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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-24276
FPA MEDICAL MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 3636 NOBEL DRIVE,
(STATE OR OTHER JURISDICTION OF SUITE 200,
INCORPORATION OR ORGANIZATION) SAN DIEGO, CA
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
33-0604264 92122
(I.R.S. EMPLOYER (ZIP CODE)
IDENTIFICATION NO.)
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Registrant's telephone number, including area code: (619) 453-1000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.002 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of
the registrant at March 21, 1997 was $604,077,078.
The number of shares outstanding of the registrant's Common Stock as of
March 21, 1997 was 30,708,632.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE FOLLOWING DOCUMENTS ARE INCORPORATED BY
REFERENCE IN THIS FORM 10-K/A.
None
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PART I
ITEM 1. BUSINESS
GENERAL
FPA Medical Management, Inc. ("FPA" or the "Company") is a national
physician practice management company ("PPM") which acquires, organizes and
manages primary care physician practice networks and provides contract
management services to hospital emergency departments. FPA provides primary and
specialty care services to prepaid managed care enrollees and fee-for-service
patients through a network of independent practice association ("IPA")
physicians and owned primary care physician groups. On March 17, 1997, the
Company completed its previously announced merger with AHI Healthcare Systems,
Inc. ("AHI") pursuant to which approximately 5.8 million shares of FPA Common
Stock were issued to AHI stockholders and AHI became a wholly-owned subsidiary
of the Company. Following the merger with AHI, FPA is affiliated with
approximately 6,100 primary care physicians and 13,500 specialty care
physicians, and provides services to approximately 830,000 enrollees of 35
health maintenance organizations ("HMOs") or other prepaid health insurance
plans (collectively, "Payors") in ten states. Through its merger with Sterling
Healthcare Group, Inc. ("Sterling") in October 1996, FPA is affiliated with
approximately 1,000 emergency department physicians and manages the emergency
departments of 104 hospitals in 20 states.
FPA's relationships with its subsidiaries, affiliated professional
corporations (the "Professional Corporations"), other providers of medical
services and Payors (collectively, the "FPA Network") offer physicians the
opportunity to participate more effectively in managed care programs by
organizing physician groups within geographic areas to contract with Payors. FPA
improves physician practice operations by assuming administrative functions
necessary in a managed care environment. These functions include claims
adjudication, utilization management of medical services, Payor contract
negotiations, credentialing, financial reporting and the operation of management
information systems. Under these arrangements, FPA, on behalf of the
Professional Corporations, is responsible for the payment of the cost of medical
services, including professional, ancillary and medical management services, and
is entitled to amounts received from Payors in excess of such costs. FPA
believes that its IPA management model is appealing to independent physicians
because it allows the physicians to retain control of their own practices while
gaining access to more patients through participation in a managed care program.
Agreements with Payors and providers are entered into with, and approved
by, one of the Professional Corporations or subsidiaries of the Company,
depending on applicable state law. Pursuant to administrative services
agreements with the Professional Corporations, payments received from Payors are
assigned to FPA.
The FPA Network manages all covered primary and specialty medical care for
each enrollee in exchange for fixed monthly capitation payments pursuant to
Payor contracts. Specialty care physician services, inpatient hospitalization
and certain other services managed by primary care physicians are subject to
preauthorization guidelines and are provided through contracts negotiated by FPA
for the Professional Corporations or subsidiaries of the Company based on
discounted fee-for-service, per diem or capitation rates. Contracts with Payors
and primary care physicians generally include shared risk arrangements and other
incentives designed to encourage the provision of high-quality, cost effective
health care. Because FPA is obligated to provide medical services, the costs of
some of which are variable, its profitability may vary based on the ability of
FPA and its affiliated providers to control such health care costs.
Additionally, state laws in California, operations in which represented
approximately 22% of FPA's operating revenues for the year ended December 31,
1996, require entities such as FPA to be licensed as health care service plans.
The application of a wholly-owned subsidiary of FPA for a restricted license was
approved by the California Department of Corporations in December 1996. The loss
or revocation of such license would have a material adverse effect on FPA. In
addition, there can be no assurance that regulatory authorities in the other
states in which FPA or its affiliates operate will not impose similar
requirements.
As part of its management and support services to hospital emergency
departments, Sterling recruits physicians and contracts for their services to
provide staffing of emergency departments. Sterling also assists its hospital
clients in such areas as physician scheduling, operations support, quality
assurance and departmental accreditation as well as billing and record keeping.
In addition, Sterling has expanded its hospital-based services to include the
management of anesthesiology departments, correctional institutional health
facilities and rural health care clinics.
The future growth of FPA is largely dependent on a continued increase in
the number of new enrollees in the FPA Network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
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serving enrollees of Payors in the FPA Network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations or
subsidiaries of FPA have contracts and whose members are patients of physicians
in the FPA Network or (iii) agreements with Payors, physicians and hospitals in
other geographic markets. The process of identifying and consummating suitable
acquisitions of, or affiliations with, physician groups can be lengthy and
complex. The marketplace for such acquisitions and affiliations is subject to
increasing competitive pressures. There can be no assurance that FPA will be
successful in identifying, acquiring or affiliating with additional physician
groups or hospitals or that the Professional Corporations or subsidiaries of FPA
will be able to contract with new Payors. In addition, there can be no assurance
that the Company's acquisitions will be successfully integrated on a timely
basis or that the anticipated benefits of these acquisitions will be realized;
failure to effectively accomplish the integration of acquired entities may have
a material adverse effect on FPA's results of operations and financial
condition. FPA's ability to expand is also dependent upon its ability to comply
with legal and regulatory requirements in the jurisdictions in which it operates
or will operate and to obtain necessary regulatory approvals, certificates and
licenses.
The health care industry is subject to extensive federal and state
legislation and regulation. Changes in the regulations or reinterpretations of
existing regulations could significantly affect the business of FPA.
THE MANAGED HEALTH CARE INDUSTRY
Medical services traditionally have been provided on a fee-for-service
basis with insurance companies assuming responsibility for paying all or a
portion of such fees. The increase in medical costs under traditional indemnity
health care plans has been caused by a number of factors, including, but not
limited to, the lack of incentives on the part of health care providers to
deliver cost-effective medical care and the absence of controls over the
utilization of costly specialty care physicians and hospitals.
As a result of escalating health care costs, employers, insurers and
governmental entities have all been seeking cost-effective approaches to the
delivery of and payment for quality health care services. HMOs and other managed
health care organizations have emerged as integral components in this effort.
HMOs enroll members by entering into contracts with employer groups or directly
with individuals to provide a broad range of health care services for a
capitation payment, with minimal or no deductibles or co-payments required of
the members. HMOs, in turn, contract either directly with physicians, or through
organizations like FPA, hospitals and other health care providers to administer
medical care to HMO members. These contracts provide for payment to the provider
on either a discounted fee-for-service or per diem basis, or through capitation
payments based on the number of members covered, regardless of the amount of
necessary medical care required within the covered benefits.
In response to the growth in HMO penetration, several provider group models
have evolved pursuant to which Payors generally shift certain administrative and
economic burdens to physicians. Administrative burdens include justifying
medical procedures, seeking authorization for tests and surgical procedures and
responding to additional oversight from Payors. These burdens have been
exacerbated by the proliferation of HMOs, which require physicians to comply
with multiple formats for claims processing, credentialing and other
administrative reporting requirements. As a result, physicians' operating
expenses and the number of hours devoted to non-medical activities have
increased. In addition to adding these administrative pressures, by capitating
payments to physicians, HMOs, in effect, have also begun to shift to physicians
a significant portion of the economic risk of providing health care. These
arrangements exert more pressure on the physician to reduce costs and
unnecessary medical treatments while continuing to deliver quality medical care.
To relieve these administrative and economic burdens, physicians have begun
to outsource to third parties, such as PPMs, both the management of economic
risk and the non-medical management tasks associated with the practice of
medicine. PPMs provide management and other administrative services to
physicians and, in certain circumstances, manage a portion of the economic risk
involved in providing health care. PPMs also help physician groups by
negotiating capitation rates and incentive payment arrangements with Payors.
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In addition to physician practices, hospitals have been affected by the
changing health care industry. Cost considerations are important to hospital
operations, particularly with respect to emergency room departments. FPA
believes that hospital emergency departments play a central role in determining
levels of admissions and profitability as well as in establishing a hospital's
reputation in the community. However, the ability of hospitals to provide high
quality health care services, including emergency care services, has been
adversely affected by recent trends in the U.S. health care industry. Continuing
cost-containment pressures are causing hospitals to seek new ways to provide
high quality services in a cost effective manner. In addition, hospitals face
numerous problems in managing their emergency departments, including
difficulties in recruiting, evaluating, scheduling and retaining emergency
physicians. Hospital emergency departments also continue to experience
increasing patient volumes, a shortage of board certified emergency physicians
and extensive use for routine primary care, particularly at night and on
weekends.
THE FPA NETWORK
The FPA Network currently has contracts to provide services to
approximately 830,000 enrollees of 35 Payors, which enrollees are serviced by
approximately 6,100 primary care physicians and 13,500 specialty care
physicians. Listed below is a breakdown as of March 21, 1997 of enrollees,
Payors, primary care physicians and specialty care physicians by region.
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STATES ENROLLEES NUMBER OF PAYORS PRIMARY CARE SPECIALTY CARE PHYSICIANS
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Arizona 194,415 3 572 1,036
California 312,288 20 1,741 5,235
Delaware 7,978 1 75 74
Florida 114,433 2 492 2,095
Michigan 34,687 1 406 1,028
New Jersey 27,618 3 926 447
North Carolina 12,205 2 52 24
South Carolina 10,384 1 207 20
Texas 118,846 9 1,067 2,495
Pennsylvania - - 351 -
Georgia 353 1 182 863
Kentucky - - 70 197
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MANAGED CARE BUSINESS
FPA provides management services to physicians, hospitals and Payors in the
FPA Network. FPA's services include: (i) comprehensive management information
systems ("MIS") that collect and assimilate data necessary for monitoring and
managing health care costs; (ii) claims administration and billing services;
(iii) utilization management of medical services and related financial reporting
and analysis; (iv) care coordination and case management assistance for
enrollees requiring medically complex or long-term health care; (v) monitoring
of the quality and cost of hospital and ancillary care; and (vi) credentialing
and recruiting of physicians.
Management Information Systems. FPA maintains an on-line database that
provides inpatient and outpatient utilization statistics and patient encounter
reporting and tracking. FPA believes that the availability of timely information
on utilization patterns improves primary care physician productivity and
effectiveness. This data also plays an integral role in the specialty care
physician and hospital utilization control process as by enabling the medical
directors and utilization control nurses to monitor encounter data, case
management decisions and patient outcomes. In addition, Serling has developed
MIS specific to hospital and clinical management services. The MIS collects data
regarding patient flow utilization, physician efficiency and other data used by
Sterling and hospital clients. In particular, Sterling uses the data to develop
staffing patterns. Further, the MIS assist FPA in performing various
administrative functions, including insurance verification, payment of accounts
payable, financial reporting and claims payment. The MIS also include the
customer service documentation system which assists FPA in resolving concerns
enrollees may have and in evaluating patient and physician satisfaction.
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Claims Administration and Billing Services. FPA possesses complete medical
bill review and claims processing capabilities. These capabilities include
determining enrollee eligibility, identifying appropriate benefits, issuing
payments to providers, processing hospital and outpatient facility charges for
the payment of claims and providing and analyzing encounter data. As a service
to certain Professional Corporations, FPA performs fee-for-service billing and
collections. Billing staff register fee-for-service patients, send monthly
statements and pursue collection.
Utilization Management. Physicians within the FPA Network have established
a utilization management program to help ensure the delivery of high quality,
cost-effective health care. Utilization management encourages physicians in the
FPA Network to provide cost-effective, quality care by emphasizing preventive
medicine and by eliminating unnecessary tests, procedures, surgeries,
hospitalizations and referrals to specialty care physicians. Referrals to
specialty care physicians and all hospital admissions, with the exception of
emergencies, generally require prior approval by the utilization management
committees of the various Professional Corporations or subsidiaries. Each
utilization management committee has established guidelines for routine
referrals which can be authorized by the committee's staff. Following admission,
a patient's status is monitored daily by a member of the utilization management
committee, in conjunction with the admitting physician or in-house intensivist,
to assure timely and appropriate hospital discharge. A member of the utilization
management committee coordinates with hospital nurses for discharge planning and
use of sub-acute alternatives to hospitalization. FPA has developed separate
utilization management committees on a regional basis due to expansion into new
geographic markets.
Case Management. Case management is a service administered by the various
utilization management committees and is a clinical and administrative process
by which health care services are identified, coordinated, implemented and
evaluated on an ongoing basis for enrollees experiencing selected health
problems. Such selected health problems include chronic disability, complex
medical cases or problems requiring long-term care. Case management involves the
coordination of a variety of services, including home nursing, home infusion and
the provision of durable medical equipment. This approach provides a continuum
of quality care throughout the extended treatment period.
Quality Assurance. The FPA Network maintains, as a service to both its
physicians and Payors, a comprehensive quality assurance program designed to
improve patient care. The quality assurance program incorporates peer review,
patient satisfaction surveys, medical records audit, continuing medical staff
development and regular continuing medical education seminars as required by
accrediting organizations, state law and licensing requirements. Medical staff
development includes the provision of training and support programs to encourage
the team-oriented delivery of high quality, cost-effective medical care.
Physician Credentialing and Recruitment. As a service to Payors and the
Professional Corporations, FPA verifies that the credentials of physicians in
the FPA Network meet the minimum requirements specified in Payor contracts. In
addition, FPA assists the Professional Corporations in the recruitment of highly
competent physicians who share in the philosophy of prepaid managed health care.
The recruitment process includes a lengthy series of interviews and reference
checks incorporating a number of credentialing and competency assurance
protocols. All of the FPA Network's physicians are licensed to practice medicine
in the state where they provide medical services and are generally either board
certified or board eligible.
EMERGENCY DEPARTMENT BUSINESS
General. With the acquisition of Sterling, FPA provides physician practice
management services to 104 hospital emergency departments, one hospital
anesthesiology department and four correctional institutional health
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facilities in 20 states. FPA contracts with approximately 1,000 affiliated
physicians. These contracts typically provide all necessary physician coverage
for hospital emergency departments on a 24-hour, 365-day basis. The Company
identifies and recruits physicians as candidates for admission to a client's
medical staff and coordinates the on-going scheduling of staff physicians, who
provide clinical coverage in the area of emergency medicine and, in one
hospital, anesthesiology. The Company also provides an on-site medical director
for the hospital's emergency department, who works directly with the hospital
medical staff and administration in such areas as quality assurance, risk
management and departmental accreditation.
Physician Recruiting. Recruiting physicians is an essential service
provided by Sterling to its hospital clients. Sterling's physician recruitment
methods include the use if its in-house search firm and certain third party
search firms, direct contact with residency programs, mail solicitations,
medical journal advertising, telemarketing and use of personal contacts.
Sterling has developed a proprietary computer database, which is periodically
updated, to identify physicians who might be available as independent
contractors for Sterling.
Affiliating with Sterling offers physicians the opportunity to minimize
their administrative burden and concentrate on the practice of medicine. The
Company believes that many physicians enjoy the relative freedom from the
business aspects of medicine, including the development of a patient base, the
financing of a practice and the complexity associated with billing and
collection procedures, that results from affiliation with Sterling. As a
provider of contract management services across a broad geographic spectrum,
Sterling can offer a physician substantial flexibility in terms of geographic
location, type of facility and opportunities for relocation. The physician also
tends to gain greater individual control over the number and scheduling of hours
worked. Physicians under contract with Sterling also have the option of
conveniently obtaining professional liability insurance with somewhat more
favorable terms than might otherwise be available.
AGREEMENTS WITH PAYORS, PROVIDERS AND EMERGENCY DEPARTMENTS; ADMINISTRATIVE
SERVICE AGREEMENTS
Contracts with Payors. FPA arranges for contracts between Payors and the
Professional Corporations or subsidiaries. These contracts generally provide for
terms of one to thirty years, with automatic renewal periods, terminable upon
prior notice (generally between 30 and 180 days) by either party. These
contracts obligate the Professional Corporations or subsidiaries to deliver
covered medical benefits and to coordinate all inpatient and outpatient care for
enrollees. Under most of these arrangements, the Professional Corporation or
subsidiary receives a capitation payment for each Payor enrollee who selects a
primary care physician who is employed by or affiliated with such Professional
Corporation or subsidiary. These capitation payments, in turn, are assigned to
FPA pursuant to FPA's administrative services agreement with the Professional
Corporation. The Professional Corporations (and indirectly, FPA) retain a level
of risk for the provision of appropriate medical care. In addition, these
contracts typically provide for bonuses derived from shared risk arrangements
and provide other financial incentives designed to encourage efficient
utilization of hospital and other medical services provided to enrollees. To
encourage efficient utilization of hospital and related services, the Payor
contracts typically establish a yearly shared risk pool from which all payments
for hospitalization and other specified services are deducted. At the end of the
period, the Professional Corporation or subsidiary is entitled to a portion of
any excess amounts over actual expenditures deducted from the pool. Certain of
the Payor contracts which are material to FPA obligate the Professional
Corporation to bear a portion of any deficit in this fund. To date, however,
neither FPA nor any Professional Corporation has been called upon to pay any
deficit. Under most circumstances, when such deficits do occur, they are carried
forward and offset against future surpluses. Additionally, some Payor contracts
contain similar arrangements with respect to other specialty care services. FPA
purchases stoploss insurance protection which provides thresholds or "attachment
points," generally $100,000 for inpatient services (up to an aggregate of $5
million) and $25,000 for outpatient services (up to an aggregate of $1 million)
per year, at which substantially all financial exposure for an enrollee beyond
such thresholds is contractually shifted to the insurer. The failure of FPA to
negotiate favorable attachments points in the future could have a material
adverse effect on FPA's financial condition, results of operations and/or
liquidity. There can be no assurance that FPA will be able to negotiate
favorable attachment points in the future.
In 1996, revenue from two Payors, Physician Corporation of America and
Foundation Health Corporation, each exceeded 10% of FPA's operating revenue, and
collectively accounted for approximately 25% of FPA's operating revenue. The
loss of either of these Payors could have a material adverse effect on FPA.
Contracts with Providers. The FPA Network, through the Professional
Corporations, subsidiaries and Payors, contracts with a variety of providers,
including primary and specialty care physicians, hospitals and other ancillary
providers. These agreements generally have terms up to three years, are
automatically renewable and are terminable by either party on the
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following December 31 upon at least 90 days' prior notice. A primary care
physician's affiliation and compensation arrangement with a Professional
Corporation or subsidiary may take one of several forms. The physician may be
(i) an individual or a member of a group practice or an IPA which (a) contracts
with FPA and a Professional Corporation for FPA's services and receives
capitation payments based on the number of enrollees and is entitled to
additional compensation based upon efficiency in utilizing the services of
specialty care providers, subject to other factors including but not limited to
compliance with contractual quality standards or (b) enters into an arrangement
with FPA and one of its Professional Corporations; or (ii) an individual or
group practice of physicians which sells to FPA and a Professional Corporation
the assets of its practice and receives as compensation for employment a base
salary and productivity bonus, or receives a percentage of net collections of
the practice determined in accordance with applicable law. The physician or
group which sells its practice still practices medicine in the same location.
While such physician or group is employed and paid by a Professional Corporation
or subsidiary, FPA provides most employees and administrative services to such
physician or group. In general, a primary care physician is entitled to earn
additional compensation if the medical practice, determined in accordance with
applicable law, meets certain performance standards.
In November 1994, the Board of Directors approved a physician stock option
program effective January 1, 1995. Under this program, physicians are eligible
to receive options to purchase FPA's Common Stock if they reach objective
quality standards set by FPA.
The compensation structures for primary care physicians are set to be
competitive within the geographic area in which each physician is employed. FPA
currently surveys physician compensation patterns and programs in HMO and other
group practice settings to ensure that FPA Network physicians' compensation and
benefits are competitive.
Specialty care providers contract with a Professional Corporation or
subsidiary to provide medical services to enrollees and are compensated on a
discounted fee-for-service or capitated basis. Hospital and affiliated medical
facilities contract with a Professional Corporation or subsidiary and Payors to
provide both inpatient and outpatient services to enrollees on a
fee-for-service, per diem or capitated basis, which are discounted from
customary charges.
Emergency Departments-Client Contracts. Sterling provides physician
practice management services to hospitals under fee-for-service contracts and
flat-rate contracts. A substantial portion of Sterling's hospital-based net
revenues are derived from payments made on a fee-for-service basis. Hospitals
entering into fee-for-service contracts agree, in exchange for Sterling's
services, to authorize Sterling and its contracted health care professionals to
bill and collect the professional component of the charges for medical services
rendered by Sterling's contracted health care professionals. Under the
fee-for-service arrangements with hospital clients, Sterling receives direct
disbursements of the amounts collected and, depending on the magnitude of
services provided to the hospital and payor mix, may also receive a subsidy from
the hospital client for Sterling's physician practice management services.
Pursuant to such arrangement, Sterling accepts responsibility for billing and
collection and assumes the risks of changes in patient volume, payor mix and
third-party reimbursement rates, delays attendant to reimbursement through
government programs and other third-party payors and uncollectibility of
accounts. All of these factors are taken into consideration by Sterling in
arriving at contractual arrangements with health care institutions and
professionals. Clients entering into flat-rate contracts pay fees to Sterling
based on the hours of physician coverage provided.
Sterling provides physician practice management services to hospitals under
contracts that generally have terms of one or two years, renewable automatically
under the same terms and conditions unless either party gives the other written
notice of its intent not to renew at least 90 days prior to the end of the then
current term. Many of these agreements provide for termination by the hospital
without cause on relatively short notice.
Emergency Departments-Physician Contracts. Sterling contracts with
physicians as independent contractors to provide services to hospital clients.
Professional fees from Sterling to the physicians are typically calculated on a
flat rate based on the number of hours of coverage provided. Some physicians may
receive, in addition to a flat hourly fee, other compensation based upon
departmental performance and their individual contribution to such performance.
Consistent with Sterling's treatment of the physicians as independent
contractors, under his or her contract, each physician is responsible for his or
her own self-employment tax, social security and workers' compensation insurance
payments, if any. Under Sterling's contracts with hospitals, a physician who
provides services at hospitals is required to obtain professional liability
insurance with coverage limits as specified in such contracts. Agreements
between Sterling and its independent contractor physicians typically can be
terminated by Sterling at any time under certain circumstances
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(including, in the case of the independent contractors retained to staff
hospital emergency rooms, termination of Sterling's contract with the hospital)
or by either party without cause, typically upon 90 to 120 days' prior notice.
Administrative Services Agreements. FPA has entered into administrative
services agreements with the Professional Corporations which delegate to FPA
certain administrative, management and support functions which are required by
physicians in the practice of medicine (the "Administrative Services
Agreements"). Pursuant to the Administrative Services Agreements, FPA generally
provides facilities, fixtures and equipment for the provision of all medical
services. The Administrative Services Agreements generally have either (i)
initial terms of 10 years and are renewable for an additional 10 year period at
FPA's election and thereafter renew automatically for a third 10-year term
unless either party elects to terminate or (ii) a term of 40 years.
Pursuant to the Administrative Services Agreements, the Professional
Corporations have assigned to FPA, as agent for the Professional Corporations
and as security for the payment to FPA of its management fee, substantially all
revenue received by the Professional Corporations, retain the rights to its
fee-for-service revenue and provide for its own operating costs. "Revenue" is
generally defined as all capitated sums which the Professional Corporations
receive or become entitled to receive for the performance of medical services by
physicians employed by or under contract with the Professional Corporations, all
fee-for-service revenue and substantially all shared risk pool revenue received.
Amounts that may not be assigned to FPA under applicable law (including
traditional fee-for-service Medicare payments) are not included in the revenue
assigned to FPA. As compensation for services rendered to the Professional
Corporations by FPA under the Administrative Services Agreements, FPA receives a
management fee, which consists of assigned revenues minus the costs associated
with the provision of medical care and general and administrative expenses. FPA
remits a portion of the capitation payments on behalf of the Professional
Corporations to the primary care physicians in the FPA Network based on the
number of enrollees each physician covers, regardless of the amount of medical
care provided. Pursuant to the Administrative Services Agreements, the
Professional Corporations appoint FPA as collection and disbursement agent to
collect receivables and disburse funds required to discharge obligations arising
form the Payor agreements.
AGREEMENTS WITH BILLING FIRMS
Sterling's fee-for-service hospital-based billing and collection services
are provided by two nonaffiliated billing firms. Sterling enters into a separate
written agreement with each billing firm for each hospital client to which
services are provided. Each billing firm reviews patient charts, prepares
invoices for the services provided and submits insurance claims, if any. Under
Sterling's arrangements with independent contractor physicians, collections are
paid directly to accounts from which Sterling has the right to withdraw its
management fees. Sterling receives monthly reports on billings invoiced and cash
collected. As of December 1996, the monthly rates paid by Sterling to the
billing firms and collection services were approximately $900,000, collectively.
Sterling's primary care billing and collection functions are serviced
internally.
COMPETITION
The health care industry is highly competitive and is subject to continuing
changes in how services are provided and how providers are selected and paid.
Generally, FPA and the Professional Corporations compete with any entity that
contracts with Payors for the provision of prepaid health care services. The FPA
Network also competes with other companies, including PPMs, which provide
management services to health care providers. FPA also competes with local
physician groups and hospitals for the provision of physician practice
management services to hospital emergency departments. FPA also competes with
other companies for acquisitions of PPMs, IPAs and physician practices. Certain
competitors are significantly larger and better capitalized than FPA, provide a
wider variety of services, have greater experience in providing physician
practice management services and have longer-established relationships with
buyers of such services than does the Company.
GOVERNMENTAL REGULATION
The health care industry is highly regulated, and there can be no assurance
that the regulatory environment in which FPA operates will not change
significantly in the future. Generally, regulation of health care companies is
increasing.
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Reimbursement. Various proposals affecting federal and state regulation of
the health care industry, including limitations on Medicare and Medicaid
payments, have been introduced in the past, including provisions that would
reduce funds available for the Medicare program. Any limitation on Medicare,
Medicaid or other government sponsored payments may adversely affect FPA. For
example, Sterling derived approximately 30% of its 1996 hospital-based operating
revenue from payments made by government-sponsored health care programs,
principally Medicare and Medicaid. Furthermore, funds received under these
programs are subject to audit and retroactive review. In addition, many of
Sterling's services are reimbursed pursuant to Resource Based Relative Value
Scale ("RBRVS"). FPA believes that the impact of RBRVS on Sterling's operations
and financial condition has not been significant. However, if future changes are
adopted relating to the RBRVS fee structure, the aggregate fee payments from
Medicare for certain emergency department procedures could be affected. If the
result is a reduction in such fees, especially if followed by reductions in
reimbursement by commercial third party payors, the RBRVS system could adversely
affect Sterling's operating results or financial condition. There can be no
assurance that the payments under any governmental and private third party payor
program will remain at levels comparable to present levels or will be sufficient
to cover the costs allocable to patients eligible for reimbursement pursuant to
such programs. Furthermore, changes in reimbursement regulations, policies,
practices, interpretations or statutes could adversely affect the operations of
the Company.
Corporate Practice of Medicine. Federal law and the laws of the states
where FPA and the Professional Corporations currently operate generally specify
who may practice medicine and limit the scope of relationships between medical
practitioners and other parties. Under certain states' laws, FPA is prohibited
from practicing medicine or exercising control over the provisions of medical
services. In order to comply with such laws, the FPA Network is organized so
that all physician services are offered by the physicians who are employed by or
affiliated with the Professional Corporations. In order to comply with such
laws in those states, FPA does not employ practicing physicians as
practitioners, exert control over their decisions regarding medical care or
represent to the public that it offers medical services. FPA has entered into
administrative services agreements with the Professional Corporations which
delegate to FPA the performance of certain administrative, management and
support functions. FPA believes that the services it provides to the FPA Network
do not constitute the practice of medicine under applicable laws.
Licensing Requirements. Every state imposes licensing requirements on
individual physicians and on facilities and services operated by physicians. In
addition, federal and state laws regulate HMOs and other managed care
organizations with which the physician groups may have contracts. Many states
require regulatory approval, including certificates of need, before establishing
or expanding certain types of health care facilities, offering certain services
or making expenditures in excess of statutory thresholds for health care
equipment, facilities or programs. Some states also require licensing of
third-party administrators, entities performing utilization management functions
and collection agencies. Certain of FPA's subsidiaries have obtained third-party
administrator and utilization management licenses. In connection with its
existing operations and its expansion into new markets, FPA believes it is in
compliance with all such laws and regulations and current interpretations
thereof, but there can be no assurance that such laws, regulations or
interpretations will not restrict expansion or affect operations in the future
or that additional laws and regulations will not be enacted. The ability of FPA
to operate profitably will depend in part upon FPA and its affiliated physician
groups obtaining and maintaining all necessary licenses, certificates of need
and other approvals and operating in compliance with applicable health care
regulations.
Fraud and Abuse; Self-referral. Federal law prohibits the offer, payment,
solicitation or receipt of any form of remuneration in return for, or in order
to induce: (i) the referral of a person for services; (ii) the furnishing or
arranging for the furnishing of items or services; or (iii) the purchase, lease
or order of arranging or recommending purchasing; leasing or ordering of any
item or service, in each case, reimbursable under Medicare or Medicaid. Pursuant
to this anti-kickback law, the federal government has announced a policy of
increased scrutiny of joint ventures and other transactions among health care
providers in an effort to reduce potential fraud and abuse relating to Medicare
patients. The applicability of these provisions to many kinds of business
transactions in the health care industry has not yet been subject to judicial
and regulatory interpretation. In addition, federal legislation currently
restricts the ability of physicians to refer patients to entities in which they
have an ownership interest or compensation arrangement for clinical laboratory
services. Effective January 1, 1995, the federal anti-referral legislation
extended to entities that provide certain other "designated health services."
Many states, including those in which FPA presently does business, have similar
anti-kickback and anti-referral laws.
A violation of the federal anti-kickback statute generally requires several
elements: (i) the offer, payment, solicitation or receipt of remuneration; (ii)
the intent to induce referrals; and (iii) the ability of the parties to make or
influence
9
<PAGE> 10
referrals of patients for services reimbursable under Medicare or Medicaid
programs or to provide items or services reimbursable under such programs.
Noncompliance with, or violation of, the federal anti-kickback legislation can
result in exclusion for Medicare and Medicaid programs and civil and criminal
penalties. With respect to the self-referral prohibition, the entity and the
referring physician are prohibited from receiving Medicare or Medicaid
reimbursement for services rendered. Similar penalties are provided for
violation of state and anti-kickback and anti-referral laws. The federal
government has promulgated "safe harbor" regulations that identify certain
business and payment practices which are deemed not to violate the federal
anti-kickback statute. Although FPA's business does not fall within certain of
the current or proposed safe harbors, FPA believes that its operations
materially comply with such statutes and regulations.
FPA believes that its business operations do not involve the offer,
payment, solicitation or receipt of remuneration to induce referrals of patients
because compensation arrangements with primary care physicians who make
referrals are designed to discourage referrals to the extent they are
unnecessary. These physicians are paid either on a capitation or fee-for-service
basis and do not receive any financial benefit from making referrals. FPA also
believes that its business arrangements do not involve the referral of patients
to entities with whom referring physicians have an ownership interest or
compensation arrangement within the meaning of federal and state anti-referral
laws, because most referrals are made directly to other providers rather than to
entities in which referring physicians have an ownership or compensation
arrangement. FPA further believes its compensation arrangements with physicians
fall within various exceptions to state and federal anti-referral laws,
including exceptions for ownership or compensation arrangements with certain
managed care organizations and for physician incentive plans that limit
referrals. In addition, FPA believes that the methods used to acquire existing
physician practices and to recruit new physicians do not violate anti-kickback
and anti-referral laws and regulations. Should any of FPA's business
arrangements be deemed to constitute arrangements designed to induce the
referral of Medicare or Medicaid patients or to involve referrals to entities
with whom the referring physician has an ownership interest or compensation
arrangement, then such arrangements could be viewed as possibly violating
anti-kickback or anti-referral laws and regulations. A determination of
liability under any such law could have a material adverse effect on FPA's
results of operations.
Insurance Regulation. Federal and state laws regulate insurance companies,
HMOs and other managed care organizations. Generally, these laws apply to
entities that accept financial risk. Certain of the risk arrangements entered
into by FPA could be characterized by some states as the business of insurance.
FPA, however, believes that the acceptance of capitation payments by a health
care provider does not constitute the conduct of the business of insurance. Many
states also regulate the establishment and operation of networks of health care
providers. Generally, these laws do not apply to the hiring and contracting of
physicians by other health care providers. There can be no assurance that
regulators in the states in which FPA operates would not apply these laws to
require licensure of FPA's operations as an insurer or provider network. FPA
believes that it is in compliance with these laws in the states in which it does
business, but there can be no assurance that future interpretations of these
laws by the regulatory authorities in these states or the states in which FPA
may expand will not require licensure or a restructuring of some or all of FPA's
operations. In the event that FPA is required to become licensed under these
laws, the licensure process can be lengthy and time consuming and, unless the
regulatory authority permits FPA to continue to operate while the licensure
process is progressing, FPA could experience a material adverse change in its
business while the licensure process is pending. In addition, many of the
licensing requirements mandate strict financial and other requirements which FPA
may not immediately be able to meet. Further, once licensed, FPA would be
subject to continuing oversight by and reporting to the respective regulatory
agency.
State laws in California, operations in which represented approximately 22%
of FPA's operating revenues for the year ended December 31, 1996, require
entities such as FPA to be licensed as health care service plans. The
application of a wholly-owned subsidiary of FPA for a restricted license was
approved by the California Department of Corporations in December 1996. The loss
or revocation of such license would have a material adverse effect on FPA. In
addition, there can be no assurance that regulatory authorities in the other
states in which FPA or its affiliates operate will not impose similar
requirements.
Possible Negative Effects of Prospective Health Care Reform. Various plans
have been proposed and are being considered on federal, state and local levels
to reduce costs in health care spending. Although FPA believes its management
model responds to the concerns addressed by such plans, it is not possible to
assess the likelihood any of these proposals will be enacted or to assess the
impact any of these proposals may have on reimbursement to health care
providers. Any plan to control health care costs, however, could result in lower
rates of reimbursement. Lower rates of
10
<PAGE> 11
reimbursement may reduce the amount assigned to FPA by the Professional
Corporations and accordingly, would have a material effect of FPA's business and
results of operations.
Other. In recent years, legislation has been proposed in Congress to
implement an "any willing provider" law on a national level. These laws, which
are in effect in some states, require managed care organizations, such as HMOs,
to contract with any physician who is appropriately licensed and who meets any
applicable membership criteria. Such laws could limit the flexibility of managed
care organizations to achieve efficiency by controlling the size of their
primary care provider networks and the number of specialty care providers to
whom enrollees are referred. At present, no state in which FPA Network
physicians practice has such a law although "any willing provider" laws have
been proposed in states in which FPA operates. FPA cannot predict what effect
such laws would have on its operations.
CORPORATE LIABILITY AND INSURANCE
In recent years, physicians, hospitals and other participants in the managed
health care industry have become subject to an increasing number of lawsuits
alleging medical malpractice and related claims based on the withholding of
approval for or reimbursement of necessary medical services. Many of these
lawsuits involve large claims and substantial defense costs.
The Company requires all physicians in the FPA Network to carry certain
minimum amounts of malpractice insurance coverage. The Professional Corporations
and certain subsidiaries maintain their own malpractice insurance. The Company
also maintains an errors and omissions insurance policy which covers utilization
review activities. Sterling currently maintains professional liability insurance
underwritten by an insurance company unaffiliated with Sterling for itself, its
hospital clients and its contracted physicians, in amounts it deems to be
appropriate, based upon historical claims and the nature and risks of its
business. The professional liability insurance coverage is on a claims-made
basis (the coverage includes claims reported during the period that the insured
was covered by the policy) and includes certain self-insurance retention. Such
insurance provides coverage, subject to policy limits, in the event that
Sterling is held liable as a co-defendant in a lawsuit against an independent
contractor physician or hospital client. In addition to any potential tort
liability of Sterling, Sterling's contracts with hospitals generally contain
provisions under which Sterling agrees to indemnify the hospital for losses
resulting from the negligence of the hospital or hospital personnel. Any claim
or claims in excess of insurance policy limits could have a material adverse
effect on FPA.
EMPLOYEES
At March 21, 1997, the Company had approximately 4,000 full time employees.
Management believes that its employee relations are good. None of the FPA
Network's employees are subject to a collective bargaining agreement, however,
certain physicians in Thomas-Davis Medical Centers, P.C., a professional
corporation affiliated with FPA, and employees in Tucson, Arizona voted in late
1996 and early 1997, respectively, to form a collective bargaining unit. Appeals
with respect to the vote are currently pending before the National Relations
Board.
11
<PAGE> 12
ITEM 2. PROPERTIES
FPA leases administrative office space in each of its regions, as follows:
<TABLE>
<CAPTION>
REGION SQUARE FEET TERMINATION DATE
------ ----------- ----------------
<S> <C> <C>
San Diego, CA................................................ 20,150 September 2001
Coral Gables, FL............................................. 38,000 April 2000
San Diego, CA................................................ 25,000 May 1999
Sacramento, CA............................................... 5,000 June 2001
Los Angeles, CA.............................................. 16,000 December 2000
Newtown Square, PA........................................... 13,000 October 2000
Phoenix, AZ.................................................. 10,000 January 2001
San Antonio, TX.............................................. 36,000 October 2005
-------
Total................................................... 163,150
=======
</TABLE>
FPA also leases certain other administrative offices and various medical
office spaces for the health centers that FPA, its subsidiaries and the
Professional Corporations operate. As FPA, its subsidiaries and the Professional
Corporations acquire additional physician practices, management expects that
FPA, its subsidiaries and the Professional Corporations will enter into
additional medical office space leases.
ITEM 3. LEGAL PROCEEDINGS
FPA is party to certain legal actions arising in the ordinary course of
business. In the opinion of FPA's management, liability, if any, under these
claims is adequately covered by insurance or will not have a material effect on
FPA's financial position or results of operations.
AHI is a defendant in a purported class action securities lawsuit entitled
In re AHI Healthcare Systems, Inc. Securities Litigation filed in the United
States District Court for the Central District of California, Western Division.
The suit was initially filed against AHI, certain of its officers and directors,
and its underwriters on December 20, 1995. The suit asserts that AHI
artificially inflated the price of its stock by, among other things, misleading
securities analysts and by failing to disclose in its initial public offering
prospectus alleged difficulties with the acquisition of Lakewood Health Plan,
Inc. and with two of AHI's payor contracts with FHP, Inc. The plaintiffs seek
unspecified damages on behalf of the stockholders who purchased AHI's common
stock between September 28, 1995 and December 19, 1995. On January 17, 1997 the
district court (a) granted AHI's motion for partial summary judgment and
dismissed the class plaintiffs' claims concerning the alleged misrepresentations
regarding AHI's intended use of initial public offering proceeds and AHI's
relationship with FHP, Inc. but (b) denied summary judgment on the claims
relating to the proposed acquisition of Lakewood Health Plan, Inc. As a result,
only those claims relating to Lakewood Health Plan and AHI's alleged liability
for the public statements of securities analysts following AHI remain in the
suit. Since the court's ruling on AHI's motion for partial summary judgment, the
plaintiffs have asked the court for leave to amend their complaint to add an
additional claim alleging problems with AHI's medical group operations in
Downey, California. Additionally, on November 12, 1996, FPA, AHI and AHI's
directors were named as defendants in a class action lawsuit filed in Delaware
Chancery Court by Joshua Chopp, a stockholder of AHI. The suit asserts, among
other things, that the "intrinsic value" of AHI's stock is higher than that
which AHI's stockholders will receive in the merger, and that the directors of
AHI breached their fiduciary duties by approving the merger without undertaking
steps to accurately ascertain AHI's market value. The stockholder further
alleges that FPA knowingly aided and abetted a breach of fiduciary duty by the
individual defendants. The stockholder is seeking equitable relief. FPA intends
to vigorously defend both of these lawsuits and does not expect that the outcome
of these lawsuits will have a material adverse effect on its financial condition
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At a special meeting of FPA stockholders held on October 31, 1996, two
matters were voted upon by the FPA stockholders. The FPA stockholders adopted an
agreement and plan of merger pursuant to which Sterling Healthcare Group, Inc.
became a wholly-owned subsidiary of FPA. The vote to adopt such agreement and
plan of merger was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 7,480,410
AGAINST 20,167
WITHHELD 32,784
ABSTENTIONS 26,753
BROKER NON-VOTES --
</TABLE>
The second matter voted upon was the approval of amendments to the FPA Omnibus
Stock Option Plan to increase the total number of shares of FPA Common Stock
issuable upon exercise of options granted under such plan by 2,500,000 to
5,000,000 and limit the number of shares of FPA Common Stock for which options
may be granted under such plan to any person during calendar year to 750,000.
The vote to approve such amendments was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 5,377,171
AGAINST 2,153,321
WITHHELD --
ABSTENTIONS 29,622
BROKER NON-VOTES --
</TABLE>
12
<PAGE> 13
At a special meeting of FPA stockholders held on March 17, 1997, two
matters were voted upon by the FPA stockholders. The FPA stockholders adopted an
agreement and plan of merger pursuant to which AHI Healthcare Systems, Inc.
became a wholly-owned subsidiary of FPA. The vote to adopt such agreement and
plan of merger was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 15,530,374
AGAINST 38,512
WITHHELD -
ABSTENTIONS 19,024
BROKER NON-VOTES -
</TABLE>
The second matter voted upon was the approval of amendments to the Omnibus Stock
Option Plan to increase the total number of shares of FPA Common Stock issuable
upon exercise of options granted under such plan by 1,500,000 to 6,500,000. The
vote to approve such amendment was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 13,361,987
AGAINST 2,171,741
WITHHELD -
ABSTENTIONS 54,182
BROKER NON-VOTES -
</TABLE>
Executive Officers of the Registrant
Set forth below is information about the executive officers of FPA. The
offices referred to below are offices of FPA unless otherwise indicated.
All executive officers are elected to serve at the pleasure of the Board of
Directors.
Dr. Sol Lizerbram (49), Chairman of the Board since 1986 and President from
1986 until October 31, 1996.
Dr. Seth Flam (38), Chief Executive Officer since 1986 and President since
November 1, 1996.
Dr. Stephen Dresnick (47), Vice Chairman of the Board since 1996 and
President, Sterling Healthcare Group, Inc. since 1987.
Dr. Howard Hassman (40), Executive Vice President -- Corporate Development
since September 1994; Chief Financial Officer from 1986 to September 1994.
Dr. Kevin Ellis (40), Chief Medical Officer since April 1995. Chief
Operating Officer from 1988 until April 1995.
Steven M. Lash (43), Executive Vice President and Chief Financial Officer
since September 1994. Executive Vice President for Institutional Care at Sharp
Health care, a health care system providing medical services throughout San
Diego, California, from April 1993 to September 1994; Senior Vice President of
Business Affairs and Chief Financial Officer of San Diego Hospital Association,
doing business as Sharp Healthcare, from 1981 to April 1993.
James A. Lebovitz (39), Senior Vice President, General Counsel and
Secretary since March 1996. Partner, Ballard Spahr Andrews & Ingersoll, a law
firm, from 1991 until March 1996.
Cheryl A. Moore (31), Vice President-Finance since July 1996; Controller
since January 1994; Vice President and Chief Accounting Officer since August
1994. Audit manager, Deloitte & Touche, from 1993 to January 1994; auditor,
Deloitte & Touche, from 1988 to 1993.
13
<PAGE> 14
PART II
ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
FPA's Common Stock is traded on The Nasdaq Stock Market under the symbol
FPAM. The table below shows the high and low bid prices for FPA's Common Stock
for each quarter during 1995 and 1996.
<TABLE>
<CAPTION>
1995 HIGH LOW
---- ---- ---
<S> <C> <C>
1st Quarter............................. $11.250 $6.000
2nd Quarter............................. 12.500 7.875
3rd Quarter............................. 12.125 8.875
4th Quarter............................. 9.750 5.875
<CAPTION>
1996 HIGH LOW
---- ---- ---
<S> <C> <C>
1st Quarter............................. $13.250 $8.625
2nd Quarter............................. 20.125 12.125
3rd Quarter............................. 27.125 12.500
4th Quarter............................. 29.500 16.375
</TABLE>
At March 21, 1997, there were approximately 251 holders of record of
Common Stock. FPA declared no cash dividends during 1995 or 1996 and has no
plans to declare cash dividends in the foreseeable future.
14
<PAGE> 15
ITEM 6. SELECTED FINANCIAL DATA.
The following statement of operations data and balance sheet data have been
derived from the audited consolidated financial statements of the Company.
Selected financial data below should be read in conjunction with the
consolidated financial statements and notes thereto, included elsewhere in this
document.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
CONSOLIDATED STATEMENTS OF OPERATIONS: 1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Operating revenue $ 8,275 $ 13,988 $ 57,691 $ 168,352 $ 440,319
Medical services expense 6,423 10,348 41,352 113,743 313,707
----------- ----------- ------------ ------------ -----------
1,852 3,640 16,339 54,609 126,612
General and administrative expenses 1,893 3,471 13,607 44,893 99,230
Merger, restructuring and other
unusual charges 1,590 37,971
----------- ----------- ------------ ------------ -----------
Income (loss) from operations (41) 169 2,732 8,126 (10,589)
Other income (expense), net 10 9 -- (1,569) (5,127)
----------- ----------- ------------ ------------ -----------
Income (loss) before income taxes (31) 178 2,732 6,557 (15,716)
Income tax (expense) benefit -- -- (942) (2,723) --
----------- ----------- ------------ ------------ -----------
Net income (loss) $ (31) $ 178 $ 1,790 $ 3,834 $ (15,716)
=========== =========== ============ ============ ===========
PRO FORMA PER SHARE DATA:
Net income per share $ 0.27 $ 0.26 $ 0.28 $ (0.72)
Weighted average shares outstanding 3,163,000 6,579,828 13,693,192 21,702,786
CONSOLIDATED BALANCE SHEET DATA:
Cash and marketable securities $ 423 $ 610 $ 12,217 $ 11,401 $ 45,595
Working capital surplus (deficit) (634) (600) 22,164 25,974 (12,078)
Total assets 1,027 1,633 45,052 152,407 539,197
Long-term liabilities -- 21 9,650 23,839 193,318
Stockholders' equity (deficit) (546) (358) 24,326 93,227 143,518
</TABLE>
15
<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
FPA Medical Management, Inc., its subsidiaries and the Professional
Corporations derive substantially all of their operating revenue from (i) the
payments made by Payors to the Professional Corporations for managed care
medical services and (ii) fee-for-service revenues for medical centers in the
managed care business and (iii) fee-for-service revenues from emergency
department medical services.
MANAGED CARE BUSINESS
The Company has two types of Payor contracts: contracts for both inpatient
and outpatient services ("global capitation" contracts) and those limited to
outpatient services or professional medical services ("outpatient capitation"
contracts). Under global capitation contracts, the Company receives a fixed
monthly amount per enrollee for which the Company is financially responsible to
provide the enrollees with all necessary inpatient and outpatient care. Under
outpatient capitation contracts, the Company receives a fixed monthly amount per
enrollee for which the Company is financially responsible to provide the
enrollees with all necessary outpatient care. Additionally, under these
outpatient capitation contracts, the Company is a party to shared risk
arrangements with Payors which generally reward the Company for the efficient
utilization of hospital inpatient services. Under these shared risk
arrangements, the Company shares any surplus or, in some cases, deficit, of
amounts pre-established by the Payor in relation to inpatient expense. Revenue
under global capitation contracts represented 0%, 20.9% and 36.3% for 1994, 1995
and 1996, respectively, of managed care business operating revenue. Revenue
under outpatient capitation contracts represented 98.5%, 72.4% and 51.7% for
1994, 1995 and 1996, respectively, of managed care business operating revenue.
The Company also generates fee-for-service revenue for the performance of
medical services through the Professional Corporations and its subsidiaries.
These revenues are presented net of contractual deductions and represented 1.5%,
6.7% and 12.0% for 1994, 1995 and 1996, respectively, of managed care business
operating revenue.
Through the Professional Corporations and its subsidiaries, the Company
contracts with various healthcare providers to provide primary care and
specialty medical services to covered enrollees. Primary care physicians are
compensated
16
<PAGE> 17
on either a salary or capitation basis. Specialty care physician services
are paid for on either a discounted fee-for-service or capitation basis. Managed
care business medical services expense paid for on a capitation basis (for
certain primary care and specialty care services) or fixed salary basis (for
primary care only) totaled 42.5%, 31.9% and 25.8% for 1994, 1995 and 1996
respectively, of managed care business operating revenues, with the remainder of
medical services expense (for primary care, specialty care, ancillary services,
inpatient and outpatient services, lab charges, etc.) paid for on a discounted
fee-for-service or per diem basis.
EMERGENCY DEPARTMENT BUSINESS
Through the emergency department business, the Company provides contract
management and support services primarily to emergency departments. As of
December 31, 1996 the Company provided physician practice management services on
a contract basis to 104 emergency departments, one anesthesia department, three
correctional health care facilities and one rural health urgent care clinic
located in 20 states. The Company contracts with approximately 1,000 affiliated
physicians who provide certain medical services to approximately 1.4 million
patients annually.
The Company's contractual arrangements with hospitals are primarily
fee-for-service contracts whereby hospitals generally agree, in exchange for the
Company's services, to authorize the Company and its contracted health care
professionals to bill and collect the professional component of the charges for
medical services rendered by the Company's contracted health care professionals.
Fee-for-service contracts may, depending on the hospital's patient volume and
payor mix, involve the payment of a subsidy to the Company by the hospital. In
1994, 1995 and 1996, respectively, 94.0%, 84.4% and 84.6% of the Company's
emergency department operating revenue was earned on a fee-for-service basis,
and the Company emphasized fee-for-service contracts in its marketing
activities.
Medical services expense for the emergency department business consists
primarily of payments made to independent contractor and employee physicians
("Physician Costs") and, to a lesser extent the costs of medical supplies and
malpractice insurance and
17
<PAGE> 18
laboratory fees. In 1994, 1995 and 1996, Physician Costs accounted for 95.1%,
91.8% and 92.1%, respectively, of emergency department medical services expense.
OPERATIONAL DEVELOPMENT
The future growth of FPA is largely dependent on a continued increase in
the number of new enrollees in the FPA network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
serving enrollees of Payors in the FPA network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations have
contracts and whose members are patients of physicians in the FPA network or
(iii) agreements with Payors, physicians and hospitals in other geographic
markets. The process of identifying and consummating suitable acquisitions of,
or affiliations with, physician groups can be lengthy and complex. The
marketplace for such acquisitions and affiliations is subject to increasing
competitive pressures. There can be no assurance that FPA will be successful in
identifying, acquiring or affiliating with additional physician groups or
hospitals or that the Professional Corporations will be able to contract with
new Payors. In addition, there can be no assurance that the Company's
acquisitions will be successfully integrated on a timely basis or that the
anticipated benefits of these acquisitions will be realized; failure to
effectively accomplish the integration of acquired companies could have a
material adverse effect on FPA's results of operations and financial condition.
FPA's ability to expand is also dependent upon its ability to comply with legal
and regulatory requirements in the jurisdictions in which it operates or will
operate and to obtain necessary regulatory approvals, certificates and licenses.
In March 1997, the Company completed its merger with AHI Healthcare
Systems, Inc. In January 1996, the Company acquired three independent practice
associations in the Los Angeles, Ventura and Sacramento regions of California,
which now service approximately 76,000 enrollees and include 570 primary care
physicians. In June 1996, FPA acquired Physicians First, Inc., operating 40
medical clinics in Florida, through which 110 primary care physicians provided
services to approximately 80,000 enrollees. In July 1996, the Company acquired
two independent practice associations, one in Arizona and Florida, providing
services to approximately 14,000 and 4,000 enrollees, respectively. In October
1996, FPA and Sterling completed a merger. Effective in December 1996, the
Company and certain Professional Corporations acquired two medical groups, one
each in California and Arizona, providing services to approximately 63,000 and
157,000 enrollees, respectively.
Listed below is a breakdown of enrollees, Payors, primary care physicians,
specialty care physicians, and emergency department business contracts
(including anesthesiology, urgent care and correctional facility business
contracts) by region at December 31, 1996.
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF NUMBER OF NUMBER OF EMERGENCY
PAYOR PRIMARY CARE SPECIALTY CARE DEPARTMENT
ENROLLEES CONTRACTS PHYSICIANS PHYSICIANS CONTRACTS
--------- --------- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C>
California 207,967 21 681 3,191 --
Arizona 186,102 4 459 771 --
New Jersey 29,029 4 926 447 --
Delaware 7,782 1 74 74 --
South Carolina 12,473 3 176 51 2
North Carolina 11,074 1 52 -- 11
Texas 46,199 6 64 427 16
Florida 95,520 3 228 777 9
Michigan 27,334 2 406 1,028 10
Louisiana -- -- -- -- 10
Mississippi -- -- -- -- 8
Tennessee -- -- -- -- 7
Alabama -- -- -- -- 6
Others -- -- -- -- 30
------- --- ----- ----- ---
Total 623,480 45 3,066 6,766 109
======= === ===== ===== ===
</TABLE>
RESULTS OF OPERATIONS
18
<PAGE> 19
The following table sets forth for 1994, 1995 and 1996 selected financial
data and selected financial data expressed as a percentage of operating revenue.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995
---- ----
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Operating revenue $ 18,435,877 $39,255,573 $57,691,450 $ 52,691,955 $115,659,527 $168,351,482
Medical services
expense 13,628,430 27,723,675 41,352,105 37,757,244 75,985,634 113,742,878
General and
administrative
expenses 4,423,842 9,183,231 13,607,073 13,310,386 33,172,287 46,482,673
------------ ----------- ----------- ------------ ------------ ------------
Income (loss)
from operations 383,605 2,348,667 2,732,272 1,624,325 6,501,606 8,125,931
Other (income)
expense (79,892) 80,301 409 (189,725) 1,758,371 1,568,646
------------ ----------- ----------- ------------ ------------ ------------
Income (loss)
before tax 463,497 2,268,366 2,731,863 1,814,050 4,743,235 6,557,285
Income tax expense 75,184 866,841 942,025 811,588 1,911,732 2,723,320
------------ ----------- ----------- ------------ ------------ ------------
Net income (loss) $ 388,313 $ 1,401,525 $ 1,789,838 $ 1,002,462 $ 2,831,503 $ 3,833,965
============ =========== =========== ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996
----
MANAGED EMERGENCY
CARE DEPARTMENT
BUSINESS BUSINESS TOTAL
-------- -------- -----
<S> <C> <C> <C>
Operating revenue $ 303,557,843 $ 136,760,770 $ 440,318,613
Medical services
expense 219,456,632 94,249,976 313,706,608
General and
administrative
expenses (1) 88,536,451 48,664,736 137,201,187
------------- ------------- -------------
Income (loss)
from operations (4,435,240) (6,153,942) (10,589,182)
Other (income)
expense 4,273,613 853,631 5,127,244
------------- ------------- -------------
Income (loss)
before tax (8,708,853) (7,007,573) (15,716,426)
Income tax expense -- -- --
------------- ------------- -------------
Net income (loss) $ (8,708,853) $ (7,007,573) $ (15,716,426)
============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995
---- ----
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Operating revenue 100% 100% 100.0% 100.0% 100.0% 100.0%
Medical services
expense 73.9% 70.6% 71.7% 71.7% 65.7% 67.6%
General and
administrative
expenses 24.0% 23.4% 23.6% 25.3% 28.7% 27.5%
----- ---- ----- ----- ----- -----
Income (loss) from
operations 2.1% 6.0% 4.7% 3.0% 5.6% 4.8%
Other (Income)
expense (0.4)% 0.2% 0.0% (0.4)% 1.5% 0.9%
----- ---- ----- ----- ----- -----
Income (loss)
before tax 2.5% 5.8% 4.7% 3.4% 4.1% 3.9%
Income tax expense 0.4% 2.2% 1.6% 1.5% 1.7% 1.6%
----- ---- ----- ----- ----- -----
Net income (loss) 2.1% 3.6% 3.1% 1.9% 2.4% 2.3%
===== ==== ===== ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996
----
MANAGED EMERGENCY
CARE DEPARTMENT
BUSINESS BUSINESS TOTAL
-------- -------- -----
<S> <C> <C> <C>
Operating revenue 100.0% 100.0% 100.0%
Medical services
expense 72.3% 68.9% 71.3%
General and
administrative
expenses (1) 29.2% 35.5% 31.2%
----- ----- -----
Income (loss)
from operations (1.5)% (4.5)% (2.4)%
Other (Income)
expense 1.4% 0.6% 1.2%
----- ----- -----
Income (loss)
before tax (2.9)% (5.1)% (3.6)%
Income tax expense 0.0% 0.0% 0.0%
----- ----- -----
Net income (Loss) (2.9)% (5.1)% (3.6)%
===== ===== =====
</TABLE>
(1) Includes nonrecurring charges of $38.0 million in 1996. Excluding
these nonrecurring charges, general and administrative expense was
22.6% of operating revenue and income from operations was 6.2% of
operating revenue in 1996.
MANAGED CARE BUSINESS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
Operating Revenue -- The Company's managed care business operating revenue
increased to $303.6 million in 1996 from $52.7 million in 1995 and $18.4 million
in 1994. The revenue increase resulted primarily from the increase in average
enrollment to 327,000 in 1996, from 63,000 in 1995 and 30,000 in 1994. As
compared to 1995, the 1996 increase resulted from the addition of (i)
approximately 161,000 enrollees in California primarily as a result of
acquisitions, (ii) approximately 174,000 enrollees in Arizona primarily as a
result of a December 1996 acquisition, (iii) enrollment of 42,000, 14,000, and
15,000 enrollees, respectively, in the Mid Atlantic region, Texas and Florida as
a result of internal growth, (iv) approximately 27,000 enrollees in Michigan and
(v) approximately 80,000 enrollees in Florida, as a result of a June 1996
acquisition. In 1996, the Company generated net fee-for-
19
<PAGE> 20
service revenue of $35.9 million compared to 1995 net fee-for-service revenue of
$2.8 million and no fee-for-service revenue in 1994. The growth in
fee-for-service revenue is attributable to the increasing number of medical
facilities managed by FPA.
Medical Services Expense -- Medical services expense for 1996 was $219.5
million or 72.3% of managed care business operating revenue as compared to $37.8
million or 71.7% of such operating revenue in 1995 and $13.6 million or 73.9% of
such operating revenue in 1994. The increase in medical services expense as a
percent of such operating revenue from 1995 to 1996 resulted primarily from
significantly increased membership in the Mid-Atlantic and Florida regions under
global capitation contracts which initially experience a higher medical loss
ratio than outpatient only capitation contracts. The decrease in medical
services expense as a percentage of such operating revenue from 1994 to 1995
resulted from a higher revenue base per member per month as a result of
increased shared risk earnings and increased capitation of specialists which
limited costs for the specialty services provided.
General and Administrative Expense -- General and administrative expense
including nonrecurring charges for 1996 was $88.5 million or 29.2% of managed
care business operating revenue as compared to $13.3 million or 25.3% of such
operating revenue in 1995 and $4.4 million or 24.0% of such operating revenue in
1994. Excluding the effect of nonrecurring charges recognized in 1996, general
and administrative expense would have decreased to 22.6% of such operating
revenue as the Company achieved economies of scale in its operations. In 1995,
the Company hired additional staffing and other personnel in new regions prior
to the addition of a significant number of enrollees. The Company has also made
significant investments in information systems, and has deployed this technology
to the majority of its regions.
Merger, Restructuring and Other Unusual Charges -- During 1996, the managed
care business of the Company incurred approximately $20.3 million in
nonrecurring charges. Approximately $6.6 million resulted from write-offs of
goodwill and other assets related to unprofitable operations in Arizona and
California. Approximately $11.7 million related to costs of legal fees,
accounting fees, investment bankers' fees and other costs associated with the
Sterling merger. As the Sterling merger was accounted for as pooling of
interests, generally accepted accounting principles require that transaction
costs be expensed as incurred. Approximately $2.0 million arose from the costs
of severance payments,
20
<PAGE> 21
lease terminations and other costs associated with consolidating medical centers
and adjusting staffing in Florida, Arizona and as a result of the Sterling
merger.
Income (Loss) from Operations -- In 1996, the managed care business of the
Company generated a loss from operations of $4.4 million including the
nonrecurring charges. Excluding such nonrecurring charges, 1996 income from
operations was $15.9 million as compared to income from operations of $1.6
million in 1995, and $.4 million in 1994.
EMERGENCY DEPARTMENT BUSINESS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
The 1994 consolidated financial statements include the activities of the
emergency department business from June 1, 1994 (date of inception) to December
31, 1994.
Operating Revenue -- Emergency department business operating revenue
consists of gross patient revenue, net of contractual deductions and estimated
uncollectible accounts, plus other revenue, which consists principally of
hospital subsidy payments, flat-rate hospital contract revenue and non-patient
generated revenues. Operating revenue increased to $136.8 million in 1996 from
$115.7 million in 1995 and $39.3 million in 1994. On a percentage basis, the
emergency department business' operating revenue grew 195% in 1995 and 18.2% in
1996. The increases were primarily attributable to the increases in the number
of the Company's emergency department contracts from 61 in 1994 and 89 in 1995
to 104 in 1996.
Medical Services Expense -- Medical services expense increased to $94.2
million for 1996 from $76.0 million in 1995 and $27.7 million in 1994 due
primarily to the increase in the number of healthcare professionals under
contract, resulting from the increase in the number of the Company's emergency
department contracts, as well as negotiated increases in fees paid to certain
healthcare professionals. Medical services expense as a percentage of operating
revenue was 68.9% in 1996, 65.7% in 1995 and 70.6% in 1994.
General and Administrative Expense -- General and administrative expense
including nonrecurring charges was $48.7 million in 1996, $33.2 million in 1995
and $9.2 million in 1994. Excluding the effect of nonrecurring charges in 1996,
general and administrative expense would have been $31.0 million. During 1995,
the emergency department business increased the number of its regional offices
as well as the number of administrative employees to accommodate the increase in
emergency department contracts. In
21
<PAGE> 22
1996, the Company, through cost cutting measures, including the closing of one
of its regional offices as well as the down-sizing of another, reduced this
expense. As a percentage of revenue, general and administrative expense was
35.5% in 1996 including non-recurring charges or 22.6% excluding non-recurring
charges, 28.7% in 1995 and 23.4% in 1994.
Merger, Restructuring and Other Unusual Charges -- During 1996, the Company
incurred approximately $17.7 million in non-recurring adjustments and
restructuring charges. Approximately $12.3 million resulted from write-offs of
goodwill and other assets related to terminated emergency department contracts.
Approximately $5.1 million related to costs of legal fees, accounting fees,
investment bankers' fees and other costs associated with the Sterling merger. As
the Sterling merger was accounted for as pooling of interests, generally
accepted accounting principles require that transaction costs be expensed as
incurred. Approximately $.3 million related to restructuring charges arose from
the costs of severance payments, lease terminations and other costs associated
with the Sterling merger.
Net Income (loss) from Operations -- In 1996, the emergency department
business of the Company generated a loss from operations of $6.2 million,
including nonrecurring charges. Excluding such charges, income from operations
would have been $11.5 million as compared to $6.5 million in 1995 and $2.3
million in 1994.
QUARTERLY RESULTS
The following table presents financial information for the eight quarters
ended December 31, 1996. In the opinion of management, this information has been
prepared on the same basis as the audited consolidated financial statements
appearing elsewhere in this document and all necessary adjustments, consisting
only of normal recurring adjustments, have been included in the amounts
presented below to present fairly the quarterly results when read in conjunction
with the audited consolidated financial statements of the Company and notes
thereto. The Company's quarterly results have in the past been subject to
fluctuation and as a result, the operating results for any quarter are not
necessarily indicative of results for any future period. All numbers in the
following table are in thousands.
22
<PAGE> 23
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995 1996 1996 1996 1996
--------- -------- ------------- ------------ --------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenue $ 29,533 $37,489 $44,569 $56,760 $73,162 $92,075 $124,034 $ 151,048
-------- ------- ------- ------- ------- ------- -------- ---------
Medical services
expense 19,804 25,255 30,035 38,648 51,550 66,120 92,126 103,911
-------- ------- ------- ------- ------- ------- -------- ---------
9,729 12,234 14,534 18,112 21,612 25,955 31,908 47,137
General and
administrative
expenses 8,467 9,883 11,559 14,984 17,108 20,286 24,592 37,244
Merger, restructuring
and other unusual
charges -- -- -- 1,590 -- -- 1,746 36,225
-------- ------- ------- ------- ------- ------- -------- ---------
Income (loss) from
operations 1,262 2,351 2,975 1,538 4,504 5,669 5,570 (26,332)
Other expense 208 410 644 307 507 838 993 2,789
-------- ------- ------- ------- ------- ------- -------- ---------
Income (loss) before
taxes 1,054 1,941 2,331 1,231 3,997 4,831 4,577 (29,121)
Income tax (benefit)
expense 434 765 970 554 1,657 2,007 1,948 (5,612)
-------- ------- ------- ------- ------- ------- -------- ---------
Net income (loss) $ 620 $ 1,176 $ 1,361 $ 677 $ 2,340 $ 2,824 $ 2,629 $ (23,509)
======== ======= ======= ======= ======= ======= ======== =========
</TABLE>
Operating and medical services expense during the first and third quarters
have been and continue to be affected by movements of members in Payor plans
from one plan to another during periods of open enrollment for Payors.
Retroactive capitation rate increases generally take effect during the second
quarter, while medical services expense increases tend to occur ratably
throughout the year. Quarterly results may be affected by final settlements of
shared risk distributions which generally occur in the second and third quarter
accrued in the previous year. From time to time, final settlements may differ
from such estimated amounts. As the Company adds new Payors into the FPA
network, the timing of these adjustments may vary and, consequently, quarterly
results may be affected in the future, especially due to the start-up of
operations in new regions where there is no operating history. Similarly, if
medical services expense varies from amounts previously accrued for claims
incurred but not reported ("IBNR"), quarterly operating results may fluctuate. A
portion of the Company's expansion strategy includes the acquisition of
individual and group physician practices by the FPA network, and any such
acquisition may materially affect quarterly operating results, causing quarterly
fluctuations.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to develop physician networks,
acquire physician practices and establish an infrastructure in new regions.
Capitation arrangements positively impact cash flow because FPA generally
receives capitation revenue prior to paying costs associated with services
provided under those agreements. However, shared risk arrangements negatively
impact cash flow because settlements in connection with
23
<PAGE> 24
these arrangements are typically not collected until significantly after the end
of the period in which they were accrued. Fee-for-service revenues also
negatively impact cash flow because payment for services rendered generally lags
by 90 to 120 days.
At December 31, 1996, the Company had cash, cash equivalents and marketable
securities of $45.6 million and a working capital deficit (current liabilities
in excess of current assets) of $12.1 million compared to cash, cash equivalents
and marketable securities of $11.4 million and working capital of $26.0 million
at December 31, 1995. The increase in cash, cash equivalents and marketable
securities of $34.2 million resulted primarily from (i) $55.0 million borrowed
under arrangements with financial institutions, (ii) net proceeds of $73.0
million from the Company's issuance of convertible subordinated notes, and (iii)
$10.6 million received from the exercise of stock options and warrants,
partially offset by (a) approximately $10.5 million of cash payments in
connection with acquisitions, (b) approximately $9.1 million for the acquisition
of property and equipment, (c) approximately $13.3 million used to purchase
intangible assets, (d) approximately $3.0 million invested in Great Lakes
Health Plan, Inc., (e) approximately $50.8 million in payments on notes payable
related to acquisitions, and (f) approximately $10.0 in net payments under a
bank line of credit. At December 31, 1996 approximately 30% of the Company's
current liabilities consist of amounts accrued as payable to specialty care
physicians, ancillary providers, hospital and other providers of medical
services. These accrued liabilities include claims received by the Company which
have not yet been paid as well as an estimate of costs for covered medical
benefits incurred by enrollees but not yet reported by providers. These amounts
are not due and payable until after the provider has presented a claim and are
typically paid within 45 business days of receipt of such claims. The increase
in claims payable, including incurred but not reported claims, from
approximately $10.3 million at December 1995 to $65.6 million at December 31,
1996 resulted primarily from significantly increased membership and the fact
that much of the new membership is under global capitation contracts (which
includes hospital services), which resulted in more claims payable per enrollee.
During 1996, the Company entered into a $55.0 million credit, security,
guarantee and pledge agreement (the "Credit Agreement") with four financial
institutions. Permitted Borrowings, as defined in the Credit Agreement,
generally include acquisitions and capital expenditures. Borrowings under this
agreement bear interest
24
<PAGE> 25
at either LIBOR plus 2-1/2%, 2-3/4% or 3%, or prime rate plus 1%, 1-1/4% or
1-1/2%, as defined in the agreement. At December 31, 1996, the Company had
borrowed the maximum of $55.0 million under the Credit Agreement.
In December 1996, the Company issued $75.0 million of convertible
subordinated debentures, which resulted in net proceeds to the Company of
approximately $73.0 million. The notes bear interest at 6-1/2%, payable
semiannually, and are convertible into shares of the Company's stock at $25.95
per share. The debentures are redeemable by the Company after December 20, 1999.
Upon the occurrence of a Repurchase Event, as defined in the debentures, each
holder has the right to require repayment of the debentures at 100% of the
principal amount plus accrued interest.
The increase in long-term debt from $26.1 million at December 31, 1995 to
$254.8 million at December 31, 1996 resulted primarily from approximately $55.0
million in borrowings under arrangements with financial institutions and the
issuance of notes payable and assumption of long-term debt in connection with
acquisitions of physician practice assets of approximately $273.6 million net of
repayments of acquisition debt of approximately $60.7 million. At December 31,
1996, long-term debt exceeded stockholders' equity.
The Company believes that its cash on hand and anticipated cash flows from
its operations will be sufficient to meet the Company's operating capital needs
through 1997. The Company intends to obtain additional financing to support
planned expansion through an expansion of a line of credit facility to
approximately $100.0 million or through other potential financing alternatives
including private and public offerings of debt and equity-related securities.
There can be no assurance that the Company will be able to obtain such increased
credit facility or that it will be able to issue debt or equity-related
securities on terms satisfactory to it. To the extent that additional financing
is not available, the Company may delay certain potential acquisitions or
certain geographic expansion or may seek alternate sources of financing.
The strategy to expand the FPA network involves the acquisition of
individual and group physician practice assets and related businesses. Such
acquisitions may be consummated using cash, stock, notes or any combination
thereof. Management does not believe that inflation will have a material effect
on the operations of the Company.
25
<PAGE> 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 3,172,225 $ 5,594,877
Marketable securities 8,228,788 40,000,000
Accounts receivable -- net of allowance for uncollectible accounts of
$47,006,677 and $59,796,488 at December 31, 1995 and December 31, 1996,
respectively 40,229,995 95,306,672
Accounts receivable - other 4,636,973 25,095,247
Notes receivable from affiliate 300,086 --
Income tax receivable 1,227,949 --
Prepaid expenses 656,003 5,397,174
Capitation deposit -- 15,409,771
Deferred income tax asset 2,861,898 3,478,751
------------- -------------
Total current assets 61,313,917 190,282,492
Property and equipment - net 9,591,799 40,139,332
Restricted cash and deposits 3,285,000 488,535
Goodwill -- net of accumulated amortization of $1,724,606 and $5,046,296 at
December 31, 1995 and December 31, 1996, respectively 69,498,404 284,288,009
Intangible assets -- net of accumulated amortization of $249,682 and
$3,123,381 at December 31, 1995 and December 31, 1996, respectively 5,988,579 6,667,269
Investment in GLHP 1,994,900 4,994,900
Deferred income tax asset -- 3,189,665
Other assets 733,937 9,146,431
------------- -------------
Total $ 152,406,536 $ 539,196,633
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 14,851,559 $ 46,215,398
Claims payable, including incurred but not reported claims 10,247,476 65,618,268
Accrued payroll and related liabilities 1,363,304 3,814,695
Income tax payable 436,775 2,294,159
Other liabilities -- 13,104,704
Borrowings on line of credit 788,325 --
Current portion of accrued liability for professional liability claims 610,000 1,297,790
Long-term debt, current portion 7,042,635 70,015,734
------------- -------------
Total current liabilities 35,340,074 202,360,748
Long-term debt, net of current portion 9,012,552 184,774,984
Bank line of credit 10,000,000 --
Accrued liability for professional liability claims, net of current portion 2,440,000 4,217,000
Deferred income tax liability 1,989,770 --
Other long-term liabilities 397,175 4,325,862
------------- -------------
Total Liabilities 59,179,571 395,678,594
Stockholders' equity:
Preferred stock, $.001 par value per share, 2,000,000 shares authorized,
no shares outstanding -- --
Common stock, $.002 par value, 98,000,000 shares authorized, 18,566,326 and
24,771,149 shares issued and outstanding at December 31, 1995 and
December 31, 1996, respectively 37,133 49,542
Additional paid-in capital 87,652,123 153,396,348
Stock payable 567,000 534,600
Accumulated earnings (deficit) 5,253,975 (10,462,451)
Less: Deferred compensation - stock options (283,266) --
------------- -------------
Total stockholders' equity 93,226,965 143,518,039
------------- -------------
Total $ 152,406,536 $ 539,196,633
============= =============
</TABLE>
See notes to consolidated financial statements.
26
<PAGE> 27
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1994 1995 1996
------------ ------------- -------------
<S> <C> <C> <C>
Managed care revenue $ 18,193,286 $ 49,880,875 $ 267,641,917
Fee-for-service revenue, net of
contractual deductions 39,498,164 118,470,607 172,676,696
------------ ------------- -------------
Operating revenue 57,691,450 168,351,482 440,318,613
Expenses:
Medical services expense - Professional
Corporations 4,173,204 7,234,374 27,190,347
Medical services expense - others 37,178,901 106,508,504 286,516,261
------------ ------------- -------------
16,339,345 54,608,604 126,612,005
General and administrative expense 13,607,073 44,892,765 99,230,319
Merger, restructuring and other unusual
charges (Note 9) -- 1,589,908 37,970,868
------------ ------------- -------------
Income (loss) from operations 2,732,272 8,125,931 (10,589,182)
Other income (expense):
Interest and other income 186,955 609,297 852,288
Interest expense (187,364) (2,177,943) (5,979,532)
------------ ------------- -------------
Total other expense (409) (1,568,646) (5,127,244)
------------ ------------- -------------
Income (loss) before income taxes 2,731,863 6,557,285 (15,716,426)
Income tax expense 942,025 2,723,320 --
------------ ------------- -------------
Net income (loss) $ 1,789,838 $ 3,833,965 $ (15,716,426)
============ ============= =============
Net income (loss) per share $ .28 $ (.72)
============= =============
Pro forma (Note 1):
Adjustment to income tax expense $ (110,235)
------------
Net income $ 1,679,603
------------
Net income per share $ .26
============
Weighted average shares
outstanding 6,579,828 13,693,192 21,702,786
============ ============= =============
</TABLE>
See notes to consolidated financial statements.
27
<PAGE> 28
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
(STOCK
SUBSCRIPTIONS
ADDITIONAL RECEIVABLE)/ ACCUMULATED DEFERRED
COMMON PAID-IN- STOCK EARNINGS/ COMPENSATION
STOCK CAPITAL PAYABLE (DEFICIT) STOCK OPTIONS TOTAL
----- ------- ------- --------- ------------- -----
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1994 $ 2,188 $ 9,812 $ -- $ (369,828) $ -- $ (357,828)
Pooling of interests combination
with Sterling Healthcare Group,
Inc. effective October 31, 1996 16,195 8,552,074 -- -- (369,000) 8,199,269
Common stock issued through
private placement for cash, net
of costs 1,294 4,571,625 -- -- -- 4,572,919
Preferred stock issued and
redeemed (3,750,000) -- -- -- (3,750,000)
Common stock issued through
initial public offering for cash,
net of costs 2,795 11,574,068 -- -- -- 11,576,863
Common stock issued in connection
with acquisition 313 1,953,250 -- -- -- 1,953,563
Net income for the year -- -- -- 1,789,838 1,789,838
Other 36 333,329 (14,227) -- 22,658 341,796
One-for-one stock dividend,
effective March 1, 1995 6,626 (6,626) -- -- -- --
----------- ------------- --------- ------------ ------------ -------------
Balances, December 31, 1994 29,447 23,237,532 (14,227) 1,420,010 (346,342) 24,326,420
Common stock issued through
public offering for cash, net of
costs 8,501 50,392,907 -- -- -- 50,401,408
Common stock issued in
connection with acquisitions 450 13,889,419 -- -- -- 13,889,869
Common stock payable issued in
connection with acquisitions -- -- 567,000 -- -- 567,000
Net income for the year -- -- -- 3,833,965 -- 3,833,965
Other (1,265) 132,265 14,227 -- 63,076 208,303
----------- ------------- --------- ------------ ------------ -------------
Balances, December 31, 1995 37,133 87,652,123 567,000 5,253,975 (283,266) 93,226,965
Stock options and warrants
exercised 515 10,305,788 -- -- -- 10,306,303
Common stock issued in connection
with acquisitions 3,407 52,200,372 41,500 -- -- 52,245,279
Common stock issued in connection
with conversion of debt 1,086 3,498,914 -- -- -- 3,500,000
Net loss for the year -- -- -- (15,716,426) -- (15,716,426)
Other 7,401 (260,849) (73,900) -- 283,266 (44,082)
----------- ------------- --------- ------------ ------------ -------------
Balances, December 31, 1996 $ 49,542 $ 153,396,348 $ 534,600 $(10,462,451) $ -- $ 143,518,039
=========== ============= ========= ============ ============ =============
</TABLE>
See notes to consolidated financial statements.
28
<PAGE> 29
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1994 1995 1996
------------ ------------ -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,789,838 $ 3,833,965 $ (15,716,426)
Adjustments to reconcile net income (loss)
to net cash used by
operating activities:
Depreciation and amortization 570,733 3,419,060 10,736,151
Imputed interest on notes payable -- 132,489 98,023
Loss on disposal of business -- 772,875 --
Deferred compensation stock options 22,658 38,076 --
Impairment of goodwill -- 434,602 18,900,000
Changes in assets and liabilities, net
of effects of acquisitions:
Accounts receivable (4,448,976) (17,983,548) (68,452,200)
Income tax receivable/payable (163,560) (1,064,389) 3,397,211
Capitation deposit -- -- (15,409,771)
Deferred income taxes (205,580) 591,545 (5,302,617)
Accounts payable and accrued expenses 850,558 469,485 13,818,166
Claims payable, including incurred but
not reported claims (315,194) 5,348,274 43,807,285
Accrued liability for professional
liability claims (124,216) (738,500) 2,464,790
Accrued payroll and related liabilities (7,157) 336,625 2,451,391
Prepaid expenses and other assets (129,057) (507,908) 548,093
------------ ------------ -------------
Total adjustments (3,949,791) (8,751,314) 7,056,522
------------ ------------ -------------
Net cash used by operating activities (2,159,953) (4,917,349) (8,659,904)
Cash flows from investing activities:
Purchase of property and equipment (971,053) (4,808,619) (9,126,829)
Payments for intangible assets (270,621) (1,703,570) (13,341,849)
Net payments (to) from affiliate 44,372 (214,546) (350,867)
Investment in GLHP -- (1,994,900) (3,000,000)
Net sale (purchase) of marketable securities (10,079,811) 1,851,023 (31,771,212)
Acquisitions, net of cash acquired (3,713,133) (38,529,816) (10,491,630)
Payments escrowed for acquisitions -- (3,285,000) 2,796,465
Proceeds from sale of business -- 1,600,000 --
Other -- (46,212) --
------------ ------------ -------------
Net cash used by investing activities (14,990,246) (47,131,640) (65,285,922)
------------ ------------ -------------
Cash flows from financing activities:
Proceeds from merger, net 5,699,870 -- (169,334)
Net proceeds from issuance of common
stock 11,441,604 50,401,408 --
Net proceeds from private placement of
stock 4,812,919 -- --
Redemption of preferred stock (3,750,000) -- --
Issuance of convertible subordinate notes
payable 1,000,000 -- 73,125,000
</TABLE>
29
<PAGE> 30
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S> <C> <C> <C>
Proceeds from exercise of stock options and
warrants 43,365 156,000 10,575,526
Issuance of notes payable -- -- 53,628,334
Net borrowings under bank line of credit 207,242 7,814,781 --
Receipt of payment for stock subscriptions 35,773 14,227 --
Payments on long-term debt (922,779) (5,302,072) (60,791,048)
------------ ------------ -------------
Net cash provided by financing
activities 18,567,994 53,084,344 76,368,478
------------ ------------ -------------
Net increase in cash and cash equivalents 1,417,795 1,035,355 2,422,652
Cash and cash equivalents, beginning
of year 719,075 2,136,870 3,172,225
------------ ------------ -------------
Cash and cash equivalents, end of year $ 2,136,870 $ 3,172,225 $ 5,594,877
============ ============ =============
Supplemental cash flow information:
Cash paid for interest $ 117,400 $ 1,957,194 4,026,106
Cash paid for income taxes $ 1,840,296 $ 4,781,045 870,382
Equipment acquired under capital leases $ 155,361 $ 438,643 2,009,655
Common stock issued in connection with
acquisitions $ 4,741,976 $ 13,889,870 $ 52,245,279
Effects of acquisitions:
Fair value of assets acquired $ 7,371,926 $ 78,845,644 $ 273,610,635
Liabilities assumed $ 3,658,793 $ 40,315,828 $ 263,119,005
Net cash paid for acquisitions $ 3,713,133 $ 38,529,816 $ 10,491,630
============ ============ =============
</TABLE>
See notes to consolidated financial statements.
30
<PAGE> 31
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General -- FPA Medical Management, Inc. ("FPA" or the "Company"), a
Delaware corporation incorporated in 1994, is a national physician practice
management company, which, through its network of primary care physicians,
affiliated professional corporations ("Professional Corporations") and
subsidiaries, contracts with health maintenance organizations ("HMOs") and other
prepaid health insurance plans (collectively, "Payors") to provide and manage
physician and related healthcare services to enrollees who select FPA network
primary care physicians. FPA also provides contract management services to
hospital emergency and anesthesia departments in twenty states.
On October 31, 1996, FPA and Sterling Healthcare Group, Inc. ("Sterling")
consummated a business combination (the "Merger"). As a result of the Merger,
each outstanding share of Sterling common stock $.0001 par value per share was
converted to .951 shares of FPA Common Stock, $.002 par value per share (FPA
"Common Stock"). Sterling's stockholders were issued 8,097,781 shares of FPA
Common Stock representing approximately 37% of the total issued and outstanding
shares of FPA Common Stock after the Merger. The shares of FPA Common Stock
issued to the Sterling stockholders have been registered on a Registration
Statement on Form S-4 filed under the Securities Act of 1933, as amended. The
Merger has been treated as a tax-free reorganization and accounted for as a
pooling of interests and, accordingly, the accompanying consolidated financial
statements have been prepared on a basis that includes the accounts of Sterling
since June 1, 1994, Sterling's date of inception. Information concerning Common
Stock and per share data has been restated on an equivalent share basis.
Presented below is the effect of the pooling of interests on previously reported
results of operations for the years ended December 31:
<TABLE>
<CAPTION>
1994 1995
---- ----
<S> <C> <C>
Operating revenue:
FPA $ 18,435,877 $ 52,691,955
Sterling 39,255,573 115,659,527
------------ ------------
$ 57,691,450 $168,351,482
============ ============
Net income:
FPA $ 388,313 $ 1,002,462
Sterling 1,401,525 2,831,503
------------ ------------
$ 1,789,838 $ 3,833,965
============ ============
</TABLE>
31
<PAGE> 32
Managed Care Business -- FPA, its subsidiaries and the Professional
Corporations currently manage the provision of prepaid managed healthcare
services for networks of primary care physicians in numerous states. The "FPA
Network" consists of FPA, its subsidiaries, the Professional Corporations and
various independent practitioners.
The Professional Corporations and certain subsidiaries contract with Payors
to provide for the delivery of healthcare services on a capitation basis (i.e.,
a fixed payment per enrollee per month). Through administrative services
agreements, the Professional Corporations assign payments from Payors to the
Company in return for management services, specialty medical care claims
administration and payment, and other services.
FPA has direct or indirect unilateral and perpetual control over the assets
and operations of the Professional Corporations for all periods presented, other
than by means of owning the majority of the voting stock of the Professional
Corporations. FPA and its subsidiaries are unable to own a majority interest in
the Professional Corporations formed in states which prohibit the corporate
practice of medicine. The Professional Corporations have as shareholders and
directors certain physicians who are employees of FPA or one of its
subsidiaries. Each shareholder/director has entered into a succession agreement
which requires such shareholder/director to sell to a designee of FPA such
shareholder/director's shares of stock for a nominal amount if such
shareholder/director is terminated from employment with FPA. This ensures
unilateral and perpetual control over the Professional Corporations by FPA. Due
to a parent-subsidiary relationship under generally accepted accounting
principles, FPA has consolidated the financial statements of the Professional
Corporations. FPA believes that consolidation of the financial statements of
these Professional Corporations is necessary to present fairly the financial
position and results of operations of the Company. All significant inter-entity
transactions have been eliminated in consolidation. The consolidated financial
statements include the operations of the Company, all of the Company's
subsidiaries and Professional Corporations since they were acquired, were
incorporated, or entered into an administrative services agreement with FPA or
one of its subsidiaries.
Managed care capitation payments from Payors are paid monthly and are
recognized as revenue during the period in which enrollees are entitled to
receive services. Contracts with Payors generally provide for terms of one to
thirty years, with automatic renewal periods, terminable on prior notice
(generally between 30 and 180 days).
32
<PAGE> 33
The Company has two types of managed care Payor contracts: contracts for
both inpatient and outpatient services ("global capitation" contracts) and those
limited to outpatient services ("outpatient capitation" contracts). Under global
capitation contracts, which accounted for approximately 20.9% and 36.3% of
managed care business operating revenue in 1995, and 1996, respectively, the
Company receives a fixed monthly amount per enrollee for which the Company is
financially responsible to provide the enrollees with all necessary inpatient
and outpatient care. In 1994, the Company had no global capitation contracts.
Under outpatient capitation contracts, the Company receives a fixed monthly
amount per enrollee for which the Company is financially responsible to provide
the enrollees with all necessary outpatient care. Additionally, under these
outpatient capitation contracts, the Company is a party to shared risk
arrangements with Payors which generally reward the Company for the efficient
utilization of inpatient services. Under these shared risk arrangements, the
Company shares any surplus or, in some cases, deficit of inpatient cost in
relation to amounts pre-established by the Payor. Estimates of shared risk funds
to be received or paid by the Company are recorded based on estimates of
hospital utilization costs. Differences between actual settlements and amounts
estimated as receivable (or payable) relating to the shared risk arrangements
are recorded at the time of settlement, generally in the second or third quarter
of the following year. The Company does not believe that the final settlements
of these shared risk arrangements will differ materially from the estimated
amounts recorded in the financial statements. Revenue under outpatient
capitation contracts represented 98.5%, 72.4% and 51.7% of managed care business
operating revenue in 1994, 1995 and 1996, respectively.
The Company also generates fee-for-service revenue for the performance of
medical services through the Professional Corporations. These revenues are
presented net of contractual deductions and represented 1.5%, 6.7% and 12.0% for
1994, 1995 and 1996, respectively, of managed care business operating revenue.
Emergency Department Business -- The Company provides physician contract
management for hospital emergency and anesthesia departments in twenty states at
December 31, 1996. Contractual arrangements with hospitals are primarily
fee-for-service whereby hospitals agree to authorize the Company and its
contracted healthcare professionals to bill and collect for the professional
component of the charges for medical services rendered by the Company's
contracted healthcare professionals.
Through the emergency department business, the Company generates
fee-for-service revenues. These revenues are presented net of contractual
deductions, and represented 94.0%, 84.4% and 84.6% of the emergency department
business operating revenues in 1994, 1995 and 1996, respectively. The Company
has arrangements with certain hospitals for monthly subsidy amounts
33
<PAGE> 34
which either compensate for patient revenues not achieving specified levels or
to fund front-end staffing and insurance costs. The Company also has a physician
recruiting and medical management consulting division.
Revenue Recognition and Accounts Receivable -- Fee-for-service revenue is
reported on the accrual basis, net of estimated third-party contractual
deductions. Further adjustments are recorded to reflect amounts estimated to be
uncollectible based upon individual contract experience. The allowance
considered necessary to cover contractual deductions and uncollectible accounts
is based on an analysis of current and past due accounts, collection experience
in relation to amounts billed and other relevant information. Accounts
receivable represents amounts due from third-party payors including Medicare and
Medicaid, patients and others for services rendered.
For emergency department receivables, the concentration of credit risk
relating to accounts and subsidy receivables is limited by the number and
geographic dispersion of hospital emergency departments managed by the Company,
as well as by the large number of patients and payors, including various
governmental agencies in the states in which the Company operates.
In 1994, 1995 and 1996, revenues from governmental agencies made up
approximately 33%, 19% and 34%, respectively, of operating revenue for both
divisions of the Company.
Medical Services Expense -- Through the Professional Corporations and its
subsidiaries, the Company contracts with various healthcare providers to provide
medical services to covered enrollees. Primary care physicians are compensated
by the Company under compensation arrangements with the Professional
Corporations on either a salary or capitation basis and the cost is recorded as
"Medical services expense -- Professional Corporations" in the accompanying
consolidated statements of operations. The costs of referrals to specialty care
physicians are paid on either a discounted fee-for-service or capitation basis.
Under global capitation contracts, the Company contracts for inpatient services
which are paid on a fee-for-service or per diem basis. Medical services expense
paid through capitation (for certain primary care and specialty care services),
fixed salary (for primary care only) or for contracted hours of emergency
department coverage at fixed hourly rates totaled 14%, 51% and 38% of operating
revenues in 1994, 1995 and 1996, respectively, with the remainder of medical
services expense (for primary care, specialty care, ancillary services,
inpatient and outpatient services, lab charges, etc.) paid for on a discounted
fee-for-service or per diem basis. The costs of healthcare services paid for on
a fee-for-service or per diem basis are recorded by the Company in the period
for which services are provided based
34
<PAGE> 35
in part on estimates, including an accrual for medical services provided but not
yet billed to the Company ("incurred but not reported") and are included in
claims payable in the accompanying consolidated balance sheets.
The Company has negotiated "attachment points" for stoploss insurance
independent of Payor contracts which represent the contractual limits, generally
$25,000 per year per enrollee for outpatient services and $100,000 per year per
enrollee for inpatient services. In 1997, the Company increased its outpatient
services attachment point to $50,000 in most cases.
Cash and Cash Equivalents -- Cash and cash equivalents are defined as
highly liquid financial instruments with original maturities of three months or
less. A substantial portion of the Company's cash is deposited in three
financial institutions. The Company monitors financial conditions of each
financial institution and does not believe that the deposits are subject to a
significant degree of risk.
Marketable Securities -- Marketable securities consist of corporate debt
securities and certificates of deposit. Such securities have been classified by
management of FPA as available for sale in accordance with the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". The estimated fair value of the
Company's marketable securities is based on quoted market prices, which
approximate cost, and therefore no unrealized gains or losses have been recorded
in the accompanying consolidated financial statements. Marketable securities at
December 31, 1995 consist of corporate debt securities and at December 31, 1996
consist of Eurodollar certificates of deposit.
Capitation Deposits -- Capitation deposits represent funds on deposit from
a major Payor in Florida. In accordance with the Payor contract, 60% of the
capitation revenue earned each month is set aside for payment of claims. The
Company is entitled to all of the interest earned on this account. The contract
requires a minimum balance in this account.
Property and Equipment -- Property and equipment are recorded at cost, less
accumulated depreciation and amortization. Depreciation and amortization are
computed on a straight-line basis over the estimated useful lives of the assets,
generally three to seven years. Leasehold improvements are amortized over the
lesser of the estimated useful life or the remaining life of the related lease.
Restricted Cash and Deposits -- The Company records as restricted cash
funds escrowed for payment of claims, for future acquisitions, and other funds
contractually required to be segregated from the Company's operating cash.
Goodwill -- The Company has classified as goodwill the excess of the
purchase price over the fair value of the net assets of entities acquired.
Goodwill is being amortized on a straight-line basis over the estimated periods
of future benefit of 15 to 30 years. At each balance sheet date following the
acquisition of a business, the Company reviews
35
<PAGE> 36
the carrying value of the goodwill to determine if facts and circumstances
suggest that it may be impaired or that the amortization period may need to be
changed. The Company considers external factors relating to each acquired
business, including hospital and physician contract changes, local market
developments, changes in third party payments, national health care trends, and
other publicly available information. If these external factors indicate that
the goodwill will not be recoverable, as determined based upon undiscounted cash
flows before interest charges of the business acquired over the remaining
amortization period, the carrying value of the goodwill will be reduced. In
December 1995, the Company sold and closed a total of eight primary care
clinics. In connection with the sale and closing, the Company recorded a charge
for impairment of goodwill in the amount of $434,000. In 1996, the Company
recorded charges for impairment of goodwill of $4.1 million as a result of a
1995 acquisition in Arizona and $14.8 million related to terminated emergency
department contracts. The Company does not believe there currently are any
indicators that would require an additional adjustment to the carrying value of
the goodwill or its remaining useful life at December 31, 1996.
Intangible Assets -- Intangible assets consist of capitalized costs of
geographic expansion related to the Company's operations in new regions and
non-compete agreements associated with acquisitions. Intangible assets are being
amortized on a straight-line basis over the expected period of future benefit,
ranging from 5 to 15 years.
Income Taxes -- The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting For Income
Taxes," which requires the use of the liability method for deferred income taxes
(see Note 8).
Professional Liability Coverage - The Company maintains professional
liability coverage for the Company and its employee and independent contractor
physicians on a claims made basis. The Company records an estimate of its
liabilities for medical malpractice claims incurred but not reported. Such
liabilities are not discounted.
36
<PAGE> 37
Pro Forma Information -- The pro forma net income and net income per share
information in the 1994 consolidated statement of operations reflect the effect
on historical results as if FPA had been a C Corporation rather than an S
Corporation for income tax purposes, and no tax benefit arose as a result of the
change in tax status.
Net Income (Loss) per Common Share -- Net income (loss) per Common Share is
computed based on the weighted average number of shares and share equivalents
(options and warrants) outstanding, giving retroactive effect to all stock
splits, including a one-for-one common stock dividend effective March 1, 1995.
Accounting Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
New Accounting Standards -- In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation," which was effective for the
Company beginning January 1, 1996. SFAS No. 123 requires expanded disclosures of
stock-based compensation arrangements with employees and encourages (but does
not require) compensation cost to be measured based on the fair value of the
equity instrument awarded. Corporations are permitted, however, to continue to
apply Accounting Principles Board ("APB") Opinion No. 25, which recognizes
compensation cost based on the intrinsic value of the equity instrument awarded.
The Company has continued to apply APB Opinion No. 25 to its stock-based
compensation awards to employees and has disclosed the required pro forma effect
on net income (loss) per share (See Note 7).
Reclassifications -- Certain reclassifications have been made to prior
years' financial statements to conform to current year classifications.
37
<PAGE> 38
2. RELATED PARTY TRANSACTIONS
In Texas, the Company leases its main facility, certain leasehold
improvements, and certain medical and office equipment from an officer of a
Texas subsidiary pursuant to a noncancelable operating lease agreement expiring
November 8, 2005. The agreement provides for monthly payments of $58,654,
subject to certain increases based on the consumer price index. The lease also
contains certain provisions that may, at the option of the officer, require FPA
to acquire the facility at its fair market value.
Effective October 1, 1996, a Professional Corporation and FPA acquired
substantially all of the assets and assumed certain liabilities of Family
Practice Associates of San Diego, an Osteopathic Corporation ("FPASD"), owned by
certain officers of the Company. The purchase price was supported by an
independent valuation and approved by a committee of the Independent Directors
of the Company. During 1995, FPA entered into a loan agreement with FPASD under
which FPASD was permitted to borrow a maximum of $650,000 for working capital
purposes. This loan replaces a previous loan with a maximum balance of $155,000.
At December 31, 1995 and 1996, the balance was $300,086 and $0, respectively.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Land and buildings $ 164,825 $ 523,758
Computer hardware and software 1,730,733 12,526,830
Furniture, fixtures and equipment, including medical equipment 7,519,444 25,677,238
Leasehold improvements 1,479,653 6,764,846
Vehicles -- 311,972
------------ ------------
Total 10,894,655 45,804,644
Less accumulated depreciation and amortization (2,576,385) (6,358,498)
------------ ------------
Subtotal 8,318,270 39,446,146
Capitalized software development costs 1,273,529 693,186
------------ ------------
Property and equipment -- net $ 9,591,799 $ 40,139,332
============ ============
</TABLE>
38
<PAGE> 39
4. DEBT
Convertible Subordinated Notes Payable -- On October 5, 1994, FPA sold
$1.0 million of convertible subordinated notes to representatives of the
underwriters of FPA's initial public offering. The notes bore interest at 6%,
payable semiannually, with principal due October 1999. During 1996, the notes
were converted into 200,000 shares of FPA Common Stock.
In December 1996, the Company issued $75.0 million of convertible
subordinated debentures due December 2001, which resulted in net proceeds to the
Company of approximately $73.0 million. The notes bear interest at 6-1/2%, with
interest payable semiannually, and are convertible into FPA Common Stock at
$25.95 per share. The debentures are redeemable by the Company after December
20, 1999. Upon the occurrence of a Repurchase Event, as defined in the
debenture, each holder has the right to require repayment of the debentures at
100% of the principal amount plus accrued interest. In January 1997, upon
exercise of the overallotment option granted to the Initial Purchasers, the
Company issued additional convertible subordinated debentures with the same
terms for net proceeds of $5.4 million.
Convertible Promissory Note -- In connection with the acquisition of a
Texas subsidiary on November 1, 1995, FPA issued a 36-month, $2.5 million 9%
convertible promissory note with payments of interest only due for the first 24
months and principal and interest monthly thereafter. During 1996, the note was
converted into 243,191 shares of FPA Common Stock.
Notes Payable -- In connection with certain acquisitions, the Company
has issued various other notes payable. Following is a summary of all long-term
debt.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1995 1996
----------- ----------
<S> <C> <C>
Notes payable, interest ranging from 7% to 10.25% and principal due
through December 2000 $ 5,270,421 $3,484,627
Note payable, interest at 9% and principal due November 1997 2,500,000 --
Convertible note payable, interest at 9% and principal due November 1998 2,500,000 --
Convertible debentures payable, interest at 6.5% and principal due
December 2001 -- 75,000,000
Notes payable to former shareholders of Sterling Healthcare, Inc., interest
at rates ranging from 5% to 5.54%, payable in 60 monthly installments
through January 1998 1,372,895 759,420
Notes payable, interest at prime, payable in two equal installments in --
December 1996 and 1997 1,200,000 600,000
6% convertible subordinated notes, interest payable each April
and October through 1999, principal due October 1999 1,000,000 --
</TABLE>
39
<PAGE> 40
<TABLE>
<S> <C> <C>
Notes payable to financial institutions, interest at 5.5%, due in full
in October 1997 714,858 55,000,000
Note payable, interest at LIBOR, 59 payments of principal and interest
due commencing February 1999, through December 2003 -- 97,759,244
Notes payable interest at 6.02% and principal due January 2006 -- 20,174,914
Other 1,497,013 2,012,513
----------- ------------
Total 16,055,187 254,790,718
Less current portion 7,042,635 70,015,734
----------- ------------
Long term debt, net of current portion $ 9,012,552 $184,774,984
=========== ============
</TABLE>
At December 31, 1996 future payments on long-term debt are as follows:
<TABLE>
<CAPTION>
NOTES PAYABLE CAPITAL
AND OTHER LEASES
--------- ------
<S> <C> <C>
1997 $ 68,885,510 $ 1,130,244
1998 1,859,868 585,239
1999 8,024,125 226,843
2000 8,722,934 67,358
2001 83,755,099 --
Thereafter 81,855,064 --
------------ ------------
$253,102,600 2,009,664
============
Less amount representing interest on capital leases (321,546)
------------
Present value of net minimum capital lease payments 1,688,118
Notes payable and other 253,102,600
------------
Total $254,790,718
============
</TABLE>
The fair market value of the Company's debt approximates its carrying value.
Credit Agreement -- On January 29, 1996, the Company entered into a credit,
security, guarantee and pledge agreement ("Credit Agreement") with certain
financial institutions. Permitted Borrowings, as defined in the Credit
Agreement, generally include those for acquisitions and capital expenditures.
The Company and the financial institutions amended the Credit Agreement during
1996. Fees of $1,250,000 were paid in connection with the Credit Agreement
during 1996. Borrowings bear interest at rates ranging from either LIBOR plus
2 1/2%, 2 3/4% or 3%, or prime rate plus 1%, 1 1/4%, or 1 1/2% as defined by the
Credit Agreement. The balance outstanding is due on October 31, 1997. Periodic
payments of accrued interest are due during the term of the Credit Agreement.
Additionally, the financial institutions were granted a security interest in
substantially all of the assets of the Company (excluding those of FPA Medical
Management of Michigan, Inc. d/b/a QualNet, Inc., and the stock of certain
subsidiaries of FPA) and Professional Corporations. The debt is also guaranteed
by the Professional Corporations. In connection with the Credit Agreement, the
Company must maintain certain debt and equity ratios and profitability
thresholds. The Company issued to the financial institutions a warrant to
purchase
40
<PAGE> 41
50,000 shares of Common Stock at $9.125 per share exercisable prior to February
2, 2001, subject to certain anti-dilution provisions. At December 31, 1996, the
Company had borrowed the maximum of $55.0 million under the Credit Agreement.
5. MAJOR CUSTOMERS
In 1994, two Payors accounted for 11% and 34%, respectively, of the
Company's operating revenue. In 1995, two Payors accounted for 10% and 19%
respectively, of the Company's operating revenue. In 1996, two Payors accounted
for 11% and 14%, respectively, of the Company's operating revenue.
6. COMMITMENTS AND CONTINGENCIES
Legal -- The Company is party to certain legal actions arising in the
ordinary course of business. In the opinion of the Company's management,
liability, if any, under these claims is adequately covered by insurance and
will not have a material effect on the Company's financial position or results
of operations. The Company maintains professional liability insurance.
Operating Leases -- The Company is a party to certain facilities and
equipment leases which terminate at various dates through November 8, 2005.
Future minimum lease payments required under all operating leases are as
follows:
<TABLE>
<S> <C>
1997 $21,911,887
1998 19,606,444
1999 17,329,150
2000 15,214,255
2001 2,352,625
Thereafter 1,878,572
-----------
Total $78,292,933
===========
</TABLE>
For 1994, 1995 and 1996, total expense under these non-cancelable operating
leases was $844,094, $2,966,964, and $6,909,028, respectively.
7. STOCKHOLDERS' EQUITY
41
<PAGE> 42
Stock Splits and Dividends -- The accompanying consolidated financial
statements and notes retroactively reflect all stock splits, and a one-for-one
Common Stock dividend distributed April 3, 1995 to stockholders of record on
March 1, 1995. All share, per share and stock option data have been restated to
reflect the stock splits and dividend.
Preferred Stock -- During 1994, FPA issued a stock dividend consisting of
one share of Series A Redeemable Preferred Stock (the "Preferred Stock") for
each 437,600 shares of FPA's Common Stock. Accordingly, five shares of Preferred
Stock were issued through the stock dividend, one to each of the Company's five
founding directors. The Preferred Stock was subsequently redeemed by FPA at the
redemption price of $750,000 per share of Preferred Stock (aggregate $3,750,000)
in connection with the 1994 private placement of Common Stock.
Omnibus Stock Option Plan -- During 1994, FPA adopted the Omnibus Stock
Option Plan under which an aggregate of 1,000,000 shares of Common Stock of FPA
may be issued through incentive stock options or nonqualified stock options. On
July 13, 1995, October 31, 1996 and March 17, 1997, the stockholders of the
Company authorized an increase in the total number of shares which may be
granted under the plan to 1,500,000, 5,000,000 and 6,500,000, respectively. The
option price per share may not be less than 100% of the fair market value of the
Common Stock on the date of grant, as defined in the stock option plan document.
Options granted under the plan generally vest over three to five years.
1994 Physician Stock Option Plan -- During 1994, FPA adopted the 1994
Physician Stock Option Plan under which an aggregate of 1,000,000 shares of
Common Stock of FPA may be issued through nonqualified stock options. The
option price per share may not be less than 100% of the fair market value of the
Common Stock on the date of grant, as defined in the stock option plan document.
Options granted under the plan generally vest over two to five years.
1995 Non-Employee Directors Non-Qualified Stock Option Plan -- On July 13,
1995, the stockholders of the Company approved the 1995 Non-Employee Directors
Non-Qualified Stock Option Plan under which options to purchase up to 200,000
shares of Common Stock may be granted to non-employee directors. Options granted
under the plan generally vest over one year.
Stock option transactions and prices are summarized as follows:
42
<PAGE> 43
<TABLE>
<CAPTION>
1995
OMNIBUS 1994 NON-EMPLOYEE DIRECTORS
STOCK PHYSICIAN STOCK NON-QUALIFIED
OPTION PLAN OPTION PLAN STOCK OPTION PLAN
----------- ----------- -----------------
<S> <C> <C> <C>
Shares under option:
Outstanding at January 1, 1994 -- -- --
Granted 858,254 -- --
Exercised -- -- --
Canceled (3,000) -- --
---------- -------- ---------
Outstanding at December 31, 1994 855,254 -- --
Granted 709,072 477,460 17,500
Exercised -- -- --
Canceled (13,692) (25) --
---------- -------- ---------
Outstanding at December 31, 1995 1,550,634 477,435 17,500
Granted in connection with Sterling merger 1,313,583
Otherwise granted 3,077,801 184,292 12,500
Exercised (181,421) (14,200) (5,000)
Canceled (35,477) (10,100) --
---------- -------- ---------
Outstanding at December 31, 1996 5,725,120 637,427 25,000
========== ======== =========
Average option price per share:
At December 31, 1994 $ 5.11 N/A N/A
At December 31, 1995 $ 6.27 $ 7.02 $ 8.40
At December 31, 1996 $ 13.75 $ 9.33 $ 13.51
Options exercisable:
At December 31, 1994 100,000 -- --
At December 31, 1995 215,332 31,500 --
At December 31, 1996 1,705,560 146,689 12,500
</TABLE>
Common Stock -- All stock options are granted at fair market value of the
Common Stock at the grant date. The weighted average fair value of the stock
options granted during 1996 was $8.63. The fair value of each stock option grant
is estimated on the date of grant using the Black Scholes option pricing model
with the following weighted average assumptions used for grants in 1996:
risk-free interest rate of 5.7%; expected divided yield of 0%; expected life of
3 years; and expected volatility of 48%. Stock options generally expire ten
years from the grant date. Stock options generally vest over a three year
period, with one-third of the shares becoming exercisable on each of the first
three anniversaries of the grant date. The outstanding stock options at December
31, 1996 have weighted average remaining contractual life of 8.42 years. The
number of stock option shares exercisable at December 31, 1996 was 1,864,749.
These stock options have a weighted average exercise price of $10.94 per share.
The Company accounts for its options in accordance with Accounting
Principles Board Opinion No. 25, under which no compensation cost has been
recognized for stock option awards. Had compensation cost been determined
43
<PAGE> 44
consistent with SFAS No. 123, the Company's pro forma net income and earnings
per share for 1995 would have been $1,867,126 and $.14, respectively, and the
Company's pro forma net loss and net loss per share for 1996 would have been
$21,875,211 and $1.01, respectively. Because the SFAS No. 123 method of
accounting has not been applied to options granted prior to January 1, 1995, the
resulting pro forma compensation cost may not be representative of that to be
expected in future years.
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
RANGE OF EXERCISE OUTSTANDING REMAINING WEIGHTED AVERAGE NUMBER EXERCISABLE WEIGHTED AVERAGE
PRICES AT DECEMBER 31, 1996 CONTRACTUAL LIFE EXERCISE PRICE AT DECEMBER 31, 1996 EXERCISE PRICE
------ -------------------- ---------------- ---------------- -------------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 5.0000-$ 8.6250 1,759,463 8.03 $ 6.3571 789,214 $ 6.1599
$ 8.8750-$13.7500 1,664,773 8.17 11.5848 663,630 12.0322
$13.8125-$18.8438 1,022,647 8.28 16.2501 180,487 14.5660
$19.0625-$28.3750 1,940,664 9.04 19.5457 231,418 21.2547
--------- ---- --------- --------- ---------
$ 5.0000-$28.3750 6,387,547 8.42 $ 13.3104 1,864,749 $ 10.9366
========= ==== ========= ========= =========
</TABLE>
8. INCOME TAXES
Upon the inception of FPA in October 1992, FPA elected S Corporation status
under the Internal Revenue Code which provides that taxable income or loss is
attributable to the stockholders. Effective January 1, 1994, FPA revoked its
election to be treated as an S Corporation and became subject to income taxes.
In accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," the Company recognized a deferred tax benefit on
the date it became a taxable enterprise.
The components of income tax expense as of December 31 are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Federal Expense:
Current $ 974,870 $ 2,190,978 $ 5,230,179
Deferred (181,312) 204,808 (5,230,179)
State Expense:
Current 171,936 348,882 1,566,982
Deferred (23,469) (21,348) (1,566,982)
----------- ----------- -----------
Total $ 942,025 $ 2,723,320 $ --
=========== =========== ===========
</TABLE>
The Company's income tax expense differs from the amount that would have
resulted from applying the Federal statutory rate to pretax income because of
the effect of the following items:
44
<PAGE> 45
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Tax expense (benefit) at U.S. statutory rate 34.0% 34.0% (35.0%)
Revocation of FPA S Corporation status (4.9%) -- --
State taxes, net of Federal income tax benefit 3.2% 3.7% (1.8%)
Nondeductible goodwill amortization -- 1.7% 11.0%
Nondeductible acquisition costs -- -- 21.5%
Other 2.2% 2.1% 4.3%
---- ---- -----
34.5% 41.5% --
==== ==== =====
</TABLE>
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for reporting and the
amounts used for income tax purposes. The tax effects of items comprising the
Company's net deferred tax assets and liabilities at December 31 are as follows:
<TABLE>
<CAPTION>
1995 1996
---- ----
<S> <C> <C>
Deferred tax assets:
Goodwill -- $ 4,087,001
Allowance for uncollectible accounts $ 2,307,580 2,700,811
Accrued liability for professional liability claims 321,256 595,000
Net operating losses 296,511 67,058
Other 50,392 720,821
----------- ------------
Total deferred tax assets $ 2,975,739 $ 8,170,691
----------- ------------
Deferred tax liabilities:
Geographic expansion costs $ (179,893) $ (392,305)
Start-up costs (231,498) --
State income tax -- (290,987)
Deferred compensation (57,565) (19,069)
Depreciation and amortization (1,008,458) (799,914)
----------- ------------
Total deferred tax liabilities $(1,477,414) $ (1,502,275)
----------- ------------
Net deferred tax assets $ 1,498,325 $ 6,668,416
=========== ============
</TABLE>
No valuation allowance was deemed necessary as a result of management's
evaluation of the likelihood that all of the deferred tax assets will be
realized.
9. MERGER, RESTRUCTURING AND OTHER UNUSUAL CHARGES
In 1995, the Company recorded nonrecurring expenses of $1.6 million. This
amount includes a $434,000 charge for impairment of goodwill, a $773,000 charge
for the loss on disposition of businesses and $375,000 relating to the
bankruptcy of one of its hospital clients. In 1995, the Company sold
45
<PAGE> 46
six and closed two primary care clinics (seven in Florida and one in Texas). The
goodwill impairment and loss on sale are directly related to the sale and
closure of the primary care clinics. These clinics accounted for approximately
$2.1 million in revenue and generated an operating loss (including the unusual
items) of $3.7 million during 1995.
In 1996, the Company recorded nonrecurring expenses of $38.0 million
($28.8 million after tax or $1.32 per share). This amount is comprised of (i)
costs related to the Merger in the amount of $16.8 million comprised of
investment bankers' fees, attorneys' fees, accountants' fees, legal fees, and
severance and compensation required to be paid as part of the Merger, (ii)
write-offs of goodwill and other assets in the amount of $18.9 million related
to terminated emergency room contracts and an unprofitable acquisition in
Arizona, and (iii) restructuring charges in the amount of $2.3
million primarily related to severance for terminated employees.
10. SEGMENT INFORMATION
Sterling is a physician practice management company engaged in the business
of providing contract management and support services primarily to hospital
based emergency departments ("Emergency Department"). FPA manages the provision
of prepaid managed healthcare services for networks of primary care physicians
("Managed Care"). The activities related to the Managed Care segment and the
Emergency Department segment are as follows:
<TABLE>
<CAPTION>
EMERGENCY MANAGED
DEPARTMENT CARE CONSOLIDATED
---------- ---- ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
DECEMBER 31, 1996
Operating revenues $ 136,761 $ 303,558 $ 440,319
Operating loss (6,154) (4,435) (10,589)
Assets employed at year-end 77,900 499,370 577,270
Depreciation and amortization 3,204 7,532 10,736
Capital expenditures 650 8,477 9,127
DECEMBER 31,1995
Operating revenues $ 115,660 $ 52,691 $ 168,351
Operating income 6,502 1,624 8,126
Assets employed at year-end 78,608 73,799 152,407
Depreciation and amortization 2,260 1,159 3,419
Capital expenditures 1,634 3,175 4,809
DECEMBER 31,1994
Operating revenues $ 39,256 $ 18,435 $ 57,691
Operating income 2,349 383 2,732
</TABLE>
46
<PAGE> 47
<TABLE>
<S> <C> <C> <C>
Assets employed at year-end 26,742 18,310 45,052
Depreciation and amortization 438 133 571
Capital expenditures 499 472 971
</TABLE>
11. ACQUISITIONS
Following is a summary of material acquisitions consummated during 1996 by
the Company, one of its subsidiaries, or one of the Professional Corporations.
Such acquisitions were accounted for using the purchase method of accounting.
Goodwill totaling approximately $242 million was recorded, which is being
amortized over periods ranging from 25 to 30 years. In connection with these
acquisitions, the Company issued (i) FPA Common Stock valued at $51.6 million,
(ii) notes payable of $163.8 million, and (iii) cash of $19.4 million.
VIP, IPA, A Professional Corporation January 1996
Foundation Health IPA January 1996
Century Family Medical Group, IPA January 1996
Century Family Medical Group, Inc. January 1996
Chabot Medical Group IPA January 1996
Physicians First, Inc. June 1996
Family First Pharmacy, Inc. June 1996
FPA Family Pharmacy, Inc. June 1996
Physicians Medical Group of Florida, Inc. June 1996
FHC IPA, Inc. July 1996
Intergroup IPA, P.C. July 1996
Foundation Health Medical Services(1) December 1996
Foundation Health Medical Group, Inc.(1) December 1996
FHMG/TDMC Medical Group, A Professional Corporation(1) December 1996
Thomas Davis Medical Centers, P.C.(1) December 1996
(1) The Company is in the process of determining the appropriate values to be
assigned to the assets acquired and liabilities assumed in connection with
these acquisitions. Accordingly, the Company's estimate of these values are
subject to revision upon completion of an independent valuation which may
result in an adjustment to goodwill.
The following unaudited pro forma financial information presents the
consolidated results of operations as if all significant acquisitions had
occurred as of the beginning of the periods presented, after including the
impact of certain adjustments, such as amortization of intangibles and goodwill,
executive compensation per employment agreements, and the related income tax
effects.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996
------------- -------------
<S> <C> <C>
Revenues $ 366,483,000 $ 599,662,000
Net loss (43,914,000) (77,348,857)
Net loss per share (2.40) (3.00)
</TABLE>
47
<PAGE> 48
The Company believes that this unaudited pro forma information is not
indicative of future results of operations, nor of historical operations, if the
acquisitions had occurred as of the beginning of the periods presented.
12. MICHIGAN SUBSIDIARY
On April 10, 1995, the Company signed an exclusive agreement to provide
management services through a majority-owned subsidiary, with Great Lakes Health
Plan, Inc. ("GLHP") headquartered in Southfield, Michigan. In connection with
this transaction, the Company invested $2 million in GLHP and the subsidiary.
The subsidiary began limited start-up operations on April 10, 1995. Included in
intangible assets are $266,034 in start-up costs related to activity in
Michigan. These costs are being amortized over five years. On March 7, 1996, FPA
made an additional capital contribution of $3 million to GLHP in connection with
the acquisition by GLHP of a clinic health plan and a number of clinics in
Michigan. The acquired plan currently services approximately 27,000 Medicaid
enrollees.
13. LICENSURE
The application of Family and Senior Care, Inc., a wholly-owned subsidiary
of FPA, for a restricted healthcare service plan license was approved by the
California Department of Corporations on December 5, 1996. Following that date,
all of the Company's managed care activity in the State of California occurred
in this subsidiary.
14. SUBSEQUENT EVENTS
The following significant events have occurred subsequent to the balance
sheet date:
On March 17, 1997, FPA completed the merger (the "AHI Merger") of FPA
Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of FPA,
with and into AHI Healthcare Systems, Inc., a Delaware corporation ("AHI").
Pursuant to the AHI Merger, AHI became a wholly-owned subsidiary of FPA and each
outstanding share of AHI Common Stock was exchanged for .391 shares of FPA
Common Stock. The shares of FPA Common Stock issued to the AHI stockholders were
registered on a Registration Statement on Form S-4 filed
48
<PAGE> 49
under the Securities Act of 1933, as amended. The AHI Merger will be treated as
a tax-free reorganization and accounted for as a pooling of interests.
The following pro forma unaudited consolidated information presents the
operations of FPA and AHI, as though the AHI Merger had occurred as of the
beginning of the periods presented. The 1996 information includes the twelve
months ended September 30, 1996 for AHI as information for the twelve months
ended December 31, 1996 is not yet available.
Management believes that when actual twelve month financial statements
for the year ended December 31, 1996 are available, they will result in a net
loss higher than that presented in the following table as a result of higher
medical costs experienced recently by AHI.
49
<PAGE> 50
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996
------------- -------------
<S> <C> <C>
Revenues $ 282,635,482 $ 559,386,613
Net income (loss) 470,965 (32,061,426)
Net income (loss) per share .04 (1.19)
</TABLE>
50
<PAGE> 51
INDEPENDENT AUDITORS' REPORT
To the Stockholders of FPA Medical Management, Inc.:
We have audited the consolidated balance sheets of FPA Medical Management, Inc.
and subsidiaries as of December 31, 1995 and 1996 and the related consolidated
statements of operations, changes in stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial statements give
retroactive effect to the merger with Sterling Healthcare Group, Inc., which
has been accounted for as a pooling of interests as described in Note 1 to the
consolidated financial statements. We did not audit the consolidated balance
sheet of Sterling Healthcare Group, Inc. as of December 31, 1995, or the
related consolidated statements of operations, changes in stockholders' equity
and cash flows of Sterling Healthcare Group, Inc. for the period June 1, 1994
(date of inception) to December 31, 1994 and the year ended December 31, 1995,
which statements reflect total assets of $78,608,252 as of December 31, 1995,
and total revenues of $39,255,573 and $115,659,527 for the seven-month period
ended December 31, 1994 and the year ended December 31, 1995, respectively.
Such financial statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for Sterling Healthcare Group, Inc. for 1994 and 1995, is based solely on the
report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, such
consolidated financial statements present fairly, in all material respects, the
financial position of FPA Medical Management, Inc. and subsidiaries as of
December 31, 1995 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
San Diego, California
March 21, 1997
51
<PAGE> 52
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
Sterling Healthcare Group, Inc.
Coral Gables, Florida
We have audited the consolidated balance sheets of Sterling Healthcare Group,
Inc. as of December 31, 1995, and the related consolidated statements of
operations, changes in stockholders' equity, and cash flows for year ended
December 31, 1995 and the seven month period ended December 31, 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Sterling Healthcare
Group, Inc. as of December 31, 1995, and the results of their operations and
their cash flows for the year ended December 31, 1995 and the seven month
period ended December 31, 1994, in conformity with generally accepted
accounting principles.
/s/ COOPERS & LYBRAND LLP
Miami, Florida
March 15, 1996
52
<PAGE> 53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NOT APPLICABLE
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors. The information with respect to the directors required
under this item is set forth below.
The Registrant's Board of Directors is classified into three classes.
Directors are elected by the stockholders of the Registrant at each annual
meeting of stockholders and serve until the third annual meeting of
stockholders following their election and until their successors are elected and
qualified or until their earlier removal or resignation. The offices referred
to in the table are offices of the Registrant, unless otherwise indicated.
<TABLE>
<CAPTION>
YEAR FIRST BECAME
NAME AND AGE A DIRECTOR PRINCIPAL OCCUPATION DURING THE PAST FIVE YEARS
- ------------ ----------------- ------------------------------------------------
<S> <C> <C>
Members of the Board of Directors--terms expiring in 1999;
Dr. Seth Flam, 38 1986 Chief Executive Officer since 1986 and President
since November 1, 1996.
Dr. Howard Hassman, 40 1986 Executive Vice President - Corporate Development
since September 1994; Chief Financial Officer from
1986 to September 1994.
Sheldon Derezin, 49 1996 Managing Partner, Derezin Breier & Company, a
public accounting firm, since 1982.
Dr. Stephen J. Dresnick, 47 1996 Vice Chairman of the Board since 1996 and
President and Chief Executive Officer, Sterling
Healthcare Group, Inc. since 1987. Director,
Embassy Acquisition Corp. and Trustee, Florida
International University.
Members of the Board of Directors--terms expiring in 1998;
Dr. Kevin Ellis, 40 1988 Chief Medical Officer since April 1995; Chief
Operating Officer from 1988 until April 1995.
Dr. Herbert A. Wertheim, 57 1996 Founder, Chairman and Chief Executive Officer,
Brain Power Incorporated, a manufacturer of optical
instruments and chemicals, since 1971. Director,
Bacou USA, Inc. and Trustee, Florida International
University.
Members of the Board of Directors--terms expiring in 1997;
Dr. Sol Lizerbram, 49 1986 Chairman of the Board since 1986 and President
from 1986 until October 31, 1996. Director,
MedNet, MPC Corporation, a publicly held
managed pharmacy service company.
Dr. Michael Feinstein, 48 1986 Primary Care Physician, Family Practice Associates
of San Diego, Inc., an osteopathic medical
corporation since 1986; Director of
Medical Education from 1986 until January 1996.
</TABLE>
Pursuant to the terms of the Agreement and Plan of Merger dated May 19,
1996 by and among the Registrant, Sterling Acquisition Corporation and Sterling
Healthcare Group, Inc., Dr. Dresnick and Dr. Wertheim were appointed to the
Board of Directors until the date of the 1999 and 1998 annual meeting of
stockholders, respectively.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the
directors, certain officers of the Registrant and beneficial owners of more than
ten percent of the Registrant's Common Stock to file reports of securities
ownership and changes in such ownership with the Securities and Exchange
Commission. Based solely upon a review of the copies of such forms furnished
to the Registrant and the representations made by such persons to the
Registrant, the Registrant believes that during the last fiscal year its
directors, officers and ten percent beneficial owners complied with all
reporting requirements under Section 16(a) of the Securities Exchange Act of
1934.
(b) Executive Officers of the Registrant. The information with respect to
the executive officers required under this item is set forth in Part I of this
Report.
53
<PAGE> 54
ITEM 11. EXECUTIVE COMPENSATION
The information required under this item is set forth below.
EXECUTIVE COMPENSATION
Cash Compensation
The following table sets forth certain information regarding
compensation from the Registrant which was awarded to, earned by, or paid to
the Registrant's Chief Executive Officer and the four other most highly
compensated executive officers in 1996.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM
-------------------------------------- COMPENSATION AWARDS
OTHER ANNUAL ------------------- ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION SHARES UNDERLYING COMPENSATION
POSITION YEAR ($)(1) ($) ($)(2) OPTIONS/SARs(#) ($)(3)
- ------------------ ---- -------- ---------- ------------ ------------------- ------------
<S> <C>
Seth Flam................................... 1994 $172,500 $ 4,953 50,000 $750,000
President, Chief Executive Officer and 1995 201,000 18,226 60,000 3,606
Director(4) 1996 296,048 $ 800,000 14,727 671,000 1,204
Sol Lizerbram............................... 1994 150,000 7,010 50,000 757,030
Chairman of the Board of Directors(5) 1995 189,750 16,214 60,000 16,397
1996 296,048 800,000 22,091 671,000 19,404
Stephen J. Dresnick......................... 1994 262,000 205,635(6) 300,000
Vice Chairman of the Board of Directors 1995 325,000 303,349(7) 252,000
and President, Sterling Healthcare 1996 330,208 1,592,859 722,502(8) 481,250
Group, Inc.
Steven M. Lash(9)........................... 1994 68,974 3,676 269,274 773
Executive Vice President and Chief 1995 205,000 50,000 11,645 20,000 7,246
Financial Officer 1996 257,583 800,000 8,431 437,250 113,125
Howard Hassman.............................. 1994 150,000 7,368 50,000 754,941
Executive Vice President -- Corporate 1995 174,750 16,815 60,000 6,566
Development and Director 1996 232,465 800,000 22,150 303,000 7,026
</TABLE>
- ------------------
(1) Includes compensation accrued for the benefit of Drs. Flam, Lizerbram,
Dresnick and Hassman of $68,546, $68,546, $42,706 and $32,965,
respectively, and $47,583 for the benefit of Mr. Lash as of December 31,
1996, that was paid in March 1997.
(2) Includes payment by the Registrant of auto expenses.
(3) Includes a stock dividend received by Drs. Flam, Lizerbram and Hassman,
which stock was subsequently redeemed for $750,000. Includes stock received
by Mr. Lash in 1996 valued at $106,500 and taxable income resulting from
the exercise of non-qualified stock options received by Dr. Dresnick in
1996 in the amount of $481,250. Also includes life and disability insurance
premiums paid on behalf of each such officer.
(4) Dr. Flam was elected President effective November 1, 1996.
(5) Dr. Lizerbram served as President until November 1, 1996.
54
<PAGE> 55
(6) $80,635 of such amount was accrued for Dr. Dresnick's benefit as of
December 31, 1994 and paid to Dr. Dresnick in February 1995.
(7) $68,807 of such amount was accrued for Dr. Dresnick's benefit as of
December 31, 1995 and paid to Dr. Dresnick in April 1996.
(8) Includes 572,502 options granted by the Registrant after completion of
the merger with Sterling Healthcare Group, Inc. to replace options
previously granted to Dr. Dresnick by Sterling Healthcare Group, Inc.
(9) Mr. Lash commenced employment with the Registrant on September 1, 1994.
Stock Option Grants in 1996
The following table sets forth information concerning stock options
granted to the named executive officers in 1996.
OPTION GRANTS DURING 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------------------------------------
Potential Realizable
Shares % of Total Value at Assumed Annual
Underlying Options/ Rates of Stock Price
Options/ SARs Exercise Appreciation for
SARs Granted to or Base Option Term(3)
Granted Employees Price Expiration -------------------------
Name (#)(1) During Year ($/Sh)(2) Date 5%($) 10%($)
---- ---------- ----------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Seth Flam. . . . . . . 100,000(A) 2.26 $10.8125 3/12/2006 $ 679,992 $ 1,723,234
51,000(B) 1.15 13.7500 7/10/2006 440,859 1,117,137
120,000(C) 2.72 17.0000 7/26/2006 1,282,945 3,251,234
400,000(D) 9.05 19.0625 11/29/2006 4,795,322 12,152,286
Sol Lizerbraun . . . . 100,000(A) 2.26 10.8125 3/12/2006 679,992 1,723,234
51,000(B) 1.15 13.7500 7/10/2006 440,860 1,117,137
120,000(C) 2.72 17.0000 7/26/2006 1,282,945 3,251,235
400,000(D) 9.05 19.0625 11/29/2006 4,785,322 12,152,286
Stephen J. Dresnick. . 95,100(E) 2.15 21.2300 9/08/2001 308,522 898,266
95,100(F) 2.15 14.4600 5/06/2007 1,692,236 3,626,956
1,902(G) 0.04 13.1400 6/01/2000 18,764 26,708
95,100(G) 2.15 11.4400 4/03/2000 1,082,683 1,457,566
285,300(G) 6.46 12.6200 10/31/2006 5,374,489 10,690,662
150,000(D) 3.39 19.0625 11/29/2006 1,796,246 4,557,107
Steven M. Lash . . . . 80,000(A) 1.81 10.8125 3/12/2006 543,994 1,376,587
47,250(B) 1.07 13.7500 7/10/2006 408,444 1,034,995
60,000(C) 1.36 17.0000 7/26/2006 641,473 1,625,617
250,000(D) 5.66 19.0625 11/29/2006 2,997,076 7,595,179
Howard Hassman . . . . 60,000(A) 1.36 10.8125 3/12/2006 407,996 1,033,940
45,000(B) 1.02 13.7500 7/10/2006 388,993 985,709
48,000(C) 1.09 17.0000 7/26/2006 513,178 1,300,494
150,000(D) 3.39 19.0625 11/20/2006 1,798,246 4,557,107
</TABLE>
- ---------------
(1) A. One-fourth of these options vest on each of March 12, 1998, 1999, 2000
and 2001.
B. One-third of these options vest on each of August 1, 1997, 1998 and 1999.
C. One-third of these options vest on each of July 26, 1999, 2000 and 2001.
55
<PAGE> 56
D. One-tenth of these options vest on each of the first through
tenth anniversaries of the date of grant, November 29, 1996,
upon achievement of earnings per share targets.
E. These options have vested.
F. Two-thirds of these options have vested, and one-third will
vest upon the earlier of May 6, 2005 or the date the Registrant
obtains net earnings per share of $.73 for the trailing four
quarters.
G. These options have vested.
(2) The option exercise price may be paid in shares of the Registrant's
Common Stock, in cash, or in any other form of valid consideration or a
combination of any of the foregoing, as determined by the Compensation
Committee of the Registrant's Board in its discretion.
(3) The potential realizable value portion of the foregoing table
illustrates value that might be realized should the granted options be
exercised immediately prior to their expiration date and assumes that
the respective rates of appreciation on the Registrant's Common Stock
compound annually until such exercise. These figures make no allowance
for any reduction of potential value which may be caused because of the
termination of the options following termination of employment,
nontransferability or vesting over periods of up to five years.
Aggregated Stock Option Exercises in 1996 and Stock Option Values at December
31, 1996
The following tables set forth information concerning the number of
stock options granted during 1996 and the value of unexercised options to
purchase the Registrant's Common Stock held by the named executive officers at
December 31, 1996. None of the named executive officers exercised any stock
options during 1996.
OPTION EXERCISES DURING 1996 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS
YEAR END($) AT YEAR END($)(1)
----------------------------- -----------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Seth Flam............ 37,000 744,000 $ 597,063 $4,614,000
Sol Lizerbram........ 37,000 744,000 597,063 4,616,000
Stephen J. Dresnick.. 524,592 197,910 4,171,533 982,376
Steven M. Lash....... 131,456 595,068 2,261,332 5,130,052
Howard Hassman....... 37,000 376,000 597,063 2,907,625
</TABLE>
- ------------
(1) The closing price for the Common Stock as reported on the Nasdaq National
Market on December 31, 1996 was $22.375. Value is calculated on the basis
of the difference, if any, between the option exercise price and $22.375,
multiplied by the number of shares of the Registrant's Common Stock
issuable upon exercise of the option.
56
<PAGE> 57
Employment Agreements
The Registrant entered into employment agreements with Drs. Flam,
Lizerbram and Hassman, and Mr. Lash, as President and Chief Executive Officer;
Chairman; Executive Vice President -- Corporate Development; and Executive Vice
President and Chief Financial Officer, respectively, each effective as of
October 1, 1996 and terminating on December 31, 2002, subject to two automatic
one-year extensions unless notice by either party is given. Pursuant to these
agreements as amended, Drs. Flam, Lizerbram and Hassman and Mr. Lash receive
annual base salaries, commencing October 1, 1996, of $425,000, $425,000,
$250,000 and $325,000, respectively. Such salaries will be subject to annual
increases after 1997 as determined subjectively by the Compensation Committee of
the Registrant's Board based on individual performance and the Registrant's
results of operations. In addition, each of the executives will be entitled to a
bonus calculated as a percentage of base salary based on pre-established
performance targets for each year.
The employment agreements generally provide that if the employee is
terminated other than for cause, the employee is entitled to full salary and
benefits through December 31, 2002. In the event of a change in control of he
Registrant, each of the executives will be entitled to payments equal to
approximately three times the previous year's base salary and bonus. The
employment agreements also provide each of the above officers with a car
allowance, professional fees, term life insurance, vacation, medical insurance,
disability insurance and liability insurance. In addition, each of the
employment agreements contains a covenant not to compete during employment and
for five years thereafter.
Dr. Dresnick has entered into an employment agreement terminating on
October 31, 1999 pursuant to which he receives an annual base salary of
$325,000, which salary is subject to annual increases at the discretion of the
Board of Directors of Sterling Healthcare Group, Inc. ("Sterling"), and an
annual bonus based on the net income, before taxes of Sterling. Dr. Dresnick is
not entitled to any compensation in the event of a change in control or
non-renewal of his employment agreement upon termination. The employment
agreement provides Dr. Dresnick with a car allowance, vacation and medical
insurance and contains a covenant not to compete during employment and for two
years thereafter.
Compensation of Directors
Non-employee directors currently receive $1,000 per Board of Directors
or committee meeting attended. The Company also reimburses directors for
expenses incurred in connection with attendance at meetings of the Board of
Directors and committees.
In addition, under the Company's 1995 Non-Employee Directors'
Non-Qualified Stock Option Plan (the "Directors' Plan"), non-employee directors
receive an annual grant of options to purchase 5,000 shares of Common Stock at
a price equal to the fair market
57
<PAGE> 58
value of the Common Stock on the date the option is granted. Each option
generally expires upon the earlier of twelve months after the optionee ceases
to be a director of the Company or ten years after the date of grant. The
purpose of the Directors' Plan is to attract and retain independent directors
and to strengthen the mutuality of interests between such directors and the
Company's stockholders.
Compensation Committee Report
The Compensation Committee of the Board of Directors (the "Committee")
made all recommendations regarding salaries and incentive compensation for the
senior executive officers during 1996.
The Committee is composed entirely of outside, nonmanagement directors.
No member of the Committee is a former or current officer of the Company. The
Committee employed in 1996 and the Committee will employ in 1997 the following
policies for determining compensation for the Company's executive officers.
The goals of the Company's compensation program continue to be to
attract and retain executive officers, motivate such officers to achieve the
Company's business objectives and to contribute to the long-term success of the
Company, foster teamwork and reward officers for the achievement of such goals.
The Company utilizes salary and performance-based bonuses and stock options to
meet these goals.
Specifically, the Company seeks to: (i) provide rewards which are
closely linked to Company, team and individual performance; (ii) align the
interests of the Company's employees with those of its stockholders; and (iii)
ensure that compensation and benefits are at levels which enable the Company to
attract and retain high-quality employees.
The Company applies these objectives and policies to most employees
through a combination of base salaries, performance-based cash incentive
opportunities and stock option grants based upon pre-established revenue and
profit targets, significant corporate achievements and other subjective job
performance criteria.
The Company has considered and will continue to consider the potential
impact of Section 162(m) of the Internal Revenue Code adopted under the Revenue
Reconciliation Act of 1993. Section 162(m) disallows a tax deduction for any
publicly-held corporation for individual compensation exceeding $1 million in
any taxable year for the named executive officers, unless compensation is
performance-based. Since the targeted non-performance based cash compensation
of each of the named executive officers is below the $1 million threshold and
any options granted under the Company's stock option plan will meet the
requirement of being performance-based, the Company believes that this section
will not reduce the tax deduction available to the Company. The Company's
policy is to qualify to the maximum extent possible its executives'
compensation for deductibility under applicable tax laws.
58
<PAGE> 59
Base Salary and Bonus
Executive officer base salary and individual performance-based bonus
awards are determined by reference to Company-wide and individual performance
for the previous fiscal year, based on a wide range of quantitative and
qualitative measures which permit comparisons with competitors' performance and
internal earnings and market share targets set before the start of each year.
In addition to Company-wide measures of performance, the Company considers
those performance factors particular to each executive officer, the performance
of the group or groups for which such officer had management responsibility and
individual managerial accomplishments.
The Company relies heavily, but not exclusively, on these quantitative
and qualitative measures in setting compensation for all officers and, in
particular, the executive officers. The Company also exercises subjective
judgment and discretion in light of these measures and in view of the Company's
compensation objectives and policies described above to determine base
salaries, overall bonus funds and individual bonus awards.
Stock Options and Stock Grants
In addition to base salary and bonus, the Company may utilize stock
options and stock grants to motivate and retain executive officers. The Company
believes that this form of compensation closely aligns the officers' interests
with those of stockholders and provides a major incentive to officers in
building stockholder value. Options are granted annually and are subject to
vesting provisions to encourage officers to remain employed with the Company.
During the past fiscal year, each executive officer received stock options in
amounts based upon a determination of that officer's relative position,
responsibilities, performance during the previous fiscal year and anticipated
performance in the upcoming year. The Company also reviews the total holdings
of the executive officers and the prior level of grants to the officers and
other members of senior management, including the number of shares which
continue to be subject to vesting under outstanding options, in setting the
level of options to be granted to the executive officers.
Compensation of the Chief Executive Officer
The Company's approach in establishing Dr. Flam's annual compensation
was governed by the Company's overall compensation strategy as discussed above.
This report was provided by the following members of the Board of
Directors for 1996:
Sheldon Derezin
Dr. Herbert Wertheim
59
<PAGE> 60
Stock Performance Graph
The following performance graph compares the performance of the
Company's Common Stock to the Nasdaq Stock Market U.S. Index and the Nasdaq
Stock Market Health Services Index (the "Indices") from October 20, 1994, the
date of the Company's initial public offering of Common Stock, until December
31, 1996. The graph is based on publicly available information. The graph
assumes an investment of $100 in the Company's Common Stock and in each of the
Indices on October 20, 1994, the date of the Company's initial public offering
of Common Stock, and assumes reinvestment of dividends.
Price Points
FPA MEDICAL MANAGEMENT
PRICE POINTS
<TABLE>
<CAPTION>
10/20/94 12/30/94 3/31/95 6/30/95 9/29/95 12/29/95 3/29/96 6/28/96 9/30/96 12/31/96
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
FPAM 100 125 225 200 185 187.5 250 311.25 527.5 447.5
Nasdaq (US) 100 98.27 107.13 122.54 137.3 138.97 145.46 157.34 162.93 170.92
Nasdaq Health Service Stocks 100 97.74 107.1 92.18 107.03 124.15 129.44 141.1 140.57 124.28
</TABLE>
60
<PAGE> 61
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of shares of Common Stock as of April 1, 1997 by (i) each
person known by the Company to be the beneficial owner of more than 5% of the
outstanding shares of Common Stock, (ii) each of the Company's directors who
owns shares of Common Stock, (iii) each executive officer named in the table
under the caption "Executive Compensation" and (iv) all directors and officers
as a group.
<TABLE>
<CAPTION>
Percentage
Name and Address of Beneficial Owner (1) Shares of Common Stock Beneficially
- ---------------------------------------- ---------------------- ------------
<S> <C> <C>
Sol Lizerbram(2)...................................... 380,113 1.2%
Seth Flam............................................. 396,175 1.3%
Howard Hassman(3)..................................... 396,600 1.3%
Kevin Ellis........................................... 410,600 1.3%
Michael Feinstein..................................... 408,100 1.3%
Stephen Dresnick(4)................................... 1,869,254 5.7%
Sheldon Derezin....................................... 25,500 *
Steven Lash........................................... 170,692 *
Herbert Wertheim...................................... 203,894 *
Foundation Health Corporation(5)...................... 4,076,087 11.7%
All officers and directors as a group (11 persons).... 4,303,978 12.3%
</TABLE>
- ---------------
* Less than 1%.
(1) Unless otherwise indicated, the address of each of the persons named above
is in care of the Registrant at 3636 Nobel Drive, Suite 200, San Diego,
California 92122. A person is deemed to be the beneficial owner of
securities that can be acquired by such person within 60 days from April 1,
1997 upon the exercise of options or warrants. Each beneficial owner's
number of shares is determined by assuming that options or warrants that
are held by such person (but not those held by any other person) and that
are exercisable within 60 days from April 1, 1997 have been exercised. The
total outstanding shares used to calculate each beneficial owner's
percentage includes such options and warrants. Unless otherwise noted, the
Registrant believes that all persons named in the table have sole voting
and investment power with respect to all shares of Common Stock
beneficially owned to them.
(2) Shares attributable to Dr. Lizerbram are held by the Lizerbram Family
Trust, of which Dr. Lizerbram is Trustee and together with his wife, the
sole beneficiaries.
(3) Shares attributable to Dr. Hassman are held by Hassman, L.P., a limited
partnership of which Clinical Partners Medical Group, P.C. is the General
Partner, of which Dr. Hassman is the sole shareholder.
(4) Shares attributable to Dr. Dresnick are held by several corporations and
limited partnerships in which Dr. Dresnick or a corporation owned by him is
the sole stockholder and limited and general partners.
(5) Foundation Health Corporation ("FHC") and the Registrant entered into a
voting agreement as of November 29, 1996 pursuant to which FHC has agreed
to vote its shares of FPA Common Stock in accordance with the
recommendation of the Board of Directors of FPA as to all matters with
respect to which the Board makes a recommendation except with respect to
(a) any sale, lease, assignment, transfer or other conveyance of all or
substantially all of the assets or capital stock of FPA, or any
consolidation or merger involving FPA, or any reclassification or other
change of any stock, or any recapitalization of FPA and (b) any amendment
of the Certificate of Incorporation or By-laws of FPA if such amendment
would change any of the rights, preferences or privileges of the FPA Common
Stock.
61
<PAGE> 62
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Effective October 1, 1996, one of the Registrant's affiliated
professional corporations and the Registrant acquired substantially all of the
assets and assumed certain liabilities of Family Practice Associates of San
Diego, an Osteopathic Corporation ("FPASD"), for aggregate consideration of
approximately $4,200,000. FPASD is owned by Drs. Flam, Lizerbram, Hassman,
Feinstein and Kevin Ellis, the Registrant's Executive Vice President and Chief
Medical Officer.
62
<PAGE> 63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
(1) Financial Statements:
Report of Independent Public Accountants
Consolidated Balance Sheets, December 31, 1995 and 1996
Consolidated Statements of Operations for the Years Ended
December 31, 1994, 1995 and 1996
Consolidated Statements of Stockholders' Equity (Deficit) for the
Years Ended December 31, 1994, 1995 and 1996
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1994, 1995 and 1996
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
All schedules have been omitted because they are inapplicable, not
required, or the information is included elsewhere in the consolidated
Financial Statements or Notes thereto.
(3) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF DOCUMENTS
- ----------- ------------------------
<S> <C>
3.1 Certificate of Incorporation.*
3.2 Bylaws.
3.3 Certificate of Amendment of Certificate of Incorporation filed
October 20, 1994 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1994 at Exhibit No.
3.3) .
3.4 Certificate of Amendment of Certificate of Incorporation filed
August 6, 1996.
4.1 Specimen of Common Stock Certificate.*
4.2 Form of Warrant.*
10.1 IPA Medicare Partial Risk Services Agreement between PacifiCare of
California and Family Practice Associates of San Diego, Inc.
("FPASD") dated January 1, 1993, including an amendment thereto
effective the date thereof and an amendment thereto date effective
January 1, 1994.* **
10.2 [Reserved]
10.3 Medical Services Organization Agreement dated January 21, 1995
between FPANJ and Medigroup, Inc. (HMO Blue).* **
10.4 PacifiCare IPA Commercial Services Agreement with FPASD dated May 1,
1995.* **
10.5 Amendment to IPA Medicare Partial Risk Services Agreement between
PacifiCare of California and FPASD dated April 1995.* **
10.6 [Reserved]
10.7 Form of Primary Care Physician Agreement/California.* **
10.8 Form of Specialty Care Physician Agreement/California.* **
10.9 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
10.10 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
</TABLE>
63
<PAGE> 64
<TABLE>
<CAPTION>
<S> <C>
10.11 Form of Succession Agreement.*
10.12 Employment Agreement between FPA and Dr. Sol Lizerbram effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.13) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.12).* +
10.13 Employment Agreement between FPA and Dr. Seth Flam effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.14) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.13).* +
10.14 Employment Agreement between FPA and Dr. Howard Hassman effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.15) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.14).* +
10.15 Employment Agreement between FPA and Dr. Kevin Ellis effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.16) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.15).* +
10.16 Amended and Restated Employment Agreement between FPA and Steven M.
Lash effective September 1, 1994 (incorporated by reference to FPA's
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit No. 10.26). +
10.17 Amended and Restated Employment Contract dated as of January 1, 1995
between Sterling Healthcare Group, Inc. and Stephen J. Dresnick,
M.D. (incorporated by reference to Sterling Healthcare Group, Inc.'s
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit 10.31). +
10.18 Employment Agreement between FPA and James A. Lebovitz effective
March 1, 1996 (incorporated by reference to FPA's Annual Report on
Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.18). +
10.19 FPA Omnibus Stock Option Plan (incorporated by reference to
Registration Statement No. 33-79714 at Exhibit No. 10.19). +
10.20 Indenture dated as of December 18, 1996 by and between FPA and First
Union National Trust Bank relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.1).
10.21 Registration Rights Agreement dated December 13, 1996 by and among
FPA and the Initial Purchasers relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.2).
10.22 Form of Rule 144A Restricted Global Debenture relating to FPA's 6
1/2% Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.4).
10.23 Form of Regulation S Global Debenture relating to FPA's 6 1/2%
Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.5).
10.24 401(K) Salary Savings Plan effective January 1, 1994. +
10.25 1995 Directors Stock Option Plan.* +
10.26 1994 Physicians Stock Option Plan.*
10.27 Credit, Security, Guarantee and Pledge Agreement dated as of January
29, 1996 among FPA and its subsidiaries and certain guarantors and
the lenders named therein and Banque Paribas, as amended March 15,
1996 (incorporated by reference to FPA's Annual Report on Form 10-K
for the year ended December 31, 1995 at Exhibit No. 10.27).
</TABLE>
64
<PAGE> 65
<TABLE>
<CAPTION>
<S> <C>
10.28 [Reserved]
10.29 Form of Indemnification Agreement.*
21 Subsidiaries of the Registrant.
23 Consent of Deloitte & Touche LLP.
23.1 Consent of Coopers & Lybrand LLP.
</TABLE>
* Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form S-1, Reg. No. 33-97456, at the
exhibit number set forth opposite such exhibit's description above.
** Registrant has requested confidential treatment from the Securities
and Exchange Commission for portions of this exhibit, which
confidential portions have been filed separately.
+ Constitutes a management contract or compensatory plan to be filed
as an Exhibit to this Report pursuant to Item 14(c) of Form 10-K.
(b) Reports on Form 8-K. The Registrant filed the following current Reports
on Form 8-K during the quarter ended December 31, 1996 and through March 21,
1997:
DATE OF REPORT ITEMS REPORTED
- -------------- --------------
October 31, 1996.................................................2 and 7
November 8, 1996.................................................5 and 7
November 26, 1996................................................5 and 7
December 10, 1996................................................2 and 7
December 13, 1996................................................5 and 7
December 18, 1996................................................7 and 9
March 17, 1997...................................................2 and 7
65
<PAGE> 66
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
FPA MEDICAL MANAGEMENT, INC.
(Registrant)
By: /s/ SETH FLAM
------------------------
Seth Flam
President
April 28, 1997
66
<PAGE> 67
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF DOCUMENTS
----------- ------------------------
<TABLE>
<CAPTION>
<S> <C>
3.1 Certificate of Incorporation.*
3.2 Bylaws.
3.3 Certificate of Amendment of Certificate of Incorporation filed
October 20, 1994 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1994 at Exhibit No.
3.3) .
3.4 Certificate of Amendment of Certificate of Incorporation filed
August 6, 1996.
4.1 Specimen of Common Stock Certificate.*
4.2 Form of Warrant.*
10.1 IPA Medicare Partial Risk Services Agreement between PacifiCare of
California and Family Practice Associates of San Diego, Inc.
("FPASD") dated January 1, 1993, including an amendment thereto
effective the date thereof and an amendment thereto date effective
January 1, 1994.* **
10.2 [Reserved]
10.3 Medical Services Organization Agreement dated January 21, 1995
between FPANJ and Medigroup, Inc. (HMO Blue).* **
10.4 PacifiCare IPA Commercial Services Agreement with FPASD dated May 1,
1995.* **
10.5 Amendment to IPA Medicare Partial Risk Services Agreement between
PacifiCare of California and FPASD dated April 1995.* **
10.6 [Reserved]
10.7 Form of Primary Care Physician Agreement/California.* **
10.8 Form of Specialty Care Physician Agreement/California.* **
10.9 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
10.10 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
10.11 Form of Succession Agreement.*
10.12 Employment Agreement between FPA and Dr. Sol Lizerbram effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.13) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.12).* +
10.13 Employment Agreement between FPA and Dr. Seth Flam effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.14) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.13).* +
10.14 Employment Agreement between FPA and Dr. Howard Hassman effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.15) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.14).* +
10.15 Employment Agreement between FPA and Dr. Kevin Ellis effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.16) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.15).* +
</TABLE>
<PAGE> 68
<TABLE>
<CAPTION>
<S> <C>
10.16 Amended and Restated Employment Agreement between FPA and Steven M.
Lash effective September 1, 1994 (incorporated by reference to FPA's
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit No. 10.26). +
10.17 Amended and Restated Employment Contract dated as of January 1, 1995
between Sterling Healthcare Group, Inc. and Stephen J. Dresnick,
M.D. (incorporated by reference to Sterling Healthcare Group, Inc.'s
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit 10.31). +
10.18 Employment Agreement between FPA and James A. Lebovitz effective
March 1, 1996 (incorporated by reference to FPA's Annual Report on
Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.18). +
10.19 FPA Omnibus Stock Option Plan (incorporated by reference to
Registration Statement No. 33-79714 at Exhibit No. 10.19). +
10.20 Indenture dated as of December 18, 1996 by and between FPA and First
Union National Trust Bank relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.1).
10.21 Registration Rights Agreement dated December 13, 1996 by and among
FPA and the Initial Purchasers relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.2).
10.22 Form of Rule 144A Restricted Global Debenture relating to FPA's 6
1/2% Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.4).
10.23 Form of Regulation S Global Debenture relating to FPA's 6 1/2%
Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.5).
10.24 401(K) Salary Savings Plan effective January 1, 1994. +
10.25 1995 Directors Stock Option Plan.* +
10.26 1994 Physicians Stock Option Plan.*
10.27 Credit, Security, Guarantee and Pledge Agreement dated as of January
29, 1996 among FPA and its subsidiaries and certain guarantors and
the lenders named therein and Banque Paribas, as amended March 15,
1996 (incorporated by reference to FPA's Annual Report on Form 10-K
for the year ended December 31, 1995 at Exhibit No. 10.27).
10.28 [Reserved]
10.29 Form of Indemnification Agreement.*
21 Subsidiaries of the Registrant.
23 Consent of Deloitte & Touche LLP.
23.1 Consent of Coopers & Lybrand LLP.
</TABLE>
* Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form S-1, Reg. No. 33-97456, at the
exhibit number set forth opposite such exhibit's description above.
** Registrant has requested confidential treatment from the Securities
and Exchange Commission for portions of this exhibit, which
confidential portions have been filed separately.
+ Constitutes a management contract or compensatory plan to be filed
as an Exhibit to this Report pursuant to Item 14(c) of Form 10-K.
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements on Form
S-3 (Nos. 333-3760 and 333-2007) and Form S-8 (Nos. 33-00074, 33-00076,
333-16741 and 333-15755) of FPA Medical Management, Inc. of our report dated
March 21, 1997, appearing in this Annual Report on Form 10-K/A of FPA Medical
Management, Inc. for the year ended December 31, 1996.
/s/ Deloitte & Touche LLP
San Diego, California
April 25, 1997
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statements of
FPA Medical Management, Inc. on Form S-3 (File Nos. 333-3760 and 333-2007) and
on Form S-8 (File Nos. 333-00076, 333-16741 and 333-15755) of our report dated
March 15, 1996, on our audits of the consolidated financial statements of
Sterling Healthcare Group, Inc. as of December 31, 1995, and for the year ended
December 31, 1995 and for the period from June 1, 1994 to December 31, 1994,
which report is included in this Annual Report on Form 10-K/A.
/s/ COOPERS & LYBRAND LLP
Miami, Florida
April 22, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 5,594,877
<SECURITIES> 40,000,000
<RECEIVABLES> 216,272,051
<ALLOWANCES> 59,796,488
<INVENTORY> 0
<CURRENT-ASSETS> 228,356,136
<PP&E> 46,497,830
<DEPRECIATION> 6,358,498
<TOTAL-ASSETS> 577,270,277
<CURRENT-LIABILITIES> 240,434,392
<BONDS> 0
<COMMON> 49,542
0
0
<OTHER-SE> 143,468,497
<TOTAL-LIABILITY-AND-EQUITY> 577,270,277
<SALES> 0
<TOTAL-REVENUES> 440,318,613
<CGS> 0
<TOTAL-COSTS> 313,706,608
<OTHER-EXPENSES> 137,201,187
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (5,127,244)
<INCOME-PRETAX> (15,716,426)
<INCOME-TAX> 0
<INCOME-CONTINUING> (15,716,426)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,716,426)
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