tranche 2 Cumulative
Members, minus (ii) the aggregate of the Tranche 2 Payments paid to Aetna for
all previous Contract Years and (b) $35.0 million. The amount shall be zero with
respect to any Contract Year in which the Tranche 2 Cumulative Members is a
negative number.
"Tranche 2 Cumulative Members" means, with respect to any Contract Year, (i)
the Equivalent Members serviced by the Company during such Contract Year for
Tranche 2 Members, minus (ii) the Tranche 2 Members as of September 30, 1997,
subject to certain upward adjustments. There were 936,391 Tranche 2 Members
prior to such upward adjustments. "Tranche 2 Members" means Members for whom the
Company provides products or services in the HMO category. The "Tranche 2
Multiplier" with respect to each Contract Year is $65 in the event that the
Tranche 2 Cumulative Members are less than 2,100,000 and $70 if more than or
equal to 2,100,000.
For each Contract Year, the Company shall pay to Aetna the amount of Tranche
2 Payment payable for such Contract Year. All rights to receive Tranche 2
Payment shall expire following the payment of the Tranche 2 Payment in respect
to the Contract Year ending in 2002, subject to certain exceptions.
Notwithstanding anything herein to the contrary, in no event shall the aggregate
Tranche 2 Payment to Aetna exceed $175.0 million, subject to certain exceptions.
The purchase price the Company originally paid for Allied was subject to
increase or decrease based on the operating performance of Allied during the
three years following the closing. The Company was required to pay up to $40.0
million during the three years following the closing of the Allied acquisition
based on Allied's performance relative to certain earnings targets.
On November 25, 1998, the Company and the former owners of Allied amended
the Allied purchase Agreement (the "Allied Amendment"). The Allied Amendment
resulted in the following changes to the original terms of the Allied purchase
agreement:
- Approximately $18.9 million of the original $20.0 million placed in escrow
by the Company at the consummation of the Allied acquisition, plus accrued
interest, was repaid to the Company.
- The Company paid certain of the former owners of Allied approximately $4.0
million in settlement of a portion of their potential future contingent
consideration.
- The Company's maximum remaining contingent consideration payable to the
former owners of Allied is approximately $6.1 million, less the
approximate $1.1 million that remains in escrow. The future contingent
payments, if any, will be based upon the operating performance of Allied
for fiscal 1999 through fiscal 2001.
In connection with Merit's acquisition of CMG, the Company, by acquiring
Merit, may be required to make certain future contingent payments in fiscal 1999
to the former shareholders of CMG based upon the performance of three CMG
customer contracts. No contingent consideration will be payable to the former
shareholders of CMG based on the performance of two of the three CMG customer
contracts at September 30, 1998. The Company may still be required to pay
contingent consideration to the former
52
<PAGE>
shareholders of CMG depending on the financial performance of Choice Behavioral
Health Partnership ("CHOICE"). CHOICE is a joint venture with Value Options,
Inc. that services a contract with CHAMPUS. The Company and Value Options, Inc.
each own 50% of CHOICE. The payment of contingent consideration to the former
shareholders of CMG depends on the financial performance of CHOICE from October
1, 1996 to June 30, 1997, which is subject to a CHAMPUS Adjustment the Company
expects to receive in fiscal 1999. Such contingent payments are subject to an
aggregate maximum of $23.5 million.
The Revolving Facility will provide the Company with revolving loans and
letters of credit in an aggregate principal amount at any time not to exceed
$150.0 million. At September 30, 1998, the Company had approximately $92.5
million of availability under the Revolving Facility. The Company estimates that
it will spend approximately $50.0 million for capital expenditures in fiscal
1999. The majority of the Company's anticipated capital expenditures relate to
management information systems and related equipment. The Company believes that
the cash flows generated from its operations, together with amounts available
for borrowing under the New Credit Agreement, should be sufficient to fund its
debt service requirements, anticipated capital expenditures, contingent
payments, with respect to HAI, Allied and CMG and other investing and financing
activities. The Company's future operating performance and ability to service or
refinance the Notes or to extend or refinance the indebtedness outstanding
pursuant to the New Credit Agreement will be subject to future economic
conditions and to financial, business and other factors, many of which are
beyond the Company's control.
The New Credit Agreement imposes restrictions on the Company's ability to
make capital expenditures and both the New Credit Agreement and the Indenture
governing the Notes limit the Company's ability to incur additional
indebtedness. Such restrictions, together with the highly leveraged financial
condition of the Company, may limit the Company's ability to respond to market
opportunities. The covenants contained in the New Credit Agreement also, among
other things, restrict the ability of the Company to dispose of assets, repay
other indebtedness, amend other debt instruments (including the Indenture), pay
dividends, create liens on assets, enter into sale and leaseback transactions,
make investments, loans or advances, redeem or repurchase common stock and make
acquisitions. See "Business-Cautionary Statements-Substantial Leverage and Debt
Service Obligations."
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 establishes accounting guidance for
internal-use software. SOP 98-1 requires the following:
- Computer software costs that are incurred in the preliminary project stage
(as described in SOP 98-1) should be expensed as incurred. Once the
capitalization criteria of SOP 98-1 have been met, external direct costs
of materials and services consumed in developing or obtaining internal-use
computer software; payroll and payroll-related costs for employees who are
directly associated with and who devote time to the internal-use computer
software project (to the extent of the time spent directly on the
project); and interest costs incurred when developing computer software
for internal use should be capitalized. Training costs and data conversion
costs should generally be expensed as incurred.
- Internal costs incurred for upgrades and enhancements should be expensed
or capitalized in accordance with SOP 98-1. Internal costs incurred for
maintenance should be expensed as incurred. Entities that cannot separate
internal costs on a reasonably cost-effective basis between maintenance
and relatively minor upgrades and enhancements should expense such costs
as incurred.
- External costs incurred under agreements related to specified upgrades and
enhancements should be expensed or capitalized in accordance with SOP
98-1. However, external costs related
53
<PAGE>
to maintenance, unspecified upgrades and enhancements, and costs under
agreements that combine the costs of maintenance and unspecified upgrades
and enhancements should be recognized in expense over the contract period
on a straight-line basis unless another systematic and rational basis is
more representative of the services received.
- Impairment should be recognized and measured in accordance with the
provisions of FASB Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF.
- The capitalized costs of computer software developed or obtained for
internal use should be amortized on a straight-line basis unless another
systematic and rational basis is more representative of the software's
use.
SOP 98-1 becomes effective for financial statements for fiscal years
beginning after December 15, 1998. The provisions of SOP 98-1 should be applied
to internal-use software costs incurred in those fiscal years for all projects,
including those projects in progress upon initial application of SOP 98-1. Costs
incurred prior to the initial application of SOP 98-1, whether capitalized or
not, should not be adjusted to the amounts that would have been capitalized had
SOP 98-1 been in effect when those costs were incurred.
The Company must adopt SOP 98-1 no later than October 1, 1999. Each of the
Company's operating units maintains its own information systems, which include
internal-use software as defined by SOP 98-1. The care management and claims
processing systems used in the Company's managed care segments are the Company's
most significant internal-use software applications. The Company adopted SOP
98-1, effective October 1, 1997. The Company's adoption of SOP 98-1 had no
impact on its financial position or results of operations.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5 requires all
nongovernmental entities to expense costs of start-up activities as those costs
are incurred. Start-up costs, as defined by SOP 98-5, include pre-operating
costs, pre-opening costs and organization costs.
SOP 98-5 becomes effective for financial statements for fiscal years
beginning after December 15, 1998. At adoption, a company must record a
cumulative effect of a change in accounting principle to write off any
unamortized start-up costs remaining on the balance sheet when SOP 98-5 is
adopted. Prior year financial statements cannot be restated. The Company will
adopt SOP 98-5 effective October 1, 1998. The Company's adoption of SOP 98-5
will have no impact on its financial position or results of operations.
Emerging Issues Task Force Issue 96-16, "Investor's Accounting for an
Investee When the Investor Has a Majority of the Voting Interest but a Minority
Shareholder or Shareholders Have Certain Approval or Veto Rights" ("EITF 96-16")
supplements the guidance contained in AICPA Accounting Research Bulletin 51,
"Consolidated Financial Statements", and in Statement of Financial Accounting
Standards No. 94, "Consolidation of All Majority-Owned Subsidiaries" ("ARB
51/FAS 94"), about the conditions under which the Company's consolidated
financial statements should include the financial position, results of
operations and cash flows of subsidiaries which are less than wholly-owned along
with those of the Company and its subsidiaries.
In general, ARB 51/FAS 94 requires consolidation of all majority-owned
subsidiaries except those for which control is temporary or does not rest with
the majority owner. Under the ARB 51/FAS 94 approach, instances of control not
resting with the majority owner were generally regarded to arise from such
events as the legal reorganization or bankruptcy of the majority-owned
subsidiary. EITF 96-16 expands the definition of instances in which control does
not rest with the majority owner to include those where significant approval or
veto rights, other than those which are merely protective of the minority
shareholder's interest, are held by the minority shareholder or shareholders
("Substantive
54
<PAGE>
Participating Rights"). Substantive Participating Rights include, but are not
limited to: i) selecting, terminating and setting the compensation of management
responsible for implementing the majority-owned subsidiary's policies and
procedures and ii) establishing operating and capital decisions of the
majority-owned subsidiary, including budgets, in the ordinary course of
business.
The provisions of EITF 96-16 apply to new investment agreements made after
July 24, 1997, and to existing agreements which are modified after such date.
The Company has made no new investments, and has modified no existing
investments, to which the provisions of EITF 96-16 would have applied.
In addition, the transition provisions of EITF 96-16 must be applied to
majority-owned subsidiaries previously consolidated under ARB 51/FAS 94 for
which the underlying agreements have not been modified in financial statements
issued for years ending after December 15, 1998 (fiscal 1999 for the Company).
The adoption of the transition provisions of EITF 96-16 on October 1, 1998 will
have the following effect on the Company's consolidated financial position:
<TABLE>
<CAPTION>
OCTOBER 1,
1998
-----------
<S> <C>
Increase (decrease) in:
Cash and cash equivalents................................................................ $ (21,092)
Other current assets..................................................................... (9,538)
Long-term assets......................................................................... (30,049)
Investment in unconsolidated subsidiaries................................................ 26,498
-----------
Total Assets........................................................................... $ (34,181)
-----------
-----------
Current liabilities...................................................................... $ (10,381)
Minority interest........................................................................ (23,800)
-----------
Total Liablities....................................................................... $ (34,181)
-----------
-----------
</TABLE>
POTENTIAL IMPACT OF YEAR 2000 COMPUTER ISSUES
The year 2000 computer problem is the inability of computer systems, which
store dates by using the last two digits of the year (i.e. "98" for "'1998"), to
reliably recognize that dates after December 31, 1999 are later than, and not
before, 1999. For instance, the date January 1, 2000, may be mistakenly
interpreted as January 1, 1900, in calculations involving dates on systems which
are non-year 2000 compliant.
The Company relies on information technology ("IT") systems and other
systems and facilities such as telephones, building access control systems and
heating and ventilation equipment ("Embedded Systems") to conduct its business.
These systems are potentially vulnerable to year 2000 problems due to their use
of date information.
The Company also has business relationships with customers and health care
providers and other critical vendors who are themselves reliant on IT and
Embedded Systems to conduct their businesses.
STATE OF READINESS
The Company's IT systems are largely decentralized, with each major
operating unit having its own standards for systems which include both purchased
and internally-developed software. The Company's IT hardware infrastructure is
built mainly around mid-range computers and IBM PC-compatible servers and
desktop systems.
The Company's principal means of ensuring year 2000 compliance for purchased
software has been the replacement of non-compliant systems. This replacement
process would have been undertaken for business reasons irrespective of the year
2000 problem; however, it would, more than likely, have been implemented over a
longer period of time. The Company's internally-developed software was
55
<PAGE>
either designed to be year 2000 compliant from inception or is in the process of
being modified to be compliant. Approximately 70% of the Company's mid-range IT
hardware has been certified as year 2000 compliant, with the remainder scheduled
to be certified by the end of the second quarter of fiscal 1999. Most of the
Company's non-compliant IBM PC-compatible servers and desktops have been
replaced, with the remainder expected to be replaced by the end of fiscal 1999.
Additionally, the Company is in the process of integrating recently acquired
businesses and their associated IT systems. A primary focus of the integration
is on standardization of systems where possible, including ensuring the year
2000 compliance of the surviving systems.
Each of the Company's major operating units has a Chief Information Officer
who is responsible for ensuring that all year 2000 issues are addressed and
mitigated before any computational problems related to dates after December 31,
1999, occur.
The Company's plan for IT systems consists of several phases, primarily:
(i) Inventory--identifying all IT systems and the magnitude of year 2000
compliance risk of each according to its potential business impact;
(ii) Date assessment--identifying IT systems that use date functions and
assessing them for year 2000 functionality;
(iii) Remediation--reprogramming, or replacing where necessary, inventoried
items to ensure they are year 2000 ready; and
(iv) Testing and certification--testing the code modifications and new
inventory with other associated systems, including extensive date
testing and performing quality assurance testing to ensure successful
operation in the post-1999 environment. The Company has substantially
completed the inventory and assessment phases for substantially all of
its IT systems. The Company's IT systems are currently in the
remediation and testing and certification phases. The Company plans to
complete the remediation of substantially all of its critical IT
systems by the end of the second quarter of fiscal 1999, the
remediation of its other IT systems by the end of the third quarter of
fiscal 1999 and the testing and certification of all of its IT systems
by the end of fiscal 1999.
The Company leases most of the office space in which its reliance on
Embedded Systems presents a potential problem and is currently working with the
respective lessors to identify and correct any potential year 2000 problems
related to these Embedded Systems.
The Company believes that its year 2000 projects generally are on schedule.
EXTERNAL RELATIONSHIPS
The Company also faces the risk that one or more of its critical suppliers
or customers ("External Relationships") will not be able to interact with the
Company due to the third party's inability to resolve its own year 2000 issues,
including those associated with its own External Relationships. The Company has
completed its inventory of External Relationships and risk rated each External
Relationship based upon the potential business impact, available alternatives
and cost of substitution. The Company is attempting to determine the overall
year 2000 readiness of its External Relationships. In the case of significant
customers and mission critical suppliers such as banks, telecommunications
providers and other utilities and IT vendors, the Company is engaged in
discussions with the third parties and is attempting to obtain detailed
information as to those parties' year 2000 plans and state of readiness. The
Company, however, does not have sufficient information at the current time to
predict whether its External Relationships will be year 2000 ready.
56
<PAGE>
YEAR 2000 COSTS
Total costs incurred solely for remediation of potential year 2000 problems
are currently estimated to be approximately $1.0 million in fiscal 1999. A large
majority of these costs are expected to be incremental expenses that will not
recur in the year 2000 or thereafter. Year 2000 costs incurred were $1.0 million
in fiscal 1998 and were not material in fiscal 1997. The Company expenses these
costs as incurred and funds these costs through operating cash flows. In
addition, the Company estimates that it will accelerate approximately $5.0
million of capital expenditures that would have been budgeted for future periods
into fiscal 1999 to ensure year 2000 compliance for outdated systems.
Year 2000 compliance is critical to the Company. The Company has redeployed
some resources from non-critical system enhancements to address year 2000
issues. Due to the importance of IT systems to the Company's business,
management has deferred non-critical systems enhancements to become year 2000
ready. The Company does not expect these redeployments and deferrals to have a
material impact on the Company's financial condition or results of operations.
RISKS AND CONTINGENCY/RECOVERY PLANNING
If the Company's year 2000 issues were unresolved, the most reasonably
likely worst case scenario would include, among other possibilities, the
inability to accurately and timely authorize and process benefits and claims,
accurately bill customers, assess claims exposure, determine liquidity
requirements, report accurate data to management, stockholders, customers,
regulators and others, business interruptions or shutdowns, financial losses,
reputational harm, loss of significant customers, increased scrutiny by
regulators and litigation related to year 2000 issues. The Company is attempting
to limit the potential impact of the year 2000 by monitoring the progress of its
own year 2000 project and those of its critical external relationships and by
developing contingency/recovery plans. The Company cannot guarantee that it will
be able to resolve all of its year 2000 issues. Any critical unresolved year
2000 issues at the Company or its external relationships, however, could have a
material adverse effect on the Company's results of operations, liquidity or
financial condition.
The Company has developed contingency/recovery plans aimed at ensuring the
continuity of critical business functions before and after December 31, 1999. As
part of that process, the Company has substantially completed the development of
manual work alternatives to automated processes which will both ensure business
continuity and provide a ready source of input to affected systems when they are
returned to an operational status. These manual alternatives presume, however,
that basic infrastructure such as electrical power and telephone service, as
well as purchased systems which are advertised to be year 2000 compliant by
their manufacturers (primarily personal computers and productivity software)
will remain unaffected by the year 2000 problem.
See "Business-Cautionary Statements--The Company".
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to this item is contained in the Company's
Consolidated Financial Statements and financial statement schedule indicated in
the Index on Page F-1 of this Annual Report on Form 10-K and is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
57
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the Company's executive officers is contained
under "Item 1. Business--Executive Officers of the Registrant." Pursuant to
General Instruction G(3) to Form 10-K, the information required by this item
with respect to directors and compliance with Section 16(a) of the Securities
Exchange Act of 1934 has been omitted inasmuch as the Company files with the
Securities and Exchange Commission a definitive proxy statement not later than
120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction G(3) to Form 10-K, the information required
with respect to this item has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instruction G(3) to Form 10-K, the information required
with respect to this item has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction G(3) to Form 10-K, the information required
with respect to this item has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THE REPORT:
1. FINANCIAL STATEMENTS
Information with respect to this item is contained on Pages F-1 to F-66 of
this Annual Report on Form 10-K.
2. FINANCIAL STATEMENT SCHEDULES
Information with respect to this item is contained on page S-1 to S-2 of
this Annual Report on Form 10-K.
58
<PAGE>
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
<C> <S>
2(a) Stock Purchase Agreement, dated November 14, 1995, among Blue Cross and Blue Shield of New Jersey, Inc.
Health Care Service Corporation, Independence Blue Cross, Medical Service Association of Pennsylvania,
Pierce County Medical Bureau, Inc., Veritus, Inc., Green Spring Health Services, Inc. and the Company,
which was filed as Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q for the Quarterly period
ended December 31, 1995, and is incorporated herein by reference.
2(b) GPA Stock Exchange Agreement, dated November 14, 1995, between Green Spring Health Services, Inc. and
the Company, which was filed as Exhibit 10(f) to the Company's Quarterly Report on Form 10-Q for the
Quarterly period ended December 31, 1995, and is incorporated herein by reference.
2(c) Real Estate Purchase and Sale Agreement, dated January 29, 1997, between the Company and Crescent Real
Estate Equities Limited Partnership, which was filed as Exhibit 2(a) to the Company's current report on
Form 8-K filed on April 23, 1997, and is incorporated herein by reference.
2(d) Amendment No. 1, dated February 28, 1997, to the Real Estate Purchase and Sale Agreement, dated January
29, 1997, between the Company and Crescent Real Estate Equities Limited Partnership, which was filed as
Exhibit 2(b) to the Company's current report on Form 8-K filed on April 23, 1997, and is incorporated
herein by reference.
2(e) Amendment No. 2, dated May 29, 1997, to the Real Estate Purchase and Sale Agreement, dated January 29,
1997, between the Company and Crescent Real Estate Equities Limited Partnership, which was filed as
Exhibit 2(c) to the Company's current report on Form 8-K, which was filed on June 30, 1997, and is
incorporated herein by reference.
2(f) Contribution Agreement, dated June 16, 1997, between the Company and Crescent Operating, Inc., which was
filed as Exhibit 2(d) to the Company's current report on Form 8-K which was filed on June 30, 1997, and
is incorporated herein by reference.
2(g) Stock Purchase Agreement, dated August 5, 1997, between the Company and Aetna Insurance Company of
Connecticut, which was filed as Exhibit 2(a) to the Company's current report on Form 8-K, which was
filed on December 17, 1997, and is incorporated herein by reference.
2(h) Master Service Agreement, dated August 5, 1997, between the Company, Aetna U.S. Healthcare, Inc. and
Human Affairs International, Incorporated, which was filed as Exhibit 2(b) to the Company's current
report on Form 8-K, which was filed on December 17, 1997, and is incorporated herein by reference.
2(i) Amendment to Stock Purchase Agreement, dated December 4, 1997, between the Company and Aetna Insurance
Company of Connecticut, which was filed as Exhibit 2(c) to the Company's current report on Form 8-K,
which was filed on December 17, 1997, and is incorporated herein by reference.
2(j) First Amendment to Master Services Agreement, dated December 4, 1997, between the Company, Aetna U.S.
Healthcare, Inc. and Human Affairs International, Incorporated, which was filed as Exhibit 2(d) to the
Company's current report on Form 8-K, which was filed on December 17, 1997, and is incorporated herein
by reference.
2(k) Asset Purchase Agreement, dated October 16, 1997, among the Company; Allied Health Group, Inc.; Gut
Management, Inc.; Sky Management Co,; Florida Specialty Network, LTD; Surgical Associates of South
Florida, Inc.; Surginet, Inc.; Jacob Nudel, M.D.; David Russin, M.D. and Lawrence Schimmel, M.D., which
was filed as Exhibit 2(e) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended
December 31, 1997, and is incorporated herein by reference.
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
<C> <S>
2(l) First Amendment to Asset Purchase Agreement, dated December 5, 1997, among the Company; Allied Health
Group, Inc.; Gut Management, Inc.; Sky Management Co.; Florida Specialty Network, LTD; Surgical
Associates of South Florida, Inc.; Surginet, Inc.; Jacob Nudel, M.D.; David Russin M.D.; and Lawrence
Schimmel, M.D., which was filed as Exhibit 2(f) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended December 31, 1997, and is incorporated herein by reference.
2(m) Second Amendment to Asset Purchase Agreement, dated November 18, 1998, among the Company; Allied Health
Group, Inc.; Gut Management, Inc.; Sky Management Co.; Florida Specialty Network, LTD; Surgical
Associates of South Florida, Inc.; Surginet, Inc.; Jacob Nudel, M.D.; David Russin M.D.; and Lawrence
Schimmel, M.D.
2(n) Agreement and Plan of Merger, dated October 24, 1997, among the Company, Merit Behavioral Care
Corporation and MBC Merger Corporation which was filed as Exhibit 2(g) to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended December 31, 1997, and is incorporated herein by reference.
3(a) Restated Certificate of Incorporation of the Company, as filed in Delaware on October 16, 1992, which
was filed as Exhibit 3(a) to the Company's Annual Report on Form 10-K for the year ended September 30,
1992, and is incorporated herein by reference.
3(b) Bylaws of the Company.
3(c) Certificate of Ownership and Merger merging Magellan Health Services, Inc. (a Delaware corporation) into
Charter Medical Corporation (a Delaware corporation), as filed in Delaware on December 21, 1995, which
was filed as Exhibit 3(c) to the Company's Annual Report on Form 10-K for the year ended September 30,
1995, and is incorporated herein by reference.
4(a) Stockholders' Agreement, dated December 13, 1995, among Green Spring Health Services, Inc., Blue Cross
and Blue Shield of New Jersey, Inc., Health Care Service Corporation, Independence Blue Cross, Pierce
County Medical Bureau, Inc. and the Company, which was filed as Exhibit 4(d) to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended December 31, 1995, and is incorporated herein by
reference.
4(b) First Amendment to Stockholders' Agreement, dated February 28, 1997, among Green Spring Health Services,
Inc, Blue Cross and Blue Shield of New Jersey, Inc., Health Care Service Corporation, Independence Blue
Cross, Pierce County Medical Bureau, Inc. and the Company, which was filed as Exhibit 4(af) to the
Company's Annual Report on Form 10-K for the year ended September 30, 1997, and is incorporated herein
by reference.
4(c) Exchange Agreement, dated December 13, 1995, among Blue Cross and Blue Shield of New Jersey, Inc.,
Health Care Service Corporation, Independence Blue Cross, Pierce County Medical Bureau, Inc. and the
Company, which was filed as Exhibit 4(e) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended December 31, 1995, and is incorporated herein by reference.
4(d) Stock and Warrant Purchase Agreement, dated December 22, 1995, between the Company and Richard E.
Rainwater, which was filed as Exhibit 4(f) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended December 31, 1995, and is incorporated herein by reference.
4(e) Amendment No. 1 to Stock and Warrant Purchase Agreement, dated January 25, 1996, between the Company and
Rainwater-Magellan Holdings, L.P., which was filed as Exhibit 4.7 to the Company's Registration
Statement on Form S-3 dated February 26, 1996, and is incorporated herein by reference.
</TABLE>
60
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
<C> <S>
4(f) Warrant Purchase Agreement, dated January 29, 1997, between the Company and Crescent Real Estate
Equities Limited Partnership which was filed as Exhibit 4(a) to the Company's current report on Form
8-K, which was filed on April 23, 1997, and is incorporated herein by reference.
4(g) Amendment No. 1, dated June 17, 1997, to the Warrant Purchase Agreement, dated January 29, 1997, between
the Company and Crescent Real Estate Equities Limited Partnership, which was filed as Exhibit 4(b) to
the Company's current report on Form 8-K, which was filed on June 30, 1997, and is incorporated herein
by reference.
4(h) Indenture, dated as of February 12, 1998, between the Company and Marine Midland Bank, as trustee,
relating to the 9% Senior Subordinated Notes due February 15, 2008 of the Company, which was filed as
Exhibit 4(a) to the Company's Current Report on Form 8-K, which was filed April 3, 1998, and is
incorporated herein by reference.
4(i) Purchase Agreement, dated February 5, 1998, between the Company and Chase Securities Inc., which was
filed as Exhibit 4(b) to the Company's Current Report on Form 8-K, which was filed April 3, 1998, and is
incorporated herein by reference.
4(j) Exchange and Registration Rights Agreement, dated February 12, 1998, between the Company and Chase
Securities Inc., which was filed as Exhibit 4(c) to the Company's Current Report on Form 8-K, which was
filed on April 3, 1998, and is incorporated herein by reference.
4(k) Credit Agreement, dated February 12, 1998, among the Company, certain of the Company's subsidiaries
listed therein and The Chase Manhattan Bank, as administrative agent, which was filed as Exhibit 4(d) to
the Company's Current Report on Form 8-K, which was filed April 3, 1998, and is incorporated herein by
reference.
4(l) Amendment No. 1, dated as of September 30, 1998, to the Credit Agreement, dated as of February 12, 1998,
among the Company, certain of the Company's subsidiaries listed therein and The Chase Manhattan Bank, as
administrative agent, which was filed as Exhibit 4(e) to the Company's Registration Statement Form S-4
(no. 333-49335), which was filed on October 5, 1998, and is incorporated herein by reference.
The Company agrees, pursuant in (b)(4)(iii) of Item 601 of Regulation S-K, to furnish to the
Commission, upon request, a copy of each agreement relating to long-term debt where the total
amount of debt under each such agreement does not exceed 10% of the Company's respective total on
a consolidated basis.
*10(a) 1992 Stock Option Plan of the Company, as amended, which was filed as Exhibit 10(c) to the Company's
Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated herein by
reference.
*10(b) Directors' Stock Option Plan of the Company, as amended, which was filed as Exhibit 10(d) to the
Company's Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated herein
by reference.
*10(c) 1994 Stock Option Plan of the Company, as amended, which was filed as Exhibit 10(e) to the Company's
Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated herein by
reference.
*10(d) Directors' Unit Award Plan of the Company, which was filed as Exhibit 10(i) to the Company's
Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by
reference.
*10(e) 1996 Stock Option Plan of the Company, which was filed as Exhibit 10(a) to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1996 and is incorporated herein by
reference.
</TABLE>
61
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
<C> <S>
*10(f) 1996 Directors' Stock Option Plan of the Company, which was filed as Exhibit 10(b) to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996 and is incorporated herein
by reference.
*10(g) 1997 Stock Option Plan of the Company, which was filed as Exhibit 10(i) to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 1997, and is incorporated herein by
reference.
*10(h) Employment Agreement, dated February 28, 1995, between the Company and John Cook Barlett, Executive Vice
President--Quality Improvement, which was filed as Exhibit 10(k) to the Company's Annual Report on Form
10-K for the year ended September 30, 1995, and is incorporated herein by reference.
*10(i) Employment Agreement, dated March 31, 1995, between the Company and Craig L. McKnight, Executive Vice
President and Chief Financial Officer, which was filed as Exhibit 10(l) to the Company's Annual Report
on Form 10-K for the year ended September 30, 1995, and is incorporated herein by reference.
*10(j) Employment Agreement, dated October 1, 1995, between the Company and E. Mac Crawford, Chairman of the
Board of Directors, President and Chief Executive Officer, which was filed as Exhibit 10(m) to the
Company's Annual Report on Form 10-K for the year ended September 30, 1995, and is incorporated herein
by reference.
*10(k) Employment Agreement, dated March 1, 1997, between the Company and E. Mac Crawford, which was filed as
Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30,
1997, and is incorporated herein by reference.
*10(l) Letter Agreement, dated November 9, 1993, between Green Spring Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(c) to the Company's Quarterly Report on Form
10-Q for the quarterly period ended December 31, 1995 and is incorporated herein by reference.
*10(m) Letter Agreement, dated September 19, 1994 between Green Spring Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(d) to the Company's Quarterly Report on Form
10-Q for the quarterly period ended December 31, 1995 and is incorporated herein by reference.
*10(n) Employment Agreement dated May 1, 1996, between the Company and Dr. Danna Mauch, President and Chief
Operating Officer of Magellan Public Solutions, Inc. and Executive Vice President of the Company, which
was filed as Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996 and is incorporated herein by reference.
*10(o) Employment Agreement dated April 15, 1996, between the Company and John M. DeStefanis, President and
Chief Operating Officer of Charter Behavioral Health Systems, Inc. and Executive Vice President of the
Company, which was filed as Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1996 and is incorporated herein by reference.
*10(p) Employment Agreement dated May 7, 1996, between the Company and Steve J. Davis, Executive Vice
President, Administrative Services and General Counsel, which was filed as Exhibit 10(c) to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 and is incorporated
herein by reference.
</TABLE>
62
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
<C> <S>
*10(q) Employment Agreement dated February 28, 1996, between Green Spring Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(t) to the Company's annual report on Form
10-K for the year ended September 30, 1996, and is incorporated herein by reference.
*10(r) Compensation Agreement dated September 30, 1996, between Magellan Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(u) to the Company's annual report on Form
10-K for the year ended September 30, 1996, and is incorporated herein by reference.
*10(s) Written description of the Green Spring Health Services, Inc. Annual Incentive Plan for the period ended
September 30, 1998.
*10(t) Written description of the Green Spring Health Services, Inc. Annual Incentive Plan for the year ended
September 30, 1997, which was filed as Exhibit 10(w) to the Company's Annual Report on Form 10-K for the
year ended September 30, 1997, and is incorporated by reference.
10(u) Master Lease Agreement, dated June 16, 1997, between Crescent Real Estate Funding VII, L.P., as
Landlord, and Charter Behavioral Health Systems, LLC, as Tenant, which was filed as Exhibit 99(b) to the
Company's current report on Form 8-K, which was filed on June 30, 1997, and is incorporated herein by
reference.
10(v) Master Franchise Agreement, dated June 17, 1997, between the Company and Charter Behavioral Health
Systems, LLC, which was filed as Exhibit 99(c) to the Company's current report on Form 8-K, which was
filed on June 30, 1997, and is incorporated herein by reference.
10(w) Form of Franchise Agreement, dated June 17, 1997, between the Company, as Franchisor, and Franchise
Owners, which was filed as Exhibit 99(d) to the Company's current report on Form 8-K, which was filed on
June 30, 1997, and is incorporated herein by reference.
10(x) Subordination Agreement, dated June 16, 1997, between the Company, Charter Behavioral Health Systems,
LLC and Crescent Real Estate Equities Limited Partnership, which was filed as Exhibit 99(e) to the
Company's current report on Form 8-K, which was filed on June 30, 1997, and is incorporated herein by
reference.
10(y) Operating Agreement of Charter Behavioral Health Systems, LLC, dated June 16, 1997, between the Company
and Crescent Operating, Inc., which was filed as Exhibit 99(f) to the Company's current report on Form
8-K, which was filed on June 30, 1997, and is incorporated herein by reference.
10(z) Warrant Purchase Agreement, dated June 16, 1997, between the Company and Crescent Operating, Inc., which
was filed as Exhibit 99(g) to the Company's current report on Form 8-K, which was filed on June 30,
1997, and is incorporated herein by reference.
*10(aa) 1998 Stock Option Plan of the Company which was filed as Exhibit (ay) to the Company's Registration
Statement on Form S-4, which was filed on April 3, 1998, and is incorporated herein by reference.
*10(ab) Letter Agreement, dated May 7, 1997, between Green Spring Health Services, Inc. and John J. Wider, Jr.,
Executive Vice President and Chief Operating Officer of Green Spring Health Services, Inc., which was
filed as Exhibit 10 (az) to the Company's Registration Statement on Form S-4, which was filed on April
3, 1998, and is incorporated herein by reference.
</TABLE>
63
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
<C> <S>
*10(ac) Employment Agreement, dated March 12, 1997, between Green Spring Health Services, Inc. and Clarissa C.
Marques, Chief Clinical Officer of Green Spring Health Services, Inc., which was filed as Exhibit 10
(ba) to the Company's Registration Statement on Form S-4, which was filed on April 3, 1998, and is
incorporated herein by reference.
*10(ad) Letter Agreement, dated February 2, 1995, between Green Spring Health Services, Inc. and Clarissa C.
Marques, Senior Vice President of Green Spring Health Services, Inc., which was filed as Exhibit 10 (bb)
to the Company's Registration Statement on Form S-4, which was filed on April 3, 1998, and is
incorporated herein by reference.
*10(ae) Employment Agreement, dated June 25, 1998, between the Company and Henry T. Harbin, M.D., President,
Chief Executive Officer of the Company, which was filed as exhibit 10(a) to the Company's quarterly
report on Form 10-Q for the quarterly period ended June 30, 1998 and is incorporated herein by
reference.
10(af) Offer to Purchase and Consent Solicitation Statement, dated January 12, 1998, by the Company for all of
its 11 1/4% Series A Senior Subordinated Notes due 2008, which was filed as Exhibit 10(ad) to the
Company's Registration Statement on Form S-4, which was filed on April 3, 1998, and is incorporated
herein by reference.
10(ag) Offer to Purchase and Consent Solicitation Statement, dated January 12, 1998, by Merit Behavioral Care
Corporation for all of its 11 1/2% Senior Subordinated Notes due 2005, which was filed as Exhibit 10(ad)
to the Company's Registration Statement on Form S-4, which was filed on April 3, 1998, and is
incorporated herein by reference.
10(ah) Agreement and Plan of Merger by and among Merit Behavioral Care Corporation, Merit Merger Corp., and CMG
Health, Inc. dated as of July 14, 1997.
21 List of subsidiaries of the Company.
23 Consent of independent public accountants.
27 Financial Data Schedule
</TABLE>
- ------------------------
* Constitutes a management contract or compensatory plan arrangement.
(B) REPORTS ON FORM 8-K:
There were no current reports on Form 8-K filed by the Registrant with the
Securities and Exchange Commission during the quarter ended September 30,
1998.
(C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K:
Exhibits required to be filed by the Company pursuant to Item 601 of
Regulation S-K are contained in a separate volume.
(D) FINANCIAL STATEMENT SCHEDULES REQUIRED BY REGULATION S-X:
Information with respect to this item is contained on pages S-1 to S-2 of
this Annual Report on Form 10-K.
64
<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.
MAGELLAN HEALTH SERVICES, INC.
(Registrant)
Date: December 28, 1998 /S/ CRAIG L. MCKNIGHT
------------------------------------------
Craig L. McKnight
Executive Vice President and
Chief Financial Officer
Date: December 28, 1998 /S/ JEFFREY T. HUDKINS
------------------------------------------
Jeffrey T. Hudkins
Vice President and Controller
(Chief Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ HENRY T. HARBIN President, Chief Executive
- ------------------------------ Officer and Director December 28, 1998
Henry T. Harbin
/s/ EDWIN M. BANKS Director
- ------------------------------ December 28, 1998
Edwin M. Banks
/s/ G. FRED DIBONA, JR. Director
- ------------------------------ December 28, 1998
G. Fred DiBona, Jr.
/s/ ANDRE C. DIMITRIADIS Director
- ------------------------------ December 28, 1998
Andre C. Dimitriadis
/s/ A.D. FRAZIER, JR. Director
- ------------------------------ December 28, 1998
A.D. Frazier, Jr.
/s/ RAYMOND H. KIEFER Director
- ------------------------------ December 28, 1998
Raymond H. Kiefer
65
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
<C> <S> <C>
/s/ GERALD L. MCMANIS Director
- ------------------------------ December 28, 1998
Gerald L. McManis
/s/ DANIEL S. MESSINA Director
- ------------------------------ December 28, 1998
Daniel S. Messina
/s/ ROBERT W. MILLER Chairman of the Board of
- ------------------------------ Directors December 28, 1998
Robert W. Miller
/s/ DARLA D. MOORE Director
- ------------------------------ December 28, 1998
Darla D. Moore
/s/ JEFFREY A. SONNENFELD Director
- ------------------------------ December 28, 1998
Jeffrey A. Sonnenfeld
</TABLE>
66
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant and its
subsidiaries are submitted herewith in response to Item 8 and Item14(a)1:
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
MAGELLAN HEALTH SERVICES, INC.
Audited Consolidated Financial Statements
Report of independent public accountants............................................................... F-2
Consolidated balance sheets as of September 30, 1997 and 1998.......................................... F-3
Consolidated statements of operations for the years ended September 30, 1996, 1997 and 1998............ F-4
Consolidated statements of changes in stockholders' equity for the years ended September 30, 1996, 1997
and 1998.............................................................................................. F-5
Consolidated statements of cash flows for the years ended September 30, 1996, 1997 and 1998............ F-6
Notes to consolidated financial statements............................................................. F-7
</TABLE>
The following financial statement schedule of the Registrant and its
subsidiaries is submitted herewith in response to Item 14(a)2:
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Schedule II--Valuation and qualifying accounts......................................................... S-1
Financial Statements in response to Rule 3-09 of Regulation S-X:
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
Audited Consolidated Financial Statements
Report of independent public accountants............................................................... F-49
Consolidated balance sheet as of September 30, 1997 and 1998........................................... F-50
Consolidated statement of operations for the 106 days ended September 30, 1997 and the year ended
September 30, 1998.................................................................................... F-52
Consolidated statement of changes in members' capital for the 106 days ended September 30, 1997 and the
year ended September 30, 1998......................................................................... F-53
Consolidated statement of cash flows for the 106 days ended September 30, 1997 and the year ended
September 30, 1998.................................................................................... F-54
Notes to consolidated financial statements............................................................. F-55
</TABLE>
The following financial statement schedule for Charter Behavioral Health
Systems, LLC and its subsidiaries is submitted herewith in response to Item
14(a)2:
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Schedule II--Valuation and qualifying accounts............................................................. S-2
</TABLE>
CHOICE BEHAVIORAL HEALTH PARTNERSHIP
The Audited Consolidated Financial Statements of CHOICE Behavioral Health
Partnership ("Choice") will be filed in an amendment to this Form 10-K no later
than March 31, 1999. Choice's fiscal year end is December 31, 1998.
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Magellan Health Services, Inc:
We have audited the accompanying consolidated balance sheets of Magellan
Health Services, Inc. (a Delaware corporation) and subsidiaries as of September
30, 1997 and 1998, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for each of the three years in
the period ended September 30, 1998. These consolidated financial statements and
the schedule referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Magellan Health Services,
Inc. and subsidiaries as of September 30, 1997 and 1998 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1998 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our opinion, fairly
states, in all material respects, the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
December 3, 1998
F-2
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------
1997 1998
--------- ----------
<S> <C> <C>
ASSETS
Current Assets:
Cash, including cash equivalents of $319,823 at September 30, 1997 and $14,185 at
September 30, 1998 at cost, which approximates market value.......................... $ 372,878 $ 92,050
Accounts Receivable, less allowance for doubtful accounts of $40,311 at September 30,
1997 and $34,867 at September 30, 1998............................................... 107,998 174,846
Restricted cash and investments....................................................... -- 89,212
Refundable income taxes............................................................... 2,466 4,939
Other current assets.................................................................. 23,696 38,677
--------- ----------
Total Current Assets................................................................ 507,038 399,724
Assets restricted for settlement of unpaid claims and other long-term liabilities......... 87,532 37,910
Property and equipment, net............................................................... 109,214 177,169
Deferred income taxes..................................................................... 1,158 97,386
Investment in CBHS........................................................................ 16,878 --
Other long-term assets.................................................................... 20,893 46,481
Goodwill, net of accumulated amortization of $14,006 at September 30, 1997 and $32,785 at
September 30, 1998...................................................................... 114,234 992,431
Other intangible assets, net of accumulated amortization of $5,855 at September 30, 1997
and $12,343 at September 30, 1998....................................................... 38,673 165,189
--------- ----------
$ 895,620 $1,916,290
--------- ----------
--------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable........................................................................ $ 45,346 $ 42,873
Accrued liabilities..................................................................... 133,921 193,530
Medical claims payable.................................................................. 36,508 195,330
Current maturities of long-term debt and capital lease obligations...................... 3,601 23,033
--------- ----------
Total Current Liabilities......................................................... 219,376 454,766
Long-term debt and capital lease obligations.............................................. 391,693 1,202,613
Reserve for unpaid claims................................................................. 49,113 30,280
Deferred credits and other long-term liabilities.......................................... 16,110 14,011
Minority interest......................................................................... 61,078 26,985
Commitments and Contingencies
Stockholders' Equity:
Preferred Stock, without par value
Authorized--10,000 shares
Issued and outstanding--none.......................................................... -- --
Common Stock, par value $.25 per share
Authorized--80,000 shares
Issued and outstanding--33,439 shares at September 30, 1997 and 33,898 shares at
September 30, 1998.................................................................... 8,361 8,476
Other Stockholders' Equity:
Additional paid-in capital............................................................ 340,645 349,651
Accumulated deficit................................................................... (129,955) (149,238)
Warrants outstanding.................................................................. 25,050 25,050
Common stock in treasury, 4,424 shares at September 30, 1997 and 2,289 shares at
September 30, 1998................................................................... (82,731) (44,309)
Cumulative foreign currency adjustments............................................... (3,120) (1,995)
--------- ----------
Total Stockholders' Equity........................................................ 158,250 187,635
--------- ----------
$ 895,620 $1,916,290
--------- ----------
--------- ----------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these balance sheets.
F-3
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------
<S> <C> <C> <C>
1996 1997 1998
-------- -------- ----------
Net revenue..................................................................................... $1,345,279 $1,210,696 $1,512,454
-------- -------- ----------
Costs and expenses:
Salaries, cost of care and other operating expenses........................................... 1,064,445 978,513 1,294,481
Bad debt expense.............................................................................. 81,470 46,211 4,977
Equity in loss of CBHS........................................................................ -- 8,122 31,878
Depreciation and amortization................................................................. 48,924 44,861 54,885
Interest, net................................................................................. 48,017 45,377 75,375
Stock option expense (credit)................................................................. 914 4,292 (5,623)
Managed Care integration costs................................................................ -- -- 16,962
Loss on Crescent Transactions................................................................. -- 59,868 --
Unusual items, net............................................................................ 37,271 357 458
-------- -------- ----------
1,281,041 1,187,601 1,473,393
-------- -------- ----------
Income before income taxes, minority interest
and extraordinary items....................................................................... 64,238 23,095 39,061
Provision for income taxes...................................................................... 25,695 9,238 20,033
-------- -------- ----------
Income before minority interest and extraordinary items......................................... 38,543 13,857 19,028
Minority interest............................................................................... 6,160 9,102 5,296
-------- -------- ----------
Income before extraordinary items............................................................... 32,383 4,755 13,732
Extraordinary items--net losses on early extinguishments of
debt (net of income tax benefit of $3,503 in 1997 and $22,010 in 1998)........................ -- (5,253) (33,015)
-------- -------- ----------
Net income (loss)............................................................................... $ 32,383 $ (498) $ (19,283)
-------- -------- ----------
-------- -------- ----------
Average number of common shares outstanding--basic.............................................. 31,014 28,781 30,784
-------- -------- ----------
-------- -------- ----------
Average number of common shares outstanding--diluted............................................ 31,596 29,474 31,198
-------- -------- ----------
-------- -------- ----------
Income (loss) per common share--basic:
Income before extraordinary items............................................................. $ 1.04 $ 0.17 $ 0.45
-------- -------- ----------
-------- -------- ----------
Extraordinary losses on early extinguishments of debt......................................... $ -- $ (0.18) $ (1.07)
-------- -------- ----------
-------- -------- ----------
Net income (loss)............................................................................... $ 1.04 $ (0.02) $ (0.63)
-------- -------- ----------
-------- -------- ----------
Income (loss) per common share--diluted:
Income before extraordinary items............................................................. $ 1.02 $ 0.16 $ 0.44
-------- -------- ----------
-------- -------- ----------
Extraordinary losses on early extinguishments of debt......................................... $ -- $ (0.18) $ (1.06)
-------- -------- ----------
-------- -------- ----------
Net income (loss)............................................................................... $ 1.02 $ (0.02) $ (0.62)
-------- -------- ----------
-------- -------- ----------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-4
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Common Stock:
Balance, beginning of period................................................. $ 7,101 $ 8,252 $ 8,361
Exercise of options and warrants............................................. 97 109 115
Green Spring Health Services, Inc. acquisition............................... 54 -- --
Issuance of Common Stock, net of issuance costs.............................. 1,000 -- --
--------- --------- ---------
Balance, end of period....................................................... 8,252 8,361 8,476
--------- --------- ---------
Additional paid-in capital:
Balance, beginning of period................................................. 253,295 327,681 340,645
Stock option expense (credit)................................................ 914 4,292 (5,623)
Green Spring Health Services, Inc. acquisition............................... 4,263 -- --
Exercise of options and warrants............................................. 1,636 8,156 3,867
Issuance of Common Stock, net of issuance costs.............................. 67,573 -- --
Green Spring Minority Stockholder Conversion................................. -- -- 10,722
Other........................................................................ -- 516 40
--------- --------- ---------
Balance, end of period....................................................... 327,681 340,645 349,651
--------- --------- ---------
Accumulated deficit:
Balance, beginning of period................................................. (161,840) (129,457) (129,955)
Net income (loss)............................................................ 32,383 (498) (19,283)
--------- --------- ---------
Balance, end of period....................................................... (129,457) (129,955) (149,238)
--------- --------- ---------
Warrants outstanding:
Balance, beginning of period................................................. 64 54 25,050
Exercise of warrants......................................................... (10) (4) --
Issuance of warrants to Crescent and COI..................................... -- 25,000 --
--------- --------- ---------
Balance, end of period....................................................... 54 25,050 25,050
--------- --------- ---------
Common stock in treasury:
Balance, beginning of period................................................. (9,238) (82,731) (82,731)
Purchases of treasury stock.................................................. (73,493) -- (14,352)
Green Spring Minority Stockholder Conversion................................. -- -- 52,774
--------- --------- ---------
Balance, end of period....................................................... (82,731) (82,731) (44,309)
--------- --------- ---------
Cumulative foreign currency adjustments:
Balance, beginning of period................................................. (822) (1,982) (3,120)
Foreign currency translation gain (loss)..................................... (1,160) (1,138) 1,125
--------- --------- ---------
Balance, end of period....................................................... (1,982) (3,120) (1,995)
--------- --------- ---------
Total Stockholders' Equity..................................................... $ 121,817 $ 158,250 $ 187,635
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-5
<PAGE>
MAGELLAN HEALTH SERVICES, INC. SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Cash Flows From Operating Activities
Net income (loss)............................................................ $ 32,383 $ (498) $ (19,283)
--------- --------- ----------
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Gain on sale of assets................................................. (2,062) (5,747) (3,001)
Depreciation and amortization.......................................... 48,924 44,861 54,885
Impairment of long-lived assets........................................ -- -- 2,507
Non-cash portion of unusual items...................................... 31,206 -- --
Equity in loss of CBHS................................................. -- 8,122 31,878
Loss on Crescent Transactions.......................................... -- 59,868 --
Stock option expense (credit).......................................... 914 4,292 (5,623)
Non-cash interest expense.............................................. 2,424 1,710 2,935
Extraordinary losses on early extinguishments of debt.................. -- 8,756 55,025
Cash flows from changes in assets and liabilities, net of effects from
sales and acquisitions of businesses:
Accounts receivable, net................................................. 15,495 60,675 (1,585)
Restricted cash and investments.......................................... -- -- (21,782)
Other current assets..................................................... 129 4,708 (3,010)
Other long-term assets................................................... 6,569 3,156 (7,840)
Accounts payable and accrued liabilities................................. (7,516) (60,659) (43,724)
Income taxes payable and deferred income taxes........................... 14,925 (14,669) (14,489)
Reserve for unpaid claims................................................ (29,985) (26,553) (19,177)
Other liabilities........................................................ (18,968) (23,038) (9,290)
Minority interest, net of dividends paid................................. 6,406 9,633 (929)
Other.................................................................... 1,022 (1,018) (1,701)
--------- --------- ----------
Total adjustments........................................................ 69,483 74,097 15,079
--------- --------- ----------
Net cash provided by (used in) operating activities.................... 101,866 73,599 (4,204)
--------- --------- ----------
Cash Flows From Investing Activities:
Capital expenditures......................................................... (38,801) (33,348) (44,213)
Acquisitions and investments in businesses, net of cash acquired............. (50,918) (50,876) (1,046,436)
Distributions received from unconsolidated subsidiaries...................... -- -- 11,441
Decrease (increase) in assets restricted for settlement of unpaid claims and
other long-term liabilities................................................ (17,732) 17,209 51,006
Proceeds from sale of assets................................................. 5,248 18,270 18,088
Proceeds from sale of property and equipment to Crescent and CBHS,
net of transaction costs................................................... -- 380,425 (6,213)
--------- --------- ----------
Net cash provided by (used in) investing activities.................... (102,203) 331,680 (1,016,327)
--------- --------- ----------
Cash Flows From Financing Activities:
Payments on debt and capital lease obligations............................... (85,835) (390,254) (438,633)
Proceeds from issuance of debt, net of issuance costs........................ 104,800 203,643 1,188,706
Proceeds from issuance of common stock....................................... 68,573 -- --
Proceeds from exercise of stock options and warrants......................... 3,401 8,265 5,739
Proceeds from issuance of warrants........................................... -- 25,000 --
Purchases of treasury stock.................................................. (73,493) -- (14,352)
Income tax payments made on behalf of stock optionee......................... (1,678) -- (1,757)
--------- --------- ----------
Net cash provided by (used in) financing activities.................... 15,768 (153,346) 739,703
--------- --------- ----------
Net increase (decrease) in cash and cash equivalents........................... 15,431 251,933 (280,828)
Cash and cash equivalents at beginning of period............................... 105,514 120,945 372,878
--------- --------- ----------
Cash and cash equivalents at end of period..................................... $ 120,945 $ 372,878 $ 92,050
--------- --------- ----------
--------- --------- ----------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements
F-6
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements of Magellan Health Services, Inc., a
Delaware corporation, ("Magellan" or the "Company") include the accounts of the
Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
The Company's primary business segment, as of September 30, 1998, was its
behavioral managed healthcare operations. The Company operates in four other
business segments, which are described in further detail in Note 15, "Business
Segment Information."
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 the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
MANAGED CARE REVENUE
Managed care revenue is recognized over the applicable coverage period on a
per member basis for covered members and as earned and estimable for
performance-based revenues. Deferred revenue is recorded when premium payments
are received in advance of the applicable coverage period.
FRANCHISE REVENUE
Continuing annual franchise fees are recognized as the fees are earned and
become receivable from franchisees, subject to an allowance for estimated
uncollectible amounts. Costs relating to continuing franchise fees are expensed
as incurred. Individual franchise sales are recognized when all material
services or conditions relating to the sale have been substantially performed or
satisfied by the Company. Direct costs relating to franchise sales are deferred
until the related revenue is recognized up to the amount of anticipated revenue
less estimated additional related costs.
PROVIDER NET REVENUE
Provider net revenue is based on established billing rates, less estimated
allowances for patients covered by Medicare and other contractual reimbursement
programs, and discounts from established billing rates. Amounts received by the
Company for treatment of patients covered by Medicare and other contractual
reimbursement programs, which may be based on cost of services provided or
predetermined rates, are generally less than the established billing rates of
the Company's hospitals. Final determination of amounts earned under contractual
reimbursement programs is subject to review and audit by the applicable
agencies. The Company recorded net revenue in fiscal 1996, 1997 and 1998 of
$28.3 million, $27.4 million and $7.0 million, respectively, for the settlement
and adjustment of reimbursement issues related to earlier fiscal periods.
Management believes that adequate provision has been made for any adjustments
that may result from such reviews in future periods.
F-7
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
The production costs of advertising are expensed as incurred. The Company
does not consider any of its advertising costs to be direct-response and,
accordingly, does not capitalize such costs. Advertising costs consist primarily
of radio and television air time, which is amortized as utilized, and printed
media services. Advertising expense was approximately $30.5 million, $19.2
million and $4.7 million for the years ended September 30, 1996, 1997 and 1998,
respectively.
CHARITY CARE
The Company provides healthcare services without charge or at amounts less
than its established rates to patients who meet certain criteria under its
charity care policies. Because the Company does not pursue collection of amounts
determined to be charity care, they are not reported as revenue. For the years
ended September 30, 1996, 1997 and 1998, the Company provided, at its
established billing rates, approximately $37.9 million, $19.5 million and $3.7
million, respectively, of such care.
INTEREST, NET
The Company records interest expense net of interest income. Interest income
for the years ended September 30, 1996, 1997, and 1998 was approximately $10.5
million, $10.1 million and $11.9 million, respectively.
CASH AND CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid interest-bearing investments
with a maturity of three months or less when purchased, consisting primarily of
money market instruments.
RESTRICTED CASH AND INVESTMENTS
Restricted cash and investments at September 30, 1998 include approximately
$89.2 million that is held for the payment of claims under the terms of certain
behavioral managed care contracts and for regulatory purposes related to the
payment of claims in certain jurisdictions.
CONCENTRATION OF CREDIT RISK
Accounts receivable from human services revenue and healthcare provider
revenue subject the Company to a concentration of credit risk with third party
payors that include insurance companies, managed healthcare organizations and
governmental entities. The Company establishes an allowance for doubtful
accounts based upon factors surrounding the credit risk of specific payors,
historical trends and other information. Management believes the allowance for
doubtful accounts is adequate to provide for normal credit losses.
ASSETS RESTRICTED FOR THE SETTLEMENT OF UNPAID CLAIMS AND OTHER LONG-TERM
LIABILITIES
Assets restricted for the settlement of unpaid claims and other long-term
liabilities include investments which are carried at fair market value. Transfer
of such investments from the Company's insurance subsidiaries to Magellan or any
of its other subsidiaries is subject to approval by certain regulatory
authorities.
The investments can be classified into three categories: (i) held to
maturity; (ii) available for sale; and (iii) trading. Unrealized holding gains
or losses are recorded for trading and available for sale
F-8
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
securities. The Company's investments are classified as available for sale. The
unrealized gain or loss on investments available for sale was not material at
September 30, 1997 and 1998.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, except for assets that have been
impaired, for which the carrying amount is reduced to estimated fair value.
Expenditures for renewals and improvements are charged to the property accounts.
Replacements and maintenance and repairs that do not improve or extend the life
of the respective assets are expensed as incurred. Internal-use software is
capitalized in accordance with SOP 98-1 (as defined). See "--Recent Accounting
Pronouncements" Amortization of capital lease assets is included in depreciation
expense. Depreciation is provided on a straight-line basis over the estimated
useful lives of the assets, which is generally ten to forty years for buildings
and improvements, three to ten years for equipment and three to five years for
capitalized internal-use software. Depreciation expense was $40.0 million, $34.1
million and $24.0 million for the fiscal years ended September 30, 1996, 1997
and 1998, respectively.
Property and equipment, net, consisted of the following at September 30,
1997 and 1998 (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
<S> <C> <C>
1997 1998
----------- -----------
Land.......................................................................... $ 11,667 $ 11,607
Buildings and improvements.................................................... 70,174 78,886
Equipment..................................................................... 61,671 112,422
Capitalized internal-use software............................................. 2,048 33,923
----------- -----------
145,560 236,838
Accumulated depreciation...................................................... (37,038) (60,100)
----------- -----------
108,522 176,738
Construction in progress...................................................... 692 431
----------- -----------
Property and equipment, net................................................. $ 109,214 $ 177,169
----------- -----------
----------- -----------
</TABLE>
INTANGIBLE ASSETS
Intangible assets are composed principally of (i) goodwill, (ii) customer
lists, and (iii) deferred financing costs. Goodwill represents the excess of the
cost of businesses acquired over the fair value of the net identifiable assets
at the date of acquisition and is amortized using the straight-line method over
25 to 40 years. Customer lists and other intangible assets are amortized using
the straight-line method over their estimated useful lives of 4 to 30 years.
Deferred financing costs are amortized over the terms of the underlying
agreements.
The Company continually monitors events and changes in circumstances which
could indicate that carrying amounts of intangible assets may not be
recoverable. When events or changes in circumstances are present that indicate
the carrying amount of intangible assets may not be recoverable, the Company
assesses the recoverability of intangible assets by determining whether the
carrying value of such intangible assets will be recovered through the future
cash flows expected from the use of the asset and its eventual disposition. No
impairment losses on intangible assets were recorded by the Company in 1996.
Impairment losses of approximately $14.4 million and $1.9 million were recorded
in fiscal 1997 and fiscal 1998, respectively. (See Notes 3 and 11)
F-9
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MEDICAL CLAIMS PAYABLE
Medical claims payable represent the liability for healthcare services
authorized or incurred and not yet paid by the Company's managed care
businesses. Medical claims payable are estimated based upon authorized
healthcare services, past claim payment experience for member groups,
adjudication decisions, patient census data and other factors. While Management
believes the liability for medical claims payable is adequate, actual results
could differ from such estimates.
FOREIGN CURRENCY
Changes in the cumulative translation of foreign currency assets and
liabilities are presented as a separate component of stockholders' equity. Gains
and losses resulting from foreign currency transactions, which were not
material, are included in operations as incurred.
NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed based on the weighted average
number of shares of common stock and common stock equivalents outstanding during
the period.
The Exchange Option, as hereinafter defined (see Note 2), was classified as
a potentially dilutive security for fiscal 1996, 1997 and 1998 for the purpose
of computing diluted income per common share. The Exchange Option was
anti-dilutive for fiscal 1996, 1997 and 1998 and, therefore, was excluded from
the diluted income per common share calculations. The Exchange Option was
exercised in January 1998.
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," ("FAS 123") which became effective for fiscal years beginning
after December 15, 1995 (fiscal 1997 for the Company). FAS 123 established new
financial accounting and reporting standards for stock-based compensation plans.
Entities are allowed to measure compensation cost for stock-based compensation
under FAS 123 or APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Entities electing to remain with the accounting in APB Opinion No. 25 are
required to make pro forma disclosures of net income and income per common share
as if the provisions of FAS 123 had been applied. The Company has adopted FAS
123 on a pro forma disclosure basis (see Note 8).
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued FAS 128, which applies to entities with
publicly held common stock or potential common stock. FAS 128 replaces APB
Opinion 15, "Earnings per Share" and related interpretations. APB Opinion 15
required that entities with simple capital structures present a single "earnings
per common share" ("EPS") on the face of the income statement, whereas those
with complex capital structures present both "primary" and "fully diluted" EPS.
Primary EPS shows the amount of income attributed to each share of common stock
if every common stock equivalent were converted into common stock. Fully diluted
EPS considers common stock equivalents and all other securities that could be
converted into common stock.
FAS 128 simplifies the computation of EPS by replacing the presentation of
primary EPS with a presentation of basic EPS. The Statement requires dual
presentation of basic and diluted EPS by entities with complex capital
structures. Basic EPS includes no dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for
F-10
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the period. Diluted EPS reflects the potential dilution of securities that could
share in the earnings of an entity, similar to fully diluted EPS under APB
Opinion 15. The Company adopted FAS 128 during the fiscal year ended September
30, 1998. See Note 8, "Stockholder's Equity".
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 establishes accounting guidance for
internal use software and requires the following:
- Computer software costs that are incurred in the preliminary project stage
(as described in SOP 98-1) should be expensed as incurred. Once the
capitalization criteria of SOP 98-1 have been met, external direct costs
of materials and services consumed in developing or obtaining internal-use
computer software; payroll and payroll-related costs for employees who are
directly associated with and who devote time to the internal-use computer
software project (to the extent of the time spent directly on the project)
and interest costs incurred when developing computer software for internal
use should be capitalized. Training costs and data conversion costs should
generally be expensed as incurred.
- Internal costs incurred for upgrades and enhancements should be expensed
or capitalized in accordance with SOP 98-1. Internal costs incurred for
maintenance should be expensed as incurred. Entities that cannot separate
internal costs on a reasonably cost-effective basis between maintenance
and relatively minor upgrades and enhancements should expense such costs
as incurred.
- External costs incurred under agreements related to specified upgrades and
enhancements should be expensed or capitalized in accordance with SOP
98-1. However, external costs related to maintenance, unspecified upgrades
and enhancements and costs under agreements that combine the costs of
maintenance and unspecified upgrades and enhancements should be recognized
in expense over the contract period on a straight-line basis unless
another systematic and rational basis is more representative of the
services received.
- Impairment should be recognized and measured in accordance with the
provisions of FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
- The capitalized costs of computer software developed or obtained for
internal use should be amortized on a straight-line basis unless another
systematic and rational basis is more representative of the software's
use.
SOP 98-1 becomes effective for financial statements for fiscal years
beginning after December 15, 1998. The provisions of SOP 98-1 should be applied
to internal-use software costs incurred in those fiscal years for all projects,
including those projects in progress upon initial application of SOP 98-1. Costs
incurred prior to the initial application of SOP 98-1, whether capitalized or
not, should not be adjusted to the amounts that would have been capitalized had
SOP 98-1 been in effect when those costs were incurred.
The Company adopted SOP 98-1 effective October 1, 1997. Each of the
Company's operating units maintains its own information systems, which include
internal-use software as defined by SOP 98-1. The care management and claims
processing systems used in the Company's managed care businesses are the
Company's most significant internal-use software applications. The adoption of
SOP 98-1 had no impact on the Company's financial position or results of
operations.
F-11
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5 requires all
nongovernmental entities to expense costs of start-up activities as those costs
are incurred. Start-up costs, as defined by SOP 98-5, include pre-operating
costs, pre-opening cost and organizational costs. SOP 98-5 becomes effective for
financial statements for fiscal years beginning after December 15, 1998. At
adoption, a company must record a cumulative effect of a change in accounting
principle to write off any unamortized start-up costs remaining on the balance
sheet when SOP 98-5 is adopted. Prior year financial statements cannot be
restated. The Company will adopt SOP 98-5 on October 1, 1998. The adoption of
SOP 98-5 will have no impact on the Company's financial position or results of
operations.
Emerging Issues Task Force Issue 96-16, "Investor's Accounting for an
Investee When the Investor Has a Majority of the Voting Interest but the
Minority Shareholder or Shareholders Have Certain Approval or Veto Rights"
("EITF 96-16") supplements the guidance contained in AICPA Accounting Research
Bulletin 51, "Consolidated Financial Statements", and in Statement of Financial
Accounting Standards No. 94, "Consolidation of All Majority-Owned Subsidiaries"
("ARB 51/FAS 94"), about the conditions under which the Company's consolidated
financial statements should include the financial position, results of
operations and cash flows of subsidiaries which are less than wholly-owned along
with those of the Company's wholly-owned subsidiaries.
In general, ARB 51/FAS 94 requires consolidation of all majority-owned
subsidiaries except those for which control is temporary or does not rest with
the majority owner. Under the ARB 51/FAS 94 approach, instances of control not
resting with the majority owner were generally regarded to arise from such
events as the legal reorganization or bankruptcy of the majority-owned
subsidiary. EITF 96-16 expands the definition of instances in which control does
not rest with the majority owner to include those where significant approval or
veto rights, other than those which are merely protective of the minority
shareholder's interest, are held by the minority shareholder or shareholders
("Substantive Participating Rights"). Substantive Participating Rights include,
but are not limited to: i) selecting, terminating and setting the compensation
of management responsible for implementing the majority-owned subsidiary's
policies and procedures, and ii) establishing operating and capital decisions of
the majority-owned subsidiary, including budgets, in the ordinary course of
business.
The provisions of EITF 96-16 apply to new investment agreements made after
July 24, 1997, and to existing investment agreements which are modified after
this date. The Company has made no new investments, and has modified no existing
investments, to which the provisions of EITF 96-16 would have applied.
In addition, the provisions of EITF 96-16 must be applied to majority-owned
subsidiaries previously consolidated under ARB 51/FAS 94 for which the
underlying agreements have not been modified in financial statements issued for
years ending after December 15, 1998 (fiscal 1999 for the Company). The
F-12
<PAGE>
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
adoption of the provisions of EITF 96-16 on October 1, 1998, will have the
following effects on the Company's consolidated financial position:
<TABLE>
<CAPTION>
OCTOBER 1,
1998
-----------
<S> <C>
INCREASE (DECREASE) IN:
Cash and cash equivalents....................................................... $ (21,092)
Other current assets........................................................... (9,538)
Long-term assets............................................................... (30,049)
Investment in unconsolidated subsidiaries...................................... 26,498
-----------
Total Assets................................................................. $ (34,181)
-----------
-----------
Current liabilities............................................................ $ (10,381)
Minority interest.............................................................. (23,800)
-----------
Total Liabilities............................................................ $ (34,181)
-----------
-----------
</TABLE>
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("FAS 131"). FAS 131 redefines how operating segments are determined and
requires disclosure of certain financial and descriptive information about a
company's operating segments. The Company has adopted FAS 131 in fiscal 1998.
Accordingly, segment disclosure for fiscal 1996 and 1997 has been restated to
conform to the fiscal 1998 presentation. See Note 15, "Business Segment
Information."
RECLASSIFICATIONS
Certain reclassifications have been made to fiscal 1996 and 1997 amounts to
conform to fiscal 1998 presentation.
2. ACQUISITIONS AND JOINT VENTURES
ACQUISITIONS
MERIT ACQUISITION. On February 12, 1998, the Company consummated the
acquisition of Merit Behavioral Care Corporation ("Merit") for cash
consideration of approximately $448.9 million plus the repayment of Merit's
debt. Merit manages behavioral healthcare programs across all segments of the
healthcare industry, including HMOs, Blue Cross/Blue Shield organizations and
other insurance companies, corporations and labor unions, federal, state and
local governmental agencies and various state Medicaid programs. The Company
accounted for the Merit acquisition using the purchase method of accounting. On
September 12, 1997, Merit completed the acquisition of CMG Health, Inc. ("CMG").
CMG is also a national behavioral managed healthcare. Merit paid approximately
$48.7 million in cash and issued approximately 739,000 shares of Merit common
stock as consideration for CMG. The former owners of CMG may be entitled to
additional consideration, depending on the performance of three CMG customer
contracts. Such contingent payments are subject to an aggregate maximum of $23.5
million. No contingent consideration will be payable to the former shareholders
of CMG based on the performance of two of the three CMG customer contracts at
September 30, 1998. The Company may still be required to pay contingent
consideration to the former shareholders of CMG depending on the financial
performance of CHOICE Behavioral Health Partnership ("Choice"). Choice is a
joint venture with Value Options, Inc. that services a contract with CHAMPUS (as
defined). The Company and Value Options, Inc. each own 50% of Choice. The
payment of contingent consideration, if any, to the former shareholders of CMG,
depends on the financial performance of Choice from October 1, 1996 to June 30,
F-13
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
1997, which is subject to a CHAMPUS Adjustment (as defined) the Company expects
to receive in fiscal 1999.
In connection with the acquisition of Merit, the Company (i) terminated its
existing credit agreement; (ii) repaid all loans outstanding pursuant to Merit's
existing credit agreement; (iii) completed a tender offer for its 11.25% Series
A Senior Subordinated Notes due 2004 (the "Old Notes"); (iv) completed a tender
offer for Merit's 11.50% Senior Subordinated notes due 2005 (the "Merit
Outstanding Notes"); (v) entered into a new senior secured bank credit agreement
(the "New Credit Agreement") providing for a revolving credit facility (the
"Revolving Facility") and a term loan facility (the "Term Loan Facility") of up
to $700 million; and (vi) issued $625 million in 9.0% Senior Subordinated Notes
due 2008 (the "Notes").
The following table sets forth the sources and uses of funds for the Merit
acquisition and related transactions (the "Transactions") at closing (in
thousands):
<TABLE>
<S> <C>
SOURCES:
Cash and cash equivalents.............................................. $ 59,290
New Credit Agreement:
Revolving Facility (1)............................................... 20,000
Term Loan Facility................................................... 550,000
The Notes.............................................................. 625,000
----------
Total sources...................................................... $1,254,290
----------
----------
USES:
Cash paid to Merit Shareholders........................................ $ 448,867
Repayment of Merit existing credit agreement (2)....................... 196,357
Purchase of the Old Notes (3).......................................... 432,102
Purchase of Merit Outstanding Notes (4)................................ 121,651
Transaction costs (5).................................................. 55,313
----------
Total uses......................................................... $1,254,290
----------
----------
</TABLE>
- ------------------------
(1) The Revolving Facility provides for borrowings of up to $150.0 million. The
Company had $112.5 million available for borrowing pursuant to the Revolving
Facility after consummating the Transactions, excluding approximately $17.5
million of availability reserved for certain letters of credit.
(2) Includes principal amount of $193.6 million and accrued interest of $2.7
million.
(3) Includes principal amount of $375.0 million, tender premium of $43.4 million
and accrued interest of $13.7 million.
(4) Includes principal amount of $100.0 million, tender premium of $18.9 million
and accrued interest of $2.8 million.
(5) Transaction costs include, among other things, expenses associated with the
debt tender offers, the Notes offering, the Merit acquisition and the New
Credit Agreement.
The purchase price allocation for the Merit acquisition is tentative and
subject to adjustment pending determination of final valuation allowances on
deferred tax assets, integration plan matters (see Note 11), CHAMPUS Adjustments
(as defined) and certain other matters. The Company expects the Merit purchase
price allocation to be finalized by February 12, 1999.
HAI ACQUISITION. On December 4, 1997, the Company consummated the purchase
of Human Affairs International, Incorporated ("HAI"), formerly a unit of
Aetna/U.S. Healthcare ("Aetna"), for approximately
F-14
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
$122.1 million, which the Company funded from cash on hand. The Company
accounted for the HAI acquisition using the purchase method of accounting. HAI
manages behavioral healthcare, primarily through EAPs and other behavioral
managed healthcare plans. The Company may be required to make additional
contingent payments of up to $60.0 million annually to Aetna over the five year
period subsequent to closing. The amount and timing of the payments will be
contingent upon net increases in the number of HAI's covered lives in specified
products.
The Company may be required to make additional contingent payments of up to
$300 million to Aetna (the "Contingent Payments") over the five-year period
(each year a "Contract Year") subsequent to closing. The amount and timing of
the Contingent Payments will depend upon HAI's receipt of additional covered
lives as computed, under two separate calculations. Under the first calculation,
the Company may be required to pay up to $25 million per year for each of five
years following the acquisition based on the net annual growth in the number of
lives covered in specified HAI products. Under the second calculation, the
Company may be required to pay up to $35 million per Contract Year, based on the
net cumulative increase in lives covered by certain other HAI products.
The Company is obligated to make contingent payments under two separate
calculations (as previously described) as follows: In respect of each Contract
Year, the Company may be required to pay to Aetna the "Tranche 1 Payments" (as
defined) and the "Tranche 2 Payments" (as defined).
Upon the expiration of each Contract Year, the Tranche 1 Payment shall vest
with respect to such Contract Year in an amount equal to the product of (i) the
Tranche 1 Cumulative Incremental Members (as defined) for such Contract Year and
(ii) the Tranche 1 Multiplier (as defined) for such Contract Year. The vested
amount of Tranche 1 Payment shall be zero with respect to any Contract Year in
which the Tranche 1 Cumulative Incremental Members is a negative number.
Furthermore, in the event that the number of Tranche 1 Cumulative Incremental
Members with respect to any Contract Year is a negative number due to a decrease
in the number of Tranche 1 Cumulative Incremental Members for such Contract Year
(as compared to the immediately preceding Contract Year), Aetna will forfeit the
right to receive a certain portion (which may be none or all) of the vested and
unpaid amounts of the Tranche 1 Payment relating to preceding Contract Years.
"Tranche 1 Cumulative Incremental Members" means, with respect to any
Contract Year, (i) the number of Equivalent Members (as defined) serviced by the
Company during such Contract Year for Tranche 1 Members, minus (ii)(A) for each
Contract Year other than the Initial Contract Year, the number of Equivalent
Members serviced by the Company for Tranche 1 Members during the immediately
preceding Contract Year or (B) for the Initial Contract Year, the number of
Tranche 1 Members as of September 30, 1997, subject to certain upward
adjustments. There were 3,761,253 Tranche 1 Members for the initial Contract
Year, prior to such upward adjustments. "Tranche 1 Members" are members of
managed behavioral healthcare plans for whom the Company provides services in
any of specified categories of products or services. "Equivalent Members" for
any Contract Year equals the aggregate Member Months for which the Company
provides services to a designated category or categories of members during the
applicable Contract Year divided by 12. "Member Months" means, for each member,
the number of months for which the Company provides services and is compensated.
The "Tranche 1 Multiplier" is $80, $50, $40, $25, and $20 for the Contract Years
1998, 1999, 2000, 2001, and 2002, respectively.
For each Contract Year, the Company is obligated to pay to Aetna the lesser
of (i) the vested portion of the Tranche 1 Payment for such Contract Year and
the vested and unpaid amount relating to prior Contract Years as of the end of
the immediately preceding Contract Year and (ii) $25.0 million. To the extent
that the vested and unpaid portion of the Tranche 1 Payment exceeds $25.0
million, the Tranche 1 Payment remitted to Aetna shall be deemed to have been
paid first from any vested but unpaid amounts
F-15
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
from previous Contract Years in order from the earliest Contract Year for which
vested amounts remain unpaid to the most recent Contract Year at the time of
such calculation. Except with respect to the Contract Year ending in 2002, any
vested but unpaid portion of the Tranche 1 Payment shall be available for
payment to Aetna in future Contract Years, subject to certain exceptions. All
vested but unpaid amounts of Tranche 1 Payments shall expire following the
payment of the Tranche 1 Payment in respect to the Contract Year ending in 2002,
subject to certain exceptions. In no event shall the aggregate Tranche 1
Payments to Aetna exceed $125.0 million.
Upon the expiration of each Contract Year, the Tranche 2 Payment shall be an
amount equal to the lesser of: (a)(i) the product of (A) the Tranche 2
Cumulative Members (as defined) for such Contract Year and (B) the Tranche 2
Multiplier (as defined) applicable to such number of Tranche 2 Cumulative
Members, minus (ii) the aggregate of the Tranche 2 Payments paid to Aetna for
all previous Contract Years and (b) $35.0 million. The amount shall be zero with
respect to any Contract Year in which the Tranche 2 Cumulative Members is a
negative number.
"Tranche 2 Cumulative Members" means, with respect to any Contract Year; (i)
the Equivalent Members serviced by the Company during such Contract Year for
Tranche 2 Members, minus (ii) the Tranche 2 Members as of September 30, 1997,
subject to certain upward adjustments. There were 936,391 Tranche 2 Members
prior to such upward adjustments. "Tranche 2 Members" means Members for whom the
Company provides products or services in the HMO category. The "Tranche 2
Multiplier" with respect to each Contract Year is $85 in the event that the
Tranche 2 Cumulative Members are less than 2,100,000, and $70 if more than or
equal to 2,100,000.
For each Contract Year, the Company shall pay to Aetna the amount of Tranche
2 Payment payable for such Contract Year. All rights to receive Tranche 2
Payment shall expire following the payment of the Tranche 2 Payment in respect
to the Contract Year ending in 2002, subject to certain exceptions.
Notwithstanding anything herein to the contrary, in no event shall the aggregate
Tranche 2 payment to Aetna exceed $175.0 million, subject to certain exceptions.
The Company would record contingent consideration payable, if any, as
goodwill and identifiable intangible assets.
ALLIED ACQUISITION. On December 5, 1997, the Company purchased the assets of
Allied Health Group, Inc. and certain affiliates ("Allied"). Allied provides
specialty managed care services, including risk-based products and
administrative services to a variety of insurance companies and other customers.
Allied has over 80 physician networks across the eastern United States. Allied's
networks include physicians specializing in cardiology, oncology and diabetes.
The Company paid approximately $70.0 million for Allied, with cash on hand, of
which $50.0 million was paid to the seller at closing with the remaining $20.0
million placed in escrow. The Company accounted for the Allied acquisition using
the purchase method of accounting. The escrowed amount was payable in one-third
increments if Allied achieved specified earnings targets during each of the
three years following the closing. Additionally, the purchase price could have
been increased during the three year period by up to $40.0 million if Allied's
performance exceeded specified earnings targets.
On November 25, 1998, the Company and the former owners of Allied amended
the Allied purchase agreement (the "Allied Amendment"). The Allied Amendment
resulted in the following changes to the original terms of the Allied purchase
agreement:
- Approximately $18.9 million of the original $20.0 million placed in escrow
by the Company at the consummation of the Allied acquisition, plus accrued
interest, was repaid to the Company.
F-16
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
- The Company paid certain of the former owners of Allied approximately $4.0
million in settlement of a portion of their potential future contingent
consideration.
- The Company's maximum remaining contingent consideration payable to the
former owners of Allied is approximately $6.1 million less approximately
$1.1 million that remains in escrow. The future contingent payments, if
any, will be based upon the operating performance of Allied for fiscal
1999 through fiscal 2001.
The Company would record contingent consideration payable, if any, as
additional goodwill.
The preliminary allocation of the Allied purchase price to goodwill and
identifiable intangible assets was based on the Company's preliminary
valuations, which are subject to change upon receiving independent appraisals of
identifiable assets. The Company expects the Allied purchase price allocation to
be finalized by December 5, 1998.
The following unaudited pro forma information for the years ended September
30, 1997 and 1998 has been prepared assuming the Crescent Transactions (as
defined), Allied acquisition, HAI acquisition, Merit acquisition, the
Transactions and the Green Spring Minority Shareholder Conversion (as defined)
were consummated on October 1, 1996. The unaudited pro forma information does
not purport to be indicative of the results that would have actually been
obtained had such transactions been consummated on October 1, 1996 or which may
be attained in future periods (in thousands, except per share data):
<TABLE>
<CAPTION>
PRO FORMA
FOR THE YEAR ENDED
------------------------------
<S> <C> <C>
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
-------------- --------------
Net revenue...................................................................... $ 1,589,776 $ 1,813,768
Income before extraordinary item(1).............................................. 18,910 14,941
Net income(1)(2)................................................................. 13,657 14,941
Income per common share--basic:
Income before extraordinary item............................................... 0.60 0.47
Net income..................................................................... 0.43 0.47
Income per common share--diluted:
Income before extraordinary item............................................... 0.59 0.47
Net income..................................................................... 0.42 0.47
</TABLE>
- ------------------------
(1) Excludes expected unrealized cost savings related to the Integration Plan
(as defined), Managed Care integration costs (See Note 11) and Loss on
Crescent Transactions.
(2) Excludes the extraordinary losses on early extinguishment of debt for the
year ended September 30, 1998, that were directly attributable to the
consummation of the Transactions.
HUMAN SERVICES ACQUISITIONS During fiscal 1998, the Company acquired seven
businesses in its human services segment for an aggregate purchase price of
approximately $57.0 million (collectively, the "Human Services Acquisitions").
The Human Services Acquisitions have been accounted for using the purchase
method of accounting. The Human Services Acquisitions provide various
residential and day services for individuals with acquired brain injuries and
for individuals with mental retardation and developmental disabilities.
GREEN SPRING ACQUISITION. On December 13, 1995, the Company acquired a 51%
ownership interest in Green Spring Health Services, Inc. ("Green Spring") for
approximately $68.9 million in cash, the issuance of 215,458 shares of Magellan
Common Stock valued at approximately $4.3 million and the
F-17
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
contribution of Group Practice Affiliates, Inc. ("GPA"), a wholly-owned
subsidiary of the Company, which became a wholly-owned subsidiary of Green
Spring. In addition, the minority stockholders of Green Spring were issued an
option agreement whereby they could exchange their interests in Green Spring for
an equivalent of the Company's Common Stock or subordinated notes (the "Exchange
Option"). On December 20, 1995, the Company acquired an additional 10% ownership
interest in Green Spring for approximately $16.7 million in cash as a result of
an exercise by a minority stockholder of its Exchange Option. In January, 1998,
the minority stockholders of Green Spring converted their collective 39%
interest in Green Spring into an aggregate of 2,831,516 shares of the Company's
common stock through exercise of the Exchange Option (the "Green Spring Minority
Stockholder Conversion"). As a result of the Green Spring Minority Stockholder
Conversion, the Company owns 100% of Green Spring. The Company issued shares
from treasury to effect the Green Spring Minority Stockholder Conversion and
accounted for it as a purchase of minority interest at a fair value of
consideration paid of approximately $63.5 million.
The Company recorded the investments in Green Spring using the purchase
method of accounting. Green Spring's results of operations have been included in
the consolidated financial statements since the acquisition date, less minority
interest through January, 1998, at which time the Company became the sole owner
of Green Spring.
At each reporting date through January 1998, the Company assessed the fair
value of the Exchange Option in relation to the redemption price available to
the minority stockholders. In any period that the fair value of the Exchange
Option was determined to be less than the redemption price, the difference would
have been recognized as an adjustment to minority interest. No losses were
recorded in fiscal 1996, 1997 and 1998 as a result of changes in the fair value
of the Exchange Option.
JOINT VENTURES
Through its acquisition of Merit, the Company became a 50% partner with
Value Options, Inc. in Choice, a managed behavioral healthcare company. Choice
derives all of its revenues from a contract with the Civilian Health and Medical
Program of the Uniformed Services ("CHAMPUS"), and with TriCare, the successor
to CHAMPUS. The Company accounts for its investment in Choice using the equity
method.
F-18
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
A summary of financial information for the Company's investment in Choice is
as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
--------------------
<S> <C>
Current assets.......................................................... $ 22,974
Property and equipment, net............................................. 345
--------
Total assets.......................................................... $ 23,319
--------
--------
Current liabilities..................................................... $ 16,829
Partners' capital....................................................... 6,490
--------
$ 23,319
--------
--------
Magellan Investment in Choice........................................... $ 3,245
--------
--------
FOR THE 231 DAYS ENDED SEPTEMBER 30, 1998
Net revenue............................................................. $ 38,676
Operating expenses...................................................... 22,914
--------
Net income............................................................ $ 15,762
--------
--------
Magellan equity income.................................................. $ 7,881
--------
--------
</TABLE>
In June 1996, Green Spring became a 33 1/3% member in Premier Behavioral
Systems of Tennessee, LLC ("Premier") with Managed Health Network, Inc. and
Columbia Behavioral Health of Tennessee, LLC equally owning the remaining
membership interests. In July 1996, Green Spring's membership interest increased
to 50% by virtue of Managed Health Network, Inc.'s withdrawal from Premier.
Premier was formed to manage behavioral healthcare benefits for the State of
Tennessee's TennCare program. The Company accounts for its investment in Premier
using the equity method. The Company's investment in Premier at September 30,
1997 and 1998 was $(0.7) million and $5.8 million, respectively. The Company's
equity in income (loss) of Premier for fiscal 1996, 1997 and 1998 was $(2.0)
million, $(5.6) million and $4.7 million, respectively. Equity in income (loss)
of CHOICE and Premier is included in net revenue.
The Company is an owner in six hospital-based joint ventures ("Provider
JV's") at September 30, 1998. Generally, each member of the joint venture leased
and/or contributed certain assets in each respective market to the joint venture
with the Company becoming the managing member.
The Provider JV's results of operations have been included in the
consolidated financial statements since inception, less minority interest. A
summary of the Provider JV's is as follows:
<TABLE>
<CAPTION>
OWNERSHIP
MARKET DATE PERCENTAGE MINORITY OWNER/S
- ----------------------------------- ----------------- ----------------- --------------------------------------------
<S> <C> <C> <C>
Chicago, IL........................ June 1994 75% Naperville Health Ventures
Boston, MA......................... February 1995 95% Westwood/Pembroke Corp.,
Psychiatric Associates of Norfolk County,
Inc.
Albuquerque, NM.................... May 1995 67% Columbia/HCA Healthcare Corporation
Raleigh, NC........................ June 1995 50% Columbia/HCA Healthcare Corporation
Lafayette, LA...................... October 1995 50% Columbia/HCA Healthcare Corporation
Anchorage, AK...................... August 1996 57% Columbia/HCA Healthcare Corporation
</TABLE>
F-19
<PAGE>
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
The Company's ownership interests in the Provider JV's have been managed by
CBHS (as defined) for a fee equivalent to Magellan's portion of the joint
ventures earnings since June 17, 1997.
On October 1, 1998, the Provider JV's, excluding Westwood/Pembroke, were
converted from consolidation to the equity method of accounting due to the
Company's implementation of the transition guidance set forth in EITF 96-16. See
Note 1, "Recent Accounting Pronouncements".
3. CRESCENT TRANSACTIONS
On June 17, 1997, the Company consummated a series of transactions including
the sale of substantially all of its domestic hospital real estate and related
personal property (the "Assets") to Crescent Real Estate Equities Limited
Partnership ("Crescent") and Charter Behavioral Hospital System, LLC ("CBHS").
In addition, CBHS was formed as a joint venture to operate the domestic portion
of the Company's provider business segment. CBHS is owned equally by Magellan
and Crescent Operating, Inc., ("COI") an affiliate of Crescent. The Company
accounts for its 50% investment in CBHS under the equity method of accounting
(See Note 4). The Company received approximately $417.2 million in cash (before
costs estimated to be $16.0 million) and warrants in COI for the purchase of
2.5% of COI's common stock at $18.32, which are exercisable over 12 years. The
Company also issued 1,283,311 warrants each to Crescent and COI (the "Crescent
Warrants") for the purchase of Magellan common stock at an exercise price of $30
per share. (See Note 8.)
In related agreements, (i) Crescent leased the hospital real estate and
related assets to CBHS for initial annual rent beginning at approximately $41.7
million with a 5% annual escalation clause compounded annually (the "Facilities
Lease") and (ii) CBHS will pay Magellan approximately $78.3 million in annual
franchise fees, subject to increase, for the use of assets retained by Magellan
and for support in certain areas. The franchise fees to be paid by CBHS to the
Company are subordinated to the lease obligations in favor of Crescent. The
assets retained by Magellan include, but are not limited to, the "CHARTER" name,
intellectual property, protocols and procedures, clinical quality management,
operating processes and the "1-800-CHARTER" telephone call center. Magellan
provides CBHS ongoing support in areas including advertising and marketing
assistance, risk management services, outcomes monitoring, and consultation on
matters relating to reimbursement, government relations, clinical strategies,
regulatory matters, strategic planning and business development.
The Company initially used approximately $200 million of the proceeds from
the sale of the Assets to reduce its long-term debt, including borrowings under
its then existing credit agreement. In December 1997, the Company used the
remaining proceeds from the sale of the Assets to acquire additional managed
care businesses. See Note 2, "Acquisitions and Joint Ventures."
The Company recorded a loss before income taxes of approximately $59.9
million as a result of the Crescent Transactions, which consisted of the
following (in thousands):
<TABLE>
<S> <C>
Accounts receivable collection fees............................... $ 21,400
Impairment losses on intangible assets............................ 14,408
Exit costs and construction obligation............................ 12,549
Loss on the sale of property and equipment........................ 11,511
---------
$ 59,868
---------
---------
</TABLE>
Accounts receivable collection fees represent the reduction in the net
realizable value of accounts receivable for estimated collection fees on
retained hospital-based receivables for CBHS pursuant to a contractual
obligation with CBHS, whereby CBHS receives a fee equal to 5% of collections for
the first
F-20
<PAGE>
3. CRESCENT TRANSACTIONS (CONTINUED)
120 days after consummation of the Crescent Transaction and estimated bad debt
agency fees of 40% for receivables collected subsequent to 120 days after the
consummation of the Crescent Transactions.
The Company disposed of a significant portion of its provider business
segment as part of the Crescent Transactions. The impairment loss on intangible
assets resulted from reducing the book value of the Company's investment in CBHS
to its approximate fair value at the consummation date. The fair value of CBHS
was determined by the Company's financial advisors using a discounted cash flows
analysis. The impairment losses represent the carrying amount of goodwill and
other intangible assets related to the divested or contributed CBHS operations.
The $5.0 million of exit costs accrued as a result of the Crescent
transactions include incremental staffing, consulting and related costs to
prepare and coordinate audits of terminating Medicare cost reports, prepare and
file income tax, property tax, sales and use tax and other tax returns and
perform accounting functions related to the divested businesses (CBHS). The
Company incurred approximately $0.6 million and $1.8 million of such costs
during the years ended September 30, 1997 and 1998, respectively.
The Company constructed a hospital in Philadelphia as required by the
Crescent Real Estate Purchase Agreement to replace the existing Philadelphia
hospital operated by CBHS. The Company incurred approximately $5.5 million in
construction costs through September 30, 1998.
4. INVESTMENT IN CBHS
The Company owned a 50% interest in CBHS as of September 30, 1997 and 1998.
The Company became a 50% owner of CBHS upon consummation of the Crescent
Transactions. The Company accounts for its investment in CBHS using the equity
method.
A summary of financial information for CBHS is as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
-------------------- --------------------
<S> <C> <C>
Current assets.................................... $ 148,537 $ 147,119
Property and equipment, net....................... 18,424 21,148
Other noncurrent assets........................... 8,633 8,871
---------- ----------
Total Assets.................................... $ 175,594 $ 177,138
---------- ----------
---------- ----------
Current liabilities............................... $ 68,497 $ 141,379
Long-term debt.................................... 65,860 67,200
Other noncurrent liabilities...................... 7,481 35,437
Members' capital (deficit)........................ 33,756 (66,878)
---------- ----------
Total Liabilities and Members' Capital
(Deficit)..................................... $ 175,594 $ 177,138
---------- ----------
---------- ----------
</TABLE>
F-21
<PAGE>
4. INVESTMENT IN CBHS (CONTINUED)
<TABLE>
<CAPTION>
FOR THE
106 DAYS ENDED FISCAL YEAR ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
-------------------- --------------------
<S> <C> <C>
Net revenue....................................... $ 213,730 $ 730,447
---------- ----------
Operating expenses................................ 228,382 822,099
Interest, net..................................... 1,592 5,263
---------- ----------
Net loss........................................ $ (16,244) $ (96,915)
---------- ----------
---------- ----------
Cash used in operating activities................. $ (67,831) $ (788)
---------- ----------
---------- ----------
Magellan equity loss(1),(3)....................... $ (8,122) $ (31,878)
---------- ----------
---------- ----------
</TABLE>
The Company's transactions with CBHS and related balances are as follows (in
thousands):
<TABLE>
<CAPTION>
106 DAYS ENDED FISCAL YEAR ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
-------------------- --------------------
<S> <C> <C>
Franchise Fee revenue(1).......................... $ 22,739 $ 55,600
-------- --------
Costs:
Accounts receivable collection fees............. $ 4,993 $ 1,980
Provider JV management fees..................... 2,111 5,329
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
-------------------- --------------------
<S> <C> <C>
Due to CBHS, net(2)............................... $ 5,090 $ 1,127
-------- --------
-------- --------
Prepaid Charter call center management fees....... $ -- $ 2,953
-------- --------
-------- --------
Investment in CBHS(1),(3)......................... $ 16,878 $ --
-------- --------
-------- --------
</TABLE>
- ------------------------
(1) The Company's Franchise Fee revenue for the year ended September 30, 1998,
was approximately $55.6 million while CBHS recorded Franchise Fee expense of
approximately $78.6 million for the year ended September 30, 1998.
Accordingly, the Company has eliminated the intercompany loss for the
proportionate share of the difference between Franchise Fee revenue and
expense reflected in the Company's financial statements and CBHS' financial
statements of approximately $11.5 million.
(2) The nature of hospital accounts receivable billing and collection processes
have resulted in the Company and CBHS receiving remittances from payors
which belong to the other party. Additionally, the Company and CBHS have
established a settlement and allocation process for the accounts receivable
related to those patients who were not yet discharged from their treatment
on June 16, 1997. In an effort to settle these amounts on a timely basis,
and in light of CBHS start up operations and cash flow requirements, the
Company made advances to CBHS periodically during fiscal 1998, which have
been repaid by CBHS. Such advances, net of all settlement activity and
certain other amounts due to CBHS for certain shared services and related
matters, resulted in the amount presented as due to CBHS.
(3) Franchise Fees due from CBHS were approximately $38.0 million as of
September 30, 1998. CBHS's independent public accountants' report on CBHS's
financial statements for the year ended September 30, 1998 makes reference
to uncertainty regarding CBHS's ability to continue as a going concern. The
Company recorded equity in loss in excess of its investment in CBHS until
all Franchise Fees due from CBHS were reduced to $0 at September 30, 1998.
Equity in losses of
F-22
<PAGE>
4. INVESTMENT IN CBHS (CONTINUED)
CBHS in excess of the Company's investment in CBHS of $5.1 million,
excluding the $11.5 million in (1) above, have not been reflected in the
Company's financial statements since the Company has no remaining obligation
or commitment to fund CBHS and has no guarantees outstanding for any CBHS
obligations.
5. UNUSUAL ITEMS
GENERAL
The following table summarizes unusual items recorded during the three years
in the period ended September 30, 1998 (in thousands):
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Insurance settlements....................................... $ 30,000 $ -- $ --
Facility closures........................................... 4,116 4,201 --
Asset impairments........................................... 1,207 -- --
Gains on the sale of psychiatric hospitals, net............. -- (5,388) (3,000)
Termination of CBHS sale transaction........................ -- -- 3,458
Other....................................................... 1,948 1,544 --
--------- --------- ---------
$ 37,271 $ 357 $ 458
--------- --------- ---------
--------- --------- ---------
</TABLE>
INSURANCE SETTLEMENTS
In August 1996, the Company and a group of insurance carriers resolved a
billing dispute which arose in fiscal 1996 related to matters originating in the
1980's. As part of the settlement of these claims, certain related payer matters
and associated legal fees, the Company recorded a charge of approximately $30.0
million during fiscal 1996. The Company will pay the insurance settlement amount
in twelve installments over a three year period, beginning August 1996. As part
of the settlement, the Company and the insurance carriers agreed that the
dispute and settlement would not negatively impact any present or pending
business relationships nor would it prevent the parties from negotiating in good
faith concerning additional business opportunities available to, and future
relationships between, the parties. The Company will make final payments
totaling $6.0 million in fiscal 1999 for insurance settlements.
FACILITY CLOSURES
During fiscal 1996 and 1997, the Company consolidated, closed or sold nine
and three psychiatric facilities and its one general hospital (the "Closed
Facilities"), respectively, exclusive of the Crescent Transactions. The three
psychiatric facilities closed in 1997 were sold as part of the Crescent
Transactions. The Closed Facilities that are still owned by the Company will be
sold, leased or used for alternative purposes depending on the market conditions
in each geographic area and are reflected as other long-term assets in the
accompanying balance sheets.
The Company recorded charges of approximately $4.1 million and $4.2 million
related to facility closures in fiscal 1996 and 1997, respectively, as follows
(in thousands):
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Severance and related benefits........................................... $ 2,334 $ 2,976
Contract terminations and other.......................................... 1,782 1,225
--------- ---------
$ 4,116 $ 4,201
--------- ---------
--------- ---------
</TABLE>
F-23
<PAGE>
5. UNUSUAL ITEMS (CONTINUED)
Approximately 620 and 700 employees were terminated at the facilities closed
in fiscal 1996 and 1997, respectively. The recorded amounts have been paid as of
September 30, 1998.
The following table presents net revenue, salaries, cost of care and other
operating expenses and bad debt expenses and depreciation and amortization of
the Closed Facilities (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER
30,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Net revenue............................................................ $ 82,568 $ 19,582
Salaries, cost of care and other operating expense and bad debt
expenses............................................................. 86,426 23,263
Depreciation and amortization.......................................... 2,015 349
</TABLE>
The Company also recorded a charge of approximately $2.0 million in fiscal
1996 related to severance and related benefits for approximately 275 employees
who were terminated pursuant to planned overhead reductions.
ASSET IMPAIRMENTS
During fiscal 1996, the Company recorded impairment losses on property and
equipment of approximately $1.2 million. Such losses resulted from changes in
the manner that certain of the Company's assets were to be used in future
periods and current period operating losses at certain of the Company's
operating facilities combined with projected future operating losses. Fair
values of the long-lived assets that have been written down were determined
using the best available information in each individual circumstance, which
included quoted market price, comparable sales prices for similar assets or
valuation techniques utilizing present value of estimated expected cash flows.
GAINS ON SALE OF PSYCHIATRIC FACILITIES, NET AND OTHER
During fiscal 1997 and 1998, the Company recorded gains of approximately
$5.4 million and $3.0 million, respectively, related to the sales of psychiatric
hospitals and other real estate. The Company also recorded a charge of
approximately $1.6 million during fiscal 1997 for costs incurred related
primarily to the expiration of its agreement to sell its three European
Hospitals.
TERMINATION OF CBHS SALE TRANSACTION
On March 3, 1998, the Company and certain of its wholly owned subsidiaries
entered into definitive agreements with COI and CBHS pursuant to which the
Company would have, among other things, sold the Company's franchise operations,
certain domestic provider operations and certain other assets and operations. On
August 19, 1998, the Company announced that it had terminated discussions with
COI for the sale of its interest in CBHS. Furthermore, the Company exercised, in
the fourth quarter of fiscal 1998, certain limited management rights available
to it under the Master Franchise Agreement and, with CBHS's Board's support,
made operational and management changes at CBHS aimed at improving profitability
and cash flows. The Company has since restored all management rights to the CBHS
Board.
F-24
<PAGE>
5. UNUSUAL ITEMS (CONTINUED)
In connection with the termination of the CBHS sale transaction, the Company
recorded a charge of approximately $3.5 million as follows (in thousands):
<TABLE>
<S> <C>
Severance(1)....................................................... $ 488
Lease termination(1)............................................... 1,067
Impairment of long-lived assets.................................... 153
Transaction costs and other........................................ 1,750
---------
$ 3,458
---------
---------
</TABLE>
- ------------------------
(1) Relates to staffing reductions and lease terminations incurred in the
Company's franchising and outcomes monitoring subsidiaries.
6. BENEFIT PLANS
During fiscal 1992, the Company reinstated a defined contribution plan (the
"Magellan 401-K Plan"). Effective January 1, 1997, the plan was amended to allow
participants to contribute up to 15% of their compensation to the Magellan 401-K
Plan. The Company makes a discretionary contribution of 2% of each employee's
compensation and matches 50% of each employee's contribution up to 3% of their
compensation. During the years ended September 30, 1996, 1997 and 1998, the
Company made contributions of approximately $5.3 million, $5.7 million and $3.2
million respectively, to the Magellan 401-K Plan.
Green Spring maintains a defined contribution plan (the "Green Spring 401-K
Plan"). Employee participants can elect to voluntarily contribute up to 6% or
12% of their compensation, depending upon each employee's compensation level, to
the Green Spring 401-K Plan. Green Spring matches up to 3% of each employee's
compensation. Employees vest in employer contributions over five years. During
the years ended September 30, 1996, 1997 and 1998 Green Spring contributed
approximately $0.8 million, $1.3 million and $1.2 million, respectively, to the
Green Spring 401-K Plan.
Merit maintains a 401(k) savings plan covering substantially all employees
who have completed one year of active employment during which 1,000 hours of
service has been credited. Under the plan, an employee may elect to contribute
on a pre-tax basis to a retirement account up to 15% of the employee's
compensation up to the maximum annual contributions permitted by the Internal
Revenue Code. Merit matches employee contributions at the rate of 50% of the
employee's contributions to the 401(k) savings plan, up to a maximum of 6% of an
employee's annual compensation. Merit's 401(k) savings plan contribution
recognized as expense for the year ended September 30, 1998 was $1.1 million.
F-25
<PAGE>
7. LONG-TERM DEBT, CAPITAL LEASE OBLIGATIONS AND OPERATING LEASES
Information with regard to the Company's long-term debt and capital lease
obligations at September 30, 1997 and 1998 is as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
-------------- --------------
<S> <C> <C>
Credit Agreement:
Revolving Facility (7.84% to 7.88% at September 30, 1998)
due through 2004......................................... $ -- $ 40,000
Term Loan Facility (7.84% to 8.34% at September 30, 1998)
due through 2006......................................... -- 550,000
11.25% Series A Senior Subordinated Notes.................... 375,000 --
9.0% Senior Subordinated Notes due 2008...................... -- 625,000
6.31% to 11.50% Mortgage and other notes payable through
2005....................................................... 7,721 4,198
7.5% Swiss Bonds............................................. 6,443 --
3.8% Capital lease obligations due through 2014.............. 6,438 6,448
-------------- --------------
395,602 1,225,646
Less amounts due within one year........................... 3,601 23,033
Less debt service funds.................................... 308 --
-------------- --------------
$ 391,693 $ 1,202,613
-------------- --------------
-------------- --------------
</TABLE>
The aggregate scheduled maturities of long-term debt and capital lease
obligations during the five years subsequent to September 30, 1998 are as
follows (in thousands): 1999--$23,033; 2000-- $32,429; 2001--$38,929;
2002--$49,429 and 2003--$92,030.
The Notes which are carried at cost, had a fair value of approximately $534
million at September 30, 1998, based on market quotes. The Company's remaining
debt is also carried at cost, which approximates fair market value.
In connection with the acquisition of Merit, the Company (i) terminated its
Credit Agreement; (ii) repaid all loans outstanding pursuant to Merit's existing
credit agreement; (iii) completed a tender offer for the Old Notes; (iv)
completed a tender offer for the Merit Outstanding Notes; (v) entered into the
New Credit Agreement providing for Credit Facilities of up to $700 million; and
(vi) issued the Notes. See Note 2--"Acquisitions and Joint Ventures--Merit
Acquisition."
The Company recognized a net extraordinary loss from the early
extinguishment of debt of approximately $33.0 million, net of income tax
benefit, during fiscal 1998, to write off unamortized deferred financing costs
related to terminating the previous credit agreement and extinguishing the Old
Notes, to record the tender premium and related costs of extinguishing the Old
Notes and to record the gain on extinguishment of the 7.5% Swiss Bonds.
The New Credit Agreement provides for a Term Loan Facility in an aggregate
principal amount of $550 million, consisting of an approximately $183.3 million
Tranche A Term Loan (the "Tranche A Term Loan"), an approximately $183.3 million
Tranche B Term Loan (the "Tranche B Term Loan") and an approximately $183.3
million Tranche C Term Loan (the "Tranche C Term Loan"), and a Revolving
Facility providing for revolving loans to the Company and the "Subsidiary
Borrowers" (as defined therein) and the issuance of letters of credit for the
account of the Company and the Subsidiary Borrowers in an aggregate principal
amount (including the aggregate stated amount of letters of credit) of $150
million.
F-26
<PAGE>
7. LONG-TERM DEBT, CAPITAL LEASE OBLIGATIONS AND OPERATING LEASES (CONTINUED)
The Tranche A Term Loan and the Revolving Facility mature on February 12,
2004. The Tranche B Term Loan matures on February 12, 2005 and the Tranche C
Term Loan matures on February 12, 2006. The Tranche A Term Loan amortizes in
installments in each fiscal year in amounts equal to $16.5 million in 1999,
$28.0 million in 2000, $34.5 million in 2001, $45.0 million in 2002, $48.0
million in 2003 and $11.3 million in 2004. The Tranche B Term Loan amortizes in
installments in amounts equal to $1.7 million in 1999, $2.2 million in each of
2000 through 2002, $41.8 million in 2003, $103.4 million in 2004 and $29.8
million in 2005. The Tranche C Term Loan amortizes in installments in each
fiscal year in amounts equal to $1.7 million in 1999, $2.2 million in each of
2000 through 2003, $41.8 million in 2004, $101.9 million in 2005 and $29.1
million in 2006. In addition, the Credit Facilities are subject to mandatory
prepayment and reductions (to be applied first to the Term Loan Facility) in an
amount equal to (a) 100% of the net proceeds of certain offerings of equity
securities by the Company or any of its subsidiaries, (b) 100% of the net
proceeds of certain debt issues of the Company or any of its subsidiaries, (c)
75% of the Company's excess cash flow, as defined, and (d) 100% of the net
proceeds of certain asset sales or other dispositions of property of the Company
and its subsidiaries, in each case subject to certain limited exceptions.
The New Credit Agreement contains a number of covenants that, among other
things restrict the ability of the Company and its subsidiaries to dispose of
assets, incur additional indebtedness, incur or guarantee obligations, prepay
other indebtedness or amend other debt instruments (including the Indenture for
the New Notes), pay dividends, create liens on assets, make investments, make
loans or advances, redeem or repurchase common stock, make acquisitions, engage
in mergers or consolidations, change the business conducted by the Company and
its subsidiaries and make capital expenditures. In addition, the New Credit
Agreement requires the Company to comply with specified financial ratios and
tests, including minimum coverage ratios, maximum leverage ratios, maximum
senior debt ratios, minimum "EBITDA" (as defined in the New Credit Agreement)
and minimum net worth tests.
At the Company's election, the interest rates per annum applicable to the
loans under the New Credit Agreement are a fluctuating rate of interest measured
by reference to either (a) an adjusted London inter-bank offered rate ("LIBOR")
plus a borrowing margin or (b) an alternate base rate ("ABR") (equal to the
higher of the Chase Manhattan Bank's published prime rate or the Federal Funds
effective rate plus 1/2 of 1%) plus a borrowing margin. The borrowing margins
applicable to the Tranche A Term Loan and loans under the Revolving Facility are
currently 1.25% for ABR loans and 2.25% for LIBOR loans, and are subject to
reduction if the Company's financial results satisfy certain leverage tests. The
borrowing margins applicable to the Tranche B Term Loan and the Tranche C Term
Loan are 1.50% and 1.75%, respectively, for ABR loans and 2.50% and 2.75%,
respectively, for LIBOR loans, and are not subject to reduction. Amounts
outstanding under the credit facilities not paid when due bear interest at a
default rate equal to 2.00% above the rates otherwise applicable to each of the
loans under the Term Loan Facility and the Revolving Facility.
The obligations of the Company and the Subsidiary Borrowers under the New
Credit Agreement are unconditionally and irrevocably guaranteed by, subject to
certain exceptions, each wholly owned domestic subsidiary and, subject to
certain exceptions, each foreign subsidiary of the Company. In addition, the
Credit Facilities and the guarantees are secured by security interests in and
pledges of or liens on substantially all the material tangible and intangible
assets of the guarantors, subject to certain exceptions.
The Notes are general unsecured senior subordinated obligations of the
Company. The Notes are limited in aggregate principal amount to $625 million and
will mature on February 15, 2008. Interest on the Notes accrues at the rate of
9.0% per annum and is payable semi-annually on each February 15 and
F-27
<PAGE>
7. LONG-TERM DEBT, CAPITAL LEASE OBLIGATIONS AND OPERATING LEASES (CONTINUED)
August 15, commencing on August 15, 1998. The Notes were originally issued as
unregistered securities and later exchanged for securities which were registered
with the Securities and Exchange Commission. Due to a delay in the registration
of the Notes to be exchanged, the Company was required to increase the interest
rate on the Notes by 100 basis points per annum for the period from July 13,
1998 through November 9, 1998, the date of issuance of the Notes to be
exchanged.
The Notes are redeemable at the option of the Company. The Notes may be
redeemed at the option of the Company, in whole or in part, at the redemption
prices (expressed as a percentage of the principal amount) set forth below, plus
accrued and unpaid interest, during the twelve-month period beginning on
February 15 of the years indicated below:
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICES
- ------------------------------------------------------------ -------------
<S> <C>
2003........................................................ 104.5%
2004........................................................ 103.0%
2005........................................................ 101.5%
2006 and thereafter......................................... 100.0%
</TABLE>
In addition, at any time and from time to time prior to February 15, 2001,
the Company may, at its option, redeem up to 35% of the original aggregate
principal amount of the Notes at a redemption price (expressed as a percentage
of the principal amount) of 109%, plus accrued and unpaid interest with the net
cash proceeds of one or more equity offerings; provided that at least 65% of the
original aggregate principal amount of Notes remains outstanding immediately
after the occurrence of such redemption and that such redemption occurs within
60 days of the date of the closing of any such equity offering.
The Indenture for the Notes limits, among other things: (i) the incurrence
of additional indebtedness by the Company and its restricted subsidiaries; (ii)
the payment of dividends on, and redemption or repurchase of, capital stock of
the Company and its restricted subsidiaries and the redemption of certain
subordinated obligations of the Company; (iii) certain other restricted
payments, including investments; (iv) sales of assets; (v) certain transactions
with affiliates; (vi) the creation of liens; and (vii) consolidations, mergers
and transfers of all or substantially all the Company's assets. The Indenture
for the Notes also prohibits certain restrictions on distributions from
restricted subsidiaries. However, all such limitations and prohibitions are
subject to certain qualifications and exceptions.
The Company recorded extraordinary losses of approximately $5.3 million, net
of tax, during fiscal 1997 to write off unamortized deferred financing costs
related to its previous credit agreement and for costs related to paying off the
variable rate secured notes.
The Company leases certain of its operating facilities, some of which may be
purchased during the lease term or at expiration of the leases. The book value
of the capital leased assets was approximately $3.3 million at September 30,
1998. The leases, which expire at various dates through 2069, generally require
the Company to pay all maintenance, property and tax insurance costs.
At September 30, 1998, aggregate amounts of future minimum payments under
operating leases were as follows: 1999--$31.1 million; 2000--$27.2 million;
2001--$23.2 million; 2002--$19.0 million; 2003--$14.5 million; subsequent to
2003--$65.5 million.
Rent expense for the years ended September 30, 1996, 1997 and 1998 was $18.7
million, $19.2 million and $30.6 million, respectively.
F-28
<PAGE>
8. STOCKHOLDERS' EQUITY
Pursuant to the Company's Restated Certificate of Incorporation, the Company
is authorized to issue 80 million shares of common stock, $.25 par value per
share, and 10 million shares of preferred stock, without par value. No shares of
preferred stock have been issued as of September 30, 1998.
COMMON STOCK
The Company is prohibited from paying dividends on its Common Stock under
the terms of the Indenture and New Credit Agreement except under certain limited
circumstances.
1992 STOCK OPTION PLAN
The 1992 Stock Option Plan provided for the issuance of approximately 3.4
million options to purchase shares of Common Stock. A summary of changes in
options outstanding and other related information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------------------------
<S> <C> <C> <C>
1996 1997 1998
---------------- --------------- -----------
Balance, beginning of period................. 715,516 368,990 368,990
Canceled................................... -- -- --
Exercised.................................. (346,526) -- (362,990)
---------------- --------------- -----------
Balance, end of period....................... 368,990 368,990 6,000
---------------- --------------- -----------
---------------- --------------- -----------
Option prices, end of period................. $ 4.36-$22.75 $ 4.36-$22.75 $ 22.75
Price range of exercised options............. $ 4.36-$16.875 -- $ 4.36
Average exercise price....................... $ 4.59 -- $ 4.36
</TABLE>
The exercise price of certain options would have been reduced upon
termination of employment of a certain optionee without cause. The Company
records compensation expense for the difference between the exercise price of
these options and the fair value of the Company's common stock until the
measurement date is known. Such compensation expense was included in stock
option expense (credit) in the Company's statements of operations until such
options were exercised in August 1998.
Options issued pursuant to the 1992 Stock Option Plan are exercisable upon
vesting and expire through October 2000. As of September 30, 1998, 100% of the
options outstanding were vested.
F-29
<PAGE>
1994 STOCK OPTION PLAN
The 1994 Stock Option Plan provided for the issuance of approximately 1.3
million options to purchase shares of Common Stock. Officers and key employees
of the Company are eligible to participate. The options have an exercise price
which approximates fair market value of the Common Stock at the date of grant. A
summary of changes in options outstanding and other related information is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------
<S> <C> <C> <C>
1996 1997 1998
------------------- ------------------- -------------------
Balance, beginning of period...... 1,162,331 948,669 1,028,494
Granted......................... 161,000 341,166 --
Canceled........................ (330,162) (87,498) (298,276)
Exercised....................... (44,500) (173,843) (49,001)
------------------- ------------------- -------------------
Balance, end of period............ 948,669 1,028,494 681,217
------------------- ------------------- -------------------
------------------- ------------------- -------------------
Option prices, end of period...... $ 15.687-$27.875 $ 15.687-$27.718 $ 15.687-$27.718
Price range of exercised
options....................... $ 15.687-$27.875 $ 15.687-$27.875 $ 16.125-$22.875
Average exercise price.......... $ 20.70 $ 22.20 $ 19.903
</TABLE>
Options granted under the 1994 Stock Option Plan are exercisable to the
extent vested. An option vests at the rate of 33 1/3% of the shares covered by
the option on each of the first three anniversary dates of the grant of the
option if the optionee is an employee of the Company on such dates. Options must
be exercised no later than ten years after the date of grant. As of September
30, 1998, 88.5% of the options outstanding were vested.
1996 STOCK OPTION PLAN
The 1996 Stock Option Plan (the "1996 Plan") provides for the issuance of
1.75 million options to purchase shares of the Company's Common Stock. Options
must be granted on or before December 31, 1999. Officers and key employees of
the Company are eligible to participate. The options have an exercise price
which approximates fair market value of the Common Stock at the date of grant. A
summary of changes in options outstanding and other related information is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
----------------------------------------------------------
<S> <C> <C> <C>
1996 1997 1998
---------------- ------------------- -------------------
Balance, beginning of period.... -- 1,298,500 1,411,292
Granted....................... 1,413,000 310,667 50,000
Canceled...................... (114,500) (96,125) (42,000)
Exercised..................... -- (101,750) (178,375)
---------------- ------------------- -------------------
Balance, end of period.......... 1,298,500 1,411,292 1,240,917
---------------- ------------------- -------------------
---------------- ------------------- -------------------
Option prices, end of period.... $ 15.75-$24.00 $ 15.75-$30.875 $ 15.75-$30.875
Price range of exercised
options....................... -- $ 18.125-$18.875 $ 15.75-$25.156
Average exercise price.......... -- $ 18.348 $ 18.568
</TABLE>
Options granted under the 1996 Plan are exercisable to the extent vested. An
option vests at the rate of 25% of the shares covered by the option on each of
the four anniversary dates of the grant of the
F-30
<PAGE>
option if the optionee is an employee of the Company on such dates. Options must
be exercised no later than November 30, 2005.
The 1996 Plan provides that the options granted thereunder, upon the
occurrence of certain events, vest and become fully exercisable upon the "sale,
lease, transfer of other disposition... of all or substantially all" of the
Company's assets. Based upon a review of relevant Delaware case law, the Company
believes that substantial uncertainty existed regarding whether the Crescent
Transactions, which are described in Note 3, constituted a "sale ... of all or
substantially all" of the Company's assets. Accordingly, the Company's Board of
Directors determined it should treat the Crescent Transactions as such an event
in order to eliminate the risk of a dispute. Options outstanding under the 1996
Plan immediately vested upon closing the Crescent Transactions. As of September
30, 1998, 94.5% of the options outstanding under the 1996 Plan were vested.
1997 STOCK OPTION PLAN
The 1997 Stock Option Plan (the "1997 Plan") provides for the issuance of
1.5 million options to purchase shares of the Company's Common Stock. Options
must be granted on or before December 31, 2000. Officers and key employees of
the Company are eligible to participate. The options have an exercise price
which approximates fair market value of the Common Stock at the date of grant. A
summary of changes in options outstanding and other related information is as
follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------------
<S> <C> <C>
1997 1998
------------------ -------------------
Balance, beginning of period......................... -- 988,333
Granted.............................................. 988,333 396,000
Canceled............................................. -- (652,055)
------------------ -------------------
Balance, end of period............................... 988,333 732,278
------------------ -------------------
------------------ -------------------
Option prices, end of period......................... $ 24.375-$31.00 $ 22.328-$31.063
</TABLE>
Options granted under the 1997 Plan are exercisable to the extent vested. An
option vests at the rate of 33 1/3% of the shares covered by the option on each
of the three anniversary dates of the grant of the option if the optionee is an
employee of the Company on such dates. Options must be exercised no later than
February 28, 2007. As of September 30, 1998, 42.9% of the options outstanding
under the 1997 Plan were vested. Certain of the options granted under the 1997
stock option plan were granted prior to the stockholder approval date. The
measurement date for purposes of measuring compensation expense for such grants
under the 1997 Stock Option Plan was the date of stockholder approval, which
resulted in compensation expense of approximately $0.5 million and $0.2 million
in fiscal 1997 and 1998, respectively.
1998 STOCK OPTION PLAN
The 1998 Stock Option Plan (the "1998 Plan") provides for the issuance of
1.0 million options to purchase shares of the Company's Common Stock. Options
must be granted on or before December 31, 2001. Officers and key employees of
the Company are eligible to participate. The options have
F-31
<PAGE>
an exercise price which approximates fair market value of the Common Stock at
the date of grant. A summary of changes in options outstanding and other related
information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1998
------------------
<S> <C>
Balance, beginning of period.............................................. --
Granted................................................................... 890,500
Canceled.................................................................. (90,000)
------------------
Balance, end of period.................................................... 800,500
------------------
------------------
Option prices, end of period.............................................. $ 14.56-$22.875
</TABLE>
Options granted under the 1998 Plan are exercisable to the extent vested. An
option vests over the period specified in each stock option grant. Options must
be exercised no later than December 31, 2008. As of September 30, 1998, 8.3% of
the options outstanding under the 1998 Plan were vested.
1994 EMPLOYEE STOCK PURCHASE PLAN
The 1994 Employee Stock Purchase Plan (the "1994 ESPP") covered 600,000
shares of Common Stock that could be purchased by eligible employees of the
Company.
The initial offering period began on April 1, 1994 and expired on March 31,
1995. The second offering period began on April 1, 1995 and ended March 31,
1996. On the first date of these offering periods, each participant was granted
an option to purchase shares of Common Stock at a purchase price equal to 85% of
the fair value of a share of Common Stock on such date. Total options granted on
April 1, 1994 and April 1, 1995 were 85,115 and 41,565, respectively, with
option prices of $21.144 and $15.831, respectively. A total of 4,872 and 22,065
options were exercised at the end of the first and second offering periods,
respectively.
Effective August 1, 1995, the Company amended the 1994 ESPP to change the
option price in subsequent offering periods to the lesser of (i) 85% of the fair
value of a share of Common Stock on the first day of the offering period or (ii)
85% of the fair value of a share of Common Stock on the last day of the offering
period. Holders of the options from the second offering period as of July 31,
1995 were given the choice of (i) canceling their options to purchase shares of
Common Stock, (ii) exercising the option to purchase shares of Common Stock at a
purchase price of $15.831 or (iii) keeping their options. A total of 11,870
options were exercised on July 31, 1995. The third offering period began August
1, 1995 and ended December 31, 1995. A total of 29,217 options were exercised at
a purchase price of $16.681 at the end of the third offering period.
The fourth offering period began January 1, 1996 and ended on June 30, 1996.
A total of 68,146 options were exercised at a purchase price of $18.275 at the
end of the fourth offering period. The fifth offering period began July 1, 1996
and ended on December 31, 1996. A total of 80,018 options were exercised at a
purchase price of $17.85 at the end of the fifth and final offering period.
1997 EMPLOYEE STOCK PURCHASE PLAN
The 1997 Employee Stock Purchase Plan (the "1997 ESPP") covers 600,000
shares of Common Stock that can be purchased by eligible employees of the
Company. The 1997 ESPP offering periods will have a term not less than three
months and not more than 12 months. The first offering period under the 1997
ESPP began January 1, 1997 and the last offering period will end on or before
December 31, 1999. The option price of each offering period will be the lesser
of (i) 85% of the fair value of a share of Common Stock on the first day of the
offering period or (ii) 85% of the fair value of a share of Common Stock on the
last day of the offering period.
F-32
<PAGE>
A summary of the 1997 ESPP is as follows:
<TABLE>
<CAPTION>
OFFERING OPTIONS EXERCISE
PERIOD BEGAN ENDED EXERCISED PRICE
- --------------- ------------------- ----------------------- ----------- -----------
<C> <S> <C> <C> <C>
1 January 2, 1997 June 30, 1997 73,410 $ 19.125
2 August 1, 1997 December 31, 1997 26,774 $ 19.125
3 January 1, 1998 June 30, 1998 43,800 $ 18.4875
4 July 1, 1998 December 31, 1998 -- --
</TABLE>
The number of options granted and the option price for the fourth offering
period will be determined on December 31, 1998 when the option price is known.
1992 DIRECTORS' STOCK OPTION PLAN AND DIRECTORS' UNIT AWARD PLAN
The 1992 Directors' Stock Option Plan provides for the grant of options to
non-employee members of the Company's Board of Directors to purchase up to
175,000 shares of the Company's Common Stock, subject to adjustments to reflect
certain changes in capitalization. The options have an exercise price which
approximates the fair market value of the Common Stock on the date of grant.
During fiscal 1996, 1997 and 1998, no options were granted. As of September 30,
1998, 125,000 options were outstanding at exercise prices ranging from $14.56 to
$22.875. No options were exercised during fiscal 1996, 1997 and 1998.
Options granted can be exercised from the date of vesting until February 1,
2003. No options can be granted after December 31, 1995. Options vest 20% when
granted and an additional 20% on each successive February 1 for a period of four
years, if the optionee continues to serve as a non-employee director on the
applicable February 1. Unvested options vest in full in certain instances of
termination. As of September 30, 1998, 96.0% of the options outstanding were
vested.
In addition, during fiscal 1994, the Company approved the Directors' Unit
Award Plan (the "Unit Plan") which provides for the award of a maximum of 15,000
units (the "Units") that, upon vesting under the terms of the Unit Plan, would
result in the issuance of an aggregate of 15,000 shares of Common Stock in
settlement of Units.
The Unit Plan provides for the award to each director who is not an employee
of the Company of 2,500 Units. Upon vesting of the Units awarded to a director,
the Company will settle the Units by issuing to the director, with no exercise
price, a number of shares of the Company's Common Stock equal to the number of
vested Units.
1996 DIRECTORS' STOCK OPTION PLAN
The 1996 Directors' Stock Option Plan provides for the grant of options to
non-employee members of the Company's Board of Directors to purchase up to
250,000 shares of the Company's Common Stock, subject to adjustments to reflect
certain changes in capitalization. The options have an exercise price which
approximates the fair market value of a share of the Common Stock on the date of
grant. During fiscal 1996, 175,000 options were granted at exercise prices
ranging from $18.25 to $23.375. During fiscal 1997, 25,000 options were granted
at an exercise price of $30.812. During fiscal 1998, 50,000 options were granted
at an exercise prices ranging from $20.25 to $22.4375. As of September 30, 1998,
250,000 options were outstanding at exercise prices ranging from $18.25 to
$30.812. No options were exercised during fiscal 1996, 1997 or 1998.
Options granted can be exercised from the date of vesting until November 30,
2005. No options can be granted after December 31, 1999. Options vest at the
rate of 25% of the shares covered on each of the four anniversary dates of the
grant of the option if the optionee continues to serve as a non-employee
director on such dates. Options vest in full in certain instances of
termination. As of September 30, 1998, 41.7% of the options outstanding were
vested.
F-33
<PAGE>
RIGHTS PLAN
The Company adopted a Share Purchase Rights Plan in fiscal 1992 (the "Rights
Plan"). Pursuant to the Rights Plan, each share of Common Stock also represents
one Share Purchase Right (collectively, the "Rights"). The Rights trade
automatically with the underlying shares of Common Stock. Upon becoming
exercisable, but prior to the occurrence of certain events, each Right initially
entitles its holder to buy one share of Common Stock from the Company at an
exercise price of $60.00. The Rights will be distributed and become exercisable
only if a person or group acquires, or announces its intention to acquire,
Common Stock exceeding certain levels, as specified in the Rights Plan. Upon the
occurrence of such events, the exercise price of each Right reduces to one-half
of the then current market price. The Rights also give the holder certain rights
in an acquiring company's common stock. The Company is entitled to redeem the
Rights at a price of $.01 per Right at any time prior to the distribution of the
Rights. The Rights have no voting power until exercised.
COMMON STOCK WARRANTS
The Company issued 114,690 warrants in fiscal 1992 which expire on June 30,
2002 (the "2002 Warrants") to purchase one share each of the Company's Common
Stock. The 2002 Warrants have an exercise price of $5.24 per share. During
fiscal 1996, 1997 and 1998, 4,320, 1,397 and 1,553 shares were issued,
respectively, upon the exercise of 2002 Warrants. At September 30, 1998, 18,920
of the 2002 Warrants were outstanding.
The 2006 Warrants, which expire on September 1, 2006, were subject to
certain adjustments, and accordingly, 146,791 of such warrants are currently
outstanding with an exercise price of $38.70 per share.
Crescent and COI each have the right to purchase 1,283,311 shares of Common
Stock (2,566,622 shares in aggregate) at a warrant exercise price of $30 per
share (subject to adjustment pursuant to antidilution provisions). The Crescent
Warrants will be exercisable at the following times and in the following
amounts:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF
DATE FIRST COMMON STOCK END OF
EXERCISABLE ISSUABLE UPON EXERCISE EXERCISE PERIOD
JUNE 17, OF WARRANTS JUNE 17,
- ------------------------------ ------------------------------ ------------------------------
<S> <C> <C>
1998 30,000 2001
1999 62,325 2002
2000 97,114 2003
2001 134,513 2004
2002 174,678 2005
2003 217,770 2006
2004 263,961 2007
2005 313,433 2008
2006 366,376 2009
2007 422,961 2009
2008 483,491 2009
</TABLE>
Crescent's and COI's rights with respect to the Crescent Warrants are not
contingent on or subject to the satisfaction or completion of any obligation
that Crescent or COI may have to CBHS, or that CBHS may have to the Company, or
by any subordination of fees otherwise payable to the Company by CBHS.
The Crescent Warrants contain provisions relating to adjustments in the
number of shares covered by the Crescent Warrants and the warrant exercise price
in the event of stock splits, stock dividends, mergers, reorganizations and
similar transactions.
F-34
<PAGE>
The Crescent Warrants were recorded at $25 million upon issuance, or their
approximate fair value upon execution of the Warrant Purchase Agreement in
January 1997.
PRIVATE PLACEMENT TRANSACTION
On January 25, 1996, the Company issued 4 million shares of Common Stock
(the "Shares") along with a warrant to purchase an additional 2 million shares
of Common Stock (the "Warrant") pursuant to a Stock and Warrant Purchase
Agreement. The Warrant entitles the holders to purchase such additional shares
of Common Stock at a per share price of $26.15, subject to adjustment for
certain dilutive events, and provides registration rights for the shares of
Common Stock underlying the Warrant. The aggregate purchase price for the Shares
and the Warrant was approximately $69.73 million. The Warrant became exercisable
on January 25, 1997 and expires on January 25, 2000.
Approximately $68.0 million of the proceeds were used to repay outstanding
borrowings under the then existing credit agreement.
TREASURY STOCK TRANSACTIONS
On August 15, 1996, the Company commenced a "Dutch Auction" self-tender
offer to stockholders for the repurchase of 1,891,891 shares of its own Common
Stock. On September 5, 1996, the Company increased the self-tender offer to
3,300,000 shares. Under the terms of the offer, stockholders were invited to
tender their shares by September 18, 1996 at prices ranging from $16.50 to
$18.50 per share as specified by each stockholder.
At the conclusion of the offer, the Company repurchased 3,961,505 shares on
September 27, 1996 at $18.375 per share for a total cost of approximately $73.5
million, including transaction costs. The total shares repurchased represent
approximately 12.0% of the outstanding Common Stock at such date. The
transaction was financed through cash on hand and borrowings under the then
existing credit agreement.
During fiscal 1998, the Company repurchased an aggregate of 696,600 shares
of its common stock in the open market for approximately $14.4 million. Those
transactions were funded with cash on hand.
In January 1998, the Company issued an aggregate of 2,831,516 shares of
treasury stock to the then existing minority stockholders of Green Spring to
effect the Green Spring Minority Stockholder Conversion. See Note 2,
"Acquisitions."
INCOME (LOSS) PER COMMON SHARE
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("FAS 128"), effective October 1, 1997. Income per common
share for fiscal 1996 and 1997 have been restated to conform to FAS 128 as
required. The effect of adopting FAS 128 was not material.
The following table presents the components of weighted average common
shares outstanding-- diluted:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ---------
Weighted average common shares outstanding--basic.................................. 31,014 28,781 30,784
Common stock equivalents--stock options............................................ 563 676 399
Common stock equivalents--warrants................................................. 19 17 15
--------- --------- ---------
Weighted average common shares outstanding--diluted................................ 31,596 29,474 31,198
--------- --------- ---------
--------- --------- ---------
</TABLE>
Options to purchase approximately 2,051,000 shares of common stock at
$23.00-$31.0625 per share were outstanding during fiscal 1998 but were not
included in the computation of diluted EPS
F-35
<PAGE>
because the options exercise price was greater than the average market price of
the common shares. Approximately 1,341,000 of these options, which expire
between fiscal 2001 and 2009, were still outstanding at September 30, 1998.
Warrants to purchase approximately 4,713,000 shares of common stock at
$26.15 to $38.70 per share were outstanding during fiscal 1998 but were not
included in the computation of diluted EPS because the warrants exercise price
was greater than the average market price of the common shares. The warrants,
which expire between fiscal 2000 and 2009, were still outstanding at September
30, 1998.
The Company owned a 61% equity interest in Green Spring Health Services,
Inc. ("Green Spring") during the periods presented above. The four minority
stockholders of Green Spring had the options to exchange their ownership
interests in Green Spring for 2,831,516 shares of the Company's common stock or
$65.1 million of subordinated notes (the "Exchange Option"). The Exchange Option
was considered a potentially dilutive security since the Company acquired Green
Spring in December 1995 for the purpose of computing diluted income per common
share. The Exchange Option was anti-dilutive for all periods presented and,
therefore, was excluded from the respective diluted income per common share
calculations.
Each of the minority stockholders of Green Spring exercised the Exchange
Option in January 1998, which resulted in the issuance of 2,831,516 shares of
the Company's common stock. See Note 2-- "Acquisitions and Joint Ventures--Green
Spring."
On November 17, 1998, the Company's Board of Directors approved the
repricing of stock options outstanding under the Company's existing stock option
plans (the "Stock Option Repricing"). Each holder of 10,000 or more stock
options that was eligible to participate in the Stock Option Repricing was
required to forfeit a percentage of outstanding stock options as follows:
<TABLE>
<S> <C> <C>
Directors, including the Chief Executive 40%
- - Officer....................................
- - Named Executive Officers................... 30%
- - Holders of 50,000 or more stock options.... 25%
- - Holders of 10,000-49,999 stock options..... 15%
</TABLE>
The Stock Option Repricing was consummated on December 8, 1998 based on the
fair value of the Company's Common Stock on such date. Approximately 1.7 million
outstanding stock options were repriced to $8.41 and approximately 0.5 million
outstanding stock options were forfeited as a result of the Stock Option
Repricing. Each participant in the Stock Option Repricing is precluded from
exercising repriced stock options until June 8, 1999.
STOCK-BASED COMPENSATION
Effective October 1, 1996, the Company adopted the disclosure requirements
of FAS 123. FAS 123 requires disclosure of pro forma net income and pro forma
net income per share as if the fair value-based method of accounting for stock
options had been applied in measuring compensation cost for stock-based awards
granted in fiscal 1996, 1997 and 1998. Pro forma amounts are not representative
of the effects of stock-based awards on future pro forma net income and pro
forma net income per share because those pro forma amounts exclude the pro forma
compensation expense related to unvested stock options granted before fiscal
1996.
F-36
<PAGE>
Reported and pro forma net income and net income per share amounts are set
forth below (in thousands, except per share data):
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ----------
<S> <C> <C> <C>
Reported:
Income before extraordinary items....................... $ 32,383 $ 4,755 $ 13,732
Net income (loss)....................................... 32,383 (498) (19,283)
Income (loss) per common share--basic:
Income before extraordinary items....................... 1.04 0.17 0.45
Net income (loss)....................................... 1.04 (0.02) (0.63)
Income (loss) per common share--diluted:
Income before extraordinary items....................... 1.02 0.16 0.44
Net income (loss)....................................... 1.02 (0.02) (0.62)
Pro Forma:
Income (loss) before extraordinary items................ 28,835 (3,721) 9,787
Net income (loss)....................................... 28,835 (8,974) (23,228)
Income (loss) per common share--basic:
Income (loss) before extraordinary items................ 0.93 (0.13) 0.32
Net income (loss)....................................... 0.93 (0.31) (0.76)
Income (loss) per common share--diluted:
Income (loss) before extraordinary items................ 0.91 (0.13) 0.31
Net income (loss)....................................... 0.91 (0.31) (0.75)
</TABLE>
The fair values of the stock options and ESPP options granted were estimated
on the date of their grant using the Black-Scholes option pricing model based on
the following weighted average assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
--------- ----------- -----------
<S> <C> <C> <C>
Risk-free interest rate................................. 6% 6% 4.5%
Expected life........................................... 5 years 5.5 years 4 years
Expected volatility..................................... 35% 30% 50%
Expected dividend yield................................. 0% 0% 0%
</TABLE>
The weighted average fair value of options granted during fiscal 1996, 1997
and 1998 was $6.85, $9.67 and $9.53, respectively.
Stock option activity for all plans for 1996, 1997 and 1998 was as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996 1997 1998
------------------------ ------------------------ -------------------------
<CAPTION>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- ----------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, beginning of period........ 2,002,847 $ 15.32 2,916,159 $ 17.92 4,122,109 $ 20.13
Granted............................. 1,749,000 19.05 1,665,166 24.24 1,386,500 24.22
Canceled............................ (444,662) 21.20 (183,623) 20.84 (1,082,331) 23.66
Exercised........................... (391,026) 6.37 (275,593) 20.26 (590,366) 9.90
----------- ----------- ------------
Balance, end of period.............. 2,916,159 17.92 4,122,109 20.13 3,835,912 22.23
----------- ----------- ------------
----------- ----------- ------------
Exercisable, end of period.......... 926,195 14.75 2,419,711 17.65 2,375,919 20.89
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
F-37
<PAGE>
8. STOCKHOLDERS' EQUITY (CONTINUED)
Stock options outstanding on September 30, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------------------- ------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICE OPTIONS LIFE PRICE OPTIONS PRICE
- --------------------------------- ----------- --------------- ----------- ----------- -----------
$14.56-$20.44 1,288,579 6.70 $ 18.21 1,181,081 $ 18.15
$20.50-$23.00 1,265,722 7.61 22.32 635,557 22.34
$23.06-$31.06 1,281,611 8.51 26.24 559,281 25.04
----------- -----------
$14.56-$31.06 3,835,912 7.60 22.23 2,375,919 20.89
----------- -----------
----------- -----------
</TABLE>
9. INCOME TAXES
The provision for income taxes consisted of the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------------
<S> <C> <C> <C>
1996 1997 1998
---------- --------- ---------
Income taxes currently payable:
Federal................................................. $ 6,900 $ 11,148 $ 3,462
State................................................... (1,139) 3,959 1,794
Foreign................................................. 3,779 3,678 2,340
Deferred income taxes:
Federal................................................. 15,313 (6,670) 11,117
State................................................... 807 (2,569) 1,320
Foreign................................................. 35 (308) --
---------- --------- ---------
$ 25,695 $ 9,238 $ 20,033
---------- --------- ---------
---------- --------- ---------
</TABLE>
A reconciliation of the Company's income tax provision to that computed by
applying the statutory federal income tax rate is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ---------
Income tax provision at federal statutory income tax
rate..................................................... $ 22,483 $ 8,083 $ 13,671
State income taxes, net of federal income tax benefit...... (216) 904 2,024
Foreign income taxes, net of federal income tax benefit.... 2,479 2,190 1,521
Merit goodwill amortization................................ -- -- 4,410
Other--net................................................. 949 (1,939) (1,593)
--------- --------- ---------
Income tax provision....................................... $ 25,695 $ 9,238 $ 20,033
--------- --------- ---------
--------- --------- ---------
</TABLE>
As of September 30, 1998, the Company has estimated tax net operating loss
("NOL") carryforwards of approximately $476 million available to reduce future
federal taxable income. These NOL carryforwards expire in 2006 through 2018 and
are subject to examination by the Internal Revenue Service. In addition, the
Company also has estimated tax NOL carryforwards of approximately $151
F-38
<PAGE>
million available to reduce the federal taxable income of Merit and its
subsidiaries. These NOL carryforwards expire in 2010 through 2018 and are
subject to examination by the Internal Revenue Service. Further, these NOL
carryforwards are subject to limitations on the taxable income of Merit and its
subsidiaries. The Company has recorded a valuation allowance against the portion
of the total NOL deferred tax asset and certain other deferred tax assets, that
in management's opinion, are not likely to be recovered.
Components of the net deferred income tax (assets) liabilities at September
30, 1997 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------
<S> <C> <C>
1997 1998
------------ ------------
Deferred tax liabilities:
Insurance settlements........................................... $ 8,460 $ --
Property and depreciation....................................... -- 8,670
Long-term debt and interest..................................... 54,820 20,388
ESOP............................................................ 11,112 12,777
Other........................................................... 17,449 9,556
------------ ------------
Total deferred tax liabilities................................ 91,841 51,391
------------ ------------
Deferred tax assets:
Property and depreciation....................................... (7,123) --
Intangible Assets............................................... (6,785) (8,992)
Operating loss carryforwards.................................... (111,251) (250,512)
Self-insurance reserves......................................... (30,918) (9,534)
Restructuring costs............................................. (22,990) (4,071)
Other........................................................... (38,924) (39,561)
------------ ------------
Total deferred tax assets....................................... (217,991) (312,670)
------------ ------------
Valuation allowance............................................. 124,992 163,893
------------ ------------
Deferred tax assets after valuation allowance................... (92,999) (148,777)
------------ ------------
Net deferred tax assets......................................... $ (1,158) $ 97,386
------------ ------------
------------ ------------
</TABLE>
The Internal Revenue Service is currently examining the Company's income tax
returns for fiscal 1992 and 1993 and expects a report to be issued during fiscal
1999. In management's opinion, adequate provisions have been made for any
adjustments which may result from these examinations, including a potential
reduction in the amount of NOL carryforwards. The Company believes the
examinations could result in a reduction in NOL carryforwards available to
offset future taxable income.
F-39
<PAGE>
10. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1997 1998
----------- -----------
<S> <C> <C>
Salaries, wages and other benefits...................................................... $ 21,647 $ 23,893
Amounts due health insurance programs................................................... 14,126 9,392
Interest................................................................................ 19,739 9,271
Crescent Transactions................................................................... 14,648 3,972
CHAMPUS Adjustments..................................................................... -- 25,484
Other................................................................................... 63,761 121,518
----------- -----------
$ 133,921 $ 193,530
----------- -----------
----------- -----------
</TABLE>
11. MANAGED CARE INTEGRATION PLAN AND COSTS
INTEGRATION PLAN
The Company owns three behavioral managed care organizations ("BMCOs"),
Green Spring, HAI and Merit, as a result of acquisitions consummated in fiscal
1996 (Green Spring) and fiscal 1998 (HAI and Merit). The Company also owns two
specialty managed care organizations, Allied and Care Management Resources, Inc.
("CMR"). Management has approved and committed the Company to a plan to combine
and integrate the operations of its BMCOs and specialty managed care
organizations (the "Integration Plan") that will result in the elimination of
duplicative functions and will standardize business practices and information
technology platforms.
The Integration Plan will result in the elimination of approximately 1,000
positions during fiscal 1998 and fiscal 1999. Approximately 350 employees had
been involuntarily terminated pursuant to the Integration Plan as of September
30, 1998, and approximately 280 positions had been eliminated by normal
attrition through September 30, 1998. The remaining positions to be eliminated
have been identified, and will be eliminated through a combination of normal
attrition and involuntary termination.
The employee groups of the BMCOs that are primarily affected include
executive management, finance, human resources, information systems and legal
personnel at the various BMCOs corporate headquarters and regional offices and
credentialing, claims processing, contracting and marketing personnel at various
operating locations. The Company expects to complete the specific identification
of all personnel who will be involuntarily terminated by March 31, 1999 and will
complete its involuntary terminations by the end of fiscal 1999.
The Integration Plan has resulted in the closure and identified closure of
approximately 20 leased facilities at the BMCOs, Allied and CMR during fiscal
1998 and 1999. The Company expects the remaining office closures, if any, to be
insignificant.
The Company has recorded approximately $21.3 million of liabilities related
to the Integration Plan, of which $12.4 million was recorded as part of the
Merit purchase price allocation and $8.9 million was recorded in the statement
of operations under "Managed Care integration costs". The Company may record
additional liabilities as a result of the Integration Plan in fiscal 1999 as
final decisions regarding office closures and other contractual obligation
terminations are made.
F-40
<PAGE>
11. MANAGED CARE INTEGRATION PLAN AND COSTS (CONTINUED)
The following table provides a rollforward of liabilities resulting from the
Integration Plan (in thousands):
<TABLE>
<CAPTION>
BALANCE BALANCE
SEPTEMBER 30, SEPTEMBER 30,
TYPE OF COST 1997 ADDITIONS PAYMENTS 1998
- ------------------------------------------- ----------------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Employee termination benefits.............. $ -- $ 13,009 $ (6,819) $ 6,190
Facility closing costs..................... -- 8,008 (533) 7,475
Other...................................... -- 244 (75) 169
----- ----------- ------------- --------------
$ -- $ 21,261 $ (7,427) $ 13,834
----- ----------- ------------- --------------
----- ----------- ------------- --------------
</TABLE>
OTHER INTEGRATION COSTS
The Integration Plan will result in additional incremental costs that must
be expensed as incurred in accordance with Emerging Issues Task Force Consensus
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)"
that are not described above and certain other charges. Other integration costs
include, but are not limited to, outside consultants, costs to relocate closed
office contents and long-lived asset impairments. Other integration costs are
reflected in the statement of operations under "Managed Care integration costs".
During the year ended September 30, 1998, the Company incurred approximately
$8.1 million, in other integration costs, including long-lived asset impairments
of approximately $2.4 million, and outside consulting costs of approximately
$4.1 million. The asset impairments relate primarily to identifiable intangible
assets and leasehold improvements that no longer have value and have been
written off as a result of the Integration Plan.
12. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------------
1996 1997 1998
--------- --------- ------------
<S> <C> <C> <C>
(UNAUDITED)
Income taxes paid, net of refunds received.................................. $ 9,299 $ 18,406 $ 11,116
Interest paid, net of amounts capitalized................................... 56,248 54,378 95,153
Long-term debt assumed in connection with acquisitions...................... 12,100 -- --
Non-cash Transactions:
Initial capital contribution to CBHS, primarily property and equipment, less
assumed liabilities....................................................... -- 5,281 --
Common Stock in Treasury issued in connection with the purchase of the
remaining 39% interest in Green Spring Health Services, Inc............... -- -- 63,496
</TABLE>
13. COMMITMENTS AND CONTINGENCIES
The Company is self-insured for a substantial portion of its general and
professional liability risks. The reserves for self-insured general and
professional liability losses, including loss adjustment expenses, are included
in reserve for unpaid claims in the Company's balance sheet and are based on
actuarial estimates that are discounted at an average rate of 6% to their
present value based on the
F-41
<PAGE>
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company's historical claims experience adjusted for current industry trends. The
undiscounted amount of the reserve for unpaid claims at September 30, 1997 and
1998 was approximately $56.1 million and $34.6 million, respectively. The
carrying amount of accrued medical malpractice claims was $47.7 million and
$26.2 million at September 30, 1997 and 1998, respectively. The reserve for
unpaid claims is adjusted periodically as such claims mature, to reflect changes
in actuarial estimates based on actual experience. During fiscal 1996, 1997 and
1998, the Company recorded reductions in malpractice claim reserves of
approximately $15.3 million, $7.5 million and $4.1 million, respectively, as a
result of updated actuarial estimates. These reductions resulted primarily from
updates to actuarial assumptions regarding the Company's expected losses for
more recent policy years. These revisions are based on changes in expected
values of ultimate losses resulting from the Company's claim experience, and
increased reliance on such claim experience. While management and its actuaries
believe that the present reserve is reasonable, ultimate settlement of losses
may vary from the amount recorded.
The healthcare industry is subject to numerous laws and regulations. The
subjects of such laws and regulations include but are not limited to, matters
such as licensure, accreditation, government healthcare program participation
requirements, reimbursement for patient services, and Medicare and Medicaid
fraud and abuse. Recently, government activity has increased with respect to
investigations and/or allegations concerning possible violations of fraud and
abuse and false claims statutes and/or regulations by healthcare providers.
Entities that are found to have violated these laws and regulations may be
excluded from participating in government healthcare programs, subjected to
fines or penalties or required to repay amounts received from the government for
previously billed patient services. The Office of the Inspector General of the
Department of Health and Human Services and the United States Department of
Justice and certain other governmental agencies are currently conducting
inquiries and/ or investigations regarding the compliance by the Company and
certain of its subsidiaries and the compliance by CBHS and certain of its
subsidiaries with such laws and regulations. Certain of the inquiries relate to
the operations and business practices of the Psychiatric Hospital Facilities
prior to the consummation of the Crescent Transactions. In addition, the Company
is also subject to or party to litigation, claims and civil suits relating to
its operations and business practices. In the opinion of management, the Company
has recorded reserves that are adequate to cover litigation, claims or
assessments that have been or may be asserted against the Company arising out of
such litigation, civil suits and governmental inquiries. Furthermore, management
believes that the resolution of such litigation, civil suits and governmental
inquiries will not have a material adverse effect on the Company's financial
position or results of operations; however, there can be no assurance in this
regard.
In January 1996, the Company settled an ongoing dispute with the Resolution
Trust Corporation ("RTC"), for itself or in its capacity as conservator or
receiver for 12 financial institutions, which formerly held certain debt
securities that were issued by the Company in 1988. In connection with the
settlement, the Company, denying any liability or fault, paid $2.7 million to
the RTC in exchange for a release of all claims.
On August 1, 1996, the United States Department of Justice, Civil Division,
filed an Amended Complaint in a civil QUI TAM action initiated in November 1994
against the Company and its Orlando South hospital subsidiary ("Charter
Orlando") by two former employees. The First Amended Complaint alleges that
Charter Orlando violated the federal False Claims Act (the "Act") in billing for
inpatient treatment provided to elderly patients. The Court granted the
Company's motion to dismiss the government's First Amended Complaint yet granted
the government leave to amend its First Amended Complaint. The government filed
a Second Amended Complaint on December 12, 1996 which, similar to the First
Amended Complaint, alleges that the Company and its subsidiary violated the Act
in billing for the treatment of geriatric patients. Like the First Amended
Complaint, the Second Amended Complaint was based on disputed clinical and
factual issues which the Company believes do not constitute a violation
F-42
<PAGE>
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
of the Act. On the Company's motion, the Court ordered the parties to
participate in mediation of the matter. As a result of the mediation, the
parties reached a settlement. Pursuant to the settlement, the Company paid
approximately $4.8 million in August 1998. Furthermore, Charter Orlando (now
operated by CBHS) will not seek reimbursement for services provided to patients
covered under the Medicare program for a period of up to fifteen months. The
Company has agreed to reimburse CBHS for the resulting loss of revenues during
such period. The Company has an accrued liability of approximately $2.3 million
as of September 30, 1998 for this reimbursement.
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists, psychologists and social workers brought an
action under the federal antitrust laws in the United States District Court for
the Southern District of New York against nine behavioral health managed care
organizations, including Merit, CMG, Green Spring and HAI (collectively, the
"Defendants"). The complaint (the "Stephens Case") alleges that the Defendants
violated Section I of the Sherman Act by engaging in a conspiracy to fix the
prices at which the defendants purchase services from mental healthcare
providers such as the plaintiffs. The complaint further alleges that the
Defendants engaged in a group boycott to exclude mental healthcare providers
from the Defendants' networks in order to further the goals of the alleged
conspiracy. The complaint also challenges the propriety of the Defendants'
capitation arrangements with their respective customers, although it is unclear
from the complaint whether the plaintiffs allege that the Defendants unlawfully
conspired to enter into capitation arrangements with their respective customers.
The complaint seeks treble damages against the Defendants in an unspecified
amount and a permanent injunction prohibiting the Defendants from engaging in
the alleged conduct which forms the basis of the complaint, plus costs and
attorneys' fees. On May 12, 1998, the District Court granted the Defendants'
motion to dismiss the complaint with prejudice. On May 27, 1998, the plaintiffs
filed a notice of appeal of the District Court's dismissal of their complaint
with the United States Second Circuit Court of Appeals. On November 16, 1998,
the Second Circuit court issued a Summary Order affirming the District Court's
decision. The plaintiffs have not filed a petition for rehearing, and the time
allotted for doing so has expired. The plaintiffs have 90 days from the date of
judgment to file a petition for certiorari with the United States Supreme Court.
The plaintiffs have not indicated whether they will file such a petition. If no
petition is filed, or if a filed petition is denied, this matter will have been
concluded. The Company does not believe this matter will have a material adverse
effect on its financial position or results of operations.
On May 26, 1998, the counsel representing the plaintiffs in the Stephens
Case filed an action in the United States District Court for the District of New
Jersey on behalf of a group of thirteen plaintiffs who also purport to represent
an uncertified class of psychiatrists, psychologists and clinical social
workers. This complaint alleges substantially the same violations of federal
antitrust laws by the same nine managed behavorial healthcare organizations that
are the defendants in the Stephens Case. The Defendants believe the factual and
legal issues involved in this case are substantially similar to those involved
in the Stephens Case. The Defendants intend to vigorously defend themselves in
this litigation. On August 28, 1998, the defendants filed a joint motion
requesting that the case be: (1) transferred to the Southern District of New
York; (2) alternatively, that all proceedings be stayed pending the Second
Circuit's determination of the Stephens Case appeal, given the RES JUDICATA
effect of the Stephens Case dismissal; and (3) if the Court proceeds with the
case, that the complaint be dismissed for failure to state a claim for
substantially the same reasons as in the Stephens Case. The plaintiffs have
opposed this motion, which was argued on November 23, 1998. At the conclusion of
the November 23 hearing, the Court ruled that the case should be transferred to
the Southern District of New York. The Defendants' motion to dismiss was deemed
withdrawn without prejudice to its resubmission in the Southern District. The
plaintiffs have stated that they intend to appeal the Court's transfer order to
the United States District
F-43
<PAGE>
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Court for the District of New Jersey. The Company does not believe this matter
will have a material adverse effect on its financial position or results of
operations.
The Company provides mental health and substance abuse services, as a
subcontractor, to beneficiaries of CHAMPUS. The fixed monthly amounts that the
Company receives for medical costs under CHAMPUS contracts are subject to
retroactive adjustment ("CHAMPUS Adjustments") based upon actual healthcare
utilization during the period known as the "data collection period". The Company
has recorded reserves of approximately $25.5 million as of September 30, 1998
for CHAMPUS Adjustments. While management believes that the present reserve for
CHAMPUS Adjustments is reasonable, ultimate settlement resulting from the
adjustment and available appeal process may vary from the amount provided.
14. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Gerald L. McManis, a director of the Company, is the President of McManis
Associates, Inc. ("MAI"), a healthcare development and management consulting
firm. During fiscal 1996, 1997 and 1998, MAI provided consulting services to the
Company with respect to the development of strategic plans and a review of the
Company's business processes. The Company incurred approximately $287,000,
$865,000 and $85,000 in fees for such services and related expenses during
fiscal 1996, 1997 and 1998, respectively.
G. Fred DiBona, Jr., a director of the Company, is a Director and the
President and Chief Executive Officer of Independence Blue Cross ("IBC"), a
health insurance company.
IBC owned 16.67% of Green Spring prior to December 13, 1995. On December 13,
1995, IBC sold 4.42% of its ownership interest in Green Spring to the Company
for $5,376,000 in cash. IBC had a cost basis of $3,288,000 in the 4.42%
ownership interest sold to the Company. The Exchange Option described previously
gave IBC the right to exchange its ownership interest in Green Spring for a
maximum of 889,456 shares of Common Stock or $20,460,000 in subordinated notes
through December 13, 1998. IBC exercised its Exchange Option in January 29, 1998
for Magellan Common Stock valued at approximately $17.9 million.
IBC and its affiliated entities contract with Green Spring for provider
network, care management and medical review services pursuant to contractual
relationships entered into on July 7, 1994 with terms of up to five years.
During the period from December 14, 1995 through September 30, 1996, fiscal 1997
and fiscal 1998, IBC and its affiliated entities made payments to Green Spring
of approximately $29.2 million, $48.0 million and $54.7 and owed Green Spring
approximately $13.6 million and $13.5 at September 30, 1997 and 1998,
respectively. Green Spring recorded revenue of approximately $32.8 million,
$47.4 million and $54.6 million from IBC during fiscal 1996, 1997 and 1998,
respectively.
On July 7, 1994, IBC sold a subsidiary to Green Spring in exchange for a $15
million promissory note. As of September 30, 1998, $3 million remained
outstanding under such promissory note and is due and payable on July 7, 1999.
Darla D. Moore, a director of the Company since February 1996, is the spouse
of Richard E. Rainwater, Chairman of the Board of Crescent and the largest
stockholder of the Company (13.1% beneficial ownership as of September 30,
1998). Because of her relationship to Mr. Rainwater, Ms. Moore did not
participate in any Board action taken with respect to the Crescent Transactions.
Daniel S. Messina, a director of the Company, is the Chief Financial Officer
of Aetna. Mr. Messina became a director of the Company in December 1997. On
December 4, 1997, the Company consummated the purchase of HAI, formerly a unit
of Aetna, for approximately $122.1 million.
F-44
<PAGE>
14. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)
The Company may be required to make additional contingent payment of up to
$60.0 million annually to Aetna over the five-year period subsequent to closing.
The amount and timing of the payments will be contingent upon net increases in
the HAI's covered lives in specified products. The consideration paid for HAI
was determined through arm's length negotiations that considered, among other
factors, the historical and projected income of HAI. The consideration paid by
the Company was determined by the Board with the advice of management and the
Company's investment bankers.
Aetna and its affiliated entities contract with the Company for various
behavioral managed care services pursuant to contractual relationships, the most
material of which is the Master Service Agreement, which was entered into on
December 4, 1997. During fiscal 1998, Aetna and its affiliated entities paid the
Company approximately $72.3 million for such services. As of September 30, 1998.
Aetna and its affiliated entities owed the Company approximately $0.8 million.
The Company recorded revenue of approximately $69.2 million from Aetna during
fiscal 1998.
15. BUSINESS SEGMENT INFORMATION
The Company operates through five reportable segments engaging in (i) the
behavioral managed healthcare business, (ii) the human services business, (iii)
the specialty managed healthcare business, (iv) the healthcare franchising
business and (v) the healthcare provider business. The behavorial managed
healthcare segment provides behavioral managed care services to health plans,
insurance companies, corporations, labor unions and various governmental
agencies. The human services segment provides therapeutic foster care services
and residential and day services to individuals with acquired brain injuries and
for individuals with mental retardation and developmental disabilities. The
speciality managed healthcare segment provides managed care services to health
plans and insurance companies for chronic medical conditions. The healthcare
franchising segment "franchises" the CHARTER system of behavioral healthcare,
which includes call center management, clinical outcomes monitoring and
advertising and marketing services. The healthcare provider segment provides
behavioral healthcare services to people in the U.S., United Kingdom and
Switzerland.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates
performance of its segments based on profit or loss from operations before
depreciation, amortization, interest, stock option expense (credit), managed
care integration costs, gain or loss on asset sales, other unusual items, income
taxes and minority interest ("Segment Profit"). Intersegment sales and transfers
are not significant.
The Company's reportable segments are strategic business units that offer
different services. They are managed separately because each business has (i)
different marketing strategies due to differences in types of customers and (ii)
different capital resource needs.
F-45
<PAGE>
15. BUSINESS SEGMENT INFORMATION (CONTINUED)
The following tables summarize, for the periods indicated, operating results
and other financial information, by business segment (in thousands):
<TABLE>
<CAPTION>
BEHAVIORAL SPECIALTY
MANAGED HUMAN MANAGED HEALTHCARE HEALTHCARE CORPORATE
HEALTHCARE SERVICES HEALTHCARE FRANCHISING PROVIDER OVERHEAD CONSOLIDATED
----------- ----------- ----------- ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
1996
Net revenue................ $ 230,755 $ 69,813 $ -- $ -- $ 1,044,711 $ -- $ 1,345,279
Segment profit (loss)...... 25,589 9,910 -- -- 198,651 (34,786) 199,364
Equity in loss of
unconsolidated
subsidiary................ (2,005) -- -- -- -- -- (2,005)
Capital expenditures....... 6,018 1,964 -- -- 21,737 9,082 38,801
</TABLE>
<TABLE>
<CAPTION>
BEHAVIORAL SPECIALTY
MANAGED HUMAN MANAGED HEALTHCARE HEALTHCARE CORPORATE
HEALTHCARE SERVICES HEALTHCARE FRANCHISING PROVIDER OVERHEAD CONSOLIDATED
----------- --------- ----------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997
Net revenue................... $ 369,974 $ 88,331 $ -- $ 22,739 $ 729,652 $ -- $ 1,210,696
Segment profit (loss)......... 37,019 10,695 (2,303) 10,964 147,053 (25,578) 177,850
Equity in loss of
unconsolidated
subsidiaries................ (5,567) -- -- (8,122) -- -- (13,689)
Total assets.................. 231,543 39,454 2,366 19,134 271,555 331,568 895,620
Investment in unconsolidated
subsidiaries................ (658) -- -- 16,878 -- -- 16,220
Capital expenditures.......... 9,548 1,880 567 195 18,172 2,986 33,348
</TABLE>
<TABLE>
<CAPTION>
BEHAVIORAL SPECIALTY
MANAGED HUMAN MANAGED HEALTHCARE HEALTHCARE CORPORATE
HEALTHCARE SERVICES HEALTHCARE FRANCHISING PROVIDER OVERHEAD CONSOLIDATED
------------- ----------- ----------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
1998
Net revenue................ $ 1,039,038 $ 141,032 $ 143,503 $ 55,625 $ 133,256 $ -- $ 1,512,454
Segment profit (loss)...... 137,192 15,493 3,128 14,676 26,379 (15,750) 181,118
Equity in income (loss) of
unconsolidated
subsidiaries.............. 12,859 -- -- (31,878) -- -- (19,019)
Total assets............... 1,356,259 119,356 106,184 1,941 150,095 182,455 1,916,290
Investment in
unconsolidated
subsidiaries.............. 10,125 -- -- -- -- -- 10,125
Capital expenditures....... 27,535 8,391 3,937 1,483 2,219 648 44,213
</TABLE>
F-46
<PAGE>
15. BUSINESS SEGMENT INFORMATION (CONTINUED)
The following tables reconcile segment profit to consolidated income before
provision for income taxes, minority interest and extraordinary items:
<TABLE>
<S> <C>
1996
Segment profit................................................................... $ 199,364
Depreciation and amortization.................................................... (48,924)
Interest, net.................................................................... (48,017)
Stock option expense............................................................. (914)
Unusual items.................................................................... (37,271)
---------
Income before provision for income taxes,
minority interest and extraordinary items.................................... $ 64,238
---------
---------
</TABLE>
<TABLE>
<S> <C>
1997
Segment profit................................................................... $ 177,850
Depreciation and amortization.................................................... (44,861)
Interest, net.................................................................... (45,377)
Stock option expense............................................................. (4,292)
Loss on Crescent Transactions.................................................... (59,868)
Unusual items.................................................................... (357)
---------
Income before provision for income taxes, minority interest and extraordinary
items........................................................................ $ 23,095
---------
---------
</TABLE>
<TABLE>
<S> <C>
1998
Segment profit................................................................... $ 181,118
Depreciation and amortization.................................................... (54,885)
Interest, net.................................................................... (75,375)
Stock option credit.............................................................. 5,623
Managed care integration costs................................................... (16,962)
Unusual items.................................................................... (458)
---------
Income before provision for income taxes, minority interest and extraordinary
items........................................................................ $ 39,061
---------
---------
</TABLE>
Revenue generated and long-lived assets located in foreign countries are not
material. Revenues from one customer of the Company's behavioral managed
healthcare segment represented 10.1% of the Company's consolidated revenues for
fiscal 1998.
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the quarterly results of operations for the
years ended September 30, 1997 and 1998. The second quarter and third quarter of
fiscal 1997 include unusual items of approximately $1.4 million and ($1.0)
million, respectively. The third quarter of fiscal 1997 also includes a $59.9
million loss on the Crescent Transactions. See Notes 3 and 5 for an explanation
of these items. The fourth quarter of 1997 includes increases to income before
income taxes and minority interest for revenue and bad debt expense adjustments
of approximately $6.4 million relating to a change in estimate for contractual
allowances and allowance for doubtful accounts in the Company's provider
business. The third and fourth quarters of fiscal 1998 include unusual items of
$(3.0) million and $3.5 million, respectively. See Note 5 for an explanation of
these items. The second, third, and fourth quarters of fiscal 1998 included
managed care integrations cost of $11.0 million, $1.3 million and $4.7 million,
respectively. See Note 11 for an explanation of these costs. Net revenue and
cost of care were both reduced from amounts previously reported in the first,
second and third quarters of fiscal 1998 by $4.4 million, $0.1 million and $4.1
million, respectively.
F-47
<PAGE>
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
<TABLE>
<CAPTION>
FISCAL QUARTERS
--------------------------------------------------
<S> <C> <C> <C> <C>
FIRST SECOND THIRD FOURTH
----------- ----------- ----------- -----------
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
1997
Net revenue.................................................. $ 346,819 $ 349,922 $ 324,921 $ 189,034
Income (loss) before extraordinary items..................... 7,141 11,892 (24,441) 10,163
Net income (loss)............................................ 4,191 11,892 (26,744) 10,163
Income (loss) per common share--basic:
Income (loss) before extraordinary items................... 0.25 0.41 (0.85) 0.35
Net income (loss).......................................... 0.15 0.41 (0.93) 0.35
Income (loss) per common share--diluted:
Income (loss) before extraordinary items................... 0.25 0.41 (0.85) 0.33
Net income (loss).......................................... 0.14 0.41 (0.93) 0.33
1998
Net revenue.................................................. $ 211,737 $ 372,153 $ 470,679 $ 457,885
Income (loss) before extraordinary items..................... 7,628 (2,292) 7,410 986
Net income (loss)............................................ 7,628 (35,307) 7,410 986
Income (loss) per common share--basic:
Income (loss) before extraordinary items................... 0.26 (0.07) 0.24 0.03
Net income (loss).......................................... 0.26 (1.14) 0.24 0.03
Income (loss) per common share--diluted:
Income (loss) before extraordinary items................... 0.26 (0.07) 0.23 0.03
Net Income (loss).......................................... 0.26 (1.14) 0.23 0.03
</TABLE>
F-48
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE MEMBERS OF
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC:
We have audited the accompanying consolidated balance sheets of Charter
Behavioral Health Systems, LLC (a Delaware limited liability corporation) and
subsidiaries as of September 30, 1997 and 1998, and the related consolidated
statements of operations, changes in members' capital (deficit) and cash flows
for the period June 17, 1997 to September 30, 1997 and for the year ended
September 30, 1998. These consolidated financial statements and the schedule
referred to below are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Charter Behavioral Health
Systems, LLC and subsidiaries as of September 30, 1997 and 1998, and the results
of their operations and their cash flows for the period June 17, 1997 to
September 30, 1997 and for the year ended September 30, 1998, in conformity with
generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the financial statements, the Company has incurred recurring losses from
operations and has a net capital deficiency that raises substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to the
consolidated financial statements is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not a required part of the
basic financial statements. The schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states, in all material respects, the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
ATLANTA, GEORGIA
DECEMBER 3, 1998
F-49
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
<S> <C> <C>
1997 1998
----------- -----------
ASSETS
Current Assets:
Cash, including cash equivalents of $15,477 in 1997 and $9,117 in 1998,
at cost, which approximates market value............................................ $ 23,443 $ 13,493
Accounts receivable, less allowance for doubtful accounts of $17,605
in 1997 and $33,548 in 1998......................................................... 107,961 120,187
Accounts receivable from Magellan..................................................... 5,090 --
Supplies.............................................................................. 2,313 2,665
Prepaid expenses...................................................................... 9,385 10,538
Other current assets.................................................................. 345 236
----------- -----------
Total Current Assets.............................................................. 148,537 147,119
Property and Equipment:
Buildings and improvements............................................................ 11,879 9,616
Equipment............................................................................. 7,121 11,924
----------- -----------
19,000 21,540
Accumulated depreciation.............................................................. (662) (2,916)
----------- -----------
18,338 18,624
Construction in progress.............................................................. 86 2,524
----------- -----------
Total Property and Equipment...................................................... 18,424 21,148
Other Long-Term Assets.................................................................. 6,471 6,699
Goodwill, net of accumulated amortization of $3 in 1997 and $17 in 1998................. 286 294
Deferred Financing Fees, net of accumulated amortization of $115 in 1997 and $513 in
1998.................................................................................. 1,876 1,878
----------- -----------
$ 175,594 $ 177,138
----------- -----------
----------- -----------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these consolidated balance sheets.
F-50
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------
<S> <C> <C>
1997 1998
----------- ------------
LIABILITIES AND MEMBERS' CAPITAL (DEFICIT)
Current Liabilities:
Accounts payable..................................................................... $ 34,864 $ 54,443
Accounts payable to Magellan......................................................... -- 36,857
Accrued liabilities.................................................................. 33,578 47,279
Current maturities of long-term debt and capital lease obligations................... 55 2,800
----------- ------------
Total Current Liabilities.......................................................... 68,497 141,379
Long-Term Debt and Capital Lease Obligations........................................... 65,860 67,200
Reserve for Unpaid Claims.............................................................. 2,686 10,812
Deferred Rent.......................................................................... 3,956 17,054
Long-Term Obligations to Lessor........................................................ 803 3,803
Minority Interest and Other Long-Term Liabilities...................................... 36 3,768
Members' Capital (Deficit):
Preferred interests.................................................................. 35,000 35,000
Common interests..................................................................... 15,000 15,000
Accumulated deficit.................................................................. (16,244) (116,878)
----------- ------------
Total Members' Capital (Deficit)................................................... 33,756 (66,878)
----------- ------------
$ 175,594 $ 177,138
----------- ------------
----------- ------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these consolidated balance sheets.
F-51
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
106 DAYS ENDED YEAR ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
---------------- --------------
<S> <C> <C>
Net revenue.................................................................... $ 213,730 $ 730,447
---------------- --------------
Costs and expenses:
Salaries, supplies and other operating expenses.............................. 170,619 606,628
Franchise fees--Magellan..................................................... 22,739 78,584
Crescent Lease expense....................................................... 16,919 56,133
Bad debt expense............................................................. 17,437 63,895
Depreciation and amortization................................................ 668 5,693
Interest, net................................................................ 1,592 5,263
Unusual items................................................................ -- 11,125
---------------- --------------
229,974 827,321
---------------- --------------
Loss before minority interest.................................................. (16,244) (96,874)
Minority interest.............................................................. -- 41
---------------- --------------
Net loss....................................................................... (16,244) (96,915)
Preferred dividend requirement................................................. -- 3,719
---------------- --------------
Net loss applicable to common members.......................................... $ (16,244) $ (100,634)
---------------- --------------
---------------- --------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these consolidated statements.
F-52
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' CAPITAL (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
106 DAYS ENDED YEAR ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
---------------- --------------
<S> <C> <C>
Preferred Interests:
Balance, beginning of period................................................. $ -- $ 35,000
Issuance of cumulative redeemable preferred
interests--Magellan........................................................ 17,500 --
Issuance of cumulative redeemable preferred
interests--COI............................................................. 17,500 --
-------- --------------
Balance, end of period....................................................... 35,000 35,000
-------- --------------
Common Interests:
Balance, beginning of period................................................. -- 15,000
Capital contribution--Magellan............................................... 7,500 --
Capital contribution--COI.................................................... 7,500 --
-------- --------------
Balance, end of period....................................................... 15,000 15,000
-------- --------------
Accumulated Deficit:
Balance, beginning of period................................................. -- (16,244)
Net loss applicable to common members........................................ (16,244) (100,634)
-------- --------------
Balance, end of period....................................................... (16,244) (116,878)
-------- --------------
Total Members' Capital (Deficit)............................................... $ 33,756 $ (66,878)
-------- --------------
-------- --------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these consolidated statements.
F-53
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
106 DAYS ENDED YEAR ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
---------------- --------------
<S> <C> <C>
Cash Flows From Operating Activities
Net loss..................................................................... $ (16,244) $ (96,915)
-------- --------------
Adjustments to reconcile net loss to net cash used in operating activities:
(Gain) loss on sale of businesses.......................................... (355) 2,688
Depreciation and amortization.............................................. 668 5,693
Non-cash interest expense.................................................. 115 398
Cash flows from changes in assets and liabilities, net of effects from
sales and acquisitions of businesses:
Accounts receivable, net................................................. (98,504) (5,318)
Accounts receivable/payable to Magellan.................................. (5,090) 41,947
Other current assets..................................................... (5,089) (1,096)
Other long-term assets................................................... (4,565) (275)
Accounts payable and accrued liabilities................................. 53,791 30,848
Reserve for unpaid claims................................................ 2,686 8,126
Deferred rent............................................................ 3,956 13,098
Minority interest, net of dividends paid................................. -- (25)
Other liabilities........................................................ 800 43
-------- --------------
Total adjustments........................................................ (51,587) 96,127
-------- --------------
Net cash used in operating activities.................................. (67,831) (788)
-------- --------------
Cash Flows From Investing Activities
Capital expenditures......................................................... (149) (9,549)
Purchase of information systems equipment from Magellan...................... (5,000) --
Purchase of net assets from Magellan......................................... (11,288) --
Proceeds from sale of businesses, net of transaction costs................... -- 1,160
Acquisition of businesses, net of cash acquired.............................. -- (5,327)
-------- --------------
Net cash used in investing activities.................................. (16,437) (13,716)
-------- --------------
Cash Flows From Financing Activities
Payments on debt and capital lease obligations............................... (16) (46)
Proceeds from issuance of debt, net of issuance costs........................ 98,009 4,600
Proceeds from capital contributions--Magellan................................ 2,218 --
Proceeds from capital contributions--COI..................................... 7,500 --
-------- --------------
Net cash provided by financing activities.............................. 107,711 4,554
-------- --------------
Net increase(decrease) in cash and cash equivalents............................ 23,443 (9,950)
Cash and cash equivalents at beginning of period............................... -- 23,443
-------- --------------
Cash and cash equivalents at end of period..................................... $ 23,443 $ 13,493
-------- --------------
-------- --------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these consolidated statements.
F-54
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997 AND 1998
1. ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements of Charter Behavioral Health Systems,
LLC ("CBHS" or the "Company"), a Delaware limited liability corporation, include
the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
The Company provides behavioral healthcare services in the United States.
The Company's principal services include group and individual inpatient
treatment, day and partial hospitalization services, group and individual
outpatient treatment and residential services.
On June 17, 1997 the Company began operations pursuant to a series of
transactions (the "Crescent Transactions") between Magellan Health Services,
Inc. ("Magellan"), Crescent Real Estate Equities Limited Partnership
("Crescent") and Crescent Operating, Inc. ("COI"). The Crescent Transactions
provided for the following:
- -- Magellan sold to Crescent 80 behavioral healthcare facilities (76 operating
and four held for sale) ("Purchased Facilities") and related medical office
buildings formerly operated by Magellan.
- -- The Company operates the Purchased Facilities and the Contributed Facilities
(defined below) (together the "Facilities"). The Company is owned equally by
Magellan and COI.
- -- Magellan contributed to the Company certain property and intangible rights
used in connection with the Facilities with a net book value of
approximately $5.0 million in exchange for its equity interest in CBHS. The
property that was contributed by Magellan included five acute care
psychiatric hospitals and other ancillary facilities that Magellan leased
from third parties (together the "Contributed Facilities"). The Company also
purchased certain assets from Magellan relating to Magellan's information
systems subsidiary for $5.0 million.
- -- COI contributed $5.0 million of cash as its initial equity investment in the
Company.
- -- CBHS entered into a service agreement with Magellan pursuant to which the
Company manages Magellan's interest in certain joint ventures with
unaffiliated third parties, including joint ventures that operate or manage
ten behavioral healthcare facilities. Magellan is the general partner or
managing entity of such joint ventures.
- -- CBHS leased the Purchased Facilities from Crescent under an initial 12-year
lease term with four renewal terms of five years each ("Crescent Lease").
CBHS pays annual base rent to Crescent, which was initially $41.7 million
and increases at 5% compounded annually (See Note 5).
- -- CBHS and certain of its subsidiaries entered into franchise agreements with
Magellan (the "Franchise Agreements") pursuant to which CBHS and such
subsidiaries operate using the "CHARTER" name, services and protocols and
pay Magellan annual franchise fees, subject to increase, of approximately
$78.3 million (See Note 6). The franchise fees due Magellan are subordinate
to the payment of rent due Crescent.
- -- Both Magellan and COI contributed an additional $2.5 million in cash to the
capital of CBHS. In addition, each made a commitment to loan CBHS up to
$17.5 million each, for a period of five years. Such loans were made to CBHS
by each for $17.5 million ("Member Loans") and, effective September 30,
1997, were converted to cumulative redeemable preferred interests (See Note
8).
F-55
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
1. ORGANIZATION AND BASIS OF PRESENTATION (CONTINUED)
The Company's financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements
during the 106 days ended September 30, 1997 and the year ended September 30,
1998, the Company has incurred losses from operations, and therefore, the
Company has a significant accumulated deficit at September 30, 1998. The
financial statements do not include any adjustments relating to the
recoverability and classification of liabilities that might be necessary should
the Company be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon its ability
to generate sufficient cash flows to meet its obligations on a timely basis. The
Company believes its cash flows and profitability are influenced by the cyclical
nature of the behavioral healthcare provider business, with a reduced demand for
certain services generally occurring during the first fiscal quarter around
major holidays and during the summer months comprising the fourth fiscal
quarter. Management has formulated and implemented a business plan to reduce
overhead and add new lines of business to improve the cash flows and the
profitability of the Company. Additionally, the Company is actively pursuing
additional sources of capital and/or borrowings.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the 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 revenue and expenses during the reporting
period. Actual results could differ from those estimates.
NET REVENUE
Net revenue is based on established billing rates, less estimated allowances
for patients covered by Medicare and other contractual reimbursement programs,
and discounts from established billing rates. Amounts received by the Company
for treatment of patients covered by Medicare and other contractual
reimbursement programs, which may be based on cost of services provided or
predetermined rates, are generally less than the established billing rates of
the Company's hospitals. Final determination of amounts earned under contractual
reimbursement programs is subject to review and audit by the applicable
agencies. Net revenue in fiscal 1998 included a charge of $0.7 million for the
settlement and adjustment of reimbursement issues related to the previous fiscal
period. Management believes that adequate provision has been made for any
adjustments that may result from such reviews.
ADVERTISING COSTS
The production costs of advertising are expensed as incurred. The Company
does not consider any of its advertising costs to be direct-response and,
accordingly, does not capitalize such costs. Advertising costs consist primarily
of radio and television air time, which is amortized as utilized, and printed
media services. Advertising expense was approximately $6.4 million and $20.3
million for the 106 days ended September 30,1997 and for the year ended
September 30, 1998, respectively.
F-56
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CHARITY CARE
The Company provides healthcare services without charge or at amounts less
than its established rates to patients who meet certain criteria under its
charity care policies. Because the Company does not pursue collection of amounts
determined to be charity care, they are not reported as revenue. For the 106
days ended September 30, 1997 and for the year ended September 30, 1998, the
Company provided, at its established billing rates, approximately $5.3 million
and $28.4 million, respectively, of such care.
INTEREST, NET
The Company records interest expense net of interest income. Interest income
for the 106 days ended September 30, 1997 and for the year ended September 30,
1998 was approximately $0.2 million and $0.3 million, respectively.
CASH AND CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid interest-bearing investments
with a maturity of three months or less when purchased, consisting primarily of
money market instruments.
CONCENTRATION OF CREDIT RISK
Accounts receivable from patient revenue subject the Company to a
concentration of credit risk with third-party payors that include insurance
companies, managed healthcare organizations and governmental entities. The
Company establishes an allowance for doubtful accounts based upon factors
surrounding the credit risk of specific payors, historical trends and other
information. Management believes the allowance for doubtful accounts is adequate
to provide for normal credit losses.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures for renewals and
improvements are charged to the property accounts. Replacements and maintenance
and repairs that do not improve or extend the lives of the respective assets are
expensed as incurred. Amortization of capital lease assets is included in
depreciation expense. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally three to ten years for
equipment. Leasehold improvements are amortized over the useful lives of the
related assets or the terms of the leases, whichever is shorter. Depreciation
and amortization expense was $0.7 million and $5.7 million for the 106 days
ended September 30, 1997 and for the year ended September 30, 1998,
respectively.
INTANGIBLE ASSETS
Intangible assets are composed principally of goodwill and deferred
financing costs. Goodwill represents the excess of the cost of businesses
acquired over the fair value of the net identifiable assets at the date of
acquisition and is amortized using the straight-line method over 25 years.
Deferred financing costs are the costs incurred by the Company to obtain and
amend its credit agreement (See Note 5) and are amortized over the term of the
related agreement (five years).
F-57
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company continually monitors events and changes in circumstances which
could indicate that carrying amounts of intangible assets may not be
recoverable. When events or changes in circumstances are present that indicate
that the carrying amount of intangible assets may not be recoverable, the
Company assesses the recoverability of intangible assets by determining whether
the carrying value of such intangible assets will be recovered through the
future cash flows expected from the use of the asset and its eventual
disposition. No impairment losses on intangible assets were recorded by the
Company for the 106 days ended September 30, 1997 or for the year ended
September 30, 1998.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company estimates that the carrying amounts of financial instruments
including cash and cash equivalents, accounts receivable and accounts payable
approximated their fair values as of the date of the balance sheets due to the
relatively short maturity of these instruments.
3. ACQUISITIONS, JOINT VENTURES AND DIVESTITURES
ACQUISITIONS
On September 28, 1998, the Company acquired four inpatient behavioral
healthcare facilities, two related transitional care businesses and a behavioral
healthcare contract management business (collectively "Acquired Hospitals") from
Ramsay Health Care, Inc. The purchase price for the Acquired Hospitals was
approximately $5.3 million. The Company accounted for the acquisition using the
purchase method of accounting. The operating results of the Acquired Hospitals
are included in the Company's Consolidated Statements of Operations since the
date of acquisition.
JOINT VENTURES
Effective September 2, 1998, the Company entered into a hospital-based
behavioral healthcare joint venture ("Brentwood JV") with Brentwood Behavioral
Healthcare, LLC. The Company contributed certain assets from an existing
behavioral healthcare facility in Shreveport, Louisiana, to the joint venture in
exchange for its 50% interest in the Brentwood JV. The Company subsequently
closed its Shreveport, Louisiana, facility. The Company accounts for its
investment in the Brentwood JV using the equity method.
DIVESTITURES
On September 30, 1997, the Company sold the operations of a 60-bed
behavioral healthcare hospital in Sioux Falls, South Dakota, for $422,000.
Proceeds from the sale were not received until October 2, 1997. The transaction
resulted in a gain of $355,000.
F-58
<PAGE>
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
4. UNUSUAL ITEMS
The following table summarizes the unusual items recorded during the year
ended September 30, 1998 (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1998
--------------
<S> <C>
Purchase Terminations......................................................... $ 4,450
Severance..................................................................... 3,002
Divestitures.................................................................. 2,688
Other......................................................................... 985
--------------
$ 11,125
--------------
--------------
</TABLE>
PURCHASE TERMINATIONS
In the first quarter of fiscal 1998, the Company recorded a charge of
approximately $2.1 million related to expenses incurred in connection with a
terminated acquisition of an unrelated entity. In the fourth quarter of fiscal
1998, the Company recorded a charge of approximately $2.3 million related to
expenses incurred in connection with terminated transactions with Magellan and
COI that included (i) the purchase of Magellan's franchise operations relating
to the "CHARTER" system and certain other assets, (ii) termination of the
Franchise Agreements, (iii) the sale of Magellan's equity interest in CBHS to
COI and (iv) review of the potential to obtain new capital for the Company
(collectively the "Magellan Buyout"). See Note 12.
SEVERANCE
The Company recorded charges of approximately $3.0 million during fiscal
1998 related to severance and related benefits for employees who were terminated
during fiscal 1998 pursuant to planned overhead reductions.
DIVESTITURES
In June 1998, the Company sold a 77-bed behavioral healthcare facility in
Virginia for approximately $0.8 million which resulted in a loss of
approximately $2.7 million.
OTHER
In the fourth quarter of fiscal 1998, the Company accrued approximately $0.8
million for estimated expenses incurred in connection with the settlement of
various litigation matters. Also in the fourth quarter of fiscal 1998, the
Company closed and consolidated one behavioral health care operation in Texas
and recorded charges of approximately $0.2 million related to severance and
related benefits and closure costs.
F-59
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
5. LONG-TERM DEBT AND LEASE OBLIGATIONS
Information with regard to the Company's long-term debt and capital lease
obligations at September 30, 1997 and 1998 is as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Revolving Credit Agreement due through 2002 (6.90234% to 7.59375%)......................... $ 65,000 $ 70,000
10.5% Capital lease obligations............................................................ 915 --
--------- ---------
65,915 70,000
Less amounts due within one year......................................................... 55 2,800
--------- ---------
$ 65,860 $ 67,200
--------- ---------
--------- ---------
</TABLE>
The aggregate scheduled maturities of long-term debt during the five years
subsequent to September 30, 1998 are as follows (in thousands): 1999--$2,800;
2000--$0; 2001--$0, 2002--$67,200; 2003--$0.
The Company's debt is carried at cost which approximates fair market value.
REVOLVING CREDIT AGREEMENTS
On June 17, 1997, the Company entered into a credit agreement (the
"Revolving Credit Agreement") with certain financial institutions for a
five-year senior secured revolving credit facility in an aggregate committed
amount of $100 million. Effective September 30, 1998, the Revolving Credit
Agreement was amended to provide for, among other things, modification of
financial covenant levels and increases in interest rates.
The maximum amount allowed to be borrowed under the Revolving Credit
Agreement is based on a working capital calculation. At September 30, 1998, the
Company did not have any amounts available for borrowing under the Revolving
Credit Agreement. The Revolving Credit Agreement is secured by the tangible and
intangible personal property, including accounts receivable, owned by the
Company.
The loans outstanding under the Revolving Credit Agreement bear interest
(subject to certain potential adjustments) at a rate per annum equal to one,
two, three or six-month LIBOR plus 2.75% or the Alternative Base Rate ("ABR"),
as defined, plus 1.75%. Interest on ABR loans is payable at the end of each
fiscal quarter. Interest on LIBOR-based loans is payable at the end of their
respective terms, but at a minimum of every three months.
COVENANTS
The Revolving Credit Agreement contains a number of restrictive covenants
which, among other things, limit the ability of the Company and certain of its
subsidiaries to incur other indebtedness, engage in transactions with
affiliates, incur liens, make certain restricted payments, and enter into
certain business combinations. The Revolving Credit Agreement also requires the
Company to maintain certain specified financial ratios. The Company was in
compliance with all debt covenants under the Revolving Credit Agreement, as
amended, at September 30, 1998. Budget projections prepared by management for
the fiscal year ending September 30, 1999 estimate that the Company will be in
F-60
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
5. LONG-TERM DEBT AND LEASE OBLIGATIONS (CONTINUED)
compliance with all debt covenants under the Revolving Credit Agreement, as
amended, during fiscal 1999. Management believes that its budget projections for
fiscal 1999 are reasonable and achievable, however, there can be no assurances
that such projections will be achieved. If the Company were to fail to achieve
such budget projections during fiscal 1999, the Company could become in
noncompliance with certain debt covenants resulting in an event of default under
the Revolving Credit Agreement.
CRESCENT LEASE
Effective June 17, 1997, the Company entered into an agreement to lease the
Purchased Facilities from Crescent under an initial 12-year lease term with four
renewal terms of five years each. The Crescent Lease requires the Company to pay
all maintenance, property tax and insurance costs.
The base rent for the first year of the initial term was $41.7 million and
increases at 5% compounded annually. The Company accounts for the Crescent Lease
as an operating lease and accordingly, records base rent expense on a
straight-line basis over the lease term. Effective December 1, 1997, Crescent
and the Company amended the Crescent Lease to delete the requirement for the
Company to pay an additional annual rent of $20.0 million. This amendment has no
impact on future commitments for the Company as it remains directly liable for
the capital expenditures and other obligations under the Crescent Lease which
were to be funded by the additional annual rent.
OTHER LEASES
The Company also leases certain of its operating facilities other than the
Purchased Facilities. The leases, which expire at various dates through 2027,
generally require the Company to pay all maintenance, property tax and insurance
costs.
In connection with the purchase of the Acquired Hospitals, CBHS entered into
an agreement to lease a behavioral healthcare facility under an initial
eight-year lease term with two renewal terms of four years each. The lease
requires the Company to pay all maintenance, property tax and insurance costs.
The base rent is $270,000, subject to increases for inflation. The Company
accounts for the lease as an operating lease.
At September 30, 1998, aggregate amounts of future minimum payments under
operating leases were as follows (in thousands): 1999--$49,225; 2000--$49,719;
2001--$50,562; 2002--$52,597; 2003--$54,972; subsequent to 2003--$367,948.
Rent expense for the 106 days ended September 30, 1997 and for the year
ended September 30, 1998 was $20.0 million and $67.4 million, respectively.
6. FRANCHISE FEES--MAGELLAN
Effective June 17, 1997, the Company and certain of its subsidiaries entered
into franchise agreements with Magellan, pursuant to which CBHS and such
subsidiaries operate using the "CHARTER" name, services and protocols. The
franchise agreements provide, among other things, that:
- Magellan agrees to use its commercially reasonable best efforts, subject
to applicable law, to cause CBHS and such subsidiaries to have "preferred
provider" status in connection with
F-61
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
6. FRANCHISE FEES--MAGELLAN (CONTINUED)
Magellan's managed behavioral healthcare business on a basis
substantially consistent with existing agreements for such business.
- Magellan agrees to operate or provide a toll free "800" telephone number
and call center as a means of assisting customers to locate the places of
business of franchisees.
- Franchisees were granted a right to a defined territory to engage in the
business of providing behavioral healthcare business, as defined.
- Magellan will provide franchisees with the following assistance: (i)
advertising and marketing assistance including consultation, access to
media buying programs and access to broadcast and other advertising
materials produced by Magellan from time to time for franchisees; (ii)
risk management services, including risk financial planning, loss control
and claims management; (iii) outcomes monitoring; (iv) national and
regional contracting services; and (v) consultation by telephone or at
the Magellan offices with respect to matters relating to the franchisee's
business in which Magellan has expertise, including reimbursement,
government relations, clinical strategies, regulatory matters, strategic
planning and business development.
Franchise fees payable by the Company are the greater of (i) $78.3 million,
subject to increases for inflation; or (ii) $78.3 million, plus 3% of gross
revenues over $1 billion and not exceeding $1.2 billion and 5% of gross revenues
over $1.2 billion. Pursuant to a subordination agreement, franchise fees
generally are subordinated to base rent under the Crescent lease and the 5%
annual increase.
The initial term of the franchise agreements is 12 years with four renewal
terms of five years each.
Pursuant to the provisions of the franchise agreement, the Company must pay
additional franchise fees to Magellan on management contract agreements entered
into during the term of the Franchise Agreement ("Managed Business"). Managed
Business franchise fees payable by the Company are 15% or 30% of the Managed
Business total fees less total direct costs for contract locations within or
outside of the Company's existing franchise territories, respectively. Managed
Business franchise fees expense was $0 and $0.3 million for the 106 days ended
September 30, 1997 and for the year ended September 30, 1998, respectively.
On December 22, 1997, Magellan and the Company entered into a management
agreement relating to the operation of the "call centers" formerly operated by
Magellan. The Company received $5.9 million as consideration for performing the
various obligations relating to the "call centers" for the 18-month period ended
June 21, 1999.
The Company has not made total monthly franchise fee payments to Magellan
since February 1998, and, as a result, is in default under the franchise
agreements. Franchise fee arrearages are approximately $38.0 million at
September 30, 1998. In addition to other remedies, whenever franchise fees are
past due for any reason in the amount of $6.0 million or more, Magellan has the
right to prohibit any incentive compensation to CBHS management and prohibit any
vesting of CBHS management equity. Whenever fees are past due in the amount of
$18.0 million or more, Magellan has the right to prohibit any salary increases
for key personnel of CBHS, prohibit any additional hiring by CBHS, and prohibit
any new direct or indirect hospital acquisitions or joint ventures
participation. If franchise fees are past due in an amount greater than $24.0
million, Magellan has the right to require a 5% cutback on budgeted
F-62
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
6. FRANCHISE FEES--MAGELLAN (CONTINUED)
expenses under the then-current approved CBHS annual budget, require monthly
approval of expenditures of CBHS, including capital and operating expenditures,
and require the transfer of control and management of CBHS and CBHS franchisees
to Magellan.
During the fourth quarter of fiscal 1998, due to the franchise fee
arrearages, Magellan exercised its limited management rights under the franchise
agreements and, with CBHS's board of directors' support, made operational and
management changes at CBHS. Subsequent to September 30, 1998, Magellan notified
the CBHS board of directors that it was relinquishing its exercise of limited
management rights of CBHS.
7. BENEFIT PLAN
The Company has a defined contribution retirement plan (the "401(k) Plan").
Employee participants can elect to voluntarily contribute up to 15% of their
compensation to the 401(k) Plan. The Company makes contributions to the 401(k)
Plan based on employee compensation and contributions. The Company makes a
discretionary contribution of 2% of each employee's compensation and matches 50%
of each employee's contribution up to 3% of their compensation.
During the year ended September 30, 1998, the Company made contributions of
approximately $2.7 million to the 401(k) Plan.
8. CUMULATIVE REDEEMABLE PREFERRED INTERESTS
Effective September 30, 1997, Magellan and COI each agreed to exchange their
respective Member Loans for cumulative redeemable preferred interest ("Preferred
Interests") in the Company. The Preferred Interests are callable in whole at the
Company's option on or after April 1, 1998, at an amount equal to the initial
amount plus all accrued dividends thereon. Each holder of Preferred Interests
receives preferential allocation of the Company's profits computed at 10% per
annum on a cumulative basis, compounded monthly. In addition, each Preferred
Interests has a similar preferred position in the event of dissolution of the
Company. The Company recorded approximately $3.7 million in fiscal 1998 relating
to this dividend requirement, which is all unpaid and included in Other
Long-Term Liabilities at September 30, 1998.
9. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Salaries and wages..................................................... $ 18,220 $ 20,334
Property taxes......................................................... 4,874 5,157
Interest............................................................... 333 105
Other.................................................................. 10,151 21,683
--------- ---------
$ 33,578 $ 47,279
--------- ---------
--------- ---------
</TABLE>
F-63
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
10. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the 106 days ended September 30, 1997
and for the year ended September 30, 1998 is as follows (in thousands):
<TABLE>
<CAPTION>
106 DAYS ENDED YEAR ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
---------------- --------------
<S> <C> <C>
Interest paid.................................................................. $ 1,291 $ 5,561
Exchange of debt for cumulative preferred interest--COI........................ 17,500 --
Exchange of debt for cumulative preferred interest--Magellan................... 17,500 --
Initial capital contribution from Magellan, primarily property and equipment
less assumed liabilities..................................................... 5,282 --
Account receivable for the sale of facility.................................... 386 --
Accrued dividend requirement on cummulative redeemable preferred interests..... -- 3,719
Capital lease obligation assigned with sale of facility........................ -- 874
</TABLE>
11. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As part of the Crescent Transactions, (i) certain items of working capital
were purchased from Magellan, (ii) the Company agreed to collect Magellan's
patient accounts receivable outstanding as of the closing date for a fee of 5%
of cash collections and (iii) the Company agreed to manage Magellan's interest
in certain joint ventures for a management fee. Included in net revenues for the
106 days ended September 30, 1997 and for the year ended September 30, 1998 are
approximately $5.0 million and $2.0 million, respectively, of these collection
fee revenues and approximately $2.1 million and $5.5 million, respectively, of
these joint venture management fees.
The Company had a net receivable from Magellan as of September 30, 1997 of
approximately $5.1 million and a net payable to Magellan as of September 30,
1998 of approximately $36.9 million. This receivable/payable results from (i)
amounts due for the management of Magellan's joint ventures as of September 30,
1997 and 1998, (ii) amounts due for the collection fees on Magellan's patient
accounts receivable as of September 30, 1997 and 1998, (iii) receivable for the
settlement of working capital related matters as of September 30, 1997 and 1998,
(iv) receivable for the reimbursement effect associated with the collection fees
as of September 30, 1997 and 1998 and (v) payable for the franchise fees as of
September 30, 1998.
Effective April 1, 1998, the Company entered into an agreement with Green
Spring Health Services, Inc. ("Green Spring"), a wholly-owned subsidiary of
Magellan, for managed mental health, substance abuse and employee assistance
plan services for the Company's employees. During fiscal 1998, the Company paid
approximately $0.1 million to Green Spring for these services.
John C. Goff was the Chairman of CBHS and the Vice Chairman of both Crescent
and COI. During fiscal 1998, the Company paid approximately $0.4 million to John
Goff for salary and related benefits. In November 1998, Mr. Goff resigned his
position on the CBHS board. Richard P. Knight, the Chief Financial Officer of
COI, was appointed to fill the vacancy on the CBHS board left by Mr. Goff's
resignation. Jeffrey L. Stevens of COI was subsequently elected Chairman of
CBHS.
F-64
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
12. COMMITMENTS AND CONTINGENCIES
The Company carries general and professional liability insurance from an
unrelated commercial insurance carrier with a self insured retention of $1.5
million per occurrence and $8.0 million in the aggregate, on a claim made basis.
In addition, the Company has an umbrella policy with coverage up to
$75.0 million per occurrence and in the aggregate.
Magellan and the predecessor to the Company's Orlando, Florida facility (the
"Orlando Facility") were named as defendants in a complaint entitled United
States of America ex rel. Francine M. Mettevis and Rhea Rowan v. Charter
Hospital of St. Louis, Inc. et al. The action was filed on November 6, 1994 as a
qui tam action in the United States District court for the Middle District of
Florida. Magellan, the Department of Justice, and the Company entered into a
settlement of the action in August 1998. Pursuant to the settlement agreement,
Magellan paid the government $4.75 million and the Company entered into a
Corporate Integrity Agreement for the Orlando Facility whereby the Orlando
Facility will be monitored for five years by the Department of Health and Human
Services ("HHS) and the Office of the Inspector General ("OIG") as well as a
concurrent reviewer. In the settlement agreement, the Company also agreed that
the Orlando Facility would not bill Medicare for the treatment of Medicare
patients for a period of 12 to 15 months beginning August 1, 1998 (the
"Non-Billing Period"). The Company intends to seek indemnification from Magellan
under the Crescent Transactions for all of the fees, costs, expenses and losses
it incurs in connection with the settlement agreement and the Corporate
Integrity Agreement. The Company has been reimbursed by Magellan for losses and
costs it has incurred through October 1998 which relate to the services provided
by the Orlando Facility to Medicare beneficiaries.
In connection with the Magellan Buyout, Magellan and COI entered into a
Support Agreement pursuant to which COI agreed, under certain conditions, to
assist the Company in obtaining the funds required to consummate the
contemplated transactions and to pay expenses incurred in obtaining such funds.
On August 19, 1998, Magellan and COI each announced the termination of
negotiations regarding the Magellan Buyout. On November 5, 1998, Magellan
notified COI that Magellan believes COI owes CBHS $2.3 million for the
reimbursement of expenses incurred by the Company in connection with attempts to
obtain financing for the contemplated transactions. COI disputes this matter
which will be sent to arbitration. See Note 4.
In April 1998, following the death of a patient at the Company's Greensboro,
North Carolina facility ("Greensboro Facility"), the North Carolina Department
of Health and Human Services ("NC HHS") conducted a survey of that facility. On
April 14, 1998, the Greensboro Facility received notice that as a result of the
survey, NC HHS was recommending to the Health Care Financing Administration
("HCFA") that the Greensboro Facility be excluded from participation in Medicare
within 23 days. Similarly, on April 14, 1998, the Greensboro Facility received
notice that as a result of the survey, NC HHS intended to revoke the Greensboro
Facility's state license. In response to such notices, the Company submitted a
plan of correction and refutation of deficiencies with HCFA and NC HHS, and NC
HHS conducted a subsequent visit on May 4 through May 6, 1998. On May 7, 1998,
the Greensboro Facility received notice from HCFA that based on the findings in
the second visit, the date scheduled for involuntary termination was extended to
July 7, 1998. On June 5, 1998, the Greensboro Facility entered into a settlement
agreement with NCHHS which resolved all outstanding regulatory and operational
issues with NCHHS and HCFA arising from the patient's death. The local District
Attorney's office and the North Carolina Board of Nursing ("NCBN") have
continued their separate investigations into this incident. An indictment
F-65
<PAGE>
CHARTER BEHAVORIAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997 AND 1998
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
of one of the Greensboro Facility's employees has been returned while the NCBN
continues its investigation. At this stage, it is not possible to predict
whether any future action will be taken against the Greensboro Facility or any
of its other employees involved in the patient's death, the likelihood of an
unfavorable outcome, or the amount of any potential loss associated with any
such action.
The healthcare industry is subject to numerous laws and regulations. The
subjects of such laws and regulations include, but are not limited to, matters
such as licensure, accreditation, government healthcare program participation
requirements, reimbursement for patient services, and Medicare and Medicaid
fraud and abuse. Recently, government activity has increased with respect to
investigations and/or allegations concerning possible violations of fraud and
abuse and false claims statutes and regulations by healthcare providers.
Entities that are found to have violated these laws and regulations may be
excluded from participating in government healthcare programs, subjected to
fines or penalties or required to repay amounts received from the government for
previously billed patient services. The Office of the Inspector General of the
Department of Health and Human Services and the United States Department of
Justice and certain other governmental agencies are currently conducting
inquiries and/ or investigations regarding the compliance by the Company and
certain of its subsidiaries with such laws and regulations. In addition, the
Company is also subject to or party to litigation, claims and civil suits
relating to its operations and business practices. In the opinion of management,
the Company has recorded reserves that are adequate to cover litigation, claims
or assessments that have been or may be asserted against the Company arising out
of such litigation, civil suits and governmental inquiries. Furthermore,
management believes that the resolution of such litigation, civil suits and
governmental inquiries will not have a material adverse effect on the Company's
financial position or results of operations; however, there can be no assurance
in this regard.
F-66
<PAGE>
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS--MAGELLAN
(IN THOUSANDS)
<TABLE>
<CAPTION>
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS-- DEDUCTIONS-- END OF
CLASSIFICATION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
- ---------------------------------------------------- ----------- ------------ ------------ ------------- -----------
<S> <C> <C> <C> <C> <C>
Year ended September30, 1996:
Allowance for doubtful accounts................... $ 48,741 $ 81,470(D) $ 22,761(A) $ 103,236(B) $ 50,548
812(C)
----------- ------------ ------------ ------------- -----------
$ 48,741 $ 81,470 $ 23,573 $ 103,236 $ 50,548
----------- ------------ ------------ ------------- -----------
----------- ------------ ------------ ------------- -----------
Year ended September30, 1997:
Allowance for doubtful accounts................... $ 50,548 $ 46,211(D) $ 19,373(A) $ 89,114(B) $ 40,311
$ 21,400(E) 5,164(F)
2,943(G)
----------- ------------ ------------ ------------- -----------
$ 50,548 $ 67,611 $ 19,373 $ 97,221 $ 40,311
----------- ------------ ------------ ------------- -----------
----------- ------------ ------------ ------------- -----------
Year ended September30, 1998:
Allowance for doubtful accounts................... $ 40,311 $ 4,977(D) $ 15,031(A) $ 24,440(B) $ 34,867
4,376(C) 5,388(F)
----------- ------------ ------------ ------------- -----------
$ 40,311 $ 4,977 $ 19,407 $ 29,828 $ 34,867
----------- ------------ ------------ ------------- -----------
----------- ------------ ------------ ------------- -----------
</TABLE>
- ------------------------
(A) Recoveries of accounts receivable previously written off.
(B) Accounts written off.
(C) Allowance for doubtful accounts assumed in acquisitions.
(D) Bad debt expense.
(E) Accounts receivable collection fees included in loss on Crescent
Transactions.
(F) Accounts receivable collection fees payable to CBHS and outside vendors.
(G) Amounts reclassified to contractual allowances.
S-1
<PAGE>
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS-CBHS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------------
<S> <C> <C> <C> <C> <C>
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS- DEDUCTIONS- END
CLASSIFICATION OF PERIOD EXPENSE DESCRIBE DESCRIBE OF PERIOD
- ------------------------------------------------------ ----------- ----------- ----------- ------------ -----------
106 days ended September 30, 1997:
Allowance for doubtful accounts..................... $ -- $ 17,437 $ 39(A) $ 843(B) $ 17,605
972(C)
----------- ----------- ----------- ------------ -----------
$ -- $ 17,437 $ 1,011 $ 843 $ 17,605
----------- ----------- ----------- ------------ -----------
----------- ----------- ----------- ------------ -----------
Year ended September 30, 1998:
Allowance for doubtful accounts..................... $ 17,605 $ 63,895 $ 4,035(A) $ 51,987(B) $ 33,548
----------- ----------- ----------- ------------ -----------
$ 17,605 $ 63,895 $ 4,035 $ 51,987 $ 33,548
----------- ----------- ----------- ------------ -----------
----------- ----------- ----------- ------------ -----------
</TABLE>
- ------------------------
(A) Recoveries of amounts previously charged to income.
(B) Accounts written off.
(C) Allowance for doubtful accounts assumed in purchase of net assets from
Magellan.
S-2
<PAGE>
Exhibit 2(m)
SECOND AMENDMENT
TO
ASSET PURCHASE AGREEMENT
THIS SECOND AMENDMENT TO ASSET PURCHASE AGREEMENT (this "Amendment") is
made and entered into as of the 18th day of November, 1998, by and among Allied
Specialty Care Services, Inc., a Florida corporation formerly known as CMSF,
Inc. (the "Buyer"), Allied Health Group, Inc., a Florida corporation ("AHG"),
Gut Management, Inc., a Florida corporation ("Gut"), Sky Management Co., a
Florida corporation ("Sky"), Florida Specialty Network, Ltd., a Florida limited
partnership ("FSN"), Surgical Associates of South Florida, Inc., a Florida
corporation ("SASF"), Surginet, Inc., a Florida corporation ("Surginet" and,
together with AHG, Gut, Sky, FSN and SASF, the "Sellers" and individually, a
"Seller"), Jacob Nudel, M.D. ("Nudel"), David Russin, M.D. ("Russin"), Lawrence
Schimmel, M.D. ("Schimmel" and, together with Nudel and Russin, the "Executive
Shareholders") and Magellan Health Services, Inc., a Delaware corporation and
the ultimate corporate Parent of the Buyer (the "Parent").
RECITALS
A. The parties entered into that certain Asset Purchase Agreement dated as
of October 16, 1997, as amended on December 5, 1997 (the "Asset Purchase
Agreement"). Capitalized terms used herein and not otherwise defined shall have
the meanings ascribed to them in the Asset Purchase Agreement.
B. The parties desire to further amend the Asset Purchase Agreement, on the
terms and subject to the conditions set forth hereinbelow.
NOW, THEREFORE, in consideration of the foregoing and the mutual promises
of the parties, and in consideration of the representations, warranties and
covenants herein contained, and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto,
intending to be legally bound, hereby agree as follows:
1. Amendments.
1.1 Buy-Out. In exchange for the payment by the Buyer to AHG of the
aggregate sum of $4,000,000 (the "Buyout Price"), payable in cash at Closing
(defined below) by wire transfer of immediately available funds, (a) the Buyer
shall be entitled to receive, and the Sellers shall release all claims to,
$18,906,746 of the Escrow Deposit, and any interest or earnings thereon (the
"Released Clawback"), and (b) the Buyer shall purchase, and the Sellers shall
sell, 87 1/2% of the Year 1 Earn-Out, the Year 2 Earn-Out and the Year 3
Earn-Out (collectively, the "Purchased Earn-Out"). In addition, effective on the
Effective Date, all Executive Shareholders and Sellers other than AHG shall
cease to be entitled to any amounts payable by the Buyer under the Asset
Purchase Agreement and the representations and warranties set forth in Sections
5.5, 5.6, 5.8, 5.9, 5.10, 5.11, 5.12, 5.13, 5.16, 5.17(e)-(h), 5.18, 5.20, 5.21,
5.22 and 5.25 of the Asset Purchase Agreement shall terminate. The parties to
this Amendment acknowledge and agree that the Buyout Price is payable in
consideration for the
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Purchased Earn-Out, and the restructuring of Sections 3.3 and 3.4 of the Asset
Purchase Agreement as set forth herein, and that there is no perceived value of
future claims to the Released Clawback.
1.2 Ongoing Arrangement with AHG. Effective on the Effective Date, AHG
shall remain entitled to the amounts payable by the Buyer pursuant to Section 3
of the Asset Purchase Agreement, subject to the terms and conditions described
below.
(a) Modification of Earn-Out Provisions. Effective on the Effective
Date (except as set forth in Section 1.2(b) of this Amendment, which sets
forth certain amendments to the Remaining Earn-Out (defined below) and the
Remaining Clawback (defined below), and restates said provisions as Sections
3.3A and 3.4A of the Asset Purchase Agreement), Sections 3.3 and 3.4 of the
Asset Purchase Agreement shall be amended and restated in their entirety to
read as follows:
Section 3.3 Earn-Out. The Purchase Price shall be subject to
adjustment after the Closing as set forth in this Section 3.3:
(a) Earn-Out Definitions. Unless the context otherwise requires,
as used in this Section 3.3 and in Section 3.4, the following terms shall
have the following meanings:
(1) "Accountants" shall mean the independent public
accountants of the Buyer.
(2) "Earn-Out Period" shall mean each of the Year 2 Earn-Out
Period and the Year 3 Earn-Out Period.
(3) "EBITDA" shall mean the aggregate Net Revenue from the
operations of the Businesses, minus all expenses incurred in operating
the Businesses but before interest, income taxes, depreciation and
amortization, prepared in accordance with GAAP, consistently applied,
and adjusted as follows: (1) Introduced Business will be deemed to
have been conducted at the Businesses' cost of providing services for
such Introduced Business plus the applicable IB Profit Margin. (2) As
long as the Businesses are operated as a separate subsidiary or
division, administrative services provided to the Businesses will be
actual corporate overhead, including services provided by Parent or
Parent's Affiliates, on a cost basis, and will only include
administrative services that are reasonably and directly related to
the Businesses. In the event the Businesses are integrated into Parent
or an Affiliate of Parent to the extent that the corporate overhead
attributable to the Businesses cannot be readily determined, then, in
lieu of actual overhead, an amount equal to a percentage of Net
Revenue of the Businesses shall be allocated to the Businesses as
deemed overhead, which percentage will be established by dividing (A)
the amount of actual overhead incurred with respect to the Businesses
for the six month period immediately preceding such
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integration by (B) the Net Revenue of the Businesses for said
six-month period. Said fixed percentage shall thereafter be applied to
the Net Revenue of the Businesses for purposes of determining the
deemed overhead to be allocated to the Businesses. (3) Net proceeds
from dispositions of assets of the Businesses shall be reinvested in
the Businesses. (4) With respect to acquisitions made from and after
the Closing, in lieu of including Net Revenue and expenses related to
such acquisition in the calculation of EBITDA, net income, determined
in accordance with GAAP, from such acquisition shall be included in
EBITDA. (5) Expenses and capital expenditures with respect to the
items set forth in the Information Technologies Budget will be
allocated and treated as set forth in the Information Technologies
Budget regardless of their treatment under GAAP.
(4) "EBITDA Run Rate" shall mean an amount equal to the sum
of (i) the product of (x) two and (y) the aggregate "Per Contract
EBITDA" (as defined below) for the period from July 1, 2001 through
December 31, 2001 resulting from each contract which constitutes New
Business commencing on or before June 30, 2001, and (ii) the product
of (x) two and (y) the aggregate "Per Contract EBITDA" for the first
six months of operations resulting from each contract which
constitutes New Business commencing on or after July 1, 2001. For
purposes of this definition, the term "Per Contract EBITDA" shall mean
an amount equal to (i) revenue from each contract constituting New
Business, minus (ii) the direct costs and expenses related to each
contract constituting New Business, minus (iii) an allocated portion
of all other expenses taken into account in calculating EBITDA (other
than direct costs and expenses related to contracts not constituting
New Business), which allocation shall be based upon the number of
claims processed under each such contract constituting New Business as
compared to the number of claims processed under all contracts,
including both contracts which constitute New Business and contracts
which do not constitute New Business.
(5) "IB Profit Margin" shall mean a profit margin equal to
fifty percent (50%) or such other agreed upon percentage (the "IB
Profit Margin Percentage") of the average profit margin of the
Businesses for services similar to the applicable Introduced Business
provided during the fiscal quarter immediately preceding the fiscal
quarter in which the Businesses are to begin to provide services for
the Introduced Business. The proposed IB Profit Margin Percentage and
the proposed calculation of the IB Profit Margin (collectively, the
"IB Profit Margin Calculation") will be made by the Buyer in good
faith and presented in writing to the Executive Shareholders as soon
as practicable prior to the date on which services relating to the
Introduced Business are to be rendered. The Executive Shareholders
shall, not later that five Business
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Days after receipt of the IB Profit Margin Calculation, notify the
Buyer in writing of any objections thereto. Absent delivery of a
written objection as provided above, the IB Profit Margin Calculation
will be conclusive and binding upon the parties to this Agreement. If
written objection is delivered to the Buyer and the Buyer and the
Executive Shareholders are unable, within 5 Business Days after the
receipt by the Buyer of such written objection, to resolve the
dispute, the Buyer, in its sole discretion, may elect either (i) to
not make the Introduced Business available to the Buyer or (ii) to
submit the IB Profit Margin Calculation to an Independent Accounting
Firm mutually acceptable to the Executive Shareholders and the Buyer
whose determination shall be conclusive and binding on the parties. In
the event the Buyer elects to submit the matter to an Independent
Accounting Firm, the Businesses shall provide services for the
Introduced Business pending determination of the IB Profit Margin
Calculation.
(6) "Independent Accounting Firm" shall mean one of the
"big-five" certified public accounting firms that does not have a
conflict of interest with respect to the preparation or review of the
EBITDA Statements.
(7) "Introduced Business" shall mean business introduced to
the Buyer by Parent or Parent's Affiliates (i) as part of a contract
with Parent or its Affiliates, or (ii) by reason of introductions to
the Buyer made by Parent or Parent's Affiliates. Neither Parent nor
any Parent Affiliate shall be obligated to introduce any business to
the Buyer or to otherwise cause any business that could be conducted
by the Buyer as Introduced Business to be referred to or conducted by
the Buyer.
(8) "New Business" shall mean contracts for services to be
provided by the Businesses (and additional services to be provided
under existing contracts by the Businesses) commencing between October
1, 1998 and October 1, 2001, inclusive, and for which no notice of
cancellation or nonrenewal has been given on or before October 1,
2001, but excluding (i) renewals (including amendments, restatements
or replacements) of contracts in force as of October 1, 1998 and (ii)
contracts which will expire by their terms absent notice of intent to
renew on or before October 1, 2001 (and with respect to which no
notice of intent to renew has been given).
(9) "Net Revenue" shall be defined as the combined revenues
of the Businesses (including income on operating cash and monies held
on behalf of third parties remaining after Buyer distributes cash in
excess of working capital requirements to Parent) (after elimination
of all inter-Business transactions and balances) which are capitation
fees (net of physician services expenses for AHG only, and net of any
retroactive adjustments under the terms of any managed care
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plans), service bureau billing fees, administrative fees, facility
fees, and fee for service billings (less contractual adjustments, bad
debt expense, charity adjustments, refunds, NSF checks, collection
agency fees and other adjustments to gross revenues), all as computed
in accordance with GAAP.
(10) "Year 2 Earn-Out" shall mean the amount, if any,
payable by the Buyer to AHG in accordance with the provisions of
Section 3.3(d) and Section 3.4.
(11) "Year 3 Earn-Out" shall mean the amount, if any,
payable by the Buyer to AHG in accordance with the provisions of
Section 3.3(e) and Section 3.4.
(12) "Year 3 Run Rate Earn-Out" shall mean the amount, if
any, payable by the Buyer to AHG in accordance with the provisions of
Section 3.3(f) and Section 3.4.
(13) "Year 2 EBITDA" shall have the meaning set forth in
Section 3.3(d).
(14) "Year 3 EBITDA" shall have the meaning set forth in
Section 3.3(e).
(15) "Year 2 Earn-Out Period" shall mean the 12-month period
ending on November 30, 1999.
(16) "Year 3 Earn-Out Period" shall mean the 12-month period
ending on November 30, 2000.
(17) "Year 2 Threshold" shall mean $11,000,000.
(18) "Year 3 Threshold" shall mean the greater of (i)
$11,000,000 or (ii) Year 2 EBITDA.
(b) EBITDA Statement. Within 75 calendar days after the last day
of each of the Year 2 Earn-Out Period and the Year 3 Earn-Out Period, the
Buyer shall prepare, the Accountants shall review, and the Buyer shall
deliver to AHG a statement reflecting the EBITDA from the consolidated
operations of the Businesses during such Earn-Out Period (each, an "EBITDA
Statement"), which statement will be determined in accordance with GAAP,
applied on a basis consistent with the financial statements of the Buyer
and the Parent for such period. The parties shall ensure that the
Accountants have full access to the books, records, facilities and
employees of the Businesses for purposes of reviewing the EBITDA Statement
and shall cooperate with the Accountants to the extent reasonably requested
to review the EBITDA Statement. The EBITDA Statement will be examined by
AHG (and, if AHG so chooses, by a
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firm of independent certified public accountants), who shall, not later
than 45 calendar days after receipt of the EBITDA Statement, raise any
objections it has to the EBITDA Statement by notifying the Buyer in writing
within such time period in a statement indicating the item or items
disputed, AHG's proposed adjustments and an adjusted EBITDA Statement
reflecting such adjustments (an "Objection Notice"). During such 45 day
period, AHG and any such independent certified public accountants shall
have full access to the books and records, other financial information
(including the working papers of the Accountants) and appropriate financial
personnel of the Buyer reasonably necessary for the preparation of an
Objection Notice. Absent delivery of an Objection Notice as provided above,
the EBITDA Statement will be conclusive and binding upon the parties to
this Agreement for the purposes of any purchase price adjustment under this
Section 3.3(b). In the event that an Objection Notice is delivered by AHG
as provided above, and if the Buyer and AHG are unable, within 15 calendar
days after receipt by the Buyer of such Objection Notice, to resolve the
disputed exceptions, such disputed exceptions will be referred to an
Independent Accounting Firm mutually acceptable to AHG and the Buyer. The
Independent Accounting Firm shall, within 60 days following its engagement
by the Buyer and AHG for this purpose, deliver to AHG and the Buyer a
written report determining such disputed exceptions (the "IAF EBITDA
Statement"). During such 60 day period, the Independent Accounting Firm
shall have full access to the books and records, other financial
information (including the working papers of the Accountants and AHG's
accountants, if any) and appropriate financial personnel of the Buyer which
the Independent Accounting Firm reasonably deems necessary or advisable for
the preparation of the IAF EBITDA Statement. The EBITDA reflected in the
IAF EBITDA Statement will be conclusive and binding upon the parties to
this Agreement for the purposes of any purchase price adjustment under this
Section 3.3(b), subject to application of the following provisions: (i) if
the IAF EBITDA Statement reflects EBITDA in excess of $300,000 over the
amount of the EBITDA reflected in the EBITDA Statement for the Earn-Out
Period at issue, then EBITDA for such Earn-Out Period shall be deemed to be
equal to the EBITDA reflected in the IAF EBITDA Statement, and the Buyer
shall bear all the fees and disbursements of the Independent Accounting
Firm in respect of its services under this Section 3.3(b) for such Earn-Out
Period, (ii) if the IAF EBITDA Statement reflects EBITDA that is equal to
or less than $300,000 over the amount of the EBITDA reflected in the EBITDA
Statement for such Earn-Out Period, but greater than the amount of the
EBITDA reflected in such EBITDA Statement, then EBITDA for such Earn-Out
Period shall be deemed to be equal to (A) the sum of (1) the EBITDA
reflected in the EBITDA Statement and (2) the EBITDA reflected in the IAF
EBITDA Statement divided by (B) two, and AHG shall bear all the fees and
disbursements of the Independent Accounting Firm in respect of its services
under this Section 3.3(b) for the Earn-Out Period at issue; and (iii) if
the IAF EBITDA Statement reflects EBITDA that is equal to or less than the
amount of the EBITDA reflected in the EBITDA Statement for such Earn-Out
Period, then EBITDA for such Earn-Out Period shall be deemed to be equal to
the EBITDA reflected in the IAF EEITDA Statement, and AHG shall
6
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bear all the fees and disbursements of the Independent Accounting Firm in
respect of its services under this Section 3.3(b) for the Earn-Out Period
at issue.
(c) Run Rate Statement. Within 75 calendar days after April 1,
2002, the Buyer shall prepare, the Accountants shall review, and the Buyer
shall deliver to AHG a statement reflecting the EBITDA Run Rate (the "Run
Rate Statement"), which statement will be determined on a basis consistent
with the financial statements of the Buyer and the Parent for the fiscal
years ending September 30, 1999, 2000 and 2001. The parties shall ensure
that the Accountants have full access to the books, records, facilities and
employees of the Businesses for purposes of reviewing the Run Rate
Statement and shall cooperate with the Accountants to the extent reasonably
requested to review the Run Rate Statement. The Run Rate Statement will be
examined by AHG (and, if AHG so chooses, by a firm of independent certified
public accountants), who shall, not later than 45 calendar days after
receipt of the Run Rate Statement, raise any objections it has to the Run
Rate Statement by notifying the Buyer in writing within such time period in
a statement indicating the item or items disputed, AHG's proposed
adjustments and an adjusted Run Rate Statement reflecting such adjustments
(a "Run Rate Objection Notice"). During such 45 day period, AHG and any
such independent certified public accountants shall have full access to the
books and records, other financial information (including the working
papers of the Accountants) and appropriate financial personnel of the Buyer
reasonably necessary for the preparation of a Run Rate Objection Notice.
Absent delivery of a Run Rate Objection Notice as provided above, the Run
Rate Statement will be conclusive and binding upon the parties to this
Agreement for the purposes of any purchase price adjustment under this
Section 3.3(c). In the event that a Run Rate Objection Notice is delivered
by AHG as provided above, and if the Buyer and AHG are unable, within 15
calendar days after receipt by the Buyer of such Run Rate Objection Notice,
to resolve the disputed exceptions, such disputed exceptions will be
referred to an Independent Accounting Firm mutually acceptable to AHG and
the Buyer. The Independent Accounting Firm shall, within 60 days following
its engagement by the Buyer and AHG for this purpose, deliver to AHG and
the Buyer a written report determining such disputed exceptions (the "IAF
Run Rate Statement"). During such 60 day period, the Independent Accounting
Firm shall have full access to the books and records, other financial
information (including the working papers of the Accountants and AHG's
accountants, if any) and appropriate financial personnel of the Buyer which
the Independent Accounting Firm reasonably deems necessary or advisable for
the preparation of the IAF Run Rate Statement. The Run Rate reflected in
the IAF Run Rate Statement will be conclusive and binding upon the parties
to this Agreement for the purposes of any purchase price adjustment under
this Section 3.3(c) subject to application of the following provisions: (i)
if the IAF Run Rate Statement reflects an EBITDA Run Rate in excess of
$300,000 over the amount of the EBITDA Run Rate reflected in the Run Rate
Statement, then the EBITDA Run Rate shall be deemed to be equal to the
EBITDA Run Rate reflected in the IAF Run Rate Statement, and the Buyer
shall bear all the fees and disbursements
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of the Independent Accounting Firm in respect of its services under this
Section 3.3(c), (ii) if the IAF Run Rate Statement reflects an EBITDA Run
Rate that is equal to or less than $300,000 over the amount of the EBITDA
Run Rate reflected in the Run Rate Statement, but greater than the amount
of the EBITDA Run Rate reflected in such Run Rate Statement, then the
EBITDA Run Rate shall be deemed to be equal to (A) the sum of (1) the
EBITDA Run Rate reflected in the Run Rate Statement and (2) the EBITDA Run
Rate reflected in the IAF Run Rate Statement divided by (B) two, and AHG
shall bear all the fees and disbursements of the Independent Accounting
Firm in respect of its services under this Section 3.3(c); and (iii) if the
IAF Run Rate Statement reflects an EBITDA Run Rate that is equal to or less
than the amount of the EBITDA Run Rate reflected in the Run Rate Statement,
then the EBITDA Run Rate shall be deemed to be equal to the EBITDA Run Rate
reflected in the IAF Run Rate Statement, and AHG shall bear all the fees
and disbursements of the Independent Accounting Firm in respect of its
services under this Section 3.3(c).
(d) Year 2 Earn-Out Calculation. In the event EBITDA for the Year
2 Earn-Out Period (the "Year 2 EBIDTA") is greater than the Year 2
Threshold, then the Year 2 Earn-Out is the amount equal to the product of
(1) six multiplied by the difference between the Year 2 EBITDA and the Year
2 Threshold and (2) 0.075.
(e) Year 3 Earn-Out Calculation. In the event EBITDA for the Year
3 Earn-Out Period (the "Year 3 EBIDTA") is greater than the Year 3
Threshold, then the Year 3 Earn-Out is the amount equal to the product of
(1) four multiplied by the difference between the Year 3 EBITDA and the
Year 3 Threshold and (2) 0.075.
(f) Year 3 Run Rate Earn-Out Calculation.
(1) In the event the EBITDA Run Rate is less than
$15,000,000, then the Year 3 Run Rate Earn-Out is $0.
(2) In the event the EBITDA Run Rate is equal to or greater
than $15,000,000 but less than $20,000,000, then the Year 3 Run Rate
Earn-Out is the amount equal to a quotient (the numerator of which is
the EBITDA Run Rate less $14,999,999.99 and the denominator of which
is $20,000,000 less $14,999,999.99) multiplied by $1,500,000.
(3) In the event the EBITDA Run Rate is equal to or greater
than $20,000,000, then the Year 3 Run Rate Earn-Out is $1,500,000.
Section 3.4 Payment of Earn-Outs; Limitation on Earn-Outs. The Year 2
Earn-Out and the Year 3 Earn-Out, if any, shall be paid within 5 Business
Days of final determination of EBITDA for the applicable Earn-Out Period
pursuant to Section 3.3(b) and shall be paid to AHG, in cash by wire
transfer of immediately
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available funds. The Year 3 Run Rate Earn-Out, if any, shall be paid within
5 Business Days of final determination of the EBITDA Run Rate pursuant to
Section 3.3(c) and shall be paid to AHG, in cash by wire transfer of
immediately available funds. Notwithstanding anything to the contrary
contained in this Section 3, in no event shall the Year 2 Earn-Out and the
Year 3 Earn-Out exceed $1,500,000 in the aggregate, and in no event shall
the Year 3 Run Rate Earn-Out exceed $1,500,000.
(b) Agreement Between AHG and GHS, Inc. AHG and the Executive
Shareholders, on a joint and several basis, represent and warrant that, pursuant
to the terms and conditions of a letter agreement dated October 8, 1997 by and
among the Sellers, the Executive Shareholders and GHS, Inc. (the "Letter
Agreement"), GHS, Inc. is entitled to receive a portion of the Escrow Deposit
(the "Clawback"), if and when released to the Sellers, and of the Year 1
Earn-Out, the Year 2 Earn-Out and the Year 3 Earn-Out, if any (collectively, the
"Earn-Out"). A total of $1,093,254 of the Escrow Deposit (the "Remaining
Clawback") is being held pursuant to the terms and conditions of the Escrow
Agreement for and on behalf of AHG for further payment to GHS, Inc. under the
terms of the Letter Agreement. In addition, GHS, Inc. is entitled under the
Letter Agreement to 12 1/2% of the Earn-Out (the "Remaining Earn-Out"). The
Remaining Clawback will not be released to the Buyer and the Remaining Earn-Out
will not be purchased by the Buyer pursuant to this Amendment. Notwithstanding
any provision of this Amendment to the contrary, effective on the Effective
Date, the Buyer agrees to continue to pay to AHG, for further payment to GHS,
Inc. pursuant to the terms and conditions of the Letter Agreement, sums payable
with respect to the Remaining Earn-Out pursuant to Sections 3.3 and 3.4 of the
Asset Purchase Agreement, as amended and restated in their entirety as Sections
3.3A and 3.4A of the Asset Purchase Agreement as follows:
Section 3.3A Earn-Out. The Purchase Price shall be subject to
adjustment after the Closing as set forth in this Section 3.3A:
(a) Earn-Out Definitions. Unless the context otherwise requires,
as used in this Agreement (other than with respect to Sections 3.3 and
3.4), the following terms shall have the following meanings:
(1) "Accountants" shall mean the independent public
accountants of the Buyer.
(2) "Earn-Out Period" shall mean each of the Year 1 Earn-Out
Period, the Year 2 Earn-Out Period and the Year 3 Earn-out Period.
(3) "EBITDA" shall mean the aggregate Net Revenue from the
operations of the Businesses, minus all expenses incurred in operating the
Businesses but before interest, income taxes, depreciation and
amortization, prepared in accordance with GAAP, consistently applied, and
adjusted as follows: (1) Introduced Business will be deemed to have been
conducted at the Businesses' cost of providing services for such Introduced
Business plus the applicable IB Profit Margin. (2) Any increase in EBITDA
earned by the Businesses through the
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restructuring of the Farrell Consulting Agreement that requires one-time
cash payments by Buyer or Buyer's Affiliates shall be deducted from EBITDA.
(3) As long as the Businesses are operated as a separate subsidiary or
division, administrative services provided to the Businesses will be actual
corporate overhead, including services provided by Parent or Parent's
Affiliates, on a cost basis, and will only include administrative services
that are reasonably and directly related to the Businesses. In the event
the Businesses are integrated into Parent or an Affiliate of Parent to the
extent that the corporate-overhead attributable to the Businesses cannot be
readily determined, then, in lieu of actual overhead, an amount equal to a
percentage of Net Revenue of the Businesses shall be allocated to the
Businesses as deemed overhead, which percentage will be established by
dividing (A) the amount of actual overhead incurred with respect to the
Businesses for the six month period immediately preceding such integration
by (B) the Net Revenue of the Businesses for said six-month period. Said
fixed percentage shall thereafter be applied to the Net Revenue of the
Businesses for purposes of determining the deemed overhead to be allocated
to the Businesses. (4) Net proceeds from dispositions of assets of the
Businesses shall be reinvested in the Businesses. (5) With respect to
acquisitions made from and after the Closing, in lieu of including Net
Revenue and expenses related to such acquisition in the calculation of
EBITDA, net income, determined in accordance with GAAP, from such
acquisition shall be included in EBITDA. (6) Expenses and capital
expenditures with respect to the items set forth in the Information
Technologies Budget will be allocated and treated as set forth in the
Information Technologies Budget regardless of their treatment under GAAP.
(7) Any and all amounts payable under, or in connection with the
termination of, any Leases which are assumed by the Buyer as part of the
Contracts for Leased Real Property which is no longer used in any of the
Businesses shall be treated as current expenses for purposes of calculating
EBITDA regardless of their treatment under GAAP.
(4) "IB Profit Margin" shall mean a profit margin equal to
fifty percent (50%) or such other agreed upon percentage (the "IB Profit
Margin Percentage") of the average profit margin of the Businesses for
services similar to the applicable Introduced Business provided during the
fiscal quarter immediately preceding the fiscal quarter in which the
Businesses are to begin to provide services for the Introduced Business.
The proposed IB Profit Margin Percentage and the proposed calculation of
the IB Profit Margin (collectively, the "IB Profit Margin Calculation")
will be made by the Buyer in good faith and presented in writing to the
Executive Shareholders as soon as practicable prior to the date on which
services relating to the Introduced Business are to be rendered. The
Executive Shareholders shall, not later that five Business Days after
receipt of the IB Profit Margin Calculation, notify the Buyer in writing of
any objections thereto. Absent delivery of a written objection as provided
above, the IB Profit Margin Calculation will be conclusive and binding upon
the parties to this Agreement. If written objection is delivered to the
Buyer and the Buyer and the Executive Shareholders are unable, within 5
Business Days after the receipt by the Buyer of such written objection, to
resolve the dispute, the Buyer, in its sole
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discretion, may elect either (i) to not make the Introduced Business
available to the Buyer or (ii) to submit the IB Profit Margin Calculation
to an Independent Accounting Firm mutually acceptable to the Executive
Shareholders and the Buyer whose determination shall be conclusive and
binding on the parties. In the event the Buyer elects to submit the matter
to an Independent Accounting Firm, the Businesses shall provide services
for the Introduced Business pending determination of the IB Profit Margin
Calculation.
(5) "Independent Accounting Firm" the "big-five" certified
public accounting firms that does not a conflict of interest with respect
to the preparation or review of the EBITDA Statements.
(6) "Introduced Business" shall mean business introduced to
the Buyer by Parent or Parent's Affiliates (i) as part of a contract with
Parent or its Affiliates, or (ii) by reason of introductions to the Buyer
made by Parent or Parent's Affiliates. The Executive Shareholders
acknowledge and agree that neither Parent nor any Parent Affiliate shall be
obligated to introduce any business to the Buyer or to otherwise cause any
business that could be conducted by the Buyer as Introduced Business to be
referred to or conducted by the Buyer.
(7) "Net Revenue" shall be defined as the combined revenues
of the Businesses (including income on operating cash and monies held on
behalf of third parties remaining after Buyer distributes cash in excess of
working capital requirements to Parent) (after elimination of all
inter-Business transactions and balances) which are capitation fees (net of
physician services expenses for AHG only, and net of any retroactive
adjustments under the terms of any managed care plans), service bureau
billing fees, administrative fees, facility fees, and fee for service
billings (less contractual adjustments, bad debt expense, charity
adjustments, refunds, NSF checks, collection agency fees and other
adjustments to gross revenues), all as computed in accordance with GAAP.
(8) "Year 1 Adjustment" shall mean the amount, if any,
payable to the Buyer from the Escrow Funds in accordance with the
provisions of Section 3.3A(c) and Section 3.4A(a).
(9) "Year 2 Adjustment" shall mean the amount, if any,
payable to the Buyer from the Escrow Funds in accordance with the
provisions of Section 3.3A(d) and Section 3.4A(b).
(10) "Year 3 Adjustment" shall mean the amount, if any,
payable to the Buyer from the Escrow Funds in accordance with the
provisions of Section 3.3A(e) and Section 3.4A(c).
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(11) "Year 1 Earn-Out" shall mean the amount, if any,
payable by the Buyer to the Escrow Agent in accordance with the provisions
of Section 3.3A(c) and Section 3.4A(a).
(12) "Year 2 Earn-Out" shall mean the amount, if any,
payable by the Buyer to the Escrow Agent in accordance with the provisions
of Section 3.3A(d) and Section 3.4A(b).
(13) "Year 3 Earn-Out" shall mean the amount, if any,
payable by the Buyer to the Escrow Agent in accordance with the provisions
of Section 3.3A(e) and Section 3.4A(c).
(14) "Year 1 EBITDA" shall have the meaning set forth in
Section 3.3A(c)(1).
(15) "Year 2 EBITDA" shall have the meaning set forth in
Section 3.3A(d)(1).
(16) "Year 3 EBITDA" shall have the meaning set forth in
Section 3.3A(e)(1).
(17) "Year 1 Earn-Out Period" shall mean the 12-month period
ending on November 30, 1998.
(18) "Year 2 Earn-Out Period" shall mean the 12-month period
ending on November 30, 1999.
(19) "Year 3 Earn-Out Period" shall mean the 12-month period
ending on November 30, 2000.
(20) "Year 1 Threshold" shall mean $11,000,000.
(21) "Year 2 Threshold" shall mean the greater of (i)
$11,000,000 or (ii) Year 1 EBITDA.
(22) "Year 3 Threshold" shall mean the greater of (i)
$11,000,000, (ii) Year 1 EBITDA, or (iii) Year 2 EBITDA.
(b) EBITDA Statement. Within 75 calendar days after the last day
of each of the Year 1 Earn-Out Period, the Year 2 Earn-Out Period and the
Year 3 Earn-Out Period, the Buyer shall prepare, the Accountants shall
review, and the Buyer shall deliver to AHG a statement reflecting the
EBITDA from the consolidated operations of the Businesses during such
Earn-Out Period (each, an "EBITDA Statement"), which statement will be
determined in accordance with GAAP, applied on a basis consistent with the
financial statements of the Buyer and Parent for such period. The parties
shall ensure that the Accountants have full
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access to the books, records, facilities and employees of the Businesses
for purposes of reviewing the EBITDA Statement and shall cooperate with the
Accountants to the extent reasonably requested to review the EBITDA
Statement. The EBITDA Statement will be examined by AHG (and, if AHG so
chooses, by a firm of independent certified public accountants), who shall,
not later than 45 calendar days after receipt of the EBITDA Statement,
raise any objections it has to the EBITDA Statement by notifying the Buyer
in writing within such time period in a statement indicating the item or
items disputed, AHG's proposed adjustments and an adjusted EBITDA Statement
reflecting such adjustments (an "Objection Notice"). During such 45 day
period, AHG and any such independent certified public accountants shall
have full access to the books and records, other financial information
(including the working papers of the Accountants) and appropriate financial
personnel of the Buyer reasonably necessary for the preparation of an
Objection Notice. Absent delivery of an Objection Notice as provided above,
the EBITDA Statement will be conclusive and binding upon the parties to
this Agreement for the purposes of any purchase price adjustment under this
Section 3.3A(b). In the event that an Objection Notice is delivered by AHG
as provided above, and if the Buyer and AHG are unable, within 15 calendar
days after receipt by the Buyer of such Objection Notice, to resolve the
disputed exceptions, such disputed exceptions will be referred to an
Independent Accounting Firm mutually acceptable to AHG and the Buyer. The
Independent Accounting Firm shall, within 60 days following its engagement
by the Buyer and AHG for this purpose, deliver to AHG and the Buyer a
written report determining such disputed exceptions (the "IAF EBITDA
Statement"). During such 60 day period, the Independent Accounting Firm
shall have full access to the books and records, other financial
information (including the working papers of the Accountants and AHG's
accountants, if any) and appropriate financial personnel of the Buyer which
the Independent Accounting Firm reasonably deems necessary or advisable for
the preparation of the IAF EBITDA Statement. The EBITDA reflected in the
IAF EBITDA Statement will be conclusive and binding upon the parties to
this Agreement for the purposes of any purchase price adjustment under this
Section 3.3A(b), subject to application of the following provisions: (i) if
the IAF EBITDA Statement reflects EBITDA in excess of $300,000 over the
amount of the EBITDA reflected in the EBITDA Statement for the Earn-Out
Period at issue, then EBITDA for such Earn-Out Period shall be deemed to be
equal to the EBITDA reflected in the IAF EBITDA Statement, and the Buyer
shall bear all the fees and disbursements of the Independent Accounting
Firm in respect of its services under this Section 3.3A(b) for such
Earn-Out Period, (ii) if the IAF EBITDA Statement reflects EBITDA that is
equal to or less than $300,000 over the amount of the EBITDA reflected in
the EBITDA Statement for such Earn-Out Period, but greater than the amount
of the EBITDA reflected in such EBITDA Statement, then EBITDA for such
Earn-Out Period shall be deemed to be equal to (A) the sum of (1) the
EBITDA reflected in the EBITDA Statement and (2) the EEITDA reflected in
the IAF EBITDA Statement divided by (B) two, and AHG and the Executive
Shareholders, on a joint and several basis, shall bear all the fees and
disbursements of the Independent Accounting Firm in respect of its services
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under this Section 3.3A(b) for the Earn-Out Period at issue; and (iii) if
the IAF EBITDA Statement reflects EBITDA that is equal to or less than the
amount of the EBITDA reflected in the EBITDA Statement for such Earn-Out
Period, then EBITDA for such Earn-Out Period shall be deemed to be equal to
the EBITDA reflected in the IAF EEITDA Statement, and AHG and the Executive
Shareholders, on a joint and several basis, shall bear all the fees and
disbursements of the Independent Accounting Firm in respect of its services
under this Section 3.3A(b) for the Earn-Out Period at issue.
(c) Year 1 Adjustment/Year 1 Earn-Out Calculation.
(1) In the event the EBITDA for the Year 1 Earn-Out Period
calculated pursuant to Section 3.3A(b) above (the "Year 1 EBITDA") is less
than $10,000,000, then the Year 1 Adjustment is the amount equal to the
product of (i) seven multiplied by the difference between the Year 1 EBITDA
and $10,000,000 and (ii) 0.125.
(2) In the event the Year 1 EBITDA is equal to or less than
the Year 1 Threshold and equal to or greater than $10,000,000, then the
Year 1 Adjustment is $0.00.
(3) In the event the Year 1 EBITDA is greater than the Year
1 Threshold, then the Year I Earn-Out is the amount equal to the product of
(i) six multiplied by the difference between the Year 1 EBITDA and the Year
1 Threshold and (ii) 0.125.
(d) Year 2 Adjustment/Year 2 Earn-Out Calculation.
(1) In the event the EBITDA for the Year 2 Earn-Out Period
calculated pursuant to Section 3.3A(b) above (the "Year 2 EBITDA") is equal
to or less than the Year 2 Threshold, then the Year 2 Adjustment is the
amount equal to the sum of (i) the product of (x) six multiplied by the
difference between the Year 2 Threshold and the greater of (a) $11,000,000
or (b) the Year 2 EBITDA and (y) 0.125; plus (ii) the amount equal to the
product of (x) seven multiplied by the amount, if any, by which the Year 2
EBITDA is less than $10,000,000 and (y) 0.125; provided, however, that the
Year 2 Adjustment will be $0.00 if the Year 2 EBITDA is equal to or greater
than $10,000,000 but less than or equal to $11,000,000.
(2) In the event the Year 2 EBITDA is greater than the Year
2 Threshold, then the Year 2 Earn-Out is the amount equal to the product of
(i) six multiplied by the difference between the Year 2 EBITDA and the Year
2 Threshold and (ii) 0.125; provided, however, that the Year 2 Earn-Out
will be $0.00 if the Year 2 EBITDA is equal to or greater than $10,000,000
but less than or equal to $11,000,000.
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(e) Year 3 Adjustment/Year 3 Earn-Out Calculation.
(1) In the event the EBITDA for the Year 3 Earn-Out Period
calculated pursuant to Section 3.3A(b) above (the "Year 3 EBITDA") is equal
to or less than the Year 3 Threshold, then the Year 3 Adjustment is the
amount equal to the sum of (i) the product of (x) four multiplied by the
difference between Year 3 Threshold and the greater of (a) $11,000,000 or
(b) the Year 3 EBITDA and (y) 0.125, plus (ii) the amount equal to the
product of (x) seven multiplied by the amount, if any, by which the Year 3
EBITDA is less than $10,000,000 and (y) 0.125; provided, however, that the
Year 3 Adjustment will be $0.00 if the Year 3 EBITDA is equal to or greater
than $10,000,000 but less than or equal to $11,000,000.
(2) In the event the Year 3 EBITDA is greater than the Year
3 Threshold, then the Year 3 Earn-Out is the amount equal to the product of
(i) four multiplied by the difference between the Year 3 EBITDA and the
Year 3 Threshold and (ii) 0.125; provided, however, that the Year 3
Earn-Out will be $0.00 if the Year 3 EBITDA is equal to or greater than
$10,000,000 but less than or equal to $11,000,000.
Section 3.4A Payment of Adjustment and Earn-Out; Distribution of
Escrow. The Year 1 Adjustment or Year 1 Earn-Out, Year 2 Adjustment or Year
2 Earn-Out and Year 3 Adjustment or Year 3 Earn-Out, if any, shall be paid
within 5 Business Days of final determination of EBITDA for the applicable
Earn-Out Period pursuant to Section 3.3A(b) and shall be paid to the Buyer
or the Escrow Agent, as the case may be, in the following manner:
(a) Year 1 Adjustment/Year 1 Earn-Out.
(1) In the event the Year 1 Adjustment is calculated
pursuant to Section 3.3A(c)(1) above, then the Escrow Agent shall deliver
to Buyer from the Escrow Funds an amount equal to the Year 1 Adjustment,
together with the interest or earnings thereon as set forth in Section
3.4A(d).
(2) In the event the Year 1 Earn-Out is calculated pursuant
to Section 3.3A(c)(3) above, the Buyer shall pay to the Escrow Agent the
Year I Earn-Out in cash by wire transfer of immediately available funds,
which shall be held by the Escrow Agent as part of the Escrow Funds. Upon
receipt by the Escrow Agent of the Year 1 Earn-Out, the Escrow Agent shall
then deliver to AHG an amount equal to one-third of the principal of the
Escrow Funds, together with the interest or earnings thereon as set forth
in Section 3.4A(d).
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(b) Year 2 Adjustment/Year 2 Earn-Out.
(1) In the event the Year 2 Adjustment is calculated
pursuant to Section 3.3A(d)(1) above, then the Escrow Agent shall deliver
to the Buyer from the Escrow Funds an amount equal to the Year 2
Adjustment, together with the interest or earnings thereon as set forth in
Section 3.4A(d).
(2) In the event the Year 2 Earn-Out is calculated pursuant
to Section 3.3A(d)(2) above, then the Buyer shall pay to the Escrow Agent
the Year 2 Earn-Out in cash by wire transfer of immediately available
funds, which shall be held by the Escrow Agent as part of the Escrow Funds.
Upon receipt by the Escrow Agent of the Year 2 Earn-Out, the Escrow Agent
shall then deliver to AHG an amount equal to one-half of the principal of
the Escrow Funds, together with the interest or earnings thereon as set
forth in Section 3.4A(d).
(c) Year 3 Adjustment/Year 3 Earn-Out.
(1) In the event the Year 3 Adjustment is calculated
pursuant to Section 3.3A(e)(1) above, then the Escrow Agent shall deliver
to the Buyer from the Escrow Funds an amount equal to the Year 3
Adjustment, together with the interest or earnings thereon as set forth in
Section 3.4A(d). Any Escrow Funds remaining after distribution of the Year
3 Adjustment to the Buyer shall be disbursed to AHG, promptly after
disbursement of the Year 3 Adjustment, together with interest or earnings
thereon, to the Buyer.
(2) In the event the Year 3 Earn-Out is calculated pursuant
to Section 3.3A(e)(2) above, then the Buyer shall pay to AHG the Year 3
Earn-Out in cash by wire transfer of immediately available funds, and the
Escrow Agent shall transfer the Escrow Funds to AHG.
(d) Distributions of Interest or Earnings on the Escrow Funds.
Interest or other earnings on the Escrow Deposit and additional amounts
paid by the Buyer to the Escrow Agent pursuant to this Section 3.4A shall
be disbursed prorata to the recipient of principal held in the Escrow
Funds. For income tax purposes, it shall be assumed that AHG will be
entitled to receive all interest and other earnings on the principal
amounts held in the Escrow Fund and the Buyer and AHG agree to direct the
Escrow Agent pursuant to joint instructions to disburse to AHG an amount
from the Escrow Funds necessary for AHG or its assigns to pay their federal
income tax liability on said interest and earnings, assuming for purposes
hereof an effective tax rate of 31%. The amount of any previous
distributions for taxes made to AHG shall be taken into account in the
event that disbursements from the Escrow Funds are later made to the Buyer
and appropriate adjustments will be made in accordance with joint
instructions from the Buyer and AHG to the Escrow Agent.
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(e) Limitations on Distributions to AHG. Notwithstanding anything
to the contrary contained in Sections 3.3A and 3.4A, in no event shall
distributions to AHG pursuant to this Section 3.4A exceed $6,093,254 in the
aggregate (exclusive of interest or earnings thereon).
(f) Adjustments in Excess of Escrow Funds. In the event that the
Adjustment for any Earn-Out Period should exceed the amount of the
remaining Escrow Funds, the amount of such excess, shall be applied as a
credit in favor of the Buyer and shall be deducted from the amount
otherwise payable by the Buyer as the Year 2 Earn-Out and Year 3 Earn-Out,
as applicable.
2. Closing and Termination. The closing of the transactions contemplated by
this Amendment (the "Closing") shall take place no later than two (2) business
days after the fulfillment of all conditions precedent to Closing set forth in
Sections 3 and 4 to this Amendment, or such other date as the Buyer and AHG
shall mutually agree (the "Closing Date"). The Closing shall take place by the
delivery of documents by facsimile, overnight courier or other means on or
before the Closing Date. Notwithstanding the actual time of the Closing, the
parties hereto agree that the Closing shall be effective and deemed for all
purposes to have occurred as of 12:01 a.m. local time on October 1, 1998 (the
"Effective Date"). This Amendment may be terminated and the transactions
contemplated hereby may be abandoned at any time before the Closing:
2.1 By Consent. By the mutual written consent of all of the parties
hereto;
2.2 By the Buyer and the Parent. By the Buyer and the Parent, upon
written notice to the Sellers and the Executive Shareholders, if all the
conditions set forth in Section 4 of this Amendment shall not have been
satisfied or waived on or before November 30, 1998, unless such satisfaction has
been frustrated or made impossible by any act or failure to act of the Buyer or
the Parent; or
2.3 By the Sellers and the Executive Shareholders. By the Sellers and
the Executive Shareholders, upon written notice to the Buyer and the Parent, if
all of the conditions set forth in Section 3 of this Amendment shall not have
been satisfied or waived on or before November 30, 1998, unless satisfaction has
been frustrated or made impossible by any act or failure to act of any of the
Sellers or the Executive Shareholders.
3. Conditions Precedent to the Sellers' and the Executive Shareholders'
Obligations to Close. The obligations of the Seller and the Executive
Shareholders to consummate the transactions contemplated by this Amendment are
subject to the fulfillment, on or before the Closing Date, of the following
conditions, any one or more of which may be waived by the Sellers and the
Executive Shareholders hereto in their sole discretion.
3.1 Delivery of Buy-Out Price. The Buyer shall cause the Buyout Price
to be delivered by federal funds wire transfer to the Broad and Cassel Trust
Account, in accordance with wire transfer instructions furnished in writing by
AHG, for further credit to AHG in accordance with the agreement of the Sellers.
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3.2 Escrow Agreement. The Sellers and the Buyer shall deliver joint
written instructions to the Escrow Agent authorizing and directing the Escrow
Agent to disburse to the Buyer the Released Clawback and any interest or
earnings thereon. In addition, the Escrow Agreement shall be amended to reflect
that the Remaining Clawback and any interest or earnings thereon shall continue
to be held in escrow for the sole benefit of AHG (for further distribution to
GHS, Inc.) and the Buyer, and to reflect that all of the Sellers other than AHG
shall cease to be parties to the Escrow Agreement.
3.3 Management Agreement. The Management Agreement dated as of
December 5, 1997 by and among the Buyer, the Parent, RNSF Management, Inc., a
Florida corporation, and the Executive Shareholders shall be terminated.
3.4 Schimmel Employment Agreement. Schimmel and the Buyer shall enter
into an employment agreement (the "Schimmel Employment Agreement"), in form and
substance reasonably acceptable to the Buyer and Schimmel. The Schimmel
Employment Agreement will be for a term of two years commencing October 1, 1998
(each, an "Annual Period"). Schimmel will be entitled to an annual salary of
$50,000 during each Annual Period, during which time the Schimmel Employment
Agreement cannot be terminated by the Buyer without "cause", as defined therein.
If Schimmel terminates the Schimmel Employment Agreement on or before the end of
the first Annual Period or the second Annual Period other than for cause or
"good cause", as defined therein, he will be required to repay to the Buyer
$400,000 or $250,000, respectively, of his allocable portion of the Buyout
Price. Schimmel shall provide services to the Buyer on a part-time basis for up
to 20 hours per week in each Annual Period. The Schimmel Employment Agreement
will contain a reasonable non-compete provision.
3.5 Farrell Employment Agreement. Farrell and the Buyer shall enter into an
employment agreement, in form and substance reasonably acceptable to Farrell and
the Buyer (the "Farrell Employment Agreement"). The Farrell Employment Agreement
will be for a term of two Annual Periods. Farrell will be entitled to an annual
salary of $450,000 during the first two Annual Periods, during which time the
Farrell Employment Agreement cannot be terminated by the Buyer without "cause",
as defined therein. If Farrell terminates the Farrell Employment Agreement on or
before the end of the first Annual Period or the second Annual Period other than
for cause or "good cause", as defined therein, he will be required to repay to
the Buyer $500,000 or $300,000, respectively, of his allocable portion of the
Buyout Price. The Farrell Employment Agreement will automatically renew for a
third year (the "Renewal Period"), with an annual salary of $450,000, if the
Buyer has a "run rate" resulting from new business (and additional services
under existing contracts) commencing between October 1, 1998 and October 1,
2000, inclusive, and for which no notice of cancellation or non-renewal has been
given on or before October 1, 2000, but excluding (i) renewals (including
amendments, restatements or replacements) of contracts in force as of October 1,
1998 and (ii) contracts which will expire by their terms absent notice of intent
to renew on or before October 1, 2000 (and with respect to which no notice of
intent to renew has been given) (the "Two Year New Business"), of $15,000,000 or
more projected for the fiscal year ending September 30, 2001. The "run rate" is
to be computed by projecting, on or about October 1, 2000, EBITDA of the Buyer
resulting from the Two Year New Business for the fiscal year ending September
30, 2001. The "run rate" will
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be determined by the Buyer in good faith and consistent with the methodology
used for computing the EBITDA Run Rate. There will be a provision for resolving
disputes as to the computation of the "run rate", consistent with the provisions
of Section 3.3(c) of the Asset Purchase Agreement, as amended by this Amendment.
If the Buyer does not achieve the requisite "run rate", then the Buyer will have
the option of renewing the Farrell Employment Agreement for the Renewal Period,
at an annual salary to be determined by Farrell and the Buyer in good faith. The
Farrell Employment Agreement will contain a reasonable non-compete provision.
3.6 Jones Release. J.R. Jones, M.D. shall execute and deliver a
release in favor of AHG and the Executive Shareholders, in form and substance
reasonably acceptable to AHG, releasing any and all claims under the Bonus
Agreement, dated December 1, 1997, by and between AHG and Jones (the "Bonus
Agreement"), in exchange for receipt at Closing of a portion AHG's Applicable
Percentage of the Buyout Price.
3.7 Kanter and Young Releases. Steven Kanter, M.D. and Andrea Kanter
(collectively, the "Kanters") and Jerrold Young, M.D. and Jo-Ann Young
(collectively, the "Youngs") each shall execute and deliver a release in favor
of Schimmel, in form and substance reasonably acceptable to Schimmel,
acknowledging the release to the Buyer of the Released Clawback and releasing
and any all claims to payment of a portion of the Released Clawback under the
Purchase and Indemnification Agreement, dated December 5, 1997, by and among the
Kanters, the Youngs and Schimmel (the "Purchase and Indemnification Agreement").
3.8 Farrell Buy-Out Agreement. In consideration for the receipt of an
allocable portion of the Buyout Price, the Buy-Out Agreement, dated December 1,
1997, by and among FSN, Morgan Chase Company, Stephen Wulf and Farrell
(collectively, the "Farrell Parties"), AHG and FSN (the "Farrell Buy-Out
Agreement") shall be amended (a) to terminate all rights of the Farrell Parties
to receive a portion of the Escrow Funds and (b) to provide for payment of the
Year 3 Run Rate Earn-Out and of the Year 2 Earn-Out and the Year 3 Earn-Out (as
determined pursuant to Section 1.2(a) of this Amendment) in lieu of the Earn-Out
Payments (as such term is defined in the Farrell Buy-Out Agreement).
3.9 Authorization of the Sellers. Execution, delivery and performance
of this Amendment, and all other agreements entered into in connection with the
transactions contemplated hereby, shall have been authorized by all necessary
action on the part of each of the Sellers.
4. Conditions Precedent to the Buyer's and the Parent's Obligations to
Close. The obligations of the Buyer and the Parent to consummate the
transactions contemplated by this Amendment are subject to the fulfillment, on
or before the Closing Date, of the following conditions, any one or more of
which may be waived by the Buyer and the Parent hereto in their sole discretion:
4.1 Escrow Agreement. The Sellers and the Buyer shall deliver joint
written instructions to the Escrow Agent authorizing and directing the Escrow
Agent to disburse to the Buyer the Released Clawback and any interest or
earnings thereon. In addition, the Escrow Agreement shall be amended to reflect
that the Remaining Clawback and any interest or earnings
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thereon shall continue to be held in escrow for the sole benefit of AHG (for
further distribution to GHS, Inc.) and the Buyer, and to reflect that all of the
Sellers other than AHG shall cease to be parties to the Escrow Agreement.
4.2 Management Agreement. The Management Agreement dated as of
December 5, 1997 by and among the Buyer, the Parent, RNSF Management, Inc., a
Florida corporation, and the Executive Shareholders shall be terminated.
4.3 Schimmel Employment Agreement. Schimmel and the Buyer shall enter
into the Schimmel Employment Agreement on the terms and conditions set forth in
Section 3.4 of this Amendment.
4.4 Farrell Employment Agreement. Farrell and the Buyer shall enter
into the Farrell Employment Agreement on the terms and conditions set forth in
Section 3.5 of this Amendment.
4.5 Farrell Buy-Out Agreement. The Farrell Buy-Out Agreement shall be
amended as set forth in Section 3.8 of this Amendment.
4.6 Authorization. Each of the Sellers shall deliver an officer's
certificate dated as of the Closing Date and certifying that execution, delivery
and performance of this Amendment, and all other agreements entered into in
connection with the transactions contemplated hereby, have been authorized by
all necessary action on the part of each Seller.
5. Representations and Warranties.
5.1 Representations and Warranties of the Buyer and the Parent. In
order to induce the Seller and the Executive Shareholders to enter into this
Amendment, and to consummate the transactions contemplated hereby, the Buyer and
the Parent, on a joint and several basis, represent and warrant as follows:
(a) Corporate Status. The Buyer and the Parent are corporations
duly organized and validly existing under the laws of the State of Florida and
Delaware, respectively. The Buyer's status is active under the laws of the State
of Florida and the Parent is in good standing under the laws of the State of
Delaware. The Buyer and the Parent have all requisite corporate power and
authority to own their respective properties and assets and to carry on their
respective businesses as they are presently being conducted.
(b) Power and Authority. The Buyer and the Parent have the full
right, power and authority to enter into, and to perform their respective
obligations under, this Amendment.
(c) Binding Agreement. The execution and delivery by the Buyer
and the Parent of this Amendment and the performance of their respective
obligations hereunder have been duly authorized by all necessary corporate
action and no other proceedings on the part of the Buyer or the Parent are
necessary to authorize the execution of this Amendment and the performance of
transactions contemplated hereby. This Amendment has been duly and validly
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executed and delivered by the Buyer and the Parent and constitutes the legal,
valid and binding obligation of the Buyer and of the Parent enforceable against
the Buyer and the Parent in accordance with its terms, except as enforcement may
be limited by bankruptcy, insolvency, moratorium or other laws affecting
creditors' rights generally, or equitable principles, whether applied in a
proceeding in equity or law.
(d) Absence of Conflicting Agreements. Neither the execution or
delivery of this Amendment by the Buyer and the Parent, nor the performance by
the Buyer and the Parent of the transactions contemplated hereby, conflicts
with, or constitutes a breach of or a default under (a) the respective Articles
of Incorporation or Bylaws of the Buyer and the Parent (b) any applicable law,
or any applicable rule, judgment, order, writ, injunction or decree of any
court, (c) any applicable rule or regulation of any administrative agency or
other governmental authority, or (d) any agreement, lease, indenture, instrument
or contract to which the Buyer or the Parent is now a party or by which the
Buyer or the Parent or any of their respective properties or assets are bound,
which breach or default would have a material adverse effect on the business or
operations of the Buyer or the Parent.
5.2 Representations and Warranties of the Sellers and of the Executive
Shareholders. In order to induce the Buyer and the Parent to enter into this
Amendment, and to consummate the transactions contemplated hereby, each of the
Sellers and of the Executive Shareholders, on a joint and several basis,
represent and warrant as follows; provided, however, that the representations
and the warranties of each Executive Shareholder are made only as to himself and
to each Seller in which such Executive Shareholder owns any shares or
partnership interests, as the case may be:
(a) Corporate and Partnership Status. Each Seller (other than
FSN) is a corporation duly organized and validly existing under the laws of the
State of Florida and its status is active. FSN is a limited partnership duly
organized and validly existing under the laws of the State of Florida and its
status is active. Each Seller has all requisite corporate or partnership power
and authority to own its property and assets and to carry on its business as it
is presently being conducted.
(b) Power and Authority. On or before the Closing Date, each
Seller will have the full right, power and authority to enter into, and to
perform its obligations under, this Amendment and the consent of no other party
will be necessary or required in order to permit or allow each such Seller to
enter into and perform its obligations hereunder. Other than as provided in the
Farrell Buy-Out Agreement, the Bonus Agreement, the Letter Agreement and the
Purchase and Indemnification Agreement, no Seller has assigned or will have
assigned on or before the Closing Date any rights to any portion of the Clawback
or the Earn-Out under the Asset Purchase Agreement.
(c) Binding Agreement. On or before the Closing Date, the
execution and delivery by each Seller of this Amendment and the performance of
its obligations hereunder will have been duly authorized by all necessary
corporate or partnership action, as applicable, and no other proceedings on the
part of such Seller will be necessary to authorize the execution of this
Amendment and the performance of transactions contemplated hereby. On or before
the Closing Date, this Amendment will have been duly and validly executed and
delivered by each
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Seller and will constitute the legal, valid and binding obligation of such
Seller enforceable against such Seller in accordance with its terms, except as
enforcement may be limited by bankruptcy, insolvency, moratorium or other laws
affecting creditors' rights generally, or equitable principles, whether applied
in a proceeding in equity or law. This Amendment has been duly and validly
executed and delivered by each Executive Shareholder and constitutes the legal,
valid and binding obligation of such Executive Shareholder enforceable against
such Executive Shareholder in accordance with its terms, except as enforcement
may be limited by bankruptcy, insolvency, moratorium or other laws affecting
creditors' rights generally, or equitable principles, whether applied in a
proceeding in equity or law.
(d) Absence of Conflicting Amendments. Neither the execution or
delivery of this Amendment by each Seller and each Executive Shareholder, nor
the performance by each Seller and each Executive Shareholder of the
transactions contemplated hereby, conflicts with, or constitutes a breach of or
a default under (a) the Articles of Incorporation or Bylaws (or, in the case of
FSN, the Certificate of Limited Partnership or the FSN Limited Partnership
Agreement) of such Seller, (b) any applicable law, or any applicable rule,
judgment, order, writ, injunction or decree of any court, (c) any applicable
rule or regulation of any administrative agency or other governmental authority,
or (d) any agreement, lease, indenture, instrument or contract to which such
Seller or Executive Shareholder is now a party or by which such Seller or
Executive Shareholder or any of their respective properties or assets are bound,
which breach or default would have a material adverse effect on the business or
operations of such Seller or the assets of such Executive Shareholder.
6. Ratification. Except as modified by this Amendment, the Asset Purchase
Amendment is and shall continue to be in full force and effect and is hereby in
all respects confirmed, approved and ratified.
7. Miscellaneous.
7.1 Further Assurances. At any time, and from time to time, each party
will execute such additional instruments and take such action as may be
reasonably requested by the other party to confirm or perfect title to any
property transferred hereunder or otherwise to carry out the intent and purposes
of this Amendment.
7.2 Costs and Expenses. Each party hereto agrees to pay its own costs
and expenses incurred in negotiating this Amendment and consummating the
transactions described herein.
7.3 Time. Time is of the essence.
7.4 Entire Amendment. This Amendment and the transactions contemplated
hereby constitute the entire Amendment among the parties hereto with respect to
the subject matter hereof, and supersede all prior negotiations, letters and
understandings relating to the subject matter hereof.
22
<PAGE>
7.5 Amendment. This Amendment may not be amended, supplemented or
modified in whole or in part except by an instrument in writing signed by the
party or parties against whom enforcement of any such amendment, supplement or
modification is sought.
7.6 Assignment. Except as otherwise provided in Section 12.1 the Asset
Purchase Agreement, this Amendment may not be assigned by any party hereto
without the prior written consent of the other parties.
7.7 Choice of Law. This Amendment will be interpreted, construed and
enforced in accordance with the laws of the State of Florida.
7.8 Headings. The section and subsection headings in this Amendment
are inserted for convenience only and shall not affect in any way the meaning or
interpretation of this Amendment.
7.9 Pronouns. All pronouns and any variations thereof shall be deemed
to refer to the masculine, feminine, neuter, singular or plural as the context
may require.
7.10 Number and Gender. Words used in this Amendment, regardless of
the number and gender specifically used, shall be deemed and construed to
include any other number, singular or plural, and any other gender, masculine,
feminine or neuter, as the context indicates is appropriate.
7.11 Construction. The parties hereto and their respective legal
counsel participated in the preparation of this Amendment; therefore, this
Amendment shall be construed neither against nor in favor of any of the parties
hereto, but rather in accordance with the fair meaning thereof.
7.12 Effect of Waiver. The failure of any party at any time or times
to require performance of any provision of this Amendment will in no manner
affect the right to enforce the same. The waiver by any party of any breach of
any provision of this Amendment will not be construed to be a waiver by any such
party of any succeeding breach of that provision or a waiver by such party of
any breach of any other provision.
7.13 Severability. The invalidity, illegality or unenforceability of
any provision or provisions of this Amendment will not affect any other
provision of this Amendment, which will remain in full force and effect, nor
will the invalidity, illegality or unenforceability of a portion of any
provision of this Amendment affect the balance of such provision. In the event
that any one or more of the provisions contained in this Amendment or any
portion thereof shall for any reason be held to be invalid, illegal or
unenforceable in any respect, this Amendment shall be reformed, construed and
enforced as if such invalid, illegal or unenforceable provision had never been
contained herein.
7.14 Binding Nature. This Amendment will be binding upon and will
inure to the benefit of any successor or successors of the parties hereto.
23
<PAGE>
7.15 No Third-Party Beneficiaries. Notwithstanding anything in this
Amendment to the contrary, no person (including, without limitation, GHS, Inc.)
shall be deemed to possess any third-party beneficiary right pursuant to this
Amendment. It is the intent of the parties hereto that no direct benefit to any
third party is intended or implied by the execution of this Amendment.
7.16 Counterparts. This Amendment may be executed in one or more
counterparts, each of which will be deemed an original and all of which together
will constitute one and the same instrument.
[SIGNATURES BEGIN ON THE FOLLOWING PAGE]
24
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as
of the date first above written.
ALLIED SPECIALTY CARE SERVICES, INC.
By:
----------------------------------
Name:
--------------------------------
Title:
-------------------------------
ALLIED HEALTH GROUP, INC.
By:
----------------------------------
Lawrence Schimmel, M.D., President
GUT MANAGEMENT, INC.
By:
----------------------------------
Jacob Nudel, M.D., President
SKY MANAGEMENT CO.
By:
----------------------------------
Lawrence Schimmel, M.D., President
FLORIDA SPECIALTY NETWORK, LTD.
By:Florida Specialty Network, Inc., General Partner
By:
----------------------------------
Lawrence Schimmel, M.D., President
25
<PAGE>
SURGICAL ASSOCIATES OF SOUTH FLORIDA, INC.
By:
----------------------------------
David Russin, M.D., President
SURGINET, INC.
By:
----------------------------------
Lawrence Schimmel, M.D., President
--------------------------------------
JACOB NUDEL, M.D.
--------------------------------------
DAVID RUSSIN, M.D.
--------------------------------------
LAWRENCE SCHIMMEL, M.D.
MAGELLAN HEALTH SERVICES, INC.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
26
<PAGE>
Exhibit 3(b)
BYLAWS
OF
MAGELLAN HEALTH SERVICES, INC.
<PAGE>
BYLAWS
OF
MAGELLAN HEALTH SERVICES, INC.
<TABLE>
<S> <C>
ARTICLE I. OFFICES..............................................................- 1 -
Section 1. Registered Office....................................................- 1 -
Section 2. Other Offices........................................................- 1 -
ARTICLE II. MEETINGS OF STOCKHOLDERS............................................- 1 -
Section 1. Place of Meetings....................................................- 1 -
Section 2. Date of Meetings.....................................................- 1 -
Section 3. Notice of Meetings...................................................- 1 -
Section 4. List of Stockholders.................................................- 1 -
Section 5. Special Meetings.....................................................- 2 -
Section 6. Notice of Special Meetings...........................................- 2 -
Section 7. Limitations on Special Meetings......................................- 2 -
Section 8. Quorum and Adjournment...............................................- 2 -
Section 9. Stockholder Action...................................................- 2 -
Section 10. Voting Rights.......................................................- 2 -
Section 11. Proxies and Voting Rights...........................................- 3 -
Section 12. Action by Consent...................................................- 3 -
Section 13. Inspector of Elections..............................................- 3 -
Section 14. Presiding Officer...................................................- 3 -
ARTICLE III. DIRECTORS..........................................................- 3 -
Section 1. Number, Election and Term of Office..................................- 3 -
Section 2. Vacancies............................................................- 4 -
Section 3. Removal..............................................................- 4 -
Section 4. Powers of Directors..................................................- 4 -
Section 5. Place of Meetings....................................................- 4 -
Section 6. Time of Meetings.....................................................- 4 -
Section 7. Regular Meetings.....................................................- 4 -
Section 8. Special Meetings.....................................................- 4 -
Section 9. Quorum...............................................................- 5 -
Section 10. Action by Consent...................................................- 5 -
Section 11. Telephone Conference Call...........................................- 5 -
Section 12. Executive and Other Committees......................................- 5 -
Section 13 . Minutes of Committee Meetings......................................- 6 -
Section 14. Compensation........................................................- 6 -
</TABLE>
i
<PAGE>
<TABLE>
<S> <C>
ARTICLE IV. NOTICES.............................................................- 6 -
Section 1. Procedure............................................................- 6 -
Section 2. Waiver and Consent...................................................- 6 -
ARTICLE V. OFFICERS.............................................................- 6 -
Section 1. General..............................................................- 6 -
Section 2. Election of Officers.................................................- 7 -
Section 3. Additional Officers..................................................- 7 -
Section 4. Compensation.........................................................- 7 -
Section 5. Tenure...............................................................- 7 -
Section 6. President - Powers and Duties........................................- 7 -
Section 7. President - Execution of Documents...................................- 7 -
Section 8. Vice Presidents - Powers and Duties..................................- 7 -
Section 9. Secretary - Powers and Duties........................................- 7 -
Section 10. Assistant Secretary.................................................- 8 -
Section 11. Treasurer - Powers and Duties.......................................- 8 -
Section 12. Treasurer - Disbursements and Accounting............................- 8 -
Section 13. Assistant Treasurer.................................................- 8 -
Section 14. Bonds...............................................................- 8 -
ARTICLE VI. CERTIFICATES FOR SHARES OF STOCK....................................- 8 -
Section 1. Rights to Certificate................................................- 8 -
Section 2. Classes of Stock - Rights............................................- 9 -
Section 3. Officers' Signatures.................................................- 9 -
Section 4. Lost Certificates....................................................- 9 -
Section 5. Transfers of Stock...................................................- 9 -
Section 6. Fixing of Record Date................................................- 9 -
Section 7. Registered Stockholders.............................................- 10 -
ARTICLE VII. INDEMNIFICATION....................................................- 10 -
Section 1. Actions Not By or In the Right of the Corporation...................- 10 -
Section 2. Actions By or In the Right of the Corporation.......................- 10 -
Section 3. Indemnification Where Director or Officer Successfully
Defends Action.....................................................- 11 -
Section 4. Determinations Required Prior to Indemnification....................- 11 -
Section 5. Advances............................................................- 11 -
Section 6. General.............................................................- 11 -
Section 7. Insurance...........................................................- 11 -
Section 8. The Corporation.....................................................- 11 -
Section 9. Employee Benefit Plans..............................................- 12 -
Section 10. Continuation.......................................................- 12 -
Section 11. Future Amendments..................................................- 12 -
ARTICLE VIII. GENERAL PROVISIONS...............................................- 12 -
Section 1. Dividends...........................................................- 12 -
Section 2. Reserves............................................................- 13 -
Section 3. Annual Statement....................................................- 13 -
</TABLE>
ii
<PAGE>
<TABLE>
<S> <C>
Section 4. Checks..............................................................- 13 -
Section 5. Fiscal Year.........................................................- 13 -
Section 6. Seal................................................................- 13 -
Section 7. Miscellaneous.......................................................- 13 -
ARTICLE IX. AMENDMENTS.........................................................- 13 -
</TABLE>
iii
<PAGE>
iv
<PAGE>
v
<PAGE>
BYLAWS
OF
MAGELLAN HEALTH SERVICES, INC.
ARTICLE I.
OFFICES
Section 1. Registered Office. The registered office shall be in the
City of Wilmington, County of New Castle, State of Delaware.
Section 2. Other Offices. The corporation may also have offices at such
other places both within and without the State of Delaware as the board of
directors may from time to time determine or the business of the corporation may
require.
ARTICLE II.
MEETINGS OF STOCKHOLDERS
Section 1. Place of Meetings. All meetings of the stockholders for the
election of directors shall be held in the City of Atlanta, State of Georgia, at
such place as may be fixed from time to time by the Board of Directors, or at
such other place either within or without the State of Delaware as shall be
designated from time to time by the Board of Directors and stated in the notice
of the meeting. Meetings of stockholders for any other purpose may be held at
such time and place, within or without the State of Delaware, as shall be stated
in the notice of the meeting or in a duly executed waiver of notice thereof.
Section 2. Date of Meetings. Annual meetings of stockholders shall be
held on a date and at a time as shall be designated from time to time by the
Board of Directors and stated in the notice of the meeting, at which the
stockholders shall elect members of the Board of Directors and transact such
other business as may properly be brought before the meeting. Election of
directors need not be by written ballot.
Section 3. Notice of Meetings. Written notice of the annual meeting
stating the place, date and hour of the meeting shall be given to each
stockholder entitled to vote at such meeting not less than ten nor more than
sixty days before the date of the meeting.
Section 4. List of Stockholders. The officer who has charge of the
stock ledger of the corporation shall prepare and make, or cause to be prepared
and made, at least ten days before every meeting of stockholders, a complete
list of the stockholders entitled to vote at the meeting, arranged in
alphabetical order, and showing the address of each stockholder and the number
of shares registered in the name of each stockholder. Such list shall be open to
the examination of any stockholder, for any purpose germane to the meeting,
during ordinary business hours, for a period
<PAGE>
of at least ten days prior to the meeting, either at a place within the city
where the meeting is to be held, which place shall be specified in the notice of
the meeting, or, if not so specified, at the place where the meeting is to be
held. The list shall also be produced and kept at the time and place of the
meeting during the whole time thereof, and may be inspected by any stockholder
who is present.
Section 5. Special Meetings. Special meetings of the stockholders, for
any purpose or purposes, unless otherwise prescribed by statute or by the
certificate of incorporation, may be called only by the affirmative vote of a
majority of the Board of Directors.
Section 6. Notice of Special Meetings. Written notice of a special
meeting stating the place, date and hour of the meeting and the purpose or
purposes for which the meeting is called, shall be given not less than ten nor
more than sixty days before the date of the meeting, to each stockholder
entitled to vote at such meeting.
Section 7. Limitations on Special Meetings. Business transacted at any
special meeting of stockholders shall be limited to the purposes stated in the
notice.
Section 8. Quorum and Adjournment. The holders of a majority of the
shares of all classes of stock issued and outstanding and entitled to vote
thereat, present in person or represented by proxy, shall constitute a quorum at
all meetings of the stockholders for the transaction of business, except as
otherwise provided by statute or by the certificate of incorporation. If,
however, such quorum shall not be present or represented at any meeting of the
stockholders, the stockholders entitled to vote thereat, present in person or
represented by proxy, shall have power to adjourn the meeting from time to time,
without notice other than announcement at the meeting, until a quorum shall be
present or represented. At such adjourned meeting at which a quorum shall be
present or represented any business may be transacted which might have been
transacted at the meeting as originally notified. If the adjournment is for more
than thirty days, or if after the adjournment a new record date is fixed for the
adjourned meeting, a notice of the adjourned meeting shall be given to each
stockholder of record entitled to vote at the meeting.
Section 9. Stockholder Action. Except as provided in Section 3 of
Article III of these Bylaws, or unless the question is one upon which, by
express provision of statute or the certificate of incorporation, a different
vote is required, in which case such express provision shall govern and control
the decision of such question: (1) in all matters other than the election of
directors, the affirmative vote of the majority of shares present in person or
represented by proxy at the meeting and entitled to vote on the subject matter
shall be the act of the stockholders; (2) directors shall be elected by a
plurality of the votes of the shares present in person or represented by proxy
at the meeting and entitled to vote on the election of directors; and (3) in
voting on such questions, every stockholder of record who is entitled to vote
shall be entitled to one vote for each share of stock held by him on the record
date for such meeting.
Section 10. Voting Rights. Except as otherwise provided by law or by
the certificate of incorporation, the holders of shares of all classes of stock
shall have the right to vote, in person or by proxy, together on all matters to
come before a meeting of the stockholders.
2
<PAGE>
Section 11. Proxies and Voting Rights. No proxy shall be voted on after
three years from its date, unless the proxy provides for a longer period. A duly
executed proxy shall be irrevocable if it states that it is irrevocable and if,
and only as long as, it is coupled with an interest sufficient in law to support
an irrevocable power. A proxy may be made irrevocable regardless of whether the
interest with which it is coupled is an interest in the stock itself or an
interest in the corporation generally. In the event that any proxy shall
designate two or more persons to act as proxies, a majority of such persons
present at the meeting, or if only one be present that one, shall have all of
the powers conferred by the proxy upon all of the persons so designated unless
the proxy shall otherwise provide.
Section 12. Action by Consent. The stockholders may not take any
actions required to be taken at an annual or special meeting of the
stockholders, or any actions which may be taken at an annual meeting or special
meeting of the stockholders, by written consent in lieu of a meeting.
Section 13. Inspector of Elections. The Board of Directors, in advance
of any meeting of the stockholders of the Corporation, shall appoint one or more
inspectors of elections to act at such meeting, and any adjournment thereof. In
case any person who has been designated as an inspector of elections fails to
appear or act, the vacancy may be filled by an alternate appointed by the Board,
in advance of the meeting, or at the meeting by the person presiding thereat. An
inspector, before entering upon discharge of his duties, shall take and sign an
oath faithfully to execute the duties of inspector with strict impartiality and
according to the best of his ability. The inspector or inspectors so appointed
shall perform the duties required by Section 231 of the Delaware General
Corporation Law.
Section 14. Presiding Officer. The Chairman of the Board of Directors,
or in his absence the President, shall serve as Chairman of every stockholders'
meeting unless some other person is elected to serve as Chairman by a majority
vote of the voting power of the shares represented at the meeting. The Chairman
shall appoint the Secretary of the corporation, or in his absence an Assistant
Secretary, as Secretary of every stockholders' meeting and such other persons as
he deems required to assist with the meeting.
ARTICLE III.
DIRECTORS
Section 1. Number, Election and Term of Office. The number of directors
which shall constitute the whole Board shall be eight. A change in the number of
directors shall only occur by an affirmative vote of at least seventy-five
percent (75%) of the issued and outstanding shares of the corporation entitled
to vote thereon cast at a meeting of the stockholders called for such purpose.
The Board of Directors shall be divided into three classes, as nearly equal in
numbers as the then total number of directors constituting the whole Board
permits, with the term of office of one class expiring each year. The directors
shall be elected at the annual meeting of the stockholders, except as provided
in Sections 2 and 3 of this Article, and each director elected shall hold office
until his successor is elected and qualifies. Directors need not be stockholders
or a resident of the State of Delaware.
3
<PAGE>
Section 2. Vacancies. Any vacancies in the Board of Directors for any
reason, and any newly created directorships resulting from any increase in the
authorized number of directors, may be filled by a majority of the directors
then in office, though less than a quorum, or by a sole remaining director, and
the directors so chosen shall hold office until the next election of the
respective class or classes for which such directors shall have been chosen and
until their successors are duly elected and shall qualify, unless sooner
displaced. If there are no directors in office, then an election of directors
may be held in the manner provided by statute.
Section 3. Removal. Notwithstanding any other provision of these Bylaws
(and notwithstanding the fact that some lesser percentage may be specified by
law), any director or the entire Board of Directors of the corporation may be
removed from office at any time, but only (i) for cause by the affirmative vote
of the holders of a majority of the issued and outstanding shares of the capital
stock of the corporation entitled to vote thereon cast at a meeting of the
stockholders called for that purpose, or (ii) without cause by the affirmative
vote of the holders of at least seventy-five percent (75%) of the issued and
outstanding shares of capital stock of the corporation entitled to vote thereon
cast at a meeting of the stockholders called for that purpose.
Section 4. Powers of Directors. The business of the corporation shall
be managed by its Board of Directors which may exercise all such powers of the
corporation and do all such lawful acts and things as are not by statute or by
the certificate of incorporation or by these Bylaws directed or required to be
exercised or done by the stockholders.
Section 5. Place of Meetings. The Board of Directors of the corporation
may hold meetings, both regular and special, either within or without the State
of Delaware. The Board of Directors shall appoint from its members a Chairman of
the Board of Directors who shall preside at all meetings of the stockholders and
the Board of Directors. In the absence of the Chairman of the Board of Directors
from a meeting of the Board of Directors, the Board of Directors shall appoint
from its members, by a majority vote of all directors constituting a quorum,
another director who shall preside at such meeting. The Chairman of the Board of
Directors may but need not be an officer of or employed in an executive or any
other capacity by the corporation.
Section 6. Time of Meetings. A meeting of the Board of Directors shall
be held immediately following the annual meeting of stockholders at the same
place as such annual meeting or, in the alternative, at such time and place as
shall be fixed by the vote of the stockholders at the annual meeting. No notice
of such meeting shall be necessary, provided a quorum shall be present. In the
event such meeting is not held at the time and place determined under the
preceding sentence, the meeting may be held at such time and place as shall be
specified in a notice given as hereinafter provided for special meetings of the
Board of Directors, or as shall be specified in a written waiver signed by all
of the directors.
Section 7. Regular Meetings. Regular meetings of the Board of Directors
may be held without notice at such time and at such place as shall from time to
time be determined by the Board of Directors.
Section 8. Special Meetings. Special meetings of the Board of Directors
may be called by the Chairman of the Board of Directors, the President, or a
majority of the directors then in office
4
<PAGE>
(a) by written notice mailed to each director first class postage prepaid, not
later than the fifth day before the meeting, or (b) by either written or oral
notice given personally or by telephone or other means of electronic
communication, in which case the meeting may be held as soon after such notice
is given as a quorum shall be assembled at the place of the meeting or by
telephone conference call, unless another time shall be specified in the notice.
Section 9. Quorum. At all meetings of the Board of Directors, a
majority of the directors then in office shall constitute a quorum for the
transaction of business and the act of a majority of the directors present at
any meeting at which there is a quorum shall be the act of the Board of
Directors, except as may be otherwise specifically provided by statute, by the
certificate of incorporation or by these Bylaws. If a quorum shall not be
present at any meeting of the Board of Directors, the directors present thereat
may adjourn the meeting from time to time, without notice other than
announcement at the meeting, until a quorum shall be present.
Section 10. Action by Consent. Unless otherwise restricted by the
certificate of incorporation or these Bylaws, any action required or permitted
to be taken at any meeting of the Board of Directors or of any committee thereof
may be taken without a meeting, if all members of the Board or committee, as the
case may be, consent thereto in writing, and the writing or writings are filed
with the minutes of proceedings of the Board or committee.
Section 11. Telephone Conference Call. Unless otherwise restricted by
the Certificate of Incorporation or these Bylaws, members of the board of
directors, or any committee designated by the board of directors, may
participate in a meeting of the board of directors, or any committee, by means
of conference telephone or similar communications equipment by means of which
all persons participating in the meeting can hear each other, and such
participation in a meeting shall constitute presence in person at the meeting.
Section 12. Executive and Other Committees. The Board of Directors may,
by resolution adopted by a majority of the whole Board of Directors, appoint
three or more of its members to constitute an Executive Committee which to the
extent provided by the Board of Directors shall have and exercise all of the
authority of the Board of Directors, except as otherwise provided by law, in the
management of the business and affairs of the corporation, and may authorize the
seal of the corporation to be affixed to all papers which may require it. All
action taken by the Executive Committee shall be reported to the Board of
Directors at its first meeting thereafter. The Board of Directors may also from
time to time by resolution passed by a majority of the whole Board appoint other
committees, consisting of one or more members, from among its members; and such
committee or committees shall have such powers and duties as the Board of
Directors may from time to time prescribe. Unless otherwise provided by the
Board of Directors, a majority of the members of any committee appointed by the
Board of Directors pursuant to this Section 12 shall constitute a quorum at any
meeting thereof and the act of a majority of the members present at a meeting at
which a quorum is present shall be the act of such committee. Action may be
taken by any such committee without a meeting by a writing as provided in
Section 10 of this Article III. Any such committee shall, subject to any rules
prescribed by the Board of Directors, prescribe its own rules for calling,
giving notice of and holding meetings and its method of procedure at such
meetings and shall keep a written record of all action taken by it.
5
<PAGE>
Section 13. Minutes of Committee Meetings. Each committee shall keep
regular minutes of its meetings and periodically report the same to the Board of
Directors.
Section 14. Compensation. The directors may be paid their expenses, if
any, of attendance at each meeting of the Board of Directors and may be paid a
fixed sum for attendance at each meeting of the Board of Directors or a stated
salary as director or a combination thereof. No such payment shall preclude any
director from serving the corporation in any other capacity and receiving
compensation therefor. Members of special or standing committees may be allowed
like compensation for attending committee meetings.
ARTICLE IV.
NOTICES
Section 1. Procedure. Whenever, under the provisions of the statutes or
of the certificate of incorporation or of these Bylaws, notice is required to be
given to any director or stockholder, it shall not be construed to mean personal
notice, but such notice may be given in writing, by mail, addressed to such
director or stockholder, at his address as it appears on the records of the
corporation, with postage thereon prepaid, and such notice shall be deemed to be
given at the time when the same shall be deposited in the United States mail.
Notice to directors may also be given as provided in Section 8 of Article III.
Section 2. Waiver and Consent. Whenever any notice is required to be
given under the provisions of the statutes or of the certificate of
incorporation or of these Bylaws, a waiver thereof in writing, signed by the
person or persons entitled to said notice, whether before or after the time
stated therein, shall be deemed equivalent thereto. Notice of all stockholders'
meetings, whether annual or special, shall be given in writing and may be given
by the Chairman of the Board of Directors or the Secretary (or in case of their
refusal, by the person or persons entitled to call meetings under the provisions
of these Bylaws). The notice shall state the general nature of the business to
be transacted at the meeting and the place, day and hour thereof. If such notice
is mailed or telegraphed, it shall be deemed to have been given when deposited
in the United States mail or with a telegraph office for transmission, as the
case may be. If any meeting is adjourned to another time or place, no notice as
to such adjourned meeting or of the business to be transacted thereat need be
given other than by announcement at the meeting at which such adjournment is
given, except as otherwise expressly provided in Section 8 of Article II.
ARTICLE V.
OFFICERS
Section 1. General. The officers of the corporation shall be chosen by
the Board of Directors and shall be a President, a Vice President, a Secretary
and a Treasurer. The Board of Directors may also choose additional Vice
Presidents, and one or more Assistant Secretaries and Assistant Treasurers.
6
<PAGE>
Section 2. Election of Officers. The Board of Directors at its first
meeting after each annual meeting of stockholders shall choose a President, one
or more Vice Presidents, a Secretary and a Treasurer, or shall continue the
incumbents in office.
Section 3. Additional Officers. The Board of Directors may appoint such
other officers and agents as it shall deem necessary who shall hold their
offices for such terms and shall exercise such powers and perform such duties as
shall be determined from time to time by the Board of Directors.
Section 4. Compensation. The salaries of all officers and agents of the
corporation shall be fixed by the Board of Directors or by a duly authorized
committee.
Section 5. Tenure. Each officer of the Corporation shall hold office
until the earliest to occur of (a) his successor is elected and qualifies, (b)
death or retirement of such officer, (c) resignation of such officer or (d)
removal of such officer in the manner provided by these bylaws. Any officer
elected or appointed by the Board of Directors may be removed at any time by the
affirmative vote of a majority of the Board of Directors or, in the case of all
officers except the President, by the President. Any vacancy occurring in any
office of the Corporation and all newly created officer positions shall be
filled by the Board of Directors.
Section 6. President - Powers and Duties. The President shall be and
perform the duties and responsibilities of the Chief Executive Officer of the
corporation and as such shall have general supervision and control over all the
affairs of the corporation, its officers and employees. The President may, but
need not, be designated the Chief Operating Officer of the corporation. The
President shall report to the Board of Directors regarding the affairs of the
corporation and shall have such other duties and powers as may be assigned to or
vested in him from time to time by the Board of Directors or by the Executive
Committee and as prescribed by these Bylaws.
Section 7. President - Execution of Documents. The President shall
execute bonds, mortgages and other contracts requiring a seal, under the seal of
the corporation, except where required or permitted by law to be otherwise
signed and executed and except where the signing and execution thereof shall be
delegated by the Board of Directors or the Executive Committee to some other
officer or agent of the corporation.
Section 8. Vice Presidents - Powers and Duties. The Vice President, or
if there shall be more than one the Vice Presidents, shall perform such duties
and have such powers as the Board of Directors may from time to time prescribe.
Section 9. Secretary - Powers and Duties. The Secretary shall attend
all meetings of the Board of Directors and all meetings of the stockholders and
record or cause to be recorded all the proceedings of the meetings of the
corporation and of the Board of Directors in a book to be kept for that purpose
and shall perform like duties for the standing committees when required. He
shall give, or cause to be given, notice of all meetings of the stockholders and
special meetings of the Board of Directors, and shall perform such other duties
as may be prescribed by the Board of Directors or Chairman of the Board of
Directors, under whose supervision he shall be. He shall have custody of the
corporate seal of the corporation, and he, or an Assistant Secretary, shall have
authority to affix the same to any instrument requiring it; when so affixed, it
may be attested by his signature or by
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the signature of such Assistant Secretary. The Board of Directors may give
general authority to any other officer to affix the seal of the corporation and
to attest the affixing by his signature.
Section 10. Assistant Secretary. The Assistant Secretary, or if there
be more than one the Assistant Secretaries in the order determined by the Board
of Directors, shall, in the absence or disability of the Secretary, perform the
duties and exercise the powers of the Secretary and shall perform such other
duties and have such other powers as the Board of Directors may from time to
time prescribe.
Section 11. Treasurer - Powers and Duties. The Treasurer shall have
custody of the corporate funds and securities, shall together with the
Controller keep full and accurate accounts of receipts and disbursements in
books belonging to the corporation and shall deposit all moneys and other
valuable effects in the name and to the credit of the corporation in such
depositories as may be designated by the Board of Directors.
Section 12. Treasurer - Disbursements and Accounting. The Treasurer and
Controller shall disburse the funds of the corporation as may be ordered by the
Board of Directors, and shall render to the Board of Directors, at its regular
meetings, or when the Board of Directors so requires, an account of the
financial condition of the corporation.
Section 13. Assistant Treasurer. The Assistant Treasurer, or if there
shall be more than one the Assistant Treasurers in the order determined by the
Board of Directors, shall, in the absence or disability of the Treasurer,
perform the duties and exercise the powers of the Treasurer and shall perform
such other duties and have such other powers as the Board of Directors may from
time to time prescribe. Any one or more of the duties of the Treasurer may be
delegated by the Board of Directors to the Controller, an Assistant Treasurer or
any other officer of the corporation.
Section 14. Bonds. If required by the Board of Directors, any officer
shall give the corporation a bond in such sum and with such surety or sureties
as shall be satisfactory to the Board of Directors for the faithful performance
of the duties of his office and for the restoration to the corporation, in case
of his death, resignation, retirement or removal from office, of all books,
papers, vouchers, money and other property of whatever kind in his possession or
under his control belonging to the corporation.
ARTICLE VI.
CERTIFICATES FOR SHARES OF STOCK
Section 1. Rights to Certificate. Every holder of stock in the
corporation shall be entitled to have a certificate, signed by, or in the name
of the corporation, by the Chairman of the Board of Directors, the President or
a Vice President and the Treasurer or an Assistant Treasurer, or the Secretary
or an Assistant Secretary of the corporation, certifying the number of shares of
capital stock of the corporation owned by him in the corporation.
Section 2. Classes of Stock - Rights. If the corporation shall be
authorized to issue more than one class of stock, or more than one series of any
class, the powers, designations, preferences
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and relative, participating, optional or other special rights of each class of
stock or series thereof and the qualifications, limitations or restrictions of
such preferences and/or rights shall be set forth in full or summarized on the
face or back of the certificate which the corporation shall issue to represent
such class of stock; provided, however, that, except as otherwise provided in
Section 202 of the General Corporation Law of Delaware, in lieu of the foregoing
requirements there may be set forth on the face or back of the certificate which
the corporation shall issue to represent such class or series of stock, a
statement that the corporation will furnish without charge to each stockholder
who so requests, the powers, designations, preferences and relative,
participating, optional or other special rights of each class of stock or series
thereof and the qualifications, limitations or restrictions of such preferences
and/or rights.
Section 3. Officers' Signatures. Where a certificate is signed (1) by a
transfer agent or an assistant transfer agent or (2) a registrar, the signature
of any such officer may be facsimile. In case any officer or officers who have
signed, or whose facsimile signature or signatures have been used on, any such
certificate or certificates shall cease to be such officer or officers of the
corporation, whether because of death, resignation or otherwise, before such
certificate or certificates have been delivered by the corporation, such
certificate or certificates may nevertheless be adopted by the corporation and
be issued and delivered as though the person or persons who signed such
certificate or certificates or whose facsimile signature or signatures have been
used thereon had not ceased to be such officer or officers of the corporation.
Section 4. Lost Certificates. The Board of Directors may direct a new
certificate or certificates to be issued in place of any certificate or
certificates theretofore issued by the corporation alleged to have been lost or
destroyed, upon the making of an affidavit of that fact by the person claiming
the certificate of stock to be lost or destroyed. When authorizing such issue of
a new certificate or certificates, the Board of Directors may, in its discretion
and as a condition precedent to the issuance thereof, require the owner of such
lost or destroyed certificate or certificates, or his legal representative, to
advertise the same in such manner as it shall require and/or to give the
corporation a bond in such sum as it may direct as indemnity against any claim
that may be made against the corporation with respect to the certificate alleged
to have been lost or destroyed.
Section 5. Transfers of Stock. Upon surrender to the corporation or the
transfer agent of the corporation of a certificate for shares duly endorsed or
accompanied by proper evidence of succession, assignment or authority to
transfer, in each case with signatures guaranteed, it shall be the duty of the
corporation to issue a new certificate to the person entitled thereto, cancel
the old certificate and record the transaction upon its books.
Section 6. Fixing of Record Date. The Board of Directors shall fix in
advance a date, not less than ten nor more than sixty days preceding the date of
any meeting of stockholders, or the date for the payment of any dividend, or the
date for the allotment of rights, or the date when any change or conversion or
exchange of capital stock shall go into effect, or a date in connection with
obtaining a consent, as a record date for the determination of the stockholders
entitled to notice of, and to vote at, any such meeting, and any adjournment
thereof, or entitled to receive payment of any such dividend, or to any such
allotment of rights, or to exercise the rights in respect of any such change,
conversion or exchange of capital stock, or to give such consent, and in such
case such stockholders as shall be stockholders of record on the date so fixed
shall be entitled to such notice of, and to vote
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<PAGE>
at, such meeting and any adjournment thereof, or to receive payment of such
dividend, or to receive such allotment of rights, or to exercise such rights, or
to give such consent, as the case may be, notwithstanding any transfer of any
stock on the books of the corporation after any such record date fixed as
aforesaid.
Section 7. Registered Stockholders. The corporation shall be entitled
to recognize the exclusive right of a person registered on its books as the
owner of shares to receive dividends, and to vote as such owner, and to hold
liable for calls and assessments a person registered on its books as the owner
of shares, and shall not be bound to recognize any equitable or other claim to
or interest in such share or shares on the part of any other person, whether or
not it shall have express or other notice thereof, except as otherwise provided
by the laws of Delaware.
ARTICLE VII.
INDEMNIFICATION
Section 1. Actions Not By or In the Right of the Corporation. The
corporation shall indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the corporation) by reason of the fact that he
is or was a director, officer or employee of the corporation, or is or was
serving at the request of the corporation as a director, officer, employee or
agent of another corporation, partnership, joint venture, trust or other
enterprise, against expenses (including attorneys' fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by him in connection
with such action, suit or proceeding if he acted in good faith and in a manner
he reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. The termination of any
action, suit or proceeding by judgment, order, settlement, conviction, or upon a
plea of nolo contendere or its equivalent, shall not, of itself, create a
presumption that the person did not act in good faith and in a manner which he
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had
reasonable cause to believe that his conduct was unlawful.
Section 2. Actions By or In the Right of the Corporation. The
corporation shall indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action or suit by or in
the right of the corporation to procure a judgment in its favor by reason of the
fact that he is or was a director, officer or employee of the corporation, or is
or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, against expenses (including attorneys' fees) actually and
reasonably incurred by him in connection with the defense or settlement of such
action or suit if he acted in good faith and in a manner he reasonably believed
to be in or not opposed to the best interests of the corporation and except that
no indemnification shall be made in respect of any claim, issue or matter as to
which such person shall have been adjudged to be liable to the corporation
unless and only to the extent that the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that, despite
the adjudication of liability
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<PAGE>
but in view of all the circumstances of the case, such person is fairly and
reasonably entitled to indemnity for such expenses which the Court of
Chancery or such other court shall deem proper.
Section 3. Indemnification Where Director or Officer Successfully
Defends Action. To the extent that a director, officer or employee of the
corporation has been successful on the merits or otherwise in defense of any
action, suit or proceeding referred to in Sections 1 and 2 of this Article VII,
or in defense of any claim, issue or matter therein, he shall be indemnified
against expenses (including attorneys' fees) actually and reasonably incurred by
him in connection therewith.
Section 4. Determinations Required Prior to Indemnification. Except as
provided in Section 3 of this Article VII and except as may be ordered by a
court, any indemnification under Sections 1 and 2 of this Article VII shall be
made by the corporation only as authorized in the specific case upon a
determination that indemnification of the director, officer or employee is
proper in the circumstances because he has met the applicable standard of
conduct set forth in Sections 1 and 2 of this Article VII, as the case may be.
Such determination shall be made (1) by a majority vote of the directors who
were not parties to such action, suit or proceeding, even though less than a
quorum; or (2) if there are no such directors, or if such directors so direct,
by independent legal counsel in a written opinion; or (3) by the stockholders.
Section 5. Advances. Expenses (including attorney's fees) incurred by
an officer or director in defending any civil, criminal, administrative, or
investigative action, suit or proceeding shall be paid by the corporation in
advance of the final disposition of such action, suit or proceeding upon receipt
of an undertaking by or on behalf of the director or officer to repay such
amount if it shall ultimately be determined that he is not entitled to be
indemnified by the corporation as authorized in this Article. Such expenses
(including attorney's fees) incurred by other employees may be so paid upon such
terms and conditions, if any, as the Board of Directors deems appropriate.
Section 6. General. The indemnification and advancement of expenses
provided by or granted pursuant to these Bylaws shall not be deemed exclusive of
any other rights to which those seeking indemnification or advancement of
expenses may be or shall become entitled under any agreement, vote of
stockholders or disinterested directors or otherwise, both as to actions in an
official capacity and as to actions in another capacity while holding such
office.
Section 7. Insurance. The corporation may purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise against any liability asserted against
him and incurred by him in any such capacity, or arising out of his status as
such, whether or not the corporation would have the power to indemnify him
against such liabilities under the certificate of incorporation, the provisions
of these Bylaws or under the provisions of the General Corporation Law of the
State of Delaware.
Section 8. The Corporation. For purposes of this Article VII,
references to "the corporation" shall include, in addition to the resulting
corporation, any constituent corporation (including any constituent of a
constituent) absorbed in a consolidation or merger which, if its separate
existence had continued, would have had the power and authority to indemnify its
directors, officers and
11
<PAGE>
employees, so that any person who is or was a director, officer or employee of
such constituent corporation, or is or was serving at the request of such
constituent corporation as a director, officer or employee of another
corporation, partnership, joint venture, trust or other enterprise, shall stand
in the same position under the provisions of this Article VII with respect to
the resulting or surviving corporation as he would have with respect to such
constituent corporation if its separate existence had continued.
Section 9. Employee Benefit Plans. For purposes of this Article VII,
references to "other enterprises" shall include employee benefit plans; the
reference to "fines" shall include any excise taxes assessed on a person with
respect to an employee benefit plan; and references to "serving at the request
of the corporation" shall include any service as a director, officer, employee
or agent of the corporation which imposes duties on, or involves services by,
such director, officer or employee with respect to an employee benefit plan, its
participants or beneficiaries; and a person who acted in good faith and in a
manner he reasonably believed to be in the interest of the participants and
beneficiaries of an employee benefit plan shall be deemed to have acted in a
manner "not opposed to the best interests of the corporation" as referred to in
this Article VII.
Section 10. Continuation. The indemnification and advancement of
expenses provided by, or granted pursuant to, these Bylaws shall continue as to
a person who has ceased to be a director, officer or employee and shall inure to
the benefit of the heirs, executors and administrators of such a person.
Section 11. Future Amendments. In the event of any amendment or
addition to ss. 145 of the General Corporation Law of the State of Delaware or
the addition of any other section of such law with regard to indemnification,
the corporation shall indemnify to the fullest extent authorized or permitted by
such then-existing General Corporation Law of the State of Delaware, as amended,
any person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (including an action by or in the
right of the corporation), by reason of the fact that he is or was a director,
officer or employee of the corporation or is or was serving at the request of
the corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, or other enterprise against
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement actually and reasonably incurred by him in connection with such
action, suit or proceeding.
ARTICLE VIII.
GENERAL PROVISIONS
Section 1. Dividends. Dividends upon the capital stock of the
corporation, subject to the provisions of the certificate of incorporation, if
any, may be declared by the Board of Directors at any regular or special
meeting, pursuant to law. Dividends may be paid in cash, in property, or in
shares of the capital stock, subject to the provisions of the certificate of
incorporation.
Section 2. Reserves. Before payment of any dividend, there may be set
aside out of any funds of the corporation available for dividends such sum or
sums as the Board of Directors from
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<PAGE>
time to time, in their absolute discretion, think proper as a reserve or
reserves to meet contingencies, or for equalizing dividends, or for repairing or
maintaining any property of the corporation, or for such other purpose as the
Board of Directors shall think conducive to the interest of the corporation, and
the Board of Directors may modify or abolish any such reserve in the manner in
which it was created.
Section 3. Annual Statement. The Board of Directors shall present at
each annual meeting, and at any special meeting, of the stockholders when called
for by vote of the stockholders a concise statement of the business and
condition of the corporation.
Section 4. Checks. All checks or demands for money and notes of the
corporation shall be signed by such officer or officers or such other person or
persons as the Board of Directors may from time to time designate.
Section 5. Fiscal Year. The fiscal year of the corporation shall be
determined by the Board of Directors, and shall be from October 1 through
September 30, unless otherwise determined by the Board of Directors.
Section 6. Seal. The corporate seal shall be in the form prescribed by
the Board of Directors. The seal may be used by causing it or a facsimile
thereof to be impressed or affixed or reproduced or otherwise.
Section 7. Miscellaneous. Unless otherwise ordered by the Board of
Directors, the President, any Vice President, the Secretary, any Assistant
Secretary or the Treasurer in person or by proxy appointed by any of them shall
have full power and authority on behalf of the corporation to vote, act and
consent with respect to any shares of stock issued by other corporations which
the corporation may own or as to which the corporation has the right to vote,
act or consent.
ARTICLE IX.
AMENDMENTS
These Bylaws may be altered or repealed at any regular meeting of the
stockholders or of the Board of Directors or at any special meeting of the
stockholders or of the Board of Directors if such notice of such alteration or
repeal be contained in the notice of such special meeting. No Bylaw adopted by
vote of the stockholders shall be subject to amendment by the Board of Directors
if such Bylaw so provides. Notwithstanding the foregoing, neither Sections 5 nor
12 of Article II may be amended, altered, changed or repealed except by the
affirmative vote of the holders of at least seventy-five percent (75%) of the
issued and outstanding shares of capital stock of the Corporation entitled to
vote thereon cast at a meeting of the stockholders called for that purpose.
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Exhibit 10(s)
PLAN OBJECTIVES
The primary objective of the Green Spring annual incentive program is to foster
our overall compensation philosophy of paying for performance. The Plan helps
prioritize and focus employees' efforts on the accomplishment of various goals
established through the annual planning and budget process. This is achieved by
linking a significant element of variable cash compensation to the
accomplishment of these specified goals.
While base salaries are targeted to be merely at 50% of market, at targeted
performance levels, the Plan provides incentive compensative opportunities
which, in combination with base salary, will yield total annual compensation
that is very competitive..
ELIGIBILITY CRITERIA
All regular non-clinical employees, except commissioned sales, Maryland clinical
and temporary employees are eligible. While employees will be immediately
eligible upon employment, it will be up to senior management to determine
whether employees hired after June 30th have contributed enough to merit an
annual incentive.
In order to receive an incentive award, an employee must be employed by the
company at the time of pay out. The one exception to this is an employee who is
separated from employment due to the eliminated of his/her position and had
worked at least nine months during the calendar year for which incentives are
being paid.
PERFORMANCE GOALS
Incentive award pay outs will be tied to the accomplishment of goals and
objectives. These goals will be established and communicated to employees at the
beginning of each year. Each goal should be weighted according to its relative
importance and priority, and the degree to which the employee can influence its
accomplishment. Each goal will have performance standards tied to target (100%)
and maximum (150%) award levels.
FUNDING
Funds for the pay-out of incentives shall be accrued for each unit based upon
financial performance. The national pool shall be established based upon
National's financial results [Earning Before Taxes - EBT] versus target.
Individual state pools shall be established based 50% upon their financial
performance versus targeted contribution margin and 50% based upon National's
financial results [Earnings Before Taxes - EBT] versus target. The rate the
pools shall increase will be 2% for every 1% above target. The funding pools may
grow up to 150% of target. No funding will be established unless at least 80% of
the goal is met (threshold funding).
<PAGE>
TARGET INCENTIVE LEVELS
The following are the target incentive levels assuming target performance and
target funding:
<TABLE>
<CAPTION>
GRADE PERCENTAGE
- ----- ----------
<S> <C>
1- 9 2%
11 - 16 3%
17 8%
18 10%
19 12%
20 15%
21-23* 20%
23* 25 - 30%
24* 30%
24 30%
25 30%
26+ 35%
</TABLE>
The amounts are established as a percentage of midpoint for the grade and not
the employee's actual salary. Individual pay outs may increase by 50% based upon
performance versus established goals (see Performance Goals) and increase by 50%
again based upon financial results (see Funding).
PLAN ADMINISTRATION, MODIFICATION AND ADJUSTMENT
The Plan will be administered by Green Spring's CEO and Board of Directors. The
CEO and Board will approve award levels for Plan participants, as recommended by
managers, and be responsible for changes in plan design, participation, and
other aspects of Plan administration.
OTHER CONDITIONS
This Plan and the applicable Incentive Schedules do not constitute either an
express or implied contract of employment.
At their discretion, the CEO and Board reserves the right to amend, change,
interpret, replace and/or terminate this Plan and the individual incentive
opportunities at any time.
<PAGE>
Exhibit 10(ah)
AGREEMENT AND PLAN OF MERGER
THIS AGREEMENT AND PLAN OF MERGER (this "Agreement") is entered into as
of July 14, 1997, by and among Merit Behavioral Care Corporation, a Delaware
corporation ("Parent"), Merit Merger Corp., a Delaware corporation and a wholly
owned subsidiary of Parent ("Merger Sub"), and CMG Health, Inc., a Maryland
corporation (the "Company").
W I T N E S S E T H:
WHEREAS, the respective Boards of Directors of Parent, Merger Sub and
the Company each have determined that it is in the best interests of their
respective stockholders for Merger Sub to merge with and into the Company upon
the terms and subject to the conditions of this Agreement (the "Merger"), and
such Boards of Directors have approved such Merger, pursuant to which each share
of common stock, par value $.00333 per share, of the Company ("Company Common
Stock") issued and outstanding immediately prior to the Effective Time of the
Merger, and each share of preferred stock, par value $.00333 per share, of the
Company ("Company Preferred Stock") issued and outstanding immediately prior to
the Effective Time, will be converted into the right to receive the
consideration set forth in Article III hereof;
WHEREAS, concurrently with the execution of this Agreement, and as an
inducement to Parent to enter into this Agreement, certain stockholders of the
Company have entered into Stockholder Support Agreements (the "Stockholder
Support Agreements") with the Company and Parent, pursuant to which such
stockholders have, among other things, represented that they will vote all
voting securities of the Company beneficially owned by them in favor of approval
and adoption of this Agreement and the transactions contemplated hereby and,
further, that they agree, among other things, to take any further actions as
stockholders as may be required to approve this Agreement and the transactions
contemplated hereby; and
WHEREAS, each of Parent, Merger Sub and the Company desires to make
certain representations, warranties, covenants and agreements in connection with
the Merger and to prescribe various conditions to the Merger.
NOW, THEREFORE, in consideration of the foregoing, and the mutual
representations, warranties, covenants and agreements contained herein, the
parties hereto do hereby agree as follows:
ARTICLE I.
THE MERGER
<PAGE>
1.1. The Merger.
Subject to the terms and conditions set forth in this Agreement, and in
accordance with the Maryland General Corporation Law (the "MGCL") and the
General Corporation Law of the State of Delaware (the "DGCL"), Merger Sub shall
be merged with and into the Company at the Effective Time. As provided in and
subject to Section 1.4 hereof, following the Effective Time, the separate
corporate existence of Merger Sub shall cease and the Company shall continue as
the surviving corporation (the "Surviving Corporation") and shall succeed to and
assume all the rights and obligations of Merger Sub and the Company in
accordance with the MGCL. The Merger shall have the effect set forth in Section
3-114 of the MGCL and Section 252 of the DGCL.
1.2. The Closing.
(a) The closing of the Merger (the "Closing") will take place at 10:00 a.m.
Eastern Time as soon as practicable following the satisfaction or waiver of all
of the conditions set forth in Article XII hereof (the "Closing Date"), at the
offices of Latham & Watkins, New York, New York, unless another date or place is
agreed to in writing by the parties hereto.
(b) At the Closing, the Company shall deliver or cause to be delivered to Parent
the following:
(i) Officers' Certificate. (A) The certificate required to be delivered by the
Chief Executive Officer of the Company pursuant to Section 12.2(q) and (B) the
certificate required to be delivered by the Chief Financial Officer of the
Company pursuant to Section 12.2(r).
(ii) Certificates of Good Standing. (A) A certificate of good standing for the
Company from the State Department of Assessments and Taxation of the State of
Maryland; and (B) certificates of good standing (or equivalent certification)
for each of the entities listed in Sections 4.2(a) and 4.2(b) of the Company
Disclosure Schedule from their respective states of formation.
(iii) Secretary's Certificate. A certificate, executed by the Secretary of the
Company, dated as of the Closing Date, which certifies the continued
effectiveness without modification since the date hereof of resolutions adopted
by the members of the Board of Directors of the Company duly authorizing the
execution, delivery and performance of this Agreement, the other agreements
referred to herein and the transactions contemplated hereby and thereby, the
continued effectiveness without modification since the date hereof of
resolutions adopted by the stockholders of the Company duly approving the
Merger, and such other matters as may be reasonably requested by Parent.
<PAGE>
(iv) Opinions of Counsel.
(A) Opinions of Skadden, Arps, Slate, Meagher & Flom (Illinois), counsel to the
Company, dated the Closing Date, addressing the matters set forth on Exhibit
1.2(b)(iv)(A).
(B) An opinion of Jill B. Reamer, Esq., Vice President of Mergers and
Acquisitions and General Counsel of the Company, dated the Closing Date,
addressing the matters set forth on Exhibit 1.2(b)(iv)(B).
(v) Director Resignations. Resignations of all members of the Board of Directors
of the Company and each Company Subsidiary, effective as of the Closing.
(vi) Stockholders Agreement. An agreement entered into by and among the ACR
Beneficiaries, certain stockholders of Parent and Parent, effective as of the
Closing Date (the "Stockholders Agreement"), which Stockholders Agreement shall
be substantially in the form attached as Exhibit 1.2(b)(vi) hereto, fully
executed by such holders.
(vii) Escrow Agreement. An escrow agreement, dated as the Closing Date (the
"Escrow Agreement"), by and between the ACR Representative and NationsBank,
N.A., as escrow agent (the "Escrow Agent"), which Escrow Agreement shall be
substantially in the form of Exhibit 1.2(d)(vii) hereto, fully executed by the
parties thereto.
(c) At the Closing, Parent shall deliver or cause to be delivered to those
holders of the Exchanging Company Shares who have complied with Section 3.3 the
Merger Consideration set forth in clause (i) of Section 3.1(b) in immediately
available funds.
(d) At the Closing, Parent shall deliver or caused to be delivered to the
Company the following:
(i) Officers' Certificates. The certificates required to be delivered by the
Chief Executive Officers of Parent and Merger Sub pursuant to Section 12.3(f).
(ii) Certificate of Good Standing. Certificates of good standing for Parent and
Merger Sub from the Secretary of State of the State of Delaware.
(iii) Secretaries' Certificates. Certificates, executed by the Secretaries of
Parent and Merger Sub, dated as of the Closing Date, which certify the continued
effectiveness without modification since the date hereof of the resolutions
adopted by the directors of Parent and Merger Sub, respectively, duly
authorizing the execution, delivery and performance of this Agreement, the other
agreements referred to herein and the transactions contemplated hereby and
<PAGE>
thereby, and such other matters as may be reasonably requested by the Company.
(iv) Stockholders Agreement. The Stockholders Agreement, fully executed by
Parent and those stockholders of Parent that are a party thereto.
(v) Opinion of Counsel. An opinion of Richards, Layton & Finger, special
Delaware counsel to Parent, dated the Closing Date, addressing the matters set
forth on Exhibit 1.2(d)(v).
(vi) Opinion of General Counsel. An opinion of Michael G. Lenahan, Esq.,
Executive Vice President -- Mergers & Acquisitions and General Counsel of
Parent, dated the Closing Date, addressing the matters set forth on Exhibit
1.2(d)(vi).
1.3. Effective Time.
Subject to the provisions of this Agreement, the parties shall file (i) articles
of merger (the "Maryland Articles of Merger") executed in accordance with the
relevant provisions of the MGCL and (ii) a certificate of merger (the "Delaware
Certificate of Merger") executed in accordance with the relevant provisions of
the DGCL and shall make all other filings or recordings required under the MGCL
and the DGCL on the Closing Date. The Merger shall become effective at the
latest of such time as (i) the Maryland Articles of Merger are duly filed with
the State Department of Assessments and Taxation of the State of Maryland, (ii)
the Delaware Certificate of Merger is filed with the Secretary of State of the
State of Delaware, or (iii) at such other time as the Company and Parent shall
agree should be specified in the Maryland Articles of Merger and the Delaware
Certificate of Merger (the "Effective Time").
1.4. Effect of the Merger.
When the Merger has been effected, the separate existence of Merger Sub shall
cease, the Surviving Corporation shall have all of the rights, privileges,
immunities and powers and shall be subject to all the duties and liabilities of
a corporation organized under Maryland law, the Surviving Corporation shall
thereupon and thereafter possess all the rights, privileges, immunities and
franchises of a public as well as of a private nature of Merger Sub and the
Company (together, the "Constituent Corporations"); all property, real, personal
and mixed, and all debts due on whatever account, including subscriptions to
shares and all other choses in action, and all and every other interest, of or
belonging to or due each of the Constituent Corporations, shall be taken and
deemed to be transferred to and vested in the Surviving Corporation without
further act or deed. The Surviving Corporation shall thenceforth be responsible
and liable for all liabilities and obligations of each of the Constituent
Corporations so merged; and any claim existing or action or proceeding pending
<PAGE>
by or against either of the Constituent Corporations may be prosecuted as if the
Merger had not taken place, or the Surviving Corporation may be substituted in
its place. Neither the rights of creditors nor any liens upon the respective
properties of the Constituent Corporations and the Surviving Corporation shall
be impaired by the Merger, all with the effect set forth in the MGCL and the
DGCL.
ARTICLE II.
CHARTER, BYLAWS, DIRECTORS AND
OFFICERS OF THE SURVIVING CORPORATION
2.1. Charter of the Surviving Corporation.
The charter of the Company, as in effect immediately prior to the Effective
Time, shall be the charter of the Surviving Corporation from and after the
Effective Time and until thereafter amended as provided by law.
2.2. Bylaws of the Surviving Corporation.
The Bylaws of the Company as in effect immediately prior to the Effective Time,
shall be the Bylaws of the Surviving Corporation from and after the Effective
Time and until thereafter altered, amended or repealed in accordance with the
laws of the State of Maryland, the charter of the Company and the said Bylaws.
2.3. Directors of the Surviving Corporation.
The Board of Directors of the Surviving Corporation shall be comprised of the
directors of Merger Sub immediately prior to the Effective Time until their
respective successors are duly elected and qualified. The Company shall cause
each member of its Board of Directors and of its subsidiaries, and each other
member of the Board of Directors of a Group Entity which is identified by Parent
in writing prior to the Effective Time, to tender his or her resignation prior
to the Effective Time, each such resignation to be effective as of the Effective
Time.
2.4. Officers of the Surviving Corporation.
The officers of the Company immediately prior to the Effective Time shall be the
officers of the Surviving Corporation until their respective successors are duly
elected and qualified.
ARTICLE III.
EFFECT OF THE MERGER ON CAPITAL STOCK
<PAGE>
3.1. Effect on Capital Stock.
As of the Effective Time, by virtue of the Merger and without any action on the
part of any holder of any shares of Company Common Stock or Company Preferred
Stock or any holder of shares of capital stock of Merger Sub:
(a) Capital Stock of Merger Sub. Each issued and outstanding share of capital
stock of Merger Sub shall be converted into and become one fully paid and
nonassessable share of common stock, par value $.00333 per share, of the
Surviving Corporation.
(b) Conversion of the Company Common Stock. Each issued and outstanding share of
Company Common Stock shall be converted into the right to receive, subject to
any applicable withholding taxes, the following (collectively, the "Merger
Consideration"):
(i) a cash amount equal to the Cash Price (as calculated below, subject to
recalculation pursuant to the terms of Section 3.3.1); and
(ii) provided that the holder of such share of Company Common Stock is a party
to the Stockholders Agreement, one (1) right to the additional consideration set
forth in Section 3.7 (each, an "Additional Consideration Right"); each holder of
an Additional Consideration Right being deemed herein an "ACR Beneficiary."
As used herein, the "Cash Price" shall be calculated as follows:
Cash Price = [$51,500,000 +.5 (AEPUO) + AEPFO + AEPVO - .5 (ADJ) - EA - EX]
M246 [.5 (UO) + CS + VO + FO]
The abbreviations used in the formula above shall have the following meanings:
ADJ shall be the amount designated as the "Adjustment Amount"
on Exhibit 3.1(b).
AEPFO shall be an amount equal to the aggregate exercise
prices of all Frozen Options.
AEPUO shall be an amount equal to the aggregate exercise
prices of all Unvested Options.
AEPVO shall be an amount equal to the aggregate exercise
prices of all Vested Options.
CS shall be the number of outstanding shares of Company Common
Stock immediately prior to the Effective Time, deeming the
<PAGE>
Company Preferred Stock to have been converted into Company
Common Stock at a conversion rate of one share of Company
Common Stock for each share of Company Preferred Stock.
EA shall be an amount equal to $60,000 (the "Escrow Amount"),
which shall represent the amount deposited into the Escrow
Account pursuant to Section 10.6 hereof.
EX shall be the amount designated as the "Excess Amount" on
Exhibit 3.1(b).
FO shall be the number of shares of Company Common Stock for
which Stock Options issued under the 1996 Option Plan which
are not vested immediately prior to or at the Effective Time
but which, for a period of twelve months after the Effective
Time, are subject to vesting upon the happening of certain
events in accordance with the terms of the agreements and
instruments governing such Stock Options (each, a "Frozen
Option").
UO shall be the number of shares of Company Common Stock for
which Stock Options were granted in 1995 under the 1994 Option
Plan which are not vested immediately prior to the Effective
Time but which, upon the Effective Time, consistent with the
terms of the agreements and instruments governing such Stock
Options, have been vested by action of the Board of Directors
of the Company and, in accordance with Section 3.2 hereof,
converted into the right to receive the Merger Consideration
(each, an "Unvested Option").
VO shall be the number of shares of Company Common Stock for
which Stock Options which are either (i) vested immediately
prior to the Effective Time (without giving effect to the
Merger or the Stockholder Support Agreements) or (ii) vested
at the Effective Time pursuant to the terms of the 1996 Option
Plan (each, a "Vested Option").
(c) Conversion of the Company Preferred Stock. Each issued and outstanding share
of Company Preferred Stock shall be converted into the right to receive the
Merger Consideration such holder would have received if such holder had
converted its shares of Company Preferred Stock into Company Common Stock
immediately prior to the Effective Time. The conversion rate of the Company
Preferred Stock is and shall be one share of Company Common Stock for each share
of Company Preferred Stock.
<PAGE>
(d) Status of the Shares. As of the Effective Time, all shares of Company Common
Stock and Company Preferred Stock shall no longer be outstanding and shall
automatically be canceled and retired and shall cease to exist, and each holder
of a certificate representing any Company Common Stock or Company Preferred
Stock (collectively, "Exchanging Company Shares") shall cease to have any rights
with respect thereto, except the right to receive the Merger Consideration to be
paid in consideration therefor upon surrender of such certificate in accordance
with Section 3.3, without interest.
(e) Dissenters' Rights. Notwithstanding any provision of this Agreement to the
contrary, and subject to the provisions of the Stockholder Support Agreements,
any Exchanging Company Shares outstanding immediately prior to the Effective
Time held by a holder who has complied with the provisions of Sections
3-203(a)(1)(ii) and 3-203(a)(2) of the MGCL and as of the Effective Time has not
withdrawn or forfeited such right to such appraisal shall not be converted into
or represent a right to receive the Merger Consideration, but the holder thereof
shall only be entitled to such rights as are granted by the MGCL. If a holder of
Exchanging Company Shares who demands appraisal of those Exchanging Company
Shares under the MGCL shall effectively withdraw or forfeit (through failure to
perfect or otherwise) the right to appraisal, then, as of the Effective Time or
the occurrence of such event, whichever last occurs, those Exchanging Company
Shares shall be converted into and represent only the right to receive the
Merger Consideration as provided in Section 3.1(b)(i), without interest, upon
the surrender of the certificate or certificates representing those Exchanging
Company Shares. The Company shall give Parent (i) prompt notice of any written
demands for appraisal of any Exchanging Company Shares, attempted withdrawals of
such demands, and any other instruments served pursuant to the MGCL received by
the Company relating to stockholders' rights of appraisal and (ii) the
opportunity to direct all negotiations and proceedings with respect to demands
for appraisal under the MGCL. The Company shall not, except with the prior
written consent of Parent, voluntarily make any payment with respect to any
demands for appraisals of capital stock of the Company, offer to settle or
settle any such demands or approve any withdrawal of any such demands.
(f) Calculation of Cash Price. On the business day immediately preceding the
Closing Date, the Company's Chief Financial Officer shall deliver to Parent a
true, correct and complete statement of each of the items set forth in the
definition of Cash Price.
(g) Equity Rights. As used in this Agreement, "Equity Rights" shall mean any
options, warrants, rights of conversion (including under the Company Preferred
Stock) or agreements, arrangements or commitments (whether or not in writing)
obligating the Company (with or without consideration and whether or not
presently exercisable or convertible) to issue or sell shares of its capital
stock.
<PAGE>
3.2. Stock Options.
(a) The Board of Directors of the Company (or the proper committee thereof), by
amendment of the appropriate Stock Option plan or by resolution of the Board of
Directors, as may be appropriate, shall cause, immediately prior to the
Effective Time, each unvested Stock Option (other than Frozen Options), which is
outstanding immediately prior to the Effective Time, without any action on the
part of the holder thereof, to become fully vested (in the case of all
outstanding Stock Options granted under the 1992 Option Plan, the 1994 Option
Plan and the 1995 Option Plan and those Stock Options granted under the 1996
Option Plan and listed in Attachment 4.4(2) of the Company Disclosure Schedule
in the columns headed "1996 Options" - "10%" or "COC") or canceled (in the case
of Stock Options granted under the 1996 Option Plan, which are not Frozen
Options and which are not referred to in the immediately preceding
parenthetical) pursuant to the terms thereof, and if vested, converted (along
with each otherwise Vested Option outstanding immediately prior to the Effective
Time) into the right to receive, less applicable withholding taxes and without
interest, (A) cash in an amount equal to the difference (if positive) between
(x) the Cash Price and (y) the exercise price of such option, provided, if the
difference between (x) the Cash Price and (y) the exercise price of such option
is zero or less, such option shall, immediately prior to the Effective Time, and
without any action on the part of the holder thereof, be canceled and no
consideration shall be issued in exchange therefor; and (B) if the holder of
such Stock Option becomes a party to the Stockholders Agreement, in respect of
each share of Company Common Stock which such holder had the right to acquire at
an exercise price per share of Company Common Stock which is less than the Cash
Price, one Additional Consideration Right. The Company shall pay amounts due to
the holders of Stock Options under this Section 3.2(a) immediately prior to the
Effective Time. As used herein, "Stock Option" shall mean stock options issued
pursuant to the CMG Health, Inc. Stock Option Plan, dated July 1, 1992 (the
"1992 Option Plan"), the CMG Health, Inc. Non-Qualified Stock Option Plan, dated
July 1, 1994 (the "1994 Option Plan"), the CMG Health, Inc. Non-Qualified
Non-Employee Director's Stock Option Plan, dated February 1, 1995 (the "1995
Option Plan"), and the Performance Equity Incentive Plan, amended and restated
as of November 1, 1996 (the "1996 Option Plan").
(b) If at any time during the twelve month period beginning at the Effective
Time, a Frozen Option shall have its vesting accelerated pursuant to the terms
of the 1996 Option Plan, such Frozen Option shall be converted, as of the date
of the event effecting such acceleration, into the right to receive, less
applicable withholding taxes and without interest, (A) cash in an amount equal
to the difference (if positive) between (x) the Cash Price and (y) the exercise
price of such Frozen Option, provided, if the difference between (x) the Cash
Price and (y) the exercise price of such Frozen Option is zero or less, such
Frozen Option shall, without any action on the part of the holder thereof, be
<PAGE>
canceled and no consideration shall be issued in exchange therefor; and (B) if
the holder of such Frozen Option becomes a party to the Stockholders Agreement,
in respect of each share of Company Common Stock which such holder had the right
to acquire at an exercise price per share of Company Common Stock which is less
than the Cash Price, one Additional Consideration Right. The Surviving
Corporation shall pay amounts due to the each holder of Frozen Options under
this Section 3.2(b) within five (5) business days following the receipt by the
Surviving Corporation of an agreement, fully executed by such holder, releasing
the Surviving Corporation from any and all liabilities and obligations to such
holder arising under the 1996 Option Plan and providing that the consideration
to be paid such holder pursuant to this Section 3.2(b) constitutes full and
complete payment in respect of such holder's Frozen Options.
3.3. Exchange of Certificates; Procedures.
(a) Immediately following the Effective Time, each record holder of any
certificate or certificates which, immediately prior to the Effective Time,
represented outstanding Exchanging Company Shares (the "Certificates") whose
Exchanging Company Shares were converted into the right to receive a portion of
the Merger Consideration shall be entitled to surrender its Certificates to
Parent for cancellation in exchange for the Merger Consideration and, subject to
receipt of such certifications as Parent may reasonably request, Parent hereby
agrees to cause such Merger Consideration to be paid to such person at such
time; provided, however, the rights represented by the Additional Consideration
Rights shall be uncertificated and be evidenced only by Section 3.7 hereof. The
Litigation Shares shall be issued to the ACR Beneficiaries at the Effective
Time, in the amounts and subject to the provisions set forth in Section 3.7(c)
hereof, and shall be delivered at the time and in the manner set forth in the
preceding sentence with respect to the right to receive Merger Consideration
generally. If any stockholder shall fail to surrender its Certificates promptly
following the Effective Time, Parent shall send to such stockholder notice of
the Merger and instructions for use in effecting the surrender of the
Certificates in exchange for the stockholder's pro rata share of the Merger
Consideration and the holder of such Certificates shall be entitled to receive
in exchange therefor solely the stockholder's pro rata share of the Merger
Consideration less any applicable stock transfer taxes (whether imposed on such
stockholder or on Parent) and such Certificates shall forthwith be canceled. No
interest shall be paid or accrued for the benefit of holders of the Certificates
on the consideration payable upon the surrender of the Certificates. It shall be
a condition of payment that the Certificate so surrendered shall be properly
endorsed or otherwise be in proper form for transfer. Notwithstanding the
foregoing, no party hereto shall be liable to a holder of Exchanging Company
Shares for any cash or interest delivered to a public official pursuant to
applicable abandoned property, escheat or similar laws. If any Certificates
shall not have been surrendered prior to two years after the Effective Time (or
<PAGE>
immediately prior to such earlier date on which any payment in respect hereof
would otherwise escheat to or become the property of any governmental unit or
agency), the payment in respect of such Certificates shall, to the extent
permitted by applicable Law, become the property of the Surviving Corporation,
free and clear of all claims of interest of any person previously entitled
thereto and any holders of Certificates who have not theretofore complied with
this Article III shall thereafter look only to the Surviving Corporation for the
Merger Consideration with respect to the Exchanging Company Shares formerly
represented thereby to which such holders are entitled pursuant to this Article
III.
(b) From and after the Effective Time, there shall be no transfers on the share
transfer books of the Surviving Corporation of the Exchanging Company Shares
which were outstanding immediately prior to the Effective Time. If, after the
Effective Time, Certificates are presented to the Surviving Corporation for
payment, they shall be canceled and exchanged for the Merger Consideration in
accordance with the procedures set forth in this Section 3.3 and Section 3.1.
3.3.1. Recalculation of Cash Price.
Upon the twelve month anniversary of the Effective Time, the Cash Price shall be
recalculated, treating as never having been outstanding each Frozen Option that
has subsequently been terminated or cancelled without consideration in
accordance with its terms, and any portion of the Cash Price not previously
distributed by the Surviving Corporation which would, based upon such
recalculation, have been originally due in respect of Vested Options and
Unvested Options (pursuant to Section 3.2) and Exchanging Company Shares
(pursuant to Section 3.3), shall be distributed (without interest and subject to
applicable withholding taxes) promptly by the Surviving Corporation in respect
of (i) each such Stock Option and (ii) each Exchanging Company Share entitled to
receive Merger Consideration pursuant to the terms hereof.
3.4. No Further Rights in Exchanging Company Shares. All Merger Consideration
received by any stockholder pursuant to this Agreement shall be deemed to have
been delivered and received in full satisfaction of all rights pertaining to
such stockholder's Exchanging Company Shares. At the Effective Time, the holders
of Certificates shall cease to have any rights with respect to such shares
(other than such rights as they may have as dissenting stockholders under the
MGCL), and their sole right shall be to receive the Merger Consideration.
Dissenting stockholders shall have the rights accorded by the MGCL.
3.5. Lost Certificates.
Notwithstanding the provisions of Section 3.3, in the event any Certificate
which immediately prior to the Effective Time represented outstanding Exchanging
<PAGE>
Company Shares has been lost, stolen or destroyed (a "Lost Certificate"), upon
the making of an affidavit of that fact by the person claiming such Lost
Certificate to be lost, stolen or destroyed and an agreement to indemnify Parent
against any claim that may be made against it with respect to such Certificate,
Parent will deliver the Merger Consideration to which the Exchanging Company
Shares were entitled in respect of such Lost Certificate.
3.6. Withholding Rights.
Parent shall be entitled to deduct and withhold from the Merger Consideration or
Additional Consideration Rights otherwise payable pursuant to this Agreement to
any holder of Exchanging Company Shares or any Stock Options such amounts as
Parent is required to deduct and withhold with respect to the making of such
payment under the Internal Revenue Code of 1986, as amended, and the regulations
promulgated thereunder (the "IRC"), or any provisions of state, local or foreign
tax law. To the extent that amounts are so withheld by Parent, such withheld
amounts shall be treated for all purposes of this Agreement as having been paid
to the holder of the Exchanging Company Shares in respect of which such
deduction and withholding was made.
3.7. Additional Consideration Rights.
(a) General. Each Additional Consideration Right shall represent only a right to
receive:
(i) a cash payment (the "CHAMPUS Earn-Out Payment") from Parent, as provided and
subject to the terms set forth in Section 3.7(b).
(ii) a pro rata portion of 750,000 shares (the "Litigation Condition Shares") of
common stock, par value $.01 per share, of Parent ("Parent Common Stock"), as
provided and subject to the terms set forth in Section 3.7(c);
(iii) a pro rata portion of up to 750,000 shares of Parent Common Stock (the
"CHAMPUS Condition Shares" and together with the Litigation Condition Shares,
the "Parent Shares"), as provided and subject to the terms set forth in Section
3.7(d);
(iv) a cash payment (the "State Earn-Out Payment") from Parent, as provided and
subject to the terms set forth in Section 3.7(e);
(v) the pro rata right to receive amounts on deposit in the Escrow Account,
pursuant to the terms of the Escrow Agreement; and
(vi) a cash payment, as provided and subject to the terms set forth in Section
3.7(k).
<PAGE>
(b) CHAMPUS Earn-Out Payment.
(i) The amount of any CHAMPUS Earn-Out Payment payable with respect to each
Additional Consideration Right shall be equal to the aggregate CHAMPUS Earn-Out
Payment payable, calculated as provided on Exhibit 3.7(b), divided by the total
number of Additional Consideration Rights outstanding (the "ACR Denominator") as
of the third business day prior to the date an Earn-Out Statement is first sent
to the ACR Beneficiaries; provided, however, that if the Earn-Out Payment Date
occurs prior to the twelve month anniversary of the Effective Time, (A) the ACR
Denominator shall be adjusted for purposes of calculating the amount of the
CHAMPUS Earn-Out Payment payable to each ACR Beneficiary pursuant to this
Section 3.7(b) by adding an amount equal to "FO" (as used in the definition of
Cash Price) to the ACR Denominator, and (B) if at any time from and after the
Earn-Out Payment Date, a Frozen Option shall have its vesting accelerated
pursuant to the terms of the 1996 Option Plan, such Frozen Option shall be
converted into the right to receive, if the holder of such Frozen Option is an
ACR Beneficiary, the amount payable with respect to each Additional
Consideration Right as calculated hereinabove, which shall be payable at the
time, and only if, a payment is due to such holder pursuant to Section 3.2(b).
Upon the twelve month anniversary of the Effective Time, any CHAMPUS Earn-Out
Payment not previously paid pursuant to the terms of this Section 3.7(b) shall
be paid to all ACR Beneficiaries, pro rata in accordance with the number of
Additional Consideration Rights held by each ACR Beneficiary.
(ii) Not later than the latest of (x) thirty (30) days following the date of
final resolution with respect to the bid price adjustment provisions of the
CHAMPUS Regions 3 and 4 request for proposals of claims paid during the data
collection period (i.e., the twelve (12) month period ended June 30, 1996) under
the CHAMPUS Regions 3 and 4 program (such final resolution being deemed to occur
upon (A) the acceptance by Choice Behavioral Health Partnership ("Choice") of
the bid price adjustment of the Office of CHAMPUS ("OCHAMPUS") either by (1) the
settlement of such bid price adjustment by Humana Military Healthcare Services,
Inc. ("Humana MHS") and OCHAMPUS, or (2) Humana MHS's decision not to, or
failure to timely, appeal such final bid price adjustment determination by
OCHAMPUS (which settlement or decision is accepted by Choice) or (B) Humana
MHS's proposal to limit the impact of such bid price adjustment determination
upon Choice (which proposal is accepted by Choice)), (y) the date Humana MHS and
Choice complete all risk sharing and other calculations required for Choice to
determine its profit generated from the CHAMPUS 3/4 Subcontract for the first
year of service delivery thereunder and reflecting the results to the bid price
adjustment described above and (z) April 30, 1998, Parent shall prepare and
deliver to the ACR Beneficiaries a statement (the "Earn-Out Statement") setting
forth the calculation of the CHAMPUS Earn-Out Payment calculated in accordance
with Exhibit 3.7(b). The amount of the CHAMPUS Earn-Out Payment reflected on the
Earn-Out Statement shall be paid by Parent to the ACR Beneficiaries not later
<PAGE>
than the tenth business day following the date the Earn-Out Statement becomes
final under Section 3.7(b)(iii) (the "Earn-Out Payment Date"). As used in this
Agreement, "CHAMPUS 3/4 Subcontract" means that certain Subcontract for the
Comprehensive Management of the Delivery of Mental Health and Substance Abuse
Services dated July 28, 1995, among Humana MHS, the Company and FHC Options,
Inc. relating to that certain Request For Proposals MDA 906-94-R-002, under
which Choice operates.
(iii) The Surviving Corporation shall provide the ACR Representative and its
agents access, upon reasonable notice and during normal business hours, to the
books and records of the Surviving Corporation pertaining solely to the Earn-Out
Statement, provided that the ACR Representative and its agents execute
confidentiality agreements as may reasonably be requested by the Surviving
Corporation. If the ACR Representative shall have any objections to the Earn-Out
Statement, the ACR Representative shall deliver a complete and detailed written
statement describing its objections to Parent within 60 days after receiving the
Earn-Out Statement in question. The ACR Representative and Parent will use
reasonable efforts to resolve any objections to the Earn-Out Statement which are
timely raised by the ACR Representative as set forth herein. If any such
objections are resolved, they shall be confirmed in a writing signed by Parent
and the ACR Representative. If the parties do not obtain a final and complete
written, signed resolution within 30 days (which time period may be extended but
only by a writing signed by Parent and the ACR Representative) after Parent's
receipt of a written statement of objections, the ACR Representative and Parent
will select within 30 days thereafter an accounting firm mutually acceptable to
them to resolve by binding arbitration, with the aforesaid accounting firm
acting (as a firm) as the sole arbitrator, any remaining objections not
previously resolved in a writing signed by Parent and the ACR Representative.
The aforesaid accounting firm shall determine the procedures to be utilized by
it in resolving the remaining objections. If the ACR Representative and Parent
are unable to timely agree on the choice of an accounting firm, such accounting
firm will be selected by lot from a list of the six largest national accounting
firms remaining after excluding the regular outside accounting firms of Parent,
the Company (on the date hereof), each holder of more than 10% of the Additional
Consideration Rights and the ACR Representative. The determination of the
accounting firm as to the remaining objections will be set forth in writing and
when set forth in writing, designated as a "Final Determination" and signed by
the accounting firm. If such accounting firm thus determines that the ACR
Beneficiaries are entitled, under this Section 3.7(b), to a CHAMPUS Earn-Out
Payment in excess of that set forth in the Earn-Out Statement, Parent shall
promptly pay such amount, but Parent shall not be required to pay any interest
except as provided below in this clause (iii). In the event that the parties
submit any unresolved objections to an accounting firm for resolution as
provided in this clause (iii), the fees, charges and expenses of the accounting
firm shall (A) be borne by the ACR Beneficiaries (pro rata based upon the number
<PAGE>
of such rights held) as a set-off to the CHAMPUS Earn-Out Payment if such
accounting firm determines that no amount in excess of the CHAMPUS Earn-Out
Payment set forth in the Earn-Out Statement is due to the ACR Beneficiaries, (B)
be borne equally by Parent and the ACR Beneficiaries if the CHAMPUS Earn-Out
Payment which such accounting firm determines to be due to the ACR Beneficiaries
does not exceed the CHAMPUS Earn-Out Payment reflected on the Earn-Out Statement
by more than 7.5%, or (C) be borne by Parent if the CHAMPUS Earn-Out Payment
which such accounting firm determines to be due to the holders exceeds the
CHAMPUS Earn-Out Payment reflected on such Earn-Out Statement by more than 7.5%.
For purposes of this Agreement, the Earn-Out Statement shall become final upon
the earliest to occur of (X) the expiration of the 60-day period described in
the second sentence of this Section 3.7(b)(iii) if the ACR Representative shall
not have delivered any written statement of objections to the Earn-Out Statement
to Parent within such period (or the date prior to such expiration on which the
ACR Representative accepts the Earn-Out Statement in writing), (Y) the date on
which the ACR Representative and Parent resolve in writing all objections, if
any, of the ACR Representative to the Earn-Out Statement timely delivered to
Parent, and (Z) the date on which the accounting firm determines and delivers to
Parent and the ACR Representative in a writing designated as a "Final
Determination" and signed by the accounting firm its resolution of all
objections not otherwise previously resolved in writing by the ACR
Representative and Parent. In the event the Final Determination results in an
amount due to the ACR Beneficiaries as the CHAMPUS Earn-Out Payment in excess of
that reflected on the Earn-Out Statement first delivered, the amount of the
CHAMPUS Earn-Out Payment shall be increased by an amount equal to the amount of
interest on the CHAMPUS Earn-Out Payment accruing from the 60th day after the
Earn-Out Statement was first delivered to the ACR Beneficiaries through the date
of payment, at a rate of interest equal to LIBOR (one month maturity) plus
1.875% per annum. Upon the Earn-Out Statement becoming final as aforesaid, such
Earn-Out Statement, including but not limited to the amount to be paid to each
ACR Beneficiary and the non-existence of any other ACR Beneficiaries entitled to
an Earn-Out Payment, shall be conclusive and binding on the ACR Representative,
Parent and each ACR Beneficiary, whether or not said ACR Beneficiary is
identified therein as being entitled to an Earn-Out Payment. Notwithstanding any
other provision of this Agreement, including but not limited to any provision
stating that remedies shall be cumulative and not exclusive, and as a condition
of the receipt of Additional Consideration Rights and the consideration which
may arise in respect thereof, this Section 3.7(b)(iii) provides the sole and
exclusive method for resolving any and all disputes of each and every nature
whatever that may arise between or among the parties, the ACR Beneficiaries, or
their representatives (including the ACR Representative) with respect to any
CHAMPUS Earn-Out Payment or the Earn-Out Statement. All parties hereto, the ACR
Beneficiaries and their representatives (including the ACR Representative)
hereby irrevocably waive, relinquish and surrender all rights to, and agree that
they will not attempt to, resolve any such dispute or disputes in any manner
<PAGE>
other than as set forth in this Section 3.7(b)(iii), including but not limited
to through litigation. All parties hereto, the ACR Beneficiaries and their
representatives (including the ACR Representative) further agree that if one or
more of them should initiate any attempt to resolve any such dispute or disputes
in any manner other than the sole and exclusive manner set forth in this Section
3.7(b)(iii), said initiators shall pay and reimburse all fees, costs and
expenses incurred by anyone else as a result of, in connection with or related
to said attempt or attempts.
(iv) Payment of the CHAMPUS Earn-Out Payment shall be made by cashier's or
certified check or, if requested by a person entitled to receive payment, by
wire transfer of immediately available funds to an account specified by such
person.
(c) Litigation Condition Payment. At the Effective Time, each holder of an
Additional Consideration Right shall be entitled to receive, in respect of each
such Additional Consideration Right so held, a number of shares of Parent Common
Stock equal to (i) 750,000 (as adjusted pursuant to Section 3.7(g)) divided by
(ii) the ACR Denominator as of such date plus the number of Frozen Options;
provided, that any holder of aggregate Stock Options to acquire less than 20,000
shares of Company Common Stock immediately prior to the Effective Time shall, in
respect of the Additional Consideration Rights issuable in respect of such Stock
Options, be issued the Equivalent Cash Amount (as defined in Section 3.7(h)
below) in respect of each Litigation Condition Share which was to be issued to
such holder in respect of an Additional Consideration Right pursuant to Section
3.2 hereof. Such Litigation Condition Shares and any Equivalent Cash Amount
shall be issued or paid to the ACR Beneficiaries at the Effective Time in
respect of the Additional Conditional Rights. If at any time from and after the
Effective Time, a Frozen Option shall have its vesting accelerated pursuant to
the terms of the 1996 Option Plan, such Frozen Option shall be converted into
the right to receive, if the holder of such Frozen Option is an ACR Beneficiary,
the number of Litigation Condition Shares allocable to each Additional
Consideration Right as calculated hereinabove, which shall be issuable at the
time, and only if, a payment is due to such holder pursuant to Section 3.2(b).
Upon the twelve month anniversary of the Effective Time, any Litigation
Condition Shares not previously issued pursuant to the terms of this Section
3.7(c) shall be issued to all ACR Beneficiaries, pro rata in accordance with the
number of Additional Consideration Rights held by each ACR Beneficiary. To the
extent any Parent Share to be issued under Sections 3.7(c) or (d) is a
fractional share, at Parent's option, Parent shall either (i) issue such
fractional share, (ii) issue a whole Parent Share in lieu thereof or (iii) issue
cash in lieu thereof based upon the Equivalent Cash Amount.
(d) CHAMPUS 2/5 Condition Payment.
<PAGE>
(i) Upon satisfaction of the CHAMPUS 2/5 Condition, each holder of an Additional
Consideration Right shall be entitled to receive, in respect of each such
Additional Consideration Right so held, a number of shares of Parent Common
Stock equal to (i) 750,000 (as adjusted pursuant to Section 3.7(g) or reduced
pursuant to Exhibit 3.7(d)) divided by (ii) the ACR Denominator; provided, that
any holder of aggregate Stock Options to acquire less than 20,000 shares of
Company Common Stock immediately prior to the Effective Time shall, in respect
of the Additional Consideration Rights issuable in respect of such Stock
Options, be issued the Equivalent Cash Amount in respect of each CHAMPUS
Condition Share which was to be issued to such holder pursuant to this
subsection. Such CHAMPUS Condition Shares and any Equivalent Cash Amount shall
be issued or paid to the ACR Beneficiaries (A) subject to clause (B), upon the
latest of (1) thirty (30) days following satisfaction of the CHAMPUS 2/5
Condition, (2) ten business days following the date on which the Share
Adjustment becomes final pursuant to Section 3.7(g)(ii) hereof with respect to
any pending Share Adjustment, upon the terms and subject to the restrictions set
forth in the Stockholders Agreement, or (3) ten business days following the date
on which the CHAMPUS 2/5 Statement becomes final, or (B) in the event the
CHAMPUS 2/5 Condition is satisfied prior to the Effective Time, such CHAMPUS
Condition Shares and any Equivalent Cash Amount shall be issued or paid to the
ACR Beneficiaries at the Effective Time in respect of the Additional Conditional
Rights if the parties are then in agreement as to the CHAMPUS 2/5 Statement;
provided, however, that if the CHAMPUS Condition Shares are issued prior to the
twelve month anniversary of the Effective Time, (A) the ACR Denominator shall be
adjusted for purposes of calculating the number of CHAMPUS Condition Shares
issuable to each ACR Beneficiary pursuant to this Section 3.7(d) by adding an
amount equal to "FO" (as used in the definition of Cash Price) to the ACR
Denominator, and (B) if at any time from and after the issuance of the CHAMPUS
Condition Shares, a Frozen Option shall have its vesting accelerated pursuant to
the terms of the 1996 Option Plan, such Frozen Option shall be converted into
the right to receive, if the holder of such Frozen Option is an ACR Beneficiary,
the number of CHAMPUS Condition Shares allocable to each Additional
Consideration Right as calculated hereinabove, which shall be at the time, and
only if, a payment is due to such holder pursuant to Section 3.2(b). Upon the
twelve month anniversary of the Effective Time, any CHAMPUS Condition Shares not
previously issued pursuant to the terms of this Section 3.7(d) shall be issued
to all ACR Beneficiaries pro rata in accordance with the number of Additional
Consideration Rights held by each ACR Beneficiary. As used herein, the "CHAMPUS
2/5 Condition" shall have the meaning set forth on Exhibit 3.7(d).
(ii) The Surviving Corporation shall provide the ACR Representative and its
agents access, upon reasonable notice and during normal business hours, to the
books and records of the Surviving Corporation pertaining solely to any
adjustments (the "CHAMPUS 2/5 Adjustments") made to the number of CHAMPUS
Condition Shares to be issued pursuant to the calculations set forth on Exhibit
<PAGE>
3.7(d), provided that the ACR Representative and its agents execute
confidentiality agreements as may reasonably be requested by the Surviving
Corporation. If the ACR Representative shall have any objections to the CHAMPUS
2/5 Adjustments, the ACR Representative shall deliver a complete and detailed
written statement describing its objections to Parent within 60 days after
receiving written notice from Parent of the CHAMPUS 2/5 Adjustments in question.
The ACR Representative and Parent will use reasonable efforts to resolve any
objections to the CHAMPUS 2/5 Adjustments which are timely raised by the ACR
Representative as set forth herein. If any such objections are resolved, they
shall be confirmed in a writing signed by Parent and the ACR Representative. If
the parties do not obtain a final and complete written, signed resolution within
30 days (which time period may be extended but only by a writing signed by
Parent and the ACR Representative) after Parent's receipt of a written statement
of objections, the ACR Representative and Parent will select within 30 days
thereafter an accounting firm mutually acceptable to them to resolve by binding
arbitration, with the aforesaid accounting firm acting (as a firm) as the sole
arbitrator, any remaining objections not previously resolved in a writing signed
by Parent and the ACR Representative. The aforesaid accounting firm shall
determine the procedures to be utilized by it in resolving the remaining
objections. If the ACR Representative and Parent are unable to timely agree on
the choice of an accounting firm, such accounting firm will be selected by lot
from a list of the six largest national accounting firms remaining after
excluding the regular outside accounting firms of Parent, the Company (on the
date hereof), each holder of more than 10% of the Additional Consideration
Rights and the ACR Representative. The determination of the accounting firm as
to the remaining objections will be set forth in writing and when set forth in
writing, designated as a "Final Determination" and signed by the accounting
firm. If such accounting firm thus determines that the ACR Beneficiaries are
entitled, under this Section 3.7(d), to a number of CHAMPUS Condition Shares in
excess of that set forth in Parent's written notice of CHAMPUS 2/5 Adjustments,
Parent shall promptly pay such amount. In the event that the parties submit any
unresolved objections to an accounting firm for resolution as provided in this
clause (ii), the fees, charges and expenses of the accounting firm shall (A) be
borne by the ACR Beneficiaries (pro rata based upon the number of such rights
held) as a set-off to the number of CHAMPUS Condition Shares issuable if such
accounting firm determines that no amount in excess of the number of CHAMPUS
Condition Shares set forth in Parent's written notice of CHAMPUS 2/5 Adjustments
is due to the ACR Beneficiaries, (B) be borne equally by Parent and the ACR
Beneficiaries if the number of CHAMPUS Condition Shares which such accounting
firm determines to be due to the ACR Beneficiaries does not exceed the number
reflected on Parent's written notice of CHAMPUS 2/5 Adjustments by more than
7.5%, or (C) be borne by Parent if the number of CHAMPUS Condition Shares which
such accounting firm determines to be due to the holders exceeds the number
reflected on Parent's written notice of CHAMPUS 2/5 Adjustments by more than
7.5%. For purposes of this Agreement, the CHAMPUS 2/5 Adjustments shall become
<PAGE>
final upon the earliest to occur of (X) the expiration of the 60-day period
described in the second sentence of this Section 3.7(d)(ii) if the ACR
Representative shall not have delivered any written statement of objections to
the CHAMPUS 2/5 Adjustments to Parent within such period (or the date prior to
such expiration on which the ACR Representative accepts the CHAMPUS 2/5
Adjustments in writing), (Y) the date on which the ACR Representative and Parent
resolve in writing all objections, if any, of the ACR Representative to the
CHAMPUS 2/5 Adjustments timely delivered to Parent, and (Z) the date on which
the accounting firm determines and delivers to Parent and the ACR Representative
in a writing designated as a "Final Determination" and signed by the accounting
firm its resolution of all objections not otherwise previously resolved in
writing by the ACR Representative and Parent. In the event the Final
Determination results in a number of CHAMPUS Condition Shares issuable to the
ACR Beneficiaries as a result of the satisfaction of the CHAMPUS 2/5 Condition
in excess of that reflected on the written notice of CHAMPUS 2/5 Adjustments
first delivered by Parent, the amount of CHAMPUS Condition Shares issuable to
the ACR Beneficiaries shall be increased by an amount equal to the difference
between (1) the number set forth in the Final Determination and (2) the number
set forth on Parent's written notice of CHAMPUS 2/5 Adjustments, in both cases,
with respect to the aggregate number of CHAMPUS Condition Shares issuable. Upon
the number of CHAMPUS Condition Shares issuable and any CHAMPUS 2/5 Adjustments
becoming final as aforesaid, such number of CHAMPUS Condition Shares issuable
and any CHAMPUS 2/5 Adjustments, including but not limited to the number of
CHAMPUS Condition Shares to be issued to each ACR Beneficiary and the
non-existence of any other ACR Beneficiaries entitled to receive CHAMPUS
Condition Shares, shall be conclusive and binding on the ACR Representative,
Parent and each ACR Beneficiary, whether or not said ACR Beneficiary is
identified therein as being entitled to receive CHAMPUS Condition Shares.
Notwithstanding any other provision of this Agreement, including but not limited
to any provision stating that remedies shall be cumulative and not exclusive,
and as a condition of the receipt of Additional Consideration Rights and the
consideration which may arise in respect thereof, this Section 3.7(d)(ii)
provides the sole and exclusive method for resolving any and all disputes of
each and every nature whatever that may arise between or among the parties, the
ACR Beneficiaries, or their representatives (including the ACR Representative)
with respect to any CHAMPUS Condition Shares or CHAMPUS 2/5 Adjustments. All
parties hereto, the ACR Beneficiaries and their representatives (including the
ACR Representative) hereby irrevocably waive, relinquish and surrender all
rights to, and agree that they will not attempt to, resolve any such dispute or
disputes in any manner other than as set forth in this Section 3.7(d)(ii),
including but not limited to through litigation. All parties hereto, the ACR
Beneficiaries and their representatives (including the ACR Representative)
further agree that if one or more of them should initiate any attempt to resolve
any such dispute or disputes in any manner other than the sole and exclusive
manner set forth in this Section 3.7(d)(ii), said initiators shall pay and
<PAGE>
reimburse all fees, costs and expenses incurred by anyone else as a result of,
in connection with or related to said attempt or attempts.
(e) State Contract Earn-Out Payment.
(i) The amount of any State Earn-Out Payment payable with respect to each
Additional Consideration Right shall be equal to the aggregate State Earn-Out
Payment payable, calculated as provided on Exhibit 3.7(e), divided by the total
number of Additional Consideration Rights outstanding as of the third business
day prior to the date a State Earn-Out Statement is first sent to the ACR
Beneficiaries.
(ii) Not later than December 31, 1998, Parent shall prepare and deliver to the
ACR Beneficiaries a statement (the "State Earn-Out Statement") setting forth the
calculation of the State Earn-Out Payment calculated in accordance with Exhibit
3.7(e). The amount of the State Earn-Out Payment reflected on the State Earn-Out
Statement shall be paid by Parent to the ACR Beneficiaries not later than the
tenth business day following the date the State Earn-Out Statement becomes final
under Section 3.7(e)(iii) (the "State Payment Date"). As used in this Agreement,
"State Contract" means Contract No. 97-331-74069-0 between the Montana State
Department of Public Health and Human Services and Montana Community Partners,
Inc. and CMG Health, Inc. and Care Coalition of Montana, Inc. for managed mental
health care, dated as of December 23, 1996.
(iii) The Surviving Corporation shall provide the ACR Representative and its
agents access, upon reasonable notice and during normal business hours, to the
books and records of the Surviving Corporation pertaining solely to the State
Earn-Out Statement, provided that the ACR Representative and its agents execute
confidentiality agreements as may reasonably be requested by the Surviving
Corporation. If the ACR Representative shall have any objections to the State
Earn-Out Statement, the ACR Representative shall deliver a complete and detailed
written statement describing its objections to Parent within 60 days after
receiving the State Earn-Out Statement in question. The ACR Representative and
Parent will use reasonable efforts to resolve any objections to the State
Earn-Out Statement which are timely raised by the ACR Representative as set
forth herein. If any such objections are resolved, they shall be confirmed in a
writing signed by Parent and the ACR Representative. If the parties do not
obtain a final and complete written, signed resolution within 30 days (which
time period may be extended but only by a writing signed by Parent and the ACR
Representative) after Parent's receipt of a written statement of objections, the
ACR Representative and Parent will select within 30 days thereafter an
accounting firm mutually acceptable to them to resolve by binding arbitration,
with the aforesaid accounting firm acting (as a firm) as the sole arbitrator,
any remaining objections not previously resolved in a writing signed by Parent
and the ACR Representative. The aforesaid accounting firm shall determine the
<PAGE>
procedures to be utilized by it in resolving the remaining objections. If the
ACR Representative and Parent are unable to timely agree on the choice of an
accounting firm, such accounting firm will be selected by lot from a list of the
six largest national accounting firms remaining after excluding the regular
outside accounting firms of Parent, the Company (on the date hereof), each
holder of more than 10% of the Additional Consideration Rights and the ACR
Representative. The determination of the accounting firm as to the remaining
objections will be set forth in writing and when set forth in writing,
designated as a "Final Determination" and signed by the accounting firm. If such
accounting firm thus determines that the ACR Beneficiaries are entitled, under
this Section 3.7(e), to a State Earn-Out Payment in excess of that set forth in
the State Earn-Out Statement, Parent shall promptly pay such amount, but Parent
shall not be required to pay any interest except as provided below in this
clause (iii). In the event that the parties submit any unresolved objections to
an accounting firm for resolution as provided in this clause (iii), the fees,
charges and expenses of the accounting firm shall (A) be borne by the ACR
Beneficiaries (pro rata based upon the number of such rights held) as a set-off
to the State Earn-Out Payment if such accounting firm determines that no amount
in excess of the State Earn-Out Payment set forth in the State Earn-Out
Statement is due to the ACR Beneficiaries, (B) be borne equally by Parent and
the ACR Beneficiaries if the State Earn-Out Payment which such accounting firm
determines to be due to the ACR Beneficiaries does not exceed the State Earn-Out
Payment reflected on the State Earn-Out Statement by more than 7.5%, or (C) be
borne by Parent if the State Earn-Out Payment which such accounting firm
determines to be due to the holders exceeds the State Earn-Out Payment reflected
on such State Earn-Out Statement by more than 7.5%. For purposes of this
Agreement, the State Earn-Out Statement shall become final upon the earliest to
occur of (X) the expiration of the 60-day period described in the second
sentence of this Section 3.7(e)(iii) if the ACR Representative shall not have
delivered any written statement of objections to the State Earn-Out Statement to
Parent within such period (or the date prior to such expiration on which the ACR
Representative accepts the State Earn-Out Statement in writing), (Y) the date on
which the ACR Representative and Parent resolve in writing all objections, if
any, of the ACR Representative to the State Earn-Out Statement timely delivered
to Parent, and (Z) the date on which the accounting firm determines and delivers
to Parent and the ACR Representative in a writing designated as a "Final
Determination" and signed by the accounting firm its resolution of all
objections not otherwise previously resolved in writing by the ACR
Representative and Parent. In the event the Final Determination results in an
amount due to the ACR Beneficiaries as the State Earn-Out Payment in excess of
that reflected on the State Earn-Out Statement first delivered, the amount of
the State Earn-Out Payment shall be increased by an amount equal to the amount
of interest on the State Earn-Out Payment accruing from the 60th day after the
State Earn-Out Statement was first delivered to the ACR Beneficiaries through
the date of payment, at a rate of interest equal to LIBOR (one month maturity)
<PAGE>
plus 1.875% per annum. Upon the State Earn-Out Statement becoming final as
aforesaid, such State Earn-Out Statement, including but not limited to the
amount to be paid to each ACR Beneficiary and the non-existence of any other ACR
Beneficiaries entitled to a State Earn-Out Payment, shall be conclusive and
binding on the ACR Representative, Parent and each ACR Beneficiary, whether or
not said ACR Beneficiary is identified therein as being entitled to a State
Earn-Out Payment. Notwithstanding any other provision of this Agreement,
including but not limited to any provision stating that remedies shall be
cumulative and not exclusive, and as a condition of the receipt of Additional
Consideration Rights and the consideration which may arise in respect thereof,
this Section 3.7(e)(iii) provides the sole and exclusive method for resolving
any and all disputes of each and every nature whatever that may arise between or
among the parties, the ACR Beneficiaries, or their representatives (including
the ACR Representative) with respect to any State Earn-Out Payment or the State
Earn-Out Statement. All parties hereto, the ACR Beneficiaries and their
representatives (including the ACR Representative) hereby irrevocably waive,
relinquish and surrender all rights to, and agree that they will not attempt to,
resolve any such dispute or disputes in any manner other than as set forth in
this Section 3.7(e)(iii), including but not limited to through litigation. All
parties hereto, the ACR Beneficiaries and their representatives (including the
ACR Representative) further agree that if one or more of them should initiate
any attempt to resolve any such dispute or disputes in any manner other than the
sole and exclusive manner set forth in this Section 3.7(e)(iii), said initiators
shall pay and reimburse all fees, costs and expenses incurred by anyone else as
a result of, in connection with or related to said attempt or attempts.
(iv) Payment of the State Earn-Out Payment shall be made by cashier's or
certified check or, if requested by a person entitled to receive payment, by
wire transfer of immediately available funds to an account specified by such
person.
(f) Additional Consideration Rights Generally.
(i) The Additional Consideration Rights are personal to each initial holder
thereof and shall not be transferable for any reason other than (A) to an
Affiliate of such holder, (B) to another holder of Additional Consideration
Rights or (C) by operation of law or by will or the laws of descent and
distribution. Any attempted transfer of an Additional Consideration Right by any
holder thereof (other than as permitted by the immediately preceding sentence)
shall be null and void. Additional Consideration Rights shall not possess any
attributes of common stock or other security and shall not entitle the holders
of the Additional Consideration Rights to any rights of any kind other than as
specifically set forth in this Agreement.
(ii) As a condition to the receipt of any Additional Consideration Rights, each
<PAGE>
ACR Beneficiary has duly appointed Alan J. Shusterman as its designated
representative (together with any designee of Alan J. Shusterman (or his
properly designated successor), acceptable to Parent in its reasonable
discretion (provided that any representative of Humana Inc. shall be deemed
acceptable to Parent), the "ACR Representative") and as such ACR Beneficiary's
attorney-in-fact, to act on such ACR Beneficiary's behalf and to take any and
all actions required or permitted to be taken by the ACR Representative under
this Agreement. Parent and the Company shall be entitled to rely upon as being
binding upon each ACR Beneficiary any document or other paper believed by Parent
or the Company, respectively, to be genuine and correct and to have been signed
or sent by the ACR Representative, and neither Parent or the Company shall be
liable to any of ACR Beneficiaries for any action taken or omitted to be taken
by Parent or the Company, respectively, in such reliance. All fees and expenses
of the ACR Representative and its agents shall be paid by the ACR Beneficiaries.
Neither Parent nor the Company shall in any event incur any liability for (i)
any such fees or expenses or (ii) any losses, damages or expenses incurred by
any ACR Beneficiary arising from or related to any action (or failure to act) by
the ACR Representative.
(g) Adjustment of Share Amounts.
(i) In the event that, prior to the issuance of the Parent Shares under Sections
3.7(c) or 3.7(d), the outstanding shares of Parent Common Stock are hereafter
changed into or exchanged for a different number or kind of shares or other
securities of Parent or of another corporation, by reason of reorganization,
merger, consolidation, recapitalization, reclassification, stock split-up, stock
dividend or combination of shares, appropriate and equitable adjustments (each,
a "Share Adjustment") shall be made by the Board of Directors of Parent to the
number and kind of the Parent Shares issuable to the ACR Beneficiaries, prior to
the issuance thereof, pursuant to Sections 3.7(c) and 3.7(d). Parent shall give
the ACR Representative prompt notice of the number and kind of adjustments which
have been made.
(ii) Parent shall provide the ACR Representative and its agents access upon
reasonable notice and during normal business hours to the books and records of
Parent pertaining solely to the Share Adjustment. If the ACR Representative
shall have any objections to any Share Adjustment, the ACR Representative shall
deliver a complete and detailed written statement describing its objections to
Parent within 60 days after receiving the notice of the Share Adjustment
required pursuant to Section 3.7(g)(i), above. The ACR Representative and Parent
will use reasonable efforts to resolve any objections to the Share Adjustment
which are timely raised by the ACR Representative as set forth herein. If any
such objections are resolved, they shall be confirmed in a writing signed by
Parent and the ACR Representative. If the parties do not obtain a final and
complete written, signed resolution within 30 days (which time period may be
<PAGE>
extended but only by a writing signed by Parent and the ACR Representative)
after Parent's receipt of a written statement of objections, the ACR
Representative and Parent will select within 45 days thereafter an accounting
firm mutually acceptable to them to resolve by binding arbitration, with the
aforesaid accounting firm acting (as a firm) as the sole arbitrator, any
remaining objections not previously resolved in a writing signed by Parent and
the ACR Representative. The aforesaid accounting firm shall determine the
procedures to be utilized by it in resolving the remaining objections. If the
ACR Representative and Parent are unable to timely agree on the choice of an
accounting firm, such accounting firm will be selected by lot from a list of the
six largest national accounting firms remaining after excluding the regular
outside accounting firms of Parent, the Company (on the date hereof), each
holder of more than 10% of the Additional Consideration Rights and the ACR
Representative. The determination of the accounting firm as to the remaining
objections will be set forth in writing and when set forth in writing,
designated as a "Final Determination," and signed by the accounting firm. If
such accounting firm thus determines that the ACR Beneficiaries are entitled,
under this Section 3.7(g), to a number or kind of shares or other securities of
Parent other than as contemplated by the Share Adjustment, Parent shall promptly
authorize and issue or authorize for future issuance the number and kind of
shares or securities to which the ACR Beneficiaries are entitled. In the event
that the parties submit any unresolved objections to an accounting firm for
resolution as provided in this clause (ii), the fees, charges and expenses of
the accounting firm shall (A) be borne by the ACR Beneficiaries (pro rata based
upon the number of Additional Consideration Rights held) as a set-off to the
number of Parent Shares issued or issuable to the ACR Beneficiaries (based upon
the Equivalent Cash Amount at the time of the issuance of Parent Shares) in the
event such accounting firm determines that the Share Adjustment, as determined
by Parent pursuant to Section 3.7(g)(i), is appropriate, (B) be borne equally by
Parent and the ACR Beneficiaries (by the same method of set-off) if such
accounting firm determines that the Share Adjustment requires modification so as
to increase the number of shares or other securities of Parent to be issued or
issuable to the ACR Beneficiaries by less than or equal to 7.5% (calculated as a
percentage of the number of shares of Parent Common Stock comprising the Share
Adjustment), or (C) be borne by Parent if such accounting firm determines that
the Share Adjustment requires modification so as to increase the number of
shares or other securities of Parent to be issued or issuable to the ACR
Beneficiaries by more than 7.5% (calculated as a percentage of the number of
shares of Parent Common Stock comprising the Share Adjustment). For purposes of
this Agreement, the Share Adjustment shall become final upon the earliest to
occur of (X) the expiration of the 60-day period described in the second
sentence of this Section 3.7(g)(ii) if the ACR Representative shall not have
delivered any written statement of objections to the Share Adjustment to Parent
within such period (or the date prior to such expiration on which the ACR
Representative accepts the Share Adjustment in writing), (Y) the date on which
<PAGE>
the ACR Representative and Parent resolve in writing all objections, if any, of
the ACR Representative to the Share Adjustment timely delivered to Parent, and
(Z) the date on which the accounting firm determines and delivers to Parent and
the ACR Representative in a writing designated as a "Final Determination" and
signed by the accounting firm its resolution of all objections not otherwise
previously resolved in writing by the ACR Representative and Parent. Upon the
Share Adjustment becoming final as aforesaid, such Share Adjustment, including
but not limited to the amount to be paid to each ACR Beneficiary and the
non-existence of any other ACR Beneficiaries entitled to a Share Adjustment,
shall be conclusive and binding on the ACR Representative, Parent and each ACR
Beneficiary, whether or not said ACR Beneficiary is identified therein as being
entitled to a Share Adjustment. Notwithstanding any other provision of this
Agreement, including but not limited to any provision stating that remedies
shall be cumulative and not exclusive, and as a condition of the receipt of
Parent Shares and the consideration which may arise in respect thereof, any
dispute that may arise between or among the parties, the ACR Beneficiaries, or
their representatives (including the ACR Representative) with respect to any
Share Adjustment shall be governed and resolved solely and exclusively by this
Section 3.7(g)(ii). All parties hereto, the ACR Beneficiaries and their
representatives hereby irrevocably waive, relinquish and surrender all rights
to, and agree that they will not attempt to, resolve any such dispute or
disputes in any manner other than as set forth in this Section 3.7(g)(ii),
including but not limited to through litigation. All parties hereto, the ACR
Beneficiaries and their representatives further agree that if one or more of
them should initiate any attempt to resolve any such dispute or disputes in any
manner other than the sole and exclusive manner set forth in this Section
3.7(g)(ii), said initiators shall pay and reimburse all fees, costs and expenses
incurred by anyone else as a result of, in connection with or related to said
attempt or attempts. Upon the Share Adjustment becoming final as aforesaid, such
determination with respect to the Share Adjustment, including but not limited to
the number and kind of shares of Parent Common Stock issued or issuable to each
ACR Beneficiary, shall be conclusive and binding on the ACR Representative,
Parent and each ACR Beneficiary, whether or not said ACR Beneficiary is
identified therein as being entitled to a Share Adjustment.
(h) Determination of Equivalent Cash Amount. The "Equivalent Cash Amount" with
respect to each Parent Share shall be an amount established by the Board of
Directors of Parent, in good faith, as the fair market value of a Parent Share
as of the date of its issuance to the ACR Beneficiaries.
(i) Escrow Arrangement. The ACR Representative shall be entitled to withdraw
funds necessary to perform his duties on behalf of the ACR Beneficiaries
hereunder from the Escrow Account, in the amounts set forth in and subject to
the provisions of the Escrow Agreement.
<PAGE>
(j) Parent's Acceleration Rights. On any date subsequent to the Effective Time,
upon not less than five (5) business days' notice and notwithstanding the
occurrence of any event or fulfillment of any condition (or failure thereof to
occur or be fulfilled), Parent may elect to (i) issue any or all of the shares
of Parent Common Stock constituting the CHAMPUS Condition Shares to the ACR
Beneficiaries (to the extent such shares have not, as of such date, been issued
to the ACR Beneficiaries), and (ii) pay an amount equal to the maximum amount
that could then be paid out under Section 3.7(l), were a payment to then be made
under Sections 3.7(b) and 3.7(e), in full satisfaction of the CHAMPUS Earn-Out
Payment and the State Earn-Out Payment (to the extent such amounts have not, as
of such date, been paid to the ACR Beneficiaries).
(k) Unpaid Severance Amount. Each Additional Consideration Right shall also
represent the right to receive an amount, if any, equal to one-half (.5)
multiplied by the aggregate Unpaid Severance Amount, divided by the total number
of Additional Consideration Rights outstanding as of the third business day
prior to the Unpaid Severance Amount Payment Date. The "Unpaid Severance Amount"
shall mean that portion of the payments described under clause (v) of Exhibit
3.1(b) which, on the first anniversary of the Effective Time, has not yet been
paid and is not then payable (unless the obligation to pay such amount is then
being contested, in which case such amount shall be deemed to have been paid as
severance until it is thereafter finally determined that such amount is not
payable as severance, at which time (or within 10 business days thereafter) such
amount shall be deemed to be an Unpaid Severance Amount, and shall be paid as
provided in this Section 3.7(k)). The "Unpaid Severance Amount Payment Date"
shall mean the 15th day (or, if such day is not a business day, the next
succeeding business day) following the first anniversary of the Effective Time.
(l) Payment Limitation. Notwithstanding anything to the contrary in this
Agreement, in no event shall Parent be required to pay to the ACR Beneficiaries
more than $23,500,000 in total under Sections 3.7(b) and 3.7(e). Accordingly, if
at any time the payment of an amount to the ACR Beneficiaries under Section
3.7(b) or 3.7(e) hereof would, when added to the aggregate amounts previously
paid under either of said Sections, exceed $23,500,000, then any such excess
amount shall be retained by Parent (such reduction being applied to the ACR
Beneficiaries pro rata based upon the number of Additional Consideration Rights
held by each ACR Beneficiary) and not paid to the ACR Beneficiaries.
ARTICLE IV.
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company hereby represents and warrants to Parent and Merger Sub as
follows, subject to qualification by the specific disclosures set forth in the
written statement signed by the Chief Executive Officer of the Company and
<PAGE>
delivered by the Company to Parent at least three (3) business days prior to the
date hereof (the "Company Disclosure Schedule"), which disclosure shall
expressly reference the representations and warranties so qualified:
4.1. Organization, Existence and Good Standing.
The Company is a corporation duly organized, validly existing and in good
standing under the laws of the State of Maryland and has all necessary corporate
power to own, operate or lease the properties and assets owned, operated or
leased by it and to carry on its business as presently conducted, except where
failure to so qualify or be in good standing would not have a Material Adverse
Effect (as defined in Section 13.7 hereof) with respect to the Company. The
Company is duly qualified as a foreign corporation to do business, and is in
good standing, in each jurisdiction in which the character of its properties and
assets owned, operated or leased by it or the nature of its activities makes
such qualification necessary, except for such failures which, when taken
together with all other such failures, would not have a Material Adverse Effect
on the Company. The Company has heretofore made available to Parent complete and
correct copies of its charter and Bylaws, each of the foregoing as amended to
the date of this Agreement.
4.2. Subsidiaries and Affiliated Partnerships.
(a) Section 4.2(a) of the Company Disclosure Schedule lists all Subsidiaries of
the Company (individually, a "Company Subsidiary," and collectively, the
"Company Subsidiaries"). As used herein, "Subsidiary" shall mean any corporation
in which the Company, directly or indirectly, beneficially owns any Equity
Interest.
(b) Set forth in Section 4.2(b) of the Company Disclosure Schedule is a list of
all general partnerships in which a general partner is the Company, a Company
Subsidiary or another Company Partnership (individually, a "Company Partnership"
and collectively, the "Company Partnerships"), and any limited liability company
in which the Company, a Company Subsidiary or a Company Partnership is a member
or manager (a "Company LLC"). The Company Partnerships and the Company LLCs are
collectively referred to herein as the "Company Other Entities" and the Company,
the Company Subsidiaries and the Company Other Entities are collectively
referred to herein as "Group Entities." Company Other Entities which are not
Affiliates of the Company are referred to herein as "Unaffiliated Entities."
(c) Other than the Group Entities, there are no corporations, partnerships,
joint ventures, associations or other entities in which any Group Entity owns,
of record or beneficially, any direct or indirect equity or other interest or
any right (contingent or otherwise) to acquire the same. Except as set forth in
Section 4.2(d) of the Company Disclosure Schedule, no Group Entity is a member
<PAGE>
of (nor is any part of its business of any Group Entity collectively conducted
through) any partnership, joint venture or similar arrangement.
(d) Section 4.2(d) of the Company Disclosure Schedule sets forth the
jurisdiction of incorporation, organization or formation of each Group Entity;
its authorized capital stock or other equity interests; the number and type of
its issued and outstanding shares of capital stock, partnership interests or
limited liability company interests ("Equity Interest"); and the current
ownership by each Group Entity of any Equity Interests (collectively, the
"Company Equity Interests"). Except as set forth in Section 4.2(d) of the
Company Disclosure Schedule, the Company Equity Interests are owned free and
clear of all security interests, pledges, mortgages, liens, charges, adverse
claims of ownership, voting restrictions, limitations on transfer or proxies or
use or other encumbrances of any kind (collectively, "Encumbrances"). All of the
Company Equity Interests have been duly authorized and validly issued and are
fully paid and non-assessable and were not issued in violation of any preemptive
rights; except as set forth in Section 4.2(d) of the Company Disclosure
Schedule, there are no options, warrants or rights of conversion or other
rights, agreements, arrangements or commitments relating to the Equity Interests
of any Group Entity obligating any Group Entity, as applicable, to issue or sell
any of its Equity Interests.
4.3. Organization, Existence and Good Standing of the Company Subsidiaries and
the Company Other Entities.
(a) Each Company Subsidiary is a corporation duly organized, validly existing
and in good standing under the laws of its respective state of incorporation.
Each Company Subsidiary has all necessary corporate power to own, lease or
operate its properties and assets owned, leased or operated by it and to carry
on its business as presently conducted. Each Company Subsidiary is duly
qualified as a foreign corporation to do business, and is in good standing, in
each jurisdiction in which the character of properties and assets owned,
operated or leased by it or the nature of its activities makes such
qualification necessary, except for such failures which, when taken together
with all other such failures, would not have a Material Adverse Effect with
respect to the Company. True and complete copies of the certificate of
incorporation or by-laws of each Company Subsidiary, each as amended to the date
of this Agreement, have been heretofore made available to Parent.
(b) Each Company Partnership has been duly formed, is validly existing and is in
good standing under the laws of its respective state of organization and has all
necessary power to own, lease or operate its property and assets owned, leased
or operated by it and to carry on its business as presently conducted. Each
Company Partnership is duly qualified as a foreign partnership to do business in
each jurisdiction in which the character of properties and assets owned,
<PAGE>
operated or leased by it or the nature of its activities makes such
qualification necessary, except for such failures which, when taken together
with all other such failures, would not have a Material Adverse Effect with
respect to the Company. True and complete copies of the partnership agreement
and other organizational documents of each Company Partnership, each as amended
to the date of this Agreement, have been heretofore made available to Parent.
(c) Each Company LLC is a limited liability company duly formed, validly
existing and in good standing under the laws of its respective state of
organization. Each Company LLC has all necessary power to own, lease or operate
its property and assets owned, leased or operated by it and to carry on its
business as presently conducted. Each Company LLC is duly qualified as a foreign
limited liability company to do business in each jurisdiction in which the
character of properties and assets owned, operated or leased by it or the nature
of its activities makes such qualification necessary, except for such failures
which, when taken together with all other such failures, would not have a
Material Adverse Effect with respect to the Company. True and complete copies of
the articles of organization, operating agreement and other organizational
documents of each Company LLC, each as amended to the date of this Agreement,
have been heretofore made available to Parent.
4.4. Company Capital Stock. The Company's authorized capital stock consists of
57,000,000 shares of capital stock, comprised of 36,000,000 shares of Class A
Voting Common Stock, par value $.00333 per share, and 12,000,000 shares of Class
B Non-Voting Common Stock, par value $.00333 per share, of which 9,000,000 and
5,266,122 shares, respectively, are issued and outstanding on the date hereof,
and 9,000,000 shares Company Preferred Stock, comprised of 6,000,000 shares
designated as Class A Convertible Preferred Stock, par value $.00333 per share,
and 3,000,000 shares designated as Class B Convertible Preferred Stock, par
value $.00333 per share, of which 4,537,815 and 2,632,152 shares, respectively,
are issued and outstanding on the date hereof. All of the issued and outstanding
shares of Company Common Stock and Company Preferred Stock are duly and validly
issued, fully paid and nonassessable and were not issued in violation of any
preemptive rights. The owners of all issued and outstanding shares of Company
Common Stock and Company Preferred Stock, together with number, class and series
of such stock held by such stockholder as of the date hereof, are set forth in
Section 4.4 of the Company Disclosure Schedule. The holders of all outstanding
Equity Rights, and number of such Equity Rights so held as of the date hereof,
are set forth in Section 4.4 of the Company Disclosure Schedule. Except as set
forth in Section 4.4 of the Company Disclosure Schedule, there are no voting
trusts, stockholders agreements, proxies or other similar agreements in effect
with respect to the voting or transfer of the Company Common Stock or Company
Preferred Stock. There is no liability for dividends declared or accumulated but
unpaid with respect to any of the shares of Company Common Stock or Company
Preferred Stock. Set forth in Section 4.4 of the Company Disclosure Schedule is
<PAGE>
a true and complete listing of each Vested Option, each Unvested Option, and
each Frozen Option, and the holders thereof, the terms of vesting with respect
to each such Unvested Option, the exercise price of each Stock Option listed,
and the Stock Option plan under which each Stock Option listed was issued (and
any restatements, amendments or supplements to any such plans prior to the date
hereof).
4.5. Power and Authority.
(a) The Company has all necessary corporate power and authority to execute,
deliver and perform this Agreement and to consummate the transactions
contemplated hereby, and has taken all action required by Law, its charter,
Bylaws or otherwise, to authorize the execution, delivery and performance of
this Agreement and the consummation of the transactions contemplated hereby
(other than the Stockholder Approvals, as defined in Section 4.5(b)). This
Agreement has been duly executed and delivered by the Company and, assuming this
Agreement constitutes a valid and binding obligation of Parent and Merger Sub,
as the case may be, constitutes a valid and binding obligation of the Company,
enforceable against the Company in accordance with its terms except that the
enforcement hereof may be limited by (i) bankruptcy, insolvency, reorganization,
moratorium or other similar laws now or hereafter in effect relating to
creditors' rights generally and (ii) general principles of equity (regardless of
whether enforceability is considered in a proceeding in equity or at law).
(b) The Company has duly noticed a meeting of holders of all outstanding shares
of the Company Common Stock and Company Preferred Stock, pursuant to Section
2-504 of the MGCL, which meeting is scheduled to take place on or about July 29,
1997, for the purpose of obtaining the approval and adoption of (i) with respect
to the Company Common Stock and Company Preferred Stock, holders of not less
than a majority of the Company Class A Common Stock and the Company Preferred
Stock, voting together as a single class, and (ii) with respect to the Company
Preferred Stock, holders of not less than sixty percent (60%) of such shares
voting together as a class, in each case, with respect to this Agreement, the
Merger and the transactions contemplated hereby and thereby (the approval and
adoption described in this Section 4.5(b) being herein referred to as the
"Stockholder Approvals").
4.6. Legal Proceedings.
(a) Except as set forth in Section 4.6(a) of the Company Disclosure Schedule,
there is no claim, action, suit, arbitration, litigation, governmental
investigation or other proceeding (each, an "Action") pending against any Group
Entity or its properties or business, or the transactions contemplated by this
Agreement. To the knowledge of the Company, except as set forth in Section
4.6(a) of the Company Disclosure Schedule, there is no Action threatened against
<PAGE>
any Group Entity or its properties or business, or the transactions contemplated
by this Agreement, which is reasonably likely to have a Material Adverse Effect
on the Group Entities, taken as a whole. None of the Group Entities or their
respective assets or properties is subject to any material order, judgment,
injunction, decree, stipulation or determination entered by or with any
government, governmental or regulatory authority, board, agency or other entity,
or any court, tribunal or judicial body, whether federal, state or local (each,
a "Governmental Authority"). No Group Entity has received any opinion or
memorandum from internal or outside legal counsel to the effect that it is
exposed, from a legal standpoint, to any liability that is reasonably likely to
have a Material Adverse Effect on such Group Entity. Section 4.6(a) of the
Company Disclosure Schedule sets forth all closed litigation matters involving
amounts in dispute in excess of $100,000 to which any Group Entity was a party
during the three years preceding the Closing, the date such litigation was
commenced and concluded, and the nature of the resolution thereof (including
amounts paid in settlement or judgment).
(b) The Company has provided outside counsel to Parent complete and candid
access to all members of the Board of Directors, officers, employees and agents
of the Company with knowledge pertaining to the matters in connection with the
litigation which is the subject of the complaint as previously filed of Vista of
Montana, Inc. filed in the action captioned Vista of Montana, Inc. v. Department
of Administration of the State of Montana and the Department of Public Health
and Human Services of the State of Montana and Montana Community Partners, Inc.,
(Case No.: BDV97-192), and complete access to all Company documentation material
thereto. The Company has not failed and will not fail to disclose any
information or documentation which is known to the Company and which is material
to such counsel's analysis of the claims in such litigation and the Company has
caused the members of its Board of Directors, officers, employees and agents to
cooperate fully in such analysis and to make full disclosure of all facts and
information which is known to the Company and which is material to such
analysis.
(c) The Company has retained the firm of Piper & Marbury, L.L.P. ("Piper &
Marbury") as its legal counsel in the litigation pending in the United States
District Court for the Southern District of New York captioned: Edward M.
Stephens, M.D., et al. v. CMG Health, et al., 96 Cir. 198 (KMW) ("Stephens").
The Company has provided Piper & Marbury complete and candid access to all
members of the Board of Directors, officers, employees and agents of the Company
with knowledge pertaining to the matters which are the subject of the Stephens
litigation and complete access to all Company documentation pertinent to the
Stephens litigation. The Company has not failed and will not fail to disclose
any information or documentation which is known to the Company and which is
material to Piper & Marbury's analysis of the claims in Stephens and it has
caused and will cause the members of its Board of Directors, officers, employees
<PAGE>
and agents to cooperate fully in such analysis and to make full disclosure of
all facts and information which is known to the Company and which is material to
such analysis.
4.7. Financial Statements.
The Company has heretofore furnished to Parent copies of the following financial
statements: (a) the audited Consolidated Balance Sheets of the Company as of
December 31, 1995 and 1996, and the audited Consolidated Statements of
Operations, Stockholders' Equity, and Cash Flows for each of the years in the
three year period ended December 31, 1996 (the "Latest Statement Date"),
together with the notes thereto (the "Latest Company Financial Statements"), and
the unqualified opinion of Ernst & Young LLP, the Company's independent
auditors, and (b) the Consolidated Balance Sheet of the Company and the
Consolidated Statement of Operations for each month ended between the Latest
Statement Date and May 31, 1997 (collectively with the Latest Company Financial
Statements, the "Company Financial Statements"). The Company Financial
Statements fairly present the consolidated financial position, consolidated
results of operations and consolidated cash flows of the Company as of the dates
and for the periods indicated therein. Each of the Company Financial Statements
has been prepared in accordance with generally accepted accounting principles
("GAAP") (applied on a consistent basis except as disclosed in the footnotes
thereto) and, with respect to financial statements referred to in clause (b) of
the first sentence of this Section 4.7, subject to normal year-end adjustments
and the absence of footnotes. The "Supplemental Schedules" set forth in Section
4.7 of the Company Disclosure Schedule fairly present, in accordance with GAAP,
the results of operations and variances in revenue for each of the items
described therein, for each month during the period from January 1, 1996 through
May 31, 1997. The Subsequent Company Financial Statements, delivered pursuant to
Section 8.1(h), will fairly present the consolidated financial position,
consolidated results of operations and consolidated cash flows of the Company as
of the dates and for the periods indicated therein, and the Subsequent
Supplemental Schedules, also delivered pursuant to Section 8.1(h), will fairly
present, in accordance with GAAP, the results of operations and variances in
revenue for each of the items described therein, for each month during the
period covered by the Subsequent Company Financial Statements. Each of the
Subsequent Company Financial Statements will be prepared in accordance with GAAP
(applied on a consistent basis except as disclosed in the footnotes thereto),
subject to normal year-end adjustments and the absence of footnotes.
4.8. No Undisclosed Liabilities.
Neither the Company nor any other Group Entity has any liabilities or
obligations of any nature, whether accrued, absolute, fixed or contingent,
except (i) to the extent reflected and accrued for or fully reserved against in
<PAGE>
the Company Financial Statements, (ii) for liabilities disclosed in Section 4.8
of the Company Disclosure Schedule, (iii) for liabilities and obligations not
required under GAAP to be disclosed on the balance sheets included in the
Company Financial Statements or in the financial footnotes thereto, or (iv) for
liabilities and obligations which have arisen after the Latest Statement Date in
the ordinary course of business consistent with past custom and practice (in
each case of this clause (iv), none of which is a liability resulting from
breach of contract, breach of warranty, tort, infringement claim or lawsuit).
4.9. No Violation.
Except as set forth in Section 4.9 of the Company Disclosure Schedule, neither
the execution and delivery of this Agreement nor the consummation by the Company
of the transactions contemplated hereby will (a) violate, conflict with or
result in any breach of any provision of the respective organizational documents
of any Group Entity, (b) violate any order, decree, injunction, judgment,
ruling, law, statute, regulation, rule or other determination of any
Governmental Authority (collectively, "Laws") applicable to any Group Entity,
(c) require the giving of notice to any party to a Material Contract or accord
any such party the right to modify a Material Contract, or (d) conflict with or
result in a breach of any provision of, or constitute a material default (or an
event which, with notice or lapse of time or both, would constitute a material
default) under or give to others any rights of termination, amendment,
acceleration, suspension, revocation or cancellation of, or result in any
Encumbrance on the shares of Company Common Stock or Company Preferred Stock or
the properties or assets of the Company, the Company Subsidiaries or the Company
Other Entities pursuant to (i) any material agreement, contract or other
instrument binding upon any Group Entity or (ii) any material License (as
defined in Section 4.15) held by any Group Entity.
4.10. Material Contracts.
(a) Section 4.10(a) of the Company Disclosure Schedule sets forth (grouped by
each clause of this Section 4.10(a)) the following contracts (collectively,
along with each Lease and each other contract which is material to the Group
Entities, taken as a whole, or the conduct of its business or the absence of
which would have a Material Adverse Effect on the Company, "Material Contracts")
in effect as of the date of this Agreement to which any Group Entity is a party:
(i) any contract (excluding any customer, provider or employment contract) that
the Company reasonably anticipates will, in accordance with its terms, involve
aggregate annual payments after the date hereof by any Group Entity of more than
$100,000 and that is not cancelable without liability within 60 days;
(ii) any contract, note or other instrument with any customer of the Company;
<PAGE>
(iii) each provider contract or other contract with an individual, facility,
program or entity rendering professional health care services as a contractor to
any Group Entity under which $100,000 has been paid in calendar year 1996 or is
reasonably likely to be paid in calendar year 1997 and that is not cancelable
without payment to a third party or liability within 90 days;
(iv) any employment or consulting contracts (including without limitation any
arrangements or obligations with respect to severance, change in control or
termination pay) with any member of the Board of Directors, officer or employee
of any Group Entity;
(v) all partnership, joint venture or similar contracts of any Group Entity;
(vi) any note, loan, letter of credit, contract relating to indebtedness for
borrowed money or capitalized leases, or other contract in respect of which any
Group Entity is obligated in any way to provide funds in respect of, or to
guarantee or assume, any debt, obligation or dividend of any person or entity
involving aggregate obligations of the Group Entities of more than $50,000;
(vii) any indemnity arrangement arising in connection with any sale or
disposition of assets (other than sales of assets in the ordinary course of
business);
(viii) any acquisition or disposition contracts of any Group Entity under which
a party thereto remains obliged to pay monies or perform;
(ix) all contracts with any Governmental Authority or with any labor union;
(x) contracts for capital expenditures requiring payments by any Group Entity
after the date hereof in excess of $100,000 for any single project;
(xi) all patent, trademark, service mark, trade name, copyright and franchise
licenses, royalty agreements or similar contracts;
(xii) any material contracts relating to the licensure or ownership of the
hardware or software utilized in any Group Entity's information systems; and
(xiii) each contract to which any Group Entity is a party (i) limiting the right
of any Group Entity prior to or after the Closing Date, or Parent or any of its
subsidiaries or Affiliates at or after the Closing Date, (A) to engage in, or to
compete with any person in, any business, including each contract or agreement
containing exclusivity provisions restricting the geographical area in which, or
the method by which, any business may be conducted by any Group Entity prior to
or after the Closing Date, or Parent or any of its subsidiaries or Affiliates
after the Closing Date or (B) to solicit any customer, client or patient or (ii)
<PAGE>
containing "most favored nations" or similar provisions affecting the pricing
terms of contracts to which it is a party.
The Company has made available to Parent true and complete copies of all written
Material Contracts (including all amendments thereto). Without limiting the
generality of the foregoing, the Company has provided to Parent a true and
complete copy of the amendment to its existing contract with Physician Health
Services ("PHS") relating to the Connecticut Medicaid business, extending the
terms of such existing contract through December 31, 1998. Set forth in Section
4.10(a)(xiv) of the Company Disclosure Schedule is a true and complete list of
base compensation as reported on Form W-2 for each person disclosed as being the
beneficiary of a contract or obligation pursuant to Section 4.10(a)(iv) hereof,
since and including calendar year 1991, or with respect to any person whose
employment with the Company commenced subsequent to 1991, since and including
the first calendar year of such person's employment.
(b) Each Material Contract which is a customer contract, and each other material
contract of any Group Entity which is a customer contract which would have been
required to be disclosed in Section 4.10(a) of the Company Disclosure Schedule
had such contract been entered into prior to the date of this Agreement, is in
full force and effect and is a legal, valid and binding obligation, and there is
not (i) any material default (or any event which, with the giving of notice or
lapse of time or both, would be a material default) by any Group Entity or, to
the knowledge of the Company, any other party, in the timely performance of any
obligation to be performed or paid under any such Material Contract or any such
other material contract, (ii) to the Company's knowledge, any threat of
cancellation or termination of any such Material Contract or other such material
contract, (iii) any contract that has been canceled or otherwise terminated
within the last 12 months which would have been such a Material Contract had
such contract not been canceled or terminated, or (iv) to the Company's
knowledge, any material amendment to any such Material Contract, which amendment
has been entered into or became effective in the last twelve months, except, in
each case, as specifically described in Section 4.10(b) of the Company
Disclosure Schedule.
(c) Each Material Contract which is not a customer contract, and each other
material contract of any Group Entity which is not a customer contract and which
would have been required to be disclosed in Section 4.10(a) of the Company
Disclosure Schedule had such contract been entered into prior to the date of
this Agreement, is in full force and effect and is a legal, valid and binding
obligation, and there is (i) no material default (or any event which, with the
giving of notice or lapse of time or both, would be a material default) by any
Group Entity or, to the knowledge of the Company, any other party, in the timely
performance of any obligation to be performed or paid under any such Material
Contract or any such other material contract, or (ii) to the knowledge of the
<PAGE>
Company, no threat of cancellation or termination of any such Material Contract
or other such material contract, except, in each case, as specifically described
in Section 4.10(c) of the Company Disclosure Schedule.
(d) As used herein, (1) "contract" means any written agreement and any legally
binding oral agreement, commitment or arrangement and (2) "customer contract"
means a contract with a customer of any Group Entity.
4.11. Compliance With Law; Consents and Authorizations.
(a) Except as set forth in Section 4.11(a) of the Company Disclosure Schedule,
each Group Entity has, in all material respects, operated its business in
compliance with applicable Law and it and its business are not in material
violation of any Law applicable to such Group Entity.
(b) No consent, authorization, license, approval, order or permit of, or
declaration, filing or registration with, or notification to, any Governmental
Authority or any other third party, is required to be made or obtained by any
Group Entity or any stockholder thereof in connection with the execution,
delivery and performance of this Agreement and the consummation of the
transactions contemplated hereby, except (i) as set forth in Section 4.11(b) of
the Company Disclosure Schedule; (ii) pursuant to applicable requirements, if
any, of the MGCL, the DGCL and the Hart-Scott-Rodino Antitrust Improvements Act
of 1974, as amended (the "HSR Act"); (iii) the Stockholder Approvals; or (iv) as
would not, if not so obtained, (A) have a Material Adverse Effect upon the Group
Entities, taken as a whole or (B) prevent or materially interfere with the
consummation of the transactions contemplated hereby.
(c) The representations and warranties in this Section 4.11 shall be deemed not
to cover matters which are expressly subject to the representations and
warranties set forth in Section 4.15 hereof.
4.12. Insurance.
(a) Section 4.12(a) of the Company Disclosure Schedule lists all of the Group
Entities' insurance policies or binders covering the assets, employees and
operations of the Group Entities as of the date hereof, showing the insurers,
limits, type of coverage, annual premiums, deductibles and expiration dates. All
such policies or binders are in full force and effect. In the case of
professional liability, medical malpractice and errors and omissions, Section
4.12(a) of the Company Disclosure Schedule sets forth such information for each
policy or binder held by any Group Entity since January 1, 1991. Section 4.12(a)
of the Company Disclosure Schedule also describes each pending claim under the
professional liability, medical malpractice or errors and omissions policies. To
the Company's knowledge, no Group Entity that is not an Unaffiliated Entity is
<PAGE>
in default with respect to any provision contained in any such policy or binder,
which default would compromise the coverage under any such policy or binder.
Attached to Section 4.12(a) of the Company Disclosure Schedule are copies of all
letters from each Group Entity's insurance providers concerning the provider's
acceptance, denial or qualification of coverage for any pending claims which may
be subject to such provider's insurance coverage.
(b) The business policy of the Group Entities with respect to the requirements
for each individual or entity rendering professional health care services as an
employee of or contractor to any Group Entity for professional liability or
medical malpractice insurance is set forth in Section 4.12(b) of the Company
Disclosure Schedule.
4.13. Tax Matters.
The Group Entities have timely filed with the appropriate tax authorities all
tax returns required to be filed by or on behalf of the Group Entities, and such
tax returns are true, complete and correct in all material respects, and the
Group Entities have paid all material Taxes and any other charges, whether or
not shown to be due and owing on such tax returns. The Group Entities have
withheld and paid in full on a timely basis or accrued as a liability on the
balance sheet of the Group Entities as of the Closing Date all material Taxes
required to be withheld and paid in connection with amounts paid or owing to any
employee, independent contractor, creditor, stockholder or other third party.
The Group Entities have not received written notice of, and the Company has no
knowledge of, any action, suit, proceeding, audit, claim, deficiency or
assessment pending with respect to any Taxes. There are no outstanding waivers
of statute of limitations with respect to any tax return or report of the Group
Entities and no request for such waiver is pending. No claim has been made by an
authority in a jurisdiction where a Group Entity does not file tax returns that
the Group Entity may be subject to taxation by the jurisdiction. The Group
Entities have not made, are not obligated to make and will not become obligated
under any contract entered into prior to or contemporaneously with the Closing
to make any payments, separately or in the aggregate, that will be nondeductible
under Section 280G of the IRC or subject to excise tax to the recipient under
Section 4999 of the IRC. Except for the group of which Company and its
Subsidiaries are presently members, none of Company or any of its Subsidiaries
have ever been a member of an affiliated group of corporations, within the
meaning of Section 1504 of the IRC. The Company has not filed a consent pursuant
to Section 341(f) of the IRC or agreed to have Section 341(f)(2) of the IRC
apply to any disposition of any asset owned by it or any of its Subsidiaries.
The Company and its Subsidiaries have no deferred intercompany transactions or
other deferred items of income or gain. The Company is not a personal holding
company within the meaning of Section 542 of the IRC. Neither the Company nor
any of its Subsidiaries is a party to or is bound by any tax-indemnity,
<PAGE>
tax-sharing, or tax-allocation agreement. The Company Financial Statements
include all reserves for matters concerning Taxes as are required under GAAP.
Since December 31, 1995, no Group Entity has made or rescinded any express or
deemed election relating to Taxes, settlement or compromise of any claim,
action, suit, litigation, proceeding, arbitration, investigation, audit or
controversy relating to Taxes, or made any change in any methods of reporting
income or deductions for federal income Tax purposes from those employed in the
preparation of the federal income Tax returns, as amended, for the taxable year
ending December 31, 1995, except as may be required by applicable Law.
4.14. Employee Benefit Plans.
(a) Except as set forth in Section 4.14(a) of the Company Disclosure Schedule,
no Group Entity has established or maintains, is obligated to make contributions
to or under, or otherwise to participate in, or has any liability or obligations
with respect to (i) any bonus, stock option, stock purchase, stock appreciation,
phantom stock or other type of incentive compensation plan, program, agreement,
policy, commitment, contract or arrangement (whether or not set forth in a
written document), (ii) any pension, profit-sharing, retirement or other plan,
program or arrangement, or (iii) any other employee benefit plan, fund or
program, including, but not limited to, those described in Section 3(3) of the
Employee Retirement Income Security Act of 1974, as amended, and the rules and
regulations promulgated thereunder ("ERISA"). All such plans (individually, a
"Plan" and, collectively, the "Plans") have been operated and administered, in
all material respects, in accordance with, as applicable, ERISA, the IRC, Title
VII of the Civil Rights Act of 1964, as amended, the Equal Pay Act of 1967, as
amended, the Age Discrimination in Employment Act of 1967, as amended, and the
related rules and regulations adopted by those federal agencies responsible for
the administration of such laws. No act or failure to act by any Group Entity
has resulted in a "prohibited transaction" (as defined in ERISA and in Section
4975 of the IRC) with respect to the Plans that is not subject to a statutory or
regulatory exception or in any breach of fiduciary duty under Title I of ERISA.
No Group Entity has previously made, is currently making, or is obligated in any
way to make, any contributions to, or has any liability or obligations with
respect to, any multiemployer plan within the meaning of Section 3(37) or
Section 4001(a)(3) of ERISA or any pension plan which is subject to Section 412
of the IRC or Title IV of ERISA. Other than as set forth in Section 4.14(a) of
the Company Disclosure Schedule, no Group Entity has any obligation, under any
Plan or otherwise, to provide any employee or former employee with any
postretirement, medical, life or other welfare benefit, except as required by
Section 4980B of the IRC. The Internal Revenue Service has issued, with respect
to each Plan and each related trust agreement, annuity contractor other funding
instrument which is intended to be qualified and tax-exempt under the provisions
of Sections 401(a) and 501(a) of the IRC, respectively, a favorable
determination letter with respect to such qualification and tax-exempt status
for all periods from the effective date of each Plan to date. The Company has no
<PAGE>
knowledge of any facts which exist or any events which have occurred that would
adversely effect such qualification and tax-exempt status. All contributions
required to be made to any Plan by any Group Entity have been made when due on a
timely basis. No Group Entity is or at any time has been a member of a
"controlled group of corporations" with or under "common control" with any
corporation or any trades or businesses other than with one or more Group
Entities. With the exception of the Employee Assistance Service, Inc. Employee
Assistance Program, all Plans set forth in Section 4.14(a)(6) of the Company
Disclosure Schedule are terminable on not more than 60 days' notice without
liability.
(b) True and complete copies of each of the following documents have been made
available by the Company with respect to each Plan: (i) each Plan document (and,
if applicable, related trust agreements) and all amendments thereto, all written
interpretations thereof and written descriptions thereof which have been
distributed to the employees of any Group Entity, (ii) for the three (3) most
recent Plan years, Annual Reports on Form 5500 Series filed with any
governmental agency for each Plan which is subject to such filing requirement
and (iii) the most recent determination letter issued by the Internal Revenue
Service for each Plan which is intended to be qualified under Section 401(a) of
the IRC.
(c) Section 4.14(c) of the Company Disclosure Schedule sets forth, opposite the
name of each employee of the Company who may be eligible to receive severance
payments under the Company's severance policy, an agreement (whether oral or
written) with the Company or otherwise, the amount of such severance to which
the applicable employee may be entitled.
4.15. Licenses; Accreditation and Regulatory Approvals.
To the Company's knowledge, the Group Entities hold all material licenses,
permits, franchises, certificates of need and other governmental or regulatory
authorizations and approvals which are needed or required by Law with respect to
their businesses, operations and facilities as they are currently owned or
presently conducted (collectively, the "Licenses"). All such material Licenses
are in full force and effect and each Group Entity is in compliance in all
material respects with all conditions and requirements of the Licenses and with
all rules and regulations relating thereto, except as set forth in Section 4.15
of the Company Disclosure Schedule. No such License has been revoked,
conditioned or restricted except as for customary conditions or restrictions or
as can be cured by a Group Entity within the period allowed by the applicable
Governmental Authority for such cure without having a Material Adverse Effect
upon the Company or its business, and no Action is pending, or to the Company's
knowledge, threatened which in any way challenges the validity of, or seeks to
revoke, condition or restrict any such License. Except as set forth in Section
<PAGE>
4.15 of the Company Disclosure Schedule, no transfer of any material License is
necessary to allow the Surviving Corporation to continue after the Effective
Time to operate the Company's facilities as presently operated.
4.16. Absence of Certain Changes or Events.
Except as set forth in Section 4.16 of the Company Disclosure Schedule, since
the Latest Statement Date to the date of this Agreement there has not been:
(a) any material damage, destruction or loss (whether or not covered by
insurance) with respect to any material assets of any Group Entity;
(b) any change by any Group Entity in its accounting methods, principles or
practices, other than such changes required by GAAP;
(c) any (i) increase in the compensation payable or to become payable to any
member of the Board of Directors, officer or employee, except for increases in
salary or wages payable or to become payable in the ordinary course of business
and consistent with past practice to employees of such Group Entity who are not
members of the Board of Directors or officers of such Group Entity; (ii) grant
of any severance or termination pay (other than pursuant to the normal severance
policy of such Group Entity as in effect on the date of this Agreement) to, or
entry into any employment or severance agreement with, any member of the Board
of Directors, officer or employee; or (iii) promise of an increase in the
benefits under, or the establishment or amendment of, any bonus, insurance,
severance, deferred compensation, pension, retirement, profit sharing, stock
option (including, without limitation, the granting of stock options, stock
appreciation rights, performance awards or restricted stock awards), stock
purchase or other employee benefit plan (except as may be contractually required
under Law), or promise of any other increase in the compensation payable or to
become payable to members of the Board of Directors, officers or employees of
any Group Entity, except for increases in salaries or wages payable or to become
payable in the ordinary course of business and consistent with past practice to
employees of any Group Entity who are not members of the Board of Directors or
officers of any Group Entity and that in the aggregate have not resulted in or
will not result in a material increase in the benefits or compensation expense
of any Group Entity;
(d) any transaction or contract material to the Group Entities taken as a whole,
or any commitment to do the same, entered into by any Group Entity (other than
in the ordinary course of business and consistent with past practice) or any
material changes in the customary method of operations of any Group Entity,
including, without limitation, practices and policies relating to marketing,
selling and pricing;
<PAGE>
(e) any transfer, Encumbrance, lease, sublease, license or other disposition by
any Group Entity of any of its assets and any action described in Section 8.2(f)
hereof, other than in the ordinary course of business and consistent with past
practice and not material in the aggregate;
(f) any writing down, in accordance with GAAP and consistent with past practice,
of the value of any inventories or accounts receivable or any revaluation by any
Group Entity of any of its assets or any cancellation or writing off as
worthless and uncollectable of any debt, note or account receivable by any Group
Entity, or any waiver by any Group Entity of a right of substantial value;
(g) to the Company's knowledge, any cancellation, termination, waiver,
modification, release or relinquishment by any party (including a Group Entity)
to a Material Contract (excluding customer contracts), or, to the Company's
knowledge, any receipt by any Group Entity of notice that any such Material
Contract to which any Group Entity is a party has been or will be canceled, or
that any services provided or to be provided thereunder by any Group Entity will
be discontinued;
(h) any individual capital expenditure by any Group Entity or commitment to make
such capital expenditure in excess of $25,000, except in the ordinary course of
business and consistent with past practice;
(i) any payment or incurring of liability to pay any Taxes, assessments, fees,
penalties, interest or other governmental charges other than those arising and
discharged or to be discharged in the ordinary course of business and consistent
with past practice;
(j) any loans, advances or capital contributions made by any Group Entity to, or
investments by any such party in, any person or entity (other than another
wholly-owned Group Entity, as to which the uses of the transferred cash or
property are not subject to restrictions greater than those imposed prior to
such transfer), including, without limitation, to any employee, officer or
member of the Board of Directors of any Group Entity;
(k) any incurring or guarantee of indebtedness by any Group Entity or commitment
to incur or guarantee indebtedness, or of liabilities (except in the ordinary
course of business), by any Group Entity exceeding $50,000 in the aggregate,
other than as described in Section 4.16(h), above, and other than as may be
incurred in the ordinary course of business under the revolving credit agreement
for working capital purposes;
(l) any failure to maintain the Group Entity plant, property and equipment in
good repair and operating condition, ordinary wear and tear excepted;
<PAGE>
(m) any failure to pay any creditor any material amount owed to such creditor,
or to discharge any material obligation, when such payment or discharge is due
or within 30 days of such date, except where such obligation is contested in
good faith by a Group Entity;
(n) any declaration, setting aside or payment of dividends or distributions in
respect of any Equity Interests of any Group Entity (other than to a
wholly-owned Group Entity, as to which the uses of the transferred cash or
property are not subject to restrictions greater than those imposed prior to
such transfer) or any redemption, purchase or other acquisition of any Equity
Interests or other securities of any Group Entity;
(o) any issuance by any Group Entity of any share of capital stock, bond, note,
option, warrant or other corporate security (other than option exercises for
Company Common Stock), or other action described in Section 8.2(d) hereof;
(p) any acquisition of assets by any Group Entity of any corporation,
partnership or other business organization or division thereof, or any other
action described in Section 8.2(e) hereof;
(q) any (i) reorganization or recapitalization of any Group Entity other than
the Company; or (ii) split, combination or reclassification of any of the
capital stock or issue or authorize or propose the issuance of any other
securities in respect of, in lieu of or in substitution for, shares of capital
stock, of any Group Entity other than the Company;
(r) a Material Adverse Change with respect to the Company; or
(s) any authorization, approval, agreement or commitment by any Group Entity to
take any action described in clauses (a) through (q) above.
4.17. Personal Property; Information Systems.
(a) The Group Entities collectively own, have a valid leasehold interest in, or
have legal right to use, all of the tangible personal property necessary to
carry on the business of the Group Entities as presently conducted, free and
clear of all Encumbrances except for (i) Encumbrances for inchoate mechanics'
and materialmens' liens for construction in progress and workmens', repairmens',
warehousemens' and carriers' liens arising in the ordinary course of business,
(ii) Encumbrances for Taxes not yet payable, (iii) Encumbrances arising out of,
under, or in connection with, this Agreement and (iv) Encumbrances set forth in
Section 4.17 of the Company Disclosure Schedule arising in connection with the
Company's revolving credit agreement (collectively, "Permitted Encumbrances").
(b) The operating and applications computer programs and data bases ("Software")
<PAGE>
which the Group Entities currently use or have available for use are adequate
and sufficient to service their existing customers on the date hereof through
the end of the current term of the contracts with such customers. All such
Software is owned outright by a Group Entity or, if not owned by a Group Entity,
a Group Entity has the right to use the same pursuant to valid licenses
therefor. None of the Software owned by a Group Entity and, to the Company's
knowledge, none of the Software licensed by a Group Entity, infringes upon or
violates any patent, copyright, trade secret or other property right of any
other Person.
(c) The central processing units, monitors, printers and other computer-related
hardware ("Hardware") which the Group Entities currently use or have available
for use are adequate and sufficient to service their existing customers on the
date hereof through the end of the current term of the contracts with such
customers. All such Hardware is owned outright by a Group Entity or, if not
owned by a Group Entity, a Group Entity has the right to use the same pursuant
to valid licenses therefor.
4.18. Real Property.
(a) No Group Entity owns any real property.
(b) Section 4.18(b) of the Company Disclosure Schedule lists each parcel of real
property leased by each Group Entity, as tenant (collectively, "Leased Real
Property"), together with a description of the approximate square footage of
each parcel of Leased Real Property and the initial and renewal terms under the
applicable Lease with respect to each parcel of Leased Real Property. Except as
set forth in Section 4.18(b) of the Company Disclosure Schedule, each Group
Entity party to the respective leases for the Leased Real Property (the
"Leases") (i) has a valid and subsisting leasehold interest in each Lease, (ii)
has not subleased or assigned any interest in any such Lease and (iii) has not
received any written notice of material default under any such Lease which is
still in effect.
4.19. Customers.
Section 4.10(a)(ii) of the Company Disclosure Schedule contains a complete and
accurate list, as of the date of this Agreement, of each customer of each Group
Entity, and the amount of revenue generated for each such customer during the
twelve month period ended December 31, 1996 and during the four-month period
ended April 30, 1997. No Group Entity has received any notice, and the Company
has no knowledge, that any customer of any Group Entity has ceased, or will
cease, to use the services of such Group Entity, or that any customer of any
Group Entity has reduced, or will reduce, the use of such services at any time
or has threatened to do so. Except as set forth in Sections 4.10(a) and (b) of
<PAGE>
the Company Disclosure Schedule, no Group Entity has received notice from any
existing customer of any Group Entity requesting, nor does the Company have
knowledge of an intention by any existing customer to request, that any Group
Entity grant price concessions, rebates or reductions on products or services
provided by such Group Entity, or any other modification of any contract with a
Group Entity that has had, or could reasonably be expected to have, a Material
Adverse Effect upon the economic benefits of the relationship with such customer
(collectively, "Customer Modifications"). Section 4.19 of the Company Disclosure
Schedules sets forth the Company's treatment (i.e., deferral, expensing and
amortization) during the fiscal years 1995 and 1996 and the period ending April
30, 1997 of start-up costs for each customer contract listed in Section
4.10(a)(ii) of the Company Disclosure Schedule.
4.20. Receivables; IBNR Claims.
The accounts receivable of any Group Entity reflected on the Consolidated
Balance Sheet as of May 31, 1997 have arisen in the ordinary course of business
and represent bona fide claims of a Group Entity against debtors for sales made,
services performed or other charges arising on or before the date hereof, are
not subject to valid claims of set-off or other defenses or counterclaims, and,
subject to the reserves therefor set forth on such balance sheet (which have
been recorded on a consistent basis in a manner consistent with GAAP), will be
collectible in the ordinary course of business, without resort to litigation or
extraordinary collection activity. All items which are required by GAAP to be
reflected as accounts receivable on the Latest Company Financial Statements and
the Consolidated Balance Sheet as of May 31, 1997 and the books and records of
any Group Entity are so reflected. The reserves for "incurred but not reported"
claims ("IBNR Claims") reflected on the Company Financial Statements for the
fiscal year ended December 31, 1996 and the month ended immediately preceding
the Closing Date are and will be adequate and sufficient, and were determined in
accordance with the Company's customary internal accounting practices with
respect to reserves for IBNR Claims. Set forth in Section 4.20 of the Company
Disclosure Schedule is the Company's IBNR "cushion" as of May 31, 1997, as well
as changes in such IBNR "cushion" during the period commencing on January 1,
1997 and ending on May 31, 1997.
4.21. Transactions with Affiliates.
Except as disclosed in Section 4.21 of the Company Disclosure Schedule, from the
Latest Statement Date to the date of this Agreement, there have been no material
transactions, contracts or arrangements between any Group Entity, on the one
hand, and (i) the Company or any of its Affiliates (other than a wholly-owned
Group Entity, except any transaction which will result in any cash or property
transferred in any such transaction becoming more restricted as to use or
disposition than it was prior to such transaction), (ii) any member of the Board
<PAGE>
of Directors or officer of the Company or any of its Affiliates, (iii) any
holder of Company Equity Interests or (iv) any member of the immediate family of
any individual described in (i), (ii) or (iii), on the other hand. As used in
this Agreement, "Affiliate" means, when used with respect to a specified party,
another party that, either directly or indirectly through one or more
intermediaries, controls or is controlled by or is under common control with the
party specified.
4.22. Restricted Cash.
Except as set forth in Section 4.22 of the Company Disclosure Schedule, there
are no regulatory or contractual restrictions on the ability of any Group Entity
to freely transfer its cash and cash equivalents.
4.23. Commissions and Fees.
The Company has not employed any investment banker, broker, finder, consultant
or intermediary in connection with the transactions contemplated by this
Agreement which would be entitled to any investment banking, brokerage, finder's
or similar fees or commissions in connection with this Agreement or the
transactions contemplated hereby payable by the Company, except for the fees of
Merrill Lynch & Co. as set forth on Exhibit 3.1(b) hereto.
4.24. Environmental Matters.
No Group Entity is currently Handling, nor in the past has Handled, any
Materials of Environmental Concern in any material quantity at, on or from any
property or facility owned, leased, operated or occupied by any of them,
including any previously owned, leased, operated or occupied property or
facility. To the Company's knowledge, no Group Entity is the subject of any
federal, state, local or foreign investigation, and no Group Entity has received
any written notice or claim, or entered into any negotiations or agreements with
any third party, relating to any liability or remedial action or potential
liability or remedial action under Environmental Laws, and there are no pending
or, to the Company's knowledge, threatened actions, suits or proceedings against
or affecting the Group Entities, or their properties, assets or operations, in
connection with any such Environmental Laws that if adversely determined, might
result in any Material Adverse Change in the Group Entities. There are no past
or present Environmental Conditions that are, to the Company's knowledge, likely
to form the basis of any claim under existing law against them which might
result in any Material Adverse Change of the Group Entities. The term "Handling"
or "Handled" means the production, use, generation, storage, treatment,
recycling, disposal, discharge, release, processing, distribution, transport or
other handling or disposition of any kind. The term "Environmental Laws" means
all federal, state, local or foreign statutes, ordinances, regulations, rules,
<PAGE>
judgments, orders, notice requirements, court decisions, agency guidelines or
principles of law, as they may be hereinafter amended from time to time, that
(i) regulate or relate to the protection, investigation, remediation or clean-up
of the environment or the Handling of any Material of Environmental Concern, the
preservation or protection of waterways, groundwater, drinking water, air,
wildlife, plants or other natural resource, or the health and safety of persons
or property (including without limitation occupational safety and health), or
(ii) impose or create liability or responsibility with respect to any of the
foregoing. The term "Environmental Condition" means any occurrence, fact or
other condition at any location in, on, about or beneath any property owned,
leased, operated or otherwise occupied by any Group Entity, including any
previously owned, leased or occupied property, resulting from, relating to or
arising out of the presence, emission, exposure, migration, dispersal or
threatened release, spill, leak, escape into the environment, or Handling of any
Material of Environmental Concern. The term "Material of Environmental Concern"
means any substance that is regulated by or forms the basis for liability under
any applicable Environmental Laws.
4.25. Labor Matters.
No Group Entity is a party to any labor agreement with respect to its employees
with any labor organization, group or association nor, to the knowledge of the
Company, within the last year, have there been attempts to organize. Except as
set forth in Section 4.25 of the Company Disclosure Schedule, there is no
complaint, charge or claim pending or, to the knowledge of the Company,
threatened against any Group Entity with any Governmental Authority, arising out
of, in connection with, or otherwise relating to the employment by any Group
Entity of any individual.
4.26. Disclosure.
None of the representations, warranties or statements by the Company in this
Agreement contains or will contain any untrue statement of a material fact, or
omits or will omit to state any material fact necessary to make the statements
or facts contained herein not misleading. To the Company's knowledge, there is
no fact in existence which has, or is reasonably likely to have, a Material
Adverse Effect on the Company or the due performance by the Company of its
obligations hereunder, which has not been expressly set forth in this Agreement,
or in the other documents described herein.
ARTICLE V.
REPRESENTATIONS AND WARRANTIES
<PAGE>
OF MERGER SUB AND PARENT
Merger Sub and Parent, jointly and severally, hereby represent and
warrant to the Company as follows:
5.1. Organization. Existence and Capital Stock.
Merger Sub is a corporation duly organized and validly existing and is in good
standing under the laws of the State of Delaware. The authorized capital of
Merger Sub consists of l,000 shares of common stock, par value $.01 per share
("Merger Sub Common Stock"), all of which shares are issued and registered in
the name of Parent.
5.2. Power and Authority.
Merger Sub has all necessary corporate power and authority to execute, deliver
and perform this Agreement and to consummate the transactions contemplated
hereby, and has taken all action required by Law, its charter, Bylaws or
otherwise, to authorize the execution, delivery and performance of this
Agreement and the consummation of the transactions contemplated hereby. The
execution and delivery of this Agreement by Merger Sub, performance of its
obligations hereunder and consummation of the transactions contemplated hereby
have been duly authorized by all necessary corporate action on the part of
Merger Sub and Parent. This Agreement has been duly executed and delivered by
Merger Sub and, assuming this Agreement constitutes a valid and binding
obligation of the Company, constitutes a valid and binding obligation of Merger
Sub, enforceable against Merger Sub in accordance with its terms except that the
enforcement hereof may be limited by (a) bankruptcy, insolvency, reorganization,
moratorium or other similar laws now or hereafter in effect relating to
creditors' rights generally and (b) general principles of equity (regardless of
whether enforceability is considered in a proceeding in equity or at law).
5.3. Consents and Approvals; No Violation.
Neither the execution and delivery of this Agreement nor the consummation by
Merger Sub of the transactions contemplated hereby will (a) violate, conflict
with or result in any breach of any provision of the charter or Bylaws of Merger
Sub, (b) violate any Laws applicable to Merger Sub, (c) conflict with or result
in a breach of any provision of, or constitute a default (or an event which,
with notice or lapse of time or both, would constitute a default) under or give
to others any rights of termination, amendment, acceleration, suspension,
revocation or cancellation of, or result in any Encumbrance on the properties or
assets of Merger Sub pursuant to, (i) any material agreement, contract or other
instrument binding upon Merger Sub or (ii) any material license, franchise,
permit or other similar authorization held by Merger Sub or (d) require any
<PAGE>
consent, approval or authorization of, notice or declaration to, or filing or
registration with, any Governmental Authority, except (1) pursuant to applicable
requirements, if any, of the MGCL, the DGCL and the HSR Act, or (2) as would
not, if not so obtained, (A) have a Material Adverse Effect upon Merger Sub or
(B) prevent or materially interfere with the consummation of the transactions
contemplated hereby.
5.4. Legal Proceedings.
On the date hereof, there are no Actions pending or, to Merger Sub's knowledge,
threatened against, Merger Sub, at law or in equity, relating to the Merger.
5.5. No Prior Activities.
Merger Sub is not a party to any material agreements and has not conducted any
activities other than in connection with the organization of Merger Sub, the
negotiation and execution of this Agreement and the consummation of the
transactions contemplated hereby. Merger Sub has no subsidiaries.
ARTICLE VI.
REPRESENTATIONS AND WARRANTIES OF PARENT
Parent hereby represents and warrants to the Company as follows:
6.1. Organization. Existence and Good Standing.
Parent is a corporation duly organized and validly existing and is in good
standing under the laws of the State of Delaware. Parent has all necessary
corporate power to own its properties and assets and to carry on its business as
presently conducted and is duly qualified to do business and is in good standing
in all jurisdictions in which the character of the property owned, leased or
operated or the nature of the business transacted by it makes qualification
necessary, except where the failure to be in good standing or qualify would not
have a Material Adverse Effect on Parent.
6.2. Power and Authority.
Parent has all necessary corporate power and authority to execute, deliver and
perform this Agreement and to consummate the transactions contemplated hereby
and has taken all corporate actions required to authorize the execution,
delivery and performance of this Agreement and the consummation of the
transactions contemplated hereby. The execution and delivery of this Agreement
has been approved by the Board of Directors of Parent. This Agreement has been
duly executed and delivered by Parent and Merger Sub and, assuming this
<PAGE>
Agreement constitutes a valid and binding obligation of the Company, constitutes
a valid and binding obligation of Parent and Merger Sub, enforceable against
Parent and Merger Sub in accordance with its terms except that the enforcement
hereof may be limited by (a) bankruptcy, insolvency, reorganization, moratorium
or other similar laws now or hereafter in effect relating to creditors' rights
generally and (b) general principles of equity (regardless of whether
enforceability is considered in a proceeding in equity or at law).
6.3. Financing.
Parent has provided true and complete copies of all commitment letters for the
benefit of Parent (the "Commitment Letters") relating to the Merger and the
transactions contemplated thereby. The financing outlined in the Commitment
Letters is sufficient, assuming funding of such amounts, to pay the portion of
the Merger Consideration payable under Section 3.1(b)(i) in connection with the
transactions contemplated hereby.
6.4. Legal Proceedings.
On the date hereof, there are no Actions pending or, to Parent's knowledge,
threatened against Parent, at law or in equity, relating to the Merger.
6.5. Consents and Approvals; No Violation.
Neither the execution and delivery of this Agreement nor the consummation by
Parent of the transactions contemplated hereby will (a) violate, conflict with
or result in any breach of any provision of the respective organizational
documents of Parent, (b) violate any Law applicable to Parent, (c) conflict with
or result in a breach of any provision of, or constitute a default (or an event
which, with notice or lapse of time or both, would constitute a default) under,
or give to others any rights of termination, amendment, acceleration,
suspension, revocation or cancellation of, or result in any Encumbrance on the
shares of Parent's capital stock or the properties or assets of Parent pursuant
to, (i) any material agreement, contract or other instrument binding upon Parent
or (ii) any material license, franchise, permit or other similar authorization
held by Parent, or (d) require any consent, approval or authorization of, notice
or declaration to, or filing or registration with, any Governmental Authority,
except (1) pursuant to applicable requirements, if any, of the MGCL, the DGCL
and the HSR Act, or (2) as would not, if not so obtained, (A) have a Material
Adverse Effect upon Parent or (B) prevent or materially interfere with the
consummation of the transactions contemplated hereby.
6.6. Parent Capital Stock.
Parent's authorized capital stock consists of 40,000,000 shares of Parent Common
<PAGE>
Stock, of which 28,559,800 shares are issued and outstanding on the date hereof,
and 1,000,000 shares of preferred stock, par value $.01 per share ("Parent
Preferred Stock"), of which no shares are issued and outstanding on the date
hereof. Such shares constitute all of the issued and outstanding shares of
capital stock of Parent. All of the issued and outstanding shares of Parent
Common Stock are duly and validly issued, fully paid and nonassessable and were
not issued in violation of any preemptive rights. All of the Parent Shares, if
and when issued in accordance with Section 3.7 hereof, will be duly and validly
issued, fully paid and nonassessable, and will not be issued in violation of any
preemptive rights. Parent has authorized options to acquire 9,561,000 shares of
Parent Common Stock under its 1995 Stock Purchase and Option Plan for Employees
of Merit Behavioral Care Corporation and Subsidiaries and its 1996 Employee
Stock Option Plan of Merit Behavioral Care Corporation, of which options to
acquire not more than 7,000,000 shares of Parent Common Stock are issued and
outstanding on the date hereof.
6.7. SEC Documents; No Material Adverse Change.
The Parent has filed all forms, reports, statements and other documents required
to be filed by it with the Securities and Exchange Commission ("SEC") since
March 20, 1996 (such forms, reports, statements and other documents are referred
to herein as the "Parent SEC Documents"). The Parent SEC Documents filed by
Parent with the SEC prior to and after the date of this Agreement (i) complied,
or will comply, when filed, in all material respects with the applicable
requirements of GAAP, the Securities Act of 1933, as amended, the Securities
Exchange Act of 1934, as amended, and the rules and regulations thereunder, and
(ii) did not, or will not, when filed, contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading. Since December 31,
1996, there has been no Material Adverse Change with respect to Parent not
disclosed in the Parent SEC Documents.
ARTICLE VII.
ACCESS TO INFORMATION AND DOCUMENTS
7.1. Access to Information.
Between the date hereof and the Closing Date, the Company will, and will cause
each Group Entity (other than an Unaffiliated Entity) and their respective
officers, stockholders, employees, accountants, counsel, financial advisors and
other representatives (collectively, the "Company Parties") to provide Parent
and its Affiliates, officers, employees, stockholders, subsidiaries, counsel,
accountants, financing sources, financial advisors and other representatives
<PAGE>
(collectively, the "Parent Representatives") full access, at reasonable times,
to all the properties, documents, contracts, personnel files and other records
of the Company Parties and shall furnish the Parent Representatives with access
to the employees of such Company Parties and copies of such documents and with
such information with respect to the affairs of such Company Parties as the
Parent Representatives may from time to time reasonably request. Each Company
Party will disclose and make available to the Parent Representatives all books,
contracts, accounts, personnel records, letters of intent, papers, records,
communications with Governmental Authorities and other documents relating to the
business and operations of such Company Party. All information disclosed by any
Company Party shall be deemed to be "Confidential Information" under the terms
of the Confidentiality Agreement dated March 28, 1997, between the Company and
Parent (the "Confidentiality Agreement"). No investigation pursuant to this
Section 7.1 shall affect any representations or warranties of the parties herein
or the conditions to the obligations of the parties hereto.
ARTICLE VIII.
COVENANTS OF THE COMPANY
8.1. Affirmative Covenants.
Unless otherwise expressly contemplated by this Agreement, or consented to in
writing by Parent, the Company hereby covenants and agrees to, the Company
hereby covenants and agrees to cause each Group Entity other than an
Unaffiliated Entity to, and the Company hereby covenants and agrees to use its
best efforts to cause each Unaffiliated Entity to, between the date hereof and
the Effective Time:
(a) operate the business of such Group Entity only in the usual, regular and
ordinary course consistent with past practice;
(b) use reasonable efforts to preserve intact the business organization and
assets, maintain the rights and franchises, retain the services of the
respective officers, key employees and consultants, and maintain the
relationships with the respective customers and suppliers of the business of
such Group Entity;
(c) maintain and keep the properties and assets of such Group Entity in as good
repair and condition as at present in all material respects, ordinary wear and
tear excepted;
(d) keep in full force and effect insurance and bonds comparable in amount and
scope of coverage to that currently maintained by such Group Entity;
<PAGE>
(e) perform in all material respects all obligations required to be performed
under all Material Contracts, leases, contracts and documents relating to or
affecting the assets, properties or operations of such Group Entity;
(f) comply with and perform in all material respects all obligations and duties
imposed by all applicable Laws;
(g) maintain the books, accounts and records of such Group Entity in the usual,
regular and ordinary manner on a basis consistent with past practice;
(h) deliver to Parent, within fifteen (15) business days after the end of each
calendar month, an unaudited, consolidated balance sheet, statement of
operations, statement of stockholders' equity and cash flow statement for the
Company for such month just ended (the "Subsequent Company Financial
Statements"), schedules showing the results of operations and variances in
revenue for each of the items set forth therein (the "Subsequent Supplemental
Schedules"), and within 45 days after the end of each fiscal quarter, an
unaudited, condensed balance sheet, statement of operations, statement of
stockholders' equity and cash flow statement for the Company for such fiscal
quarter just ended;
(i) notify Parent of any material Action commenced by or against such Group
Entity or any Actions commenced or threatened which relate to the transactions
contemplated by this Agreement;
(j) consult with Parent as to additional expenditures with respect to any Group
Entity's information systems exceeding $100,000 in the aggregate;
(k) through its Board of Directors, recommend to the holders of Company Common
Stock at the meeting noticed as described in Section 4.5(b) hereof and scheduled
to occur on or about July 29, 1997, approval of the Merger, this Agreement and
the transactions contemplated thereby and hereby, and take all other necessary
and appropriate action to properly notice and convene such meeting and obtain
the Stockholder Approvals. In connection with such meeting, the Company shall
provide to Parent and its counsel drafts of, and accept (pursuant to the
reasonable requests of Parent), Parent's comments on and revisions to, the
disclosure materials to be provided to the holders of Company Common Stock and
Company Preferred Stock in connection with such meeting;
(l) obtain the approval described in Section 12.2(m), at the meeting noticed as
described in Section 4.5(b) hereof and scheduled to occur on or about July 29,
1997; and
(m) use reasonable efforts, in connection with the payment described in Section
9.2, to arrange for evidence of the full and complete satisfaction of the debt
<PAGE>
owed to NationsBank, N.A. and the release of any related guarantees (the
"Existing Debt"), which satisfaction and release shall occur at the Effective
Time.
8.2. Negative Covenants.
Unless otherwise expressly contemplated by this Agreement, consented to in
writing by Parent or disclosed in Section 8.2 of the Company Disclosure
Schedule, the Company hereby covenants and agrees not to, the Company hereby
covenants and agrees not to permit any Group Entity other than an Unaffiliated
Entity to, and the Company hereby covenants and agrees to use its best efforts
to cause each Unaffiliated Entity not to, do any of the following between the
date hereof and the Effective Time:
(a) (i) increase the compensation payable or to become payable to any member of
the Board of Directors or Board of Managers, officer or employee, except for
increases in salary or wages payable or to become payable in the ordinary course
of business and consistent with past practice to employees of such Group Entity
who are not members of the Board of Directors or Board of Managers or officers
of such Group Entity; (ii) grant any severance or termination pay (other than
pursuant to the normal severance policy of such Group Entity as in effect on the
date of this Agreement) to, or enter into any employment or severance agreement
with, any member of the Board of Directors or Board of Managers, officer or
employee; or (iii) grant, promise an increase in benefits under, establish or
amend, or pay any bonus, insurance, deferred compensation, pension, retirement,
profit sharing, stock option (including, without limitation, the granting of
stock options, stock appreciation rights, performance awards or restricted stock
awards), stock purchase or other similar employee benefit plans or arrangements
in respect of members of the Board of Directors or Board of Managers, officers
or employees of such Group Entity, except to the extent that such Group Entities
are, on the date hereof, contractually obligated or required by Law to do so;
(b) declare, set aside or pay any dividend on, or make or incur any obligation
to make any other distribution in respect of, outstanding Equity Interests of
such Group Entity or effect any other payment or distribution to the holders of
Company Equity Interests, except any dividend or distribution to a wholly-owned
Group Entity of the respective Group Entity which will result in the cash or
other property so transferred becoming more restricted as to use or disposition
than it was prior to such dividend or distribution;
(c) (i) redeem, purchase or otherwise acquire any shares of capital stock or
other equity interests or any securities or obligations convertible or
exchangeable for any shares of capital stock or other equity interests, or any
options, warrants or conversion or other rights to acquire any shares of the
capital stock, equity interests or any such securities or obligations, in each
<PAGE>
case of such Group Entity; (ii) effect any reorganization or recapitalization;
or (iii) split, combine or reclassify any of the capital stock or issue or
authorize or propose the issuance of any other securities in respect of, in lieu
of or in substitution for, shares of capital stock, in each case of such Group
Entity;
(d) issue, deliver, award, grant or sell, or authorize or propose the issuance,
delivery, award, grant or sale (including the grant of any Encumbrances,
limitations on voting rights or other encumbrances) of, any shares of any class
of capital stock or other equity interests (including shares held in treasury),
any securities convertible into or exercisable or exchangeable for any such
shares or other equity interests, or any rights, warrants or options to acquire,
any such shares or other equity interests, of such Group Entity (except for the
issuance of shares of Company Common Stock upon exercise of options outstanding
on the date hereof) or amend or otherwise modify the terms of any such rights,
warrants or options, the effect of which shall be favorable to the holders
thereof;
(e) acquire or agree to acquire, by merging or consolidating with, by purchasing
an equity interest in or a portion of the assets of, or by any other manner, any
business or any corporation, partnership, association or other business
organization or division thereof, or otherwise acquire or agree to acquire any
assets of any other person (other than the purchase of assets from suppliers or
vendors in the ordinary course of business and consistent with past practice);
(f) sell, lease, exchange, mortgage, pledge, transfer or otherwise dispose of,
or agree (or solicit any inquiries or proposals or enter into any discussions or
negotiations) to sell, lease, exchange, mortgage, pledge, transfer or otherwise
dispose of, any of the properties or assets of such Group Entity (including,
without limitation, any Equity Interest in a Group Entity) or cancel, release or
assign any indebtedness owed to or any claims held by such Group Entity, except
for dispositions of immaterial assets in the ordinary course of business and
consistent with past practice;
(g) propose or adopt any amendments to the articles of organization or bylaws or
equivalent organizational documents of such Group Entity, other than as
contemplated by Article II hereof;
(h) (i) change any methods of accounting in effect at December 31, 1996, (ii)
make or rescind any express or deemed election relating to Taxes, settle or
compromise any claim, action, suit, litigation, proceeding, arbitration,
investigation, audit or controversy relating to Taxes, or change any methods of
reporting income or deductions for federal income Tax purposes from those
employed in the preparation of the federal income Tax returns for the taxable
year ending December 31, 1995, except as may be required by applicable Law or
<PAGE>
(iii) file any income or franchise tax returns without first submitting such
returns to Parent for its review, and unless Parent provides its prior written
consent, which consent shall not be unreasonably withheld, file its 1996 federal
and state income tax returns prior to the fifth business day before the due date
of such returns, with extensions;
(i) incur any indebtedness for borrowed money or purchase money indebtedness
(other than in connection with the acquisition of fixed assets in the ordinary
course of business which do not exceed $100,000 in the aggregate), or assume,
guarantee, endorse or otherwise become responsible for indebtedness of any other
person, or make any loans or advances to any person;
(j) enter into any contract material to the Company;
(k) terminate, modify or amend any Material Contract, Lease, License, or other
contract or commitment, except in the ordinary course of business and not
involving a material increase in liability or reduction in revenue, settle or
otherwise resolve any financial issue, claim or adjustment under any such
Material Contract, Lease, License, or other contract or commitment (including,
without limitation, any resolution or settlement of the bid price adjustment of
OCHAMPUS described in Section 3.7(b)(ii) hereof), or make any payment or effect
any modification to any Material Contract, Lease or License in connection with
obtaining any consent or approval necessitated by the transactions contemplated
hereby (other than payments and modifications which, individually, and in the
aggregate, are immaterial);
(l) enter into any material transactions, agreements, or arrangements between
such Group Entity, on the one hand, and (i) the Company or any of its Affiliates
(other than wholly-owned Group Entities, except any transaction which will
result in any cash or property transferred in any such transaction becoming more
restricted as to use or disposition than it was prior to such transaction), (ii)
any member of the Board of Directors or Board of Managers or officer of the
Company or any of its Affiliates (other than wholly-owned Group Entities, except
any transaction which will result in any cash or property transferred in any
such transaction becoming more restricted as to use or disposition than it was
prior to such transaction), (iii) any holder of Company Equity Interests or (iv)
any member of the immediate family of any individual described in (i), (ii) or
(iii) on the other hand;
(m) settle or compromise any Action (i) for any amount in excess of $100,000 or
(ii) that involves any commitment or arrangement which has, or is reasonably
likely to have, a material effect on the prospects, operations, results of
operations, assets or condition (financial or otherwise) of the Group Entities,
taken as a whole;
<PAGE>
(n) make any payment in respect of any component of the Adjustment Amount
described on Exhibit 3.1(b) in excess of the amount specified for such component
on such Exhibit; or
(o) agree, authorize, approve or commit in writing or otherwise to do any of the
foregoing.
Notwithstanding the foregoing, the Company's actions and payments required under
Section 3.2 and the payment of the amounts set forth on Exhibit 3.1(b) shall not
be prohibited by the terms of this Section 8.2.
8.3. CHAMPUS 2/5 Subcontract.
The Company covenants that the definitive subcontract between Humana MHS and the
Company, dated June 26, 1997, relating to the provision of behavioral health
managed care services by the Company on behalf of Humana MHS with respect to
CHAMPUS Regions 2 and 5 (the "CHAMPUS 2/5 Subcontract"), attached hereto as
Exhibit 8.3, represents a legal, valid and binding agreement of the Company and
is in full force and effect as of the date hereof.
8.4. No Solicitations.
From the date hereof until the earlier of the Effective Time or the termination
of this Agreement in accordance with its terms (the "Acquisition Exclusivity
Period"), the Company hereby covenants and agrees not to, and agrees to cause
each other Group Entity other than an Unaffiliated Entity not to, permit any of
the members of their respective Boards of Directors or Board of Managers, or any
of their respective stockholders, officers, members, agents, advisors, counsel
or representatives (collectively, "Representatives") to, directly or indirectly,
(a) solicit or entertain any inquiries or proposals or enter into or continue
any discussion, negotiations or agreements relating to the sale or other
disposition of the Company (whether through a merger, reorganization, stock
purchase or otherwise) or its assets, properties, business or operations (a
"Proposed Acquisition") to or with any person or entity other than Parent or (b)
provide any assistance or any information to any person or entity other than
Parent relating to any Proposed Acquisition. The Company agrees that it will
immediately cease and cause to be terminated any existing activities,
discussions or negotiations with any parties (other than Parent) heretofore
conducted, or the provision by the Company or any Group Entity (other than an
Unaffiliated Entity) or their respective Representatives of information to any
party (other than Parent) to which information heretofore has been provided. If,
after the date hereof, the Company or any Group Entity (other than an
Unaffiliated Entity) receives any such inquiry or proposal or request for
information, or offer to discuss or negotiate any Proposed Acquisition, the
Company will immediately provide notice thereof to Parent.
<PAGE>
ARTICLE IX.
COVENANTS OF THE PARENT AND MERGER SUB
9.1. Financing.
Parent will use its reasonable efforts to obtain the financing necessary for the
consummation of the transactions contemplated hereby from a bank or banks or
other institutional lenders. The Company shall cooperate with, and provide all
necessary assistance to, Parent in connection with Parent's financing
contemplated under the Commitment Letters.
9.2. Existing Debt.
Parent shall, subject to the provisions of Section 9.1 and the Company's
fulfillment of its covenant in Section 8.1(m), at the Effective Time pay to
NationsBank, N.A. an amount required to fully and completely satisfy, retire and
release the Existing Debt.
ARTICLE X.
COVENANTS OF THE COMPANY, PARENT AND MERGER SUB
10.1. Public Disclosures.
Parent and the Company will consult with each other before issuing any press
release or otherwise making any public statement with respect to the
transactions contemplated by this Agreement, and shall not issue any such press
release or make any such public statement prior to such consultation, including
as may be required by applicable Law or requirements of the SEC.
10.2. Notification of Certain Matters.
The Company shall give prompt notice to Parent, and Parent shall give prompt
notice to the Company, of (i) the occurrence, or failure to occur, of any event
which occurrence or failure would be likely to cause any representation or
warranty contained in this Agreement to be untrue or inaccurate in any material
respect at any time from the date hereof to the Effective Time and (ii) any
material failure of the Company or Parent, as the case may be, or of any
Affiliate thereof, to comply with or satisfy any covenant, condition or
agreement to be complied with or satisfied by it hereunder; provided, however,
that no such notification shall affect the representations or warranties of the
parties or the conditions to the obligations of the parties hereunder.
10.3. Other Actions.
<PAGE>
None of the Company, Parent and Merger Sub shall knowingly or intentionally take
any action, or omit to take any action, if such action or omission would, or
reasonably might be expected to, result in any of its representations and
warranties set forth herein being or becoming untrue in any material respect, or
in any of the conditions to the Merger set forth in this Agreement not being
satisfied, or (unless such action or omission is required by applicable Law)
which would materially and negatively affect the ability of the Company or
Parent to obtain any consents or approvals required for the consummation of the
Merger or which would otherwise materially impair the ability of the Company or
Parent to consummate the Merger in accordance with the terms of this Agreement
or materially delay such consummation, in each case without consent of the other
party.
10.4. Regulatory and Other Authorizations; Consents.
Each party hereto shall use its commercially reasonable efforts to (a) take, or
cause to be taken, all appropriate action, and do, or cause to be done, all
things necessary, proper or advisable under applicable Law or otherwise to
promptly consummate and make effective the transactions contemplated by this
Agreement and (b) obtain all authorizations, consents, orders and approvals of,
and to give all notices to and make all filings with, all Governmental
Authorities and other third parties that may be or become necessary for its
execution and delivery of, and the performance of its obligations pursuant to,
this Agreement including, without limitation, those consents set forth in
Section 4.11(b) of the Company Disclosure Schedule. Each party will cooperate
fully with the other party in promptly seeking to obtain all such
authorizations, consents, orders and approvals, giving such notices, and making
such filings. In connection with obtaining such consents from third parties,
neither party shall be required to make payments, commence litigation or agree
to modifications of the terms thereof (other than payments and modifications
which individually, and in the aggregate, are immaterial), and no material
modification shall be made to any contract, agreement or other commitment of any
Group Entity without the prior written consent of Parent. Each party hereto
agrees to make an appropriate filing of a Notification and Report Form pursuant
to the HSR Act with respect to the transactions contemplated hereby as soon as
practicable following the date hereof and to supply promptly any additional
information and documentary material that may be requested pursuant to the HSR
Act. The parties hereto agree not to take any action that will have the effect
of unreasonably delaying, impairing or impeding the receipt of any required
authorizations, consents, orders or approvals. Prior to making any application
or filing with any Governmental Authority or other person or entity in
connection with this Agreement, the Company, on the one hand, and Parent, on the
other hand, shall provide the other with drafts thereof and afford the other a
reasonable opportunity to comment on such drafts. Without limiting the
generality of the preceding sentences, each of Parent and the Company agrees to
<PAGE>
cooperate and use all commercially reasonable efforts to vigorously contest and
resist any action, suit, proceeding or claim, and to have vacated, lifted,
reversed or overturned any injunction, order, judgment or decree (whether
temporary, preliminary or permanent), that delays, prevents or otherwise
restricts the consummation of the Merger or any other transaction contemplated
by this Agreement, and to take any and all actions as may be required by
Governmental Authorities as a condition to the granting of any such necessary
approvals or as may be required to avoid, vacate, lift, reverse or overturn any
injunction, order, judgment, decree or regulatory action (provided, however,
that in no event shall any party hereto take, or be required to take, any action
that would have a Material Adverse Effect on Parent or the Group Entities).
Notwithstanding the foregoing, in no event shall Parent be required at any time
from the date hereof through and following the Effective Time to dispose of the
assets, or divest the businesses, of Parent, any Group Entity or any of their
respective Affiliates.
10.5. Employee Transition Matters.
The parties hereto shall address certain matters concerning employees of Group
Entities as provided on Exhibit 10.5.
10.6. Escrow Agreement.
Pursuant to the terms of the Escrow Agreement, Parent shall have deposited an
amount equal to the Escrow Amount into the Escrow Account (as defined in the
Escrow Agreement).
ARTICLE XI.
TERMINATION, AMENDMENT AND WAIVER
11.1. Termination.
This Agreement may be terminated at any time prior to the Effective Time:
(a) by mutual written consent of Parent and the Company;
(b) by either Parent or the Company:
(i) if the Merger shall not have been consummated on or before the 75th day
after the date hereof , unless the failure to consummate the Merger is the
result of a willful and material breach of this Agreement by the party seeking
to terminate this Agreement or further, in the case of the Company, any breach
of a Stockholder Support Agreement by any stockholder which is a party thereto;
<PAGE>
(ii) if any Governmental Authority shall have issued an order, decree or ruling
or taken any other action permanently enjoining, restraining or otherwise
prohibiting the Merger and such order, decree, ruling or other action shall have
become final and nonappealable;
(iii) in the event of a breach by the other party of any representation,
warranty, covenant or other agreement contained in this Agreement which (A)
would give rise to the failure of a condition set forth in Article XII and (B)
has not been cured within 30 days after the giving of written notice to the
breaching party of such breach (a "Material Breach") (provided that the
terminating party is not then in Material Breach of any representation,
warranty, covenant or other agreement contained in this Agreement); or
(iv) in the event that (A) all of the conditions to the obligation of such party
to effect the Merger set forth in Section 12.1 shall have been satisfied and (B)
any condition to the obligation of such party to effect the Merger set forth in
Section 12.2 (in the case of Parent) or Section 12.3 (in the case of the
Company) is not capable of being satisfied prior to the end of the period
referred to in Section 11.1(b)(i); or
(c) by Parent, in the event of a breach by a stockholder of any representation,
warranty, covenant or other agreement contained in a Stockholder Support
Agreement which cannot be or has not been cured within 30 days after the giving
of written notice to the breaching stockholder of such breach.
11.2. Effect of Termination.
In the event of termination of this Agreement as provided in Section 11.1, this
Agreement shall forthwith become void and have no effect, without any liability
or obligation on the part of any party, other than the provisions of Sections
7.1 and 11.3 and this Section 11.2, and except to the extent that such
termination results from the willful and material breach by a party of any of
its representations, warranties, covenants or other agreements set forth in this
Agreement.
11.3. Expenses and Fees.
With the exception of the expenses and fees set forth on Exhibit 3.1(b) hereto
to be paid by the Company, all costs and expenses incurred in connection with
this Agreement and the transactions contemplated hereby shall be paid by the
party incurring such expense.
ARTICLE XII.
CONDITIONS TO CLOSING
<PAGE>
12.1. Mutual Conditions.
The respective obligations of each party to effect the Merger shall be subject
to the satisfaction, at or prior to the Closing Date, of the following
conditions (any of which may be waived in writing by Parent and the Company):
(a) None of Parent, Merger Sub or the Company nor any of their respective
subsidiaries shall be subject to any order, decree or injunction by a
Governmental Authority which prevents or materially delays the consummation of
the Merger.
(b) No statute, rule, regulation, order, decree, judgment, injunction,
stipulation or determination shall have been enacted by any Governmental
Authority that makes the consummation of the Merger and any other transaction
contemplated hereby illegal.
12.2. Conditions to Obligations of Parent and Merger Sub.
The obligations of Parent and Merger Sub to consummate the Merger and the other
transactions contemplated hereby shall be subject to the satisfaction, at or
prior to the Closing Date, of the following conditions (any of which may be
waived by Parent or Merger Sub):
(a) Each of the agreements of the Company to be performed at or prior to the
Closing Date pursuant to the terms hereof shall have been duly performed in all
material respects, and the Company shall have performed, in all material
respects, all of the acts required to be performed by it at or prior to the
Closing Date by the terms hereof.
(b) The representations and warranties of the Company set forth in this
Agreement that are qualified as to materiality shall be true and correct, and
those that are not so qualified shall be true and correct in all material
respects, as of the date of this Agreement and as of the Closing as though made
at and as of such time, except to the extent such representations and warranties
expressly relate to an earlier date (in which case such representations and
warranties that are qualified as to materiality shall be true and correct, and
those that are not so qualified shall be true and correct in all material
respects, as of such earlier date).
(c) The applicable waiting period under the HSR Act shall have expired or been
terminated; and, except as set forth in Section 4.11(b) of the Company
Disclosure Schedule, all consents and approvals of Governmental Authorities
necessary for consummation of the transactions contemplated hereby and all
consents and approvals set forth on Section 4.11(b) of the Company Disclosure
Schedule shall have been obtained.
<PAGE>
(d) Neither Parent nor Merger Sub nor any of their respective Affiliates shall
be subject to any (i) Action brought by any third party challenging the
transactions contemplated hereby which would, if decided adversely to Parent or
any Group Entity, have a Material Adverse Effect on Parent or the Group
Entities, in either case, taken as a whole, on or after the Effective Time, or
(ii) order, decree or injunction by a Governmental Authority which would impose
any material limitation on the ability of Parent effectively to exercise full
rights of ownership of, or control over, the common stock of the Surviving
Corporation or any material portion of the assets or business of the Group
Entities, taken as a whole.
(e) Parent and/or Merger Sub shall have obtained the financing set forth in the
Commitment Letters on the terms set forth in such Commitment Letters and other
terms reasonably acceptable to Parent, and such financing has been funded on
such terms.
(f) The Stockholder Support Agreements shall be in full force and effect in
accordance with their terms. The parties to the Stockholder Support Agreements
shall have performed and complied with all covenants and agreements required to
be performed or complied with therein by such parties.
(g) Holders of not more than 5% (excluding outstanding shares of Company Common
Stock and Company Preferred Stock held by Ronald E. Cann, M.D.) of the
outstanding shares of Company Common Stock and Company Preferred Stock shall
have filed with the Company a written objection to the Merger meeting the
requirements of Section 3-203(a)(1) of the MGCL with respect to their shares of
Company Common Stock or Company Preferred Stock.
(h) From the date of this Agreement until the Effective Time, there shall not
have occurred any Material Adverse Change with respect to the Company.
(i) (1) Each of the agreements listed in Exhibit 12.2(i)(1) shall have been
terminated without cost or liability to Parent, Merger Sub or any Group Entity,
and shall be of no further force or legal effect; and (2) the agreements listed
in Exhibit 12.2(i)(2) shall remain in full force and effect, without any
assertion by Humana Inc. of any breach or default thereunder.
(j) The CHAMPUS 2/5 Subcontract shall not have been terminated by Humana.
(k) [intentionally omitted].
(l) Parent or one of its subsidiaries shall have been provided reasonable access
to each of the customers of the Company set forth on Exhibit 12.2(l) hereto, and
Parent shall have received verbal or written confirmation reasonably
satisfactory to Parent from each such customer that such customer will not
<PAGE>
terminate or modify in any material respect its business relationship with the
Company as a result of the consummation of the transactions contemplated by this
Agreement.
(m) The Stockholder Approvals shall have been obtained.
(n) Parent shall have received, for the months of June 1997 and July 1997, each
of the Subsequent Company Financial Statements and the Subsequent Supplemental
Schedules for such months.
(o) The payment of the amounts set forth in clause (iv) of the definition of
"Adjustment Amount" in Exhibit 3.1(b) hereto shall have been approved by the
Company's stockholders in accordance with Section 280G of the IRC.
(p) The Employment and Consulting Agreement, dated as of the date hereof,
between the Company and Dr. Alan J. Shusterman shall have become and shall
remain effective as of the Closing Date, and the Letter Agreement, dated as of
the date hereof, between the Company and Dr. Douglass Kay shall have become and
shall remain effective as of the Closing Date.
(q) Parent and Merger Sub shall have been furnished with a certificate, executed
by the Chief Executive Officer of the Company, dated the Closing Date,
certifying in such detail as Parent and Merger Sub may reasonably request as to
the fulfillment of the conditions set forth in Sections 12.2(a), (b), (g), (h),
(i), (j), (k), (m), (n) and (o).
(r) Parent and Merger Sub shall have been furnished with a certificate, executed
by the Chief Financial Officer of the Company, dated the Closing Date,
certifying in such detail as Parent and Merger Sub may reasonably request as to
the fulfillment of the conditions set forth in paragraphs 1, 2(D) and 2(F) of
Exhibit 13.7.
(s) The holders of Stock Options identified on Exhibit 12.2(s) shall have
delivered to Parent and the Company consents to the treatment of their Stock
Options in accordance with Section 3.2.
12.3. Conditions to Obligations of the Company.
The obligations of the Company to consummate the Merger and the other
transactions contemplated hereby shall be subject to the satisfaction, at or
prior to the Closing Date, of the following conditions (any of which may be
waived by the Company):
(a) Each of the agreements of Parent and Merger Sub to be performed at or prior
to the Closing Date pursuant to the terms hereof shall have been duly performed,
<PAGE>
in all material respects, and Parent and Merger Sub shall have performed, in all
material respects, all of the acts required to be performed by them at or prior
to the Closing Date by the terms hereof.
(b) The representations and warranties of Parent and Merger Sub set forth in
Article V shall be true and correct in all material respects as of the date of
this Agreement and as of the Closing Date. The representations and warranties of
Parent set forth in Article VI of this Agreement that are qualified as to
materiality shall be true and correct, and those that are not so qualified shall
be true and correct in all material respects, as of the date of this Agreement
and as of the Closing Date as though made at and as of such time, except to the
extent such representations and warranties expressly relate to an earlier date
(in which case such representations and warranties that are qualified as to
materiality shall be true and correct, and those that are not so qualified shall
be true and correct in all material respects, as of such earlier date).
(c) From the date of this Agreement until the Effective Time, there shall not
have occurred any Material Adverse Change with respect to Parent and its
Affiliated subsidiaries, taken as a whole.
(d) The Stockholder Approvals shall have been obtained.
(e) The applicable waiting period under the HSR Act shall have expired or been
terminated.
(f) The Company shall have been furnished with certificates, executed by the
Chief Executive Officers of Parent and Merger Sub, dated the Closing Date,
certifying in such detail as the Company may reasonably request as to the
fulfillment of the conditions set forth in Sections 12.3(a), (b) and (c).
ARTICLE XIII.
MISCELLANEOUS
13.1. Nonsurvival of Representations and Warranties.
None of the representations and warranties in this Agreement or in any
instrument delivered pursuant to this Agreement shall survive the Effective
Time.
13.2. Scope of Representations and Warranties.
The Company shall not be deemed to have made to Parent any representation or
warranty other than as expressly made by the Company in Article IV hereof.
Without limiting the generality of the foregoing, and notwithstanding any
<PAGE>
otherwise express representations and warranties made by the Company in Article
IV hereof, the Company makes no representation or warranty to Parent with
respect to (a) any projections, estimates or budgets heretofore delivered or
made available to Parent of future revenues, expenses or expenditures, future
results of operations and other similar projections or estimates or (b) any
other information or documents made available to Parent or its counsel,
accountants, or advisors with respect to the Group Entities, except as expressly
covered by a representation and warranty contained in Article IV hereof.
13.3. Notices.
Any communications required or desired to be given hereunder shall be deemed to
have been properly given if sent by hand delivery or by facsimile and overnight
courier to the parties hereto at the following addresses, or at such other
address as either party may advise the other in writing from time to time:
If to the Company:
CMG Health, Inc.
25 Crossroads Drive
Owings Mills, Maryland 21117
Attention: Alan J. Shusterman, Ph.D.
Facsimile: (410) 654-2655
with a copy to:
CMG Health, Inc.
25 Crossroads Drive
Owings Mills, Maryland 211117
Attention: Jill B. Reamer, Esq.
Vice President of Mergers and Acquisitions
and General Counsel
Facsimile: (410) 654-2655
and
William R. Kunkel, Esq.
Skadden, Arps, Slate, Meagher
& Flom (Illinois)
333 West Wacker Drive, Suite 2100
Chicago, Illinois 60606
Facsimile: (312) 407-0411
If to Parent or Merger Sub:
<PAGE>
Merit Behavioral Care Corporation
One Maynard Drive
Park Ridge, New Jersey 07446
Attention: Michael G. Lenahan, Esq.
Executive Vice President --
Mergers & Acquisitions and General Counsel
Facsimile: (201) 573-1324
with a copy to:
Mark D. Gerstein, Esq.
Latham & Watkins
Sears Tower, Suite 5800
Chicago, Illinois 60606
Facsimile: (312) 993-9767
All such communications shall be deemed to have been delivered on the date of
hand delivery or facsimile transmission, or on the next business day following
the deposit of such communications with the overnight courier.
13.4. Further Assurances.
Each party hereby agrees to perform any further acts and to execute and deliver
any documents which may be reasonably necessary to carry out the provisions of
this Agreement.
13.5. Governing Law.
The Laws of the State of Delaware shall govern the interpretation, validity and
performance of the terms of this Agreement, regardless of the law that might be
applied under principles of conflicts of law. Any suit, action or proceeding by
a party hereto with respect to this Agreement, or any judgment entered by any
court in respect of any thereof, may be brought in any state or federal court of
competent jurisdiction in the State of Delaware, and each party hereto hereby
submits to the exclusive jurisdiction of such courts for the purpose of any such
suit, action, proceeding or judgment. By the execution and delivery of this
Agreement, (i) Parent and Merger Sub each appoints The Corporation Trust
Company, at its office in Wilmington, Delaware, as its agent upon which process
may be served in any such suit, action or proceeding and (ii) the Company
appoints Skadden, Arps, Slate, Meagher & Flom LLP, at its office at One Rodney
Square, P.O. Box 636, Wilmington, Delaware 19899-0636, as its agent upon which
process may be served in any such suit, action or proceeding. Service of process
upon such agent, together with notice of such service given to a party hereto in
the manner provided in Section 13.3 hereof, shall be deemed in every respect
effective service of process upon it in any suit, action or proceeding. Nothing
<PAGE>
herein shall in any way be deemed to limit the ability of a party hereto to
serve any such writs, process or summonses in any other manner permitted by
applicable Law. Each party hereto hereby irrevocably waives any objections which
it may now or hereafter have to the laying of the venue of any suit, action or
proceeding arising out of or relating to this Agreement brought in any state or
federal court of competent jurisdiction in the State of Delaware, and hereby
further irrevocably waives any claim that any such suit, action or proceeding
brought in any such court has been brought in any inconvenient forum. No suit,
action or proceeding against a party hereto with respect to this Agreement may
be brought in any court, domestic or foreign, or before any similar domestic or
foreign authority other than in a court of competent jurisdiction in the State
of Delaware, and each party hereto hereby irrevocably waives any right which it
may otherwise have had to bring such an action in any other court, domestic or
foreign, or before any similar domestic or foreign authority.
13.6. Knowledge.
As used herein, "knowledge," "to the knowledge," "to the best knowledge," or any
similar phrase shall be deemed to refer to the actual knowledge of the Chief
Executive Officer, Chief Operating Officer, Chief Financial Officer and General
Counsel of that party and all persons reporting directly to any such officer,
after due inquiry by each such officer and person reporting directly to such
officer regarding the business of the Group Entities or of Parent, as
applicable.
13.7 "Material Adverse Effect" or "Material Adverse Change".
"Material Adverse Change" or "Material Adverse Effect" means, when used in
connection with a party, any change, effect, event or occurrence that has, or is
reasonably likely to have, individually or in the aggregate, a material adverse
impact on the business, prospects, operations, results of operations, assets or
condition (financial or otherwise) of such party and its subsidiaries taken as a
whole. As used in this Section 13.7, "subsidiary" means any entity which is a
Significant Subsidiary of such party as such term is defined in Regulation S-X
of the SEC. Without limiting the generality of the foregoing, and
notwithstanding anything else to the contrary in this Agreement, a Material
Adverse Change will be deemed to have occurred, and a Material Adverse Effect
shall be deemed to exist, with respect to the Company, in the event that any of
the events or circumstances set forth on Exhibit 13.7 shall have occurred or be
deemed to have occurred, or any Group Entity or Parent receives notice, or
otherwise has knowledge, that any of the events or circumstances set forth on
Exhibit 13.7 shall exist or have occurred (subject to the exceptions set forth
on Exhibit 13.7).
For purposes of this Agreement, the term "tax" or "taxes" (whether or not
<PAGE>
capitalized) shall mean all taxes, charges, fees, stamp taxes and duties,
levies, penalties or other assessment, together with any interest and any
penalties, additions to tax or additional amounts imposed by any United States
federal, state, local or foreign taxing authority, including, but not limited
to, income, gross receipts, use, employment, profits, capital stock, premium,
minimum and alternative minimum, excise, property, sales, transfer, franchise,
payroll, withholding, Social Security or other taxes, including any interest,
penalties or additions attributable thereto. For purposes of this Agreement, the
term "tax return" shall mean any return, report, information return or other
document (including any related or supporting information) with respect to
Taxes.
13.8. Captions.
The captions or headings in this Agreement are made for convenience and general
reference only and shall not be construed to describe, define or limit the scope
or intent of the provisions of this Agreement.
13.9. Integration of Company Disclosure Schedule and Exhibits.
The Exhibits and the Company Disclosure Schedule attached to this Agreement are
integral parts of this Agreement as if fully set forth herein.
13.10. Entire Agreement; No Third-Party Beneficiaries.
This instrument, including the Company Disclosure Schedule and all Exhibits
attached hereto, together with the Confidentiality Agreement, contains the
entire agreement of the parties and supersedes any and all prior or
contemporaneous agreements between the parties, written or oral, with respect to
the transactions contemplated hereby. This Agreement is for the sole benefit of
the parties hereto, their permitted assigns and the ACR Beneficiaries, and
nothing herein, express or implied, is intended to or shall confer upon any
other person or entity any legal or equitable right, benefit or remedy of any
nature whatsoever under or by reason of this Agreement.
13.11. Counterparts.
This Agreement may be executed in several counterparts, each of which, when so
executed, shall be deemed to be any original, and such counterparts shall,
together, constitute and be one and the same instrument.
13.12. Binding Effect.
This Agreement shall be binding on, and shall inure to the benefit of, the
parties hereto, and their respective successors and assigns, and no other person
<PAGE>
shall acquire or have any right under or by virtue of this Agreement. No party
may assign any right or obligation hereunder without the prior written consent
of the other parties.
13.13. Severability.
If any term or other provision of this Agreement is invalid, illegal or
incapable of being enforced by any rule or law or public policy, all other
conditions and provisions of this Agreement shall nevertheless remain in full
force and effect so long as the economic or legal substance of the transactions
contemplated hereby is not affected in any manner adverse to any party. Upon
such determination that any term or other provision is invalid, illegal or
incapable of being enforced, the parties hereto shall negotiate in good faith to
modify this Agreement so as to effect the original intent of the parties as
closely as possible in a mutually acceptable manner in order that the
transactions contemplated hereby be consummated as originally contemplated to
the greatest extent possible.
13.14. Waivers and Amendments.
This Agreement may be amended or modified, and the terms and conditions hereby
may be waived, only by a written instrument signed by the parties hereto or, in
the case of a waiver, by the party waiving compliance; provided, however, that
there shall be no amendment or change to the provisions hereof which by Law
requires further approval by the stockholders of the Company, without such
further approval. No delay on the part of any party in exercising any right,
power or privilege hereunder shall operate as a waiver thereof, nor shall any
waiver on the part of any party of any right, power or privilege hereunder, nor
any single or partial exercise of any other right, power or privilege hereunder,
preclude any other or further exercise thereof or the exercise of any other
right, power or privilege hereunder. The rights and remedies herein provided are
cumulative and are not exclusive of any rights or remedies which any party may
otherwise have at Law or in equity.
13.15. Specific Performance.
The parties hereto agree that irreparable damage would occur in the event any
provision of this Agreement required to be performed prior to the Closing was
not performed in accordance with the terms hereof and that, prior to the
Closing, the parties shall be entitled to specific performance of the terms
hereof, in addition to any other remedy at Law or in equity.
<PAGE>
IN WITNESS WHEREOF, Parent, Merger Sub and the Company have caused this
Agreement and Plan of Merger to be executed by their respective duly authorized
officers, and have caused their respective corporate seals to be hereunto
affixed, all as of the day and year first above written.
CMG HEALTH, INC.
/s/ Alan J. Shusterman
By
----------------------------------------
a duly authorized signatory
MERIT BEHAVIORAL CARE CORPORATION
/s/ Michael G. Lenahan
By
----------------------------------------
a duly authorized signatory
MERIT MERGER CORP.
/s/ Michael G. Lenahan
By
----------------------------------------
a duly authorized signatory
<PAGE>
Exhibit 21
MAGELLAN HEALTH SERVICES, INC.
SUBSIDIARIES
September 30, 1998
The following corporations are all of the direct or indirect subsidiary
corporations of Magellan Health Services, Inc., a Delaware corporation. Magellan
Health Services, Inc. directly or indirectly owns all of the outstanding voting
securities of such subsidiaries except where noted.
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Allied Specialty Care Services, Inc. Florida
Care Management Resources, Inc.(1) Florida
Charter Advantage, LLC Delaware
Subsidiaries:
Charter Call Center, Inc. Delaware
Charter Call Center of Texas, Inc. Delaware
Charter Managed Care Services, LLC Delaware
Charter Behavioral Corporation Delaware
Subsidiary:
Charter System, LLC Delaware
Green Spring Health Services, Inc. Delaware
Subsidiaries:
Advantage Behavioral Systems, Inc. Pennsylvania
Subsidiary:
Resource Day Treatment Center Pennsylvania
AdvoCare of Tennessee, Inc. Tennessee
Subsidiary:
Premier Holdings, Inc. Tennessee
Subsidiary:
Premier Behavioral Systems of Tennessee, LLC(2) Tennessee
Ceres Behavioral Healthcare System, LLC(3) Oregon
Green Spring Canadian Holding, Inc. Delaware
</TABLE>
- ----------------------------------
(1) 85% owned by Magellan Health Services, Inc.
(2) approximately 50% owned by Premier Holdings, Inc.
(3) 95% owned by Green Spring Health Services, Inc.
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Subsidiary:
Green Spring Health Services of Canada Co.(4) Nova Scotia
Green Spring Health Services of Michigan, Inc. Michigan
Green Spring of Pennsylvania, Inc. Pennsylvania
Group Practice Affiliates, Inc. Delaware
Subsidiaries:
GMV, LLC(5) Virginia
Capital Area PsySystems, Inc.(6) Texas
Subsidiaries:
Capital Area Psych Services Texas
Integrated Mental Health, LLC(7) Texas
Subsidiary:
Integrated Mental Health Texas
GPA Arizona, Inc. Arizona
GPA Pennsylvania, Inc. Pennsylvania
Integrated Behavioral Care, Inc.(8) Virginia
Novapsy Clinic, LLC(9) Virginia
Pacific Behavioral Management, LLC(10) California
Managed Care Services Mainstay of Central Pennsylvania, Inc. Pennsylvania
Maryland Health Partners, LLC(11) Maryland
Maschhoff, Barr & Associates, Inc. Washington
Vista Behavioral Health Plans, Inc. California
</TABLE>
- ----------------------------------
(4) 80% owned by Green Spring Canadian Holding, Inc.
(5) 50% owned by Group Practice Affiliates, Inc.
(6) 50% owned by Group Practice Affiliates, Inc.
(7) 50% owned by Capital Area PsySystems, Inc.
(8) 50% owned by Group Practice Affiliates, Inc.
(9) 50% owned by Group Practice Affiliates, Inc.
(10) 70% owned by Group Practice Affiliates, Inc.
(11) 50% owned by Green Spring Health Services, Inc.; 50% owned by CMG
Health, Inc., a direct subsidiary of Merit Behavioral Care
Corporation.
2
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Human Affairs International, Incorporated Utah
Subsidiaries:
Behavioral Healthcare Solutions, Inc. Delaware
Human Affairs of Alaska, Inc. Alaska
Human Affairs Global Services, Inc. Delaware
Human Affairs International of California California
Human Affairs International IPA, Inc. New York
Human Affairs International of Pennsylvania, Inc. Pennsylvania
Human Affairs International of Texas, Inc. Texas
Magellan Behavioral Health, Inc. Delaware
Magellan Capital, Inc. Delaware
Magellan CBHS Holdings, Inc. Delaware
Subsidiaries:
Behavioral Health Systems of Indiana, Inc. Indiana
Subsidiaries:
The Charter Arbor Indy Behavioral Health System, Delaware
LLC(12)
The Charter Behavioral Health System of Evansville, Delaware
LLC(13)
The Charter Behavioral Health System of Michigan Delaware
City, LLC(14)
The Charter Behavioral Health System of Northwest Delaware
Indiana, LLC(15)
Blue Grass Physician Management Services, Inc. Kentucky
C.A.C.O. Services, Inc. Ohio
CCM, Inc.(16) Nevada
Charter Alvarado Behavioral Health System, Inc. California
</TABLE>
- ----------------------------------
(12) 5% owned by Behavioral Health Systems of Indiana, Inc.; 95% owned by
Charter Indiana BHS Holding, Inc.
(13) 5% owned by Behavioral Health Systems of Indiana, Inc.; 95% owned by
Charter Indiana BHS Holding, Inc.
(14) 5% owned by Behavioral Health Systems of Indiana, Inc.; 95% owned by
Charter Indiana BHS Holding, Inc.
(15) 5% owned by Behavioral Health Systems of Indiana, Inc.; 95% owned by
Charter Indiana BHS Holding, Inc.
(16) 50% owned by Magellan CBHS Holdings, Inc.; 50% owned by CMCI, Inc.
3
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Charter Asheville Behavioral Health System, Inc. North Carolina
Charter Bay Harbor Behavioral Health System, Inc. Florida
Charter Behavioral Health System of Athens, Inc. Georgia
Subsidiary:
Charter Behavioral Health System of Northern California
California, Inc.
Charter Behavioral Health System of Baywood, Inc. Texas
Charter Behavioral Health System of Bradenton, Inc. Florida
Subsidiary:
Charter Behavioral Health System at Manatee Florida
Adolescent Treatment Services, Inc.
Charter Behavioral Health System of Central Georgia, Inc. Georgia
Charter Behavioral Health System of Central Virginia, Inc. Virginia
Subsidiary:
Mental Healthsource, L.L.C.(17)
Charter Behavioral Health System of Charleston, Inc. South Carolina
Charter Behavioral Health System of Charlottesville, Inc. Virginia
Charter Behavioral Health System of Chicago, Inc. Illinois
Charter Behavioral Health System of Chula Vista, Inc. California
Charter Behavioral Health System of Columbia, Inc. Missouri
Charter Behavioral Health System of Corpus Christi, Inc. Texas
Charter Behavioral Health System of Dallas, Inc. Texas
Charter Behavioral Health System of Delmarva, Inc. Maryland
Charter Behavioral Health System at Fair Oaks, Inc. New Jersey
Charter Behavioral Health System of Fort Worth, Inc. Texas
Charter Behavioral Health System at Hidden Brook, Inc. Maryland
Charter Behavioral Health System of Jackson, Inc. Mississippi
Charter Behavioral Health System of Jacksonville, Inc. Florida
Charter Behavioral Health System of Kansas City, Inc. Kansas
</TABLE>
- ----------------------------------
(17) 50% owned by Charter Behavioral Health System of Central Virginia,
Inc.
4
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Charter Behavioral Health System of Lafayette, Inc. Louisiana
Subsidiary:
The Charter Cypress Behavioral Health System, L.L.C.(18) Tennessee
Charter Behavioral Health System of Lake Charles, Inc. Louisiana
Charter Behavioral Health System at Los Altos, Inc. California
Charter Behavioral Health System of Massachusetts, Inc. Massachusetts
Subsidiary:
Westwood/Pembroke Health System Limited Massachusetts
Partnership(19)
Charter Behavioral Health System of Mississippi, Inc. Mississippi
Charter Behavioral Health System of Nashua, Inc. New Hampshire
Charter Behavioral Health System of Nevada, Inc. Nevada
Charter Behavioral Health System of New Mexico, Inc. New Mexico
Subsidiary:
The Charter Heights Behavioral Health System Limited Delaware
Partnership(20)
Charter Behavioral Health System of Northwest Arkansas, Inc. Arkansas
Charter Behavioral Health System of Paducah, Inc. Kentucky
Charter Behavioral Health System at Potomac Ridge, Inc. Maryland
Charter Behavioral Health of Puerto Rico, Inc. Georgia
Charter Behavioral Health System of San Jose, Inc. California
Charter Behavioral Health System of Texarkana, Inc. Arkansas
Charter Behavioral Health System of Toledo, Inc. Ohio
Charter Behavioral Health System of Tucson, Inc. Arizona
Charter Behavioral Health System of Visalia, Inc. California
Charter Behavioral Health System of Waverly, Inc. Minnesota
Charter Behavioral Health System of Winston-Salem, Inc. North Carolina
Charter Behavioral Health System of Yorba Linda, Inc. California
</TABLE>
- ----------------------------------
(18) 50% owned by Charter Behavioral Health System of Lafayette, Inc.
(19) 95% owned by Charter Behavioral Health System of Massachusetts, Inc.
(20) 67% owned by Charter Behavioral Health System of New Mexico, Inc.
5
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Charter Behavioral Health Systems, LLC(21) Delaware
Charter-By-The-Sea Behavioral Health System, Inc. Georgia
Charter Canyon Behavioral Health System, Inc. Utah
Charter Canyon Springs Behavioral Health System, Inc. California
Charter Centennial Peaks Behavioral Health System, Inc. Colorado
Charter Community Hospital, Inc. California
Charter Cove Forge Behavioral Health System, Inc. Pennsylvania
Charter Fairmount Behavioral Health System, Inc. Pennsylvania
Charter Fenwick Hall Behavioral Health System, Inc. South Carolina
Charter Financial Offices, Inc. Georgia
Charter Forest Behavioral Health System, Inc. Louisiana
Charter Grapevine Behavioral Health System, Inc. Texas
Subsidiary:
Metroplex Behavioral Healthcare Services, Inc. Texas
Charter Greensboro Behavioral Health System, Inc. North Carolina
Charter Hospital of Columbus, Inc. Ohio
Charter Hospital of Mobile, Inc. Alabama
Charter Hospital of Santa Teresa, Inc. New Mexico
Charter Hospital of St. Louis, Inc. Missouri
Charter Hospital of Torrance, Inc. California
Charter Indiana BHS Holding, Inc. Indiana
Subsidiaries:
The Charter Arbor Indy Behavioral Health System, Delaware
LLC(22)
The Charter Behavioral Health System of Evansville, Delaware
LLC(23)
</TABLE>
- ----------------------------------
(21) 50% owned by Magellan CBHS Holdings, Inc.; subsidiaries of Charter
Behavioral Health Systems, LLC are not reflected on this list
(22) 95% owned by Charter Indiana BHS Holding, Inc.; 5% owned by Behavioral
Health Systems of Indiana, Inc.
(23) 95% owned by Charter Indiana BHS Holding, Inc.; 5% owned by Behavioral
Health Systems of Indiana, Inc.
6
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
The Charter Behavioral Health System of Michigan Delaware
City, LLC(24)
The Charter Behavioral Health System of Northwest Delaware
Indiana, LLC(25)
Charter Lakehurst Behavioral Health System, Inc. New Jersey
Charter Lakeside Behavioral Health System, Inc. Tennessee
Subsidiary:
Charter Lakeside Behavioral Health Network, Inc. Tennessee
Charter Laurel Heights Behavioral Health System, Inc. Georgia
Charter Linden Oaks Behavioral Health System, Inc. Illinois
Subsidiary:
Naperville Psychiatric Ventures (26) Illinois
Charter Little Rock Behavioral Health System, Inc. Arkansas
Charter Louisiana Behavioral Health System, Inc. Louisiana
Charter Louisville Behavioral Health System, Inc. Kentucky
Charter Meadows Behavioral Health System, Inc. Maryland
Charter Medical (Cayman Islands) Ltd. Cayman Islands
Charter Medical - Clayton County, Inc. Georgia
Charter Medical - Cleveland, Inc. Texas
Charter Medical of East Valley, Inc. Arizona
Charter Medical International, Inc. Cayman Islands
Charter Medical International, S.A., Inc. Nevada
Subsidiaries:
Charter Medical of England Limited United Kingdom
Societe Anonyme De La Metairie Switzerland
Charter Medical International Services, Inc. Cayman Islands
Charter Medical Leasing Limited United Kingdom
Charter Medical - Long Beach, Inc. California
</TABLE>
- ----------------------------------
(24) 95% owned by Charter Indiana BHS Holding, Inc.; 5% owned by Behavioral
Health Systems of Indiana, Inc.
(25) 95% owned by Charter Indiana BHS Holding, Inc.; 5% owned by Behavioral
Health Systems of Indiana, Inc.
(26) 75% owned by Charter Linden Oaks Behavioral Health System, Inc.
7
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Charter Medical - New York, Inc. New York
Charter Medical of North Phoenix, Inc. Arizona
Charter Medical of Puerto Rico, Inc. Commonwealth of
Puerto Rico
Charter Milwaukee Behavioral Health System, Inc. Wisconsin
Charter Mission Viejo Behavioral Health System, Inc. California
Charter MOB of Charlottesville, Inc. Virginia
Charter North Behavioral Health System, Inc. Alaska
Charter North Counseling Center, Inc. Alaska
Charter North Star Behavioral Health System, L.L.C.(27) Tennessee
Charter Northridge Behavioral Health System, Inc. North Carolina
Subsidiary:
Holly Hill/Charter Behavioral Health System, L.L.C.(28) Tennessee
Charter Oak Behavioral Health System, Inc. California
Charter Palms Behavioral Health System, Inc. Texas
Charter Park Hospital Limited United Kingdom
Charter Peachford Behavioral Health System, Inc. Georgia
Charter Pines Behavioral Health System, Inc. North Carolina
Charter Plains Behavioral Health System, Inc. Texas
Charter - Provo School, Inc. Utah
Charter Real Behavioral Health System, Inc. Texas
Charter Ridge Behavioral Health System, Inc. Kentucky
Charter Rivers Behavioral Health System, Inc. South Carolina
Charter Rockford Behavioral Health System, Inc. Delaware
Charter San Diego Behavioral Health System, Inc. California
Charter Sioux Falls Behavioral Health System, Inc. South Dakota
Charter Springs Behavioral Health System, Inc. Florida
Charter Springwood Behavioral Health System, Inc. Virginia
</TABLE>
- ----------------------------------
(27) 57% owned by Magellan CBHS Holdings, Inc.
(28) 50% owned by Charter Northridge Behavioral Health System, Inc.
8
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Charter Suburban Hospital of Mesquite, Inc. Texas
Charter Talbott Behavioral Health System, Inc. Georgia
Subsidiary:
Charter Behavioral Health System of Savannah, Inc. Georgia
Charter Thousand Oaks Behavioral Health System, Inc. California
Charter Westbrook Behavioral Health System, Inc. Virginia
Subsidiary:
CPS Associates, Inc. Virginia
Charter White Oak Behavioral Health System, Inc. Maryland
Charter Wichita Behavioral Health System, Inc. Kansas
Charter Woods Behavioral Health System, Inc. Alabama
Desert Springs Hospital, Inc. Nevada
Subsidiaries:
CMCI, Inc. Nevada
Subsidiary:
CCM, Inc.(29) Nevada
CMFC, Inc. Nevada
Employee Assistance Services, Inc. Georgia
Florida Health Facilities, Inc. Florida
Golden Isle Assurance Company Ltd. Bermuda
NEPA - Massachusetts, Inc. Massachusetts
NEPA - New Hampshire, Inc. New Hampshire
New Allied, Inc. Florida
Pacific - Charter Medical, Inc. California
Subsidiary:
Charter Behavioral Health System of the Inland Empire, California
Inc.
Plymouth Insurance Company, Ltd. Bermuda
Sistemas De Terapia Respiratoria S.A., Inc. Georgia
</TABLE>
- ----------------------------------
(29) 50% owned by CMCI, Inc.; 50% owned by Magellan CBHS Holdings, Inc.
9
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Strategic Advantage, Inc. Minnesota
Western Behavioral Systems, Inc. California
Magellan Executive Corporation Delaware
Magellan Public Solutions, Inc. Delaware
Subsidiaries:
KidsCareNet of Milwaukee, LLC(30) Wisconsin
Magellan Public Network, Inc. Delaware
Subsidiaries:
Correctional Behavioral Solutions, Inc. Delaware
Subsidiaries:
Correctional Behavioral Solutions of Indiana, Inc. Indiana
Correctional Behavioral Solutions of New Jersey, New Jersey
Inc.
Correctional Behavioral Solutions of Ohio, Inc. Ohio
National Mentor, Inc. Delaware
Subsidiaries:
Center for Comprehensive Services, Inc. Illinois
First Step Independent Living Program, Inc. California
Horrigan Cole Enterprises, Inc. California
Illinois Mentor, Inc. Illinois
Subsidiary:
Rehabilitation Achievement Center, Inc. Illinois
Massachusetts Mentor, Inc. Massachusetts
National Mentor Healthcare, Inc. Massachusetts
Subsidiaries:
Carolina Behavioral Services, LLC Delaware
Loyd's Liberty Homes, Inc. California
Ohio Mentor, Inc. Ohio
South Carolina Mentor, Inc. South Carolina
</TABLE>
- ----------------------------------
(30) 70% owned by Magellan Public Solutions, Inc.
10
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Magellan Public Solutions of Ohio, Inc. Ohio
Solutions For Care, Inc. Delaware
Magellan Specialty Medical Care Holdings, Inc. Delaware
Subsidiaries:
CAI Holdings, Inc. Delaware
Subsidiary:
CAI Merger Corporation Delaware
MBCH, Inc. Delaware
Subsidiary:
Merit Behavioral Care Corporation Delaware
Subsidiaries:
American Biodyne, Inc. Delaware
Subsidiaries:
AGCA Acquisition Corporation-New York Delaware
AGCA, Inc. Pennsylvania
Subsidiaries:
AGCA Headquarters Limited Pennsylvania
Partnership(31)
AGCA New York, Inc. New York
Subsidiaries:
Achievement and Guidance New York
Centers of New York, Inc.
AGCA IPA of New York, Inc. New York
AGCA/Better Health Plan, Inc. New York
AGCA/Chubb Health Plan, Inc. New York
MBC Behavioral Care of New New York
York, Inc., a New York
Independent Practice Association
MBC Behavioral Health Services New York
of New York, Inc., a New York
Independent Practice Association
</TABLE>
- ----------------------------------
(31) 15% owned by AGCA, Inc.
11
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
MBC Health Care of New York, New York
Inc., a New York Independent
Practice Association
MBC Health Services of New New York
York, Inc., a New York
Independent Practice Association
MBC of New York, Inc., a New New York
York Independent Practice
Association
MBC Providers of New York, Inc., New York
a New York Independent Practice
Association
U.S. IPA Providers, Inc. New York
Quality Healthcare Solutions, Inc. Pennsylvania
Subsidiary:
AGCA/Net Recovery Systems(32) Pennsylvania
Alliance Health Systems, Inc.(33) Indiana
Arizona Biodyne, Inc. Arizona
California Biodyne Health Services, Inc. California
Colorado Biodyne, Inc. Colorado
Hawaii Biodyne, Inc. Hawaii
Indiana Biodyne, Inc. Indiana
Louisiana Biodyne, Inc. Louisiana
Maine Biodyne, Inc. Maine
MBC Federal Programs, Inc. Delaware
MBC of New Mexico, Inc. New Mexico
Merit Behavioral Care of Florida, Inc. Florida
Merit Behavioral Care of Illinois, Inc. Illinois
Merit Behavioral Care of Massachusetts, Inc. Massachusetts
Merit Behavioral Care of Montana, Inc. Montana
Merit Behavioral Care of Pennsylvania, Inc. Pennsylvania
</TABLE>
- ----------------------------------
(32) 50% owned by Quality Healthcare Solutions, Inc.
(33) 80% owned by American Biodyne, Inc.
12
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Merit Behavioral Care of Texas, Inc. Texas
Michigan Biodyne, Inc. Michigan
Nevada Biodyne, Inc. Nevada
Ohio Biodyne, Inc. Ohio
Tennessee Biodyne, Inc. Tennessee
Vermont Biodyne, Inc. Vermont
BCOV-GP, Inc.(34) Delaware
Benesys, Inc. Delaware
CMG Health, Inc. Maryland
Subsidiaries:
ARD Properties, Inc. Delaware
Choice Behavioral Health Partnership(35) Virginia
CMG Behavioral Health of California, Inc. California
CMG Behavioral Healthcare of New York, Inc. New York
CMG Choice Independent Practice Association New York
of New York, Inc.
CMG Health of New York, Inc. New York
CMG Independent Practice Association of New New York
York, Inc.
CMG Plus Independent Practice Association of New York
New York, Inc.
Group Practice Management, Inc. Maryland
Inpsych, Inc. Maryland
Inpsych Kentucky, Inc. Kentucky
Inpsych Midwest, Inc. Missouri
Maryland Health Partners, LLC(36) Maryland
Montana Community Partners, Inc.(37) Montana
</TABLE>
- ----------------------------------
(34) 50% owned by Merit Behavioral Care Corporation
(35) 50% owned by CMG Health, Inc.
(36) 50% owned by CMG Health, Inc.; 50% owned by Green Spring Health
Services, Inc.
(37) 55% owned by CMG Health, Inc.
13
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Continuum Behavioral Care, LLC(38) Rhode Island
Continuum Behavioral Healthcare Corporation Delaware
Subsidiary:
Spectrum-Continuum Management Services of Delaware
New York, LLC(39)
Subsidiary:
Spectrum-Continuum IPA Providers of Delaware
New York, LLC
EMHC-MBC of New York, LLC(40) New York
EMHC/MBC IPA Providers of New York, LLC(41) New York
EMHC-MBC Services of New York, LLC(42) New York
Group Plan Clinic, Inc. Texas
MBC Health Providers of Texas, Inc. Texas
MBC of America, Inc. Delaware
Subsidiaries:
EMHC/MBC IPA Providers of New York, LLC(43) New York
EMHC-MBC Services of New York, LLC(44) New York
Empire Community Delivery Systems, LLC(45) New York
MBC Management Services of New York, LLC(46) New York
MBC of Nebraska, L.L.C.(47) Nebraska
MBC of Tennessee, Inc. Tennessee
</TABLE>
- ----------------------------------
(38) 50% owned by Merit Behavioral Care Corporation
(39) 50% owned by Continuum Behavioral Healthcare Corporation
(40) 79.8% owned by Merit Behavioral Care Corporation
(41) 99% owned by EMHC-MBC of New York, LLC; 1% owned by MBC of America,
Inc.
(42) 99% owned by EMHC-MBC of New York, LLC; 1% owned by MBC of America,
Inc.
(43) 1% owned by MBC of America, Inc.; 99% owned by EMHC-MBC of New York,
LLC
(44) 1% owned by MBC of America, Inc.; 99% owned by EMHC-MBC of New York,
LLC
(45) 16.667% owned by MBC of America, Inc.
(46) 80.2 % owned by MBC of America, Inc.
(47) 50% owned by MBC of America, Inc.
14
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
MBC of Tennessee, LLC(48) Tennessee
MBC/IPA Providers of New York, LLC(49) New York
Royal Health Care, LLC(50) New York
MBC of North Carolina, LLC North Carolina
MBC of Tennessee, LLC(51) Tennessee
MBC Washington Systems, Inc. Washington
Subsidiary:
Community Sector Systems, Inc.(52) Washington
Merit Behavioral Care Corporation of Iowa Iowa
Merit Behavioral Care of Colorado, Inc. Colorado
Merit Behavioral Care of Georgia, Inc. Georgia
Merit Behavioral Care Systems Corporation Ohio
Subsidiaries:
INROADS Behavioral Health Services of Texas, Texas
L.P.(53)
MBCS of Florida, Inc. Florida
MBCS of North Carolina, Inc. North Carolina
Merit INROADS Behavioral Health Services of Illinois
Illinois, LLC(54)
Merit Health Insurance Company Illinois
Subsidiary:
Orion Life Insurance Company Delaware
Merit Holdings Corp. Delaware
</TABLE>
- ----------------------------------
(48) MBC of America, Inc and Merit Behavioral Care Corporation serve as
sole members
(49) 80.2% owned by MBC of America, Inc.
(50) 50% owned by MBC of America, Inc.
(51) Merit Behavioral Care Corporation and MBC of America, Inc. serve as
sole members
(52) 19.9 % owned by MBC Washington Systems, Inc.
(53) 1% owned by Merit Behavioral Care Systems Corporation; 99% owned by
Merit INROADS Behavioral Health Services, LLC
(54) 1% owned by Merit Behavioral Care Systems Corporation; 99% owned by
Merit INROADS Behavioral Health Services, LLC
15
<PAGE>
<TABLE>
<CAPTION>
Name of Corporation: State/Jurisdiction of
Incorporation:
<S> <C>
Subsidiaries:
MBC National Service Corporation Delaware
MBC of Louisiana, Inc. Louisiana
Merit Behavioral Care of Arkansas, Inc. Arkansas
Merit Behavioral Care of Maryland, Inc. Maryland
Merit INROADS Behavioral Health Services, Delaware
LLC(55)
Subsidiaries:
Merit INROADS Behavioral Health Illinois
Services of Illinois, LLC(56)
INROADS Behavioral Health Services of Texas
Texas, L.P.(57)
MeritChoice, Inc.(58) Delaware
MeritChoice, Ltd.(59) Pennsylvania
ProPsych, Inc. Florida
PPC Group, Inc. Delaware
Subsidiaries:
Merit Behavioral Care of California, Inc. Missouri
P.P.C., Inc. Missouri
Subsidiary:
Personal Performance Consultants of New New York
York, Inc.
</TABLE>
- ----------------------------------
(55) 99% owned by Merit Holdings Corp.; 1% owned by Merit Behavioral Care
of Illinois, Inc.
(56) 99% owned by Merit INROADS Behavioral Health Services, LLC; 1% owned
by Merit Behavioral Care Systems Corporation
(57) 99% owned by Merit INROADS Behavioral Health Services, LLC; 1% owned
by Merit Behavioral Care Systems Corporation
(58) 50% owned by Merit Holdings Corp.
(59) 50% owned by Merit Holdings Corp.
16
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our reports dated December 3, 1998 and to all references to our
firm, included in this Form 10-K, into the Company's previously filed
Registration Statements on Form S-3 (File Nos. 333-53353, 333-20371, 333-01217,
and 333-50423).
Atlanta, Georgia
December 28, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES F-3 AND F-4 OF THE COMPANY'S FORM 10-K FOR THE YEAR-TO-DATE, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 92,050,000
<SECURITIES> 0
<RECEIVABLES> 174,846,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 399,724,000
<PP&E> 237,269,000
<DEPRECIATION> 60,100,000
<TOTAL-ASSETS> 1,916,290,000
<CURRENT-LIABILITIES> 454,766,000
<BONDS> 1,202,613,000
0
0
<COMMON> 8,476,000
<OTHER-SE> 179,159,000
<TOTAL-LIABILITY-AND-EQUITY> 1,916,290,000
<SALES> 1,512,454,000
<TOTAL-REVENUES> 1,512,454,000
<CGS> 0
<TOTAL-COSTS> 1,294,481,000
<OTHER-EXPENSES> 98,560,000
<LOSS-PROVISION> 4,977,000
<INTEREST-EXPENSE> 75,375,000
<INCOME-PRETAX> 39,061,000
<INCOME-TAX> 20,033,000
<INCOME-CONTINUING> 13,732,000
<DISCONTINUED> 0
<EXTRAORDINARY> (33,015,000)
<CHANGES> 0
<NET-INCOME> (19,283,000)
<EPS-PRIMARY> (0.63)
<EPS-DILUTED> (0.62)
</TABLE>
