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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/x/ |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended December 31, 1999
or
/ / | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 1-6639
MAGELLAN HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware |
58-1076937 |
|
---|---|---|
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
|
6950 Columbia Gateway Drive Columbia, Maryland |
|
21046 |
(Address of principal executive offices) | (Zip Code) |
(410) 953-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /
The number of shares of the registrant's common stock outstanding as of January 31, 2000 was 31,980,924.
FORM 10-Q
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
INDEX
|
Page No. |
|
---|---|---|
PART IFinancial Information: | ||
Condensed Consolidated Balance Sheets September 30, 1999 and December 31, 1999 |
1 | |
Condensed Consolidated Statements of Operations For the Three Months ended December 31, 1998 and 1999 |
2 | |
Condensed Consolidated Statements of Cash Flows For the Three Months ended December 31, 1998 and 1999 |
3 | |
Notes to Condensed Consolidated Financial Statements | 4 | |
Management's Discussion and Analysis of Financial Condition and Results of Operations | 16 | |
PART IIOther Information: |
|
|
Item 6.Exhibits and Reports on Form 8-K | 26 | |
Signatures | 27 |
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share amounts)
|
September 30, 1999 |
December 31, 1999 |
|||||
---|---|---|---|---|---|---|---|
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 37,440 | $ | 53,277 | |||
Accounts receivable, net | 198,646 | 184,355 | |||||
Restricted cash and investments | 116,824 | 112,467 | |||||
Refundable income taxes | 3,452 | 4,299 | |||||
Other current assets | 18,565 | 17,158 | |||||
Total current assets | 374,927 | 371,556 | |||||
Property and equipment, net of accumulated depreciation of $66,692 at September 30, 1999 and $74,646 at December 31, 1999 | 120,667 | 118,924 | |||||
Deferred income taxes | 91,657 | 84,619 | |||||
Investments in unconsolidated subsidiaries | 18,396 | 18,729 | |||||
Other long-term assets | 9,599 | 11,232 | |||||
Goodwill, net | 1,108,086 | 1,103,605 | |||||
Other intangible assets, net | 158,283 | 154,497 | |||||
$ | 1,881,615 | $ | 1,863,162 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY |
|
||||||
Current liabilities: | |||||||
Accounts payable | $ | 44,425 | $ | 31,183 | |||
Accrued liabilities | 209,796 | 199,979 | |||||
Medical claims payable | 189,928 | 187,085 | |||||
Current maturities of long-term debt and capital lease obligations | 30,119 | 30,226 | |||||
Total current liabilities | 474,268 | 448,473 | |||||
Long-term debt and capital lease obligations | 1,114,189 | 1,061,268 | |||||
Deferred credits and other long-term liabilities | 92,948 | 92,521 | |||||
Minority interest | 3,514 | 3,938 | |||||
Commitments and contingencies | |||||||
Redeemable preferred stock | | 54,233 | |||||
Stockholders' equity: | |||||||
Preferred stock, without par value | |||||||
Authorized10,000 shares at September 30, 1999 and 9,793 shares at December 31, 1999 | |||||||
Issued and outstandingnone | | | |||||
Common stock, par value $0.25 per share | |||||||
Authorized80,000 shares | |||||||
Issued and outstanding34,268 shares at September 30, 1999 and December 31, 1999 | 8,566 | 8,566 | |||||
Other stockholders' equity | |||||||
Additional paid-in capital | 352,030 | 351,829 | |||||
Accumulated deficit | (144,550 | ) | (138,284 | ) | |||
Warrants outstanding | 25,050 | 25,050 | |||||
Common stock in treasury, 2,289 shares at September 30, 1999 and December 31, 1999 | (44,309 | ) | (44,309 | ) | |||
Cumulative foreign currency adjustments included in comprehensive income | (91 | ) | (123 | ) | |||
Total stockholders' equity | 196,696 | 202,729 | |||||
$ | 1,881,615 | $ | 1,863,162 | ||||
The accompanying notes to Condensed Consolidated Financial Statements
are an integral part of these balance sheets.
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
|
For the Three Months Ended December 31, |
||||||
---|---|---|---|---|---|---|---|
|
1998 |
1999 |
|||||
Net Revenue | $ | 443,331 | $ | 481,825 | |||
Cost and expenses: | |||||||
Salaries, cost of care and other operating expenses | 392,313 | 428,271 | |||||
Equity in earnings of unconsolidated subsidiaries | (3,783 | ) | (3,474 | ) | |||
Depreciation and amortization | 17,513 | 19,364 | |||||
Interest, net | 24,122 | 23,991 | |||||
Managed care integration costs | 1,750 | | |||||
Special charges, net and stock option expense | 1,096 | | |||||
433,011 | 468,152 | ||||||
Income from continuing operations before provision for income taxes and minority interest |
10,320 | 13,673 | |||||
Provision for income taxes | 5,915 | 7,265 | |||||
Income from continuing operations before minority interest | 4,405 | 6,408 | |||||
Minority interest | 410 | 142 | |||||
Income from continuing operations | 3,995 | 6,266 | |||||
Income from discontinued operations (net of income tax provision of $124) | 186 | | |||||
Net income | 4,181 | 6,266 | |||||
Preferred dividend requirement and amortization of redeemable preferred stock issuance costs | | 201 | |||||
Income available to common stockholders | 4,181 | 6,065 | |||||
Unrealized foreign currency translation loss, net of income tax benefit of $436 in 1998 and $22 in 1999 |
(655 | ) | (32 | ) | |||
Comprehensive income | $ | 3,526 | $ | 6,033 | |||
Average number of common shares outstandingbasic | 31,613 | 31,980 | |||||
Average number of common shares outstandingdiluted | 31,660 | 33,324 | |||||
Income per common sharebasic: | |||||||
Income from continuing operations | $ | 0.13 | $ | 0.19 | |||
Income from discontinued operations | $ | 0.01 | $ | | |||
Net income | $ | 0.13 | $ | 0.19 | |||
Income per common sharediluted: | |||||||
Income from continuing operations | $ | 0.13 | $ | 0.19 | |||
Income from discontinued operations | $ | 0.01 | $ | | |||
Net income | $ | 0.13 | $ | 0.19 | |||
The accompanying notes to Condensed Consolidated Financial Statements
are an integral part of these statements
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
|
For the Three Months Ended December 31, |
||||||
---|---|---|---|---|---|---|---|
|
1998 |
1999 |
|||||
Cash flows from operating activities: | |||||||
Net income | $ | 4,181 | $ | 6,266 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | 17,513 | 19,364 | |||||
Equity in earnings of unconsolidated subsidiaries | (3,783 | ) | (3,474 | ) | |||
Non-cash interest expense | 954 | 1,116 | |||||
Gain on sale of assets | (1,062 | ) | | ||||
Non-cash portion of discontinued operations income | (321 | ) | | ||||
Cash flows from changes in assets and liabilities, net of effects from sales and acquisitions of businesses: | |||||||
Accounts receivable, net | (6,267 | ) | 2,867 | ||||
Other assets | 3,289 | (1,374 | ) | ||||
Restricted cash and investments | (42,887 | ) | 4,357 | ||||
Accounts payable and other accrued liabilities | 34,142 | (7,884 | ) | ||||
Medical claims payable | (3,946 | ) | (2,843 | ) | |||
Reserve for unpaid claims | (3,131 | ) | 7 | ||||
Income taxes payable and deferred income taxes | 9,363 | 6,213 | |||||
Other liabilities | (223 | ) | (434 | ) | |||
Minority interest, net of dividends paid | 924 | 424 | |||||
Other | (1,087 | ) | 6 | ||||
Total adjustments | 3,478 | 18,345 | |||||
Net cash provided by operating activities | 7,659 | 24,611 | |||||
Cash flows from investing activities: | |||||||
Capital expenditures | (14,357 | ) | (6,482 | ) | |||
Acquisitions and investments in businesses, net of cash acquired and return of escrowed funds | 6,444 | (4,149 | ) | ||||
Conversion of joint ventures from consolidation to equity method | (21,092 | ) | | ||||
Distributions received from unconsolidated subsidiaries | 9,303 | 3,140 | |||||
Decrease in assets restricted for settlement of unpaid claims | 5,808 | 314 | |||||
Proceeds from sale of assets, net of transaction costs | 3,612 | (1,576 | ) | ||||
Net cash used in investing activities | (10,282 | ) | (8,753 | ) | |||
Cash flows from financing activities: | |||||||
Proceeds from issuance of debt, net of issuance costs | (69 | ) | | ||||
Payments on debt and capital lease obligations | (40,000 | ) | (56,814 | ) | |||
Proceeds from issuance of redeemable preferred stock, net of issuance costs | | 56,793 | |||||
Net cash used in financing activities | (40,069 | ) | (21 | ) | |||
Net increase (decrease) in cash and cash equivalents | (42,692 | ) | 15,837 | ||||
Cash and cash equivalents at beginning of period | 92,050 | 37,440 | |||||
Cash and cash equivalents at end of period | $ | 49,358 | $ | 53,277 | |||
The
accompanying notes to Condensed Consolidated Financial Statements
are an integral part of these statements.
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
(Unaudited)
NOTE ABasis 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, 1999, included in the Company's Annual Report on Form 10-K. All references to fiscal years contained herein refer to periods of twelve consecutive months ending on September 30. On September 2, 1999, the Company's Board of Directors approved a formal plan to dispose of the businesses and interests that comprised the Company's healthcare provider and healthcare franchising business segments. Accordingly, the results of operations of such business segments have been reported in the condensed consolidated financial statements of which these notes are a component as discontinued operations for all periods presented. Certain reclassifications have been made to fiscal 1999 amounts to conform to fiscal 2000 presentation.
NOTE BSupplemental Cash Flow Information
Below is supplemental cash flow information related to the three months ended December 31, 1998 and 1999 (in thousands):
|
Three Months Ended December 31, |
|||||
---|---|---|---|---|---|---|
|
1998 |
1999 |
||||
Income taxes paid, net of refunds received | $ | (3,570 | ) | $ | 951 | |
Interest paid | $ | 12,601 | $ | 10,600 | ||
NOTE CLong-Term Debt and Leases
Information with regard to the Company's long-term debt and capital lease obligations at September 30, 1999 and December 31, 1999 is as follows (in thousands):
|
September 30, 1999 |
December 31, 1999 |
||||
---|---|---|---|---|---|---|
Credit Agreement: | ||||||
Revolving Facility due through 2004 | $ | 20,000 | $ | | ||
Term Loan Facility (8.5% to 9.25% at December 31, 1999) due through 2006 | 492,873 | 460,059 | ||||
9.0% Senior Subordinated Notes due 2008 | 625,000 | 625,000 | ||||
11.5% notes payable through 2005 | 35 | 35 | ||||
5.4% capital lease obligations due through 2014 | 6,400 | 6,400 | ||||
1,144,308 | 1,091,494 | |||||
Less amounts due within one year | 30,119 | 30,226 | ||||
$ | 1,114,189 | $ | 1,061,268 | |||
NOTE DAccrued Liabilities
Accrued liabilities consist of the following (in thousands):
|
September 30, 1999 |
December 31, 1999 |
||||
---|---|---|---|---|---|---|
Salaries, wages and other benefits | $ | 22,318 | $ | 18,705 | ||
CHAMPUS Adjustments | 51,784 | 16,742 | ||||
Due to providers | 35,918 | 38,153 | ||||
Other | 99,776 | 126,379 | ||||
$ | 209,796 | $ | 199,979 | |||
NOTE EIncome per Common Share
The following tables reconcile income (numerator) and shares (denominator) used in the Company's computations of income from continuing operations per common share (in thousands):
|
Three Months Ended December 31, |
||||||
---|---|---|---|---|---|---|---|
|
1998 |
1999 |
|||||
Numerator: | |||||||
Income from continuing operations | $ | 3,995 | $ | 6,266 | |||
Less: preferred dividend requirement and amortization of redeemable preferred stock issuance costs |
| (201 | ) | ||||
Income from continuing operationsbasic | | 6,065 | |||||
Add: presumed conversion of redeemable preferred stock | | 201 | |||||
Income from continuing operationsdiluted | $ | 3,995 | $ | 6,266 | |||
Denominator: | |||||||
Average number of common shares outstandingbasic | 31,613 | 31,980 | |||||
Common stock equivalentsstock options | 39 | 177 | |||||
Common stock equivalentswarrants | 8 | 3 | |||||
Common stock equivalentsredeemable preferred stock | | 1,164 | |||||
Average number of common shares outstandingdiluted | 31,660 | 33,324 | |||||
Income from continuing operations per common share: | |||||||
Basic (basic numerator/basic denominator) | $ | 0.13 | $ | 0.19 | |||
Diluted (diluted numerator/diluted denominator) | $ | 0.13 | $ | 0.19 | |||
Options to purchase approximately 3,415,000 shares of common stock at $6.16 to $24.38 per share were outstanding during the three months ended December 31, 1999, but were excluded from the calculation of average number of common shares outstandingdiluted because the options' exercise prices were greater than the average market price of the common shares underlying such options during the period. Approximately 3,246,000 of these options, which expire between fiscal 2001 and 2009, were outstanding at December 31, 1999.
Warrants to purchase approximately 4,713,000 shares of common stock at $26.15 to $38.70 per share were outstanding during the three months ended December 31, 1999, but were excluded from the calculation of average number of common shares outstandingdiluted 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, of which 2,000,000 expire in January 2000 with the remainder expiring between fiscal 2001 and 2009, were outstanding at December 31, 1999.
The Option (as defined) was outstanding at December 31, 1999. Exercise of the Option would result in the issuance of redeemable preferred stock which is convertible into a maximum of approximately 2,240,000 shares of the Company's common stock. The common shares underlying the Option were excluded from the calculation of average number of common shares outstandingdiluted because the exercise price of the Option, $9.375 per share, was greater than the average market price of the common shares underlying the Option, which will expire in fiscal 2002. See Note K"Redeemable preferred stock."
On November 17, 1998, the Company's Board of Directors (the "Board") 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 Board, 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 2.0 million outstanding stock options were repriced to $8.406 and approximately 0.7 million outstanding stock options were canceled 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 FInvestments 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.
A summary of financial information for the Company's investment in Choice is as follows (in thousands):
|
September 30, 1999 |
December 31, 1999 |
||||
---|---|---|---|---|---|---|
Current assets | $ | 19,572 | $ | 20,459 | ||
Property and equipment, net | 228 | 203 | ||||
Total assets | $ | 19,800 | $ | 20,662 | ||
Current liabilities | $ | 12,673 | $ | 13,189 | ||
Partners' capital | 7,127 | 7,473 | ||||
Total liabilities and partners' capital | $ | 19,800 | $ | 20,662 | ||
Company investment | $ | 3,563 | $ | 3,737 | ||
|
Three Months Ended December 31, 1998 |
Three Months Ended December 31, 1999 |
||||
---|---|---|---|---|---|---|
Net revenue | $ | 14,580 | $ | 14,047 | ||
Operating expenses | 8,348 | 7,422 | ||||
Net income | $ | 6,232 | $ | 6,625 | ||
Company equity income | $ | 3,116 | $ | 3,313 | ||
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, 1999 and December 31, 1999 was $12.2 million and $12.1 million, respectively. The Company's equity in earnings (losses) of Premier for the three months ended December 31, 1998 and 1999 was $0.7 million and $(0.1) million, respectively.
NOTE GDiscontinued Operations
General
On September 10, 1999, the Company consummated the transfer of assets and other interests pursuant to a Letter Agreement dated August 10, 1999 with Crescent Real Estate Equities ("Crescent"), Crescent Operating, Inc. ("COI") and Charter Behavioral Health Systems, LLC ("CBHS") that effected the Company's exit from its healthcare provider and healthcare franchising businesses (the "CBHS Transactions"). Significant terms of the CBHS Transactions are summarized as follows:
Healthcare Provider Interests
Healthcare Franchising Interests
The CBHS Transactions, together with the formal plan of disposal authorized by the Company's Board of Directors on September 2, 1999, represent the disposal of the Company's healthcare provider and healthcare franchising business segments under Accounting Principles Board Opinion No. 30, "Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30"). 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 of discontinued operations. Accordingly, the Company has restated its results of operations for all prior periods. The Company recorded an after-tax loss on disposal of its healthcare provider and healthcare franchising business segments of approximately $47.4 million, (primarily non-cash) in the fourth quarter of fiscal 1999. The Company expects to transfer the Provider JVs and related real estate to CBHS and to sell its remaining joint venture interest and related real estate by no later than August 31, 2000.
Substantially all of the Company's healthcare provider and healthcare franchising operations were either sold or assigned to CBHS during September 1999 and no income or expense related to these operations was recorded for the three months ended December 31, 1999. Accordingly, the following summary of discontinued operations income is for the three months ended December 31, 1998 only (in thousands):
|
Three Months Ended December 31, 1998 |
|||
---|---|---|---|---|
Net revenue (1) | $ | 19,812 | ||
Salaries, cost of care and other operating expenses | 20,903 | |||
Equity in earnings of unconsolidated subsidiaries | (1,199 | ) | ||
Depreciation and amortization | 878 | |||
Interest income (2) | (13 | ) | ||
Special income, net | (1,062 | ) | ||
Other expenses (3) | 119 | |||
Net income | $ | 186 | ||
Remaining assets and liabilities of the healthcare provider business at December 31, 1999 include, among other things, (i) hospital-based real estate of $7.0 million, (ii) long-term debt of $6.4 million related to the hospital-based real estate and (iii) reserve for discontinued operations of $9.2 million. The Company is also subject to inquiries and investigations from governmental agencies related to its operating and business practices prior to consummation of the Crescent Transactions (as defined) on June 17, 1997. See Note H"Contingencies."
The following table provides a rollforward of liabilities resulting from the CBHS Transactions (in thousands):
Type of Cost |
Balance September 30, 1999 |
Additions |
(Receipts) Payments |
Balance December 31, 1999 |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Transaction costs and legal fees | $ | 7,553 | $ | | $ | 2,402 | $ | 5,151 | ||||
Provider JV working capital | 3,116 | | | 3,116 | ||||||||
Other | 755 | | (150 | ) | 905 | |||||||
$ | 11,424 | $ | | $ | 2,252 | $ | 9,172 | |||||
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
(Unaudited)
NOTE HContingencies
The Company is self-insured for a portion of its general and professional liability risks. The reserves for self-insured general and professional liability losses, including loss adjustment expenses, were included in reserve for unpaid claims in the Company's balance sheet and were based on actuarial estimates that were discounted at an average rate of 6% to their present value based on the Company's historical claims experience adjusted for current industry trends. These reserves related primarily to the professional liability risks of the Company's healthcare provider segment prior to June 1997. On July 2, 1999, the Company transferred its remaining medical malpractice claims portfolio (the "Loss Portfolio Transfer") to a third-party insurer for approximately $22.3 million. The Loss Portfolio Transfer was funded from assets restricted for settlement of unpaid claims. The insurance limit obtained through the Loss Portfolio Transfer for future medical malpractice claims is $26.3 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 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 ("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 June 1997. The Department of Justice has indicated that its inquiries are based on its belief that the Federal government has certain civil and administrative causes of action under the Civil False Claims Act, the Civil Monetary Penalties Law, other federal statutes and the common law arising from the participation in federal health benefit programs of CBHS psychiatric facilities nationwide. The Department of Justice inquiries could relate to the following matters: (i) Medicare cost reports, (ii) Medicaid cost statements, (iii) supplemental applications to CHAMPUS/TriCare based on Medicare cost reports, (iv) medical necessity of services to patients and admissions, (v) failure to provide medically necessary treatment or admissions and (vi) submission of claims to government payors for inpatient and outpatient psychiatric services. No amounts related to such potential causes of action have yet been specified. The Company cannot reasonably estimate the settlement amount, if any, associated with the Department of Justice inquiries. Accordingly, no reserve has been recorded related to this matter.
On August 1, 1996, the United States Department of Justice, Civil Division, filed an Amended Complaint in a civil qui tam action initiated in November 1994 against the Company and its Orlando South hospital subsidiary ("Charter Orlando") by two former employees. The First Amended Complaint alleges that Charter Orlando violated the federal False Claims Act (the "Act") in billing for inpatient treatment provided to elderly patients. The Court granted the Company's motion to dismiss the government's First Amended Complaint yet granted the government leave to amend its First Amended Complaint. The government filed a Second Amended Complaint on December 12, 1996 which, similar to the First Amended Complaint, alleges that the Company and its subsidiary violated the Act in billing for the treatment of geriatric patients. Like the First Amended Complaint, the Second Amended Complaint was based on disputed clinical and factual issues which the Company believes do not constitute a violation of the Act. On the Company's motion, the Court ordered the parties to participate in mediation of the matter. As a result of the mediation, the parties reached a settlement. Pursuant to the settlement, the Company paid approximately $4.8 million in August 1998. Furthermore, Charter Orlando (operated by CBHS) did not seek reimbursement for services provided to patients covered under the Medicare program for a period of up to fifteen months. The Company reimbursed CBHS for the resulting loss of revenues through September 30, 1999.
On May 26, 1998, a group of eleven plaintiffs purporting to represent an uncertified class of psychiatrists, psychologists and social workers brought an action (the "Holstein Case") 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 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 discovery. On October 14, 1999, the Plaintiffs filed a motion seeking class certification for a class of approximately 200,000 providers. The court has not yet heard argument on that motion. The Company does not believe this matter will have a material adverse effect on its financial position or results of operations.
The Company is also subject to or party to other litigation, claims, and civil suits, relating to its operations and business practices. Certain of the Company's managed care litigation matters involve class action lawsuits, including the Holstein Case, in which the Company has been named as a defendant. Besides the Holstein Case, the Company has certain other class action lawsuits which allege (i) the Company inappropriately denied and/or failed to authorize benefits for mental health treatment under insurance policies with a customer of the Company and (ii) the Company was party to employee malpractice and professional negligence regarding a specific mental health illness. In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable, arising out of such other litigation, claims and civil suits. Furthermore, management believes that the resolution of such litigation, claims and civil suits 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.
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 $51.8 million and $16.7 million as of September 30, 1999 and December 31, 1999, respectively for CHAMPUS Adjustments. During the quarter ended December 31, 1999, the Company reached a settlement agreement with a contractor under one of its CHAMPUS contracts whereby the Company paid approximately $38.1 million to the contractor during such quarter. The Company and the contractor under this CHAMPUS contract are in the process of appealing the department of defense's retroactive adjustment. 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 IManaged Care Integration Plan and Costs
Integration Plan
The Company integrated three behavioral managed care organizations ("BMCOs"), Green Spring, HAI and Merit, as a result of acquisitions consummated in fiscal 1996 (Green Spring) and fiscal 1998 (HAI and Merit). The Company also integrated two specialty managed care organizations, Allied and Care Management Resources, Inc. ("CMR"). During fiscal 1998, management committed the Company to a plan to combine and integrate the operations of its BMCOs and specialty managed care organizations (the "Integration Plan") that resulted in the elimination of duplicative functions and standardized business practices and information technology platforms. The Integration Plan was completed on September 30, 1999.
The Integration Plan resulted in the elimination of approximately 1,000 positions during fiscal 1998 and fiscal 1999. Approximately 510 employees were involuntarily terminated pursuant to the Integration Plan.
The employee groups of the BMCOs that were primarily affected include executive management, finance, human resources, information systems and legal personnel at the various BMCOs corporate headquarters and regional offices and credentialing, claims processing, contracting and marketing personnel at various operating locations.
The Integration Plan resulted in the closure of approximately 20 leased facilities at the BMCOs, Allied and CMR during fiscal 1998 and 1999.
The Company recorded approximately $21.0 million of liabilities related to the Integration Plan, of which $11.6 million was recorded as part of the Merit purchase price allocation and $9.4 million ($8.9 million in fiscal 1998 and $0.5 million in fiscal 1999) was recorded in the statement of operations under "Managed care integration costs."
The following table provides a rollforward of liabilities resulting from the Integration Plan (in thousands):
Type of Cost |
Balance September 30, 1999 |
Payments |
Balance December 31, 1999 |
||||||
---|---|---|---|---|---|---|---|---|---|
Employee termination benefits | $ | 769 | $ | 431 | $ | 338 | |||
Facility closing costs | 3,094 | 269 | 2,825 | ||||||
$ | 3,863 | $ | 700 | $ | 3,163 | ||||
Other Integration Costs
The Integration Plan resulted in additional incremental costs that were 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 ended December 31, 1998, the Company incurred approximately $1.8 million in other integration costs, including outside consulting costs of approximately $0.8 million and employee office relocation costs of approximately $0.4 million.
The Company discontinued its practice of classifying other integration costs separately in its consolidated statements of operations for fiscal periods ending after September 30, 1999, on which date the Integration Plan was completed. The Company will continue to incur costs for activities which are similar in nature to those which would have been reported as integration costs prior to the completion of the Integration Plan. The Company does not expect such costs to materially impact its financial position, results of operations or cash flows.
NOTE JBusiness Segment Information
The Company operates through three reportable segments which are engaged in various aspects of the healthcare industry. The Company evaluates performance of its segments based on profit or loss from continuing operations before depreciation and amortization; interest, net; managed care integration costs; special charges, net and stock option expense; income taxes and minority interest ("Segment Profit"). Intersegment sales and transfers are not significant.
The following tables summarize, for the periods indicated, net revenue and Segment Profit by continuing business segment (in thousands):
|
Behavioral Managed Healthcare |
Human Services |
Specialty Managed Healthcare |
Corporate Overhead and other |
Consolidated |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months ended December 31, 1998 | |||||||||||||||
Net revenue | $ | 356,551 | $ | 45,739 | $ | 41,041 | $ | | $ | 443,331 | |||||
Segment Profit (loss) | $ | 52,620 | $ | 5,287 | $ | 416 | $ | (3,522 | ) | $ | 54,801 | ||||
Three Months ended December 31, 1999 | |||||||||||||||
Net revenue | $ | 385,705 | $ | 51,264 | $ | 44,856 | $ | | $ | 481,825 | |||||
Segment Profit (loss) | $ | 54,921 | $ | 5,238 | $ | 309 | $ | (3,440 | ) | $ | 57,028 | ||||
The following tables reconcile Segment Profit to consolidated income from continuing operations before provision for income taxes and minority interest (in thousands):
|
Three Months Ended December 30, |
||||||
---|---|---|---|---|---|---|---|
|
1998 |
1999 |
|||||
Segment Profit | $ | 54,801 | $ | 57,028 | |||
Depreciation and amortization | (17,513 | ) | (19,364 | ) | |||
Interest, net | (24,122 | ) | (23,991 | ) | |||
Managed care integration costs | (1,750 | ) | | ||||
Special charges, net and stock option expense | (1,096 | ) | | ||||
Income from continuing operations before provision for income taxes and minority interest | $ | 10,320 | $ | 13,673 | |||
NOTE KRedeemable Preferred Stock
On July 19, 1999, the Company 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"). On December 15, 1999, the Company and TPG amended and restated the definitive agreement and consummated the TPG Investment.
Pursuant to the amended and restated definitive agreement, TPG purchased approximately $59.1 million of the Company's Series A Cumulative Convertible Preferred Stock (the "Series A Preferred Stock") and an Option (the "Option") to purchase approximately $21.0 million of additional Series A Preferred Stock. Net proceeds from issuance of Series A Preferred Stock were $54.0 million. Approximately 50% of such net proceeds was used to reduce debt outstanding under the Term Loan Facility, with the remaining 50% being used for general corporate purposes. 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 by the holder 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 December 15, 2009. The Option will expire unless exercised by August 19, 2002. TPG may exercise the Option in whole or in part. The Company may, under certain circumstances, require TPG to exercise the Option. The terms of the shares of Series A Preferred Stock issuable pursuant to the Option are identical to the terms of the shares of Series A Preferred Stock issued to TPG at the closing of the TPG Investment.
TPG has three representatives on the Company's twelve-member Board of Directors.
The issuance of common stock in respect of accrued and unpaid dividend obligations on the Series A Preferred Stock and the issuance of common stock underlying the Option are subject to approval by the Company's stockholders. The Company intends to seek such stockholder approval no later than the next annual meeting of its stockholders, which is scheduled to be held on February 17, 2000.
The TPG Investment is reflected under the caption "Redeemable preferred stock" in the Company's condensed consolidated balance sheet as follows (in thousands):
|
December 31, 1999 |
|||
---|---|---|---|---|
Redeemable convertible preferred stock: | ||||
Series A - stated value $1, 87 shares authorized, 59 shares issued and outstanding |
$ | 59,063 | ||
Series B - stated value $1, 60 shares authorized, none issued and outstanding |
| |||
Series C - stated value $1, 60 shares authorized, none issued and outstanding |
| |||
59,063 | ||||
Less: Unamortized fair value of Series A Option | (3,308 | ) | ||
Total redeemable convertible preferred stock | 55,755 | |||
Accumulated unpaid dividends on Series A Preferred Stock | 178 | |||
Unamortized fair value of Series A Option | 3,308 | |||
Issuance costs, net of amortization of $23 | (5,008 | ) | ||
$ | 54,233 | |||
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
December 31, 1999
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF
OPERATIONS
This quarterly report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. 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 for the fiscal year ended September 30, 1999. 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 for the fiscal year ended September 30, 1999.
Overview
The Company currently operates through three principal business segments which are engaged in:
On September 10, 1999, the Company consummated a series of related transactions which are more fully described as the CBHS Transactions in Note G"Discontinued Operations" to the Company's condensed consolidated financial statements set forth elsewhere herein. The CBHS Transactions, together with the formal plan of disposal authorized by the Company's Board of Directors on September 2, 1999, represented the disposal of the Company's healthcare provider and healthcare franchising business segments under Accounting Principles Board Opinion No. 30, "Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30"). 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 of discontinued operations. Accordingly, the Company has restated its results of operations for all periods prior to the fourth quarter of fiscal 1999. The Company recorded an after-tax loss on the disposal of its healthcare provider and healthcare franchising business segments of approximately $47.4 million (primarily non-cash) in the fourth quarter of fiscal 1999.
The CBHS Transactions represented the final step in the Company's transformation from being a provider of behavioral healthcare services to patients in primarily an inpatient setting to being primarily a manager of specialty healthcare services. The Company undertook the initial steps of this transformation with the belief that becoming a fully integrated manager/provider of specialty healthcare services would simultaneously position it to take advantage of opportunities in the growing managed care industry while enhancing its ability to effectively treat patients in its inpatient psychiatric hospitals. As the Company's managed care business grew; however, it became apparent that the opportunities available to the Company through consolidating the then-fractured managed specialty healthcare industry were superior to those available to a fully integrated manager/provider company; therefore, it decided to sell its provider interests and invest the proceeds in expansion of its managed specialty healthcare business.
A brief timeline of the significant steps in this transformation is as follows:
Results of Operations
The following tables summarize, for the periods indicated, operating results by continuing business segment (in thousands).
|
Behavioral Managed Healthcare |
Human Services |
Specialty Managed Healthcare |
Corporate Overhead and other |
Consolidated |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three Months Ended December 31, 1998 | ||||||||||||||||
Net revenue | $ | 356,551 | $ | 45,739 | $ | 41,041 | $ | | $ | 443,331 | ||||||
Salaries, cost of care and other operating expenses | 307,714 | 40,452 | 40,625 | 3,522 | 392,313 | |||||||||||
Equity in earnings of unconsolidated subsidiaries | (3,783 | ) | | | | (3,783 | ) | |||||||||
303,931 | 40,452 | 40,625 | 3,522 | 388,530 | ||||||||||||
Segment Profit (1) | $ | 52,620 | $ | 5,287 | $ | 416 | $ | (3,522 | ) | $ | 54,801 | |||||
Three Months Ended December 31, 1999 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue | $ | 385,705 | $ | 51,264 | $ | 44,856 | $ | | $ | 481,825 | ||||||
Salaries, cost of care and other operating expenses | 334,258 | 46,026 | 44,547 | 3,440 | 428,271 | |||||||||||
Equity in earnings of unconsolidated subsidiaries | (3,474 | ) | | | | (3,474 | ) | |||||||||
330,784 | 46,026 | 44,547 | 3,440 | 424,797 | ||||||||||||
Segment Profit (1) | $ | 54,921 | $ | 5,238 | $ | 309 | $ | (3,440 | ) | $ | 57,028 | |||||
Quarter ended December 31, 1999, compared to the same period in fiscal 1999
Behavioral Managed Healthcare. Revenue increased 8.2% or $29.2 million, to $385.7 million for the quarter ended December 31, 1999. Salaries, cost of care and other operating expenses increased 8.6% or $26.5 million, to $334.3 million for the quarter ended December 31, 1999. Equity in earnings of unconsolidated subsidiaries decreased approximately $0.3 million, or 8.2% to $3.5 million for the quarter ended December 31, 1999 due primarily to fluctuations in the profitability of Premier. 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) higher than normal care costs resulting from unfavorable changes in utilization levels in a few select markets during the first two months of the quarter ended December 31, 1999. Total covered lives increased 7.5%, or 4.7 million, to 67.5 million at December 31, 1999, from 62.8 million at December 31, 1998.
Human Services. Revenue increased 12% or $5.5 million, to $51.3 million for the quarter ended December 31, 1999. Salaries, cost of care and other operating expenses increased 13.7% or $5.6 million, to $46.0 million for the quarter ended December 31, 1999. The increases in revenue and salaries, cost of care and other operating expenses resulted primarily from (i) growth in placements, (ii) acquisition of businesses, (iii) increased spending related to four new business starts and remediation of year 2000 computer issues during the quarter ended December 31, 1999 and (iv) pricing pressures at one local business unit acquired during fiscal 1998.
Specialty Managed Healthcare Revenue increased 9.3% or $3.8 million, to $44.9 million for the quarter ended December 31, 1999. Salaries, cost of care and other operating expenses increased 9.7% or $3.9 million, to $44.5 million for the quarter ended December 31, 1999. The increases in revenue and salaries, cost of care and other operating expenses resulted primarily from new business development and increased enrollment related to existing customers.
Depreciation and Amortization. Depreciation and amortization increased 10.6%, or $1.9 million, to $19.4 million for the quarter ended December 31, 1999, from $17.5 million in the same period in fiscal 1999. The increase is primarily attibutable to depreciation of capital expenditures made during fiscal 1999.
Interest, net. Interest expense, net was $24.0 million and $24.1 million for the quarters ended December 31, 1999 and 1998 respectively. This is primarily attributable to lower average outstanding debt during the quarter ended December 31, 1999, offset by increased interest rates.
Other Items. The Company recorded managed care integration costs of $1.8 million during the quarter ended December 31, 1998 and recorded no such cost during the fiscal 2000 quarter due to the completion of the Integration Plan. For a more complete discussion of managed care integration costs, see Note I"Managed Care Integation Plan and Costs" to the Company's condensed consolidated financial statements set forth elsewhere herein.
The Company recorded a special charge of approximately $1.1 million during the quarter ended December 31, 1998. This charge related to non-capitalizable acquistion-related expenditures in the Company's specialty managed healthcare business segment.
The Company's effective income tax rate decreased to 53.1% for the quarter ended December 31, 1999, from 57.3% for the same period in fiscal 1999. The decrease is primarily attributable to the Company's increased level of earnings in the fiscal 2000 period relative to the amount of non-deductible goodwill amortization expense associated with the Merit acquisition.
Discontinued Operations. The Company recorded income from discontinued operations of $0.2 million, net of tax, during the quarter ended December 31, 1998. During September of 1999 the Company exited its healthcare provider and healthcare franchising operations, see Note G"Discontinued Operations" to the Company's condensed consolidated financial statements set forth elsewhere herein.
Historical Liquidity and Capital Resources
Operating Activities The Company's net cash provided by operating activities was $24.6 million and $7.7 million for the three months ended December 31, 1999 and 1998, respectively. The increase in cash provided by operating activities in fiscal 2000 compared to fiscal 1999 was primarily the result of (i) increased earnings in the fiscal 2000 period (ii) timing of working capital receipts and payments and (iii) payments of managed care integration costs in the fiscal 1999 period. During the fiscal 2000 period, non-recurring cash inflows of approximately $24.0 million related to cost report settlements and non-recurring cash payments totaling $38.1 million related to CHAMPUS Adjustments were incurred.
Investing Activities Capital expenditures decreased 55%, or $7.9 million, to $6.5 million for the quarter ended December 31, 1999, compared to $14.4 million in the fiscal 1999 period. The decrease was primarily a result of (i) increased capital requirements in the fiscal 1999 period related to integration activities, (ii) reduction of expenditures related to year 2000 preparedness and (iii) timing of capital projects in the fiscal 2000 period.
The Company acquired businesses in its human services segment and paid contingent purchase consideration related to previously acquired businesses during the fiscal 2000 period. During the fiscal 1999 period, the cash paid for acquisition of businesses was offset by the return of approximately $20.0 million of escrowed amounts related to the acquisition of Allied.
The Company's cash flow for the fiscal 1999 period reflects a reduction of cash and cash equivalents of $21.1 million which is related to the conversion of eight joint ventures from consolidation to the equity method. See "Recent Accounting PronouncementsEITF 96-16". This reduction does not represent an actual reduction of cash and cash equivalents at the affected subsidiaries.
Financing Activities The Company repaid $20.0 million and $40.0 million of Revolving Facility obligations during the quarters ended December 31, 1999 and 1998, respectively. As of December 31, 1999 the Company had $124.1 million of availability under the Revolving Facility, excluding $25.9 million of availability reserved for certain letters of credit. During the fiscal 2000 period the Company reduced amounts outstanding under its Credit Agreement and other obligations by an aggregate amount of $56.8 million including amounts paid under the Revolving Facility.
The Company completed the sale of 59,063 shares of Series A Redeemable Preferred Stock to TPG during the quarter ended December 31, 1999, for a total purchase price of approximately $54.0 million, net of issuance costs. Approximately 50% of the net proceeds were used to reduce debt outstanding under the Term Loan Facility with the remaining 50% being used for general corporate purposes. See Note K"Redeemable Preferred Stock" to the Company's condensed consolidated financial statements set forth elsewhere herein.
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 $460.1 million, as of December 31, 1999, 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):
Fiscal Year |
Remaining Principal Amount |
||
---|---|---|---|
2000 | 22.7 | ||
2001 | 34.2 | ||
2002 | 43.4 | ||
2003 | 80.8 | ||
2004 | 137.6 | ||
2005 | 115.8 | ||
2006 | 25.6 | ||
2007 | | ||
2008 | $ | 625.0 |
In addition, any amounts outstanding under the Revolving Facility mature in February 2004. The Company had $60.0 million of borrowings outstanding under the Revolving Facility as of February 14, 2000.
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 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 during March, 1999 for both the full Tranche 1 Payment and the full Tranche 2 Payment for the Contract Year ended December 31, 1998. This payment was recorded as an additional $60.0 million of goodwill and other intangible assets related to the purchase of HAI.
Also, based upon the membership enrollment data related to the Contract Year ended December 31, 1999 ("Contract Year 2"), the Company, prior to the issuance of its September 30, 1999, financial statements, believed beyond a reasonable doubt that it would be required to make both the full Tranche 1 Payment and the full Tranche 2 Payment ($60.0 million in aggregate) related to Contract Year 2. Accordingly, the Company recorded an additional $60.0 million of goodwill and other intangible assets related to the purchase of HAI, for a total increase of $120.0 million during fiscal 1999. The Contract Year 2 liability of $60.0 million is included in "Deferred credits and other long-term liabilities" in the Company's condensed consolidated balance sheets as of September 30, 1999, and December 31, 1999. The Company paid $60.0 million to Aetna during February, 2000 for both the full Tranche 1 Payment and the full Tranche 2 Payment for Contract Year 2.
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 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:
By virtue of acquiring Merit, the Company may be required to make certain payments to the former shareholders of CMG Health, Inc. ("CMG") a managed behavioral healthcare company that was acquired by Merit in September, 1997. 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. Whether any contingent payments will be made to the former shareholders of CMG and the amount and timing of contingent payments, if any, may be subject to the outcome of these proceedings.
Revolving Facility and Liquidity. The Revolving Facility provides the Company with revolving loans and letters of credit in an aggregate principal amount at any time not to exceed $150.0 million. At February 14, 2000, the Company had approximately $60.2 million of availability under the Revolving Facility. The Company estimates that it will spend approximately $38.0 million for capital expenditures over the remainder of fiscal 2000, in addition to the $6.5 million spent to-date. 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, if any, with respect to HAI and CMG and other investing and financing activities for the foreseeable future. The Company has borrowed under the Revolving Facility to meet significant commitments during the second quarter of fiscal 2000 including, but not limited to, the semi-annual interest payment on the Notes of $28.1 million and contingent consideration for the Company's purchase of HAI of $60.0 million, which were paid in February, 2000. The Company expects its borrowing capacity under the Revolving Facility to decline to approximately $40.0 million to $60.0 million by March 31, 2000 depending primarily on (i) the timing and amount of contingent consideration paid related to CMG (if any), (ii) the operating and cash flow performance of the Company, (iii) capital resources needed to pursue certain new risk-based managed care business and (iv) the timing and amount of acquisition-related spending. If the Company's borrowing capacity under the Revolving Facility is expected to fall below the levels described above, management intends to delay or forego certain investing activities, including capital expenditures and acquisitions, and possibly forego certain new business opportunities. 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, regulatory 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.
Strategic Alternatives 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. On December 15, 1999, the Company received approximately $54.0 million of net proceeds (after transaction costs) upon issuance of Series A Preferred Stock to TPG. Approximately 50% of the net proceeds received from the issuance of the Series A Preferred Stock was used to reduce debt outstanding under the Term Loan Facility with the remaining 50% of the proceeds being used for general corporate purposes. 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.
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 disallowed approximately $162 million of deductions that relate primarily to interest expense in fiscal 1992. The Company filed an appeal of the IRS Assessment during September 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
Emerging Issues Task Force Issue 96-16, "Investor's Accounting for an Investee When the Investor Has a Majority of the Voting Interest but a Minority Shareholder or Shareholders Have Certain Approval or Veto Rights" ("EITF 96-16") supplements the guidance contained in AICPA Accounting Research Bulletin 51, "Consolidated Financial Statements", and in Statement of Financial Accounting Standards No. 94, "Consolidation of All Majority-Owned Subsidiaries" ("ARB 51/FAS 94"), about the conditions under which the Company's consolidated financial statements should include the financial position, results of operations and cash flows of subsidiaries which are less than wholly-owned along with those of the Company and its 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):
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October 1, 1998 |
|||
---|---|---|---|---|
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 | ) | |
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 the date information.
The Company also has business relationships with customers and healthcare providers and other critical vendors who are themselves reliant on IT and Embedded Systems to conduct their businesses.
State of Readiness. The Company completed its year 2000 remediation efforts prior to December 31, 1999, including the implementation of a company-wide year-end transition strategy. Corporate offices and regional service center teams worked diligently before,during and after the rollover to see that systems and processes were ready and that our members were able to access the quality of care they needed. The Company organized three command centers in different regions of the country, overseeing the millennium rollover of centrally and locally supported mission-critical systems. In addition, key vendors (e.g. utilities, banks, telecommunications providers, hardware and software vendors, etc.), providers and business partners were monitored for status and performance. The Company did not encounter any year 2000 related issues resulting in any disruption of service to its customers, nor did it implement any year 2000 contingency plans to continue operation of mission critical systems.
External Relationships. The Company completed its risk assessment of all External Relationships and developed contingency plans to mitigate risk. Action plans were implemented to monitor key vendors for status and performance during the millenium rollover period. The Company did not encounter any disruption of service and did not implement any of its contingency plans.
Year 2000 Costs. Total costs incurred solely for remediation of potential year 2000 problems were approximately $4.3 million in fiscal 1999. The Company incurred no significant year 2000-related costs subsequent to September 30, 1999. A large majority of these costs were incremental expenses that will not recur in calendar 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 accelerated approximately $5.5 million of capital expenditures that would have been budgeted for future periods into fiscal 1999 to ensure year 2000 readiness for outdated systems.
Item 6.Exhibits and Reports on Form 8-K
Exhibit No. |
Description of Exhibit |
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4(a | ) | Amendment No. 5, dated as of January 12, 2000, 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 | ) | Amended and Restated Investment Agreement, dated December 14, 1999, between the Company and TPG Magellan LLC, together with the form of Certificate of Designations of Series A Cumulative Convertible Preferred Stock, which were filed as Exhibit 4(r) to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1999, and are incorporated herein by reference. |
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. |
4(d | ) | Amendment Number One to Registration Rights Agreement, dated as of October 15, 1999, between the Company and TPG Magellan LLC. |
27 | Financial Data Schedule. |
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.
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MAGELLAN HEALTH SERVICES, INC. (Registrant) |
Date: February 14, 2000 |
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/s/ CLIFFORD W. DONNELLY Clifford W. Donnelly Executive Vice President and Chief Financial Officer |
Date: February 14, 2000 |
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/s/ THOMAS C. HOFMEISTER Thomas C. Hofmeister Senior Vice President and Chief Accounting Officer |
FORM 10-Q MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES INDEX
FORM 10-Q MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES SIGNATURES
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