<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-6639
------------------------
MAGELLAN HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 58-1076937
---------------------------------------- ---------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6950 COLUMBIA GATEWAY DRIVE
SUITE 400
COLUMBIA, MARYLAND 21046
---------------------------------------- ---------------------------------
(Address of principal executive offices) (Zip Code)
(410) 953-1000
(Registrant's telephone number, including area code)
3414 PEACHTREE ROAD, N.E.
SUITE 1400
ATLANTA, GEORGIA 30326
(Former name, former address and former fiscal year, if changed since last
report)
------------------------
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 / /
The number of shares of the registrant's common stock outstanding as of July
31, 1999 was 31,802,888.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
FORM 10-Q
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE NO.
-----------
<S> <C>
PART I--FINANCIAL INFORMATION:
Condensed Consolidated Balance Sheets--
September 30, 1998 and June 30, 1999................................................................ 1
Condensed Consolidated Statements of Operations--
For the Three Months and the Nine Months ended June 30, 1998 and 1999............................... 2
Condensed Consolidated Statements of Cash Flows--
For the Nine Months ended June 30, 1998 and 1999.................................................... 3
Notes to Condensed Consolidated Financial Statements.................................................. 4
Management's Discussion and Analysis of Financial Condition and Results of Operations................. 20
PART II--OTHER INFORMATION:
Item 5.--Other Information............................................................................ 35
Item 6.--Exhibits and Reports on Form 8-K............................................................. 35
Signatures............................................................................................ 37
</TABLE>
<PAGE>
MAGELLAN HEALTH SERVICES, INC.
QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
PART I--FINANCIAL INFORMATION
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1999
------------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 92,050 $ 40,307
Accounts receivable, net............................................................. 174,846 156,349
Restricted cash and investments...................................................... 89,212 111,882
Refundable income taxes.............................................................. 4,939 --
Other current assets................................................................. 38,677 24,634
------------- ---------
Total current assets............................................................... 399,724 333,172
Assets restricted for settlement of unpaid claims and other liabilities................ 37,910 28,751
Property and equipment, net of accumulated depreciation of $60,100 at September 30,
1998, and $68,043 at June 30, 1999................................................... 177,169 137,314
Deferred income taxes.................................................................. 97,386 85,767
Investments in unconsolidated subsidiaries............................................. 11,066 38,174
Other long-term assets................................................................. 35,415 21,172
Goodwill, net.......................................................................... 992,431 1,066,787
Other intangible assets, net........................................................... 165,189 152,336
------------- ---------
$ 1,916,290 $1,863,473
------------- ---------
------------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................................... $ 42,873 $ 22,182
Accrued liabilities.................................................................. 193,530 213,591
Medical claims payable............................................................... 195,330 218,915
Income taxes payable................................................................. -- 200
Current maturities of long-term debt and capital lease obligations................... 23,033 31,260
------------- ---------
Total current liabilities.......................................................... 454,766 486,148
Long-term debt and capital lease obligations........................................... 1,202,613 1,102,184
Reserve for unpaid claims.............................................................. 30,280 21,366
Deferred credits and other long-term liabilities....................................... 14,011 31,435
Minority interest...................................................................... 26,985 1,955
Commitments and contingencies
Stockholders' equity:
Preferred stock, without par value
Authorized--10,000 shares
Issued and outstanding--none....................................................... -- --
Common stock, par value $0.25 per share
Authorized--80,000 shares
Issued and outstanding--33,898 shares at September 30, 1998 and 34,067 shares at
June 30, 1999..................................................................... 8,476 8,516
Other stockholders' equity:
Additional paid-in capital......................................................... 349,651 350,774
Accumulated deficit................................................................ (149,238) (119,601)
Warrants outstanding............................................................... 25,050 25,050
Common stock in treasury, 2,289 shares at September 30, 1998 and June 30, 1999..... (44,309) (44,309)
Cumulative foreign currency adjustments included in comprehensive income........... (1,995) (45)
------------- ---------
Total stockholders' equity....................................................... 187,635 220,385
------------- ---------
$ 1,916,290 $1,863,473
------------- ---------
------------- ---------
</TABLE>
The accompanying notes to Condensed Consolidated Financial Statements
are an integral part of these balance sheets.
1
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- --------------------------
<S> <C> <C> <C> <C>
1998 1999 1998 1999
---------- ---------- ------------ ------------
Net revenue..................................................... $ 463,929 $ 486,711 $ 1,047,253 $ 1,447,169
---------- ---------- ------------ ------------
Costs and expenses:
Salaries, cost of care and other operating expenses........... 406,341 437,197 903,795 1,298,056
Equity in (earnings) losses of unconsolidated subsidiaries.... 408 (9,116) 16,905 (21,525)
Depreciation and amortization................................. 17,724 20,249 37,649 57,603
Interest, net................................................. 24,409 22,640 49,336 70,958
Stock option expense (credit)................................. 12 -- (3,527) 18
Managed care integration costs................................ 1,240 522 12,314 4,391
Gain on sale of European Hospitals............................ -- (23,912) -- (23,912)
Special charges (income)...................................... (3,049) -- (3,000) 2,274
---------- ---------- ------------ ------------
447,085 447,580 1,013,472 1,387,863
---------- ---------- ------------ ------------
Income before provision for income taxes, minority interest and
extraordinary item............................................ 16,844 39,131 33,781 59,306
Provision for income taxes...................................... 8,339 17,449 15,972 29,113
---------- ---------- ------------ ------------
Income before minority interest and extraordinary item.......... 8,505 21,682 17,809 30,193
Minority interest............................................... 1,095 183 5,063 556
---------- ---------- ------------ ------------
Income before extraordinary item................................ 7,410 21,499 12,746 29,637
Extraordinary item--net loss on early extinguishments of debt
(net of income tax benefit of $22,010)........................ -- -- (33,015) --
---------- ---------- ------------ ------------
Net income (loss)............................................... 7,410 21,499 (20,269) 29,637
Unrealized foreign currency translation gain (loss)............. 125 (88) (46) (207)
Provision for (benefit from) income taxes related to unrealized
foreign currency translation gain (loss)...................... 50 (35) (18) (83)
---------- ---------- ------------ ------------
75 (53) (28) (124)
---------- ---------- ------------ ------------
Comprehensive income (loss)..................................... $ 7,485 $ 21,446 $ (20,297) $ 29,513
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Average number of common shares outstanding--basic.............. 31,523 31,778 30,505 31,710
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Average number of common shares outstanding--diluted............ 32,131 32,041 31,099 31,822
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Income (loss) per common share--basic:
Income before extraordinary item................................ $ 0.24 $ 0.68 $ 0.42 $ 0.93
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Extraordinary loss on early extinguishments of debt............. $ -- $ -- $ (1.08) $ --
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Net income (loss)............................................... $ 0.24 $ 0.68 $ (0.66) $ 0.93
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Income (loss) per common share--diluted:
Income before extraordinary item................................ $ 0.23 $ 0.67 $ 0.41 $ 0.93
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Extraordinary loss on early extinguishments of debt............. $ -- $ -- $ (1.06) $ --
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
Net income (loss)............................................... $ 0.23 $ 0.67 $ (0.65) $ 0.93
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
</TABLE>
The accompanying notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
2
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED
JUNE 30,
------------------------
<S> <C> <C>
1998 1999
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................................................... $ (20,269) $ 29,637
----------- -----------
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization.................................................... 37,649 57,603
Equity in (earnings) losses of unconsolidated subsidiaries....................... 16,905 (21,525)
Stock option expense (credit).................................................... (3,527) 18
Non-cash interest expense........................................................ 1,984 2,882
Gain on sale of assets........................................................... (3,000) (23,623)
Impairment of long-lived assets.................................................. 2,160 --
Extraordinary loss on early extinguishments of debt.............................. 55,025 --
Cash flows from changes in assets and liabilities, net of effects from sales and
acquisitions of businesses:
Accounts receivable, net....................................................... (28,360) 4,706
Other assets................................................................... (676) 1,624
Restricted cash and investments................................................ (8,268) (22,670)
Accounts payable and other accrued liabilities................................. (40,833) (9,397)
Medical claims payable......................................................... 22,405 17,282
Reserve for unpaid claims...................................................... (16,083) (8,914)
Income taxes payable and deferred income taxes................................. (16,544) 28,700
Other liabilities.............................................................. (7,239) 8,830
Minority interest, net of dividends paid....................................... 4,354 1,583
Other.......................................................................... (1,084) (1,310)
----------- -----------
Total adjustments............................................................ 14,868 35,789
----------- -----------
Net cash provided by (used in) operating activities........................ (5,401) 65,426
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................................. (26,938) (36,259)
Acquisitions and investments in businesses, net of cash acquired and
return of escrowed funds........................................................... (1,033,155) (60,424)
Conversion of joint ventures from consolidation to equity method..................... -- (21,092)
Distributions received from unconsolidated subsidiaries.............................. -- 18,955
Decrease in assets restricted for settlement of unpaid claims........................ 46,943 14,904
Proceeds from sale of assets, net of transaction costs............................... 12,018 58,172
----------- -----------
Net cash used in investing activities.............................................. (1,001,132) (25,744)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt, net of issuance costs................................ 1,169,887 49,347
Payments on debt and capital lease obligations....................................... (438,563) (141,917)
Proceeds from exercise of stock options and warrants................................. 4,633 1,145
Purchases of treasury stock.......................................................... (12,456) --
----------- -----------
Net cash provided by (used in) financing activities................................ 723,501 (91,425)
----------- -----------
Net decrease in cash and cash equivalents.............................................. (283,032) (51,743)
Cash and cash equivalents at beginning of period....................................... 372,878 92,050
----------- -----------
Cash and cash equivalents at end of period............................................. $ 89,846 $ 40,307
----------- -----------
----------- -----------
</TABLE>
The accompanying notes to Condensed Consolidated Financial Statements
are an integral part of these statements.
3
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments, consisting of normal recurring
adjustments considered necessary for a fair presentation, have been included.
These financial statements should be read in conjunction with the audited
consolidated financial statements of Magellan Health Services, Inc. and
Subsidiaries ("Magellan" or the "Company") for the fiscal year ended September
30, 1998, included in the Company's Annual Report on Form 10-K, as amended. All
references to fiscal years contained herein refer to periods of twelve
consecutive months ending on September 30. Certain reclassifications have been
made to fiscal 1998 amounts to conform to fiscal 1999 presentation.
NOTE B--SUPPLEMENTAL CASH FLOW INFORMATION
Below is supplemental cash flow information related to the nine months ended
June 30, 1998 and 1999 (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
JUNE 30,
--------------------
<S> <C> <C>
1998 1999
--------- ---------
Income taxes paid, net of refunds received.................................................. $ 8,572 $ (585)
--------- ---------
--------- ---------
Interest paid, net of amounts capitalized................................................... $ 53,686 $ 64,116
--------- ---------
--------- ---------
Non-cash transactions:
Fair value of common stock in treasury issued in connection with the Green Spring Minority
Stockholder Conversion (as defined)....................................................... $ 63,496 $ --
--------- ---------
--------- ---------
</TABLE>
4
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE C--LONG-TERM DEBT AND LEASES
Information with regard to the Company's long-term debt and capital lease
obligations at September 30, 1998 and June 30, 1999 is as follows (in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1999
------------- ------------
<S> <C> <C>
Credit Agreement:
Revolving Facility due through 2004................................................ $ 40,000 $ --
Term Loan Facility (7.4175% to 7.9175% at June 30, 1999) due through 2006.......... 550,000 499,009
9.0% Senior Subordinated Notes due 2008.............................................. 625,000 625,000
6.0% to 11.5% notes payable through 2005............................................. 4,198 3,035
3.6% capital lease obligations due through 2014...................................... 6,448 6,400
------------- ------------
1,225,646 1,133,444
Less amounts due within one year..................................................... 23,033 31,260
------------- ------------
$ 1,202,613 $ 1,102,184
------------- ------------
------------- ------------
</TABLE>
NOTE D--ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1999
------------- ----------
<S> <C> <C>
Salaries, wages and other benefits..................................................... $ 23,893 $ 21,373
Interest............................................................................... 9,271 21,692
CHAMPUS adjustments.................................................................... 25,484 34,886
Other.................................................................................. 134,882 135,640
------------- ----------
$ 193,530 $ 213,591
------------- ----------
------------- ----------
</TABLE>
NOTE E--INCOME PER COMMON SHARE
The following table presents the components of average number of common
shares outstanding-- diluted (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
<S> <C> <C> <C> <C>
JUNE 30, JUNE 30,
-------------------- --------------------
<CAPTION>
1998 1999 1998 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Average number of common shares outstanding--basic......................... 31,523 31,778 30,505 31,710
Common stock equivalents--stock options.................................... 570 258 578 105
Common stock equivalents--warrants......................................... 38 5 16 7
--------- --------- --------- ---------
Average number of common shares outstanding--diluted....................... 32,131 32,041 31,099 31,822
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
5
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE E--INCOME PER COMMON SHARE (CONTINUED)
Options to purchase approximately 3,642,000 shares of common stock at $8.41
to $31.00 per share were outstanding during the nine months ended June 30, 1999,
but were excluded from the calculation of average number of common shares
outstanding--diluted because the options' exercise prices were greater than the
average market price of the common shares underlying such options during the
period. Approximately 3,307,000 of these options, which expire between fiscal
2001 and 2009, were outstanding at June 30, 1999.
Warrants to purchase approximately 4,713,000 shares of common stock at
$26.15 to $38.70 per share were outstanding during the nine months ended June
30, 1999, but were excluded from the calculation of average number of common
shares outstanding--diluted because the warrants' exercise prices were greater
than the average market price of the common shares underlying such warrants
during the period. All of the warrants, which expire between fiscal 2000 and
2009, were outstanding at June 30, 1999.
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 and held by current directors and full-time employees (the "Stock Option
Repricing"). Each holder of 10,000 or more stock options who chose to
participate in the Stock Option Repricing was required to forfeit a percentage
of outstanding stock options depending upon such factors as level of employment
and number of options held.
In order to participate in the Stock Option Repricing: (i) members of the
Company's Board of Directors, including the Chief Executive Officer ("CEO"),
were required to forfeit 40% of their outstanding options; (ii) Named Executive
Officers (as defined by Securities and Exchange Commission Regulations) other
than the CEO were required to forfeit 30% of their outstanding options; (iii)
all other holders of 50,000 or more options were required to forfeit 25% of
their outstanding options; and (iv) all other holders of 10,000 to 49,999
options were required to forfeit 15% of their outstanding options.
The Stock Option Repricing was consummated on December 8, 1998, based on the
fair market 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 was precluded from
exercising repriced stock options until June 8, 1999.
NOTE F--INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
CHOICE BEHAVIORAL HEALTH PARTNERSHIP. The Company is a 50% partner with
Value Options, Inc. in Choice Behavioral Health Partnership ("Choice"), a
general partnership. Choice is a managed behavioral healthcare company which
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.
6
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE F--INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
A summary of financial information for the Company's investment in Choice is
as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 JUNE 30, 1999
------------------ -------------
<S> <C> <C>
Current assets................................................................. $ 22,974 $ 20,022
Property and equipment, net.................................................... 345 248
------- -------------
Total assets............................................................... $ 23,319 $ 20,270
------- -------------
------- -------------
Current liabilities............................................................ $ 16,829 $ 13,073
Partners' capital.............................................................. 6,490 7,197
------- -------------
Total liabilities and partners' capital.................................... $ 23,319 $ 20,270
------- -------------
------- -------------
Company investment............................................................. $ 3,245 $ 3,599
------- -------------
------- -------------
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS 139 DAYS NINE MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 1998 JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenue........................................... $ 13,414 $ 13,281 $ 20,618 $ 41,027
Operating expenses.................................... 9,214 7,643 13,611 20,232
------------- ------------- ------------- -------------
Net income............................................ $ 4,200 $ 5,638 $ 7,007 $ 20,795
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Company equity income................................. $ 2,100 $ 2,819 $ 3,504 $ 10,398
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
The Company acquired its investment in Choice on February 12, 1998, as part
of the Merit (as defined) acquisition. Accordingly, statement of operations data
related to the nine months ended June 30, 1998, represents only the results of
operations of Choice from February 12, 1998 through June 30, 1998.
PREMIER BEHAVIORAL SYSTEMS, LLC. The Company owns a 50% interest in Premier
Behavioral Systems, LLC ("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, 1998 and June 30, 1999 was $5.8 million
and $13.2 million, respectively. The Company's equity in earnings of Premier for
the three months ended June 30, 1998 and 1999 was $4.6 million and $4.8 million,
respectively, and for the nine months ended June 30, 1998 and 1999 was $4.3
million and $7.4 million, respectively.
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC. The Company owned a 50% interest in
Charter Behavioral Health Systems, LLC ("CBHS") as of September 30, 1998 and
June 30, 1999. CBHS was formed on June 17, 1997, as a result of the Company's
sale of substantially all of the real estate used in its domestic psychiatric
hospital provider business (the "Psychiatric Hospital Facilities") to Crescent
Real Estate Equities, L.P. ("Crescent") (the "Crescent Transactions"). CBHS
leases the Psychiatric Hospital Facilities from Crescent. The Company accounts
for its investment in CBHS using the equity method.
7
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE F--INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
A summary of financial information for CBHS is as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1999
------------- ----------
<S> <C> <C>
Current assets.................................................................... $ 147,119 $ 157,518
Property and equipment, net....................................................... 21,148 22,792
Other nonconcurrent assets........................................................ 8,871 9,319
------------- ----------
Total assets...................................................................... $ 177,138 $ 189,629
------------- ----------
------------- ----------
Current liabilities............................................................... $ 141,379 $ 213,198
Long-term debt.................................................................... 67,200 57,194
Other nonconcurrent liabilities................................................... 35,437 58,031
Members' deficit.................................................................. (66,878) (138,794)
------------- ----------
Total liabilities and members' deficit............................................ $ 177,138 $ 189,629
------------- ----------
------------- ----------
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
<S> <C> <C> <C> <C>
1998 1999 1998 1999
---------- ---------- ---------- ----------
Net revenue................................................. $ 187,928 $ 180,935 $ 553,370 $ 554,761
---------- ---------- ---------- ----------
Crescent rent expense....................................... 14,015 14,075 42,033 42,183
Other operating expenses.................................... 191,505 193,815 563,429 576,989
Interest, net............................................... 1,300 1,454 3,975 4,468
---------- ---------- ---------- ----------
Net loss before preferred member distribution............... $ (18,892) $ (28,409) $ (56,067) $ (68,879)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Company's portion of net loss............................... $ (9,446) $ -- $ (28,034) $ --
Intercompany loss elimination............................... 2,288 -- 3,813 --
---------- ---------- ---------- ----------
Company equity loss (2)..................................... $ (7,158) $ -- $ (24,221) $ --
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Cash provided by (used in) operating activities..................................... $ (4,553) $ 20,543
---------- ----------
---------- ----------
</TABLE>
- ------------------------
(2) Note appears on page 9.
8
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE F--INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
The Company's transactions with CBHS and related balances are as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1998 1999 1998 1999
--------- --------- --------- ---------
Franchise fee revenue (2).......................................... $ 15,000 $ -- $ 51,100 $ --
Costs:
Accounts receivable collection fees................................ $ 248 $ 53 $ 1,862 $ 204
Hospital-based joint venture management fees....................... $ 1,708 $ 1,897 $ 5,191 $ 4,604
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1999
------------- -----------
<S> <C> <C>
Due to CBHS, net (1).............................................................. $ 1,127 $ 3,478
------ -----------
------ -----------
Prepaid CHARTER call center management fees (3)................................... $ 2,953 $ 3,345
------ -----------
------ -----------
Net book value of leased property (4)............................................. $ 2,850 $ 7,250
------ -----------
------ -----------
</TABLE>
- ------------------------
(1) The nature of hospital accounts receivable billing and collection processes
has resulted in the Company and CBHS receiving remittances 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. These and other events result in the amount presented as due to CBHS.
(2) Franchise fees due from CBHS were approximately $38.0 million and $99.5
million as of September 30, 1998, and June 30, 1999, respectively. CBHS'
independent public accountants' report on CBHS' financial statements for the
fiscal year ended September 30, 1998, makes reference to uncertainty
regarding CBHS' ability to continue as a going concern. The Company recorded
equity in loss of its investment in CBHS until all franchise fees due from
CBHS were reduced to $0 at September 30, 1998. The Company received no
franchise fee payments from CBHS and recorded no franchise fee revenue
related to CBHS during the three months and the nine months ended June 30,
1999, due to continuing uncertainties surrounding their collectibility.
Cumulative equity in losses of CBHS in excess of the Company's investment in
CBHS of $8.7 million ($5.1 million loss during the fiscal year ended
September 30, 1998; $3.6 million income during the the nine months ended
June 30, 1999) are not reflected in the Company's financial statements at
and for the nine months ended June 30, 1999, since the Company has no
remaining obligation or commitment to fund CBHS and has no guarantees
outstanding for any CBHS obligations.
(3) CBHS is responsible for funding substantially all of the operations of the
1-800-CHARTER call center, which is owned by the Company, under a management
agreement (the "Call Center Management Agreement") which was entered into on
December 22, 1997.
Under the Call Center Management Agreement, CBHS agreed to fund the
operations of the call center, with the exceptions of capital expenditures
and lease payments, for an initial term of eighteen
9
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE F--INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
months in exchange for payment of approximately $5.9 million, which
approximated the budgeted costs for the call center over the term of the
agreement. In December 1998, the Call Center Management Agreement was
extended for an additional twelve months at a cost to the Company of
approximately $3.3 million.
(4) CBHS leased two psychiatric hospital facilities (collectively, the "CBHS
Leaseholds") from the Company as of June 30, 1999. The CBHS Leaseholds were
acquired by the Company in connection with CBHS' acquisition of certain
businesses from Ramsay Health Care, Inc. on September 28, 1998. The Company
paid approximately $7.2 million for the CBHS Leaseholds ($2.8 million during
September 1998; $4.4 million during the nine months ended June 30, 1999).
The purchase of the CBHS Leaseholds was funded primarily through
distributions received from the Provider JV's (as defined). The CBHS
Leaseholds are leased to CBHS for a 10-year lease term at an annual rent of
$0.7 million. The Company accounted for the purchase of the CBHS Leaseholds
as an investment in income producing property. Both the Company and CBHS
account for these leases as operating leases.
Under the terms of a letter agreement dated November 10, 1998, between the
Company and Crescent Real Estate Funding VII, L.P. ("Crescent Funding"),
Crescent Funding has agreed to purchase the CBHS Leaseholds from the
Company, at the contract acquisition cost paid by the Company, upon the sale
of certain other property owned by Crescent Funding and leased by CBHS at
June 30, 1999. Crescent Funding is an affiliate of both Crescent Operating,
Inc. ("COI"), the other 50% owner of CBHS, and Crescent, the lessor of the
majority of the properties in which CBHS conducts its business.
HOSPITAL-BASED JOINT VENTURES. The Company owns non-controlling interests
in five hospital-based joint ventures ("Provider JVs"). 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 partner or
member.
A summary of the Provider JVs is as follows:
<TABLE>
<CAPTION>
FORMATION OWNERSHIP
MARKET DATE PERCENTAGE MINORITY OWNER
- ------------------------------ ---------------- --------------- ----------------------------------------------
<S> <C> <C> <C>
Chicago, IL................... June, 1994 75% Naperville Health Ventures
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>
The Provider JVs' results of operations were included in the Company's
consolidated financial statements from inception, less minority interest,
through September 30, 1998. On October 1, 1998, the Provider JVs were converted
from consolidation to the equity method. See "Management's Discussion and
Analysis--Recent Accounting Pronouncements--EITF 96-16".
The Provider JVs, along with one consolidated 97.5% owned hospital-based
joint venture with approximately $19.8 million of net assets, have been managed
by CBHS for a fee equivalent to the
10
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE F--INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
Company's portion of their earnings since June 17, 1997. Additionally, should
the Company liquidate its interests in any or all of these six hospital-based
joint ventures, the majority of the net proceeds received by the Company must be
redeployed for the benefit of CBHS.
A summary of financial information for the Company's aggregate investment in
the Provider JVs is as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1999
-------------
<S> <C>
Current assets................................................................................ $ 21,880
Property and equipment, net................................................................... 23,109
Other noncurrent assets....................................................................... 2,160
-------------
Total assets.................................................................................. $ 47,149
-------------
-------------
Current liabilities........................................................................... $ 11,028
Owners' capital............................................................................... 36,121
-------------
Total liabilities and owners' capital......................................................... $ 47,149
-------------
-------------
Company investment............................................................................ $ 18,973
-------------
-------------
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1999
------------- -------------
<S> <C> <C>
Net revenue.................................................................... $ 14,391 $ 43,501
Operating expenses............................................................. 12,845 37,730
------------- -------------
Net income..................................................................... $ 1,546 $ 5,771
------------- -------------
------------- -------------
Company equity income.......................................................... $ 918 $ 3,282
------------- -------------
------------- -------------
</TABLE>
11
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
NOTE G--ACQUISITIONS AND DIVESTITURES
MANAGED CARE ACQUISITIONS. During fiscal 1998, the Company acquired the
following businesses in its Behavioral Managed Healthcare ("Behavioral") and
Specialty Managed Healthcare ("Specialty") business segments (collectively, the
"Managed Care Acquisitions"):
<TABLE>
<CAPTION>
CONTRACT
PURCHASE
PRICE
ACQUIRED COMPANY SEGMENT ACQUISITION DATE (MILLIONS)
- ------------------------------------------------------ ------------ ---------------------- -----------
<S> <C> <C> <C>
Human Affairs International, Incorporated ("HAI")..... Behavioral December 4, 1997 $ 122.1(1)
Allied Health Group, Inc. ("Allied").................. Specialty December 5, 1997 $ 50.0(2)
Merit Behavioral Care Corporation ("Merit")........... Behavioral February 12, 1998 $ 750.0
</TABLE>
- ------------------------
(1) Excluding potential aggregate contingent consideration of up to $300.0
million (limited to $60.0 million for each of the five years from the
acquisition date). On March 26, 1999, the Company paid Aetna, Inc.
("Aetna"), the former owner of HAI, $60.0 million of additional
consideration for the purchase of HAI (the "Aetna Payment"). The Aetna
Payment was recorded as additional goodwill and identifiable intangible
assets.
(2) Excluding $4.5 million of additional consideration paid during the quarter
ended December 31, 1998, which was recorded as additional goodwill.
The Company accounted for the Managed Care Acquisitions using the purchase
method of accounting.
GREEN SPRING MINORITY STOCKHOLDER CONVERSION. In January 1998, the minority
stockholders of Green Spring Health Services, Inc. ("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 an exchange option (the
"Green Spring Minority Stockholder Conversion"). Green Spring became a wholly
owned subsidiary of the Company as a result of the Green Spring Minority
Stockholder Conversion. 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 the fair value of consideration paid.
The following unaudited pro forma information for the nine months ended June
30, 1998, has been prepared assuming the Managed Care Acquisitions and the Green
Spring Minority Stockholder Conversion occurred on October 1, 1997. The
unaudited pro forma information does not purport to be indicative
12
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE G--ACQUISITIONS AND DIVESTITURES (CONTINUED)
of the results that would have actually been obtained had such transactions
occurred on October 1, 1997, or which may be attained in future periods (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
JUNE 30, 1998
-------------
<S> <C>
Net revenue.................................................................... $ 1,346,245
-------------
-------------
Net income (1)(2).............................................................. $ 11,166
-------------
-------------
Income per common share--basic................................................. $ 0.35
-------------
-------------
Income per common share--diluted............................................... $ 0.35
-------------
-------------
</TABLE>
- ------------------------
(1) Excludes expected unrealized cost savings related to the Integration Plan
(as defined) and managed care integration costs.
(2) Excludes the extraordinary loss on early extinguishments of debt during the
nine months ended June 30, 1998, that were directly attributable to the
consummation of the Merit acquisition.
EUROPEAN PSYCHIATRIC HOSPITALS. On April 9, 1999, the Company sold its
European psychiatric provider operations to Investment AB Bure of Sweden for
approximately $57.0 million (before transaction costs of approximately $2.5
million). The sale resulted in a non-recurring gain of approximately $23.9
million before provision for income taxes.
The Company used approximately $38.2 million of the net sale proceeds to
make mandatory unscheduled principal payments on indebtedness outstanding under
the Term Loan Facility (as defined). The remaining proceeds were used to reduce
borrowings outstanding under the Revolving Facility (as defined).
These transactions are more fully described in the Company's current report
on Form 8-K which was filed with the Securities and Exchange Commission on April
14, 1999.
NOTE H--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 Company's historical claims experience adjusted for
current industry trends. The undiscounted amount of the reserve for unpaid
claims at September 30, 1998 and June 30, 1999, was approximately $34.6 million
and $24.5 million, respectively. The carrying amount of accrued medical
malpractice claims was $26.2 million and $21.4 million at September 30, 1998 and
June 30, 1999, respectively. The reserve for unpaid claims is adjusted
periodically, as such claims mature, to reflect changes in actuarial estimates
based on experience. During the nine months ended June 30, 1998, the Company
recorded reductions in malpractice claim reserves of approximately $4.1 million
as a result of updated actuarial estimates. These reductions resulted
13
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE H--CONTINGENCIES (CONTINUED)
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. On July 2, 1999,
the Company transferred its remaining medical malpractice claims portfolio (the
"Loss Portfolio Transfer") to a third-party insurer. The Loss Portfolio Transfer
was funded from assets restricted for settlement of unpaid claims and
approximated the carrying amount of accrued medical malpractice claims. The
insurance limit obtained through the Loss Portfolio Transfer for future medical
malpractice claims is $26.4 million.
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 and/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 Company's psychiatric provider
operations 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 are probable of assertion 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.
On May 26, 1998, a group of eleven 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 District of New Jersey against nine behavioral health managed care
organizations, including Merit, CMG, Green Spring and HAI (collectively, the
"Defendants"). The complaint 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
14
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE H--CONTINGENCIES (CONTINUED)
complaint, plus costs and attorneys' fees. Upon joint motion by the Defendants,
the case was transferred to the United States District Court for the Southern
District of New York, the same court where a previous similar case (the
"Stephens Case") was dismissed for failure to state a claim upon which relief
can be granted. On March 15, 1999, the Defendants filed a joint motion to
dismiss the case for substantially the same reasons as in the Stephens Case. On
June 16, 1999, the court denied the motion to dismiss. The case currently is in
the early stages of discovery. 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 $34.9 million as of June 30, 1999, 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.
NOTE I--MANAGED CARE INTEGRATION PLAN AND COSTS
INTEGRATION PLAN. During fiscal 1998, management committed the Company to a
plan to combine and integrate the operations of its Behavioral and Specialty
segments (the "Integration Plan"). The Integration Plan 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 510 employees had
been involuntarily terminated pursuant to the Integration Plan as of June 30,
1999. The Company has substantially completed involuntary terminations related
to the Integration Plan, and most of the remaining positions have been or will
be eliminated through normal attrition.
The employee groups of the Behavioral segment that are primarily affected
include executive management, finance, human resources, information systems and
legal personnel at the various corporate headquarters and regional offices and
credentialing, claims processing, contracting and marketing personnel at various
operating locations.
The Integration Plan has resulted in the closure and identified closure of
approximately 20 leased facilities during fiscal 1998 and 1999. The Company
expects the remaining office closures, if any, to be insignificant.
The Company initially 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" in fiscal 1998.
During the nine months ended June 30, 1999, the Company recorded adjustments of
approximately $0.1 million, net, to such liabilities, of which $(0.8) million
was recorded as part of the Merit purchase price allocation and $0.9 million was
recorded in the statement of operations under "Managed care integration costs."
The
15
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE I--MANAGED CARE INTEGRATION PLAN AND COSTS (CONTINUED)
Company may record additional adjustments to such liabilities through the
remainder of fiscal 1999 depending on its ability to sublease closed offices and
upon determination of the final amount of the Company's severance obligations.
The following table provides a rollforward of liabilities resulting from the
Integration Plan (in thousands).
<TABLE>
<CAPTION>
BALANCE BALANCE
SEPTEMBER 30, JUNE 30,
TYPE OF COST 1998 ADJUSTMENTS PAYMENTS 1999
- -------------------------------------------------------------- ------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Employee termination benefits................................. $ 6,190 $ 1,103 $ (6,042) $ 1,251
Facility closing costs........................................ 7,475 (826) (1,130) 5,519
Other......................................................... 169 (169) - -
------------- ------ ----------- -----------
$ 13,834 $ 108 $ (7,172) $ 6,770
------------- ------ ----------- -----------
------------- ------ ----------- -----------
</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 quarter and the nine months ended June 30, 1998, the Company
incurred approximately $1.2 million and $5.7 million in other integration costs,
respectively, including long-lived asset impairments of approximately $2.2
million during the nine months ended June 30, 1998, and outside consulting costs
of approximately $0.9 million and $3.1 million for the quarter and the nine
months ended June 30, 1998, respectively. During the quarter and the nine months
ended June 30, 1999, the Company incurred approximately $0.5 million and $3.5
million in other integration costs, respectively, primarily for outside
consulting costs and employee and office relocation costs.
NOTE J--BUSINESS SEGMENT INFORMATION
The Company operates through five reportable segments which are engaged in
various aspects of the healthcare industry. Intersegment sales and transfers
among these segments are not significant.
16
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE J--BUSINESS SEGMENT INFORMATION (CONTINUED)
The following tables summarize, for the periods indicated, net revenue and
Segment Profit (as defined) 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>
THREE MONTHS ENDED JUNE 30, 1998
Net revenue.......................... $ 332,318 $ 37,385 $ 46,160 $ 15,000 $ 33,066 $ -- $ 463,929
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
Segment Profit (loss)................ $ 45,403 $ 3,898 $ 1,490 $ 6,043 $ 4,438 $ (4,092) $ 57,180
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
THREE MONTHS ENDED JUNE 30, 1999
Net revenue.......................... $ 370,038 $ 48,642 $ 58,611 $ 113 $ 9,307 $ -- $ 486,711
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
Segment Profit (loss)................ $ 55,556 $ 6,036 $ 797 $ (1,559) $ 910 $ (3,110) $ 58,630
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
NINE MONTHS ENDED JUNE 30, 1998
Net revenue.......................... $ 694,702 $ 96,456 $ 105,593 $ 51,100 $ 99,402 $ -- $1,047,253
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
Segment Profit (loss)................ $ 88,504 $ 9,172 $ 2,026 $ 20,134 $ 18,840 $ (12,123) $ 126,553
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
NINE MONTHS ENDED JUNE 30, 1999
Net revenue.......................... $1,108,949 $ 141,363 $ 150,013 $ 403 $ 46,441 $ -- $1,447,169
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
Segment Profit (loss)................ $ 161,692 $ 16,850 $ 2,180 $ (4,527) $ 4,079 $ (9,636) $ 170,638
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
Total assets:
September 30, 1998................. $1,356,259 $ 119,356 $ 78,062 $ 1,941 $ 178,217 $ 182,455 $1,916,290
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
June 30, 1999...................... $1,422,514 $ 123,972 $ 87,470 $ 1,930 $ 90,018 $ 137,569 $1,863,473
----------- --------- ----------- ----------- ----------- ----------- ------------
----------- --------- ----------- ----------- ----------- ----------- ------------
</TABLE>
The following tables reconcile Segment Profit (as defined) to consolidated
income before provision for income taxes, minority interest and extraordinary
item (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
--------------------- ----------------------
<S> <C> <C> <C> <C>
1998 1999 1998 1999
---------- --------- ---------- ----------
Segment Profit..................................................... $ 57,180 $ 58,630 $ 126,553 $ 170,638
Depreciation and amortization...................................... (17,724) (20,249) (37,649) (57,603)
Interest, net...................................................... (24,409) (22,640) (49,336) (70,958)
Stock option (expense) credit...................................... (12) -- 3,527 (18)
Managed care integration costs..................................... (1,240) (522) (12,314) (4,391)
Gain on sale of European hospitals................................. -- 23,912 -- 23,912
Special (charges) income........................................... 3,049 -- 3,000 (2,274)
---------- --------- ---------- ----------
Income before provision for income taxes, minority interest and
extraordinary item............................................... $ 16,844 $ 39,131 $ 33,781 $ 59,306
---------- --------- ---------- ----------
---------- --------- ---------- ----------
</TABLE>
17
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
NOTE K--SUBSEQUENT EVENTS
TPG INVESTMENT. On July 19, 1999, the Company announced that it had entered
into a definitive agreement to issue approximately $75.4 million of cumulative
convertible preferred stock to TPG Magellan, LLC, an affiliate of the investment
firm Texas Pacific Group ("TPG") (the "TPG Investment").
TPG will purchase approximately $59.1 million of the Company's Series A
Cumulative Convertible Preferred Stock (the "Series A Preferred Stock") at
closing. The Series A Preferred Stock carries a dividend of 6.5% per annum,
payable in quarterly installments in cash or common stock, subject to certain
conditions. Dividends not paid in cash or common stock will accumulate. The
Series A Preferred Stock is convertible at any time into approximately 6.3
million shares of the Company's common stock at a conversion price of $9.375 per
share and carries "as converted" voting rights. The Company may, under certain
circumstances, require the holders of the Series A Preferred Stock to convert
such stock into common stock. The Series A Preferred Stock, plus accrued and
unpaid dividends thereon, must be redeemed by the Company on the tenth
anniversary of the date of its issuance.
TPG will deposit approximately $16.3 million into an interest bearing escrow
account (the "Escrow Deposit") at closing for the potential future purchase of
the Company's Series B Cumulative Convertible Preferred Stock (the "Series B
Preferred Stock"). If the Company obtains stockholder approval for the issuance
of common stock upon conversion or exchange of the Series B Preferred Stock and
the voting rights in respect of the Series B Preferred Stock (the "Series B
Preferred Stock Approval") on or prior to March 5, 2000, the Series B Preferred
Stock will be issued to TPG, and the Escrow Deposit, including interest earned
thereon, will be disbursed to the Company. If the Company does not obtain the
Series B Preferred Stock Approval, TPG may elect not to purchase the Series B
Preferred Stock and the Escrow Deposit, including interest earned thereon, will
be refunded to TPG.
If the Company's does not obtain the Series B Preferred Stock Approval on or
prior to March 5, 2000, and TPG elects to purchase the Series B Preferred Stock,
the conversion price will be reduced from $9.625 per share to $9.125 per share
and dividends will accrue at 12.0% per annum from March 5, 2000, until the date
on which stockholder approval is obtained by the Company.
The Series B Preferred Stock carries a dividend of 6.5% per annum, payable
in quarterly installments in cash or common stock, subject to certain
conditions. Dividends not paid in cash or common stock will accumulate. The
Series B Preferred Stock will be convertible at any time after stockholder
approval into approximately 1.7 million shares of the Company's common stock at
a conversion price of $9.625 per share. The Company may, under certain
circumstances, require the holders of the Series B Preferred Stock to convert
their shares into common stock. The Series B Preferred Stock, plus accrued and
unpaid dividends thereon, must be redeemed by the Company on the tenth
anniversary of the date of issuance of the Series A Preferred Stock.
Upon the closing of the TPG Investment, TPG will be entitled to nominate
three directors to the Company's twelve-member Board of Directors.
The TPG Investment is subject to certain regulatory approvals and other
customary closing conditions. The Company expects to close the TPG Investment
during the fourth quarter of fiscal 1999. Subsequent to closing, certain aspects
of the TPG Investment are subject to stockholder approval, including: (i) the
issuance of common stock in respect of accrued and unpaid dividend obligations
on the Series A and Series B Preferred Stock; (ii) the issuance of common stock
upon the conversion or exchange
18
<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1999
(UNAUDITED)
of the Series B Preferred Stock; and (iii) the vesting of voting rights in
respect of the Series B Preferred Stock. The Company intends to seek such
approval no later than the next annual meeting of its stockholders, which is
expected to be held in March 2000.
The TPG Investment is more fully described in the Company's current report
on Form 8-K, which was filed with the Securities and Exchange Commission on July
21, 1999.
RECAPITALIZATION OF CBHS. On August 10, 1999, the Company entered into a
binding Letter Agreement with Crescent, COI and CBHS relating to a proposed
recapitalization of CBHS and restructuring of relationships among the parties.
Under the Letter Agreement, the Company has agreed that it will, at the closing
of the contemplated transactions, transfer its remaining hospital-based and
franchise assets to CBHS and cancel franchise fees due from CBHS. Thereafter,
the Company will no longer be obligated to provide franchise services to CBHS.
The Company will also transfer 80% of its CBHS common interest and all of
its preferred interest to CBHS, leaving the Company with a 10% common membership
interest in CBHS.
In connection with the execution of the Letter Agreement, the Company,
Crescent, COI and CBHS have agreed to provide each other with mutual releases of
all claims and disputes against each other, with certain specified exceptions,
and Crescent has deferred the August 1999 rent due from CBHS to the last four
months of calendar 1999. Additionally, with the execution of the Letter
Agreement, the $2.5 million held in escrow in connection with a pending
arbitration between the Company and COI was released to COI. The Company and
CBHS also have modified and extended their existing arrangement which designates
CBHS a preferred provider of inpatient acute behavioral health services.
The closing of the transactions contemplated by the Letter Agreement is
anticipated to take place within 30 days, subject to the satisfaction of certain
customary closing conditions and consents and other contingencies. If the
closing does not occur within 30 days, the Letter Agreement terminates. There
can be no assurance that the proposed recapitalization of CBHS will be
consummated.
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<PAGE>
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
JUNE 30, 1999
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Form 10-Q includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (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 in the Company's Annual
Report on Form 10-K, as amended, for the fiscal year ended September 30, 1998.
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 in the Company's Annual Report on Form 10-K, as
amended, for the fiscal year ended September 30, 1998.
OVERVIEW
The Company operates through five principal business segments which are
engaged in:
- THE BEHAVIORAL MANAGED HEALTHCARE BUSINESS. The Company's MAGELLAN
BEHAVIORAL HEALTH division coordinates and manages the delivery of
behavioral healthcare treatment services through its network of providers,
which includes psychiatrists, psychologists and other medical
professionals. The treatment services provided through these networks
include outpatient programs (such as counseling or therapy), intermediate
care programs (such as intensive outpatient programs and partial
hospitalization services), inpatient treatment and alternative care
services (such as residential treatment and home or community-based
programs). The Company provides these services primarily through: (i)
risk-based products, where the Company assumes all or a portion of the
responsibility for the cost of providing treatment services in exchange
for a fixed per member per month fee, (ii) administrative services only
("ASO") products, where the Company provides services such as utilization
review, claims administration or provider network management, (iii)
employee assistance programs ("EAPs") and (iv) products which combine
features of some or all of the Company's risk-based, ASO, or EAP products.
- THE HUMAN SERVICES BUSINESS. The Company provides various human services
through its National MENTOR subsidiary. These human services include
specialty home-based healthcare services provided through "mentor" homes
as well as residential and day treatment services for individuals with
acquired brain injuries and for individuals with mental retardation and
developmental disabilities.
- THE SPECIALTY MANAGED HEALTHCARE BUSINESS. The Company's MAGELLAN
SPECIALTY HEALTH division provides specialty risk-based and ASO services
to its customers, primarily health insurance companies, through its
physician networks in the eastern United States. These networks include
physicians specializing in cardiology, oncology and diabetes.
- THE HEALTHCARE FRANCHISING BUSINESS. The Company's Charter Advantage, LLC
subsidiary franchises the "CHARTER" system of behavioral healthcare
primarily to psychiatric hospital facilities operated by CBHS. The Company
is currently seeking to divest its healthcare franchising business. See
"--Outlook--Results of Operations--Recapitalization of CBHS."
- THE HEALTHCARE PROVIDER BUSINESS. The Company's provider operations
included the ownership and operation of three psychiatric hospitals in
Europe during the nine months ended June 30, 1999. The Company sold these
European psychiatric provider operations on April 9, 1999. See
"--Outlook-- Results of Operations--Sale of European Psychiatric Provider
Operations." The Company's provider operations currently include: (i) its
50% interest in CBHS, (ii) its interests in six hospital-based joint
ventures and (iii) its provider management business in Puerto Rico. The
Company is
20
<PAGE>
currently seeking to divest the remainder of its healthcare provider
business. See "--Outlook-- Results of Operations--Recapitalization of
CBHS."
At June 30, 1999, the Company's MAGELLAN BEHAVIORAL HEALTH division, which
was formed primarily through acquisitions completed in fiscal 1996 (Green
Spring) and fiscal 1998 (HAI and Merit), managed the behavioral healthcare
benefits of approximately 64.9 million individuals; National MENTOR, which
acquired eight businesses in fiscal 1998 and fiscal 1999, provided
community-based services to approximately 6,400 individuals; and the Company's
MAGELLAN SPECIALTY HEALTH division, which was formed primarily through
acquisitions completed in fiscal 1997 (Care Management Resources, Inc.) and
fiscal 1998 (Allied) managed medical specialty benefits for approximately three
million members of health plans.
21
<PAGE>
HISTORICAL RESULTS OF OPERATIONS
The following tables summarize, for the periods indicated, operating results
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>
THREE MONTHS ENDED JUNE 30, 1998
- --------------------------------------------------
Net revenue......................... $ 332,318 $ 37,385 $ 46,160 $ 15,000 $ 33,066 $ -- $ 463,929
------------ ---------- ----------- ----------- ----------- ---------- ------------
Salaries, cost of care and other
operating expenses................ 293,665 33,487 44,670 1,799 28,628 4,092 406,341
Equity in (earnings) losses of
unconsolidated subsidiaries....... (6,750) -- -- 7,158 -- -- 408
------------ ---------- ----------- ----------- ----------- ---------- ------------
286,915 33,487 44,670 8,957 28,628 4,092 406,749
------------ ---------- ----------- ----------- ----------- ---------- ------------
Segment Profit (loss) (1)........... $ 45,403 $ 3,898 $ 1,490 $ 6,043 $ 4,438 $ (4,092) $ 57,180
------------ ---------- ----------- ----------- ----------- ---------- ------------
------------ ---------- ----------- ----------- ----------- ---------- ------------
THREE MONTHS ENDED JUNE 30, 1999
- --------------------------------------------------
Net revenue......................... $ 370,038 $ 48,642 $ 58,611 $ 113 $ 9,307 $ -- $ 486,711
------------ ---------- ----------- ----------- ----------- ---------- ------------
Salaries, cost of care and other
operating expenses................ 322,678 42,606 57,814 1,672 9,317 3,110 437,197
Equity in earnings of unconsolidated
subsidiaries...................... (8,196) -- -- -- (920) -- (9,116)
------------ ---------- ----------- ----------- ----------- ---------- ------------
314,482 42,606 57,814 1,672 8,397 3,110 428,081
------------ ---------- ----------- ----------- ----------- ---------- ------------
Segment Profit (loss) (1)........... $ 55,556 $ 6,036 $ 797 $ (1,559) $ 910 $ (3,110) $ 58,630
------------ ---------- ----------- ----------- ----------- ---------- ------------
------------ ---------- ----------- ----------- ----------- ---------- ------------
NINE MONTHS ENDED JUNE 30, 1998
- ------------------------------------
Net revenue......................... $ 694,702 $ 96,456 $ 105,593 $ 51,100 $ 99,402 $ -- $1,047,253
------------ ---------- ----------- ----------- ----------- ---------- ------------
Salaries, cost of care and other
operating expenses................ 613,514 87,284 103,567 6,745 80,562 12,123 903,795
Equity in (earnings) losses of
unconsolidated subsidiaries....... (7,316) -- -- 24,221 -- -- 16,905
------------ ---------- ----------- ----------- ----------- ---------- ------------
606,198 87,284 103,567 30,966 80,562 12,123 920,700
------------ ---------- ----------- ----------- ----------- ---------- ------------
Segment Profit (loss) (1)........... $ 88,504 $ 9,172 $ 2,026 $ 20,134 $ 18,840 $ (12,123) $ 126,553
------------ ---------- ----------- ----------- ----------- ---------- ------------
------------ ---------- ----------- ----------- ----------- ---------- ------------
NINE MONTHS ENDED JUNE 30, 1999
- ------------------------------------
Net revenue......................... $ 1,108,949 $ 141,363 $ 150,013 $ 403 $ 46,441 $ -- $1,447,169
------------ ---------- ----------- ----------- ----------- ---------- ------------
Salaries, cost of care and other
operating expenses................ 965,498 124,513 147,833 4,930 45,646 9,636 1,298,056
Equity in earnings of unconsolidated
subsidiaries...................... (18,241) -- -- -- (3,284) -- (21,525)
------------ ---------- ----------- ----------- ----------- ---------- ------------
947,257 124,513 147,833 4,930 42,362 9,636 1,276,531
------------ ---------- ----------- ----------- ----------- ---------- ------------
Segment Profit (loss) (1)........... $ 161,692 $ 16,850 $ 2,180 $ (4,527) $ 4,079 $ (9,636) $ 170,638
------------ ---------- ----------- ----------- ----------- ---------- ------------
------------ ---------- ----------- ----------- ----------- ---------- ------------
</TABLE>
22
<PAGE>
- ------------------------
(1) The Company evaluates performance of its business segments based on profit
or loss from operations before depreciation and amortization, interest,
stock option expense (credit), managed care integration costs, gains on
sales of businesses and other special charges (income), income taxes and
minority interest ("Segment Profit"). See the reconciliation of Segment
Profit to consolidated income before provision for income taxes, minority
interest and extraordinary item included in Note J--"Business Segment
Information" to the Company's condensed consolidated financial statements
set forth elsewhere herein.
QUARTER ENDED JUNE 30, 1999, COMPARED TO THE SAME PERIOD IN FISCAL 1998
BEHAVIORAL MANAGED HEALTHCARE. Revenue increased 11.3% or $37.7 million, to
$370.0 million for the quarter ended June 30, 1999, from $332.3 million in the
same period in fiscal 1998. Salaries, cost of care and other operating expenses
increased 9.9%, or $29.0 million, to $322.7 million for the quarter ended June
30, 1999, from $293.7 million in the same period in fiscal 1998. Equity in
earnings of unconsolidated subsidiaries increased $1.4 million to $8.2 million
for the quarter ended June 30, 1999, from $6.8 million for the same period in
fiscal 1998. The increases in revenue and salaries, cost of care and other
operating expenses resulted primarily from (i) increased enrollment related to
existing health plan customers, (ii) expanded services and lives under
management with certain public sector customers, (iii) new business development
and (iv) increases in retroactive customer settlements, offset by reductions in
general and administrative costs as a result of the Integration Plan and the
termination of one public sector contract in fiscal 1999. Total covered lives
increased 5.9%, or 3.6 million to 64.9 million at June 30, 1999 from 61.3
million at June 30, 1998. The Company frequently records retroactive customer
settlements, which may be favorable or unfavorable, under its commercial
behavioral managed healthcare contracts. Revenue and Segment Profit for the
quarter ended June 30, 1999, reflect approximately $5.3 million of such
favorable settlements compared to favorable settlements of $0.4 million during
the same period in fiscal 1998. Equity in earnings of unconsolidated
subsidiaries increased primarily as a result of improved performance at Choice
and Premier. Premier's results for the quarters ended June 30, 1999 and 1998,
included approximately $4.0 million of income related to adjustments to medical
claims payable as a result of favorable developments in payment trends.
HUMAN SERVICES. Revenue increased 30.0%, or $11.2 million, to $48.6 million
for the quarter ended June 30, 1999, from $37.4 million in the same period in
fiscal 1998. Salaries, cost of care and other operating expenses increased
27.2%, or $9.1 million, to $42.6 million for the quarter ended June 30, 1999
from $33.5 million in the same period in fiscal 1998. The increases were
attributable to acquisitions consummated in fiscal 1998 and fiscal 1999 and
internal growth. Placements in residential programs increased 17.1% to 3,830 at
June 30, 1999, compared to 3,270 at June 30, 1998. Total placements were 6,400
at June 30, 1999.
SPECIALTY MANAGED HEALTHCARE. Revenue increased 26.8%, or $12.4 million, to
$58.6 million for the quarter ended June 30, 1999, compared to $46.2 million in
the same period in fiscal 1998. Salaries, cost of care and other operating
expenses increased 29.3%, or $13.1 million, to $57.8 million for the quarter
ended June 30, 1999, compared to $44.7 million in the same period in fiscal
1998. The increase in revenue and salaries, cost of care and other operating
expenses was primarily related to a shift toward more risk-based business.
HEALTHCARE FRANCHISING. Revenue decreased to $0.1 million for the quarter
ended June 30, 1999, from $15.0 million in the same period in fiscal 1998.
Salaries, cost of care and other operating expenses decreased to $1.7 million
for the quarter ended June 30, 1999, from $1.8 million in the same period in
fiscal 1998. Equity in loss of CBHS decreased to $0 for the quarter ended June
30, 1999, from $7.2 million in the same period in fiscal 1998. The decrease in
revenue resulted from uncertainties surrounding the collectibility of franchise
fees due from CBHS, for which no franchise fee revenue was recognized during the
quarter ended June 30, 1999, while $15.0 million of CBHS franchise revenue was
recognized in the
23
<PAGE>
same period in fiscal 1998. The decrease in equity in loss of CBHS is
attributable to the fact that the Company had reduced its investment in CBHS to
$0 at September 30, 1998, and was no longer required to record its pro rata
share of CBHS' loss for the quarter ended June 30, 1999. See Note
F--"Investments in Unconsolidated Subsidiaries--Charter Behavioral Health
Systems, LLC" to the Company's condensed consolidated financial statements set
forth elsewhere herein.
HEALTHCARE PROVIDER. Revenue decreased 71.9%, or $23.8 million, to $9.3
million for the quarter ended June 30, 1999, from $33.1 million in the same
period in fiscal 1998. Salaries, cost of care and other operating expenses
decreased 67.5%, or $19.3 million, to $9.3 million for the quarter ended June
30, 1999, from $28.6 million in fiscal 1998. Equity in earnings of
unconsolidated subsidiaries increased to $0.9 million for the quarter ended June
30, 1999, from $0 in the same period in fiscal 1998. These changes resulted
primarily from the sale of the European hospitals on April 9, 1999 and from the
conversion of the Provider JVs from consolidation to the equity method on
October 1, 1998. See "--Recent Accounting Pronouncements--EITF 96-16" and
"Outlook--Results of Operations--Sale of European Psychiatric Provider
Operations."
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
14.1%, or $2.5 million, to $20.2 million for the quarter ended June 30, 1999,
from $17.7 million in the same period in fiscal 1998. The increase was primarily
attributable to depreciation related to recent capital expenditures and
amortization related to the Aetna Payment.
INTEREST, NET. Interest expense, net, decreased 7.4%, or $1.8 million, to
$22.6 million for the quarter ended June 30, 1999, from $24.4 million in the
same period in fiscal 1998. The decrease was primarily the result of reduced
interest expense related to lower average borrowings outstanding under the
Credit Agreement (as defined).
OTHER ITEMS. The Company recorded managed care integration costs of $0.5
million for the quarter ended June 30, 1999, compared to $1.2 million in the
same period in fiscal 1998. For a more complete discussion of managed care
integration costs, see Note I--"Managed Care Integration Plan and Costs" to the
Company's condensed consolidated financial statements set forth elsewhere
herein.
The Company recorded special income, net, of $3.0 million during the quarter
and the nine months ended June 30, 1998, for the net gain on the sale of assets
formerly used in its healthcare provider business.
The Company recorded a gain on the sale of its European psychiatric
hospitals of approximately $23.9 million for the quarter ended June 30, 1999.
See Note G--"Acquisitions and Divestitures--European Psychiatric Hospitals" to
the Company's condensed consolidated financial statements set forth elsewhere
herein.
Minority interest was immaterial for the quarter ended June 30, 1999,
compared to $1.1 million in the same period in fiscal 1998. This decrease
resulted primarily from the conversion of five provider joint ventures from
consolidation to the equity method (See "--Recent Accounting
Pronouncements--EITF 96-16").
NINE MONTHS ENDED JUNE 30, 1999, COMPARED TO THE SAME PERIOD IN FISCAL 1998
BEHAVIORAL MANAGED HEALTHCARE. Revenue increased 59.6% or $414.2 million,
to $1.11 billion for the nine months ended June 30, 1999, from $694.7 million in
the same period in fiscal 1998. Salaries, cost of care and other operating
expenses increased 57.4%, or $352.0 million, to $965.5 million for the nine
months ended June 30, 1999, from $613.5 million in the same period in fiscal
1998. Equity in earnings of unconsolidated subsidiaries increased $10.9 million,
to $18.2 million for the nine months ended June 30, 1999, from $7.3 million for
the same period in fiscal 1998. The increases resulted primarily from the HAI
and Merit acquisitions and the factors mentioned above in the comparison of the
quarter ended June 30, 1999 to the same period in fiscal 1998. Revenue and
Segment Profit for the nine months ended June 30, 1999 reflect approximately
$8.4 million of favorable retroactive customer settlements compared to favorable
settlements of $1.8 million during the same period of fiscal 1998.
24
<PAGE>
HUMAN SERVICES. Revenue increased 46.5%, or $44.9 million, to $141.4
million for the nine months ended June 30, 1999, from $96.5 million in the same
period in fiscal 1998. Salaries, cost of care and other operating expenses
increased 42.6%, or $37.2 million, to $124.5 million for the nine months ended
June 30, 1999 from $87.3 million in the same period in fiscal 1998. The
increases resulted primarily from the aforementioned factors for the quarter
ended June 30, 1999 compared to the same period in fiscal 1998.
SPECIALTY MANAGED HEALTHCARE. Revenue increased 42.0%, or $44.4 million, to
$150.0 million for the nine months ended June 30, 1999, compared to $105.6
million in the same period in fiscal 1998. Salaries, cost of care and other
operating expenses increased 42.7%, or $44.2 million, to $147.8 million for the
nine months ended June 30, 1999, compared to $103.6 million in the same period
in fiscal 1998. The increase in revenue and salaries, cost of care and other
operating expenses was primarily related to the Allied acquisition and the
factors mentioned in the comparison of the quarter ended June 30, 1999 to the
same period in fiscal 1998.
HEALTHCARE FRANCHISING. Revenue decreased to $0.4 million for the nine
months ended June 30, 1999, from $51.1 million in the same period in fiscal
1998. Salaries, cost of care and other operating expenses decreased 26.9%, or
$1.8 million, to $4.9 million for the nine months ended June 30, 1999, from $6.7
million in the same period in fiscal 1998. Equity in loss of CBHS decreased to
$0 for the nine months ended June 30, 1999, from $24.2 million in the same
period in fiscal 1998. The changes resulted primarily from the aforementioned
factors for the quarter ended June 30, 1999 compared to the quarter ended June
30, 1998. See Note F--"Investments in Unconsolidated Subsidiaries--Charter
Behavioral Health Systems, LLC" to the Company's condensed consolidated
financial statements set forth elsewhere herein.
HEALTHCARE PROVIDER. Revenue decreased 53.3%, or $53.0 million, to $46.4
million for the nine months ended June 30, 1999, from $99.4 million in the same
period in fiscal 1998. Salaries, cost of care and other operating expenses
decreased 43.4%, or $35.0 million, to $45.6 million for the nine months ended
June 30, 1999 from $80.6 million in fiscal 1998. Equity in earnings of
unconsolidated subsidiaries increased to $3.3 million for the nine months ended
June 30, 1999, from $0 in the same period in fiscal 1998. These changes resulted
primarily from the aforementioned factors for the quarter ended June 30, 1999
compared to the same period in fiscal 1998. See "--Recent Accounting
Pronouncements--EITF 96-16". During the nine months ended June 30, 1998, the
Company recorded reductions of expenses of $4.1 million 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 were based on
changes in expected values of ultimate losses resulting from the Company's claim
experience, and increased reliance on such claim experience.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
53.2%, or $20.0 million, to $57.6 million for the nine months ended June 30,
1999, from $37.6 million in the same period in fiscal 1998. The increase was
primarily attributable the Managed Care Acquisitions and the aforementioned
factors for the quarter ended June 30, 1999 compared to the same period in
fiscal 1998.
INTEREST, NET. Interest expense, net, increased 44.0%, or $21.7 million, to
$71.0 million for the nine months ended June 30, 1999, from $49.3 million in the
same period in fiscal 1998. The increase was primarily the result of interest
expense incurred on borrowings used to fund the Merit acquisition and related
transactions.
OTHER ITEMS. Stock option expense for the nine months ended June 30, 1999,
was not material compared to a credit of $3.5 million in fiscal 1998 primarily
due to fluctuations in the market price of the Company's stock in fiscal 1998.
The Company recorded managed care integration costs of $4.4 million for the
nine months ended June 30, 1999, compared to $12.3 million in the same period in
fiscal 1998. For a more complete discussion of managed care integration costs,
see Note I--"Managed Care Integration Plan and Costs" to the Company's condensed
consolidated financial statements set forth elsewhere herein.
25
<PAGE>
The Company's effective income tax rate increased to 49.1% for the nine
months ended June 30, 1999, compared to 47.3% in the same period in fiscal 1998.
The increase was primarily attributable to the increase in non-deductible
goodwill amortization resulting from the Merit acquisition of $13.5 million for
the nine months ended June 30, 1999, compared to $6.2 million for the same
period in fiscal 1998.
Minority interest decreased 88.2%, or $4.5 million, to $0.6 million,
compared to $5.1 million in the same period in fiscal 1998. This decrease
resulted primarily from the conversion of the Provider JVs from consolidation to
the equity method on October 1, 1998 (See "--Recent Accounting Pronouncements--
EITF 96-16") and from the Green Spring Minority Stockholder Conversion in
January 1998.
The Company recorded an extraordinary loss on early extinguishment of debt
of approximately $33.0 million, net of tax benefit, during the nine months ended
June 30, 1998, related primarily to refinancing the Company's long-term debt in
connection with the Merit acquisition.
OUTLOOK--RESULTS OF OPERATIONS
SALE OF EUROPEAN PSYCHIATRIC PROVIDER OPERATIONS. On April 9, 1999, the
Company sold its European psychiatric provider operations. See Note G --
"Acquisitions and Divestitures--European Psychiatric Hospitals" to the Company's
condensed consolidated financial statements set forth elsewhere herein. The sale
of the European psychiatric provider operations would have reduced the Company's
net income by approximately $1.6 million, or $.05 per diluted share, on a pro
forma basis (assuming the sale was consummated on October 1, 1997) for the
fiscal year ended September 30, 1998.
BEHAVIORAL MANAGED HEALTHCARE RESULTS OF OPERATIONS. The Company's
behavioral managed healthcare Segment Profits 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; (iv) retrospective membership adjustments; (v) timing of
implementation of new contracts and enrollment changes and (vi) pricing
adjustments upon long-term contract renewals.
The Company's contract with the State of Tennessee to manage the behavioral
healthcare benefits for the State's TennCare program ("TennCare Contract")
represented approximately 15% of the Company's behavioral managed care revenue
and approximately 10% of the Company's consolidated revenue in fiscal 1998. The
TennCare Contract contains provisions that limit the Company's profit, subject
to the carryforward of losses incurred in prior periods. The Company's profit
under the TennCare Contract benefitted from the carryforward of losses incurred
in prior periods during the quarter and the nine months ended June 30, 1999. The
Company's profit under the TennCare Contract may be lower in future quarters as
a result of these contract provisions.
TPG INVESTMENT. On July 19, 1999, the Company announced that it had entered
into the TPG Investment. See Note K--"Subsequent Events--TPG Investment". The
TPG Investment is expected to close during the fourth quarter of fiscal 1999.
The Company expects the TPG Investment to reduce fiscal 2000 diluted income per
common share by up to 15%.
RECAPITALIZATION OF CBHS. On August 10, 1999, the Company entered into a
binding Letter Agreement with Crescent, COI and CBHS relating to a proposed
recapitalization of CBHS and restructuring of relationships among the parties.
See Note K--"Subsequent Events--Recapitalization of CBHS".
The Company expects the proposed recapitalization of CBHS, as contemplated
by the Letter Agreement, to qualify as the disposal of its healthcare provider
and healthcare franchising segments under Accounting Priciples Board Opinion No.
30 ("APB 30"), "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions", if consummated. APB 30 requires that the
results of continuing operations be reported separately from those of
discontinued operations for all periods presented and that any gain or loss from
disposal of a segment of a business be reported in conjunction with the related
results
26
<PAGE>
of discontinued operations. The Company expects to record a loss on disposal
(primarily non-cash) of its healthcare provider and healthcare franchising
segments of $42.0 million to $48.0 million, net of tax, as a result of the
proposed recapitalization of CBHS, if consummated. There can be no assurance
that the proposed recapitalization of CBHS will be consummated.
HISTORICAL LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. The Company's net cash provided by (used in)
operating activities was $(5.4) million and $65.4 million for the nine months
ended June 30, 1998 and 1999, respectively. The increase in cash provided by
operating activities in fiscal 1999 compared to fiscal 1998 was primarily the
result of reduction in income taxes paid, net of refunds received, of $9.2
million, and increases in cash flows from operations as a result of the Managed
Care Acquisitions, offset by reductions in franchise fees collected from CBHS of
$30.6 million and (iv) increases in interest paid of $10.4 million.
INVESTING ACTIVITIES. Capital expenditures increased 34.9%, or $9.3
million, to $36.3 million for the nine months ended June 30, 1999, compared to
$26.9 million in the same period in fiscal 1998. This increase was due primarily
to: (i) capital expenditures of businesses acquired in fiscal 1998 and (ii)
increased capital expenditures in the Company's Behavioral Managed Healthcare
segment related to: (a) the Integration Plan (See Note I--"Managed Care
Integration Plan and Costs" to the Company's condensed consolidated financial
statements set forth elsewhere herein), and (b) acceleration of capital
expenditures related to year 2000 computer issues (See "--Potential Impact of
Year 2000 Computer Issues").
The Company used $60.4 million of funds, net of cash acquired, during the
nine months ended June 30, 1999 for acquisitions and investments in businesses,
which included (i) the Aetna Payment of $60.0 million, (ii) contingent
consideration paid to the former owners of Allied of $4.5 million and (iii)
other acquisitions and payments of contingent consideration and transaction
costs of $15.9 million offset by the refund of the $20.0 million placed in
escrow upon consummation of the Allied Acquisition.
The Company utilized $1.03 billion in funds, net of cash acquired, for
acquisitions and investments in businesses, including the Managed Care
Acquisitions, during the nine months ended June 30, 1998.
The Company's condensed consolidated balance sheet at June 30, 1999,
reflects a reduction in cash and cash equivalents of $21.1 million from the
September 30, 1998 balance which is related to the conversion of the Provider
JVs from consolidation to the equity method. See "--Recent Accounting
Pronouncements--EITF 96-16". This reduction in cash and cash equivalents appears
as net cash used in investing activities in the Company's condensed consolidated
statement of cash flows for the nine months ended June 30, 1999, but does not
represent an actual reduction of cash and cash equivalents at the affected
subsidiaries. Additionally, the Company received $19.0 million in distributions
from unconsolidated subsidiaries, including the Provider JVs, during the nine
months ended June 30, 1999. See Note F-- "Investments in Unconsolidated
Subsidiaries" to the Company's condensed consolidated financial statements set
forth elsewhere herein.
The Company received proceeds of approximately $12.0 million and $58.2
million, net of transaction costs, from the sale of assets formerly used in its
healthcare provider business during the nine months ended June 30, 1998 and
1999, respectively.
FINANCING ACTIVITIES. The Company repaid $51.0 million of debt obligations
outstanding under the Term Loan Facility (as defined) during the nine months
ended June 30, 1999. Borrowings outstanding under the Revolving Facility (as
defined) decreased $40.0 million during the nine months ended June 30, 1999 to
$0 as of June 30, 1999. As of June 30, 1999, the Company had $132.4 million of
availability under the Revolving Facility (as defined), excluding $17.6 million
of availability reserved for certain letters of credit. The Company was in
compliance with all debt covenants as of June 30, 1999.
The Company repurchased approximately 545,000 shares of its common stock for
approximately $12.5 million during the nine months ended June 30, 1998.
27
<PAGE>
OUTLOOK-LIQUIDITY AND CAPITAL RESOURCES
DEBT SERVICE OBLIGATIONS. The interest payments on the Company's $625.0
million 9% Series A Senior Subordinated Notes due 2008 (the "Notes") and
interest and principal payments on indebtedness outstanding pursuant to the
Company's $700.0 million senior secured bank credit agreement (the "Credit
Agreement") represent significant liquidity requirements for the Company.
Borrowings under the Credit Agreement bear interest at floating rates and
require interest payments on varying dates depending on the interest rate option
selected by the Company. Borrowings pursuant to the Credit Agreement include
$499.0 million under a term loan facility (the "Term Loan Facility") and up to
$150.0 million under a revolving facility (the "Revolving Facility"). The
Company is required to repay the principal amount of borrowings outstanding
under the Term Loan Facility and the principal amount of the Notes in the years
and amounts set forth in the following table (in millions):
<TABLE>
<CAPTION>
REMAINING
FISCAL YEAR PRINCIPAL AMOUNT
- ------------- -------------------
<S> <C>
1999....... $ 6.1
2000....... 30.1
2001....... 36.2
2002....... 45.9
2003....... 85.5
2004....... 145.6
2005....... 122.5
2006....... 27.1
2007....... --
2008....... $ 625.0
</TABLE>
In addition, any amounts outstanding under the Revolving Facility mature in
February 2004.
POTENTIAL PURCHASE PRICE ADJUSTMENTS. In December 1997, the Company
purchased HAI from Aetna for approximately $122.1 million, excluding transaction
costs. In addition, the Company incurred the obligation to make contingent
payments to Aetna which may total up to $60.0 million annually 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 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
28
<PAGE>
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 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 Company paid $60.0 million to Aetna for both the full Tranche 1 Payment
and the full Tranche 2 Payment for the Contract Year ended December 31, 1998, on
March 26, 1999. Accordingly, the Company recorded $60.0 million of goodwill and
other intangible assets related to the purchase of HAI during the nine months
ended June 30, 1999.
In December, 1997 the Company purchased Allied for $70.0 million, excluding
transaction costs. The purchase price the Company originally paid for Allied
consisted of a $50.0 million payment to the former owners of Allied and a $20.0
million deposit into an interest-bearing escrow account and 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 $60.0
million, of which $20.0 million would have been
29
<PAGE>
distributed from the escrow account, during the three years following the
closing of the Allied acquisition if Allied's performance exceeded certain
earnings targets.
During the quarter ended December 31, 1998, the Company and the former
owners of Allied amended the Allied purchase agreement (the "Allied
Amendments"). The Allied Amendments resulted in the following changes to the
original terms of the Allied purchase agreement:
- 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. This $20.0 million was included in the $70.0 million
originally paid for Allied.
- The Company paid the former owners of Allied $4.5 million additional
consideration which was recorded as goodwill.
- The Company capped future obligations with respect to additional
contingent payments for the purchase of Allied at $3 million. The earnings
targets which must be met by Allied for this amount to be paid were
revised upwards as well.
By virtue of acquiring Merit, the Company may be required to make certain
contingent payments in fiscal 1999 to the former shareholders of CMG Health,
Inc. ("CMG"), which was acquired by Merit in September, 1997, 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 December 31, 1998. The Company may still be
required to pay contingent consideration to the former shareholders of CMG
depending on the financial performance 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
Company has initiated legal proceedings against certain former owners of CMG
with respect to representations made by such former owners in conjunction with
Merit's acquisition of CMG. The amount and timing of contingent payments to CMG,
if any, are subject to the outcome of these proceedings.
REVOLVING FACILITY. 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 June 30, 1999, the Company had
approximately $132.4 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 Revolving Facility, should be
sufficient to fund its debt service requirements, anticipated capital
expenditures, contingent payments with respect to HAI 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 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.
RESTRICTIVE FINANCING COVENANTS. The Credit Agreement imposes restrictions
on the Company's ability to make capital expenditures, and both the Credit
Agreement and the indenture governing the Notes (the "Indenture") 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 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.
30
<PAGE>
STRATEGIC ALTERNATIVES TO REDUCE LONG-TERM DEBT AND IMPROVE LIQUIDITY. The
Company's sale of its European psychiatric provider operations in April 1999
represents another step in the Company's strategy of exiting its healthcare
provider and healthcare franchising business segments in order to reduce long-
term debt and improve liquidity. The Company is currently involved in
discussions with various parties to divest certain non-core businesses. There
can be no assurance that the Company will be able to divest any businesses or
that the divestiture of such businesses would result in significant reductions
of long-term debt or improvements in liquidity.
The Company expects to receive approximately $70 million of net proceeds
upon issuance of the Series A and Series B Preferred Stock. Approximately 50% of
the proceeds received from the issuance of the Series A Preferred Stock will be
used to reduce debt outstanding under the Term Loan Facility. Approximately 50%
of the proceeds received from the issuance of the Series B Preferred Stock will
be used to reduce debt outstanding under the Term Loan Facility if the Company
obtains the Series B Preferred Stock Approval on or before March 5, 2000. The
remaining proceeds will be available for general corporate purposes. If the
Company does not receive the Series B Preferred Stock Approval on or before
March 5, 2000 and TPG elects to purchase the Series B Preferred Stock, 100% of
the proceeds will be used to reduce debt outstanding under the Term Loan
Facility. The Company is also reviewing additional strategic alternatives to
improve its capital structure and liquidity. There can be no assurance that the
Company will be able to consummate any transaction that will improve its capital
structure and/or liquidity.
On August 10, 1999, the Company entered into a binding Letter Agreement with
Crescent, COI and CBHS relating to a proposed recapitalization of CBHS and
restructuring of relationships among the parties. See Note K--"Subsequent
Events--Recapitalization of CBHS". The Company does not believe the proposed
recapitalization of CBHS, if consummated, will have a significant impact on
liquidity.
NET OPERATING LOSS CARRYFORWARDS. During June 1999, the Company received an
assessment from the Internal Revenue Service (the "IRS Assessment") related to
its federal income tax returns for the fiscal years ended September 30, 1992 and
1993. The IRS Assessment disallows approximately $162 million of deductions that
relate primarily to interest expense in fiscal 1992. The Company plans to appeal
the IRS Assessment during the fourth quarter of fiscal 1999.
The Company had previously recorded a valuation allowance for the full
amount of the $162 million of deductions disallowed in the IRS Assessment. The
IRS Assessment is not expected to result in a material cash payment for income
taxes related to prior years; however, the Company's federal income tax net
operating loss carryforwards would be reduced if the Company's appeal is
unsuccessful.
RECENT ACCOUNTING PRONOUNCEMENTS
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 adopted
SOP 98-5 effective October 1, 1998. The Company's adoption of SOP 98-5 had 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
31
<PAGE>
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 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 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 had
the following effect on the Company's consolidated financial position (in
thousands):
<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>
POTENTIAL IMPACT OF YEAR 2000 COMPUTER ISSUES
OVERVIEW. 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.
32
<PAGE>
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 readiness for purchased
software has been the replacement, upgrade or repair 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 either designed to be year 2000 ready from
inception or is in the process of being modified to be year 2000 ready.
Approximately 87% of the Company's mission critical systems have been remediated
to a state of year 2000 readiness, with the remainder scheduled to be remediated
by the end 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 readiness 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
readiness 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, replacing or upgrading 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, 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
33
<PAGE>
Company is in the process of determining 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 in the process of obtaining 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.
YEAR 2000 COSTS. Total costs incurred solely for remediation of potential
year 2000 problems are currently estimated to be approximately $4.2 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. 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
$6.3 million of capital expenditures that would have been budgeted for future
periods into fiscal 1999 to ensure year 2000 readiness for outdated systems.
Year 2000 readiness 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, or is developing, 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 ready by their manufacturers (primarily personal
computers and productivity software) will remain unaffected by the year 2000
problem.
34
<PAGE>
PART II--OTHER INFORMATION
ITEM 5.--OTHER INFORMATION
On May 31, 1999, the Company announced that it was relocating its
headquarters from Atlanta, Georgia to Columbia, Maryland. The address of the
Company's principal executive offices is now 6950 Columbia Gateway Drive; Suite
400; Columbia, Maryland 21046.
ITEM 6.--EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- --------- ----------------------------------------------------------------------------------------------
<C> <S>
2(a) Share Purchase Agreement, dated April 2, 1999, by and among the Company, Charter Medical
International, S.A., Inc. (a wholly owned subsidiary of the Company), Investment AB Bure, and
CMEL Holding Limited (a wholly owned subsidiary of Investment AB Bure), filed with the
Company's current report on Form 8-K, which was filed on April 14, 1999, and is incorporated
herein by reference.
2(b) Stock Purchase Agreement, dated April 2, 1999, by and among the Company, Charter Medical
International, S.A., Inc. (a wholly owned subsidiary of the Company), Investment AB Bure, and
Grogrunden 515 AB (a wholly owned subsidiary of Investment AB Bure), filed with the Company's
current report on Form 8-K, which was filed on April 14, 1999, and is incorporated herein by
reference.
2(c) First Amendment to Share Purchase Agreement, dated April 2, 1999, by and among the Company,
Charter Medical International, S.A., Inc. (a wholly owned subsidiary of the Company),
Investment AB Bure, and CMEL Holding Limited (a wholly owned subsidiary of Investment AB
Bure), filed with the Company's current report on Form 8-K, which was filed on April 14, 1999,
and is incorporated herein by reference.
2(d) First Amendment to Stock Purchase Agreement, dated April 8, 1999, by and among the Company,
Charter Medical International, S.A., Inc. (a wholly owned subsidiary of the Company),
Investment AB Bure, and CMEL Holding Limited (a wholly owned subsidiary of Investment AB
Bure), filed with the Company's current report on Form 8-K, which was filed on April 14, 1999,
and is incorporated herein by reference.
4(a) Amendment No. 2, dated as of April 30, 1999, 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.
4(b) Investment Agreement, dated as of July 19, 1999, between the Company and TPG Magellan LLC
together with the following exhibits: (i) form of Certificate of Designations of Series A
Cumulative Convertible Preferred Stock; (ii) form of Certificate of Designations of Series B
Cumulative Convertible Preferred Stock; (iii) form of Certificate of Designations of Series C
Junior Participating Preferred Stock; and (iv) form of Escrow Agreement by and among The
Company, TPG Magellan LLC and SunTrust Bank, Atlanta, as escrow agent, filed as exhibit 4.1 to
the Company's current report on Form 8-K, which was filed on July 21, 1999, and is
incorporated herein by reference.
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- --------- ----------------------------------------------------------------------------------------------
<C> <S>
4(c) Registration Rights Agreement, dated as of July 19, 1999, between the Company and TPG Magellan
LLC, filed as exhibit 4.2 to the Company's current report on Form 8-K, which was filed on July
21, 1999, and is incorporated herein by reference.
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
The Company filed the following current report on Form 8-K with the
Securities and Exchange Commission during the quarter ended June 30, 1999.
<TABLE>
<CAPTION>
FINANCIAL
DATE OF STATEMENTS
REPORT ITEM REPORTED AND DESCRIPTION FILED
- ---------------- ------------------------------------------------ ----------
<C> <S> <C>
April 14, 1999 Item 2. Disposition of Assets--Europe Sale Yes (1)
</TABLE>
(1) Unaudited Pro Forma Consolidated Balance Sheet at December 31, 1998;
Unaudited Pro Forma Consolidated Statements of Operations for the fiscal
year and for the three months ended September 30, 1998 and December 31,
1998, respectively.
36
<PAGE>
FORM 10-Q
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C>
MAGELLAN HEALTH SERVICES, INC.
(Registrant)
Date: August 13, 1999 /s/ CLIFFORD W. DONNELLY
------------------------------------
Clifford W. Donnelly
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
Date: August 13, 1999 /s/ JEFFREY T. HUDKINS
------------------------------------
Jeffrey T. Hudkins
VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
</TABLE>
37
<PAGE>
Exhibit 4(a)
AMENDMENT NO. 2 entered into as of April 30,
1999 (this "AMENDMENT"), to the Credit Agreement
dated as of February 12, 1998 (as amended,
supplemented or otherwise modified from time to time,
the "CREDIT AGREEMENT"), among Magellan Health
Services, Inc., a Delaware corporation (the "PARENT
BORROWER"); Charter Behavioral Health System of New
Mexico, Inc., a New Mexico corporation; Merit
Behavioral Care Corporation, a Delaware corporation;
each other wholly owned domestic subsidiary of the
Parent Borrower that becomes a "Subsidiary Borrower"
pursuant to Section 2.23 of the Credit Agreement
(each, a "SUBSIDIARY BORROWER" and, collectively, the
"SUBSIDIARY BORROWERS" (such term is used herein as
modified in Article I of the Credit Agreement); the
Parent Borrower and the Subsidiary Borrowers are
collectively referred to herein as the "BORROWERS");
the Lenders (as defined in Article I of the Credit
Agreement); The Chase Manhattan Bank, a New York
banking corporation, as administrative agent (in such
capacity, the "ADMINISTRATIVE AGENT") for the
Lenders, as collateral agent (in such capacity the
"COLLATERAL AGENT") for the Lenders and as an issuing
bank (in such capacity, an "ISSUING BANK"); First
Union National Bank, a national banking corporation,
as syndication agent (in such capacity, the
"SYNDICATION AGENT") for the Lenders and as an
issuing bank (in such capacity, an "ISSUING BANK");
and Credit Lyonnais New York Branch, a licensed
branch of a bank organized and existing under the
laws of the Republic of France, as documentation
agent (in such capacity, the "DOCUMENTATION AGENT")
for the Lenders and as an issuing bank (in such
capacity, an "ISSUING BANK" and, together with The
Chase Manhattan Bank and First Union National Bank,
each in its capacity as an issuing bank, the "ISSUING
BANKS").
A. The Lenders and the Issuing Banks have extended credit to
the Borrowers, and have agreed to extend credit to the Borrowers, in each case
pursuant to the terms and subject to the conditions set forth in the Credit
Agreement.
B. The Parent Borrower has requested that the Required Lenders
amend certain provisions of the Credit Agreement as set forth herein.
C. The Required Lenders are willing so to amend such
provisions of the Credit Agreement pursuant to the terms and subject to the
conditions set forth herein.
D. Capitalized terms used but not defined herein have the
meanings assigned to them in the Credit Agreement.
Accordingly, in consideration of the mutual agreements herein
contained and other good and valuable consideration, the sufficiency and receipt
of which are hereby acknowledged, the parties hereto agree as follows:
SECTION 1. AMENDMENT TO SECTION 2.13. Section 2.13 of the
Credit Agreement is hereby amended by replacing the figure "100%" in paragraph
(d) thereof with the figure "75%".
SECTION 2. AMENDMENT TO SECTION 2.23. Section 2.23 of the
Credit Agreement is hereby amended and restated in its entirety to read as
follows:
<PAGE>
2
SECTION 2.23. ADDITIONAL BORROWERS. The parties
hereto agree that any wholly owned Domestic Subsidiary
Guarantor that is not a Borrower as of the Closing Date, or
that ceases to be a Borrower after the Closing Date, may enter
into and become a party to this Agreement by executing a New
Borrower Agreement. Upon execution and delivery after the date
hereof by the Administrative Agent, the Collateral Agent and
such a Domestic Subsidiary Guarantor of a New Borrower
Agreement, such Domestic Subsidiary Guarantor shall become a
Borrower hereunder to the extent provided in the New Borrower
Agreement. The Parent Borrower may terminate any Subsidiary
Borrower's interests, rights and obligations under this
Agreement in respect of (a)(i) all outstanding Term Loans and
(ii) all Revolving Loans made to, or Letters of Credit issued
for the account of, any Borrowers other than such Subsidiary
Borrower or (b) all Term Loans, Revolving Loans and Letters of
Credit, in each case to the extent provided in a Subsidiary
Borrower Termination executed and delivered by the Parent
Borrower to the Administrative Agent with respect to such
Subsidiary Borrower, PROVIDED that (x) no such Subsidiary
Borrower subject to any such termination shall cease to be a
Guarantor for so long as it shall remain a Subsidiary, except
as otherwise provided in the Guarantee Agreement, and (y) in
the case of any such termination pursuant to clause (b) above,
such Subsidiary shall cease to be a Subsidiary Borrower and a
party to this Agreement. Notwithstanding the preceding
sentence, no Subsidiary Borrower Termination pursuant to
clause (b) above will become effective as to any Subsidiary
Borrower at a time when any principal of or interest on any
Revolving Loan to such Subsidiary Borrower, or any letter of
credit issued for the account of such Subsidiary Borrower,
shall be outstanding hereunder. The execution and delivery of
a New Borrower Agreement or a Subsidiary Borrower Termination
shall not require the consent of any other Borrower hereunder.
The rights and obligations of each Borrower hereunder shall
remain in full force and effect notwithstanding the addition
of any new Borrower or termination of any Borrower as a party
to this Agreement.
SECTION 3. AMENDMENTS TO SECTION 5.04. Section 5.04 of the
Credit Agreement is hereby amended by replacing the words "Green Spring, Merit,
Human Affairs International, Incorporated, National Mentor, Inc. and such other
material Subsidiaries" in paragraphs (a) and (b) thereof with the words "the
Behavioral Managed Care, Specialty Managed Care and Human Services business
segments of the Parent Borrower and such other material business segments of the
Parent Borrower".
SECTION 4. AMENDMENT TO SECTION 9.17. Section 9.17 of the
Credit Agreement is hereby amended by deleting the first sentence of paragraph
(a) thereof and substituting the following sentence therefor:
"Each Borrower agrees that it shall, jointly with the other
Borrowers and severally, be liable for (a) all the Obligations
or (b) in the case of any Subsidiary Borrower that is the
subject of a New Borrower Agreement or Subsidiary Borrower
Termination, the Obligations specified in Section 1 of the New
Borrower Agreement or Subsidiary Borrower Termination, as the
case may be, most recently delivered in respect of such
Subsidiary Borrower."
SECTION 5. AMENDMENTS TO FORMS OF NEW BORROWER AGREEMENT AND
SUBSIDIARY BORROWER TERMINATION. The Form of New Borrower Agreement set forth as
<PAGE>
3
Exhibit C-2 to the Credit Agreement and the Form of Subsidiary Borrower
Termination set forth as Exhibit C-3 to the Credit Agreement are hereby amended
by deleting such Forms in their entirety and substituting therefor the Form of
New Borrower Agreement and Form of Subsidiary Borrower Termination set forth as
Schedule 1 and Schedule 2 hereto, respectively.
SECTION 6. AMENDMENT TO SCHEDULE 1.01(d). Schedule 1.01(d) to
the Credit Agreement is hereby amended by deleting such Schedule in its entirety
and substituting therefor the Schedule 1.01(d) set forth as Schedule 3 hereto.
SECTION 7. REPRESENTATIONS AND WARRANTIES. Each Borrower
represents and warrants to the Administrative Agent and to each of the Lenders
that:
(a) This Amendment has been duly authorized, executed and
delivered by it and constitutes a legal, valid and binding obligation of each
Loan Party party hereto, enforceable against such Loan Party in accordance with
its terms.
(b) After giving effect to this Amendment, the representations
and warranties set forth in Article III of the Credit Agreement are true and
correct in all material respects on and as of the date hereof with the same
effect as if made on and as of the date hereof, except to the extent such
representations and warranties expressly relate to an earlier date.
(c) On the date hereof and immediately after giving effect to
this Amendment, no Event of Default or Default has occurred and is continuing.
SECTION 8. AMENDMENT FEE. In consideration of the agreements
of the Required Lenders contained in this Amendment, the Parent Borrower agrees
to pay to the Administrative Agent, for the account of each Lender that delivers
an executed counterpart of this Amendment prior to 12:00 p.m., New York City
time, on the date first above written, an amendment fee (the "AMENDMENT FEE") in
an amount equal to 0.05% of the sum of such Lender's outstanding Term Loans and
Revolving Credit Commitment as of such date.
SECTION 9. CONDITIONS TO EFFECTIVENESS. This Amendment shall
become effective as of the date first above written (PROVIDED that Sections 2, 4
and 5 hereof shall become effective as of September 30, 1998) when the
Administrative Agent shall have received (a) counterparts of this Amendment
that, when taken together, bear the signatures of the Borrowers and the Required
Lenders and (b) the Amendment Fees.
SECTION 10. CREDIT AGREEMENT. Except as specifically amended
hereby, the Credit Agreement shall continue in full force and effect in
accordance with the provisions thereof as in existence on the date hereof. After
the date hereof, any reference to the Credit Agreement shall mean the Credit
Agreement as amended hereby. This Amendment shall be a Loan Document for all
purposes.
SECTION 11. APPLICABLE LAW. THIS AMENDMENT SHALL BE
GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE
STATE OF NEW YORK.
SECTION 12. COUNTERPARTS. This Amendment may be executed in
two or more counterparts, each of which shall constitute an original but all of
which when taken together shall constitute but one agreement. Delivery of an
executed signature page to this Amendment by
<PAGE>
4
facsimile transmission shall be effective as delivery of a manually signed
counterpart of this Amendment.
SECTION 13. EXPENSES. The Parent Borrower agrees to reimburse
the Administrative Agent for its out-of-pocket expenses in connection with this
Amendment, including the reasonable fees, charges and disbursements of Cravath,
Swaine & Moore, counsel for the Administrative Agent.
<PAGE>
5
IN WITNESS WHEREOF, the parties hereto have caused this
Amendment to be duly executed by their respective authorized officers as of the
day and year first written above.
MAGELLAN HEALTH SERVICES, INC.,
by
-------------------------------
Name:
Title:
CHARTER BEHAVIORAL HEALTH SYSTEM OF
NEW MEXICO, INC.,
by
-------------------------------
Name:
Title:
MERIT BEHAVIORAL CARE CORPORATION,
by
-------------------------------
Name:
Title:
THE CHASE MANHATTAN BANK, individually
and as Administrative Agent, Collateral Agent
and an Issuing Bank,
by
-------------------------------
Name:
Title:
FIRST UNION NATIONAL BANK,
individually and as Syndication Agent and an
Issuing Bank,
by
-------------------------------
Name:
Title:
<PAGE>
6
CREDIT LYONNAIS NEW YORK BRANCH,
individually and as Documentation Agent and an
Issuing Bank,
by
-------------------------------------
Name:
Title:
<PAGE>
7
To Approve the Amendment:
Name of Institution
--------------------------
by
-----------------------------
Name:
Title:
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS FOUND ON PAGES 1 AND 2 OF THE COMPANY'S FORM 10-Q FOR THE
YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 40,307,000
<SECURITIES> 0
<RECEIVABLES> 156,349,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 333,172,000
<PP&E> 205,357,000
<DEPRECIATION> 68,043,000
<TOTAL-ASSETS> 1,863,473,000
<CURRENT-LIABILITIES> 486,148,000
<BONDS> 1,102,184,000
0
0
<COMMON> 8,516,000
<OTHER-SE> 211,869,000
<TOTAL-LIABILITY-AND-EQUITY> 1,863,473,000
<SALES> 1,447,169,000
<TOTAL-REVENUES> 1,447,169,000
<CGS> 0
<TOTAL-COSTS> 1,298,056,000
<OTHER-EXPENSES> 18,849,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 70,958,000
<INCOME-PRETAX> 59,306,000
<INCOME-TAX> 29,113,000
<INCOME-CONTINUING> 29,637,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 29,637,000
<EPS-BASIC> 0.93
<EPS-DILUTED> 0.93
</TABLE>
