<PAGE> 1
This filing made pursuant
to Rule 424(b)(3) under
the Securities Act of
1933 in connection with
Registration No. 333-21721
FPA MEDICAL MANAGEMENT, INC.
3636 NOBEL DRIVE
SUITE 200
SAN DIEGO, CALIFORNIA 92122
February 14, 1997
TO OUR STOCKHOLDERS:
You are cordially invited to attend the Special Meeting of Stockholders of
FPA Medical Management, Inc. ("FPA") to be held Monday, March 17, 1997 at 10:00
a.m. local time at FPA's offices, 3636 Nobel Drive, Suite 200, San Diego,
California 92122 (the "FPA Special Meeting").
At the FPA Special Meeting, stockholders will be asked to consider and vote
upon a proposal to adopt an Agreement and Plan of Merger (as amended, the
"Merger Agreement") between FPA, FPA Acquisition Corp., a wholly owned
subsidiary of FPA ("Merger Sub"), and AHI Healthcare Systems, Inc. ("AHI"). The
Merger Agreement provides, among other things, for the merger of Merger Sub with
and into AHI (the "Merger") pursuant to which AHI will become a wholly owned
subsidiary of FPA. In connection with the Merger, each outstanding share of AHI
Common Stock, par value $.01 per share ("AHI Common Stock"), will be converted
into a fraction (the "Conversion Number") of one share of FPA Common Stock, par
value $.002 per share ("FPA Common Stock"). The Conversion Number will vary
based on the average trading price of FPA Common Stock for the ten consecutive
trading days ending two days prior to the special meeting of AHI's stockholders
relating to the Merger (the "FPA Value"). Consequently, the FPA Value may differ
from the actual market price of FPA Common Stock reported by the Nasdaq National
Market on the date of the FPA Special Meeting, the date of consummation of the
Merger, or the date that AHI stockholders actually receive their shares of FPA
Common Stock after the Merger is completed. If the FPA Value is equal to or
greater than $14.38 and less than $22.38, the Conversion Number will be adjusted
such that the "value" to be received for each share of AHI Common Stock (the
"Equivalent Value") will equal $8.75. Both the Equivalent Value and the
Conversion Number may be adjusted if the FPA Value is equal to or greater than
$22.38 or less than $14.38. The Merger Agreement may be terminated by AHI if the
FPA Value is less than $10.00. If the FPA Value is $10.00, the Conversion Number
will be .609 and the Equivalent Value will be $6.09. The adjustments to the
Conversion Number and the Equivalent Value are described more fully in the
accompanying Proxy Statement/Prospectus. STOCKHOLDERS OF FPA WILL BE ABLE TO
OBTAIN THE CONVERSION NUMBER BEGINNING TWO DAYS PRIOR TO THE FPA SPECIAL MEETING
BY CALLING (800) 965-7026. Based upon the 14,523,041 shares of AHI Common Stock
outstanding on February 7, 1997 and assuming an FPA Value of $24.25, which was
the closing price of FPA Common Stock on that date, as of such date, AHI's
stockholders would be issued approximately 5,678,509 shares of FPA Common Stock,
representing approximately 18.6% of the total issued and outstanding shares of
FPA after the Merger.
At the FPA Special Meeting, stockholders will also be asked to approve an
amendment to the FPA Medical Management, Inc. Omnibus Stock Option Plan (the
"FPA Plan"), which would, upon becoming effective, increase the total number of
shares of FPA Common Stock issuable upon exercise of options granted under such
plan from 5,000,000 to 6,500,000.
FPA stockholders will also be asked to approve the adjournment or
postponement of the FPA Special Meeting in the event that such adjournment or
postponement is necessary in order to solicit additional votes for approval of
the foregoing proposals.
Details of the foregoing proposals (the "FPA Proposals") and FPA Special
Meeting are contained in the attached Notice of Special Meeting and Proxy
Statement/Prospectus. Your votes on the FPA Proposals are important to FPA, so
please read this information carefully.
The Board of Directors of FPA believes that the Merger is fair to and in
the best interests of, and that the amendment to the FPA Plan is fair to, FPA
and its stockholders and, accordingly, has adopted such proposals. The Board of
Directors of FPA recommends that you vote FOR each of the FPA Proposals. The
Board of
<PAGE> 2
Directors of FPA has obtained an opinion from Needham & Company, Inc. as to the
fairness, from a financial point of view, to FPA's stockholders of the
consideration to be paid by FPA in the Merger.
All stockholders are invited to attend the FPA Special Meeting. To assure
your representation at the FPA Special Meeting, please complete, sign, date and
return the accompanying proxy in the enclosed postage prepaid envelope. If you
are able to attend the FPA Special Meeting, you may, if you wish, vote your
shares in person.
Sincerely yours,
DR. SOL LIZERBRAM
Chairman
<PAGE> 3
FPA MEDICAL MANAGEMENT, INC.
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD MARCH 17, 1997
To the Stockholders of FPA Medical Management, Inc.:
A Special Meeting of FPA Medical Management, Inc. ("FPA") will be held
Monday, March 17, 1997 at 10:00 a.m. local time at FPA's offices, 3636 Nobel
Drive, San Diego, California 92122 (the "FPA Special Meeting") for the following
purposes:
1. To consider and vote upon a proposal to adopt an Agreement and Plan
of Merger (as amended, the "Merger Agreement") between FPA, FPA Acquisition
Corp., a wholly owned subsidiary of FPA ("Merger Sub"), and AHI Healthcare
Systems, Inc. ("AHI"). The Merger Agreement provides, among other things,
for the merger of Merger Sub with and into AHI (the "Merger") pursuant to
which AHI will become a wholly owned subsidiary of FPA. In connection with
the Merger, each outstanding share of AHI Common Stock, par value $.01 per
share ("AHI Common Stock"), will be converted into a fraction (the
"Conversion Number") of one share of FPA Common Stock, par value $.002 per
share ("FPA Common Stock"). The Conversion Number will vary based on the
average trading price of FPA Common Stock for the ten consecutive trading
days ending two days prior to the special meeting of AHI's stockholders
relating to the Merger (the "FPA Value"). Consequently, the FPA Value may
differ from the actual market price of FPA Common Stock reported by the
Nasdaq National Market on the date of the FPA Special Meeting, the date of
consummation of the Merger, or the date that AHI stockholders actually
receive their shares of FPA Common Stock after the Merger is completed. If
the FPA Value is equal to or greater than $14.38 and less than $22.38, the
Conversion Number will be adjusted such that the "value" to be received for
each share of AHI Common Stock (the "Equivalent Value") will equal $8.75.
Both the Equivalent Value and the Conversion Number may be adjusted if the
FPA Value is equal to or greater than $22.38 or less than $14.38. The
Merger Agreement may be terminated by AHI if the FPA Value is less than
$10.00. If the FPA Value is $10.00, the Conversion Number will be .609 and
the Equivalent Value will be $6.09. The adjustments to the Conversion
Number and the Equivalent Value are described more fully in the
accompanying Proxy Statement/Prospectus. STOCKHOLDERS OF FPA WILL BE ABLE
TO OBTAIN THE CONVERSION NUMBER BEGINNING TWO DAYS PRIOR TO THE FPA SPECIAL
MEETING BY CALLING (800) 965-7026. Based upon the 14,523,041 shares of AHI
Common Stock outstanding on February 7, 1997 and assuming an FPA Value of
$24.25, which was the closing price of FPA Common Stock on that date, as of
such date, AHI's stockholders would be issued approximately 5,678,509
shares of FPA Common Stock, representing approximately 18.6% of the total
issued and outstanding shares of FPA after the Merger.
2. To approve an amendment to the FPA Medical Management, Inc. Omnibus
Stock Option Plan (the "FPA Plan"), which would, upon becoming effective,
increase the total number of shares of FPA Common Stock issuable upon
exercise of options granted under such plan from 5,000,000 to 6,500,000.
3. To approve the adjournment or postponement of the FPA Special
Meeting in the event that such adjournment or postponement is necessary in
order to solicit additional votes for approval of the foregoing proposals.
4. To vote on such other business as may properly come before the FPA
Special Meeting.
The foregoing proposals are described in the Proxy Statement/Prospectus
accompanying this Notice.
UNLESS PROPOSAL 1 IS APPROVED BY THE REQUISITE VOTE OF FPA STOCKHOLDERS,
THE MERGER WILL NOT BE CONSUMMATED.
Stockholders of record at the close of business on February 13, 1997 are
entitled to receive notice of, and to vote at, the FPA Special Meeting and any
adjournment thereof.
<PAGE> 4
It is important that your shares be represented at the FPA Special Meeting.
Whether or not you plan to attend the FPA Special Meeting, please complete,
sign, date and promptly mail the enclosed proxy in the envelope provided.
THE BOARD OF DIRECTORS OF FPA RECOMMENDS THAT ITS STOCKHOLDERS VOTE FOR
EACH OF THE PROPOSALS DESCRIBED ABOVE. PLEASE COMPLETE, SIGN, DATE AND PROMPTLY
RETURN YOUR PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE EVEN IF YOU ARE PLANNING
TO ATTEND THE FPA SPECIAL MEETING.
By Order of the Board of Directors
JAMES A. LEBOVITZ
Secretary
San Diego, California
February 14, 1997
<PAGE> 5
This filing made pursuant
to Rule 424(b)(3) under
the Securities Act of
1933 in connection with
Registration No. 333-21721
AHI HEALTHCARE SYSTEMS, INC.
12620 ERICKSON AVENUE, SUITE A
DOWNEY, CALIFORNIA 90241
February 14, 1997
TO OUR STOCKHOLDERS:
You are cordially invited to attend the Special Meeting of Stockholders of
AHI Healthcare Systems, Inc. ("AHI") to be held Monday, March 17 1997 at 10:00
a.m. local time at the Renaissance Long Beach Hotel, 111 East Ocean Boulevard,
Long Beach, California (the "AHI Special Meeting").
At the AHI Special Meeting, stockholders will be asked to consider and vote
upon a proposal to adopt an Agreement and Plan of Merger (as amended, the
"Merger Agreement") between FPA Medical Management, Inc. ("FPA"), FPA
Acquisition Corp., a wholly owned subsidiary of FPA ("Merger Sub"), and AHI. The
Merger Agreement provides, among other things, for the merger of Merger Sub with
and into AHI (the "Merger") pursuant to which AHI will become a wholly owned
subsidiary of FPA. In connection with the Merger, each outstanding share of AHI
Common Stock, par value $.01 per share ("AHI Common Stock"), will be converted
into a fraction (the "Conversion Number") of one share of FPA Common Stock, par
value $.002 per share ("FPA Common Stock"). The Conversion Number will vary
based on the average trading price of FPA Common Stock for the ten consecutive
trading days ending two days prior to the AHI Special Meeting (the "FPA Value").
Consequently, the FPA Value may differ from the actual market price of FPA
Common Stock reported by the Nasdaq National Market on the date of the AHI
Special Meeting, the date of consummation of the Merger, or the date that AHI
stockholders actually receive their shares of FPA Common Stock after the Merger
is completed. If the FPA Value is equal to or greater than $14.38 and less than
$22.38, the Conversion Number will be adjusted such that the "value" to be
received for each share of AHI Common Stock (the "Equivalent Value") will equal
$8.75. Both the Equivalent Value and the Conversion Number may be adjusted if
the FPA Value is equal to or greater than $22.38 or less than $14.38. The Merger
Agreement may be terminated by AHI if the FPA Value is less than $10.00. If the
FPA Value is $10.00, the Conversion Number will be .609 and the Equivalent Value
will be $6.09. The adjustments to the Conversion Number and the Equivalent Value
are described more fully in the accompanying Proxy Statement/Prospectus.
STOCKHOLDERS OF AHI WILL BE ABLE TO OBTAIN THE CONVERSION NUMBER BEGINNING TWO
DAYS PRIOR TO THE AHI SPECIAL MEETING BY CALLING (800) 965-7026. Based upon the
14,523,041 shares of AHI Common Stock outstanding on February 7, 1997, and
assuming an FPA Value of $24.25, which was the closing price of FPA Common Stock
on that date, as of such date, AHI's stockholders would be issued approximately
5,678,509 shares of FPA Common Stock, representing approximately 18.6% of the
total issued and outstanding shares of FPA after the Merger.
AHI stockholders will also be asked to approve the adjournment or
postponement of the AHI Special Meeting in the event that such adjournment or
postponement is necessary in order to solicit additional votes for adoption of
the Merger Agreement.
Details of the foregoing proposals and the AHI Special Meeting are
contained in the attached Notice of Special Meeting and Proxy
Statement/Prospectus. Your vote on the Merger Agreement is important to AHI, so
please read this information carefully.
The Board of Directors of AHI believes that the Merger is fair to and in
the best interests of AHI and its stockholders and, accordingly, has unanimously
approved the Merger. The Board of Directors recommends that you vote FOR the
Merger. In addition, the Board of Directors of AHI has obtained a written
opinion dated November 8, 1996 of Smith Barney Inc., AHI's financial advisor, to
the effect that, as of such date and based upon and subject to certain matters
in such opinion, the Conversion Number was fair, from a financial point of view,
to the holders of AHI Common Stock.
<PAGE> 6
All stockholders are invited to attend the AHI Special Meeting. To assure
your representation at the AHI Special Meeting, please complete, sign, date and
return the accompanying proxy in the enclosed postage prepaid envelope. If you
are able to attend the AHI Special Meeting, you may, if you wish, vote your
shares in person.
Sincerely yours,
LEONARDO BEREZOVSKY, M.D.
Chairman of the Board
and Chief Executive Officer
<PAGE> 7
AHI HEALTHCARE SYSTEMS, INC.
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD MARCH 17, 1997
To the Stockholders of AHI Healthcare Systems, Inc.:
A Special Meeting of Stockholders of AHI Healthcare Systems, Inc. ("AHI")
will be held Monday, March 17, 1997 at 10:00 a.m. local time at the Renaissance
Long Beach Hotel, 111 East Ocean Boulevard, Long Beach, California (the "AHI
Special Meeting") for the following purpose:
1. To consider and vote upon a proposal to adopt an Agreement and Plan
of Merger (as amended, the "Merger Agreement") between FPA Medical
Management, Inc. ("FPA"), FPA Acquisition Corp., a wholly owned subsidiary
of FPA ("Merger Sub"), and AHI. The Merger Agreement provides, among other
things, for the merger of Merger Sub with and into AHI (the "Merger")
pursuant to which AHI will become a wholly owned subsidiary of FPA. In
connection with the Merger, each outstanding share of AHI Common Stock, par
value $.01 per share ("AHI Common Stock"), will be converted into a
fraction (the "Conversion Number") of one share of FPA Common Stock, par
value $.002 per share ("FPA Common Stock"). The Conversion Number will vary
based on the average trading price of FPA Common Stock for the ten
consecutive trading days ending two days prior to the AHI Special Meeting
(the "FPA Value"). Consequently, the FPA Value may differ from the actual
market price of FPA Common Stock reported by the Nasdaq National Market on
the date of the AHI Special Meeting, the date of consummation of the
Merger, or the date that AHI stockholders actually receive their shares of
FPA Common Stock after the Merger is completed. If the FPA Value is equal
to or greater than $14.38 and less than $22.38, the Conversion Number will
be adjusted such that the "value" to be received for each share of AHI
Common Stock (the "Equivalent Value") will equal $8.75. Both the Equivalent
Value and the Conversion Number may be adjusted if the FPA Value is equal
to or greater than $22.38 or less than $14.38. The Merger Agreement may be
terminated by AHI if the FPA Value is less than $10.00. If the FPA Value is
$10.00, the Conversion Number will be .609 and the Equivalent Value will be
$6.09. The adjustments to the Conversion Number and the Equivalent Value
are described more fully in the accompanying Proxy Statement/Prospectus.
STOCKHOLDERS OF AHI WILL BE ABLE TO OBTAIN THE CONVERSION NUMBER BEGINNING
TWO DAYS PRIOR TO THE AHI SPECIAL MEETING BY CALLING (800) 965-7026. Based
upon the 14,523,041 shares of AHI Common Stock outstanding on February 7,
1997, and assuming an FPA Value of $24.25, which was the closing price of
FPA Common Stock on that date, as of such date, AHI's stockholders would be
issued approximately 5,678,509 shares of FPA Common Stock, representing
approximately 18.6% of the total issued and outstanding shares of FPA after
the Merger.
2. To approve the adjournment or postponement of the AHI Special
Meeting in the event that such adjournment or postponement is necessary in
order to solicit additional votes for adoption of the Merger Agreement.
3. To transact such other business as may properly come before the AHI
Special Meeting or any adjournment or postponement thereof.
The foregoing proposals are described in the Proxy Statement/Prospectus
accompanying this Notice.
UNLESS PROPOSAL 1 IS APPROVED BY THE REQUISITE VOTE OF AHI STOCKHOLDERS,
THE MERGER WILL NOT BE CONSUMMATED.
Stockholders of record at the close of business on February 7, 1997 are
entitled to receive notice of, and to vote at, the AHI Special Meeting and any
adjournment thereof.
It is important that your shares be represented at the AHI Special Meeting.
Whether or not you plan to attend the AHI Special Meeting, please complete,
sign, date and promptly mail the enclosed proxy in the envelope provided.
<PAGE> 8
THE BOARD OF DIRECTORS OF AHI RECOMMENDS THAT ITS STOCKHOLDERS VOTE FOR
EACH OF THE PROPOSALS DESCRIBED ABOVE. PLEASE COMPLETE, SIGN, DATE AND PROMPTLY
RETURN YOUR PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE EVEN IF YOU ARE PLANNING
TO ATTEND THE AHI SPECIAL MEETING.
By Order of the Board of Directors
JOSE SPIWAK, M.D.
Secretary
Downey, California
February 14, 1997
<PAGE> 9
This filing made pursuant
to Rule 424(b)(3) under
the Securities Act of
1933 in connection with
Registration No. 333-21721
<TABLE>
<S> <C>
FPA MEDICAL MANAGEMENT, INC. FPA MEDICAL MANAGEMENT, INC.
AND PROSPECTUS
AHI HEALTHCARE SYSTEMS, INC. 9,028,705 SHARES
JOINT PROXY STATEMENT COMMON STOCK
</TABLE>
This Joint Proxy Statement/Prospectus ("Proxy Statement/Prospectus")
relates to the proposed merger (the "Merger") of FPA Acquisition Corp., a wholly
owned subsidiary ("Merger Sub") of FPA Medical Management, Inc. ("FPA"), with
and into AHI Healthcare Systems, Inc. ("AHI") pursuant to an Agreement and Plan
of Merger dated as of November 8, 1996 among FPA, Merger Sub and AHI (as
amended, the "Merger Agreement"). As a result of the Merger, AHI will become a
wholly owned subsidiary of FPA. In connection with the Merger, each outstanding
share of AHI Common Stock, par value $.01 per share ("AHI Common Stock"), will
be converted into a fraction (the "Conversion Number") of one share of FPA
Common Stock, par value $.002 per share ("FPA Common Stock"). The Conversion
Number will vary based on the average closing price of FPA Common Stock as
reported on the Nasdaq National Market ("Nasdaq") for the ten consecutive
trading days ending two days prior to the special meeting of AHI's stockholders
(the "FPA Value"). Consequently, the FPA Value may differ from the actual market
price of FPA Common Stock reported by Nasdaq on the date of the special meetings
of FPA and AHI stockholders, the date of consummation of the Merger, or the date
that AHI stockholders actually receive their shares of FPA Common Stock after
the Merger is completed. If the FPA Value is equal to or greater than $14.38 and
less than $22.38, the Conversion Number will be adjusted such that the "value"
to be received for each share of AHI Common Stock (the "Equivalent Value") will
equal $8.75. Both the Equivalent Value and the Conversion Number may be adjusted
if the FPA Value is equal to or greater than $22.38 or less than $14.38. If the
FPA Value is equal to or greater than $22.38 and less than $25.38, the
Conversion Number will be .391. If the FPA Value is equal to or greater than
$25.38, the Conversion Number will be adjusted downward such that the Equivalent
Value will equal $9.92. There is no minimum Conversion Number if the FPA Value
exceeds $25.38. If the FPA Value is less than $14.38, the Conversion Number will
be .609 and the maximum number of shares will be issued to AHI Stockholders. The
Merger Agreement may be terminated by AHI if the FPA Value is less than $10.00.
If the FPA Value is $10.00, the Conversion Number will be .609 and the
Equivalent Value will be $6.09, and the maximum number of shares will be issued
to AHI Stockholders. On February 7, 1997 the closing price of FPA Common Stock
was $24.25. Assuming an FPA Value equal to such price, the Equivalent Value
would be $9.48 and the Conversion Number would be .391. Based upon the
14,523,041 shares of AHI Common Stock outstanding as of such date, AHI's
stockholders would be issued approximately 5,678,509 shares of FPA Common Stock,
representing approximately 18.6% of the total issued and outstanding shares of
FPA after the Merger. See "THE MERGER -- Adjustments to Merger Consideration."
Each FPA and AHI stockholder is urged to obtain updated market information.
STOCKHOLDERS OF FPA AND AHI MAY OBTAIN THE CONVERSION NUMBER BEGINNING TWO DAYS
PRIOR TO THE SPECIAL MEETINGS BY CALLING (800) 965-7026.
This Proxy Statement/Prospectus serves as the proxy statement for both FPA
and AHI for their respective special meetings of holders of their common stock
to be held March 17, 1997. See "THE MEETINGS."
To facilitate the voting process for the Special Meetings, stockholders of
FPA and AHI will be able to vote their shares and revoke their votes by
facsimile at the following telephone numbers: FPA -- (619) 453-1941 and AHI --
(310) 803-4695. See "THE MERGER -- Voting of Proxies" and "-- Revocation of
Proxies."
This Proxy Statement/Prospectus also constitutes a prospectus of FPA with
respect to up to approximately 9,028,705 shares of FPA Common Stock to be issued
to stockholders of AHI pursuant to the Merger Agreement. This Proxy
Statement/Prospectus and the accompanying forms of proxy are first being mailed
to stockholders of FPA and AHI on or about February 14, 1997.
SEE "RISK FACTORS" BEGINNING AT PAGE 30 FOR A DISCUSSION OF CERTAIN
CONSIDERATIONS IN EVALUATING THE MERGER, FPA AND AHI.
No persons have been authorized to give any information or to make any
representation other than those contained in this Proxy Statement/Prospectus in
connection with the solicitation of proxies or the offering of securities made
hereby and, if given or made, such information or representation should not be
relied upon as having been authorized by FPA or AHI. This Proxy
Statement/Prospectus does not constitute an offer to sell, or the solicitation
of an offer to purchase, any securities, or the solicitation of a proxy, in any
jurisdiction in which, or to any person to whom, it is unlawful to make such
offer or solicitation of an offer or proxy solicitation. Neither the delivery of
this Proxy Statement/Prospectus nor any distribution of the securities offered
hereby shall, under any circumstances, create any implication that there has
been no change in the affairs of FPA or AHI since the date hereof or that the
information set forth or incorporated by reference herein is correct as of any
time subsequent to its date. All information herein with respect to FPA and
Merger Sub has been furnished by FPA, and all information herein with respect to
AHI has been furnished by AHI.
THE SECURITIES TO WHICH THIS PROXY STATEMENT/PROSPECTUS RELATES HAVE NOT BEEN
APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROXY
STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Proxy Statement/Prospectus is February 14, 1997.
<PAGE> 10
AVAILABLE INFORMATION
FPA and AHI are subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, file reports, proxy statements, and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information may be inspected and copied at the offices of
the Commission, Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, and the Regional Offices of the Commission: Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade
Center, Suite 1300, New York, New York 10048. Copies of such materials may be
obtained from the Public Reference Section of the Commission at Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates or from the
Commission's Internet Web site at http://www.sec.gov. Shares of FPA and AHI
Common Stock are traded on Nasdaq.
FPA has filed with the Commission a registration statement (the
"Registration Statement") under the Securities Act of 1933, as amended (the
"Securities Act"), on Form S-4 with respect to the securities offered hereby.
This Proxy Statement/Prospectus also constitutes the Prospectus of FPA filed as
part of the Registration Statement and does not contain all of the information
set forth in the Registration Statement and the exhibits thereto, certain parts
of which are omitted in accordance with the rules of the Commission. Statements
made in this Proxy Statement/Prospectus as to the contents of any contract,
agreement, or other document referred to are not necessarily complete; with
respect to each such contract, agreement or other document filed as an exhibit
to the Registration Statement, reference is made to the exhibit for a more
complete description of the matter involved, and each such statement shall be
qualified in its entirety by such reference. The Registration Statement and any
amendments thereto, including exhibits filed as part thereof, are available for
inspection and copying at the Commission's offices as described above.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents, which have been filed by FPA (File No. 0-24276)
with the Commission pursuant to the Exchange Act, are incorporated by reference
in this Proxy Statement/Prospectus:
1. FPA's Annual Report on Form 10-K for the fiscal year ended December 31,
1995 filed with the Commission on March 28, 1996, as amended by Form
10-K/A filed with the Commission on March 29, 1996, and as amended by
Form 10-K/A filed with the Commission on October 3, 1996.
2. FPA's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996
filed with the Commission on May 15, 1996, as amended by Form 10-Q/A
filed with the Commission on July 24, 1996.
3. FPA's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996
filed with the Commission on August 14, 1996.
4. FPA's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996 filed with the Commission on November 13, 1996, as amended by Form
10-Q/A filed with the Commission on November 13, 1996.
5. FPA's Current Report on Form 8-K dated February 1, 1996 filed with the
Commission on February 15, 1996, as amended by Form 8-K/A dated February
1, 1996 filed with the Commission on April 12, 1996.
6. FPA's Current Report on Form 8-K dated May 19, 1996 filed with the
Commission on May 20, 1996.
7. FPA's Current Report on Form 8-K dated June 21, 1996 filed with the
Commission on July 5, 1996.
8. FPA's Current Report on Form 8-K dated October 31, 1996 filed with the
Commission on November 12, 1996.
9. FPA's Current Report on Form 8-K dated November 8, 1996 filed with the
Commission on November 13, 1996.
2
<PAGE> 11
10. FPA's Current Report on Form 8-K dated November 26, 1996 filed with the
Commission on December 12, 1996.
11. FPA's Current Report on Form 8-K dated December 10, 1996 filed with the
Commission on January 10, 1997.
12. FPA's Current Report on Form 8-K dated December 13, 1996 filed with the
Commission on January 2, 1997.
13. FPA's Current Report on Form 8-K dated December 18, 1996 filed with the
Commission on January 2, 1997.
14. The description of the FPA Common Stock contained in FPA's Registration
Statement on Form 8-A dated October 20, 1994.
All documents and reports subsequently filed by FPA pursuant to Section
13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this Proxy
Statement/Prospectus and prior to the date of the FPA Special Meeting shall be
deemed to be incorporated by reference in this Proxy Statement/Prospectus and to
be a part hereof from the date of filing of such documents or reports. Any
statement contained in a document incorporated or deemed to be incorporated by
reference herein shall be deemed to be modified or superseded for purposes of
this Proxy Statement/Prospectus to the extent that a statement contained herein
or with respect to FPA in any other subsequently filed document which also is or
is deemed to be incorporated by reference herein modifies or supersedes such
statement. Any such statement so modified or superseded, except as so modified
or superseded, shall not be deemed to constitute a part of this Proxy
Statement/Prospectus.
THE PROXY STATEMENT/PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE WHICH
ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. SUCH DOCUMENTS (OTHER THAN
EXHIBITS TO SUCH DOCUMENTS UNLESS SUCH EXHIBITS ARE SPECIFICALLY INCORPORATED BY
REFERENCE) ARE AVAILABLE TO ANY PERSON, INCLUDING ANY BENEFICIAL OWNER, TO WHICH
THIS PROXY STATEMENT/PROSPECTUS IS DELIVERED, WITHOUT CHARGE, ON WRITTEN OR ORAL
REQUEST DIRECTED TO FPA MEDICAL MANAGEMENT, INC., 3636 NOBEL DRIVE, SUITE 200,
SAN DIEGO, CALIFORNIA 92122, ATTENTION: JAMES A. LEBOVITZ (TELEPHONE NUMBER
(619) 453-1000). IN ORDER TO ENSURE TIMELY DELIVERY OF THE DOCUMENTS, ANY
REQUEST SHOULD BE MADE BY MARCH 10, 1997, THE DATE WHICH IS FIVE BUSINESS DAYS
PRIOR TO THE DATE OF THE FPA SPECIAL MEETING.
Some of the information presented in this Proxy Statement/Prospectus
constitutes forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Although FPA and AHI believe that
their expectations are based on reasonable assumptions within the bounds of
their knowledge of their respective businesses and operations, there can be no
assurance that actual results of FPA's or AHI's operations will not differ
materially from expectations. Factors which could cause actual results to differ
from expectations include, among others, FPA's ability to successfully integrate
acquisitions, FPA's ability to manage growth, the difficulty of controlling
health care costs, the reliance of FPA on capitated revenue and FPA's ability to
comply with governmental and other regulations, laws and licenses. Specific
reference is made to the risks and uncertainties described under "Risk Factors."
3
<PAGE> 12
TABLE OF CONTENTS
<TABLE>
<S> <C>
AVAILABLE INFORMATION.................................................................. 2
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE........................................ 2
GLOSSARY OF CERTAIN DEFINED TERMS...................................................... 7
SUMMARY................................................................................ 10
FPA MEDICAL MANAGEMENT, INC.......................................................... 10
AHI HEALTHCARE SYSTEMS, INC.......................................................... 13
REASONS FOR THE MERGER............................................................... 14
THE MERGER........................................................................... 15
AMENDMENT TO FPA MEDICAL MANAGEMENT, INC. OMNIBUS STOCK OPTION PLAN..................
APPROVAL OF ADJOURNMENT OR POSTPONEMENT OF SPECIAL MEETING...........................
THE MEETINGS......................................................................... 24
COMPARATIVE HISTORICAL AND PRO FORMA PER SHARE DATA.................................. 26
COMPARATIVE MARKET DATA.............................................................. 28
RISK FACTORS........................................................................... 30
Risks Relating to FPA................................................................ 30
Risks Relating to AHI................................................................ 39
Risks Relating to the Merger......................................................... 44
THE MERGER............................................................................. 47
Effects of the Merger................................................................ 47
Merger Consideration................................................................. 47
Adjustments to Merger Consideration.................................................. 47
Conversion of Shares; Procedures for Exchange of Certificates; Fractional Shares..... 48
Risk Factors......................................................................... 49
Nasdaq Listing....................................................................... 49
Background of the Merger............................................................. 49
Recommendations of the Boards of Directors and Reasons for the Merger................ 53
Opinion of FPA's Financial Advisor................................................... 56
Opinion of AHI's Financial Advisor................................................... 60
Effective Time of the Merger......................................................... 64
Interests of Certain Persons in the Merger; Possible Conflicts of Interest........... 64
Material Federal Income Tax Consequences............................................. 66
Accounting Treatment................................................................. 67
Resale of FPA Common Stock by Affiliates............................................. 67
Certain Regulatory Matters........................................................... 68
Pending Litigation................................................................... 68
Rights of Dissenting Stockholders.................................................... 69
THE MEETINGS........................................................................... 69
FPA Special Meeting.................................................................. 69
AHI Special Meeting.................................................................. 69
</TABLE>
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<PAGE> 13
<TABLE>
<S> <C>
Quorum............................................................................... 69
Vote Required........................................................................ 70
Record Date; Stock Entitled to Vote.................................................. 70
Voting of Proxies.................................................................... 70
Revocation of Proxies................................................................ 71
Solicitation of Proxies.............................................................. 71
BOARD OF DIRECTORS AND MANAGEMENT OF FPA FOLLOWING THE MERGER.......................... 72
Board of Directors of FPA Following the Merger....................................... 72
Executive Officers of FPA Following the Merger....................................... 72
Executive Compensation............................................................... 72
COMPARISON OF RIGHTS OF HOLDERS OF AHI AND FPA COMMON STOCK............................ 76
Preferred Stock...................................................................... 76
Board of Directors................................................................... 76
Bylaws............................................................................... 76
Stockholder Meetings................................................................. 77
Indemnification...................................................................... 77
Stockholder Voting Requirements...................................................... 78
Action by Consent.................................................................... 78
THE MERGER AGREEMENT................................................................... 79
AHI Option Plans..................................................................... 79
Exchange of Certificates............................................................. 79
Certain Representations and Warranties............................................... 80
Conduct of Business Pending the Merger............................................... 81
Certain Additional Agreements........................................................ 82
Conditions to Consummation of the Merger............................................. 86
Termination.......................................................................... 87
Effect of Termination................................................................ 88
Amendment............................................................................ 88
Waiver............................................................................... 88
THE FOUNDATION TRANSACTION............................................................. 89
FHMS Acquisition..................................................................... 89
Holding Company Acquisition.......................................................... 89
APPROVAL OF AMENDMENT TO FPA MEDICAL MANAGEMENT, INC. OMNIBUS STOCK OPTION PLAN........ 90
SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA....................................... 93
SELECTED PRO FORMA FINANCIAL DATA -- FPA............................................... 104
SELECTED FINANCIAL DATA -- AHI......................................................... 105
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
AHI.................................................................................. 106
BUSINESS OF AHI........................................................................ 114
</TABLE>
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<PAGE> 14
<TABLE>
<S> <C>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -- AHI.................. 123
SELECTED UNAUDITED PRO FORMA COMBINED FINANCIAL DATA................................... 125
APPROVAL OF ADJOURNMENT OR POSTPONEMENT OF SPECIAL MEETING............................. 126
LEGAL MATTERS.......................................................................... 126
ADDITIONAL INFORMATION................................................................. 126
EXPERTS................................................................................ 126
FINANCIAL STATEMENTS................................................................. F-1
APPENDIX I -- AGREEMENT AND PLAN OF MERGER DATED AS OF NOVEMBER 8, 1996 AMONG FPA, MERGER
SUB AND AHI, AS AMENDED BY AMENDMENT NO. 1 TO AGREEMENT AND PLAN OF MERGER
DATED AS OF FEBRUARY 5, 1997
APPENDIX II -- OPINION OF NEEDHAM & COMPANY, INC.
APPENDIX III -- OPINION OF SMITH BARNEY INC.
</TABLE>
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<PAGE> 15
GLOSSARY OF CERTAIN DEFINED TERMS
AHI........................ AHI Healthcare Systems, Inc.
AHI Board.................. The Board of Directors of AHI Healthcare Systems,
Inc.
AHI Common Stock........... AHI Healthcare Systems, Inc. Common Stock.
AHI Special Meeting........ The Special Meeting of stockholders of AHI to be
held Monday, March 17, 1997 at 10:00 a.m. local
time.
APB No. 16................. Accounting Principles Board Opinion No. 16.
Certificate of Merger...... The Certificate of Merger to be filed with the
Secretary of State of Delaware in connection with
the Merger.
Closing.................... The closing of the Merger.
Closing Date............... The date on which the Closing occurs.
Code....................... Internal Revenue Code of 1986, as amended.
Combined Foundation
Companies................ Foundation Health Medical Services and FHMG/TDMC
Medical Group, a professional corporation together
with its subsidiaries, Foundation Health Medical
Group, Inc. and Thomas-Davis Medical Centers, P.C.
Commission................. The Securities and Exchange Commission.
Conversion Number.......... The fraction of one share of FPA Common Stock
issuable in exchange for each share of AHI Common
Stock in connection with the Merger, subject to
adjustment.
DOJ........................ The United States Department of Justice.
Delaware Act............... Delaware General Corporation Law.
Department................. California Department of Corporations.
Effective Time............. The time at which the Merger will become effective
as provided for in the Certificate of Merger or
such other time as FPA, AHI Healthcare Systems,
Inc. and FPA Acquisition Corp. shall agree upon.
Equivalent Value........... The "value" to be received in exchange for each
share of AHI Common Stock in the Merger.
Exchange Act............... Securities Exchange Act of 1934, as amended.
Exchange Agent............. American Stock Transfer & Trust Company or another
bank or trust company designated by FPA acting as
an exchange agent.
FHMS....................... Foundation Health Medical Services.
Foundation................. Foundation Health Corporation.
Foundation Transaction..... FPA's acquisition of the Combined Foundation
Companies.
FPA........................ FPA Medical Management, Inc.
FPA Board.................. The Board of Directors of FPA Medical Management,
Inc.
FPA Common Stock........... FPA Medical Management, Inc. Common Stock, par
value $.002 per share.
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<PAGE> 16
FPA Network................ Professional corporations, other providers of
medical service and Payors affiliated with FPA.
FPA Plan................... FPA Medical Management, Inc. Omnibus Stock Option
Plan.
FPA Special Meeting........ The Special Meeting of FPA stockholders to be held
Monday, March 17, 1997 at 10:00 a.m. local time.
FPA Value.................. The average of the closing bid and ask prices of
FPA Common Stock as reported on Nasdaq for the ten
consecutive trading days ending on the date that is
two trading days prior to the date of the AHI
Special Meeting.
FTC........................ The United States Federal Trade Commission.
HMO........................ Health Maintenance Organization.
HSR Act.................... Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended.
Holding Company............ FHMG/TDMC Medical Group, a Professional
Corporation, the parent entity of Foundation Health
Medical Group, Inc. and Thomas-Davis Medical
Centers, P.C.
IPA........................ Independent practice association.
Medical Groups............. FHMS and Holding Company, together.
Merger..................... The merger of Merger Sub and AHI.
Merger Agreement........... The Agreement and Plan of Merger, as amended, among
FPA, Merger Sub and AHI.
Merger Consideration....... The consideration to be issued to each AHI
stockholder in the Merger.
Merger Sub................. FPA Acquisition Corp.
Nasdaq..................... The Nasdaq National Market.
Needham.................... Needham & Company, Inc., the financial advisor to
FPA with respect to the Merger.
PCA........................ Physician Corporation of America.
PFI........................ Physicians First, Inc.
PPM........................ Physician practice management company.
Payors..................... HMOs and other prepaid health insurance plans which
provide physician and related health care services.
Professional
Corporations............... Professional corporations affiliated with FPA.
Proxy
Statement/Prospectus....... This joint proxy statement/prospectus relating to
the Merger.
Registration Statement..... A registration statement filed under the Securities
Act of 1933.
RBRVS...................... Resource Based Relative Value Scale.
Rule 144................... Rule 144 of the Securities Act of 1933.
Rule 145................... Rule 145 of the Securities Act of 1933.
Securities Act............. Securities Act of 1933, as amended.
Smith Barney............... Smith Barney Inc., the financial advisor to AHI
with respect to the Merger.
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<PAGE> 17
Special Meetings........... The FPA Special Meeting and the AHI Special
Meeting, as the same may be adjourned.
Sterling................... Sterling Healthcare Group, Inc.
Sterling Merger............ FPA's acquisition of Sterling Healthcare Group,
Inc.
Surviving Corporation...... AHI Healthcare Systems, Inc. after the Merger.
9
<PAGE> 18
SUMMARY
The following is a summary of certain information contained elsewhere in
this Proxy Statement/Prospectus. The information contained in this summary is
qualified in its entirety by, and should be read in conjunction with, the
detailed information and financial statements, including the notes thereto,
appearing elsewhere in this Proxy Statement/Prospectus and the documents
incorporated herein by reference.
FPA MEDICAL MANAGEMENT, INC.
FPA 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-based 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.
Currently, FPA is affiliated with 3,010 primary care physicians and 5,177
specialty care physicians, and provides services to approximately 615,000
enrollees of 24 health maintenance organizations ("HMOs") or other prepaid
health insurance plans (collectively, "Payors") in ten states. Through its
recent acquisition of Sterling Healthcare Group, Inc. ("Sterling"), FPA manages
the emergency departments of 104 hospitals in 20 states.
FPA's objective is to provide cost-effective, high quality health care
services for an increasing number of Payor enrollees served by physicians in the
FPA Network (as defined below). FPA's strategy is to increase enrollment by
adding new Payor relationships and new providers. FPA believes new Payor and
provider relationships are possible because of its ability to manage the cost of
health care without sacrificing quality. The acquisition of Sterling (the
"Sterling Merger") enables FPA to further control costs by providing it with the
ability to control both points of entry into the managed health care delivery
system; the primary care physician's office and the emergency room.
FPA's relationships with its affiliated professional corporations (the
"Professional Corporations"), other providers of medical service 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 enhances 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
management model is appealing to 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, either a subsidiary of FPA or one of the Professional Corporations,
depending on applicable state law. See "RISK FACTORS -- Risks Relating to
FPA -- Possible Negative Effects of Governmental Regulations." 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 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, for fixed
capitation fees, its profitability may vary based on the ability of FPA and its
affiliated providers to control such healthcare costs. See "RISK
FACTORS -- Risks Relating to FPA -- Difficulty in Controlling Health Care Costs;
Capitated Nature of Revenue." Additionally, state laws in
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<PAGE> 19
California, operations in which represented approximately 22% of FPA's operating
revenues for the nine months ended September 30, 1996, require entities such as
FPA to be licensed as health care service plans. FPA's application 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. See "RISK FACTORS -- Risks Relating to
FPA -- Possible Negative Effects of Governmental Regulations."
With the addition of Sterling, FPA also provides contract management and
support services to hospital-based 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 recordkeeping. 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. FPA acquired Sterling, a publicly traded company based in Florida, on
October 31, 1996 in a stock-for-stock merger accounted for as a "pooling of
interests" in which FPA issued approximately 8,097,781 shares of FPA Common
Stock to Sterling shareholders.
Effective November 29, 1996, FPA acquired from Foundation Health
Corporation ("Foundation"), a publicly traded company, all of the outstanding
stock of Foundation Health Medical Services ("FHMS") and FHMG/TDMC Medical
Group, a professional corporation (the "Holding Company"). FHMS provides
facilities management and professional services to the Holding Company and its
subsidiaries, Foundation Health Medical Group, Inc. and Thomas-Davis Medical
Centers, P.C. (together with FHMS, the "Combined Foundation Companies"). The
Combined Foundation Companies provide services to approximately 242,000
enrollees in California and Arizona through approximately 188 primary care
physicians, and 2,300 specialty care physicians. The purchase price for this
acquisition (the "Foundation Transaction") was approximately $197 million,
comprised of $2 million in cash, 4,076,087 shares of FPA Common Stock and
approximately $120 million in notes. The Combined Foundation Companies have a
history of losses. In their fiscal year ended June 30, 1996, the Combined
Foundation Companies experienced a net loss of $32,256,000. While FPA intends to
institute certain measures to reduce these losses and operate the Combined
Foundation Companies profitably, there can be no assurance that it will be able
to do so. See "RISK FACTORS -- Risks Relating to FPA -- Foundation
Transaction -- History of Losses; Impact on FPA's Financial Statements" and "THE
FOUNDATION TRANSACTION."
Effective July 1, 1996, FPA acquired from Foundation an IPA located in
Arizona for approximately $4 million in cash and notes. This IPA serves
approximately 19,850 enrollees. Also effective July 1, 1996, FPA acquired from
Foundation an IPA located in Florida for approximately $16 million in cash and
notes. The Florida IPA serves approximately 3,600 enrollees, and together these
two IPAs consist of 63 primary care physicians.
Other recent acquisitions include the June 1996 acquisition of Physicians
First, Inc. ("PFI"), a wholly owned subsidiary of Physician Corporation of
America ("PCA"), a publicly traded company. PFI operates through its
subsidiaries 40 primary care clinics in Florida. The clinics have approximately
105 primary care physicians who provide services to approximately 90,000
enrollees in PCA health plans in Florida. PFI was acquired for approximately
$21.6 million in cash, notes, shares of FPA Common Stock and warrants to
purchase shares of FPA Common Stock.
On December 18, 1996, FPA sold $75,000,000 aggregate principal amount of
6 1/2% Convertible Subordinated Debentures due 2001 (the "Convertible
Subordinated Debentures") to initial purchasers in a transaction exempt from
registration under Section 4(2) of the Securities Act. The Debentures are
convertible into shares of FPA Common Stock at any time after the 60th day
following the date of original issuance at a conversion price of $25.95 per
share, subject to adjustment in certain events. On January 14, 1997, FPA sold an
additional $5,650,000 aggregate principal amount to the initial purchasers upon
exercise of the over-allotment option (the "Over-allotment Debentures" and, with
the Convertible Subordinated Debentures, the "Debentures"). The Debentures are
convertible into a total of 3,107,900 shares of FPA
11
<PAGE> 20
Common Stock. On January 17, 1997, pursuant to the terms of a registration
rights agreement between FPA and the initial purchasers, FPA filed a
registration statement on Form S-3 with the Commission under the Securities Act
to register for resale by certain holders of the Debentures and the shares of
FPA Common Stock into which such debentures are convertible. Unless otherwise
indicated, all information in this Proxy Statement/Prospectus assumes no
conversion of the Debentures.
FPA's principal executive office is located at 3636 Nobel Drive, Suite 200,
San Diego, California 92122, and its telephone number is (619) 453-1000.
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<PAGE> 21
AHI HEALTHCARE SYSTEMS, INC.
AHI is a physician practice management company that develops integrated
health care delivery networks in selected geographic areas and provides managed
care infrastructure services. AHI affiliates with individual and small groups of
physicians and, by integrating them into comprehensive local managed care
delivery networks, enables these physicians to establish relationships with
multiple Payors in order to provide a full range of high quality, cost-effective
health care services to HMO enrollees.
AHI forms its provider networks by entering into independent contractor
relationships with primary and specialty care physicians and other providers.
These networks contract with HMOs and other payors to provide medical services
to the Payors' enrollees. In exchange for the provision of medical services, the
networks receive capitation payments from the Payors and participate in
shared-risk arrangements to encourage the efficient utilization of hospital and
other specialty care services provided to enrollees. Because AHI is obligated to
provide medical services, the costs of some of which are variable, for fixed
capitation fees, its profitability may vary based on the ability of AHI and its
affiliated providers to control such healthcare costs. See "RISK
FACTORS -- Risks Relating to AHI -- Risk of Capitated Fee Revenue Reductions and
Management of Medical Cost." Additionally, state laws governing AHI's operations
in California (representing approximately 65% and 56%, respectively, of AHI's
total operating revenues for the fiscal year ended 1995 and the eleven months
ended November 30, 1996) require entities such as AHI to be licensed as health
care service plans. AHI voluntarily commenced the process of preparing an
application, through a wholly owned subsidiary, for a restricted license that
would allow AHI to maintain its California operations. The Department recently
granted FPA a restricted license in December 1996 and has granted AHI's request
to suspend the processing of AHI's license application pending the outcome of
the Merger. There can be no assurance the Department will not impose
requirements adverse to AHI's business. See "RISK FACTORS -- Risks Relating to
AHI -- Knox-Keene Act Compliance." In addition, there can be no assurance that
regulatory authorities in other states will not require AHI or its affiliates to
license their respective operations as an insurer, an HMO or as a provider
network. There can be no assurance that future interpretations of insurance laws
and healthcare network laws by the regulatory authorities in these states or the
states into which AHI may expand will not require licensure or a restructuring
of some or all of the operations of AHI.
AHI's affiliated provider networks assign all of their revenue from their
respective Payor contracts to AHI pursuant to management services agreements,
except for amounts that may not be assigned to AHI under applicable law, such as
certain Medicare payments. Such unassigned amounts were not significant for the
years ended December 31, 1995, 1994 or 1993 or for the nine months ended
September 30, 1996. In return, AHI provides its networks with a wide variety of
specialized services, including claims administration, utilization and quality
management, risk management, provider credentialing, payor contracting and
management information systems. In addition, AHI provides the administrative,
accounting, financial and other support the networks require in order to
operate. The physician network management agreements have terms of twenty years,
with automatic and perpetual renewals thereafter of ten years each, and may be
terminated by the physician network only for cause upon prior notice of 180
days. As compensation for its services, AHI retains that portion of each
physician network's assigned revenue which equals (i) a reimbursement of all of
its direct and indirect costs, including an allocated portion of AHI's overhead
expense, (ii) a fixed monthly marketing fee, (iii) a percentage of the assigned
gross revenues and (iv) any and all profits earned in risk sharing pools between
the Physician Network, HMOs and Hospitals.
These networks provide affiliated physicians with access to managed care
contracts, provide Payors with a single point of entry into an integrated health
care delivery network and offer patients a comprehensive range of health care
services in convenient locations. As of December 31, 1996, AHI had approximately
2,500 primary care and 6,500 specialty care affiliated physicians in 51
operational and 40 developing networks, which served a total of 206,489
enrollees under approximately 250 payor contracts.
AHI's principal executive offices are located at 12620 Erickson Avenue,
Suite A, Downey, California 90241 and its telephone number is (310) 803-5333.
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<PAGE> 22
REASONS FOR THE MERGER
FPA. The FPA Board has unanimously approved the Merger and recommends a
vote FOR the Merger. The FPA Board believes that the Merger is fair to and in
the best interests of FPA stockholders since the Merger is expected to (i)
enable FPA to take advantage of AHI's existing relationships in geographic areas
where FPA has no operations in order to expand the FPA Network, (ii) result in
significant financial and operational synergies including, but not limited to,
those relating to executive salaries, investor relations and audit, legal and
insurance fees, (iii) increase FPA's size both financially and geographically
which is expected to enhance FPA's national recognition, and (iv) be treated as
a "pooling of interests" under generally accepted accounting principles
("GAAP"). The FPA Board considered the fact that FPA had obtained a fairness
opinion in connection with the Merger. Disadvantages of the Merger considered by
the FPA Board were pro forma operating and net losses resulting from the Merger,
the potential costs and difficulties that may be encountered in order to
properly integrate the respective businesses of FPA and AHI and the ownership
dilution to the FPA stockholders resulting from the issuance to AHI stockholders
of shares of FPA Common Stock in the Merger. See "THE MERGER -- Recommendations
of the Boards of Directors and Reasons for the Merger -- FPA."
AHI. The AHI Board has unanimously approved the Merger and recommends a
vote FOR the Merger. The AHI Board believes the Merger is fair to and in the
best interests of AHI stockholders. In considering the advantages and
disadvantages of the Merger, the AHI Board addressed a number of considerations
including, without limitation, the following advantages: the strategic benefits
and synergies which could be obtained by combining AHI's operations with FPA's
operations; the belief that the FPA proposal presented an opportunity for AHI's
stockholders to realize future equity appreciation from the combined entity;
management's recommendation to support the Merger due to its concerns regarding
AHI's negative cash flows and the difficulties encountered in achieving its
business plan; and the terms and conditions of the Merger Agreement and the
likelihood that the conditions to the Merger would be satisfied. The AHI Board
also considered the fact that AHI had obtained a fairness opinion in connection
with the Merger. The AHI Board also considered the following disadvantages: the
size of the termination fee payable in the event the Merger Agreement is
terminated by AHI; the historical financial performance of FPA relative to the
historical financial performance of AHI; concerns regarding FPA's ability to
manage its rapid growth, including recent material acquisitions; and the fact
that under the Merger Agreement, if the FPA Value is equal to or greater than
$25.38, the Conversion Number would be reduced, and if the FPA Value falls below
$14.38, the Equivalent Value would be reduced. See "THE
MERGER -- Recommendations of the Boards of Directors and Reasons for the
Merger -- AHI."
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<PAGE> 23
THE MERGER
Effects of the Merger...... Pursuant to the Merger, Merger Sub would merge with
and into AHI, AHI would continue as the surviving
corporation (sometimes referred to as the
"Surviving Corporation") and AHI would become a
wholly-owned subsidiary of FPA. At the Effective
Time (as defined below) each outstanding share of
AHI Common Stock will be converted into a fraction
(the "Conversion Number") of one share of FPA
Common Stock. The Conversion Number will vary based
on the average closing price of FPA Common Stock as
reported on Nasdaq for the ten consecutive trading
days ending two days prior to the special meeting
of AHI's stockholders (the "FPA Value"). If the FPA
Value is equal to or greater than $14.38 and less
than $22.38, the Conversion Number will be adjusted
such that the "value" to be received for each share
of AHI Common Stock (the "Equivalent Value") will
equal $8.75. Both the Equivalent Value and the
Conversion Number may be adjusted if the FPA Value
is equal to or greater than $22.38 or less than
$14.38. If the FPA Value is equal to or greater
than $22.38 and less than $25.38, the Conversion
Number will be .391. If the FPA Value is equal to
or greater than $25.38, the Conversion Number will
be adjusted downward such that the Equivalent Value
will equal $9.92. If the FPA Value is less than
$14.38, the Conversion Number will be .609,
provided that the Merger Agreement may be
terminated by AHI if the FPA Value is less than
$10.00. STOCKHOLDERS OF FPA AND AHI MAY OBTAIN THE
CONVERSION NUMBER BEGINNING TWO DAYS PRIOR TO THE
SPECIAL MEETINGS BY CALLING (800) 965-7026. See
"THE MERGER -- Adjustments to Merger
Consideration."
On February 7, 1997 the closing price of FPA Common
Stock was $24.25. Assuming an FPA Value equal to
such price, the Equivalent Value would be $9.48 and
the Conversion Number would be .391. Based upon the
14,523,041 shares of AHI Common Stock outstanding
as of such date, AHI's stockholders would be issued
approximately 5,678,509 shares of FPA Common Stock,
representing approximately 18.6% of the total
issued and outstanding shares of FPA Common Stock
after the Merger.
If the FPA Value is $10.00, the Equivalent Value
would be $6.09, the Conversion Number would be .609
and the maximum number of shares will be issued to
AHI stockholders. In such event, based upon the
14,523,041 shares of AHI Common Stock outstanding
as of February 7, 1997, AHI's stockholders would be
issued approximately 8,844,531 shares of FPA Common
Stock, representing approximately 26.3% of the
total issued and outstanding shares of FPA Common
Stock after the Merger.
If the FPA Value is equal to or greater than
$25.38, the Conversion Number will be adjusted
downward such that the Equivalent Value will equal
$9.92. There is no minimum Conversion Number if the
FPA Value exceeds $25.38. If the FPA Value is
$25.38, the Equivalent Value would be $9.92 and the
Conversion Number would be .391. In such event,
based upon the 14,523,041 shares of AHI Common
Stock outstanding as of February 7, 1997, AHI's
stockholders would be issued approximately
5,678,509 shares of FPA Common Stock, representing
approximately 18.6% of the total issued and
outstanding shares of FPA after the Merger.
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<PAGE> 24
Unless otherwise indicated, all information in this
Proxy Statement/ Prospectus, assumes no exercise of
options to purchase up to approximately 143,000
shares of FPA Common Stock which may be exercised
immediately prior to the Effective Time. See "The
Merger -- Adjustments to Merger Consideration" and
"-- Interests of Certain Persons in the Merger;
Possible Conflicts of Interest -- AHI."
See "Risk Factors -- Risks Relating to
FPA -- Dilution; Additional Capital Needs" and
"-- Risks Relating to the Merger -- Conversion
Number May Not Fully Reflect Changes in Stock
Price."
The actual market price of the FPA Common Stock may
vary, which will cause a change in the Conversion
Number and the aggregate Merger Consideration, and
possibly a change in the Equivalent Value.
Additionally, the Equivalent Value may differ from
the actual market price of AHI Common Stock. Each
FPA stockholder and AHI stockholder is urged to
obtain updated market information.
Recommendations of the
Boards of Directors........ The FPA Board and the AHI Board believe that the
terms of the Merger are fair to and in the best
interests of the respective holders of their common
stock and have unanimously approved the Merger
Agreement and the related transactions. The FPA
Board unanimously recommends that FPA stockholders
approve the Merger Agreement. The AHI Board
unanimously recommends that AHI stockholders
approve the Merger Agreement. See "THE
MERGER -- Recommendations of the Boards of
Directors and Reasons for the Merger."
Opinion of FPA's Financial
Advisor.................. Needham & Company, Inc. ("Needham") has acted as
financial advisor to FPA in connection with the
Merger and has delivered its written opinion to the
FPA Board dated November 8, 1996, to the effect
that, as of such date and subject to the various
considerations set forth therein, the consideration
to be paid to the AHI stockholders in the Merger
was fair to the stockholders of FPA, from a
financial point of view. The full text of Needham's
opinion, which sets forth the assumptions made,
matters considered and limitations on and scope of
the review undertaken, is attached as Appendix II
to this Proxy Statement/Prospectus, and should be
read carefully in its entirety. Needham's opinion
is directed only to the fairness to the FPA
stockholders, from a financial point of view, of
the consideration to be paid to the AHI
stockholders in the Merger, does not address any
other aspect of the Merger and does not constitute
a recommendation to any FPA stockholder as to how
such stockholder should vote at the FPA Special
Meeting. See "THE MERGER -- Opinion of FPA's
Financial Advisor."
Opinion of AHI's Financial
Advisor.................. Smith Barney Inc. ("Smith Barney") has acted as
financial advisor to AHI in connection with the
Merger and has delivered to the AHI Board a written
opinion dated November 8, 1996 to the effect that,
as of the date of such opinion and based upon and
subject to certain matters stated therein, the
Conversion Number was fair, from a financial point
of view, to the holders of AHI Common Stock. The
full text of the written opinion of Smith Barney
dated November 8, 1996, which sets forth the
assumptions made, matters considered and
limitations on and scope of
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<PAGE> 25
the review undertaken, is attached as Appendix III
to this Proxy Statement/Prospectus and should be
read carefully in its entirety. Smith Barney's
opinion is directed to the AHI Board and relates
only to the fairness of the Conversion Number from
a financial point of view, does not address any
other aspect of the Merger or related transactions
and does not constitute a recommendation to any
stockholder as to how such stockholder should vote
at the AHI Special Meeting. See "THE
MERGER -- Opinion of AHI's Financial Advisor."
Effective Time of the
Merger..................... The Merger will become effective at the time (the
"Effective Time") specified in the Certificate of
Merger (the "Certificate of Merger") to be filed
with the Secretary of State of Delaware. The filing
will be made on or as soon as practicable after the
closing date of the Merger. The closing of the
Merger (the "Closing") will occur on the day of the
approval of the Merger by the stockholders of FPA
and AHI, or as otherwise agreed by the parties.
Conditions to the Merger... The obligations of FPA and AHI to consummate the
Merger are subject to certain conditions including
(i) obtaining the approval of the stockholders of
FPA and AHI, (ii) the effectiveness of the
Registration Statement of which this Proxy
Statement/Prospectus is a part, (iii) approval for
quotation on Nasdaq, subject to official notice of
issuance, of the FPA Common Stock to be issued in
connection with the Merger, (iv) the expiration or
termination of the relevant waiting period under
the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended (the "HSR Act"), (v) no order
being entered in any action or proceeding or other
legal restraint or prohibition preventing the
consummation of the Merger, (vi) the receipt by
each party of various legal opinions, comfort
letters and other certificates, consents, reports
and approvals from the other parties to the Merger
and from third parties, including assurances
relating to the treatment of the Merger as a
"pooling of interests" for financial and accounting
purposes and the treatment of the Merger as a
tax-free reorganization, and (vii) the accuracy in
all material respects of the representations and
warranties of each party and compliance with all
covenants and conditions by each party.
Additionally, the obligation of AHI to consummate
the Merger is subject to the conditions that (i)
FPA shall have entered into an agreement to provide
registration rights to certain former AHI
stockholders and (ii) the value of the FPA Common
Stock during the relevant measurement period is not
less than $10.00. Either FPA or AHI may extend the
time for performance of any of the obligations of
the other party or may waive compliance with those
obligations. To the extent material provisions or
conditions are waived, including, among others, the
condition that the Merger be treated as a "pooling
of interests" for accounting and financial
reporting purposes and that the Merger qualify as a
tax-free reorganization, FPA and AHI will amend
this Proxy Statement/Prospectus and resolicit
stockholder votes to the extent required by
applicable law. In the event the FPA Value is less
than $10.00, AHI's decision to complete the Merger
will depend upon the AHI Board's reconsideration of
the factors set forth under "-- REASONS FOR THE
MERGER." See "THE MERGER -- Certain Regulatory
Matters" and "THE MERGER AGREEMENT -- Conditions to
the Merger."
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<PAGE> 26
Termination, Amendment and
Waiver................... The Merger Agreement may be terminated at any time
prior to the Effective Time by mutual consent of
FPA and AHI, or, generally, by either party if,
among other things, (i) the Merger shall not have
been completed by April 30, 1997, (ii) if either
FPA or AHI does not obtain stockholder approval,
(iii) if any required governmental or regulatory
approval is not obtained, (iv) if either party
materially breaches any of its representations,
warranties or covenants under the Merger Agreement
or (v) if the Merger is prohibited by court order.
In addition, AHI may terminate the Merger Agreement
if the AHI Board determines in good faith that to
do so is consistent with its fiduciary obligations.
AHI's decision to terminate the Merger will depend
upon the AHI Board's reconsideration of the factors
set forth under "Reasons for the Merger." See "THE
MERGER AGREEMENT -- Termination, Amendment and
Waiver."
Rights of FPA Stockholders
and AHI Stockholders....... Both FPA and AHI are Delaware corporations and the
rights of their respective stockholders are
governed by the Delaware General Corporation Law
(the "Delaware Act") and their Certificates of
Incorporation and Bylaws. If the Merger is
consummated, AHI's stockholders will become
stockholders of FPA, and their rights will be
governed by the Certificate of Incorporation and
Bylaws of FPA. There are certain material
differences between stockholders' rights under
AHI's Certificate of Incorporation and Bylaws and
FPA's Certificate of Incorporation and Bylaws. The
material differences include supermajority
stockholder approval requirements contained in
AHI's certificate of incorporation. See "COMPARISON
OF RIGHTS OF HOLDERS OF FPA AND AHI COMMON STOCK."
Pending Litigation......... 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 a stockholder
of AHI. The stockholder alleges that AHI's
directors breached their fiduciary duties to AHI's
public stockholders by entering into the Merger
Agreement. 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 including an injunction
of the Merger. See "THE MERGER -- Pending
Litigation." Additionally, AHI, certain of its
officers and directors, and all of the underwriters
of AHI's Common Stock in its initial public
offering are defendants in a class action
securities lawsuit. See "RISK FACTORS -- Risks
Relating to AHI -- Legal Proceedings."
Dissenters' Rights......... So long as the shares of FPA and AHI Common Stock
remain quoted on Nasdaq on the date of the Special
Meetings, holders of AHI Common Stock will not be
entitled to appraisal or dissenters' rights in
connection with the Merger. See "THE
MERGER -- Rights of Dissenting Stockholders."
Certain Regulatory
Matters.................... Consummation of the Merger is subject to certain
regulatory approvals. FPA and AHI made their
respective filings with the Federal Trade
Commission ("FTC") and the Department of Justice
("DOJ") with respect to the Merger on December 4,
1996 and November 29, 1996, respectively. FPA and
AHI have received written notification dated
December 27, 1996, that early termination of the
waiting period of their
18
<PAGE> 27
respective HSR filings has been granted.
Notwithstanding the termination of the waiting
period of the HSR filings, the FTC, DOJ or others
could take action under the antitrust laws,
including after the Effective Time, seeking the
divestiture by FPA of all or any part of the assets
of AHI acquired in the Merger. There can be no
assurance that a challenge to the Merger on
antitrust grounds will not be made or, if such a
challenge is made, that it would not be successful.
Although no assurance can be given, FPA and AHI
believe that the Merger can be effected in
compliance with all federal and state regulations.
See "THE MERGER -- Certain Regulatory Matters."
Material Federal Income Tax
Consequences............. Milbank, Tweed, Hadley & McCloy, counsel to AHI,
has delivered an opinion to AHI to the effect that
(i) the Merger is intended to qualify as a tax-free
reorganization within the meaning of Section
368(a)(1)(B) and (a)(1)(A) and (a)(2)(E) of the
Internal Revenue Code of 1986 (the "Code"). As a
result, (i) AHI, FPA and Merger Sub will recognize
no gain or loss upon the receipt by FPA of all the
shares of AHI Common Stock in the Merger in
exchange for newly-issued shares of FPA Common
Stock, (ii) FPA's basis in the shares of AHI Common
Stock received in the Merger will be the same as
the aggregate basis of the AHI Common Stock in the
hands of the AHI stockholders immediately prior to
the Merger, or instead, if FPA so elects, FPA's
basis in the shares of AHI Common Stock will equal
AHI's net basis in AHI's assets, (iii) FPA's
holding period in the shares of AHI Common Stock
received in the Merger will include the period
during which the shares of AHI Common Stock were
held by AHI stockholders, (iv) an AHI stockholder
who converts shares of AHI Common Stock in the
Merger solely for shares of FPA Common Stock will
recognize no gain or loss, (v) an AHI stockholder
will have the same basis in the shares of FPA
Common Stock received in the Merger as the basis
that stockholder had in the shares of AHI Common
Stock converted therefor, reduced by the basis
allocable to any fractional share interest in FPA
Common Stock with respect to which cash is
received, (vi) an AHI stockholder's holding period
for the shares of FPA Common Stock received in the
Merger includes that stockholder's holding period
for the shares of AHI Common Stock converted
therefor in the Merger, and (vii) an AHI
stockholder will recognize capital gain or loss
equal to the difference between the cash received
and the basis of the share or shares of AHI Common
Stock allocated to any FPA fractional share
interest that, for tax purposes, will be treated as
issued to the AHI stockholder in the Merger and
then immediately redeemed from that AHI stockholder
for cash by FPA. See "THE MERGER -- Material
Federal Income Tax Consequences." EACH AHI
STOCKHOLDER IS URGED TO CONSULT HIS OR HER PERSONAL
TAX AND FINANCIAL ADVISORS CONCERNING THE FEDERAL
INCOME TAX CONSEQUENCES OF THE MERGER, AS WELL AS
ANY APPLICABLE STATE, LOCAL, FOREIGN OR OTHER TAX
CONSEQUENCES, BASED UPON SUCH HOLDER'S PARTICULAR
FACTS AND CIRCUMSTANCES.
Accounting Treatment....... The Merger will be treated as a "pooling of
interests" for accounting and financial reporting
purposes. See "THE MERGER -- Accounting Treatment."
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<PAGE> 28
Interests of Certain
Persons in the Merger;
Possible Conflicts of
Interest................. In considering the recommendation of the FPA Board
with respect to the Merger, FPA stockholders should
be aware that members of the FPA Board and FPA
executive officers and their affiliates may be
deemed to have beneficial ownership of
approximately 16.1% of the outstanding FPA Common
Stock. See "THE MERGER -- Interests of Certain
Persons in the Merger."
In considering the recommendation of the AHI Board
with respect to the Merger, AHI stockholders should
be aware that members of the AHI Board have
interests in the Merger, as described below. See
"RISK FACTORS -- Interests of Certain Persons in
the Merger; THE MERGER -- Interests of Certain
Persons in the Merger." As of the record date, the
directors and executive officers of AHI as a group
may be deemed to beneficially own approximately
62.3% of the outstanding shares of AHI Common
Stock. Certain directors and officers of AHI with
the collective power to vote approximately 55.2% of
the outstanding AHI Common Stock have entered into
voting agreements and given their irrevocable
proxies, providing that their shares shall be voted
in favor of the Merger Agreement. See "THE MERGER
AGREEMENT -- Certain Additional
Agreements -- Irrevocable Proxies." On February 7,
1997, the closing price of FPA Common Stock was
$24.25. Assuming an FPA Value equal to such price,
the Equivalent Value would be $9.48 and the
Conversion Number would be .391. Based upon the
14,523,041 shares of AHI Common Stock outstanding
as of such date, AHI Stockholders would be issued
approximately 5,678,509 shares of FPA Common Stock
in the Merger. If the Merger were consummated, the
directors and executive officers of AHI would
receive 62.3% of the shares of FPA Common Stock
issued to AHI stockholders in the Merger. Although
AHI believes the members of the AHI Board have
acted in accordance with their fiduciary duties,
the following initial terms may provide the
appearance of a possible conflict of interest. See
"RISK FACTORS -- Risks Relating to AHI -- Possible
Conflicts of Interest."
Eight senior executives of AHI will be given
severance consideration as of the closing of the
Merger including (i) the waiver of any applicable
non-compete provisions set forth in their
employment agreements; (ii) the termination of each
of their employment agreements and (iii) the
receipt of a lump-sum payment pursuant to each of
their employment agreements upon a change of
control. See "THE MERGER -- Interests of Certain
Persons in the Merger -- Severance Payments."
Pursuant to such change in control arrangements,
Leonardo Berezovsky, M.D., Saul Honigstein, H.R.
Brereton Barlow, Luis Artime, Stuart Bruck, Steven
Posar, M.D., Robert Brice and Gary Sherlock, each
of whom is an executive officer and/or a director
of AHI, will receive approximately $1,640,000,
$503,000, $724,000, $256,000, $388,000, $529,000,
$495,000 and $495,000, respectively. In connection
with the Merger, certain other officers and
employees of AHI will receive severance payments
not to exceed in the aggregate $750,000. See "THE
MERGER AGREEMENT -- Certain Additional
Agreements -- Employee Benefit Plans." AHI shall
provide for immediate vesting of, and cancellation
at the Effective Time of, all outstanding options
to the extent permitted under the terms of AHI's
stock option
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<PAGE> 29
agreements. See "THE MERGER -- Interests of Certain
Persons in the Merger; Possible Conflicts of
Interest."
AHI agreed to purchase prior to the Effective Time,
and FPA and AHI agreed to maintain, until September
28, 1999, directors' and officers' liability
insurance with respect to claims arising from facts
or events that occurred on or prior to the
Effective Time. FPA also agreed to indemnify all
directors, officers, employees, and stockholders
who are officers or directors of AHI against any
liability or losses any of them may incur because
of any claim brought against them prior to or
within five years from the Effective Time as
officers, directors, employees, agents or
stockholders of AHI. See "THE MERGER
AGREEMENT -- Certain Additional
Agreements -- Directors' and Officers'
Indemnification and Insurance."
FPA has agreed to enter into a registration rights
agreement with certain executive officers and
directors of AHI providing for the registration of
their shares of FPA Common Stock received in the
Merger. See "THE MERGER AGREEMENT -- Certain
Additional Agreements -- Registration Rights
Agreement."
Risk Factors............... Certain factors to be considered in connection with
an investment in FPA Common Stock and approval of
the Merger Agreement are set forth under "RISK
FACTORS." Risks relating to FPA include no
assurance of successful integration of
acquisitions, expanded service offering; Foundation
Transaction -- history of losses, impact on FPA's
financial statements; growth strategy, difficulty
in maintaining growth; risks related to intangible
assets; difficulty in controlling health care
costs, capitated nature of revenue; full risk
capitation; fee-for-service contracts; dependence
on government and other third party payors;
reliance on certain payors; short-term nature and
early terminability of payor contracts; dependence
on primary care physicians and emergency medicine
physicians; risks related to classification of
physicians as independent contractors; state laws
regarding prohibition of corporate practice of
medicine; possible negative effects of prospective
health care reform; possible negative effects of
governmental regulations; antitrust regulation;
competitive market forces; potential liabilities;
fluctuations in quarterly results; possible
volatility of stock price; dependence upon key
personnel, employment contracts; risks of financial
leverage; dilution, additional capital needs;
shares eligible for future sale; and anti-takeover
effect of certain charter provisions. Risks
relating to AHI include risk of capitated fee
revenue reductions and management of medical costs;
ability to manage growth; fluctuations in quarterly
operating results, recent operating losses;
dependence on certain payors; legal proceedings;
competition; governmental regulation; state laws
regarding prohibition of corporate practice of
medicine; health care reform; goodwill; potential
exposure to professional liability, availability of
insurance; termination of management agreements;
dependence on independent contractors; control of
health care costs; and Knox-Keene Act compliance.
Risks relating to the Merger include the impact on
FPA's financial statements; no assurance of
successful integration of certain operations;
conversion number may not fully reflect changes in
stock prices; deterrent effect of termination and
non-solicitation provisions; need for additional
capital;
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<PAGE> 30
possible loss of business; interests of certain
persons in the merger; and inability to consummate
merger.
Surrender of
Certificates............... Promptly after the Effective Date, FPA's exchange
agent will mail a transmittal form and exchange
instructions to each holder of record of AHI Common
Stock. CERTIFICATES FOR SHARES OF AHI COMMON STOCK
SHOULD NOT BE SURRENDERED UNTIL SUCH TRANSMITTAL
FORM AND EXCHANGE INSTRUCTIONS ARE RECEIVED.
Resale Restrictions........ All shares of FPA Common Stock received by AHI
stockholders will be freely tradeable, except that
shares of FPA Common Stock received by persons who
are deemed to be "affiliates" (as such term is
defined in the Securities Act) of AHI or FPA at the
time of the Special Meetings may be resold by them
only in certain permitted circumstances under the
Securities Act, other applicable securities laws
and rules related to "pooling of interests"
accounting treatment. See "THE MERGER -- Resale of
FPA Common Stock by Affiliates."
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<PAGE> 31
AMENDMENT TO FPA MEDICAL MANAGEMENT, INC.
OMNIBUS STOCK OPTION PLAN
At the FPA Special Meeting, stockholders of FPA will be asked to approve an
amendment to the FPA Medical Management, Inc. Omnibus Stock Option Plan (the
"FPA Plan") which would, upon becoming effective, increase the total number of
shares of FPA Common Stock issuable upon exercise of options granted under such
plan from 5,000,000 to 6,500,000. The FPA Plan was approved by the FPA
stockholders in October 1994 and amendments to the FPA Plan were approved by the
FPA stockholders in July 1995, June 1996 and October 1996.
The proposal to approve the amendment to the FPA Plan will become effective
if it receives the affirmative vote of the holders of a majority of the shares
of FPA Common Stock present in person or by proxy at the FPA Special Meeting. In
the event the amendment is not approved by FPA stockholders, the amendment will
not become effective and the FPA Plan will remain in full force and effect in
its current form.
The FPA Plan currently provides for the issuance of up to 5,000,000 shares
of FPA Common Stock. As of December 31, 1996, options to purchase 5,000,000
shares of FPA Common Stock have been granted under the FPA Plan and options to
purchase an additional 718,895 shares of FPA Common Stock have been granted
subject to stockholder approval of an amendment to increase the number of shares
available for issuance under the FPA Plan. The Board of Directors of FPA
believes that it is advisable and in the best interest of FPA to make additional
shares available for the granting of options in the future to officers and other
key employees of FPA because options provide a valuable incentive for such
persons to remain with FPA and motivate them to exert their best efforts on
behalf of FPA. Accordingly, FPA's Board of Directors recommends that the total
number of shares issuable pursuant to the FPA Plan be increased by 1,500,000.
FPA's Board of Directors recommends that you vote FOR the proposal to amend
the FPA Plan.
APPROVAL OF ADJOURNMENT OR POSTPONEMENT OF SPECIAL MEETINGS
At the FPA Special Meeting, FPA stockholders will be asked to approve the
adjournment or postponement of the FPA Special Meeting in the event that such
adjournment or postponement is necessary in order to solicit additional votes
for the adoption of the Merger Agreement or approval of the amendment to the FPA
Plan.
FPA's Board of Directors recommends that you vote FOR this proposal.
At the AHI Special Meeting, AHI stockholders will be asked to approve the
adjournment or postponement of the Special Meeting in the event that such
adjournment or postponement is necessary in order to solicit additional votes
for adoption of the Merger Agreement.
AHI's Board of Directors recommends that you vote FOR this proposal.
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<PAGE> 32
THE MEETINGS
Meetings of Stockholders... The Special Meeting of stockholders of FPA (the
"FPA Special Meeting") will be held on Monday,
March 17, 1997 at 10:00 a.m. local time at FPA's
offices at 3636 Nobel Drive, Suite 200, San Diego,
California 92122.
The Special Meeting of stockholders of AHI (the
"AHI Special Meeting") will be held on Monday,
March 17, 1997 at 10:00 a.m. local time at the
Renaissance Long Beach Hotel, 111 East Ocean
Boulevard, Long Beach, California.
Matters to be Considered at
the Special Meetings....... At the FPA Special Meeting, stockholders will be
asked to approve and adopt the Merger Agreement and
amendment to the FPA Medical Management, Inc.
Omnibus Stock Option Plan (the "FPA Plan") and to
approve the possible adjournment or postponement of
the FPA Special Meeting.
At the AHI Special Meeting, stockholders will be
asked to approve and adopt the Merger Agreement and
to approve the possible adjournment or postponement
of the AHI Special Meeting.
Pursuant to the terms of the Merger Agreement, each
share of AHI Common Stock will be converted into a
fraction of one share of FPA Common Stock. See "THE
MERGER -- Merger Consideration."
Adjournment or postponement of the FPA Special
Meeting would allow FPA to solicit from its
stockholders additional votes for adoption of the
Merger Agreement or approval of the amendment to
the FPA Plan.
Adjournment or postponement of the AHI Special
Meeting would allow AHI to solicit from its
stockholders additional votes for adoption of the
Merger Agreement.
For additional information relating to the Special
Meetings, see "THE MEETINGS."
Quorum; Vote Required...... The presence, in person or by proxy, of the holders
of a majority of the outstanding shares of FPA
Common Stock at the FPA Special Meeting is
necessary to constitute a quorum at the meeting.
Abstentions and broker non-votes are considered
present for purposes of establishing a quorum.
Adoption of the Merger Agreement, approval of the
amendment to the FPA Plan and approval of the
possible adjournment or postponement of the FPA
Special Meeting require the affirmative vote of a
majority of the shares of FPA Common Stock present
either in person or by proxy at the FPA Special
Meeting.
Because abstentions are treated as shares present
and entitled to vote at the FPA Special Meeting,
they will have the effect of a vote against
adoption of the Merger Agreement, against approval
of the amendment to the FPA Plan, and against
approval of the possible adjournment or
postponement of the FPA Special Meeting. Broker
non-votes are not allowed to vote at the FPA
Special Meeting and will have no effect on the
outcome of the vote on such proposals.
The presence in person or by proxy, of the holders
of a majority of the outstanding shares of AHI
Common Stock at the AHI Special Meeting is
necessary to constitute a quorum at the meeting.
Abstentions and
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<PAGE> 33
broker non-votes are considered present for
purposes of establishing a quorum. Approval of the
Merger Agreement requires the affirmative vote of a
majority of the issued and outstanding shares of
AHI Common Stock. Approval of the possible
adjournment or postponement of the AHI Special
Meeting requires the affirmative vote of a majority
of the shares present either in person or by proxy
at the AHI Special Meeting.
At the AHI Special Meeting, abstentions and broker
non-votes will have the effect of a vote against
adoption of the Merger Agreement. Because
abstentions are treated as shares present and
entitled to vote at the AHI Special Meeting, they
will have the effect of a vote against approval of
the possible adjournment or postponement of the AHI
Special Meeting. Broker non-votes are not allowed
to vote at the AHI Special Meeting and will have no
effect on the outcome of a proposal to approve the
possible adjournment or postponement of the AHI
Special Meeting.
See "THE MEETINGS -- Vote Required" and "THE MERGER
AGREEMENT -- Conditions to the Merger."
Voting by Facsimile........ To facilitate the voting process for the Special
Meetings, stockholders of FPA and AHI will be able
to vote their shares and revoke their votes by
facsimile. See "THE MERGER -- Voting of Proxies"
and "-- Revocation of Proxies."
Record Date................ Only stockholders of record of FPA Common Stock at
the close of business on February 13, 1997 are
entitled to notice of and to vote at the FPA
Special Meeting. On that date, there were
approximately 24,824,224 shares of FPA Common Stock
outstanding, with each share of FPA Common Stock
entitled to cast one vote with respect to the
Merger Agreement at the FPA Special Meeting.
Only stockholders of record of AHI Common Stock at
the close of business on February 7, 1997 are
entitled to notice of and to vote at the AHI
Special Meeting. On that date, there were
14,523,041 shares of AHI Common Stock outstanding,
with each share of AHI Common Stock entitled to
cast one vote with respect to the Merger Agreement
at the AHI Special Meeting.
Security Ownership of
Management............... As of the record date, the directors and executive
officers of FPA as a group had the power to vote
approximately 16.1% of the outstanding shares of
FPA Common Stock. Directors of FPA and certain
stockholders with the collective power to vote
approximately 13.8% of the outstanding FPA Common
Stock have entered into voting agreements and given
their irrevocable proxies, providing that their
shares shall be voted in favor of the Merger
Agreement.
As of the record date, the directors and executive
officers of AHI as a group had been deemed to own
approximately 62.3% of the outstanding shares of
AHI Common Stock. Directors of AHI and certain
stockholders with the collective power to vote
approximately 55.2% of the outstanding AHI Common
Stock have entered into voting agreements and given
their irrevocable proxies, providing that their
shares shall be voted in favor of the Merger
Agreement. Accordingly, approval of the AHI
stockholders is assured.
25
<PAGE> 34
COMPARATIVE HISTORICAL AND PRO FORMA PER SHARE DATA
The following summary presents selected comparative per share information
(i) for FPA on a historical basis, giving effect to the Sterling Merger, in
comparison with pro forma information giving effect to the Merger, and (ii) AHI
on a historical basis in comparison with its pro forma equivalent information
after giving effect to the Merger, including the receipt of the FPA Common Stock
in exchange for the AHI Common Stock in accordance with the Merger. The pro
forma financial information should be read in conjunction with the historical
financial statements of FPA and AHI and the related notes thereto incorporated
herein by reference or contained elsewhere herein and the Supplemental
Consolidated Financial Statements of FPA contained elsewhere herein and in
conjunction with the unaudited pro forma condensed consolidated financial
statements appearing elsewhere in this Proxy Statement/Prospectus.
Neither FPA nor AHI have declared cash dividends since inception. It is
anticipated that FPA will not declare cash dividends in the foreseeable future.
The following information is not necessarily indicative of the combined
results of operations or combined financial position that would have resulted
had the Merger been consummated at the beginning of the periods indicated, nor
is it necessarily indicative of the combined results of operations in future
periods or future combined financial position.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, NINE MONTHS ENDED
------------------------ SEPTEMBER 30,
1993 1994 1995 1996
---- ---- ------ -----------------
<S> <C> <C> <C> <C>
Net income (loss) per common and common equivalent
share:
FPA (giving effect to the Sterling Merger):
Historical(1)................................. $.27 $.19 $ .24 $ .38
Pro forma(2).................................. (2.22) (1.39)
Pro forma historical combined minimum(3)(4)... .23 .21 (1.86) (1.64)
Pro forma historical combined maximum(3)(4)... .17 .17 (1.66) (1.49)
AHI:
Historical(5)................................. .14 .13 (.29) (1.07)
Pro forma minimum equivalent(3)(4)............ .09 .08 (.73) (.64)
Pro forma maximum equivalent(3)(4)............ .10 .10 (1.01) (.91)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ -------------
<S> <C> <C>
Stockholders' equity per common and common equivalent share:
FPA historical (giving effect to the Sterling Merger)............ $ 4.86 $5.97
FPA pro forma historical combined minimum(3)(4).................. 7.75
FPA pro forma historical combined maximum(3)(4).................. 6.90
AHI historical................................................... 3.06 1.99
AHI pro forma minimum equivalent(4).............................. 3.03
AHI pro forma maximum equivalent(4).............................. 4.20
</TABLE>
- ---------------
(1) Reflects the effects on the historical net income per share for 1993 as if
FPA (i) had paid to the executive officers annual compensation consistent
with the employment agreements entered into as of January 1, 1994 and (ii)
had been treated as a C corporation rather than a S corporation for income
tax purposes, with an assumed assessed annual effective income tax rate of
40%. Pro forma net income per share for 1994 assumes no tax benefit from
termination of FPA of its S corporation election and an assumed effective
annual income tax rate of 40%.
(2) Reflects the effects of the FPA acquisitions as reflected in the Pro Forma
Condensed Consolidated Financial Statements (unaudited) of FPA Medical
Management, Inc., and Subsidiaries appearing elsewhere in this Proxy
Statement/Prospectus. The FPA acquisitions include the acquisitions of
Gonzaba Management Organization, Arizona Managed Care Services and
affiliates, Grossmont Medical Clinic,
26
<PAGE> 35
Foundation Health IPA, Physicians First, Inc., and Foundation Health Medical
Services and affiliates for the year ended December 31, 1995. The FPA
acquisitions for the nine months ended September 30, 1996 include the
acquisitions of Physicians First, Inc. and Foundation Health Medical
Services and affiliates.
(3) Reflects the effects of the Merger between FPA (giving effect to the
Sterling Merger) and AHI and the effects of the FPA acquisitions reflected
in the Pro Forma Condensed Consolidated Financial Statements (unaudited) of
FPA, Medical Management, Inc. and Subsidiaries appearing elsewhere in this
Proxy Statement/Prospectus. The FPA acquisitions include the acquisitions of
Gonzaba Management Organization, Arizona Managed Care Services and
affiliates, Grossmont Medical Clinic, Foundation Health IPA, Physicians
First, Inc., and Foundation Health Medical Services and affiliates for the
year ended December 31, 1995. The FPA acquisitions for the nine months ended
September 30, 1996 include the acquisitions of Physicians First, Inc., and
Foundation Health Medical Services and affiliates.
(4) The minimum per share data assumes an exchange ratio of .391 FPA common
shares for each AHI common share. The maximum per share data assumes an
exchange ratio of .609 FPA common shares for each AHI common share. Such
exchange ratios are defined in the Merger Agreement.
(5) Reflects the pro forma income tax effect on historical net income (loss) per
share for fiscal years 1993 through 1995 as if all the AHI consolidated
entities had been treated as C Corporations rather than S Corporations for
income tax purposes.
27
<PAGE> 36
COMPARATIVE MARKET DATA
FPA Common Stock is listed on Nasdaq under the symbol "FPAM." The range of
high and low bid prices, as reported on Nasdaq, for FPA Common Stock for the
periods indicated, is as follows:
<TABLE>
<CAPTION>
HIGH LOW
----- -----
<S> <C> <C>
1994
October 20, 1994 through December 31, 1994(1)...................... 6 3/4 5 1/8
1995
First Quarter(1)................................................... 11 1/4 6
Second Quarter..................................................... 12 1/2 7 7/8
Third Quarter...................................................... 12 1/8 8 7/8
Fourth Quarter..................................................... 9 3/4 5 7/8
1996
First Quarter...................................................... 13 1/4 8 5/8
Second Quarter..................................................... 20 1/8 12 1/8
Third Quarter...................................................... 27 1/8 12 1/2
Fourth Quarter..................................................... 29 1/2 16 3/8
1997
First Quarter (through February 7, 1997)........................... 25 5/8 19 1/4
</TABLE>
- ---------------
(1) Prices have been adjusted to reflect a 100% stock dividend of FPA Common
Stock effected April 1995.
As of the record date, FPA Common Stock was held by approximately 250
holders of record.
AHI Common Stock is listed on Nasdaq under the symbol "AHIS." The range of
high and low bid prices, as reported on Nasdaq, for AHI Common Stock for the
periods indicated, is as follows:
<TABLE>
<CAPTION>
HIGH LOW
----- -----
<S> <C> <C>
1995
From September 29 through September 30............................. 15 1/2 15
Fourth Quarter..................................................... 15 1/2 5 1/2
1996
First Quarter...................................................... 8 5 3/4
Second Quarter..................................................... 6 3/4 5 3/4
Third Quarter...................................................... 6 3/4 4 1/4
Fourth Quarter..................................................... 8 5/8 5 3/4
1997
First Quarter (through February 7, 1997)........................... 9 8 5/8
</TABLE>
As of the record date, AHI Common Stock was held by approximately 35
holders of record.
The following table sets forth the closing price per share of FPA Common
Stock and AHI Common Stock on Nasdaq, and the equivalent per share price (as
explained below) of AHI Common Stock on (i) November 8, 1996, the business day
preceding public announcement of the Merger and (ii) February 7, 1997:
<TABLE>
<CAPTION>
MARKET PRICE FPA AHI EQUIVALENT
PER SHARE AT: COMMON STOCK COMMON STOCK PER SHARE PRICE(1)
------------------------------- ------------ ------------ ------------------
<S> <C> <C> <C>
November 8, 1996 $21.25 $ 7.25 $ 8.75
February 7, 1997 $24.25 $9.125 $ 9.48
</TABLE>
- ---------------
(1) The equivalent per share price of a share of AHI Common Stock as of November
8, 1996 represents the amount fixed pursuant to the Merger Agreement based
on an assumed FPA Value equal to the market price per share of FPA Common
Stock on the date shown. The equivalent per share price of AHI
28
<PAGE> 37
Common Stock as of February 7, 1997 represents the closing price of FPA
Common Stock on such date multiplied by an assumed Conversion Number of .391
shares of FPA Common Stock for each share of AHI Common Stock. See "THE
MERGER - Adjustments to Merger Consideration."
Stockholders are advised to obtain current market quotations for FPA Common
Stock and AHI Common Stock. No assurance can be given as to the market price of
FPA Common Stock or AHI Common Stock at, or in the case of FPA Common Stock,
after the Effective Time.
29
<PAGE> 38
RISK FACTORS
In addition to other information in this Proxy Statement/Prospectus, the
following factors should be considered carefully in evaluating the proposals to
be voted on at the Special Meetings.
RISKS RELATING TO FPA
No Assurance of Successful Integration of Acquisitions; Expanded Service
Offering. Over the last two years, FPA has pursued an aggressive growth
strategy. FPA's growth has been achieved primarily through acquisitions, several
of which have been completed or become subject to a binding agreement during the
last six months. The recent acquisitions of Sterling, PFI and the Combined
Foundation Companies are large transactions which involve significant risks and
uncertainties for FPA. FPA intends to continue to pursue growth through
acquisitions. The success of past and future acquisitions is largely dependent
on the ability of FPA to integrate the operations of the acquired companies into
FPA's operations in an efficient and effective manner. The process of
integrating management services, which includes management information systems,
claims administration and billing services, utilization management of medical
services, care coordination and case management, quality and cost monitoring and
physician recruitment, as well as administrative functions, facilities and other
aspects of operations, while managing a larger and geographically expanded
entity, presents a significant challenge to FPA's management. In addition,
integration must be carried out so that FPA is able to control medical and
administrative costs. The ability to control such costs is key to the successful
future operations of FPA. There can be no assurance that FPA'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 is regularly in discussions with additional acquisition candidates and
may from time to time enter into letters of intent or definitive agreements with
respect to the acquisition of such businesses. There can be no assurance that
FPA will acquire any additional businesses.
The integration of acquired entities also requires the dedication of
management resources, which may distract the attention of management from the
day-to-day business of the combined companies. Furthermore, new acquisitions may
expose the FPA Network to new Payors and providers with which it has had no
previous business experience. FPA cannot predict whether it will be able to
enroll into the FPA Network all members currently served by physicians
affiliated with newly acquired entities. Also, there can be no assurance that
there will not be substantial unanticipated costs or other material adverse
effects associated with acquisition and integration activities, any of which
could result in significant one-time charges to earnings or otherwise adversely
affect FPA's operating results.
In addition, as a result of the acquisition of Sterling, FPA offers new
services, specifically the management and support of hospital-based emergency
departments. The addition of these new services presents certain risks and
uncertainties due to FPA's relative unfamiliarity with these types of services
and the market for such services. There can be no assurance that FPA will be
successful in developing and integrating Sterling's operations and services.
Risks of Financial Leverage. FPA's indebtedness is significant in relation
to its stockholders' equity. On a pro forma basis giving effect to the
Foundation Transaction and FPA's December 1996 issuance of the Debentures, such
debt accounts for approximately 50% of FPA's total capitalization as of
September 30, 1996. From its inception until the completion of the Foundation
Transaction and the issuance of the Debentures, FPA had not incurred significant
indebtedness as a percentage of FPA's total capitalization. While FPA believes
it will be able to service its debt, there can be no assurance to that effect.
The degree to which FPA is leveraged could affect its ability to service its
indebtedness, make capital expenditures, respond to market conditions and
extraordinary capital needs, take advantage of certain business opportunities or
obtain additional financing. Unexpected declines in FPA's future business, or
the inability to obtain additional financing on terms acceptable to FPA, if
required, could impair FPA's ability to meet its debt service obligations or
fund acquisitions and, therefore, could materially adversely affect FPA's
business and future prospects.
30
<PAGE> 39
Foundation Transaction -- History of Losses; Impact on FPA's Financial
Statements. The Combined Foundation Companies have experienced net losses of
$11,195,000, $45,341,000, and $32,256,000 for the years ended June 30, 1994,
1995 and 1996, respectively. The losses of the Combined Foundation Companies are
primarily attributable to the addition of salaried providers within their
respective networks and less than anticipated patient volume. FPA believes that
such insufficient patient volume is due in part to the Combined Foundation
Companies' inability to receive significant contracts from multiple payors,
including competitors of Foundation and their subsidiaries, because of their
relationship with Foundation. While FPA intends to institute certain measures to
reduce these losses and operate the Combined Foundation Companies profitably,
there can be no assurance that such operations will be profitable in the future.
Growth Strategy; Difficulty in Maintaining Growth. 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. 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.
Risks Related to Intangible Assets. As a result of FPA's various
acquisition transactions, intangible assets of approximately $377 million have
been recorded as of September 30, 1996 (on a pro forma basis, giving effect to
probable or completed acquisitions since such date) on FPA's balance sheet. Such
intangible assets totaled approximately 189% of FPA's stockholders' equity as of
September 30, 1996 (on a pro forma basis, giving effect to probable or completed
acquisitions since such date). Using amortization periods ranging from four to
30 years (with an average amortization period of approximately 29 years),
amortization expense relating to such intangible assets will be approximately
$13 million per year. Further acquisitions that result in the recognition of
additional intangible assets would cause amortization expense to further
increase. A portion of the amortization generated by these intangible assets is
not deductible for tax purposes.
At the time of, or following each acquisition, FPA evaluates each
acquisition and establishes an appropriate amortization period based on the
underlying facts and circumstances. Subsequent to such initial evaluation, FPA
periodically reevaluates such facts and circumstances to determine if the
related intangible asset continues to be realizable and if the amortization
period continues to be appropriate. As the underlying facts and circumstances
subsequent to the date of acquisition can change, there can be no assurance that
the value of such intangible assets will be realized by FPA. Although at
September 30, 1996, the net unamortized balance of intangible assets acquired
was not considered to be impaired, any future determination that a significant
impairment has occurred would require the write-off of the impaired portion of
unamortized intangible assets, which could have a material adverse effect on
FPA's results of operations. See Note 1 of Notes to FPA's Supplemental
Consolidated Financial Statements.
Difficulty in Controlling Health Care Costs; Capitated Nature of
Revenue. Agreements with Payors typically provide for the Professional
Corporations to receive prepaid monthly fees per enrollee known as "capitation"
payments. FPA's profitability primarily depends upon its ability to control
costs and the ability of the Professional Corporations to incur less in medical,
hospital and administrative costs than the capitation revenue received from
Payors. Such profitability is achieved through effective management of the
provision of medical services by physicians in the FPA Network including
controlling utilization of specialty care physicians and other ancillary
providers, purchasing services from physicians outside the FPA Network at
competitive prices and negotiating favorable rates with hospitals. Agreements
with Payors may also contain shared risk arrangements under which additional
compensation can be earned based on the provision of high-quality,
cost-effective health care to enrollees but which may require that a portion of
any loss in connection
31
<PAGE> 40
with such shared risk arrangements be assumed by FPA, which would reduce FPA's
net income. The amount of non-capitated medical and hospital costs in any period
could be affected by factors beyond the control of the FPA Network, such as
changes in treatment protocols, epidemics, disasters, new technologies and
inflation. To the extent that specialty care physicians' fees or hospital costs
have not been capitated and enrollees (i) require more specialty care than
anticipated or (ii) have higher than anticipated hospital utilization rates,
revenue paid to the FPA Network by Payors may not be sufficient to cover the
costs the FPA Network is obligated to pay. FPA purchases stoploss insurance
protection which provides thresholds or "attachment points," generally $100,000
for inpatient services and $25,000 for outpatient services per year, at which
substantially all financial exposure for an enrollee beyond such thresholds is
contractually shifted to the insurer up to a specified level (generally $5
million for outpatient and $1 million for inpatient), at which the risk of loss
returns to FPA. The failure of FPA to negotiate favorable attachment 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.
On December 5, 1996, the TDMC physicians located in Tucson, Arizona voted
to be represented by the Federation of Physicians and Dentists. On February 13,
1997 the TDMC employees located in Tucson are scheduled to vote on whether to be
represented by the Union of Health and Hospital Care Employees. Although FPA
does not expect union affiliations of its Arizona employees to have a material
adverse effect on its results of operations or financial condition, there can be
no assurance that future affiliations and/or collective bargaining arrangements
will not have a material adverse effect on FPA's results of operations and
financial condition.
Full Risk Capitation. Under capitation contracts generally, Professional
Corporations accept capitation payments and, as a result, accept the financial
risk for the provision of health care services, including those not normally
performed and provided by professional corporations comprised of primary care
physicians under payor contracts (e.g., specialty care physician services).
Under substantially all Payor contracts, the Professional Corporations accept
the financial risk for the provision of outpatient medical services ("fully
delegated" contracts). Under certain Payor contracts, a Professional Corporation
also accepts the financial risk for hospital services. Approximately 19% of
FPA's total operating revenue for the nine months ended September 30, 1996 was
generated from contracts in which the Professional Corporation accepted the
financial risk for outpatient medical and hospital services. In the event that
(i) FPA is unable to negotiate favorable prices or rates in contracts with
providers of these services on behalf of the Professional Corporations, (ii) a
significant number of enrollees require services up to the stoploss insurance
"attachment points" or (iii) the Professional Corporations are unable to control
effectively the utilization of these services, FPA could experience material
adverse effects on its results of operations.
Fee-for-Service Contracts. FPA's subsidiary, Sterling, provides physician
practice management services to hospitals under two types of contractual
arrangements: fee-for-service contracts and flat-rate contracts. In general,
under fee-for-service contracts, Sterling's revenue is derived from amounts
billed to patients and collected for the account of Sterling. In contrast, under
flat-rate contracts Sterling's revenue is derived from payments of negotiated
amounts paid by the hospital. Under fee-for-service contracts, Sterling accepts
responsibility for billing and collection, and consequently assumes the
financial risks related to changes in patient volume, payor mix and third party
reimbursement rates. Any change in reimbursement policies and practices, payor
mix, patient volume or covered services could materially adversely affect the
operations of FPA, particularly under fee-for-service contracts. Sterling's
fee-for-service contractual arrangements also involve a credit risk related to
uncollectibility of accounts. In addition, fee-for-service contracts have less
favorable cash flow characteristics than flat-rate contracts due to longer
collection periods. Failure to manage adequately the collection risks and
working capital demands associated with fee-for-service contracts could have a
material adverse effect on FPA.
Dependence on Government and Other Third Party Payors. With the
acquisition of Sterling, a significant portion of FPA's operating revenue will
be derived from payments made by government-sponsored health care programs as
well as from other third party payors. For the nine months ended September 30,
1996, approximately 35% of the combined FPA/Sterling/AHI entity would have been
derived from government Payors. Approximately 30% of Sterling's 1995
hospital-based operating revenue was derived from payments
32
<PAGE> 41
made by government health care programs, primarily the Medicare and Medicaid
programs. The Medicare and Medicaid programs are subject to substantial
regulation by the federal and state governments, which are continually revising
and reviewing the programs and their regulations. In addition, funds received
under these programs are subject to audit with respect to the proper billing for
physician services and, accordingly, retroactive adjustments of revenue from
these programs may occur. While FPA seeks to comply with applicable Medicare and
Medicaid reimbursement regulations, there can be no assurance that FPA would be
found to be in compliance with such regulations should it be subject to audit.
Continuing budgetary constraints at both the federal and state level and the
rapidly escalating costs of health care and reimbursement programs have led, and
may continue to lead, to significant reductions in government and other third
party reimbursements for certain medical charges and to the negotiation of
reduced contract rates or capitated or other financial risk-shifting payment
systems by third party payors with service providers. Both the federal
government and various states are considering imposing limitations on the amount
of funding available for various health care services. In recent years, the U.S.
Congress has considered various budget proposals intended to reduce the rate of
increase in Medicare and Medicaid expenditures through cost savings and other
measures. Congress passed a fiscal year 1996 budget reconciliation bill, which,
although ultimately vetoed by the President, called for reductions in the rate
of spending increases in the Medicare and Medicaid programs over the next seven
years. FPA cannot predict the effect current and future proposals regarding
government funded programs would have on its operations. Additionally, Resource
Based Relative Value Scale ("RBRVS"), a system of reimbursement intended to
reallocate medical reimbursement among medical specialties, took effect on
January 1, 1992 and was phased in over a four year period. Under the regulations
relating to the RBRVS fee structure, the aggregate fee payments from Medicare
for certain emergency department procedures may be reduced in some
circumstances. There can be no assurance that the payments under governmental
and private third party payor programs 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 that
place material limitations on reimbursement amounts or practices could adversely
affect the operations of FPA.
Reliance on Certain Payors. In 1993, contracts with four Payors accounted
for approximately 71% of FPA's operating revenue. In 1994, three Payors
accounted for approximately 57% of FPA's operating revenue. In 1994, PacifiCare
Health Systems, Inc. and Prudential Healthcare Plan of California, Inc.
represented 33% and 10%, respectively, of FPA's operating revenue. In 1995,
PacifiCare of California, Inc. (including the senior programs) and Medigroup,
Inc. each represented in excess of 10% of FPA's operating revenue and
collectively accounted for approximately 41% of FPA's operating revenue. On a
pro forma basis for fiscal 1995, giving effect to the Foundation Transaction,
approximately 39% of FPA's operating revenue would have been attributable to
Payor agreements with Foundation. The foregoing percentages exclude the effects
of the Sterling Merger. The loss of any of the foregoing significant Payors
could have a material adverse effect on FPA's results of operations.
Short-term Nature and Early Terminability of Payor Contracts. Contracts
with Payors generally provide for terms of one to three years, may be terminated
earlier without cause upon notice and upon renewal and are subject to
negotiation of capitation rates, covered benefits and other terms and
conditions. At times, Payor contracts may be continued on a month-to-month basis
while the parties renegotiate the terms of the contracts. Agreements with
hospitals to provide contract management services generally have terms of one or
two years and are renewable automatically unless either party gives written
notice of its intent not to renew at least 90 days prior to the end of the term.
Many of these agreements provide for termination by the hospital without cause
on relatively short notice. There can be no assurance that any of such contracts
will not be terminated early, will be renewed or that they will contain
favorable terms. Since January 1994, 28 of Sterling's hospital services
agreements have been terminated as a result of non-renewal, termination by the
hospital, termination by Sterling or hospital closure. Future consolidation in
the health care industry may result in future hospital services agreements being
terminated. The loss of any Payor or hospital contract and the failure to regain
or retain such Payor's members or the related revenues without entering into new
Payor relationships or hospital contracts could have a material adverse effect
on FPA.
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<PAGE> 42
After giving effect to the acquisition of the Combined Foundation
Companies, which was effective November 29, 1996, approximately 41% of FPA's
membership is pursuant to Payor agreements with Foundation. The term of the
professional group provider agreements with Foundation is thirty years with
automatic five-year renewal periods. These agreements commit the Medical Groups,
among other things, to contract with Foundation for all benefit programs and to
maintain sufficient medical personnel to provide reasonable and adequate access
to professional services for all benefit programs offered by Foundation, to keep
care centers open given specified levels of patients and to agree to certain
pricing and contracting parameters with Foundation. In consideration of such
services, Foundation has agreed to pay in the aggregate $55.0 million to the
Medical Groups. The agreements may be terminated in a number of circumstances,
including the event of a material breach or a violation of applicable laws,
rules or regulations. The termination of such agreements would have a material
adverse effect on FPA's results of operations. See "THE FOUNDATION
TRANSACTION -- Holding Company Acquisition."
Dependence on Primary Care Physicians and Emergency Medicine
Physicians. Primary care physicians are an integral part of the FPA Network, as
they provide and manage medical services offered to enrollees. FPA's growth
depends, in part, on its ability to retain existing and attract additional
primary care physicians to the FPA Network. There can be no assurance that
physicians presently in the FPA Network will not leave the FPA Network, that FPA
will be able to attract additional primary care physicians into the FPA Network
or that the amount of capitation or fee-for-service payments to physicians will
not have to be increased. To the extent that primary care physicians leave the
FPA Network or capitation or fee-for-service payments to physicians are
increased, FPA's results of operations may be materially adversely affected. In
order to provide management services to hospital emergency departments, FPA must
recruit and retain sufficient numbers of qualified physicians. There is a
substantial shortage of board certified emergency medicine physicians, and FPA
competes with many types of health care providers, as well as teaching, research
and governmental institutions, for the services of such physicians. An inability
to recruit and retain emergency medicine physicians could adversely affect FPA's
adding new and retaining existing hospital clients.
Risks Related to Classification of Physicians as Independent
Contractors. FPA's subsidiary, Sterling, generally contracts with emergency
room physicians as independent contractors to provide services to its hospital
clients. These independent contractor physicians are paid on an hourly basis.
Pursuant to such compensation arrangements, independent contractor physicians do
not share in the profit derived by FPA from FPA's operations. Because FPA
regards its contracted physicians as independent contractors and not as
employees, FPA does not withhold federal or state income taxes, make federal or
state unemployment tax payments or provide workers' compensation insurance for
such physicians. There can be no assurance that federal or state taxing
authorities or other parties will not challenge the classification of such
independent contractor physicians and determine that such physicians should be
classified as employees. In the event that the physicians under contract with
FPA are determined to be employees, FPA will be materially and adversely
affected and may be subject to retroactive taxes and penalties.
State Laws Regarding Prohibition of Corporate Practice of Medicine. In
certain states in which FPA conducts or may conduct business, general business
corporations are not permitted to practice medicine, exercise control over
physicians who practice medicine or engage in certain practices such as
fee-splitting with physicians. The corporate practice of medicine refers to the
rendering directly, or through employment, of medical services by a general
business corporation. As stated in the Notes to its Consolidated Financial
Statements incorporated herein by reference, FPA believes that it has perpetual
and unilateral control over the assets and operations of the various affiliated
Professional Corporations. There can be no assurance that regulatory authorities
will not take the position that such control conflicts with state laws regarding
the corporate practice of medicine or other federal or state restrictions.
Although FPA believes its operations as currently conducted are in material
compliance with existing applicable laws, there can be no assurance that the
existing organization of FPA and its contractual arrangements with affiliated
physicians will not be successfully challenged in such states as constituting
the unlicensed practice of medicine or that the enforceability of the provisions
of such arrangements, including non-competition agreements, will not be limited.
In the event of action by any regulatory authority limiting or prohibiting FPA
from carrying on its business or from expanding the operations of FPA to certain
jurisdictions, structural and organization
34
<PAGE> 43
modifications of such organization or arrangements may be required, which could
have an adverse effect on FPA.
Because certain state laws prohibit general business corporations from
controlling professional corporations contractually or otherwise, FPA has
structured its contracts with the Professional Corporations so that such
corporations retain the right to enter into contracts for the provision of
medical services or make other financial commitments. Such contracts allow the
Professional Corporations to make commitments which could be on terms which may
not be advantageous to FPA. For example, a Professional Corporation could
decline to enter into Payor contracts which are negotiated for it by FPA or,
alternatively, could decide to enter into Payor contracts which FPA does not
believe are financially advantageous. Physicians who contract with these
corporations may also have the legal right to decline to use other physicians in
the FPA Network or specialists having a pre-existing, subcapitated or fixed fee
relationship with the FPA Network. These decisions, if made by a Professional
Corporation or a physician, could have a material adverse effect on FPA's
business and financial condition.
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 reimbursement may reduce the amount
ultimately received by FPA and, accordingly, may have a material adverse effect
on FPA's business and results of operations.
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.
Possible Negative Effects of Governmental Regulations. The health care
industry is subject to extensive federal and state regulation. Changes in the
regulations or reinterpretations of existing regulations may significantly
affect the FPA Network. FPA and the Professional Corporations are subject to
federal legislation that prohibits activities and arrangements that provide
kickbacks or other economic inducements for the referral of business under the
Medicare and Medicaid programs. Noncompliance with the federal anti-kickback
legislation can result in exclusion from the Medicare and Medicaid programs and
civil and criminal penalties. 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. In addition,
federal legislation currently restricts the ability of physicians to refer
Medicare or Medicaid patients to certain entities in which they have an
ownership interest or compensation arrangement for health care services,
including clinical laboratory services. With respect to the self-referral
prohibitions, the entity and the referring physician are prohibited from
receiving Medicare or Medicaid reimbursement for services rendered and civil
penalties may be assessed. Many states, including states in which FPA does
business, have similar anti-kickback and anti-referral laws. Penalties similar
to those imposed by federal law are provided for violation of state anti-
kickback and anti-referral laws. FPA believes that its operations comply with
all applicable anti-kickback and anti-referral laws. In addition, health care
reforms may expand existing anti-kickback and anti-referral laws to apply to all
health care payors, not just Medicare and Medicaid. It is unclear how any reform
legislation would affect health care provider networks or other types of managed
care arrangements. There can be no assurance that FPA will be able to comply
with any new laws.
Further, a number of states prohibit sharing professional fees (or fee
splitting) with anyone other than a member of the same profession. There can be
no assurance that such laws will ultimately be interpreted in a manner
consistent with the practices of FPA.
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Federal and state laws regulate insurance companies, HMOs and other managed
care organizations. 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 of the states in which FPA operates would not
apply these laws to require licensure of FPA's operations as an HMO, an insurer
or a 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
interpretations of these laws by the regulatory authorities in these states or
in 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 be able to meet. Further,
once licensed, FPA would be subject to continuing oversight by and reporting to
the respective regulatory agency.
Although under the laws of most states the business of insurance generally
is defined to include the acceptance of financial risk and has not extended to
physician networks, the Knox-Keene Health Care Service Plan Act (the "Knox-Keene
Act"), a California statute that applies to managed care health service plans,
requires all health care service plans to be licensed by the California
Department of Corporations (the "Department"). The Department has taken the
position that entities such as FPA, which contract to provide health care
services to enrollees for prepaid or periodic charges, fall under the definition
of a health care service plan. In February 1996, following a dialogue with the
Department regarding whether FPA's operations classify it as a health care
service plan (i.e., an HMO) within the meaning of California law, FPA, on behalf
of one of its subsidiaries, filed a restricted license application with the
Department. The application was approved by the Department in December 1996.
FPA's operations continued without restriction during the period of review by
the Department. 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 or that future interpretations of insurance laws and health care
network laws by the regulatory authorities in these states or other states will
not require licensure or a restructuring of some or all of the operations of
FPA.
The National Association of Insurance Commissioners ("NAIC") recently
adopted the Managed Care Plan Network Adequacy Model Act (the "Model Act") which
is intended to establish standards for the creation and maintenance of networks
by health carriers and establish requirements for written agreements between
health carriers offering managed care plans, participating providers and
intermediaries, like FPA, which negotiate provider contracts, regarding the
standards, terms and provisions under which a participating provider will
provide services to covered persons. An NAIC model insurance act does not carry
the force of law unless it is adopted by applicable state legislatures. FPA does
not know which states, if any, will adopt the Model Act. There can be no
assurance that FPA will be able to comply with the Model Act if it is adopted in
any state in which FPA does business.
Antitrust Regulation. Because the affiliated provider entities within FPA
remain separate legal entities, they may be deemed competitors subject to a
range of antitrust laws that prohibit anti-competitive conduct, including price
fixing, concerted refusals to deal, and division of market. If FPA provider
entities are deemed by regulatory authorities or courts to be part of a single
entity or system, they may be subject to antitrust laws that prohibit
anti-competitive combinations or activities in excess of an immaterial size. FPA
believes that it is in compliance with the antitrust laws, but there can be no
assurance that FPA's interpretation is consistent with that of federal or state
authorities or courts or that such circumstances will remain as FPA grows and
matures and as further regulations and interpretations are promulgated.
Competitive Market Forces. The managed care industry is highly competitive
and is subject to continuing changes in how services are provided and how
providers are selected and paid. Increased enrollment in prepaid health care
plans because of health care reform or for other reasons, increased
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participation by physicians in group practices and other factors may attract
entrants into the physician practice management services segment of the managed
care industry and result in increased competition for FPA. In addition, local
physician groups and hospitals are also trying to combine their services into
integrated delivery networks. Certain of FPA's competitors are significantly
larger and better capitalized, provide a wider variety of services, may have
greater experience in providing physician practice management services and may
have longer established relationships with Payors. Accordingly, FPA may not be
able to continue to increase the number of providers in the FPA Network,
negotiate contracts with new Payors on behalf of the Professional Corporations
or renegotiate favorable contracts with current Payors. The inability of FPA to
increase the number of providers in the FPA Network and negotiate favorable
contracts with Payors could have a material adverse effect on FPA.
In addition, as a result of consolidations among Payors, certain Payors are
able to negotiate or are in the process of negotiating significant reductions in
the capitation payments to providers. Further, certain payors have deleted
shared risk arrangements from their contracts with providers thereby decreasing
the amount of compensation such payors are paying providers. To date, none of
the Payors has deleted shared risk arrangements from its contract with any
Professional Corporations. If Payors negotiate cost reductions with the
Professional Corporations or eliminate shared risk arrangements in which the
Professional Corporations are currently participating, such actions could have a
material adverse effect on the results of operations of FPA.
Potential Liabilities. 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 as well as 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. FPA is named in such lawsuits and claims and will likely be named as a
party in similar suits and claims in the future. FPA maintains an errors and
omissions policy relating to its utilization review activities and is included
as a named or additional insured on the policies of the Professional
Corporations. Insurance coverage for lawsuits brought or which may be brought
against FPA may not be sufficient to cover FPA's expenses or losses. There can
be no assurance that insurance coverage will be sufficient and, if insufficient,
that such suits or claims will not have a material adverse effect on FPA.
Further, FPA could be held liable for the negligence of a contracted health care
professional if such health care professional were regarded as an employee or
agent of FPA in the practice of medicine. In addition to any potential tort
liability of FPA, FPA's emergency department contracts with hospitals generally
contain provisions under which FPA agrees to indemnify the hospital for losses
resulting from the malpractice of contracted physicians.
An increasing number of health care providers and other entities are being
faced with lawsuits alleging fraudulent billing practices under the federal
Civil False Claims Act. The Civil False Claims Act permits a person (generally
employees or former employees of the health care provider or other entity) to
assert the rights of the government by initiating a qui tam action against a
health care provider or other entity if such person has or purports to have
information that the health care provider or other entity falsely and
fraudulently submitted a claim to the government for payment. Upon filing, the
government has the opportunity to intervene and assume control of the case.
Penalties of up to $10,000 for each false or fraudulent claim presented to the
government for payment may be awarded as well as treble damages. Defendants also
may be excluded permanently or for a period of time from participation in the
Medicare and Medicaid programs. Because of penalties and treble damages, many of
these lawsuits involve large monetary claims and substantial defense costs. If a
qui tam action is successfully prosecuted, no assurance can be made that such
event would not have a material adverse effect on FPA and its operations.
Fluctuations in Quarterly Results. FPA's financial statements (including
interim financial statements) contain accruals which are calculated quarterly
for estimates of amounts assigned by the Professional Corporations to FPA and
paid by Payors based upon hospital utilization ("shared risk revenues").
Quarterly results have in the past and may in the future be affected by
adjustments to such estimates for actual costs incurred. Historically, the
Professional Corporations and Payors generally reconcile differences between
actual and estimated amounts receivable or payable relating to Payor shared risk
arrangements in the second or third quarter of each year. In the event that the
Professional Corporations and Payors are unable to reconcile such
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differences, extensive negotiation, arbitration or litigation relating to the
final settlement of these amounts may occur. To the extent that the FPA Network
expands to include additional Payors, the timing of these adjustments may vary;
this variation in timing may cause FPA's quarterly results not to be directly
comparable to corresponding quarters in other years. FPA's financial statements
also include estimates of costs for covered medical benefits incurred by
enrollees, which costs have not yet been reported by the providers. While these
estimates are based on information available to FPA at the time of calculation,
actual costs may differ from FPA's estimates of such amounts. If the actual
costs differ significantly from the amounts estimated by FPA, adjustments will
be required and quarterly results may be affected. Quarterly results may also be
affected by movements of Payor members from one Payor to another, particularly
during periods of open enrollment for HMOs. Fluctuations in FPA's quarterly
operating results could result in significant volatility in, and otherwise
adversely affect, the market price of FPA Common Stock.
Possible Volatility of Stock Price. Recently, there has been significant
volatility in the market prices of securities of companies in the health care
industry, including the price of FPA Common Stock. Many factors, including
announcements of new legislative proposals or laws relating to health care
reform, the performance of, and investor expectations for, FPA, analysts'
comments, the trading volume in FPA Common Stock and general economic and market
conditions, may influence the trading price of FPA Common Stock. Accordingly,
there can be no assurance as to the price at which FPA Common Stock will trade
in the future.
Dependence Upon Key Personnel; Employment Contracts. FPA depends on the
active participation of its executive officers and directors, particularly Dr.
Sol Lizerbram, Chairman of the Board, Dr. Seth Flam, President and Chief
Executive Officer and Dr. Stephen Dresnick, President of Sterling. The loss of
the services of Drs. Lizerbram, Flam or Dresnick could have a material adverse
effect upon FPA's future operations. FPA has an employment contract with each of
Drs. Lizerbram, Flam and Dresnick. FPA has not purchased key-man life insurance
on any of its key personnel.
Dilution; Additional Capital Needs. Assuming the maximum number of shares
is issued in connection with the Merger, and after giving effect to the
acquisition of the Combined Foundation Companies and issuance of FPA Common
Stock upon conversion of the Debentures, the current FPA stockholders' ownership
of FPA will be reduced to 73%.
FPA's expansion strategy includes acquisitions of, and affiliations with,
individual and group physician practices as well as organizations that provide
management services to such practices. Such acquisitions or affiliations may be
consummated using newly issued shares of common stock, or securities convertible
or exercisable into FPA Common Stock, as consideration. The issuance of
additional shares of FPA Common Stock may have a dilutive effect on the net
tangible book value or earnings per share following such issuance.
FPA's expansion strategy also requires substantial capital investments.
Capital is needed not only for the acquisition of the assets of physician
practices, but also for their effective integration, operation and expansion and
for the addition of medical equipment and technology. In the event that FPA
Common Stock does not maintain sufficient valuation, or potential acquisition
candidates are unwilling to accept FPA Common Stock as part of the consideration
for the sale of the assets of their businesses, FPA may be required to utilize
more of its cash resources. There can be no assurance that FPA will have
sufficient cash resources or will be able to obtain additional financing or
that, if available, such financing will be on terms acceptable to FPA. Further,
an inability to obtain additional capital through subsequent debt or equity
financings may negatively affect FPA's existing operations and its future
growth.
Shares Eligible for Future Sale. Sales of substantial amounts of FPA
Common Stock in the public market, or the perception that such sales could
occur, may adversely affect prevailing market prices of the FPA Common Stock. As
of February 7, 1997, 24,824,224 shares of FPA Common Stock were issued and
outstanding. In addition, FPA has granted options or warrants to purchase, or
securities convertible into, approximately 9,300,000 shares of FPA Common Stock.
In addition to the registration rights to be granted to certain stockholders of
AHI in connection with the Merger and assuming the effectiveness of FPA's
Registration Statement on Form S-3 to register for resale approximately
8,300,000 shares of FPA Common Stock (3,100,000 of which shares are issuable
upon conversion of the Debentures), approximately 100,000 shares of outstanding
FPA Common Stock are subject to registration rights agreements which obligate
FPA to
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register such shares. The remaining shares are freely tradeable, without
restriction under the Securities Act. In connection with the Acquisition
transactions with Foundation, FPA issued to Foundation $75 million in FPA Common
Stock and granted to Foundation warrants to purchase up to 250,000 shares of FPA
Common Stock.
Anti-Takeover Effect of Certain Charter Provisions. FPA's Certificate of
Incorporation, as amended, and By-laws contain certain provisions that could
have the effect of making it more difficult for a person to acquire, or of
discouraging a third party from attempting to acquire, control of FPA. FPA's
Certificate of Incorporation authorizes the FPA Board without the approval of
the stockholders to issue preferred stock. The rights of the holders of Common
Stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The issuance of
preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
discouraging a person from acquiring a majority of the outstanding Common Stock.
There are no shares of preferred stock presently outstanding and FPA has no
present plans to issue any shares of preferred stock.
Under FPA's credit facility, a merger, consolidation or Acquisition (as
defined therein) by FPA constitutes an event of default. These provisions of
FPA's credit facility could serve to impede or prevent a change of control or
have a depressive effect on the price of FPA Common Stock.
RISKS RELATING TO AHI
Risk of Capitated Fee Revenue Reductions and Management of Medical
Costs. For each of the nine months ended September 30, 1996 and fiscal year
1995, approximately 97% of AHI's total operating revenue related to contracts
under which AHI's physician networks received a prepaid monthly fee for each
covered life and certain utilization-based incentive payments in exchange for
assuming the responsibility for the provision of specified medical services to
assigned enrollees. Payors are increasingly overseeing the provision of and the
prices charged for medical services with the goal of reducing costs and lowering
reimbursement. FPA's success with AHI therefore will depend in large part on the
effective management of health care costs, including controlling utilization of
specialty care physicians and other ancillary providers and purchasing services
from third-party providers at competitive prices. Any adjustment downward in
capitation payments caused by the increasing efforts by Payors to reduce costs
could have a material adverse effect on AHI and on FPA following the Merger.
Ability to Manage Growth. AHI's strategy involved growth through the
development of networks of physicians in existing and new markets, as well as
acquisitions and joint ventures in such markets. There can be no assurance that
FPA will be able to successfully integrate AHI's acquisitions into the FPA
Network. Certain of the acquired networks have not been financially successful
to date and there can be no assurance that FPA will be able to improve the
performance of such networks to an acceptable level or be able to maintain such
performance at an acceptable level.
Fluctuations in Quarterly Operating Results; Recent Operating
Losses. AHI's operating results have been subject to quarter-to-quarter
fluctuations. AHI's quarterly results have been affected by development and
acquisition costs, by adverse trends in risk share settlements and the cost of
medical services, and by other operational or external factors. For example,
AHI's cost of medical services increased 23.4% to $28.4 million for the third
quarter of 1996 from $23.0 million for the third quarter of 1995. As a
percentage of total operating revenue, AHI's cost of medical services increased
17.6% to 94.5% for the third quarter of 1996 from 76.9% for the third quarter of
1995. The increase in this percentage was principally due to the reduction in
revenue relating to certain of AHI's risk share arrangements, as well as an
increase in medical costs of approximately $3 million due to a revision of
claims reserves reflecting recent experience in physician claims payment
patterns. AHI and the managed care industry in general have recently experienced
an increase in medical costs. In addition, for the above reasons, AHI reported a
net loss for the third quarter of 1996 of $7.6 million and as of September 30,
1996 AHI reported a working capital deficit of approximately $2.0 million.
Quarterly results have been and may also be affected by significant differences
between actual and estimated amounts receivable or payable relating to Payor
shared risk arrangements and provider "incurred but not reported" claims
("IBNR"), which are adjusted periodically as settlements are made in the case of
shared risk
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arrangements or as actual claims adjustments occur in the case of IBNR. In
addition, movements of enrollees from one Payor to another, particularly during
periods of open enrollment for HMOs, could impact quarterly results. Because of
these quarterly fluctuations, among other things, AHI's earnings over the last
several quarters have been consistently and materially worse than management's
expectations.
Dependence on Certain Payors. AHI derives revenue from contracts between
its physician networks and Payors, which contracts generally are for one to
three year terms, may be terminated earlier upon notice and are subject to
annual negotiation of capitation rates, covered benefits and other terms and
conditions. Certain Payors represent a substantial percentage of these
contracts, although such Payors generally enter into separate contracts (with
various termination dates) with each physician network. For the years ended
December 31, 1996, 1995 and 1994, FHP, Inc. accounted for approximately 17%, 22%
and 35%, respectively, of AHI's total operating revenue and CareAmerica Southern
California, Inc. accounted for approximately 6%, 11% and 22%, respectively, of
AHI's total operating revenue. Upon completion of the acquisition of The
Healthcare Partnership in February 1995, AHI's revenue from PacifiCare Health
Systems, Inc. represented approximately 33% and 28%, respectively, of AHI's
total operating revenue for the years ended December 31, 1996 and 1995. On a pro
forma basis for fiscal years 1996 and 1995, after giving effect to the potential
merger between FHP, Inc. and PacifiCare Health Systems, Inc., approximately 50%
of AHI's total operating revenue would have been attributable to Payor
agreements with the merged FHP/PacifiCare entity.
Although AHI considers its relationships with Payors to be generally good,
there can be no assurance that Payors will not exercise their early termination
rights or elect not to renew their contracts with AHI's physician networks. In
the past, one Payor terminated two of its contracts in Southern California
(although that Payor still contracts with 11 of AHI's physician networks in
Southern California and other markets), another Payor terminated one of its ten
contracts in Southern California due to business issues that arose in one
network and another Payor terminated its contracts with AHI's physician networks
in the Dallas, Texas area after it was acquired by a company whose business
model was inconsistent with AHI's network structure. Recently, a Payor
terminated its contract with one of AHI's physician networks in Southern
California because a joint venture arrangement between AHI and another entity
failed to produce significant membership in such physician network. In addition,
AHI and a Payor mutually agreed to the early termination, effective February 28,
1997, of a contract in Florida. In the event that additional Payors elect to
terminate or fail to renew their contracts with AHI's physician networks, AHI
will experience revenue reductions which, if significant, could affect AHI's
results of operations and liquidity. In addition, the loss of one or more Payors
in individual markets could impact AHI's ability to reach or maintain critical
mass in the affected markets, further impacting AHI's results of operations. In
addition, there can be no assurance that Payors will not attempt to renegotiate
financial and other terms less advantageous to AHI, or that AHI's administrative
costs will not rise without corresponding revenue increases as Payors delegate
additional services to AHI or as the standards, such as those imposed by NCQA,
governing the performance of services AHI already performs become more
stringent.
Legal Proceedings. AHI is a defendant in a 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 on December 20, 1995 against AHI, certain
of its officers and directors, and all of the underwriters of AHI's common stock
in AHI's initial public offering. 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. AHI
and its
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directors are also named as defendants in a purported class action lawsuit filed
by Joshua Chopp, a stockholder of AHI, in the Delaware Court of Chancery on
November 12, 1996. 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 Agreement without undertaking steps to accurately ascertain
AHI's market value. See "THE MERGER - Pending Litigation." The plaintiff seeks,
on behalf of all AHI common stockholders, to enjoin the Merger as well as
rescissory and compensatory damages. FPA is also named as a defendant in the
lawsuit. AHI intends to vigorously defend both of these lawsuits and does not
expect that the outcome of these lawsuits will have a material adverse effect.
Competition. The managed care industry is highly competitive. See "RISK
FACTORS -- Risks Relating to FPA -- Competitive Market Forces."
Governmental Regulation. As a participant in the health care industry,
AHI's operations and relationships are subject to extensive and increasing
regulation by a number of governmental entities at the federal, state and local
levels. AHI and its subsidiaries and affiliates also are subject to laws and
regulations relating to business corporations in general. AHI believes that its
operations are in material compliance with applicable laws as currently
interpreted. Nevertheless, because of the structure of AHI, many aspects of
AHI's business operations fall within the regulatory oversight of federal and
state authorities, and there can be no assurance that a review of AHI's business
by courts or regulatory authorities will not result in a determination that
could adversely affect the operations of AHI and the operations of FPA following
the Merger. There also can be no assurance that the regulatory environment in
which AHI operates will not change significantly in the future, which change
could restrict AHI's existing operations, expansion, financial condition or
opportunities.
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 or 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 recently 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 costs. 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 certain entities in which they have an
ownership or financial interest. Effective January 1, 1995, the federal
anti-referral legislation extends to entities that provide certain other
"designated health services." Many states, including those in which AHI
presently does business, have similar anti-kickback and anti-referral laws. In
addition, the health care reforms that were proposed by the Clinton
Administration contemplated expanding existing federal anti-kickback and anti-
referral laws so as to apply to all Payors, and not just Medicare or Medicaid.
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 AHI's business does not fall within
certain of the current or proposed safe harbors, AHI believes that its
operations materially comply with such statutes and regulations. AHI 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. A determination of
liability under any such law could have a material adverse effect on AHI's
revenue or operating results and on FPA's revenue or operating results following
the Merger. There can be no assurance that such extension of such laws will not
be enacted by Congress or by regulation, and it is presently unclear how such
changes would impact physician networks within AHI or other types of managed
care arrangements. Such changes, however, could materially adversely affect
AHI's operating results or FPA's operating results following the Merger.
AHI's physician networks contract with physicians and other health care
professionals as independent contractors and, in accordance with federal and
state tax guidelines pertaining to independent contractors, do not withhold
federal or state income taxes, make federal or state unemployment tax payments
or provide workers' compensation insurance with respect to such independent
contractors. However, a determination by taxing authorities to the contrary with
respect to the classification of such physicians or other health care
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professionals as independent contractors could have a material adverse effect on
AHI's operating results and on FPA's operating results following the Merger.
State Laws Regarding Prohibition of Corporate Practice of Medicine. AHI
currently manages or is developing physician networks in California, Texas,
Florida, Kentucky, Arizona, Georgia, Tennessee, Louisiana and New York. Except
for Arizona, Florida and Louisiana, each of the foregoing states prohibits the
corporate practice of medicine except by professional medical corporations or
associations. In such states, all health care services are provided by, and all
contracts are held by, physician networks licensed as health care providers in
such states and AHI performs only nonmedical management and administrative
services, does not represent to the public or its clients that it offers medical
services and does not exercise influence or control over the practice of
medicine by the physicians with whom it contracts. As stated in Note 1 to its
Consolidated Financial Statements, AHI believes that it has perpetual and
unilateral control over the business enterprise of the physician networks. There
can be no assurance that regulatory authorities will not take the position that
such control conflicts with state laws regarding the corporate practice of
medicine or other federal or state restrictions. The laws in most states
regarding the corporate practice of medicine have been subjected to limited
judicial and regulatory interpretation and, therefore, no assurance can be given
that AHI's activities will be found to be in compliance, if challenged. In
states that do not prohibit the corporate practice of medicine, AHI, through its
subsidiaries, may employ physicians to practice medicine, may enter into
contracts for medical services with HMOs and other Payors and may take such
other actions as are necessary or appropriate to perform such agreements. In
addition to prohibiting the corporate practice of medicine, the laws of many
states prohibit entities like AHI from engaging in certain health care related
activities, such as splitting fees with non-physicians. AHI believes its current
and planned activities do not constitute fee-splitting as contemplated by these
laws. There can be no assurance, however, that interpretations or enforcement of
such laws will not require structural and organizational modifications of AHI's
existing relationships with its affiliated entities, physicians or with third
parties. Statutes or regulations in some states also could restrict expansion of
AHI's operations into those jurisdictions.
Health Care Reform. In addition to current regulation, the public and
state and federal governments recently have focused significant attention on
reforming the health care system in the United States. Within the past two
years, a broad range of health care reform measures have been introduced in
Congress and in certain state legislatures. Additional health care reform
measures have been brought before the public in state voter initiatives. Among
the proposals under consideration are or were cost controls on hospitals,
insurance market reforms to increase the availability of group health insurance
to small businesses, requirements that all businesses offer health insurance
coverage to their employees and the creation of a single government health
insurance plan at the state or federal level that would cover all citizens.
Legislative interest recently has also focused on the role of HMOs in the
provision of health care and the effect of managed care reimbursement mechanisms
on health care service utilization and quality of service. It is not clear at
this time what proposals, if any, will be adopted or, if adopted what effect, if
any, such proposals would have on AHI's business or, following the Merger, on
FPA's, business. There can be no assurance that any proposals adopted would be
coordinated at the federal or state level, and therefore AHI, as a national
participant in the health care industry, is subject to the existence of varying
state regulatory environments. Certain proposals, such as cutbacks in the
Medicare and Medicaid programs, containment of health care costs that could
include a freeze on prices charged by physicians, hospitals or other health care
providers, and greater state flexibility in the administration of Medicaid could
adversely affect AHI and FPA following the Merger. There can be no assurance
that currently proposed or future health care legislation or policies or other
changes in the administration or interpretation of governmental health care
programs, laws, regulations or policies will not have a material adverse effect
on AHI's operating results or on FPA's operating results following the Merger.
Goodwill. Goodwill totaling approximately $26.1 million at September 30,
1996 arose primarily as the result of AHI's acquisitions in 1994 and 1995. This
amount represents the excess of the consideration paid and liabilities assumed
over the fair value of the assets acquired. Goodwill has been recorded at cost
and is being amortized on the straightline method over 20 years. The annual
amortization expense related to goodwill is approximately $1.4 million per year.
Such amortization is expected to significantly affect AHI's profitability in the
near term. As required under generally accepted accounting principles, AHI
reviews and, upon
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consummation of the Merger, FPA will continue to review the carrying value of
goodwill at each reporting period to determine if facts or circumstances exist
which suggest that goodwill may be impaired. If impairment is determined to have
occurred, goodwill will be adjusted downward. Such adjustment, if required,
could have a material adverse effect on the operating results of AHI in the
period recorded.
Potential Exposure to Professional Liability; Availability of
Insurance. In recent years, physicians, hospitals and other participants in the
health care industry have become subject to an increasing number of lawsuits
alleging medical malpractice and related legal theories. Many of these lawsuits
involve large claims and substantial defense costs. AHI does not engage in the
practice of medicine or provide medical services, nor does it control the
practice of medicine by physicians within its physician networks or the
compliance with regulatory requirements directly applicable to such physicians
and the physician network entities with whom they contract. However, AHI is
subject to, and from time to time is involved in, litigation related to certain
of its nonmedical, administrative functions such as utilization review and
physician credentialing. AHI maintains professional liability and general
liability insurance in amounts deemed appropriate by management based on the
nature and risks of AHI's business. In addition, each physician network entity
is required to maintain professional liability insurance coverage on such entity
and on each employee and agent of such entity, and AHI generally is indemnified
under each of the management agreements by such entity for liabilities resulting
from the performance of medical services by such entity, its employees and
agents. Although AHI currently is not a party to any material litigation
relating to the practice of medicine, there can be no assurance that AHI will
not become involved in such litigation in the future, that any claim or claims
arising from such litigation will not exceed AHI's insurance coverage or that
such coverage will continue to be available.
Termination of Management Agreements. AHI and its physician networks enter
into management agreements pursuant to which AHI provides the physician network
with all of its non-medical management and administrative services. These
management agreements have an initial term of 20 years and renew automatically
and perpetually for successive ten year terms thereafter. A physician network
may only terminate its management agreement with AHI for a material breach of
the agreement or a material violation of law which likely would result in
material adverse harm to the physician network, unless, in each case, such event
is cured within 180 days, or upon the dissolution or liquidation of AHI. There
can be no assurance that any management agreement will not be terminated for
cause by a physician network. The termination of certain of AHI's management
agreements could have a material adverse effect on AHI's operating results and
financial position.
Dependence on Independent Contractors. AHI's business depends to a
significant degree on its ability to recruit and retain on a contractual basis a
sufficient number of qualified physicians. There can be no assurance that
physicians presently contracted by AHI will not leave AHI, that AHI will be able
to attract additional primary care physicians or that the amount of capitation
or other payments to physicians will not have to be increased. To the extent
that primary care physicians leave AHI or capitation or other payments to
physicians are increased, AHI's results of operations and, following the Merger,
FPA's results of operations, may be materially adversely affected.
Control of Health Care Costs. The success of AHI will depend in large part
on the effective management of health care costs. Changes in health care
practices, inflation, new technologies, major epidemics, natural disasters and
numerous other factors affecting the delivery and cost of health care are beyond
the control of management and may adversely affect the operating results of AHI.
Knox-Keene Act Compliance. Laws in all states regulate the business of
insurance and the operation of HMOs. Generally, the business of insurance is
defined to include the acceptance of financial risk and has not extended to
physician networks. Under the Department's current interpretation of the
Knox-Keene Act, the Department could seek a ruling that AHI's operations in
California, as currently conducted, are subject to the provisions of the
Knox-Keene Act. On July 2, 1996, pursuant to discussions with the Department,
AHI, through a wholly owned subsidiary, filed an application for restricted
licensure as a Knox-Keene health care service plan for its California
operations. The restricted license, if granted, would allow for the receipt of
capitation payments for both hospital and medical professional services, but
would not allow AHI to market directly to employers and subscribers. The
Department granted FPA a restricted license in December 1996
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<PAGE> 52
and has granted AHI's request to suspend the processing of AHI's license
application pending the outcome of the Merger. There can be no assurance that
AHI will be successful in obtaining a restricted license and AHI may be required
to restructure its California business operations (which, if such license is not
granted, could result in a reduction of revenue) and/or incur additional costs
in the future to meet applicable regulatory requirements. In addition, there can
be no assurance that regulatory authorities in the other states in which AHI or
its affiliates operate will not impose similar requirements or that future
interpretations of insurance laws and health care network laws by the regulatory
authorities in these states or other states will not require licensure or a
restructuring of some or all of the operations of AHI. Although AHI expects the
licensure process to have no material impact on its operations, there can be no
assurances the Department will not impose requirements adverse to AHI's business
and, following the Merger, FPA's business.
RISKS RELATING TO THE MERGER
Impact on FPA's Financial Statements. The Merger will result in a pro
forma operating loss of $66,328,827 and a pro forma net loss of $50,447,112 for
FPA for the nine months ended September 30, 1996. The Foundation Transaction and
the Merger account for approximately $65,075,000 and $16,904,000 of such pro
forma operating loss, respectively. See the Pro Forma Financial Statements
included elsewhere in this Proxy Statement/Prospectus. In addition, FPA expects
to incur non-recurring costs in connection with the Merger aggregating
approximately $19 million relating primarily to executive severance payments,
financial advisory fees, professional fees and restructuring costs.
No Assurance of Successful Integration of Certain Operations. FPA and AHI
have entered into the Merger Agreement with the expectation that the Merger will
result in certain benefits for the combined company. Achieving the anticipated
benefits of the Merger will depend in part upon whether the integration of the
two companies' business is achieved in an efficient and effective manner, and
there can be no assurance that this will occur. The combination of the two
companies will require, among other things, coordination of the companies' sales
and marketing efforts. There can be no assurance that integration will be
accomplished on a timely basis, or at all. The difficulties of such integration
may be increased by the necessity of consolidating geographically separated
organizations in order to achieve economies of scale. The integration of certain
operations following the Merger will require the dedication of management
resources which may distract attention from the day-to-day business of the
combined company. In particular, the management services provided by FPA to
physicians, hospitals and Payors in the FPA network, which include management
information systems, claims administration and billing services, utilization
management of medical services, care, coordination and case management, quality
and cost monitoring and physician recruitment, will have to be extended to new
members of the FPA Network. Failure to effectively accomplish the integration of
the two companies' operations could have a material adverse effect on FPA
results of operations and financial condition.
The Merger is expected to result in a reduction in general and
administrative expenses of $14 million. In the event such cost reductions cannot
be realized, operating losses attributable to AHI's operations will continue.
Conversion Number May Not Fully Reflect Changes in Stock Prices. The
relative stock prices of FPA Common Stock and AHI Common Stock at the Effective
Time may vary significantly from the prices as of the date of execution of the
Merger Agreement, the date hereof or the date on which stockholders vote on the
Merger due to, among other factors, changes in the business, operations and
prospects of FPA or AHI, market assessments of the likelihood that the Merger
will be consummated and the timing thereof and general market and economic
conditions.
The Conversion Number is subject to adjustment based on changes in the
market value of FPA Common Stock. However, the Conversion Number will not be
adjusted to reflect changes in the value of AHI Common Stock. The FPA Value will
be determined two days prior to the special meeting of AHI's stockholders and
the Equivalent Value may range from a low of $6.09 to a high of $9.92 per share.
Both the Equivalent Value and the Conversion Number may be adjusted if the FPA
Value is equal to or greater than $22.38 or less than $14.38. If the FPA Value
is less than $14.38, the Conversion Number will be .609 and the maximum number
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<PAGE> 53
of shares will be issued to AHI stockholders. If the FPA Value is equal to or
greater than $14.38 and less than $22.38, the Conversion Number will be adjusted
such that the Equivalent Value will equal $8.75. If the FPA Value is equal to or
greater than $22.38 and less than $25.38, the Conversion Number will be .391. If
the FPA Value is equal to or greater than $25.38, the Conversion Number will be
adjusted downward such that the Equivalent Value will equal $9.92. There is no
minimum Conversion Number if the FPA Value exceeds $25.38. Since October 1, 1996
through February 7, 1997, the high and low bid prices, as reported on Nasdaq,
for FPA Common Stock have been 25 5/8 and 19 1/4, respectively. On February 7,
1997 the closing price of FPA Common Stock was $24.25. Assuming an FPA Value
equal to such price, the Equivalent Value would be $9.48 and the Conversion
Number would be .391. Based upon the 14,523,041 shares of AHI Common Stock
outstanding as of such date, AHI's stockholders would be issued approximately
5,678,509 shares of FPA Common Stock, representing approximately 18.6% of the
total issued and outstanding shares of FPA Common Stock after the Merger. Since
the actual number of shares of FPA Common Stock issuable to AHI stockholders in
the Merger depends on the FPA Value, there is no guarantee as to the number of
shares or value of the FPA Common Stock that AHI stockholders will receive. Each
FPA and AHI stockholder is urged to obtain updated market information. See "THE
MERGER -- Adjustments to Merger Consideration."
Deterrent Effect of Termination and Non-Solicitation Provisions. If the
AHI Board determines, in the exercise of its fiduciary duties, to terminate the
Merger Agreement, then AHI will be required to pay a break-up fee equal to the
2% of the value of FPA Common Stock (determined based on the FPA Value) which
would have been issued had the closing occurred on the day of such termination.
Assuming a termination date of February 7, 1997, the break-up fee would be
approximately $2.75 million based upon the closing price of the FPA Common Stock
of $24.25 on such date. AHI has agreed not to initiate, solicit or encourage any
proposal or offer by a third party concerning a merger, sale of assets or
similar transaction, except that AHI may furnish information to and negotiate
with an unsolicited third party consistent with the good faith exercise by the
AHI Board of its fiduciary obligations. These provisions in the Merger Agreement
may have the effect of discouraging an attempt by a third party to engage in
certain acquisition transactions with AHI. See "THE MERGER AGREEMENT -- Certain
Additional Agreements" and "-- Effect of Termination."
Need for Additional Capital. Upon consummation of the Merger, FPA will be
a larger company and will therefore require additional capital in order to
continue to expand its operations. Failure to secure additional financing could
have an adverse effect on FPA's operations. There can be no assurance that FPA
will be able to obtain such additional financing, or if available it will be on
terms acceptable to FPA.
Possible Loss of Business. Despite the efforts of each of FPA, Sterling
and AHI, current key independent contractor physicians, employees or clients of
Sterling or AHI may not continue to contract with FPA subsequent to the Merger.
The loss of a material number of independent contractor physicians, employees or
clients could adversely affect the operations of Sterling or AHI.
Interests of Certain Persons in the Merger; Possible Conflicts of
Interest. In considering the recommendations of the FPA Board and the AHI
Board, the FPA stockholders and the AHI stockholders should be aware that
certain directors and executive officers of AHI have certain interests in the
Merger that are different from, or in addition to, the interests of stockholders
of AHI generally, and certain of these directors and officers could receive
significant compensation if the Merger is approved by the FPA and AHI
stockholders. See "THE MERGER -- Interests of Certain Persons in the Merger."
Eight senior executives of AHI will be given severance consideration as of the
closing of the Merger including (i) the waiver of any applicable non-compete
provisions set forth in the employment agreements; (ii) the termination of each
of their employment agreements and (iii) the receipt of a lump-sum payment
pursuant to each of their employment agreements upon a change of control.
Pursuant to such change in control arrangements, Leonardo Berezovsky, M.D., Saul
Honigstein, H.R. Brereton Barlow, Luis Artime, Stuart Bruck, Steven Posar, M.D.,
Robert Brice and Gary Sherlock, each of whom is an executive officer and/or a
director of AHI, will receive approximately $1,640,000, $503,000, $724,000,
$256,000, $388,000, $529,000, $495,000 and $495,000, respectively. In connection
with the Merger, certain other officers and employees of AHI will receive
severance payments not to exceed in the aggregate $750,000. See "THE MERGER
AGREEMENT -- Certain Additional Agreements -- Employee Benefit Plan." FPA has
agreed to enter into a
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registration rights agreement with certain executive officers and directors of
AHI. Additionally, as of the record date, directors and executive officers of
FPA and AHI and their affiliates may be deemed to beneficially own approximately
16.1% and 62.3% of the outstanding FPA Common Stock and AHI Common Stock,
respectively. Certain directors and executive officers of FPA and AHI with the
collective power to vote approximately 13.8% and 55.2%, respectively, of the
outstanding FPA Common Stock or AHI Common Stock, as applicable, have entered
into voting agreements and given their irrevocable proxies, providing that their
shares shall be voted in favor of the Merger. See "THE MERGER
AGREEMENT -- Certain Additional Agreements -- Irrevocable Proxies." On February
7, 1997, the closing price of FPA Common Stock was $24.25. Assuming an FPA Value
equal to such price, the Equivalent Value would be $9.48. Based upon the
14,523,041 shares of AHI Common Stock outstanding as of such date, AHI
Stockholders would be issued approximately 5,678,509 shares of FPA Common Stock
in the Merger. If the Merger were consummated, the directors and officers of AHI
would receive 62.3% of the shares of FPA Common Stock issued to AHI stockholders
in the Merger. AHI also agreed to purchase prior to the Effective Time, and FPA
and AHI agreed to maintain, until September 28, 1999, directors' and officers'
liability insurance with respect to claims arising from facts or events that
occurred on or prior to the Effective Time. FPA also agreed to indemnify all
directors, officers, employees, and stockholders who are officers or directors
of AHI against any liability or losses any of them may incur because of any
claim brought against them prior to or within five years from the Effective Time
as officers, directors, employees, agents or stockholders of AHI. See "THE
MERGER AGREEMENT -- Certain Additional Agreements -- Directors' and Officers'
Indemnification and Insurance." Although AHI believes the members of the AHI
Board have acted in accordance with their fiduciary duties, the terms of the
Merger may provide the appearance of a possible conflict of interest. See "THE
MERGER - Possible Conflicts of Interest."
Inability to Consummate Merger. If AHI is unable to consummate its planned
merger with FPA (see Note 9 to the AHI Consolidated Financial Statements) or is
unable to decrease its operating losses, AHI may find it necessary to dispose of
certain assets or undertake other actions to conserve its cash balances and
remain viable as a going concern. There can be no assurance these efforts would
be successful. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- AHI -- Liquidity and Capital Resources."
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THE MERGER
EFFECTS OF THE MERGER
The Merger will be consummated promptly following approval by the
respective holders of FPA Common Stock and AHI Common Stock and the satisfaction
or waiver of all other conditions to consummation of the Merger. At the
Effective Time, Merger Sub will be merged with and into AHI, with the result
that AHI will be the surviving corporation in the Merger. After the Merger, AHI
will operate as a wholly owned subsidiary of FPA. Stockholders of AHI will
become stockholders of FPA and their rights will be governed by the Certificate
of Incorporation and Bylaws of FPA.
At the Effective Time, AHI Common Stock will cease trading on Nasdaq, and
there will no longer be any public trading of AHI Common Stock. In addition, FPA
intends to take action, promptly following the Effective Time, to terminate the
registration of the AHI Common Stock under the Exchange Act. As a result, at
prescribed dates thereafter, reports, proxy statements and other information
required under the Exchange Act with respect to AHI will not be filed with the
Commission, although FPA will continue to file reports, proxy statements and
other information with respect to FPA for so long as FPA remains subject to
Exchange Act requirements.
MERGER CONSIDERATION
Pursuant to the Merger Agreement, at the Effective Time, Merger Sub will
merge with and into AHI and each share of AHI Common Stock issued and
outstanding immediately prior to the Effective Time (other than shares of AHI
Common Stock owned by AHI as treasury stock and shares of AHI Common Stock owned
by FPA, Merger Sub or any wholly owned subsidiary of FPA or AHI to be cancelled
in accordance with the Merger Agreement) shall be converted into a fraction of
one share of FPA Common Stock, as determined based on the FPA Value. See
"-- Adjustments to Merger Consideration."
On February 7, 1997 the closing price of FPA Common Stock was $24.25.
Assuming an FPA Value equal to such price, the Equivalent Value would be $9.48
and the Conversion Number would be .391. Based upon the 14,523,041 shares of AHI
Common Stock outstanding as of such date, AHI's stockholders would be issued
approximately 5,678,509 shares of FPA Common Stock, representing approximately
18.6% of the total issued and outstanding shares of FPA after the Merger. The
actual market price of the FPA Common Stock may vary, which will cause a change
in the Conversion Number and the aggregate Merger Consideration and possibly a
change in the Equivalent Value. Additionally, the Equivalent Value may differ
from the actual market price of AHI Common Stock. Each FPA and AHI stockholder
is urged to obtain updated market information.
ADJUSTMENTS TO MERGER CONSIDERATION
The consideration to be issued to each AHI stockholder in the Merger will
be that number of shares of FPA Common Stock which is determined by multiplying
the Conversion Number by the number of shares of AHI Common Stock held by such
AHI stockholder on the Closing Date (as hereinafter defined) (the "Merger
Consideration"). The Conversion Number will be determined as follows:
(a) if the FPA Value is less than $14.38, the Conversion Number shall be
0.609;
(b) if the FPA Value is equal to or greater than $14.38 and less than
$22.38, the Conversion Number shall be equal to the result obtained by
dividing $8.75 by the FPA Value (and rounding the result to three
decimal places);
(c) if the FPA Value is equal to or greater than $22.38 and less than
$25.38, the Conversion Number shall be 0.391; and
(d) if the FPA Value is equal to or greater than $25.38, the Conversion
Number shall be equal to the result obtained by dividing $9.92 by the
FPA Value (and rounding the result to the three decimal places).
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The Merger Agreement may be terminated by AHI if the FPA value is less than
$10.00.
STOCKHOLDERS OF FPA AND AHI MAY OBTAIN THE CONVERSION NUMBER BEGINNING TWO
DAYS PRIOR TO THE SPECIAL MEETINGS BY CALLING (800) 965-7026.
The following table sets forth the Conversion Number to be applied in the
Merger assuming various FPA Values as set out in Column 1, with the Equivalent
Value to be received for each share of AHI Common Stock:
<TABLE>
<CAPTION>
CONVERSION
FPA VALUE NUMBER EQUIVALENT
(COL. 1) ($) (COL. 2) VALUE ($)
------------------------------------------------ ---------- -------------------
<S> <C> <C>
10.00........................................... .609 6.09
15.00........................................... .583 8.75
19.00........................................... .461 8.75
21.00........................................... .417 8.75
23.00........................................... .391 8.99
25.38........................................... .391 9.92
</TABLE>
Since the actual number of shares of FPA Common Stock issuable to AHI
stockholders in the Merger depends on the FPA Value, there is no guarantee as to
the number of shares or value of the FPA Common Stock that AHI stockholders will
receive. If the FPA Value is greater than $25.38, the Conversion Number will be
adjusted such that the Equivalent Value to be received for each share of AHI
Common Stock will equal $9.92. Accordingly, if the FPA Value is greater than
$25.38, the Conversion Number would be reduced with the result that stockholders
of AHI would be entitled to receive fewer shares of FPA Common Stock in the
Merger. In addition, the FPA Value may differ from the actual market price of
FPA Common Stock reported by Nasdaq on the date of the Special Meetings, the
date of consummation of the Merger, or the date that AHI stockholders actually
receive their shares of FPA Common Stock after the Merger is completed.
In connection with the Merger, options to purchase up to approximately
143,000 shares of FPA Common Stock which may be exercised immediately prior to
the Effective Time, other than certain options issuable to non-employee
directors of AHI, will immediately vest and if not exercised, will be cancelled
at the Effective Time.
CONVERSION OF SHARES; PROCEDURES FOR EXCHANGE OF CERTIFICATES; FRACTIONAL SHARES
The conversion of AHI Common Stock into FPA Common Stock will occur
automatically at the Effective Time.
As soon as practicable after the Effective Time, American Stock Transfer &
Trust Company or another bank or trust company designated by FPA and reasonably
acceptable to AHI, in its capacity as Exchange Agent (the "Exchange Agent"),
will send a transmittal form to each AHI stockholder of record. The transmittal
form will contain instructions with respect to the surrender of certificates
representing AHI Common Stock to be exchanged for FPA Common Stock.
AHI STOCKHOLDERS SHOULD NOT FORWARD AHI STOCK CERTIFICATES TO THE EXCHANGE
AGENT UNTIL THEY HAVE RECEIVED TRANSMITTAL FORMS. AHI STOCKHOLDERS SHOULD NOT
RETURN STOCK CERTIFICATES WITH THE ENCLOSED PROXY.
Until the certificates representing AHI Common Stock are surrendered for
exchange after the consummation of the Merger, holders of such certificates will
not be paid dividends on the FPA Common Stock into which such shares have been
converted. When such certificates are surrendered, any unpaid dividends will be
paid without interest. For all other purposes, however, each certificate which
represents shares of AHI Common Stock at the Effective Time will be deemed to
evidence ownership of the shares of FPA Common Stock into which those shares
have been converted by virtue of the Merger.
All shares of FPA Common Stock issued upon conversion of shares of AHI
Common Stock shall be deemed to have been issued in full satisfaction of all
rights pertaining to such shares of AHI Common Stock.
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No fractional shares of FPA Common Stock will be issued to any AHI
stockholder upon consummation of the Merger. For each fractional share that
would otherwise be issued, the Exchange Agent will pay by check an amount equal
to such fraction multiplied by the Conversion Number.
RISK FACTORS
Certain factors to be considered in connection with an investment in FPA
Common Stock and approval of the Merger Agreement are set forth under "RISK
FACTORS." Risks relating to FPA include no assurance of successful integration
of acquisitions, expanded service offering; Foundation Transaction -- history of
losses, impact on FPA's financial statements; growth strategy, difficulty in
maintaining growth; risks related to intangible assets; difficulty in
controlling health care costs, capitated nature of revenue; full risk
capitation; fee-for-service contracts; dependence on government and other third
party payors; reliance on certain payors; short-term nature and early
terminability of payor contracts; dependence on primary care physicians and
emergency medicine physicians; risks related to classification of physicians as
independent contractors; state laws regarding prohibition of corporate practice
of medicine; possible negative effects of prospective health care reform;
possible negative effects of governmental regulations; antitrust regulation;
competitive market forces; potential liabilities; fluctuations in quarterly
results; possible volatility of stock price; dependence upon key personnel,
employment contracts; risks of financial leverage; dilution, additional capital
needs; shares eligible for future sale; and anti-takeover effect of certain
charter provisions. Risks relating to AHI include risk of capitated fee revenue
reductions and management of medical costs; ability to manage growth;
fluctuations in quarterly operating results, recent operating losses; dependence
on certain payors; legal proceedings; competition; governmental regulation;
state laws regarding prohibition of corporate practice of medicine; health care
reform; goodwill; potential exposure to professional liability, availability of
insurance; termination of management agreements; dependence on independent
contractors; control of health care costs; and Knox-Keene Act compliance. Risks
relating to the Merger include impact on FPA's financial statements; no
assurance of successful integration of certain operations; conversion number may
not fully reflect changes in stock prices; deterrent effect of termination and
non-solicitation provisions; need for additional capital; possible loss of
business; interests of certain persons in the merger; and inability to
consummate merger.
NASDAQ LISTING
It is a condition to the Merger that the shares of FPA Common Stock to be
issued in the Merger be authorized for listing on Nasdaq, subject to official
notice of issuance.
BACKGROUND OF THE MERGER
FPA's strategy for enhancing long-term value for its stockholders has been
to increase the number of enrollees and primary care physicians in the FPA
Network and to negotiate favorable contracts with Payors to provide physician
and related health care services to enrollees who select FPA primary care
physicians. The FPA Board believes that by doing so, FPA can enhance revenues
and earnings. FPA has grown significantly as a result of the acquisitions of
Sterling, Gonzaba Management Services Organization, Inc., PFI and the Combined
Foundation Companies. Revenues and operating expenses have increased from
approximately $18 million and $18 million, respectively, in the year ended
December 31, 1994 to approximately $53 million and $51 million, respectively, in
the year ended December 31, 1995. Revenues and operating expenses for the nine
months ended September 30, 1996 were approximately $189 million and $179
million, respectively, as compared to revenues and operating expenses of the
same period in 1995 of approximately $14 million and $14 million, respectively.
The FPA Board periodically reviews various strategic opportunities to
enhance profitability and increase stockholder value. In this regard, the FPA
Board continually evaluates the acquisition of other entities and medical
practices and has considered longer term acquisition opportunities and other
strategic alternatives.
AHI sold 3.6 million shares of its common stock in an initial public
offering on September 29, 1995. AHI's shares were offered to the public at
$14.00 per share, which resulted in net proceeds from the initial public
offering of approximately $44.5 million.
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Principally as a result of the financial and operational challenges posed
by AHI's expansion and increasing medical costs, AHI incurred larger than
expected losses over the last several quarters. These results have had a
negative impact on the market prices of the AHI Common Stock and significantly
affected AHI's ability to fund its ongoing operations. In July 1996, AHI
announced that it expected its losses for the six months ended June 30, 1996 to
be greater than originally anticipated, and announced its intent to hire a
strategic advisor. AHI's stock, which closed as high as $15.75 per share
following the initial public offering, closed at between $7.00 and $4.25 per
share in July 1996, and between $6.50 and $5.25 per share in August 1996.
In July 1996, following AHI's announcement of its intention to hire a
strategic advisor, Needham contacted FPA proposing to act as its financial
advisor in connection with a transaction with AHI. In August 1996 Needham began
acting as FPA's financial advisor for a potential transaction with AHI. FPA and
Needham subsequently entered into a formal engagement letter on August 8, 1996.
In a meeting on August 7, 1996, the AHI Board discussed AHI's operations,
need for capital to fund its operations and expansion and languishing stock
price. The AHI Board reviewed with members of management AHI's strategic
alternatives and agreed to engage Smith Barney to assist AHI in evaluating the
following options: (i) the sale of AHI to or the merger of AHI with another
company in the physician practice management business, (ii) the sale of AHI to
or the merger of AHI with a company in a related or complementary business
(i.e., an insurance company or a hospital company), (iii) a financing
transaction involving either debt or equity or a combination of both and (iv) a
reorganization of AHI's business and operations. The AHI Board also directed
management to prepare restructuring plans to reduce AHI's costs. The AHI Board
and members of management discussed the difficulty of restructuring without
losing the value of AHI's newly operational networks or the potential contained
within its developing markets.
In early September 1996, AHI's management presented its restructuring plan
to an executive committee of the AHI Board. At that time, it was determined that
AHI should place its restructuring plan on hold because management believed,
based on the preliminary indications from the search for a strategic or
financial investor, that a strategic or financial transaction would yield
greater stockholder value than a restructuring. In this regard, management noted
that a strategic or financing transaction should create greater opportunities to
enhance stockholder value because a restructuring would involve significant
non-recurring costs which would materially impact AHI's liquidity, thereby
threatening AHI's ability to survive as an independent entity. Management also
noted the risks involved in pursuing a strategy of remaining as an independent
entity without the assurance of adequate financing at a time when the physician
practice management business and the managed care industry in general are
undergoing rapid consolidation.
Following its engagement by AHI, Smith Barney, in conjunction with AHI's
management, developed a list of possible strategic buyers (companies and other
entities in the same or a related line of business for whom a transaction with
AHI could be synergistic) and financial investors (companies or other entities
who may be interested in the return an equity investment or other transaction
with AHI could generate). In this regard, in selecting prospective strategic
buyers and financial investors, Smith Barney and AHI management focused
primarily on other companies in the managed care industry, other entities in
related businesses, such as insurance companies and hospital companies, which
might be interested in entering the managed care market, and other parties who
were thought to be amenable to an investment in a company such as AHI.
From early August 1996 through late September 1996, approximately 35
strategic buyers, including FPA, and approximately 24 financial investors were
contacted to solicit indications of interest in a possible transaction involving
AHI. Confidentiality agreements were executed with, and confidential information
concerning AHI was furnished to, approximately 11 strategic buyers, including
FPA, and approximately 14 financial investors, which had indicated an interest
in such a transaction.
AHI received preliminary proposals from two strategic buyers, including
FPA, which submitted its proposal on September 27, 1996, and an oral expression
of interest from a third strategic buyer. The other strategic buyer besides FPA
that submitted a preliminary proposal was a company in the physician practice
management business ("Buyer One") and the strategic buyer that submitted an oral
expression of interest was a physician practice management affiliate of a
not-for-profit healthcare services organization ("Buyer Two").
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In addition to the proposals received from the strategic buyers, AHI also
received preliminary proposals from three financial investors. Each of the
financial investors were equity capital investment firms that were interested in
the return that an equity investment with AHI could generate.
Upon review of the two preliminary proposals and one oral expression of
interest received from strategic buyers and the three preliminary proposals
received from financial investors, AHI management determined that AHI's
stockholders would receive greater value from a strategic buyer. FPA's proposal
initially valued the AHI Common Stock at a substantial premium over market and
Buyer One's proposal contained a valuation ranging from approximately the then
current market price to a substantial premium over market. Buyer Two did not
specify the value it would place on the AHI Common Stock. Each of the
preliminary proposals from the financial investors, on the other hand, valued
the AHI Common Stock below the then current market value of such shares.
Because the strategic buyers clearly presented AHI's stockholders with a
more attractive valuation than the financial investors, and because none of the
financial investors were willing to purchase all or substantially all of the AHI
Common Stock, which AHI management believed would result in greater stockholder
value than the purchase of a minority interest, AHI management, upon
consultation with the AHI Board and Smith Barney, determined to suspend further
discussions with the financial investors pending further discussions with FPA,
Buyer One and Buyer Two. Accordingly, AHI management instructed Smith Barney to
invite FPA, Buyer One and Buyer Two to perform a more detailed due diligence
review of AHI. From October 10, 1996 through November 5, 1996, management
presentations were made to, and due diligence was conducted by, each such
strategic buyer.
From October 17, 1996 through November 6, 1996, several meetings were held
between the senior management and certain other employees of FPA and AHI to
discuss due diligence issues, as well as the potential benefits and synergies
that could be derived from a business combination between FPA and AHI. At
certain of these meetings the parties' outside legal, financial and accounting
advisors were present. Buyer One attended a management presentation by AHI on
October 10, 1996 at which AHI and such buyer discussed the potential benefits of
a transaction with AHI. Buyer Two attended similar presentations on October 17,
1996 and October 29, 1996. Management communicated with the AHI Board regarding
these activities on a regular basis. Following the management presentations to
Buyer One and Buyer Two, each such party conducted an initial due diligence
review of AHI. Buyer One requested and received supplementary due diligence
materials following its initial due diligence review, but Buyer Two made no
further information requests after its initial due diligence review. Neither
Buyer One nor Buyer Two requested a meeting with AHI following their respective
initial due diligence reviews.
On October 31, 1996, FPA submitted its formal indication of interest to
acquire AHI in a stock-for-stock merger. The terms of this indication of
interest were substantially similar to the principal terms of the Merger as set
forth in the Merger Agreement. See "THE MERGER AGREEMENT." On November 1, 1996,
AHI received an oral expression of interest from Buyer One. The expression of
interest from Buyer One proposed a stock-for-stock merger that valued the AHI
Common Stock significantly lower than the exchange ratio proposed by FPA.
Because AHI's stockholders would receive materially greater value from FPA,
AHI's management, in consultation with the AHI Board, determined not to pursue
discussions with Buyer One.
Because the expressions of interest AHI had received from potential
financial investors also indicated that AHI's stockholders would receive greater
value from a strategic buyer, AHI management further determined not to pursue
any financing alternatives until after management had explored further the FPA
proposal. In communicating its determination to the AHI Board, management
observed that the synergies a strategic buyer such as FPA could generate in a
merger or other transaction with AHI enabled strategic buyers to value the AHI
Common Stock more attractively than financial investors. Indeed, FPA's proposal
valued the AHI Common Stock at a substantial premium over market, whereas all of
the preliminary proposals from financial investors valued the AHI Common Stock
at or below the then current market value of such shares. Furthermore,
management noted that the benefits to the stockholders of a financing
transaction were more speculative than those of a strategic transaction because
to realize increased value through a financial transaction, AHI would have to
overcome its adverse cost structure without the assistance
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of a strategic partner with whom immediate synergies could be achieved. With the
concurrence of the AHI Board, management then advised Smith Barney that AHI
would pursue discussions with FPA, although neither management nor the AHI Board
precluded the possibility of entering into a transaction other than the Merger
until AHI entered into the Merger Agreement.
On November 2, 1996 and November 3, 1996, members of the management of FPA
held discussions with members of the management of AHI and representatives of
Smith Barney regarding a possible transaction. During these discussions, the
parties discussed a collar mechanism with respect to the exchange ratio, the tax
and accounting treatment of the proposed stock-for-stock merger and the
principal conditions to consummation of the transaction. After extensive
negotiations, the parties determined to proceed toward negotiation of a
definitive merger agreement.
On November 3, 1996, at a special telephonic meeting of the FPA Board, the
FPA Board reviewed with the senior management of FPA certain matters relating to
the proposed transaction, including the potential merits of a business
combination involving FPA and AHI as well as the nature of discussions to date
between the two companies. The FPA Board also reviewed certain financial matters
relating to the proposed transaction. Following these discussions the FPA Board
authorized management to negotiate a merger agreement between the two parties.
From November 4, 1996 to November 8, 1996, certain members of AHI's
management and AHI's independent auditors and counsel conducted financial and
legal due diligence with respect to FPA. During the same period, senior
management of each of FPA and AHI and their respective legal and financial
advisors negotiated the definitive terms of the Merger Agreement.
On November 8, 1996, the AHI Board met to consider approval of the Merger
Agreement. At such meeting, Smith Barney delivered to the AHI Board its oral
opinion (subsequently confirmed by delivery of a written opinion dated November
8, 1996) to the effect that, as of such date and based upon certain matters
stated in such opinion, the Conversion Number was fair to the holders of AHI
Common Stock from a financial point of view, and reviewed with the AHI Board
certain financial analyses performed by Smith Barney in connection with such
opinion. See "-- Opinion of AHI's Financial Advisor." AHI's outside legal
advisors with respect to the Merger reviewed the terms of the Merger from a
legal perspective and advised the AHI Board as to its legal obligations in
considering whether to approve the proposed transaction. After a full discussion
of all of the relevant issues and upon consideration of the factors described
under "-- Reasons for the Merger; Recommendations of the Boards of
Directors -- AHI," the AHI Board concluded that the Merger Agreement was fair to
and in the best interests of AHI's stockholders and unanimously approved the
Merger Agreement.
On November 8, 1996, at a special telephonic meeting of the FPA Board,
Needham rendered its oral opinion, subsequently confirmed in writing, to the
effect that, as of such date and based upon and subject to certain assumptions
and other matters described in its written opinion, the consideration to be paid
to the AHI stockholders in the Merger was fair to the stockholders of FPA from a
financial point of view. Following discussion with Needham and FPA's management,
and upon consideration of the factors described under "-- Reasons for the
Merger; Recommendations of the Boards of Directors -- FPA," the FPA Board
concluded that the Merger was fair to and in the best interests of FPA's
stockholders and approved the form, terms and conditions of the proposed Merger
Agreement.
On November 8, 1996, AHI and FPA executed the Merger Agreement, and on
November 11, 1996, issued a joint press release regarding the Merger. On
November 8, 1996, the business day preceding public announcement of the Merger,
the closing prices per share on Nasdaq of FPA Common Stock and AHI Common Stock
were $21.25 and $7.25, respectively. Based on the closing price of FPA Common
Stock on that date, the Equivalent Value would have been $8.75 and the
Conversion Number would have been .412. Based upon the 14,523,041 shares of AHI
Common Stock outstanding as of such date, AHI's stockholders would be issued
approximately 5,983,493 shares of FPA Common Stock, representing approximately
$127.1 million.
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On November 25, 1996, at a special telephonic meeting of the AHI Board, the
AHI Board approved an amendment to the Merger Agreement pursuant to which the
Merger is intended to qualify as a tax-free reorganization under the Code. See
"-- Certain Federal Income Tax Consequences." AHI and FPA executed such
amendment effective as of February 5, 1997.
RECOMMENDATIONS OF THE BOARDS OF DIRECTORS AND REASONS FOR THE MERGER
FPA.
For the reasons described below, the FPA Board has unanimously approved the
Merger and recommends that FPA STOCKHOLDERS VOTE FOR APPROVAL OF THE MERGER
AGREEMENT.
FPA continually analyzes potential acquisition candidates in the health
care field. The FPA Board believes that the Merger is fair to and in the best
interests of FPA and its stockholders for the reasons described below.
Accordingly, the FPA Board has approved the Merger Agreement and the
transactions contemplated thereby and has directed that the Merger Agreement and
Merger be submitted to a vote of FPA's stockholders at the FPA Special Meeting.
The FPA Board believes the negotiated terms to be the most favorable
transaction terms available, considering an array of factors which included
those both favorable and adverse to the Merger. In evaluating the Merger, the
FPA Board consulted with FPA management, legal counsel, its independent
accountants and Needham. It considered the following factors to be material to
and in support of its final determination:
(i) The Merger is expected to enable FPA to take advantage of AHI's
existing relationships with Payors in order to expand the FPA Network in
geographic areas in which FPA currently operates and to penetrate new
markets. Such expansion of the FPA Network is expected to enhance FPA's
ability to obtain new Payor contracts and to attract enrollees;
(ii) The Merger is expected to result in significant financial and
operational synergies including, but not limited to, those relating to
executive salaries, investor relations, audit, legal and insurance fees and
rent costs. The Merger is expected to result in a reduction in general and
administrative expenses of $14 million for the combined companies,
primarily by consolidating operations and eliminating corporate overhead.
The Merger is expected to result in a lower overall cost of capital to FPA
by strengthening its balance sheet and thereby enhancing FPA's ability to
raise debt financing. In addition, the increased float and market
capitalization of FPA Common Stock should improve investor awareness of FPA
and its ability to access the equity markets; and
(iii) The Merger is expected to substantially increase FPA's size
financially which is expected to enhance FPA's national recognition, making
it easier for FPA to attract and retain new physicians and obtain new Payor
contracts.
In addition to the foregoing items, the FPA Board generally considered
those matters discussed under "RISK FACTORS," which included potentially adverse
consequences to FPA posed by the Merger and, in particular, the assumption of
AHI's liabilities, uncertainties with respect to the integration of the two
entities, the need for additional capital for the combined company together with
the potential unavailability of such financing, the potential loss of business
and the fact that following the Merger, current FPA stockholders will own as
little as 73.7% of the outstanding FPA Common Stock. The FPA Board reviewed
these adverse factors in their totality, without focusing on any one individual
factor. Moreover, the FPA Board considered the management of the combined entity
to be capable of addressing and managing the integration of the two businesses.
Without giving relative weights to the respective factors, favorable and
adverse, and without drawing a correlation among the factors, the FPA Board
determined that the factors adverse to the Merger were not sufficient to negate
the incentives for pursuing, and potential benefits of, the Merger. The FPA
Board believes that the Merger will have no material adverse effects on any FPA
stockholders, including non-affiliated stockholders.
Finally, the FPA Board's approval of the Merger was conditioned upon the
subsequent receipt of an opinion from Needham confirming its oral opinion that
as of such opinion's date and based upon and subject
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to certain assumptions and other matters, the consideration to be paid to the
AHI stockholders in the Merger was fair to the stockholders of FPA from a
financial point of view. Needham's opinion dated November 8, 1996 is attached as
Appendix II to this Proxy Statement/Prospectus and should be read carefully in
its entirety. See "THE MERGER -- Opinion of FPA's Financial Advisor." In
arriving at its determination, the FPA Board took Needham's opinion into
consideration. (Needham's opinion was only one of the many factors considered by
the FPA Board in its evaluation of the Merger and should not be viewed as
determinative of the views of the FPA Board with respect to the Conversion
Number or the proposed Merger nor as a recommendation to any stockholder as to
how such stockholder should vote at the FPA Special Meeting.)
The FPA Board accordingly concluded in its subjective collective judgment
that, in light of the foregoing, the terms of the Merger Agreement are fair to
and, therefore, in the best interests of FPA and its stockholders
notwithstanding the related risks. See "THE MERGER -- Background," "THE
MERGER -- Opinion of FPA's Financial Advisor," "RISK FACTORS" and
"SUMMARY -- COMPARATIVE MARKET DATA."
In view of the wide variety of factors considered in connection with the
evaluation of the Merger, the FPA Board did not attempt to quantify or otherwise
assign relative weights to the specific factors it considered in reaching its
determination.
AHI.
On November 8, 1996, the AHI Board unanimously determined that the terms of
the Merger Agreement and the transactions contemplated thereby are fair to, and
in the best interest of, AHI and its stockholders. In reaching its decision to
recommend and approve the Merger Agreement, the AHI Board consulted with
management, as well as its financial, accounting and legal advisors, and
considered the following factors to be material and favorable in its
determination to unanimously approve the Merger Agreement and the transactions
contemplated thereby:
(i) the business and operations of AHI, including its financial
losses, increasing medical costs, costs associated with its expanding
network, negative cash flows and the uncertainty that AHI could survive as
an independent going concern. In this respect, the AHI Board also
considered the concerns expressed by AHI's management at the meeting that
AHI's inability to meet its internal projections over the last several
quarters raised doubts about achieving AHI's business plan and the
assumptions underlying such plan;
(ii) the increasing competitive pressures within the managed care
sector of the health care industry, including the trend toward
consolidation among both Payors and providers;
(iii) the rapid consolidation among HMOs and the recent trends
regarding the premiums received by HMOs and other payors, resulting in
downward pressure on rates and/or smaller rate increases in light of rising
medical costs;
(iv) greater difficulty in passing rate reductions or increased costs
through to its providers due to increasing consolidation among health care
providers;
(v) the belief that there were strategic benefits which could be
attained by combining FPA's and AHI's operations including, but not limited
to, forming one of the largest physician practice management companies in
the nation enabling AHI to operate more effectively and profitably in this
dynamic and increasingly competitive environment because of the size,
geographic scope and expertise of the combined company;
(vi) the belief that certain synergies could be attained by spreading
the relatively high costs of AHI's infrastructure over a greater membership
base and by combining AHI's and FPA's operations and development activities
in overlapping markets, thereby reducing general and administrative
expenses and contributing to the ability of the combined company to compete
effectively in the future;
(vii) the current and historical market prices and trading volume of
the shares of AHI Common Stock and FPA Common Stock and the belief that the
FPA proposal presented an opportunity for AHI's
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stockholders to realize future equity appreciation based on the AHI Board's
perception of the more favorable prospects of the combined entity, which
the AHI directors believed should be able to provide quality products with
synergies, service and efficiency better than that which AHI is achieving
at present;
(viii) the process undertaken on behalf of AHI to solicit indications
of interest in the acquisition of AHI, including the fact that
approximately 59 parties were contacted and that while AHI received five
preliminary proposals, no other written offer had been submitted to acquire
AHI or recapitalize AHI upon terms as attractive as those offered by FPA
(See "-- Background of the Merger");
(ix) the opinion of Smith Barney rendered to the AHI Board on November
8, 1996 to the effect that, as of such date and based upon and subject to
certain matters stated in such opinion, the Conversion Number was fair,
from a financial point of view, to the holders of AHI Common Stock (See
"-- Background of the Merger");
(x) the terms and conditions of the Merger Agreement and related
agreements and the likelihood that the conditions to the Merger would be
satisfied;
(xi) the willingness of management to support the Merger; and
(xii) at the time the AHI Board voted to approve and recommend the
Merger, it was aware of the advice from AHI's independent auditors that the
proposed merger terms met the criteria for "pooling of interests"
accounting treatment (although the Board did not attempt to decide at that
time upon a course of conduct or recommendation in the event the Merger
could not be accounted for as a "pooling of interests") (See "-- Accounting
Treatment").
In addition to the foregoing factors, the AHI Board consulted with
management, as well as its financial, accounting and legal advisors, and
considered the following factors to be material and adverse in its determination
to unanimously approve the Merger Agreement and the transactions contemplated
thereby:
(i) the AHI Board generally considered the matters set forth under
"RISK FACTORS;" including (A) the ability of FPA to integrate successfully
AHI's operations following consummation of the Merger, particularly in
light of FPA's recent acquisitions of PFI, Sterling and Foundation, (B) the
impact on FPA's financial statements of the Merger and the Foundation
Transaction which, taken together, will result in a pro forma operating
loss of approximately $66.5 million and a pro forma net loss of
approximately $50.5 million for FPA for the nine months ended September 30,
1996, (C) the ability of FPA to sustain its growth strategy and (D) the
amount of FPA's indebtedness in relation to its stockholder equity (the AHI
Board reviewed these adverse factors in their totality, without focusing on
any one individual factor, and concluded that on balance, despite such
factors, AHI would be better positioned to face those underlying risks as
well as accomplish its business plan if it combined with FPA. In reaching
this conclusion, the AHI Board determined that the operating efficiencies
achieved through the Merger and in conjunction with FPA's other
acquisitions could outweigh the pro forma losses. The AHI Board also
believes that FPA is capable of addressing the issues raised by the
integration of AHI's operations following consummation of the Merger); and
(ii) the AHI Board reviewed the size of the termination fee payable in
the event the Merger Agreement is terminated by AHI (See "THE MERGER
AGREEMENT -- Effect of Termination"). The AHI Board reviewed the
circumstances under which such fee would be payable by AHI, as well as
restrictions on AHI's ability to solicit potential acquirors other than FPA
prior to the closing of the Merger. The termination fee and the
restrictions on solicitation of alternate acquirors may have the effect of
decreasing the chances of AHI engaging in a business combination other than
the Merger (See "THE MERGER AGREEMENT -- Certain Additional
Agreements -- No Solicitations.").
The AHI Board reviewed the severance arrangements of executive officers of
AHI and other benefit provisions of the Merger Agreement, including the
registration rights to be granted to certain executive officers in connection
with the Merger, described under "-- Interests of Certain Persons in the
Merger." The AHI Board was aware that such arrangements may give certain
individuals interests in the Merger that are in
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addition to the interests of stockholders generally. The AHI Board considered
such severance arrangements to be a neutral factor in its determination to
approve the Merger.
The foregoing discussion of the information and factors considered is not
intended to be exhaustive, but it does include the material factors, favorable,
neutral and adverse, considered by the AHI Board in the evaluation of the
Merger. The AHI Board reviewed the foregoing factors in their totality, without
focusing on any one individual factor. Without giving relative weights to the
respective factors, favorable, neutral and adverse, and without drawing a
correlation among the factors, the AHI Board determined that the factors adverse
to the Merger were not sufficient to negate the incentives for pursuing, and
potential benefits of, the Merger. After taking into consideration all of the
factors set forth above, the AHI Board determined that the Merger was fair to
and in the best interests of the AHI stockholders and that AHI should proceed
with the Merger.
ACCORDINGLY, THE AHI BOARD UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF
AHI VOTE "FOR" APPROVAL OF THE PROPOSAL TO ADOPT THE MERGER AGREEMENT.
STOCKHOLDERS SHOULD BE AWARE THAT CERTAIN MEMBERS OF THE AHI BOARD AND
MANAGEMENT HAVE CERTAIN INTERESTS IN THE MERGER THAT MAY CONFLICT WITH AND ARE
IN ADDITION TO THOSE OF OTHER AHI STOCKHOLDERS. SEE "THE MERGER -- INTERESTS OF
CERTAIN PERSONS IN THE MERGER."
OPINION OF FPA'S FINANCIAL ADVISOR
FPA retained Needham to act as exclusive financial advisor to FPA in
connection with the proposed transaction with AHI. In connection with this
engagement, FPA requested Needham to render an opinion as to whether the
consideration paid by FPA to AHI in the Merger was fair to the stockholders of
FPA from a financial point of view. Needham was not requested to, and did not,
make any recommendation to the FPA Board as to the specific value of AHI or the
Conversion Number. The amount of consideration to be paid by FPA in the Merger
was determined through negotiations between FPA management and AHI management.
At a telephonic meeting of the FPA Board on November 8, 1996, Needham
delivered its oral opinion (subsequently confirmed in writing) that, as of such
date and based upon and subject to certain assumptions and other matters
described in its written opinion, the consideration to be paid by FPA to AHI in
the Merger is fair to the stockholders of FPA from a financial point of view.
NEEDHAM'S OPINION IS DIRECTED ONLY TO THE FINANCIAL TERMS OF THE MERGER
AGREEMENT AND DOES NOT CONSTITUTE A RECOMMENDATION TO ANY STOCKHOLDER OF FPA AS
TO HOW SUCH STOCKHOLDER SHOULD VOTE AT THE FPA SPECIAL MEETING.
Needham is not expressing any opinion as to the prices at which FPA's
Common Stock will trade at any time. The complete text of the November 8, 1996
opinion (the "Needham Opinion"), which sets forth the assumptions made, matters
considered and limitations on and scope of the review undertaken by Needham, is
attached to this Proxy Statement/ Prospectus as Appendix II, and the summary of
the Needham Opinion set forth in this Proxy Statement/Prospectus is qualified in
its entirety by reference to the Needham Opinion. FPA STOCKHOLDERS ARE URGED TO
READ THE NEEDHAM OPINION CAREFULLY AND IN ITS ENTIRETY FOR A DESCRIPTION OF THE
PROCEDURES FOLLOWED, THE FACTORS CONSIDERED AND THE ASSUMPTIONS MADE BY NEEDHAM.
In arriving at its opinion, Needham, among other things, (i) reviewed the
most current draft of the Merger Agreement; (ii) reviewed certain other
documents relating to the Merger; (iii) reviewed certain publicly available
information concerning FPA and AHI and certain other relevant financial and
operating data of FPA and AHI made available from the internal records of FPA
and AHI; (iv) visited certain locations of AHI's facilities; (v) held
discussions with members of senior management of FPA and AHI concerning their
current and future business prospects; (vi) reviewed certain financial forecasts
and projections prepared by the management of FPA and AHI; (vii) compared
certain publicly available financial data of companies whose securities are
publicly traded, which Needham deemed generally comparable to the business of
AHI, to similar data for AHI; (viii) reviewed the financial terms of certain
other business combinations that Needham deemed generally relevant; (ix)
reviewed the premiums/discounts paid by acquirors in certain other business
combinations that Needham deemed generally relevant; (x) performed an
accretion/dilution analysis and reviewed the impact of the Merger on FPA's
projected operating results; (xi) reviewed current and historical
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market closing prices and trading data for AHI's and FPA's Common Stock; and
(xii) performed and/or considered such other studies, analyses, inquiries and
investigations as Needham deemed appropriate. Needham assumed and relied upon,
without independent verification, the accuracy and completeness of the
information it reviewed for purposes of its opinion.
In its analyses, Needham utilized 1996, 1997 and 1998 projections for FPA
and AHI. The 1996, 1997 and 1998 projections for FPA are based upon publicly
available research reports published by a variety of investment firms and
research analysts. The 1996 projections for AHI were provided by AHI management.
The 1997 projections for AHI were derived from AHI management estimates and were
adjusted by FPA management. These adjustments included the impact of revenue
growth, operating synergies and cost savings projected to be realized by the
management of FPA with respect to AHI, consisting of an increase in enrollments,
two scenarios for reductions in the medical loss ratio ("MLR") and a reduction
in general and administrative expenses. The scenarios included assumed
reductions in MLR from 81.5% to a range of 75.4% to 78.5% for 1997 and from
80.0% to a range of 75.4% to 77.7% for 1998. The 1998 projections for AHI are
based on the 1997 estimates described above with various assumptions provided by
FPA management for AHI, including enrollment growth, revenue growth, MLR
assumptions and a reduction in general and administrative expenses. FPA
management assumed that the Merger would result in a reduction in general and
administrative expenses of $14 million for the combined companies primarily by
consolidating operations and eliminating corporate overhead. While a level of
synergy can be expected to be achieved in a strategic business combination such
as the Merger as a result of rationalization (including savings realized through
elimination of duplicate facilities and personnel) and cost reductions
(including savings realized through economics of scale), there can be no
assurance with respect to the amount or timing of any such synergies that may be
realized as a result of the Merger, or whether these synergies would be
obtained. The hypothetical amount of these synergies may bear no relation to the
synergies, if any, that might be realized as a result of the Merger. With
respect to AHI's financial forecasts provided to Needham by its management and
FPA management, Needham assumed that such forecasts have been reasonably
prepared on a basis reflecting the best currently available estimates and
judgments of such respective managements of FPA and AHI, at the time of
preparation, of the future operating and financial performance of AHI. Needham
did not assume any responsibility for or make or obtain any independent
evaluation, appraisal or physical inspection of the assets or liabilities of
AHI. Needham also assumed the accuracy of the advice and conclusions of FPA's
accountants with respect to accounting matters as provided to Needham by FPA's
management including, without limitation, the treatment of the Merger as a
"pooling of interests" for financial reporting purposes. Needham's opinion
states that it was based on economic, monetary and market conditions existing as
of the date of such opinion.
Based on this information, Needham performed a variety of financial
analyses of the Merger and the consideration to be paid by FPA. The following
paragraphs summarize the significant financial analyses performed by Needham in
arriving at its opinion presented to the FPA Board.
Contribution Analysis. Needham reviewed and analyzed the pro forma
contribution of each of FPA and AHI to pro forma combined operational and
financial information as of and for the twelve months ended June 30, 1996
("LTM"), projected 1996 operating results, projected 1997 operating results and
projected 1998 operating results. Needham reviewed, among other things, the pro
forma contributions to revenues, net income, assets and stockholders' equity.
Based on this analysis, AHI contributed 31.3% of the LTM pro forma combined
revenues, 26.2% of the projected pro forma 1996 combined revenues, 16.6% to
16.9% of the projected pro forma 1997 combined revenues and 15.5% of the
projected pro forma 1998 combined revenues. AHI also contributed 0.0% of the LTM
pro forma combined operating income, 0.0% of the 1996 projected pro forma
combined operating income, 9.5% to 26.9% of the 1997 projected pro forma
combined operating income and 20.0% to 24.3% of the 1998 projected pro forma
combined operating income. AHI also contributed 0.0% of the LTM pro forma
combined net income, 0.0% of the 1996 projected pro forma combined net income,
12.8% to 31.5% of the 1997 projected pro forma combined net income and 23.1% to
27.9% of the 1998 projected pro forma net income. In addition, AHI contributed
13.6% of the pro forma combined assets as June 30, 1996, and 17.2% of the pro
forma combined stockholders' equity as of June 30, 1996. Based on FPA's closing
price of $21.25 on November 7, 1996 and the resulting Conversion Number
calculated in accordance
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with the Merger Agreement, AHI stockholders will own approximately 19% on a
fully diluted basis of FPA after the Merger. The results of the contribution
analysis are not necessarily indicative of the contributions that the respective
businesses may have in the future. Needham noted that the portions of the
analysis with respect to historical and projected 1996 income and the lower end
of projected 1997 income did not reflect the expected synergies anticipated by
FPA management to be achieved by the combined companies.
Comparable Company Analysis. Needham compared selected historical and
projected operating and financial ratios of AHI to the corresponding data and
ratios of certain publicly traded physician practice management companies which
it deemed generally comparable to AHI. These companies included two that focused
their operations mainly on primary care practices, four that focused their
operations on multi-specialty practices, ten that focused their operations on
single-specialty practices and three other companies that focused their
operations on a hospital based or other operating model. Such data and ratios
included total market capitalization to historical and projected revenue, price
per share to historical and projected earnings per share and market value to
historical book value.
Companies that were deemed to be generally comparable to AHI (the
"Comparable Companies") included: American Oncology Resources, Inc.; Apogee,
Inc.; Coastal Physician Group, Inc.; Curative Health Services Inc.; EmCare
Holdings, Inc.; FPA; InPhyNet Medical Management, Inc.; MedCath Incorporated;
MedPartners, Inc.; OccuSystems, Inc.; Orthodontic Centers of America, Inc.;
Pediatrix Medical Group, Inc.; PHP Healthcare Corporation; PhyCor, Inc.;
PhyMatrix Corp.; Physician Reliance Network, Inc.; Physician Resource Group,
Inc.; Response Oncology Inc.; and Sheridan Healthcare, Inc.
Needham also calculated multiples for AHI based on the closing price of FPA
Common Stock of $21.25 per share on November 7, 1996 and the resulting
equivalent purchase price of AHI Common Stock of $8.75 per share as calculated
in accordance with the Merger Agreement. For the Comparable Companies, the
multiples of total market capitalization to LTM revenues ranged from 9.5x to
0.3x with a mean of 2.7x and a median of 2.4x, as compared with a multiple for
AHI of 0.9x. For the Comparable Companies, the multiple of total market
capitalization to projected 1996 revenues ranged from 7.5x to 0.3x with a mean
of 2.2x and a median of 1.7x, as compared with a multiple for AHI of 0.9x. For
the Comparable Companies, the multiple of total market capitalization to
projected 1997 revenues ranged from 4.8x to 0.2x with a mean of 1.5x and a
median of 1.0x, as compared with a multiple for AHI of 0.7x. For the Comparable
Companies, the LTM price-earnings multiples ranged from 225.0x to 12.5x with a
mean of 49.9x and a median of 39.5x; the projected 1996 price-earnings multiples
ranged from 81.0x to 10.6x with a mean of 32.0x and a median of 28.5x. Since
AHI's LTM and 1996 projected net income were negative, their respective
multiples were not meaningful. For the Comparable Companies, the projected 1997
price-earnings multiples ranged from 39.6x to 8.1x with a mean of 20.6x and a
median of 18.6x, as compared with multiples for AHI ranging from 13.3x to 41.7x.
For the Comparable Companies, the multiples of market value to historical book
value ranged from 12.0x to 0.7x with a mean of 3.8x and a median of 3.1x, as
compared with a multiple for AHI of 3.5x. Needham noted that the higher end of
the range of projected 1997 price-earnings multiples for AHI was based upon AHI
management's estimates and was unadjusted for any synergies that might result
from the Merger.
Comparable Transaction Analysis. Needham also analyzed publicly available
financial information for twelve selected mergers and acquisitions of companies
in the physician practice management industry. In examining these transactions,
Needham analyzed certain income statement and balance sheet parameters of the
acquired companies relative to the consideration offered, aggregate transaction
value as multiple of LTM revenues, earnings before depreciation, interest and
taxes ("EBITDA"), earnings before interest and taxes ("EBIT"), and multiples of
market value to LTM net income and historical book value. In certain cases
complete financial data was not publicly available for these transactions and
only partial information was used in such instances.
Completed physician practice management transactions (the "Comparable
Transactions") analyzed by Needham included: FPA Medical Management, Inc. /
Sterling Healthcare Group, Inc.; MedPartners/Mullikin / Caremark International,
Inc.; MedPartners/Mullikin / Pacific Physician Services, Inc.; EquiMed /
EquiVision / Colckitt Oncology Group; Physicians Resource Group, Inc. / EyeCorp,
Inc.; MedPartners, Inc. / Mullikin Medical Enterprises; Pacific Physician
Services, Inc. / Team Health Group,
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Inc.; Sterling Healthcare Group / Medical Networks, Inc.; Caremark International
Inc. / Friendly Hills Healthcare; Coastal Healthcare Group, Inc. / Health
Enterprises Inc.; Frost Hanna Halpryn Capital Group / Sterling Healthcare
Group/Sterling Healthcare Inc.; Pacific Physician Services, Inc. / Riverside
Medical Clinic. Needham also calculated multiples based on the closing price of
FPA Common Stock of $21.25 per share on November 7, 1996 and the resulting
equivalent purchase price of AHI Common Stock of $8.75 per share as calculated
in accordance with the Merger Agreement. For the Comparable Transactions, the
multiples of enterprise value to LTM sales ranged from 6.9x to 0.6x with a mean
of 1.8x and a median of 1.0x, as compared with a multiple for AHI of 0.9x. For
the Comparable Transactions, the LTM EBITDA multiples ranged from 36.6x to 2.3x
with a mean of 16.0x and a median of 13.5x; the LTM EBIT multiples ranged from
133.1x to 2.6x with a mean of 30.1x and a median of 16.7x; and the multiples of
market value to LTM net income ranged from 248.0x to 3.5x with a mean of 71.1x
and a median of 28.6x. Since AHI's LTM EBITDA, EBIT and net income were
negative, their respective multiples were not meaningful. For the Comparable
Transactions, the multiples of market value to book value ranged from 58.0x to
2.9x with a mean of 13.4x and a median of 8.1x, as compared with a multiple for
AHI of 3.5x.
No company or transaction used in any comparable analysis as a comparison
is identical to AHI, FPA or the Merger. Accordingly, these analyses are not
mathematical; rather, they involve complex considerations and judgments
concerning differences in the financial and operating characteristics of the
comparable companies and other factors that could affect the public trading
value of the comparable companies and transactions to which they are being
compared.
Premiums Paid Analysis. Needham also reviewed and analyzed publicly
available information for fifteen selected proposed and completed mergers and
acquisitions in the health care services industry with transaction values
ranging from $50.0 million and $150.0 million. In examining these transactions,
Needham analyzed the premiums / discounts paid in these transactions by the
acquiror based on the target's stock price one day prior to the announcement of
the transaction and four weeks prior to the announcement of the transaction. For
these transactions, the premiums / discounts paid by the acquiror based on the
target's stock price one day prior to the announcement ranged from 106.3% to
- -3.1% with a mean of 45.1% and a median of 40.5% and the premiums / discounts
based on the target's stock price four weeks prior to the announcement ranged
from 214.3% to 13.1% with a mean of 58.2% and a median of 49.3%. Based on the
closing price of FPA Common Stock of $21.25 on November 7, 1996 and the
resulting equivalent purchase price of AHI Common Stock of $8.75 per share as
calculated in accordance with the Merger Agreement, the implied premium paid by
FPA for AHI was 25.0% based on AHI's closing price on November 6, 1996 and 29.6%
based on AHI's closing price on October 10, 1996.
Proposed and completed health care services transactions analyzed by
Needham included: Home Intensive Care, Inc. / W.R. Grace & Co.; Vari-Care Inc. /
Living Centers of America, Inc.; Greenery Rehabilitation Group / Horizon
Healthcare Corp.; Care Enterprises, Inc. / Regency Health Services, Inc.; Home
Nutritional Services, Inc. / W.R. Grace & Co.; ReLife Inc. / HealthSouth
Rehabilitation Corp.; Rehability Corp. / Living Centers of America, Inc.; PSICOR
Inc. / Baxter Healthcare Corp.; Primedex Health Systems, Inc. / Diagnostic
Imaging Services; Professional Sports Care Management / HealthSouth Corp. (f/k/a
HealthSouth Rehabilitation Corp.); Sterling Healthcare Group, Inc. / FPA Medical
Management, Inc.; ReadiCare, Inc. / OccuSystems, Inc.; Alliance Imaging, Inc. /
U.S. Diagnostic Labs, Inc.; ReadiCare, Inc. / HealthSouth Corp.; Pacific Rehab &
Sports Medicine / Horizon/CMS Healthcare Corp.
Accretion/Dilution Analysis. Needham reviewed the impact of the Merger on
FPA's financial projections for the years ended December 30, 1997 and 1998.
Based upon these projections, Needham noted that the transaction would be
accretive to the earnings per share of FPA in 1997 and 1998 in all circumstances
with an FPA stock price in excess of $16.00 per share and the higher MLR
scenario would be $0.01 to $0.02 dilutive to FPA earnings per share with an
assumed FPA stock price of less than $16.00. Needham noted that the Merger would
be dilutive only under the higher MLR scenario where the price of FPA Common
Stock is below $16.00 per share, which is significantly below the $21.25 price
on November 7, 1996 and below the recent average trading range for FPA Common
Stock.
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FPA and AHI Stock Analysis. Needham reviewed current and historical market
closing prices and trading data of AHI's and FPA's Common Stock since the
initial public offering of AHI in September 1995 both separately and in relation
to each other and the relationship between movements of AHI Common Stock and FPA
Common Stock and movements in composite indices, such as the Nasdaq Composite
Index and the Dow Jones Industrial Average. Needham noted that during the period
since AHI's initial public offering to November 7, 1996, FPA's stock price
significantly outperformed these indices while AHI's stock price significantly
underperformed such indices. Needham also reviewed the theoretical historical
effective premium paid to AHI stockholders if the transaction had occurred at
any time since AHI's initial public offering. Based on the Conversion Number
provisions as described in the Merger Agreement and historical stock prices of
AHI and FPA, from September 29, 1995 though March 20, 1996, the effective
premium paid would have been primarily 0.0% or less. From March 21, 1996 through
November 7, 1996, the effective premium paid would have ranged from 1.0% to
105.9% with a mean of 43.6% and a median of 45.4%. Needham compared these
theoretical historical premiums derived for the Merger with the range of
premiums paid in the comparable transactions described above under "Premiums
Paid Analysis."
The preparation of a fairness opinion involves various determinations as to
the most appropriate and relevant quantitative and qualitative methods of
financial analyses and the application of those methods to the particular
circumstances and, therefore, such an opinion is not readily susceptible to
summary description. Accordingly, Needham believes that its analyses must be
considered as a whole and that considering any portions of such analyses and of
the factors considered, without considering all analyses and factors, could
create a misleading or incomplete view of the process underlying its opinion. In
its analyses, Needham made numerous assumptions with respect to industry
performance, general business and economic and other matters, many of which are
beyond the control of AHI or FPA. Any estimates contained in these analyses are
not necessarily indicative of actual values or predictive of future results or
values, which may be significantly more or less favorable as set forth therein.
Additionally, analyses relating to the values of businesses or assets do not
purport to be appraisals or necessarily reflect the prices at which businesses
or assets may actually be sold.
Pursuant to the terms of the engagement letter between Needham and FPA, FPA
has agreed to pay Needham advisory fees of $375,000 at the announcement of the
Merger and a fee for rendering the Needham Opinion of $200,000. In addition, FPA
has agreed to pay Needham $375,000 at the closing of the Merger. FPA has also
agreed to reimburse Needham for certain of its reasonable out-of-pocket expenses
and to indemnify it against certain liabilities relating to or arising out of
services performed by Needham as financial advisor to FPA.
Needham is a nationally recognized investment banking firm. As part of its
investment banking services, Needham is frequently engaged in the evaluation of
businesses and their securities in connection with mergers and acquisitions,
negotiated underwritings, secondary distributions of securities, private
placements and other purposes. Needham was retained by the FPA Board to act as
FPA's financial advisor in connection with the Merger based on Needham's
experience as a financial advisor in mergers and acquisitions as well as
Needham's familiarity with companies that are in the physician practice
management industry. In the normal course of its business, Needham may actively
trade the equity securities of FPA for its own account or for the account of its
customers and, therefore, may at any time hold a long or short position in such
securities.
OPINION OF AHI'S FINANCIAL ADVISOR
Smith Barney was retained by AHI to act as its financial advisor in
connection with the proposed Merger. In connection with such engagement, AHI
requested that Smith Barney evaluate the fairness, from a financial point of
view, to the holders of AHI Common Stock of the consideration to be received by
such holders in the Merger. On November 8, 1996, at a meeting of the AHI Board
held to evaluate the proposed Merger, Smith Barney delivered an oral opinion
(subsequently confirmed by delivery of a written opinion dated November 8, 1996)
to the AHI Board to the effect that, as of the date of such opinion and based
upon and subject to certain matters stated therein, the Conversion Number was
fair, from a financial point of view, to the holders of AHI Common Stock.
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In arriving at its opinion, Smith Barney reviewed the Merger Agreement and
held discussions with certain senior officers, directors and other
representatives and advisors of AHI and certain senior officers and other
representatives of FPA concerning the businesses, operations and prospects of
AHI and FPA. Smith Barney examined certain publicly available business and
financial information relating to AHI and FPA as well as certain financial
forecasts and other information and data for AHI and FPA which were provided to
or otherwise discussed with Smith Barney by the respective managements of AHI
and FPA, including information relating to certain strategic implications and
operational benefits anticipated to result from the Merger. Smith Barney
reviewed the financial terms of the Merger as set forth in the Merger Agreement
in relation to, among other things: current and historical market prices and
trading volumes of AHI Common Stock and FPA Common Stock; the respective
companies' historical and projected earnings and other operating data; and the
capitalization and financial condition of AHI and FPA. Smith Barney also
considered, to the extent publicly available, the financial terms of certain
other similar transactions recently effected which Smith Barney considered
relevant in evaluating the Merger and analyzed certain financial, stock market
and other publicly available information relating to the businesses of other
companies whose operations Smith Barney considered relevant in evaluating those
of AHI and FPA. Smith Barney also evaluated the potential pro forma financial
impact of the Merger on FPA. In addition to the foregoing, Smith Barney
conducted such other analyses and examinations and considered such other
financial, economic and market criteria as Smith Barney deemed appropriate in
arriving at its opinion. Smith Barney noted that its opinion was necessarily
based upon information available, and financial, stock market and other
conditions and circumstances existing and disclosed, to Smith Barney as of the
date of its opinion.
In rendering its opinion, Smith Barney assumed and relied, without
independent verification, upon the accuracy and completeness of all financial
and other information and data publicly available or furnished to or otherwise
reviewed by or discussed with Smith Barney. With respect to financial forecasts
and other information and data furnished to or otherwise reviewed by or
discussed with Smith Barney, the management of AHI and FPA advised Smith Barney
that such forecasts and other information and data were prepared on bases
reflecting reasonable estimates and judgments of the managements of AHI and FPA
as to the future financial performance of AHI and FPA and the strategic
implications and operational benefits anticipated to result from the Merger.
Smith Barney assumed, with the consent of the AHI Board that the Merger will be
treated as a "pooling of interests" in accordance with GAAP. Smith Barney's
opinion, as set forth therein, relates to the relative values of AHI and FPA.
Smith Barney did not express any opinion as to what the value of the FPA Common
Stock actually will be when issued to AHI stockholders pursuant to the Merger or
the price at which the FPA Common Stock will trade subsequent to the Merger.
Smith Barney did not make and was not provided with an independent evaluation or
appraisal of the assets or liabilities (contingent or otherwise) of AHI or FPA
nor did Smith Barney make any physical inspection of the properties or assets of
AHI or FPA. In connection with its engagement, Smith Barney was requested to
approach, and held discussions with, third parties to solicit indications of
interest in a possible acquisition of AHI. Although Smith Barney evaluated the
Conversion Number from a financial point of view, Smith Barney was not asked to
and did not recommend the specific consideration payable in the Merger, which
was determined through negotiation between AHI and FPA. No other limitations
were imposed by AHI on Smith Barney with respect to the investigations made or
procedures followed by Smith Barney in rendering its opinion.
THE FULL TEXT OF THE WRITTEN OPINION OF SMITH BARNEY DATED NOVEMBER 8,
1996, WHICH SETS FORTH THE ASSUMPTIONS MADE, MATTERS CONSIDERED AND LIMITATIONS
ON AND SCOPE OF THE REVIEW UNDERTAKEN, IS ATTACHED HERETO AS APPENDIX III AND IS
INCORPORATED HEREIN BY REFERENCE. HOLDERS OF AHI COMMON STOCK ARE URGED TO READ
THIS OPINION CAREFULLY IN ITS ENTIRETY. SMITH BARNEY'S OPINION IS DIRECTED TO
THE AHI BOARD AND RELATES ONLY TO THE FAIRNESS OF THE CONVERSION NUMBER FROM A
FINANCIAL POINT OF VIEW, DOES NOT ADDRESS ANY OTHER ASPECT OF THE MERGER OR
RELATED TRANSACTIONS AND DOES NOT CONSTITUTE A RECOMMENDATION TO ANY STOCKHOLDER
AS TO HOW SUCH STOCKHOLDER SHOULD VOTE AT THE AHI SPECIAL MEETING. THE SUMMARY
OF THE OPINION OF SMITH BARNEY SET FORTH IN THIS PROXY STATEMENT/PROSPECTUS IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF SUCH OPINION.
In preparing its opinion, Smith Barney performed a variety of financial and
comparative analyses, including those described below. The summary of such
analyses does not purport to be a complete description
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of the analyses underlying Smith Barney's opinion, but rather, sets forth the
material analyses performed by Smith Barney in connection with its opinion. The
preparation of a fairness opinion is a complex analytic process involving
various determinations as to the most appropriate and relevant methods of
financial analyses and the application of those methods to the particular
circumstances and, therefore, such an opinion is not readily susceptible to
summary description. Accordingly, Smith Barney believes that its analyses must
be considered as a whole and that selecting portions of its analyses and
factors, without considering all analyses and factors, could create a misleading
or incomplete view of the processes underlying such analyses and its opinion. In
its analyses, Smith Barney made numerous assumptions with respect to AHI, FPA,
industry performance, general business, economic, market and financial
conditions and other matters, many of which are beyond the control of AHI and
FPA. The estimates contained in such analyses and the valuation ranges resulting
from any particular analysis are not necessarily indicative of actual values or
predictive of future results or values, which may be significantly more or less
favorable than those suggested by such analyses. In addition, analyses relating
to the value of businesses or securities do not purport to be appraisals or to
reflect the prices at which businesses or securities actually may be sold.
Accordingly, such analyses and estimates are inherently subject to substantial
uncertainty. Smith Barney's opinion and analyses were only one of many factors
considered by the AHI Board in its evaluation of the Merger and should not be
viewed as determinative of the views of the AHI Board or management with respect
to the Conversion Number or the proposed Merger.
Selected Company Analysis. Using publicly available information, Smith
Barney analyzed, among other things, the market values and trading multiples of
AHI and 18 selected publicly traded companies in the physician practice
management industry, consisting of: (i) four contract/hospital based physician
practice management companies: Coastal Physician Group, Inc., Emcare Holdings,
Inc., InphyNet Medical Management, Inc., and Sheridan Healthcare, Inc. (the
"Contract/Hospital-Based PPM Companies"), (ii) six multi-specialty/primary care
physician practice management companies: Advance Health Corporation, FPA Medical
Management, Inc., Med-Partners, Inc., PHP Healthcare Corporation, PhyCor, Inc.,
and PhyMatrix Corp. (the "Multi-Specialty PPM Companies"), and (iii) eight
single-specialty physician practice management companies: American Oncology
Resources, Inc., Apogee, Inc., EquiMed, Inc., OccuSystems, Inc., Orthodontic
Centers of America, Inc., Pediatrix Medical Group, Inc., Physician Reliance
Network, Inc., and Physicians Resource Group, Inc. (the "Single-Specialty PPM
Companies" and, together with the Contract/ Hospital-Based PPM Companies and the
Multi-Specialty PPM Companies, the "Selected Companies"). With respect to the
Selected Companies, Smith Barney focused primarily on the Multi-Specialty PPM
Companies, the operations of which Smith Barney considered to be the most
comparable to AHI. Smith Barney compared market values as multiples of, among
other things, estimated calendar 1996 and 1997 net income, and adjusted market
values (equity market value, plus total debt and the book value of preferred
stock, less cash and cash equivalents) as multiples of, among other things,
latest 12 months revenue and earnings before interest, taxes, depreciation and
amortization ("EBITDA"). Net income projections for the Selected Companies were
based on estimates of selected investment banking firms as compiled by First
Call, a data service which monitors and publishes a compilation of earnings
estimates produced by selected research analysts on companies of interest to
investors, and net income projections for AHI were based on internal estimates
of the management of AHI. All multiples were based on closing stock prices as of
November 8, 1996. Applying multiples for the Multi-Specialty Companies
(excluding outliers) of estimated calendar 1996 and 1997 net income of 23.3x to
45.2x (with a mean of 32.0x) and 18.6x to 32.7x (with a mean of 25.1x),
respectively, and latest 12 months revenue and EBITDA of 0.80x to 1.70x (with a
mean of 1.3x) and 12.9x to 26.2x (with a mean of 20.1x), respectively, to
corresponding financial data for AHI resulted in an equity reference range for
AHI of approximately $3.88 to $6.82 per share, as compared to the equity value
implied by the Conversion Number of approximately $8.75 per share based on the
closing stock price of FPA Common Stock on November 8, 1996.
No company or business used in the "Selected Company Analysis" as a
comparison is identical to AHI or FPA. Accordingly, an analysis of the results
of the foregoing is not entirely mathematical; rather, it involves complex
considerations and judgments concerning differences in financial and operating
characteristics and other factors that could affect the acquisition, public
trading or other values of the Selected Companies or the business segment,
company or transaction to which they are being compared.
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Discounted Cash Flow Analysis. Smith Barney performed a discounted cash
flow analysis of the projected free cash flow of AHI for the fiscal years 1997
through 1999, based on internal estimates of AHI's management for fiscal year
1997 and extrapolated for fiscal years 1998 and 1999 based on growth rate
estimates for AHI of selected investment banking firms. The stand-alone
discounted cash flow analysis of AHI was determined by (i) adding (x) the
present value of projected free cash flows over the three-year period from 1997
to 1999 (approximately $4.6 million to $5.0 million) and (y) the present value
of AHI's estimated terminal value in year 1999 (approximately $81.1 million to
$107.0 million) and (ii) subtracting the current net debt of AHI. The range of
terminal values for AHI at the end of the three-year period was calculated by
applying terminal multiples ranging from 19.0x to 22.0x to AHI's projected 2000
unlevered net income, representing AHI's estimated value beyond the year 1999.
The cash flows and estimated terminal values of AHI were discounted to present
value using discount rates ranging from 12.5% to 17.5%, estimated based on,
among other things, AHI's cost of capital, historical and current market
conditions and AHI's historical financial performance. Based on such terminal
value multiples and discount rates, this analysis resulted in an equity
reference range for AHI of approximately $7.26 to $9.06 per share, as compared
to the equity value implied by the Conversion Number of approximately $8.75 per
share based on a closing stock price of FPA Common Stock on November 8, 1996.
Contribution Analysis. Smith Barney analyzed the respective contributions
of AHI and FPA to the estimated revenue, EBITDA and net income of the combined
company for fiscal years 1996 and 1997, based on internal estimates of the
managements of AHI and FPA. This analysis indicated that (i) in fiscal year
1996, AHI would contribute approximately 22.9% of revenue, (29.0%) of EBITDA and
(298.6%) of net income, and FPA would contribute approximately 77.1% of revenue,
129.0% of EBITDA and 398.6% of net income of the combined company, and (ii) in
fiscal year 1997, AHI would contribute approximately 16.5% of revenue, 11.1% of
EBITDA and 13.1% of net income, and FPA would contribute approximately 83.5% of
revenue, 88.9% of EBITDA and 86.9% of net income, of the combined company.
Immediately following consummation of the Merger, stockholders of AHI and FPA
would own approximately 19.9% and 80.1%, respectively, of the combined company.
Pro Forma Merger Analysis. Smith Barney analyzed certain pro forma effects
resulting from the Merger, including, among other things, the impact of the
Merger on FPA's projected EPS for fiscal years 1997 and 1998, based on internal
estimates of the managements of AHI and FPA for fiscal year 1997 and
extrapolated for fiscal year 1998 based on growth rate estimates for AHI and FPA
of selected investment banking firms. The results of the pro forma merger
analysis suggested that the Merger could be accretive to FPA's EPS in fiscal
years 1997 and 1998 by approximately 0.7% and 1.3%, respectively, assuming
certain cost savings from the Merger of approximately $3.6 million were
achieved. The actual results achieved by the combined company may vary from
projected results and the variations may be material.
Exchange Ratio Analysis. Smith Barney compared the historical ratio of the
daily closing prices of AHI Common Stock and FPA Common Stock during the
six-month and 12-month periods preceding the public announcement of the proposed
Merger with the Conversion Number. The exchange ratios of the daily closing
prices of one share of AHI Common Stock to one share of FPA Common Stock during
the six-month and 12-month periods preceding the public announcement of the
proposed Merger were 0.32 and 0.63, respectively, as compared to the Conversion
Number of between 0.391 and 0.609.
Selected Merger and Acquisition Transactions Analysis. Using publicly
available information Smith Barney reviewed the purchase price and implied
transaction multiples paid or proposed to be paid in the following eight
selected transactions in the physician practice management industry
(acquiror/target): FPA/Sterling Healthcare Group, Inc., MedPartners,
Inc./Caremark International Inc.; Physicians Resource Group, Inc./EyeCorp.,
Inc.; MedPartners, Inc./Pacific Physician Services, Inc.; MedPartners,
Inc./Mullikin Medical Enterprises, L.P.; Coastal Physician Group, Inc./Health
Enterprises, Inc.; Caremark International Inc./Friendly Hills Healthcare
Network; and Foundation Health Corporation/Thomas Davis Medical Centers, P.C.
This analysis did not result in meaningful data and, thus, Smith Barney did not
derive an equity reference range for AHI based on such analysis.
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Other Factors and Comparative Analyses. In rendering its opinion, Smith
Barney considered certain other factors and conducted certain other comparative
analyses, including, among other things, a review of (i) preliminary indications
of interest received from third parties other than FPA; (ii) AHI's and FPA's
historical and projected financial results; (iii) the history of trading prices
and volume for AHI Common Stock and FPA Common Stock and the relationship
between movements of such Common Stock, movements of the common stock of the
Selected Companies and movements in the S&P 500 Index; (iv) selected published
analysts' reports on FPA, including analysts' estimates as to the earnings
growth potential of FPA; (iv) the premiums paid in selected transactions having
a transaction value of $100 million to $500 million; and (v) the pro forma
ownership of the combined company.
Pursuant to the terms of Smith Barney's engagement, AHI has agreed to pay
Smith Barney for its services in connection with the Merger an aggregate
financial advisory fee equal to 1.35% of the total consideration payable in
connection with the Merger. AHI has also agreed to reimburse Smith Barney for
travel and other out-of-pocket expenses incurred by Smith Barney in performing
its services, including the reasonable fees and expenses of its legal counsel,
and to indemnify Smith Barney and related persons against certain liabilities,
including liabilities under the federal securities laws, arising out of Smith
Barney's engagement.
Smith Barney has advised AHI that, in the ordinary course of business,
Smith Barney and its affiliates may actively trade or hold the securities of AHI
and FPA for their own account or for the account of customers and, accordingly,
may at any time hold a long or short position in such securities. Smith Barney
has in the past provided certain investment banking services to AHI unrelated to
the proposed Merger, including acting as lead underwriter for AHI's initial
public offering of AHI Common Stock in 1995, for which services Smith Barney has
received compensation, and also has provided services to FPA from time to time.
In addition, Smith Barney and its affiliates (including Travelers Group Inc. and
its affiliates) may maintain relationships with AHI and FPA.
Smith Barney is a nationally recognized investment banking firm and was
selected by AHI based on Smith Barney's experience, expertise and familiarity
with AHI and its business. Smith Barney regularly engages in the valuation of
businesses and their securities in connection with mergers and acquisitions;
negotiated underwritings, competitive bids; secondary distributions of listed
and unlisted securities; private placements and valuations for estate, corporate
and other purposes.
EFFECTIVE TIME OF THE MERGER
Upon the terms and conditions of the Merger Agreement, Sub will be merged
with and into AHI at the Effective Time. The Merger will become effective
immediately when the Certificate of Merger is filed with the Secretary of State
of Delaware or at such time thereafter as is provided in the Certificate of
Merger. The filing of the Certificate of Merger will be made as soon as
practicable on or after the Closing.
The Closing shall take place on the day of the approval of the Merger
Agreement by the stockholders of FPA and AHI (the "Closing Date"), at the
offices of Milbank, Tweed, Hadley & McCloy, 601 South Figueroa Street, Los
Angeles, California 90017, unless another date or place is agreed to by the
parties. See "THE MERGER AGREEMENT -- Conditions to the Merger."
INTERESTS OF CERTAIN PERSONS IN THE MERGER; POSSIBLE CONFLICTS OF INTEREST
FPA
Beneficial Ownership of FPA Common Stock by Directors and Officers of
FPA. As of the record date, directors and executive officers of FPA and their
affiliates may be deemed to be beneficial owners of approximately 16.1% of the
outstanding FPA Common Stock. Certain directors and officers of FPA with the
collective power to vote approximately 13.8% of the outstanding FPA Common Stock
have entered into voting agreements and given their irrevocable proxies,
providing that their shares shall be voted in favor of the Merger Agreement. See
"THE MERGER AGREEMENT -- Certain Additional Agreements -- Irrevocable Proxies."
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AHI
In considering the recommendation of the AHI Board with respect to the
Merger, AHI stockholders should be aware that members of the AHI Board have
interests in the Merger, as described below. Although AHI believes the members
of the AHI Board have acted in accordance with their fiduciary duties, the
following initial terms may provide the appearance of a possible conflict of
interest. See "RISK FACTORS -- Interests of Certain Persons in the Merger;
Possible Conflicts of Interest."
Beneficial Ownership of AHI Common Stock by Directors and Officers of
AHI. As of the record date, directors and executive officers of AHI and their
affiliates may be deemed to be beneficial owners of approximately 62.3% of the
outstanding AHI Common Stock. Certain directors and officers of AHI with the
collective power to vote approximately 55.2% of the outstanding AHI Common Stock
have entered into voting agreements and given their irrevocable proxies,
providing that their shares shall be voted in favor of the Merger Agreement. See
"The MERGER AGREEMENT -- Certain Additional Agreements -- Irrevocable Proxies."
On February 7, 1997, the closing price of FPA Common Stock was $24.25. Assuming
an FPA Value equal to such price, the Equivalent Value would be $9.48 and the
Conversion Number would be .391. Based upon the 14,523,041 shares of AHI Common
Stock outstanding as of such date, AHI Stockholders would be issued
approximately 5,678,509 shares of FPA Common Stock in the Merger. If the Merger
were consummated, the directors and executive officers of AHI would receive
62.3% of the shares of FPA Common Stock issued to AHI stockholders in the
Merger.
AHI Severance Payments. Pursuant to the terms of the Merger Agreement and
each of their respective employment agreements, eight senior executives of AHI
will be given severance consideration as of the closing of the Merger including
(i) the waiver of any applicable non-compete provisions set forth in their
employment agreements; (ii) the termination of each of their employment
agreements and (iii) the receipt of a lump-sum payment pursuant to each of their
employment agreements upon a change of control. Pursuant to such change in
control arrangements, Leonardo Berezovsky, M.D., Saul Honigstein, H.R. Brereton
Barlow, Luis Artime, Stuart Bruck, Steven Posar, M.D., Robert Brice and Gary
Sherlock, each of whom is an executive officer and/or a director of AHI, will
receive approximately $1,640,000, $503,000, $724,000, $256,000, $388,000,
$529,000, $495,000 and $495,000, respectively. In connection with the Merger,
certain other officers and employees of AHI will receive severance payments not
to exceed in the aggregate $750,000. The "MERGER AGREEMENT -- Certain Additional
Agreements -- Employee Benefit Plans."
Directors' and Officers' Insurance and Indemnification. AHI agreed to
purchase prior to the Effective Time, and FPA and AHI agreed to maintain, until
September 28, 1999, directors' and officers' liability insurance with respect to
claims arising from facts or events that occurred on or prior to the Effective
Time. FPA also agreed to indemnify all directors, officers, employees, and
stockholders who are officers or directors of AHI against any liability or
losses any of them may incur because of any claim brought against them prior to
or within five years from the Effective Time as officers, directors, employees,
agents or stockholders of AHI. See "THE MERGER AGREEMENT -- Certain Additional
Agreements -- Directors' and Officers' Indemnification and Insurance."
AHI Option Plans. AHI shall provide for immediate vesting of, and
cancellation at the Effective Time, of all outstanding options to the extent
permitted under the terms of AHI's 1995 Non-Employee Directors Stock Option
Program, 1994 Long-Term Incentive Plan, 1995 Long-Term Incentive Plan and the
stock option agreements executed pursuant thereto. See "THE MERGER
AGREEMENT -- AHI Option Plans." Pursuant to such vesting arrangements and upon
conversion into FPA Common Stock at an assumed Equivalent Value of $9.48 per
share, Saul Honigstein, Steven Posar, M.D., Stuart Bruck, Luis Artime and
certain non-employee directors shall receive in a cashless exercise at the
Effective Time, FPA Common Stock worth approximately $1,050,000, $598,000,
$919,000, $46,000 and $4,100, respectively. Additionally, certain non-employee
directors hold approximately 15,000 "out of the money" options to purchase AHI
Common Stock. In the event of a Voluntary Termination from the AHI Board
(resignation from or refusal to stand for election to the AHI Board), such
non-employee directors' options shall automatically expire on the effective date
of such termination. In the event of an Involuntary Termination from the AHI
Board (any termination event other than a Voluntary Termination), such
non-employee directors' options shall be converted into
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options to purchase FPA Common Stock. Such non-employee directors' options shall
vest immediately on the Effective Time and the non-employee directors shall have
two years from the Effective Time to exercise such options.
Registration Rights Agreement. FPA has agreed to enter into a registration
rights agreement with each of Leonardo Berezovsky, M.D., Jose Spiwak, M.D. and
Kaushal Tamboli, M.D. See "THE MERGER AGREEMENT -- Certain Additional
Agreements -- Registration Rights Agreement."
MATERIAL FEDERAL INCOME TAX CONSEQUENCES
The following summary describes the material federal income tax
consequences of the Merger to AHI, Merger Sub, and FPA and to AHI stockholders
who are citizens of or residents in the United States. This summary does not
discuss all the tax consequences that may be relevant to AHI stockholders
because of their particular tax situation (e.g., insurance companies, financial
institutions, dealers in securities, tax-exempt organizations or non-U.S.
persons) or to AHI stockholders who acquired their shares of AHI Common Stock
pursuant to the exercise of employee stock options or warrants, or otherwise as
compensation. This summary also does not discuss the tax consequences to holders
of outstanding AHI options.
Neither AHI, Merger Sub nor FPA has requested a ruling from the IRS with
regard to any of the federal income tax consequences of the Merger. However,
Milbank, Tweed, Hadley & McCloy, counsel to AHI, has delivered to AHI a legal
opinion letter relating to certain federal income tax consequences of the
Merger. The opinions expressed in such letter are based on federal income tax
law as it exists and is interpreted at the time such opinion letter is delivered
and on the assumptions that (i) each AHI stockholder's shares of AHI Common
Stock are capital assets in that stockholder's hands at the time the opinion is
delivered, (ii) representations made as of the time the opinion letter is
delivered by AHI, Merger Sub, FPA and certain significant AHI stockholders are
accurate, (iii) the Merger will qualify as a merger under applicable state law,
(iv) the Merger and related transactions will occur as described in the Merger
Agreement, and (v) all parties to the Merger Agreement will comply with their
covenants contained in the Merger Agreement. Any change in federal income tax
law after the date the opinion letter is delivered or any change in those
assumptions could vary the tax consequences of the Merger described below.
Based upon the foregoing, the opinion letter of Milbank, Tweed, Hadley &
McCloy delivered to AHI states, among other things, that the Merger will qualify
as a tax-free "reorganization" within the meaning of Code Sections 368(a)(1)(B)
and 368(a)(1)(A) and (a)(2)(E). As a result, (i) AHI, FPA and Merger Sub will
recognize no gain or loss upon the receipt by FPA of all the shares of AHI
Common Stock in the Merger in exchange for newly-issued shares of FPA Common
Stock; (ii) FPA's basis in the shares of AHI Common Stock received in the Merger
will be the same as the aggregate basis of the AHI Common Stock in the hands of
the AHI stockholders immediately prior to the Merger, or instead, if FPA so
elects, FPA's basis in the shares of AHI Common Stock will equal AHI's net basis
in AHI's assets; (iii) FPA's holding period in the shares of AHI Common Stock
received in the Merger will include the period during which the shares of AHI
Common Stock were held by AHI stockholders; (iv) an AHI stockholder who converts
shares of AHI Common Stock in the Merger solely for shares of FPA Common Stock
will recognize no gain or loss; (v) an AHI stockholder will have the same basis
in the shares of FPA Common Stock received in the Merger as the basis that
stockholder had in the shares of AHI Common Stock converted therefor, reduced by
the basis allocable to any fractional share interest in FPA Common Stock with
respect to which cash is received; (vi) an AHI stockholder's holding period for
the shares of FPA Common Stock received in the Merger includes that
stockholder's holding period for the shares of AHI Common Stock converted
therefor in the Merger; and (vii) an AHI stockholder will recognize capital gain
or loss equal to the difference between the cash received and the basis of the
share or shares of AHI Common Stock allocated to any FPA fractional share
interest that, for tax purposes, will be treated as issued to the AHI
stockholder in the Merger and then immediately redeemed from that AHI
stockholder for cash by FPA. The foregoing description of the material federal
income tax consequences of the Merger to the stockholders of AHI is qualified in
its entirety by reference to the opinion letter of Milbank, Tweed, Hadley &
McCloy attached as an exhibit to the registration statement.
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THE ABOVE SUMMARY DISCUSSION IS INTENDED ONLY AS A GENERAL SUMMARY OF THE
MATERIAL FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER AND DOES NOT PURPORT TO
BE AN ANALYSIS OR DISCUSSION OF ANY CONSEQUENCES ARISING UNDER THE TAX LAWS OF
ANY STATE, LOCALITY OR FOREIGN JURISDICTION. AHI STOCKHOLDERS ARE URGED TO
CONSULT THEIR OWN TAX ADVISORS CONCERNING THE U.S. FEDERAL, STATE, LOCAL AND
FOREIGN TAX CONSEQUENCES OF MERGER TO THEM.
ACCOUNTING TREATMENT
The Merger will be accounted for using the "pooling of interests" method of
accounting pursuant to Accounting Principles Board Opinion No. 16 ("APB No.
16"). The "pooling of interests" method of accounting assumes that the combining
companies have been merged from inception, and the historical financial
statements for periods prior to consummation of the Merger are restated as
though the companies had been combined from inception. The restated financial
statements are adjusted to conform the accounting policies of the separate
companies. See "Pro Forma Financial Information."
FPA, Merger Sub and AHI have agreed that during the period from the date of
the Merger Agreement through the Effective Time, neither FPA nor AHI or any of
their respective subsidiaries shall knowingly take or fail to take any action
which action or failure to act would jeopardize the treatment of the Merger as a
"pooling of interests" for accounting purposes. See "THE MERGER
AGREEMENT -- Certain Additional Agreements."
It is a condition to the Merger that FPA and AHI each receive letters from
their respective independent auditors stating that the Merger will qualify as a
"pooling of interests" for accounting and financial reporting purposes. FPA and
AHI may extend the time for performance of or waive compliance with this
obligation. To the extent the condition is waived, FPA and AHI will amend this
Proxy Statement/Prospectus and resolicit stockholder votes to the extent
required by applicable law. See "THE MERGER AGREEMENT -- Conditions to the
Merger."
RESALE OF FPA COMMON STOCK BY AFFILIATES
FPA Common Stock to be issued to stockholders of AHI in connection with the
Merger has been registered under the Securities Act. FPA Common Stock received
by the stockholders of AHI upon consummation of the Merger will be freely
transferable under the Securities Act, except for shares issued to any person
who may be deemed an "Affiliate" (as defined below) of AHI or FPA within the
meaning of Rule 145 under the Securities Act ("Rule 145"). Affiliates are
generally defined as persons who control, are controlled by, or are under common
control with AHI or FPA at the time of the Special Meetings (generally,
directors, certain executive officers and major stockholders). Affiliates of AHI
or FPA may not sell their shares of FPA Common Stock acquired in connection with
the Merger, except pursuant to an effective registration statement under the
Securities Act covering such shares or in compliance with Rule 145 or another
applicable exemption from the registration requirements of the Securities Act.
In general, under Rule 145, for two years following the Effective Time, an
Affiliate (together with certain related persons) would be entitled to sell
shares of FPA Common Stock acquired in connection with the Merger only through
unsolicited "broker transactions" or in transactions directly with a "market
maker," as such terms are defined in Rule 144 under the Securities Act ("Rule
144"). Additionally, the number of shares to be sold by an Affiliate (together
with certain related persons and certain persons acting in concert) during such
two-year period within any three-month period for purposes of Rule 145 may not
exceed the greater of 1% of the outstanding shares of FPA Common Stock or the
average weekly trading volume of such stock during the four calendar weeks
preceding such sale. Rule 145 would remain available to Affiliates only if FPA
remained current with its information filings with the Commission under the
Exchange Act. Two years after the Effective Time, an Affiliate would be able to
sell such FPA Common Stock without such manner of sale or volume limitations,
provided that FPA was current with its Exchange Act information filings and such
Affiliate was not then an Affiliate of FPA. Three years after the Effective
Time, an Affiliate would be able to sell such shares of FPA Common Stock without
any restrictions provided such Affiliate has not been an Affiliate of FPA for at
least three months prior thereto. In addition, under rules relating to "pooling
of interests" accounting, shares of
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FPA Common Stock issued to affiliates of AHI may not be resold by them until
combined results of operations of FPA and AHI covering at least thirty days of
operations are published. In connection with the Merger, FPA has agreed to enter
into a registration rights agreement with certain stockholders of AHI. See "THE
MERGER AGREEMENT -- Certain Additional Agreements -- Registration Rights
Agreement."
CERTAIN REGULATORY MATTERS
FPA and AHI believe that the Merger does not violate the federal antitrust
laws and intend to resist vigorously any assertion to the contrary by the FTC,
the DOJ or others. Any such resistance could delay consummation of the Merger,
perhaps for a considerable period. FPA and AHI made their respective filings
with the FTC and the DOJ with respect to the Merger on December 4, 1996 and
November 29, 1996, respectively. FPA and AHI have received written notification
dated December 27, 1996, that early termination of the waiting period of their
respective HSR filings has been granted. Notwithstanding the termination of the
waiting period of the HSR filings, the FTC, DOJ or others could take action
under the antitrust laws, including after the Effective Time, seeking the
divestiture by FPA of all or any part of the assets of AHI acquired in the
Merger. There can be no assurance that a challenge to the Merger on antitrust
grounds will not be made or, if such a challenge is made, that it would not be
successful.
Certain persons, such as state's attorneys general and private parties,
could challenge the Merger as violative of the federal antitrust laws and seek
to enjoin the consummation of the Merger and, in the case of private persons,
also seek to obtain treble damages. There can be no assurance that a challenge
to the Merger on antitrust grounds will not be made or, if such a challenge is
made, that it will not be successful. Neither FPA nor AHI intends to seek any
further stockholder approval or authorization of the Merger Agreement as a
result of any action that it may take to resist or resolve any FTC, DOJ or other
objections, unless required to do so by applicable law.
PENDING LITIGATION
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 including an injunction of the Merger. AHI is a
defendant in a 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 on December 20, 1995 against AHI, certain of its officers and directors,
and all of the underwriters of AHI's common stock in AHI's initial public
offering. 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.
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RIGHTS OF DISSENTING STOCKHOLDERS
So long as the shares of FPA Common Stock and AHI Common Stock remain
quoted on Nasdaq on the date of the AHI Special Meeting, holders of AHI Common
Stock shall have no appraisal or dissenters' rights in connection with the
Merger.
THE MEETINGS
FPA SPECIAL MEETING
The FPA Special Meeting will be held at FPA's offices, 3636 Nobel Drive,
San Diego, California 92122, on Monday, March 17, 1997, at 10:00 a.m., local
time, and at any adjournment or postponement thereof.
At the FPA Special Meeting, the stockholders of FPA will be asked to
consider and vote upon the adoption and approval of the Merger Agreement under
which, among other things, Merger Sub would be merged into AHI with AHI
surviving the Merger as a wholly owned subsidiary of FPA. Pursuant to the
Merger, each outstanding share of AHI Common Stock will be converted into a
fraction of one share of FPA Common Stock equal to the Conversion Number. The
Conversion Number will vary based on the FPA Value. Based upon the 14,523,041
shares of AHI Common Stock outstanding on February 7, 1997, and assuming an FPA
Value equal to $24.25, which was the closing price of FPA Common Stock on that
date, as of such date, AHI's stockholders would be issued approximately
5,678,509 shares of FPA Common Stock in connection with the Merger. See "THE
MERGER -- Adjustments to the Merger Consideration."
The FPA Board has unanimously approved the Merger Agreement and recommends
a vote FOR approval of the Merger Agreement.
At the FPA Special Meeting, stockholders will also be asked to approve an
amendment to the FPA Plan which would, upon becoming effective, increase the
total number of shares of FPA Common Stock issuable upon exercise of options
granted under such plan from 5,000,000 to 6,500,000.
The FPA Board of Directors has unanimously approved the amendment to the
FPA Plan and recommends a vote FOR approval of the amendment to the FPA Plan.
AHI SPECIAL MEETING
The AHI Special Meeting will be held at the Renaissance Long Beach Hotel,
111 East Ocean Boulevard, Long Beach, California, on Monday, March 17, 1997, at
10:00 a.m., local time, and at any adjournment or postponement thereof.
At the AHI Special Meeting, the stockholders of AHI will be asked to
consider and vote upon the adoption and approval of the Merger Agreement under
which, among other things, Merger Sub would be merged into AHI with AHI
surviving the Merger as a wholly owned subsidiary of FPA. Pursuant to the
merger, each outstanding share of AHI Common Stock will be converted into a
fraction of one share of FPA Common Stock equal to the Conversion Number. The
Conversion Number will vary based on the FPA Value. Based upon the 14,523,041
shares of AHI Common Stock outstanding on February 7, 1997, and assuming an FPA
Value equal to $24.25, which was the closing price of FPA Common Stock on that
date, as of such date, AHI's stockholders would be issued approximately
5,678,509 shares of FPA Common Stock in connection with the Merger. See "THE
MERGER -- Adjustments to the Merger Consideration."
The AHI Board has unanimously approved the Merger Agreement and recommends
a vote FOR approval of the Merger Agreement.
QUORUM
The presence, in person or by proxy, of the holders of a majority of the
outstanding shares of FPA Common Stock at the FPA Special Meeting is necessary
to constitute a quorum at the FPA Special Meeting. Abstentions and broker
non-votes will be included in determining the presence of a quorum.
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The presence, in person or by proxy, of the holders of a majority of the
outstanding shares of AHI Common Stock at the AHI Special Meeting is necessary
to constitute a quorum at the AHI Special Meeting. Abstentions and broker
non-votes will be included in determining the presence of a quorum.
VOTE REQUIRED
The affirmative vote of the holders of a majority of shares of FPA Common
Stock present, either in person or by proxy, at the FPA Special Meeting is
required to adopt the Merger Agreement, to approve the amendment to the FPA
Plan, and to approve the possible adjournment or postponement of the FPA Special
Meeting.
The affirmative vote of the holders of a majority of the outstanding shares
of AHI Common Stock, either in person or by proxy, at the AHI Special Meeting is
required to approve the Merger Agreement. The affirmative vote of the holders of
a majority of shares of AHI Common Stock present, either in person or by proxy,
at the AHI Special Meeting is required to approve the possible adjournment or
postponement of the AHI Special Meeting.
RECORD DATE; STOCK ENTITLED TO VOTE
The FPA Board has established February 13, 1997 as the date to determine
those record holders of FPA Common Stock entitled to notice of and to vote at
the FPA Special Meeting. On that date, there were approximately 24,824,224
shares of FPA Common Stock outstanding, with each share entitled to one vote
with respect to the Merger Agreement and the amendment to the FPA Plan.
The AHI Board has established February 7, 1997 as the date to determine
those record holders of AHI Common Stock entitled to notice of and to vote at
the AHI Special Meeting. On that date, there were 14,523,041 shares of AHI
Common Stock outstanding, with each share entitled to one vote with respect to
the Merger Agreement.
In the event the Merger is not approved and adopted by the stockholders of
FPA and AHI, the Merger Agreement may be terminated in accordance with its
terms. See "THE MERGER AGREEMENT -- Termination."
VOTING OF PROXIES
Shares represented by all properly executed proxies received in time for
the Special Meetings will be voted at such meetings in the manner specified by
the holders thereof. Proxies that do not contain voting instructions will be
voted FOR approval of the Merger Agreement and the amendment to the FPA Plan at
the FPA Special Meeting and for approval of the Merger Agreement at the AHI
Special Meeting. It is not expected that any matter other than those referred to
herein will be brought before either of the Special Meetings.
If a holder of FPA Common Stock or AHI Common Stock does not return a
signed proxy card, his or her shares will not be voted. Shares not voted will
have no effect on the voting with respect to the proposals at the FPA Special
Meeting. Shares not voted will have the effect of a vote against the Merger
Agreement at the AHI Special Meeting.
Because abstentions are treated as shares present and entitled to vote at
the FPA Special Meeting, they will have the effect of a vote against adoption of
the Merger Agreement, against approval of the amendment to the FPA Plan, and
against approval of the possible adjournment or postponement of the FPA Special
Meeting. Broker non-votes are not allowed to vote at the FPA Special Meeting and
will have no effect on the outcome of the vote on such proposals.
At the AHI Special Meeting, abstentions and broker non-votes will have the
effect of a vote against adoption of the Merger Agreement. Because abstentions
are treated as shares present and entitled to vote at the AHI Special Meeting,
they will have the effect of a vote against approval of the possible adjournment
or postponement of the AHI Special Meeting. Broker non-votes are not allowed to
vote at the AHI Special
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Meeting and will have no effect on the outcome of a proposal to approve the
possible adjournment or postponement of the AHI Special Meeting.
To facilitate the voting process for the Special Meetings, stockholders of
FPA and AHI may vote their shares by facsimile at the following telephone
numbers: FPA -- (619) 453-1941 and AHI -- (310) 803-4695.
REVOCATION OF PROXIES
Except for those who have executed irrevocable proxies, any holder of FPA
Common Stock has the unconditional right to revoke his or her proxy at any time
prior to the voting thereof at the FPA Special Meeting by (i) filing a written
revocation with the Secretary of FPA prior to the voting of such proxy, (ii)
giving a duly executed proxy bearing a later date, or (iii) attending the FPA
Special Meeting and voting in person. Attendance by a stockholder at the FPA
Special Meeting will not itself revoke his or her proxy.
Except for those who have executed irrevocable proxies, any holder of AHI
Common Stock has the unconditional right to revoke his or her proxy at any time
prior to the voting thereof at the AHI Special Meeting by (i) filing a written
revocation with the Secretary of AHI prior to the voting of such proxy, (ii)
giving a duly executed proxy bearing a later date, or (iii) attending the AHI
Special Meeting and voting in person. Attendance by a stockholder at the AHI
Special Meeting will not itself revoke his or her proxy.
To facilitate the voting process for the Special Meetings, stockholders of
FPA and AHI may revoke votes for their shares by facsimile at the following
telephone numbers: FPA -- (619) 453-1941 and AHI -- (310) 803-4695.
SOLICITATION OF PROXIES
Solicitation of proxies for use at the FPA Special Meeting may be made in
person or by mail, telephone, telecopy or telegram. FPA will bear the cost of
the solicitation of proxies from its stockholders. In addition to solicitation
by mail, the directors, officers and employees of FPA may solicit proxies from
FPA stockholders by telephone or telegram or in person. Such directors, officers
and employees will not be compensated for such solicitation. FPA has requested
that banking institutions, brokerage firms, custodians, trustees, nominees and
fiduciaries forward solicitation materials to the beneficial owners of FPA
Common Stock held of record by such entities, and FPA will, upon the request of
such record holders, reimburse reasonable forwarding expenses. FPA has also
engaged Georgeson & Co., Inc. to assist it in the solicitation of proxies for
the FPA Special Meeting. The costs of solicitation, which are not expected to
exceed $10,000, will be borne by FPA. FPA does not anticipate that it will incur
any fees in connection with the solicitation of proxies, except as set forth in
this paragraph.
Solicitation of proxies for use at the AHI Special Meeting may be made in
person or by mail, telephone, telecopy or telegram. AHI will conduct the
solicitation of proxies for the AHI Special Meeting and will bear the cost of
the solicitation of such proxies from its stockholders. In addition to
solicitation by mail, the directors, officers and employees of AHI may solicit
proxies from AHI stockholders by telephone or telegram or in person. Such
directors, officers and employees will not be compensated for such solicitation.
AHI has requested that banking institutions, brokerage firms, custodians,
trustees, nominees and fiduciaries forward solicitation materials to the
beneficial owners of AHI Common Stock held of record by such entities, and AHI
will, upon the request of such record holders, reimburse reasonable forwarding
expenses. AHI does not anticipate that it will incur any fees in connection with
the solicitation of proxies, except as set forth in this paragraph.
To facilitate the voting process for the Special Meetings, stockholders of
FPA and AHI may revoke votes for their shares by facsimile at the following
telephone numbers: FPA -- (619) 453-1941 and AHI -- (310) 803-4695.
AHI STOCKHOLDERS SHOULD NOT SEND STOCK CERTIFICATES WITH THEIR PROXY CARDS.
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<PAGE> 80
BOARD OF DIRECTORS AND MANAGEMENT OF
FPA FOLLOWING THE MERGER
BOARD OF DIRECTORS OF FPA FOLLOWING THE MERGER
Upon consummation of the Merger, Sheldon Derezin and Harvey Wilson, and
Drs. Stephen J. Dresnick, Kevin Ellis, Michael Feinstein, Seth Flam, Howard
Hassman, Sol Lizerbram and Herbert A. Wertheim, each of whom is currently a
director of FPA, will continue to serve as directors of FPA.
EXECUTIVE OFFICERS OF FPA FOLLOWING THE MERGER
The following table sets forth certain information, including age and
positions, of each person who will serve as an executive officer of FPA upon
consummation of the Merger:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- ------------------------------------------------------
<S> <C> <C>
Dr. Sol Lizerbram............. 48 Chairman of the Board of Directors
Dr. Seth Flam................. 38 President, Chief Executive Officer and Director
Dr. Stephen J. Dresnick....... 45 Vice Chairman of the Board of Directors and President,
Sterling Healthcare Group, Inc.
Steven M. Lash................ 42 Executive Vice President, Chief Financial Officer and
Treasurer
James A. Lebovitz............. 39 Senior Vice President, General Counsel and Secretary
Cheryl A. Moore............... 30 Vice President-Finance and Chief Accounting Officer
</TABLE>
EXECUTIVE COMPENSATION
CASH COMPENSATION
The following table sets forth certain information regarding compensation
from FPA which was awarded to, earned by, or paid to FPA's Chief Executive
Officer and the four other most highly compensated executive officers in 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------------- -------------------
NAME AND PRINCIPAL OTHER ANNUAL SHARES UNDERWRITTEN ALL OTHER
POSITION YEAR SALARY($)(1) BONUS($) COMPENSATION($)(2) OPTIONS/SARS(#) COMPENSATION($)(3)
- ------------------------ ----- ------------ ---------- ------------------ ------------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Seth Flam............... 1994 $172,500 $ 4,953 50,000 $750,000
President, Chief 1995 201,000 18,226 60,000 3,606
Executive Officer 1996 296,048 $ 800,000 14,727 671,000 1,204
and Director(4)
Sol Lizerbram........... 1994 150,000 7,010 50,000 757,030
Chairman of the Board 1995 189,750 16,214 60,000 16,397
of Directors(5) 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 1995 325,000 303,349(7) 252,000
Board and President; 1996 330,208 1,592,859 722,502(8) 481,250
Sterling Healthcare
Group, Inc.
Steven M. Lash(9)....... 1994 68,974 3,676 269,274 773
Executive Vice 1995 205,000 50,000 11,645 20,000 7,246
President and Chief 1996 257,583 800,000 8,431 437,250 113,125
Financial Officer
Howard Hassman.......... 1994 150,000 7,368 50,000 754,941
Executive Vice 1995 174,750 16,815 60,000 6,566
President -- Corporate 1996 232,465 800,000 22,150 303,000 7,026
Development and
Director
</TABLE>
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<PAGE> 81
- ---------------
(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 will
be paid in March 1997.
(2) Includes payment by FPA 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.
(6) $80,635 of such amount was accrued for Dr. Dresnick's benefit as of December
31, 1994 and paid to Dr. Dresnick in February 1995.
(7) 68,807 of which was accrued for Dr. Dresnick's benefit as of December 31,
1995 and paid to Dr. Dresnick in April 1996.
(8) Includes 572,502 options granted by FPA after completion of the Sterling
Acquisition to replace options previously granted to Dr. Dresnick by
Sterling.
(9) Mr. Lash commenced employment with FPA on September 1, 1994.
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<PAGE> 82
STOCK OPTION GRANTS IN 1996
The following table sets forth information concerning stock options granted
to the named executive officers in 1996.
OPTION GRANTS DURING 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------------------------------------------
POTENTIAL REALIZABLE
SHARES % OF TOTAL VALUE AT ASSUMED ANNUAL
UNDERLYING OPTIONS/ RATES OF STOCK PRICE
OPTIONS/ SARS EXERCISE APPRECIATION FOR OPTION
SARS GRANTED TO OR BASE TERM(3)
GRANTED EMPLOYEES PRICE EXPIRATION -------------------------
NAME (#)(1) DURING YEAR ($/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 Lizerbram............ 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 Haasman........... 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.
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. One-half of these options have vested and the balance will vest on
September 9, 1997.
F. One-third of these options have vested, one-third will vest upon the
earlier of May 6, 2005 or the date FPA obtains net earnings per share
of $.53 for the trailing four quarters, and one-third will vest upon
the earlier of May 6, 2005 or the date FPA obtains net earnings per
share of $.73 for the trailing four quarters.
G. These options have vested.
(2) The option exercise price may be paid in shares of FPA's Common Stock, in
cash, or in any other form of valid consideration or a combination of any of
the foregoing, as determined by the Compensation Committee of the FPA's
Board in its discretion.
(3) The potential realizable value portion of the foregoing table illustrates
value that might be realized should the granted options be exercised
immediately prior to their expiration date and assumes that the respective
rates of appreciation on FPA Common Stock compound annually until such
exercise. These figures make no allowance for any reduction of potential
value which may be caused because of the termination of the options
following termination of employment, nontransferability or vesting over
periods of up to five years.
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<PAGE> 83
AGGREGATED STOCK OPTION EXERCISES IN 1996 AND STOCK OPTION VALUES AT DECEMBER
31, 1996
The following tables set forth information concerning the number of stock
options granted during 1996 and the value of unexercised options to purchase FPA
Common Stock held by the named executive officers at December 31, 1996. None of
the named executive officers exercised any stock options during 1996.
OPTION EXERCISES DURING 1996 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBERS OF SHARES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS
OPTIONS/SARS AT
YEAR END (#) AT YEAR END ($)(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 4,614,000
Stephen J. Dresnick................................. 461,552 260,950 4,117,088 1,036,821
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 FPA Common Stock issuable upon
exercise of the option.
EMPLOYMENT AGREEMENTS
FPA entered into employment agreements with Drs. Flam, Lizerbram, Hassman
and Dresnick, and Mr. Lash, as President and Chief Executive Officer; Chairman;
Executive Vice President -- Corporate Development; Vice Chairman and President,
Sterling Healthcare Group, Inc.; 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, Hassman and Dresnick, and Mr. Lash receive annual base
salaries, commencing October 1, 1996, of $425,000, $425,000, $250,000, $325,000
and $325,000, respectively. Such salaries will be subject to annual increases
after 1997 as determined subjectively by the Compensation Committee of the FPA
Board based on individual performance and FPA's results of operations. In
addition, each physician executive officer 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. 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.
75
<PAGE> 84
COMPARISON OF RIGHTS OF HOLDERS OF AHI
AND FPA COMMON STOCK
Both FPA and AHI are Delaware corporations and the rights of their
respective stockholders are governed by the Delaware Act and their Certificates
of Incorporation and Bylaws. If the Merger is consummated, AHI stockholders will
become stockholders of FPA, and their rights will be governed by the Certificate
of Incorporation and Bylaws of FPA. The following is a brief summary of certain
differences between the rights of AHI stockholders and FPA stockholders and is
qualified in its entirety by reference to the relevant provisions of the
Delaware Act, FPA's Certificate of Incorporation and Bylaws and AHI's
Certificate of Incorporation and Bylaws.
PREFERRED STOCK
The Boards of Directors of FPA and AHI are authorized to provide for the
issuance of shares of preferred stock, in one or more series, and to fix for
each such series such voting powers, designations, preferences and relative,
participating, optional or other special rights, and such qualifications,
limitations or restrictions, as are stated in the resolution adopted by the
Board of Directors providing for the issuance of such series and as permitted by
the Delaware Act. FPA currently has authorized 2,000,000 shares of preferred
stock, $.001 par value; AHI currently has authorized 25,000,000 shares of
preferred stock, $.01 par value. Neither FPA nor AHI has authorized or issued
any shares of preferred stock.
BOARD OF DIRECTORS
FPA's Certificate of Incorporation provides that the FPA Board shall have
not less than three nor more than twelve members, as determined from time to
time by resolution of the board. AHI's Certificate of Incorporation provides
that the number of directors on the AHI Board shall be specified in AHI's Bylaws
and may be increased or decreased from time to time by the affirmative vote of
the holders of not less than two-thirds of the outstanding shares of capital
stock of AHI entitled to vote thereon.
FPA's Bylaws provide that any or all of FPA's directors may be removed with
or without cause, by the holders of a majority of shares then entitled to vote
at an election of directors. AHI's Certificate of Incorporation provides that
any or all of AHI's directors may be removed from office at any time, but only
for cause and only by the affirmative vote of the holders of at least two-thirds
of the outstanding shares of capital stock of AHI entitled to vote generally in
the election of directors, voting together as a single class.
AHI's Certificate of Incorporation states that election of directors shall
be by written ballot unless AHI's Bylaws provide otherwise, while FPA's
Certificate of Incorporation states that election of directors need not be by
written ballot.
AHI's Bylaws provide that only persons who are nominated in accordance with
certain provisions of such Bylaws shall be eligible for election to the AHI
Board. FPA's Bylaws do not contain a similar provision.
AHI's Articles of Incorporation and Bylaws provide that a vacancy on the
AHI Board may be filled by a majority vote of the directors then in office, even
if less than a quorum, or by a sole remaining director, and AHI's Bylaws also
provide that a vacancy created by the resignation of a director may be filled by
a vote of the holders of not less than two-thirds of the outstanding shares of
capital stock of AHI entitled to vote thereon. FPA's Certificate of
Incorporation provides that a vacancy on the FPA Board shall be filled solely by
the affirmative vote of a majority of the remaining directors then in office,
even though less than a quorum, or by a sole remaining director.
BYLAWS
FPA's Certificate of Incorporation authorizes the FPA Board to repeal,
alter, amend and rescind FPA's Bylaws. AHI's Certificate of Incorporation
provides that the AHI Board may adopt, repeal, alter, amend or rescind AHI's
Bylaws; provided, however, that the authorized number of directors set forth in
AHI's Bylaws is not subject to alteration, modification or repeal by the AHI
Board. In addition, AHI's Bylaws may be adopted, repealed, altered, amended or
rescinded by the affirmative vote of the holders of not less than two-thirds of
the
76
<PAGE> 85
outstanding shares of capital stock of AHI entitled to vote thereon. FPA's
Bylaws provide that such Bylaws may be altered, amended or repealed or new
bylaws may be adopted by the stockholders of FPA.
STOCKHOLDER MEETINGS
AHI's Bylaws provide that special meetings of stockholders may be called by
the Chairman of the Board, the AHI Board, or a committee of the AHI Board which
has been duly authorized by the AHI Board to call such meetings and shall be
called by the Chairman of the Board at the written request of persons holding,
directly or indirectly, not less than ten percent of outstanding shares of
capital stock of AHI entitled to vote thereon. FPA's Bylaws provide that special
meetings of stockholders may be called by the President and shall be called by
the President or Secretary at the request in writing of a majority of the FPA
Board or stockholders owning a majority in amount of the entire capital stock of
FPA issued and outstanding and entitled to vote.
INDEMNIFICATION
Under the Delaware Act, a corporation may generally indemnify its officers,
directors, employees and agents against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement of any proceedings (other than
derivative actions), if they acted in good faith and in a manner they reasonably
believed to be in or not opposed to the best interests of the corporation and,
with respect to any criminal action or proceeding, had no reasonable cause to
believe their conduct was unlawful. A similar standard is applicable in
derivative actions, except that indemnification may be made only for (1)
expenses (including attorneys' fees) and certain amounts paid in settlement and
(2) in the event the person seeking indemnification has been adjudicated liable,
amounts deemed proper, fair and reasonable by the appropriate court upon
application thereto. The Delaware Act provides that to the extent that such
persons have been successful in defense of any proceeding, they must be
indemnified by the corporation against expenses actually and reasonably incurred
in connection therewith.
FPA's Certificate of Incorporation requires indemnification for directors
and officers, their legal representatives, and persons serving at the request of
FPA as a director, officer, employee or agent of another corporation,
partnership, or other entity ("FPA Indemnitees") for actions undertaken in an
official capacity or any other capacity. AHI's Bylaws require indemnification
solely for directors and officers ("AHI Indemnitees"), and only for actions
taken in an official capacity.
FPA's Certificate of Incorporation provides for the continuation of
indemnification for FPA Indemnitees no longer employed by FPA (where the conduct
at issue occurred while the FPA Indemnitee was employed by FPA). FPA's
Certificate of Incorporation also provides for the benefits of indemnification
to inure to the heirs, executors and administrators of the FPA Indemnitee.
Further, FPA's Certificate of Incorporation requires, as a prerequisite to
indemnification in connection with a suit initiated by the FPA Indemnitee, that
the FPA Indemnitee receive authorization from the FPA Board prior to initiating
the suit. Neither AHI's Bylaws nor its Certificate of Incorporation contains
comparable provisions to the FPA provisions described in this paragraph.
FPA's Certificate of Incorporation grants FPA Indemnitees the right to
receive an advance of funds from FPA to pay for anticipated legal costs in
defending a lawsuit for which indemnification is sought. However, to the extent
required by the Delaware Act, an FPA Indemnitee may be required to deliver an
undertaking to FPA to repay all amounts advanced should the FPA Indemnitee
ultimately be determined not to be entitled to indemnification. Neither AHI's
Bylaws nor its Certificate of Incorporation contains similar provisions.
FPA's Certificate of Incorporation provides that if an FPA Indemnitee is
not advanced funds for anticipated costs in defending a lawsuit within thirty
days of FPA receiving a written request for such funds, the FPA Indemnitee may
sue FPA for the unpaid amount. If the FPA Indemnitee has delivered to FPA an
undertaking to repay such advance, FPA may not offer as a defense to such claim
for indemnity that the claimant has not met the standard of conduct for
indemnification under the Delaware Act. However, if no such undertaking has been
delivered to FPA, FPA may offer this as a defense. FPA may not offer as a
defense to the advancement of funds that it has not yet determined whether the
FPA Indemnitee has met the
77
<PAGE> 86
appropriate standard of conduct. Neither AHI's Bylaws nor its Certificate of
Incorporation contains comparable provisions.
STOCKHOLDER VOTING REQUIREMENTS
Under the Delaware Act, unless otherwise provided by the Delaware Act or a
Delaware corporation's certificate of incorporation or bylaws, if a quorum
exists, action on a matter is approved by the affirmative vote of a majority of
the shares represented at a meeting and entitled to vote on the matter.
Neither FPA's Certificate of Incorporation nor its Bylaws contains a
provision requiring a greater vote on any matter than required by the Delaware
Act.
AHI's Certificate of Incorporation contains provisions requiring the
affirmative vote of the holders of at least two-thirds of AHI's outstanding
shares to increase or decrease the size of the board of directors, to remove
directors from office for cause or to amend AHI's Bylaws. Additionally, the
substantive provisions of AHI's Certificate of Incorporation, including those
authorizing AHI's directors to designate series of preferred stock, providing
for a classified board of directors, requiring that directors be elected only by
written ballot, prohibiting stockholder action by written consent, and limiting
director liability for breach of fiduciary duties, may not be amended without
the approval of at least two-thirds of AHI's outstanding shares.
ACTION BY CONSENT
The Delaware Act provides that, unless otherwise provided in the
Certificate of Incorporation, any action required or permitted to be taken at
any annual or special meeting of stockholder may be taken without a meeting,
without prior notice and without a vote, by written consent of the holders of
outstanding stock having not less than the minimum number of votes that would be
necessary to authorize or take such action at a meeting. FPA's Bylaws permit
action by written consent. AHI's Certificate of Incorporation prohibits
stockholders from taking action by written consent.
78
<PAGE> 87
THE MERGER AGREEMENT
The following is a summary of the material provisions of the Merger
Agreement not summarized elsewhere in this Proxy Statement/Prospectus. A copy of
the Merger Agreement is attached as Appendix I to this Proxy
Statement/Prospectus and is incorporated herein by reference. The following
summary does not purport to be complete and is qualified in its entirety by
reference to the Merger Agreement.
AHI OPTION PLANS
AHI shall provide for immediate vesting of, and cancellation at the
Effective Time of, all outstanding options to the extent permitted under the
terms of AHI's 1995 Non-Employee Directors Stock Option Program, 1994 Long-Term
Incentive Plan, 1995 Long-Term Incentive Plan and the stock option agreements
executed pursuant thereto.
EXCHANGE OF CERTIFICATES
Exchange Agent. On the Closing Date, FPA shall make available to the
Surviving Corporation for deposit with the Exchange Agent, certificates
representing the number of duly authorized whole shares of FPA Common Stock
issuable in connection with the Merger plus an amount of cash equal to the
aggregate amount payable in lieu of fractional shares in accordance with the
Merger Agreement, to be held for the benefit of and distributed to such holders
in accordance with the Merger Agreement. The Exchange Agent shall agree to hold
such shares of FPA Common Stock and funds (such shares of FPA Common Stock and
funds, together with earnings thereon, being referred to herein as the "Exchange
Fund") for delivery as contemplated by the Merger Agreement and upon such
additional terms as may be agreed upon by the Exchange Agent, AHI and FPA before
the Effective Time. If for any reason (including losses) the amount of cash in
the Exchange Fund is inadequate to pay the cash amounts to which holders of
shares of AHI Common Stock shall be entitled pursuant to the Merger Agreement,
FPA shall make available to the Surviving Corporation additional funds for the
payment thereof.
Exchange Procedures. As soon as reasonably practicable after the Effective
Time, FPA shall cause the Exchange Agent to mail to each holder of record of a
certificate or certificates which immediately prior to the Effective Time
represented outstanding shares of AHI Common Stock (the "Certificates") whose
shares are converted pursuant to the Merger Agreement into the right to receive
shares of FPA Common Stock (i) a letter of transmittal (which shall specify that
delivery shall be effected, and risk of loss and title to the Certificates shall
pass, only upon delivery of the Certificates to the Exchange Agent and shall be
in such form and have such other provisions as FPA may reasonably specify) and
(ii) instructions for use in effecting the surrender of the Certificates in
exchange for certificates representing shares of FPA Common Stock and cash in
lieu of fractional shares. Upon surrender of a Certificate for cancellation to
the Exchange Agent, together with such letter of transmittal duly executed and
completed in accordance with its terms, the holder of such Certificate shall be
entitled to receive in exchange therefor a certificate representing that number
of whole shares of FPA Common Stock, plus the cash amount payable in lieu of
fractional shares in accordance with the Merger Agreement, which such holder has
the right to receive pursuant to the provisions of the Merger Agreement, and the
Certificate so surrendered shall forthwith be canceled. In no event shall the
holder of any Certificate be entitled to receive interest on any funds to be
received in the Merger. In the event of a transfer of ownership of AHI Common
Stock which is not registered in the transfer records of AHI, a certificate
representing that number of whole shares of FPA Common Stock, plus the cash
amount payable in lieu of fractional shares, may be issued to a transferee if
the Certificate representing such AHI Common Stock is presented to the Exchange
Agent accompanied by all documents required to evidence and effect such transfer
and by evidence that any applicable stock transfer taxes have been paid. Until
surrendered as contemplated pursuant to the Merger Agreement, each Certificate
shall be deemed at any time after the Effective Time for all corporate purposes
of FPA, except as limited by the Merger Agreement, to represent ownership of the
number of shares of FPA Common Stock into which the number of shares of AHI
Common Stock shown thereon have been converted as contemplated by the Merger
Agreement. See "THE MERGER -- Procedures for Exchange of Certificates."
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<PAGE> 88
Distributions with Respect to Unexchanged Shares. No dividends or other
distributions declared or made after the Effective Time with respect to FPA
Common Stock with a record date on or after the Effective Time shall be paid to
the holder of any unsurrendered Certificate with respect to the shares of FPA
Common Stock represented thereby and no cash payment in lieu of fractional
shares shall be paid to any such holder until the holder of record of such
Certificate shall surrender such Certificate in accordance with the Merger
Agreement. Subject to the effect of applicable laws, following surrender of any
such Certificate, there shall be paid to the record holder of the certificates
representing whole shares of FPA Common Stock issued in exchange therefor,
without interest, (i) at the time of such surrender, the amount of dividends or
other distributions, if any, with a record date on or after the Effective Time
which theretofore became payable, but which were not paid by reason of the
immediately preceding sentence, with respect to such whole shares of FPA Common
Stock, and (ii) at the appropriate payment date, the amount of dividends or
other distributions with a record date on or after the Effective Time but prior
to surrender and a payment date subsequent to surrender payable with respect to
such whole shares of FPA Common Stock.
No Further Ownership Rights in AHI Common Stock. All shares of FPA Common
Stock issued upon the surrender for exchange of Certificates in accordance with
the terms of the Merger Agreement shall be deemed to have been issued at the
Effective Time in full satisfaction of all rights pertaining to the shares of
AHI Common Stock represented thereby. From and after the Effective Time, the
stock transfer books of AHI shall be closed and there shall be no further
registration of transfers on the stock transfer books of the Surviving
Corporation of the shares of AHI Common Stock which were outstanding immediately
prior to the Effective Time. If, after the Effective Time, Certificates are
presented to the Surviving Corporation for any reason, they shall be canceled
and exchanged as provided in the Merger Agreement.
Termination of Exchange Fund. Any portion of the Exchange Fund which
remains undistributed to the stockholders of AHI for twelve months after the
Effective Time shall be delivered to FPA, upon demand, and any stockholders of
AHI who have not theretofore complied with the Merger Agreement shall thereafter
look only to FPA (subject to abandoned property, escheat and other similar laws)
as general creditors for payment of their claim for FPA Common Stock, any cash
in lieu of fractional shares of FPA Common Stock and any dividends or
distributions with respect to FPA Common Stock. Neither FPA nor the Surviving
Corporation shall be liable to any holder of shares of AHI Common Stock for
shares of FPA Common Stock (or dividends or distributions with respect thereto)
or cash payable in respect of fractional share interests delivered to a public
official pursuant to any applicable abandoned property, escheat or similar law.
STOCKHOLDERS OF AHI SHOULD NOT FORWARD THEIR STOCK CERTIFICATES TO THE
EXCHANGE AGENT WITHOUT A LETTER OF TRANSMITTAL AND SHOULD NOT RETURN THEIR STOCK
CERTIFICATES WITH THE ENCLOSED PROXY CARD.
CERTAIN REPRESENTATIONS AND WARRANTIES
The Merger Agreement contains various customary representations and
warranties of each of FPA, Merger Sub and AHI (which are subject, in certain
cases, to specified exceptions, and all of which terminate at the Effective
Time) relating to, among other things: (i) organization and qualification to do
business; (ii) capitalization; (iii) the authorization, execution, delivery and
enforceability of the Merger Agreement and the transactions contemplated
thereunder; (iv) the absence of any conflict, breach or default of any corporate
charter documents or applicable law in connection with entering into the Merger
Agreement; (v) the absence of any governmental or regulatory consent or approval
required to enter into the Merger Agreement and to consummate the transactions
contemplated thereby; (vi) the accuracy of certain documents and reports filed
by each party with the Commission and the accuracy of the financial information
contained therein; (vii) the absence of certain changes or events; (viii) the
absence of undisclosed liabilities; (ix) the absence of pending or threatened
legal proceedings; (x) the accuracy of the information each party has supplied
with respect to the filings required with the Commission in order to consummate
the Merger and the transactions contemplated by the Merger Agreement; (xi)
certain tax matters; (xii) matters concerning employee benefit plans and ERISA;
(xiii) stockholders' vote to approve the Merger; (xiv) accounting matters
relating to "pooling of interests;" (xv) the inapplicability of state
antitakeover laws; (xvi) title to assets and (xvii) permits.
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CONDUCT OF BUSINESS PENDING THE MERGER
At all times from and after the date of the Merger Agreement until the
Effective Time, each of FPA and AHI covenants and agrees as to itself and its
subsidiaries (unless expressly provided for in the Merger Agreement, or to the
extent that the other party shall otherwise consent in writing), to: (i) conduct
their respective businesses only in the ordinary course consistent with past
practice; (ii) use all commercially reasonable efforts to preserve intact in all
material respects their present business organizations and reputation; (iii)
keep available the services of their key officers and employees; (iv) maintain
their assets and properties in good working order and condition (ordinary wear
and tear excepted); (v) maintain insurance on their tangible assets and
businesses in such amounts and against such risks and losses as in effect on the
date of the Merger Agreement; (vi) preserve their relationships with customers
and suppliers and others having significant business dealings with them; and
(vii) comply in all material respects with all laws and orders of all applicable
governmental or regulatory authorities.
At all times from and after the date of the Merger Agreement until the
Effective Time, each of FPA and AHI has further agreed that it will not, and
will not permit any of its subsidiaries (unless expressly provided for in the
Merger Agreement, or to the extent that the other party shall otherwise consent
in writing), to: (i) amend or propose to amend its certificate or articles of
incorporation or bylaws (or other comparable corporate charter); (ii) declare,
set aside or pay any dividends on or make other distributions in respect of any
of its capital stock; (iii) split, combine, reclassify or take similar action
with respect to any of its capital stock or issue or authorize or propose the
issuance of any other securities in respect of, in lieu of or in substitution
for shares of its capital stock; (iv) adopt a plan of complete or partial
liquidation or resolutions providing for or authorizing such liquidation or a
dissolution, merger, consolidation, restructuring, recapitalization or other
reorganization; (v) directly or indirectly redeem, repurchase or otherwise
acquire any shares of its capital stock or any options with respect thereto;
(vi) issue, deliver, sell or exchange, or authorize or propose the issuance,
delivery, sale or exchange of, any shares of its capital stock or any options
with respect thereto, other than (A) the issuance of options by FPA pursuant to
its option plans, in accordance with their present terms, (B) the issuance of
shares of AHI Common Stock and FPA Common Stock, as the case may be, upon
exercise of previously granted options pursuant to AHI's option plans and FPA's
option plans, in each case in accordance with their present terms or the
outstanding warrants to purchase FPA's Common Stock, (C) the issuance by a
wholly owned subsidiary of its capital stock to its parent corporation or (D)
modify or amend any right of any holder of outstanding shares of capital stock
or options with respect thereto; (vii) other than acquisitions by FPA in
accordance with its ongoing acquisition program, acquire (by merging or
consolidating with, or by purchasing a substantial equity interest in or a
substantial portion of the assets of, or by any other manner) any business or
any corporation, partnership, association or other business organization or
division thereof or otherwise acquire or agree to acquire any assets which are
material, individually or in the aggregate, to such party and its subsidiaries
taken as a whole; (viii) other than dispositions of assets which are not,
individually or in the aggregate, material to such party and its subsidiaries
taken as a whole, sell, lease, grant any security interest in or otherwise
dispose of or encumber any of its assets or properties; (ix) except to the
extent required by applicable law, (A) permit any material change in (y) any
pricing, marketing, purchasing, investment, accounting, financial reporting,
inventory, credit, allowance or tax practice or policy or (z) any method of
calculating any bad debt, contingency or other reserve for accounting, financial
reporting or tax purposes or (B) make any material tax election or settle or
compromise any material income tax liability with any governmental or regulatory
authority; (x) incur (which shall not be deemed to include entering into credit
agreement, lines of credit or similar arrangements until borrowings are made
under such arrangements) any indebtedness for borrowed money or guarantee any
such indebtedness other than in the ordinary course of its business consistent
with past practice in an aggregate principal amount exceeding $5,000,000 with
respect to AHI and its subsidiaries and $250,000,000 with respect to FPA and its
subsidiaries (in each case net of any amounts of any such indebtedness
discharged during such period); (xi) voluntarily purchase, cancel, prepay or
otherwise provide for a complete or partial discharge in advance of a scheduled
repayment date with respect to, or waive any right under, any indebtedness for
borrowed money other than in the ordinary course of its business consistent with
past practice in an aggregate principal amount exceeding $5,000,000 with respect
to AHI and its subsidiaries and $250,000,000 with respect to FPA and its
subsidiaries; (xii) enter into, adopt, amend in any material respect (except as
may be required by applicable law) or terminate any AHI employee
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benefit plan or FPA employee benefit plan, as the case may be, or other
agreement, arrangement, plan or policy between such party or one of its
subsidiaries and one or more of its directors, officers or employees, or, except
for normal increases in the ordinary course of business consistent with past
practice that, in the aggregate, do not result in a material increase in
benefits or compensation expense to such party and its subsidiaries taken as a
whole, increase in any manner the compensation or fringe benefits of any
director, officer or employee or pay any benefit not required by any plan or
arrangement in effect as of the date of the Merger Agreement; (xiii) enter into
any contract or amend or modify any existing contract, or engage in any new
transaction outside the ordinary course of business consistent with past
practice or not on an arms' length basis, with any affiliate of such party or
any of its subsidiaries; (xiv) make any capital expenditures or commitments for
additions to plant, property or equipment constituting capital assets except in
the ordinary course of business consistent with past practice in an aggregate
amount exceeding $5,000,000 with respect to AHI and its subsidiaries and
$15,000,000 with respect to FPA and its subsidiaries; (xv) make any change in
the lines of business in which it participates or is engaged; or (xvi) enter
into any contract, commitment or arrangement to do or engage in any of the
foregoing.
At all times from and after the date of the Merger Agreement until the
Effective Time, each of FPA and AHI has further agreed that prior to the
Effective Time as to itself and its subsidiaries that (unless expressly provided
for in the Merger Agreement, or to the extent that the other party shall
otherwise consent in writing) each party shall confer on a regular and frequent
basis with the other with respect to its business and operations and other
matters relevant to the Merger, and shall promptly advise the other, orally and
in writing, of any change or event, including, without limitation, any
complaint, investigation or hearing by any governmental or regulatory authority
(or communication indicating the same may be contemplated) or the institution or
threat of litigation, having, or which, insofar as can be reasonably foreseen,
could have, a material adverse effect on AHI or FPA, as the case may be, and its
subsidiaries taken as a whole or on the ability of AHI or FPA, as the case may
be, to consummate the transactions contemplated by the Merger Agreement.
CERTAIN ADDITIONAL AGREEMENTS
Pursuant to the Merger Agreement, FPA and AHI have made the following
additional agreements.
Access to Information. Each of FPA and AHI shall, and shall cause each of
its subsidiaries to, throughout the period from the date of the Merger Agreement
to the Effective Time, (i) provide the other party and its directors, officers,
employees, legal, investment, banking and financial advisors, accountants and
any other agents and representatives (collectively, "Representatives") with full
access, upon reasonable prior notice and during normal business hours, to all
officers, employees, agents and accountants of FPA and AHI, as the case may be,
and its subsidiaries and their respective assets, properties, books and records,
but only to the extent that such access does not unreasonably interfere with the
business and operations of FPA and AHI, as the case may be, and its
subsidiaries, and (ii) furnish promptly to such persons (x) a copy of each
report, statement, schedule and other document filed or received by FPA or AHI,
as the case may be, or any of its subsidiaries pursuant to the requirements of
federal or state securities laws or filed with any other governmental or
regulatory authority, and (y) all other information and data concerning the
business and operations of FPA or AHI, as the case may be, and its subsidiaries
as the other party or any of such other persons reasonably may request.
In the event that the Merger Agreement is terminated without the
transactions contemplated thereby having been consummated, upon the request of
FPA or AHI, as the case may be, the other party will, and will cause its
Representatives to, promptly (and in no event later than five (5) days after
such request) redeliver or cause to be redelivered all copies of documents and
information furnished by FPA or AHI, as the case may be, or its Representatives
to such party and its Representatives in connection with the Merger Agreement or
the transactions contemplated thereby and destroy or cause to be destroyed all
notes, memoranda, summaries, analyses, compilations and other writings related
thereto or based thereon prepared by FPA or AHI, as the case may be, or its
Representatives.
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Inclusion of Shares on Nasdaq. FPA agreed to use its best efforts to cause
the shares of FPA Common Stock to be issued in the Merger in accordance with the
Merger Agreement to be approved for inclusion on Nasdaq, subject to official
notice of issuance, prior to the Closing Date.
Regulatory and Other Approvals. Subject to the terms and conditions of the
Merger Agreement, each of AHI and FPA agreed to proceed diligently and in good
faith and to use all commercially reasonable efforts to do, or cause to be done,
all things necessary, proper or advisable to, as promptly as practicable, (a)
obtain all consents, approvals or actions of, make all filings with and give all
notices to governmental or regulatory authorities or any other public or private
third parties required of FPA, AHI or any of their subsidiaries to consummate
the Merger and the other matters contemplated hereby, and (b) provide such other
information and communications to such governmental or regulatory authorities or
other public or private third parties as the other party or such governmental or
regulatory authorities or other public or private third parties may reasonably
request in connection therewith. In addition to and not in limitation of the
foregoing, each of the parties agreed to (x) take promptly all actions necessary
to make the filings required of FPA and AHI or their affiliates under the HSR
Act, (y) comply at the earliest practicable date with any request for additional
information received by such party or its affiliates from the FTC or the DOJ
pursuant to the HSR Act, and (z) cooperate with the other party in connection
with such party's filings under the HSR Act and in connection with resolving any
investigation or other inquiry concerning the Merger or the other matters
contemplated by the Merger Agreement commenced by either the FTC or the DOJ or
state attorneys general.
Employee Benefit Plans. FPA agreed to allow retained employees of AHI and
its subsidiaries to participate, effective as of the Closing Date, under the
terms of FPA's employee benefit plans, including without limitation its health,
medical, disability, life or other insurance, retirement, 401(k) or severance
plans, as employees of similar salary and position at FPA or its subsidiaries as
if such employees had been employees of FPA or its subsidiaries during their
employment by AHI and its subsidiaries. Nothing in the Merger Agreement shall
(i) obligate FPA to offer employment to or to continue to employ any person
employed by AHI prior to the Effective Time or (ii) prevent FPA from reducing or
discontinuing any benefit for all of its employees, including those employed by
AHI prior to the Effective Time. Any employee of AHI or its subsidiaries
retained by FPA shall be an "at will" employee, unless otherwise provided by
agreement between FPA and such employee.
FPA agreed to, and agreed to cause the Surviving Corporation to, honor
without modification all employee severance plans (or policies) and employment
and severance agreements of AHI or any of its subsidiaries in existence on the
date of the Merger Agreement as such agreements shall be in effect in accordance
with the terms of the Merger Agreement at the Effective Time. FPA notifies and
agrees with AHI that upon the Effective Time, the employees designated in the
AHI Disclosure Letter (as defined in the Merger Agreement) are terminated and
entitled to severance for termination upon a change of control as set forth in
their employment agreements with AHI, are not subject to any noncompetition
agreement, and their severance shall be paid by AHI in one lump sum at the
Closing, or such other payment arrangement as may be agreed upon by FPA and such
terminated employee. See " -- Certain Additional Agreements -- Employee Benefit
Plans."
Directors' and Officers' Indemnification and Insurance. AHI agreed to
purchase prior to the Effective Time, and FPA and AHI agreed to maintain, until
September 28, 1999, the policies of directors' and officers' liability insurance
maintained by AHI with respect to claims arising from facts or events that
occurred on or prior to the Effective Time. Except to the extent required by
law, until the fifth anniversary of the Effective Time, FPA agreed not to take
any action so as to amend, modify or repeal the provisions for indemnification
of directors, officers, stockholders, employees or agents contained in the
certificates or articles of incorporation or bylaws (or other comparable charter
documents) of the Surviving Corporation and its subsidiaries (which as of the
Effective Time shall be no less favorable to such individuals than those
maintained by AHI and its subsidiaries on the date of the Merger Agreement) in
such a manner as would materially and adversely affect the rights of any
individual who shall have served as a director, officer, stockholder, employee
or agent of AHI or any of its subsidiaries prior to the Effective Time (each an
"Indemnified Party") to be indemnified by such corporations in respect of their
serving in such capacities prior to the Effective Time. FPA agreed to indemnify
all directors, officers, employees, and stockholders who are officers or
directors of AHI against any liability or
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losses (including attorney's fees for counsel who are reasonably acceptable to
FPA) any of them may incur because of any claim brought against them prior to or
within five years from the Effective Time as officers, directors, employees,
agents or stockholders of AHI, and in connection therewith, agreed to advance
attorney's fees to them to defend any such claim; provided that FPA shall be
entitled to cooperate in the defense of any such matter; and provided, further,
that FPA shall not be liable for any settlement effected without its written
consent (which consent shall not be unreasonably withheld); and provided,
further, that FPA shall not be obligated pursuant to the Merger Agreement to pay
the fees and disbursements of more than one counsel for all Indemnified Parties
in any single action, except to the extent that, in the opinion of counsel for
the Indemnified Parties, two or more of such Indemnified Parties have
conflicting interests in the outcome of such action. FPA may obtain directors'
and officers' liability insurance covering its obligations under this Section.
Expenses. Whether or not the Merger is consummated, all costs and expenses
incurred in connection with the Merger Agreement and the transactions
contemplated thereby shall be paid by the party incurring such cost or expense,
except (i) that expenses incurred in connection with printing and mailing this
Proxy Statement/Prospectus and the Registration Statement, as well as any filing
fees relating thereto, shall be shared equally by FPA and AHI and (ii) the
termination fee, if applicable, as set forth in the Merger Agreement shall be
paid by AHI. See " -- Effect of Termination."
Pooling of Interests. FPA and AHI agreed that from and after the date of
the Merger Agreement and until the Effective Time, neither FPA nor AHI nor any
of their respective subsidiaries or other affiliates shall knowingly take any
action, or knowingly fail to take any action, that would jeopardize the
treatment of FPA's acquisition of AHI as a "pooling of interests" for accounting
purposes. Following the Effective Time, FPA shall use its best efforts to
conduct the business of the Surviving Corporation, and shall cause the Surviving
Corporation to use its best efforts to conduct its business, in a manner that
would not jeopardize the characterization of the Merger as a "pooling of
interests" for accounting purposes. FPA agreed that on or prior to the later of
February 28, 1997 or sixty (60) days after the Effective Time, FPA shall cause
publication of the combined results of operations of FPA, Merger Sub and AHI for
a period of the first 30 days of combined operations of AHI and the FPA (the
"Combined Results"). For purposes of this paragraph, the term, "publication"
shall have the meaning provided in SEC Accounting Series Release No. 135.
Brokers or Finders. Each of FPA and AHI represented, as to itself and its
affiliates, that no agent, broker, investment banker, financial advisor or other
firm or person is or will be entitled to any broker's or finder's fee or any
other commission or similar fee in connection with any of the transactions
contemplated by the Merger Agreement, except Smith Barney, whose fees and
expenses will be paid by AHI in accordance with AHI's agreement with such firm,
and Needham, whose fees and expenses will be paid by FPA in accordance with
FPA's agreement with such firm, and each of FPA and AHI agreed to indemnify and
hold the other harmless from and against any and all claims, liabilities or
obligations with respect to any other such fee or commission or expenses related
thereto asserted by any person on the basis of any act or statement alleged to
have been made by such party or its affiliate.
Standstill. Each of FPA and AHI agreed that until the expiration of three
years from the date of termination of the Merger Agreement, without the prior
written consent of the other, it will not (a) in any manner acquire, agree to
acquire or make any proposal to acquire, directly or indirectly (i) a
substantial portion of the assets of the other and its subsidiaries taken as a
whole or (ii) any of the issued and outstanding shares of stock of the other (b)
make or in any way participate, directly or indirectly, in any "solicitation" of
"proxies" (as such terms are used in the proxy rules of the Commission) to vote,
or seek to advise or influence any person with respect to the voting of, any
voting securities of the other or any of its subsidiaries or (c) form, join or
in any way participate in a "group" (within the meaning of Section 13(d) of the
Exchange Act) with respect to any voting securities of the other or any of its
subsidiaries.
Notice and Cure. Each of FPA and AHI agreed to notify the other in writing
of, and contemporaneously to provide the other with true and complete copies of
any and all information or documents relating to, and will use best efforts to
cure before the Closing, any event, transaction or circumstance, as soon as
practical after it becomes known to such party, occurring after the date of the
Merger Agreement that causes or will cause any covenant or agreement of FPA or
AHI, as the case may be, under the Merger Agreement to be
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breached or that renders or will render untrue any representation or warranty of
FPA or AHI, as the case may be, contained in the Merger Agreement as if the same
were made on or as of the date of such event, transaction or circumstance. Each
of FPA and AHI also agreed to notify the other in writing of, and to use best
efforts to cure, before the Closing, any violation or breach, as soon as
practical after it becomes known to such party, of any representation, warranty,
covenant or agreement made by FPA or AHI, as the case may be, in the Merger
Agreement, whether occurring or arising prior to, on or after the date of the
Merger Agreement.
Fulfillment of Conditions. Subject to the terms and conditions of the
Merger Agreement, each of FPA and AHI agreed to take or cause to be taken all
steps necessary or desirable and proceed diligently and in good faith to satisfy
each condition to the other's obligations contained in the Merger Agreement and
to consummate and make effective the transactions contemplated by the Merger
Agreement, and further agreed that neither FPA nor AHI will, nor will it permit
any of its subsidiaries to, take or fail to take any action that could be
reasonably expected to result in the nonfulfillment of any such condition.
No Solicitations. Prior to the Effective Time, AHI agreed (a) that neither
it nor any of its subsidiaries shall, and it shall use its best efforts to cause
their respective Representatives not to, initiate, solicit or encourage,
directly or indirectly, any inquiries or the making or implementation of any
proposal or offer (including, without limitation, any proposal or offer to its
stockholders) with respect to a merger, consolidation or other business
combination including AHI or any of its subsidiaries or any acquisition or
similar transaction (including, without limitation, a tender or exchange offer)
involving the purchase of (i) all or any significant portion of the assets of
AHI and its subsidiaries taken as a whole, (ii) 20% or more of the outstanding
shares of AHI Common Stock or (iii) 20% or more of the outstanding shares of the
capital stock of any subsidiary of AHI (any such proposal or offer being
hereinafter referred to as an "Alternative Proposal"), or engage in any
negotiations concerning, or provide any confidential information or data to, or
have any discussions with, any person or group relating to an Alternative
Proposal (excluding the transactions contemplated by the Merger Agreement), or
otherwise facilitate any effort or attempt to make or implement an Alternative
Proposal; (b) that it will notify FPA immediately if any such inquiries,
proposals or offers are received by, any such information is requested from, or
any such negotiations or discussions are sought to be initiated or continued
with, it or any such person or group; and (c) that it will, prior to accepting
any Alternative Proposal, (i) receive a determination from an independent
financial advisor that such Alternative Proposal is more favorable (from a
financial point of view) to AHI's stockholders than the Merger, (ii) determine
in the exercise of its fiduciary obligations under applicable law as advised by
independent counsel that such Alternative Proposal is more favorable to AHI's
stockholders than the Merger, and (iii) deliver to FPA a definitive agreement of
such Alternative Proposal or a description of the material terms thereof and,
except as would violate a fiduciary or contractual obligation, a copy of any
information provided by such person or group, including the identity of such
person or group, and give FPA at least three (3) days to offer a counterproposal
prior to executing such definitive agreement; provided, however, that nothing
contained in the Merger Agreement shall prohibit the AHI Board from (1)
furnishing information to or entering into discussions or negotiations with any
person or group that makes an unsolicited bona fide Alternative Proposal, if,
and only to the extent that, (A) the AHI Board based upon the written opinion of
outside counsel (a copy of which shall be provided promptly to FPA), determines
in good faith that such action is required or appropriate for the AHI Board to
comply with its fiduciary duties to stockholders imposed by law, (B) the AHI
Board has reasonably concluded in good faith that the person or group making
such Alternative Proposal will have adequate sources of financing to consummate
such Alternative Proposal and that such Alternative Proposal is more favorable
to AHI's stockholders than the Merger and (C) prior to furnishing such
information to, or entering into discussions or negotiations with, such person
or group, AHI provides written notice to FPA to the effect that it is furnishing
information to, or entering into discussions or negotiations with, such person
or group; and (2) to the extent applicable, complying with Rule 14e-2
promulgated under the Exchange Act with regard to an Alternative Proposal.
Irrevocable Proxies. Each of FPA and AHI agreed to use its best efforts to
cause its officers and employee directors to execute and deliver to the other
party to the Merger Agreement irrevocable proxies in a form reasonably
acceptable to the parties thereto authorizing the other party to vote all shares
of AHI Common Stock and FPA Common Stock, as the case may be, which such
executive officers and
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directors are entitled to vote in favor of the Merger. Such proxies shall be
revocable in the event that the Merger Agreement is terminated.
AHI Affiliates. AHI has agreed that within at least thirty days after the
date of the Merger Agreement, (i) it will deliver a letter to FPA identifying
all persons who may be deemed affiliates of AHI under Rule 145, including,
without limitation, all directors and executive officers of AHI, and (ii) it
shall advise the persons identified in such letter of the resale restrictions
imposed by applicable securities laws, including ASR 135. Each of FPA and AHI
agreed to use its reasonable best efforts to obtain as soon as practicable after
the date of the Merger Agreement from affiliates of FPA and AHI an agreement
that such persons will comply with the provisions of ASR 135.
Registration Rights Agreement. FPA agreed to enter into a registration
rights agreement with the Selling Stockholders (as defined below) providing that
if, during the three month period following the date on which the Combined
Results are published, any of Leonardo Berezovsky, M.D., Jose Spiwak, M.D. and
Kaushal Tamboli, M.D. (the "Selling Stockholders") was or would have been unable
to sell at least 850,000 shares of the FPA Common Stock received in the Merger
in accordance with the provisions of Rule 144, FPA will use its best efforts to
file a registration statement with the Commission to register on behalf of any
such Selling Stockholder a number of shares of FPA Common Stock received in the
Merger equal to three (3) times the amount by which 850,000 exceeds the number
of shares such Selling Stockholder sold, or would have been able to sell under
Rule 144 during such three-month period. Additionally, the registration rights
agreement will provide that, in the event no registration statement was filed at
the end of the initial three-month period for any such Selling Stockholder and,
during the six-month period following the date on which the Combined Results are
published, any such Selling Stockholder was or would have been unable to sell at
least 1,700,000 shares of FPA Common Stock received in the Merger in accordance
with Rule 144, FPA will use its best efforts to file a registration statement
with the Commission to register on behalf of any such Selling Stockholder a
number of shares of FPA Common Stock equal to two (2) times the amount by which
1,700,000 exceeds the number of shares such Selling Stockholder sold, or would
have been able to sell under Rule 144 during such six-month period.
Notwithstanding anything in the Merger Agreement to the contrary, any
registration rights granted in the registration rights agreement are subordinate
to and shall not contravene any registration rights granted by FPA prior to the
date of the Merger Agreement. Such registration rights agreement shall contain
such other terms as are customary and reasonably acceptable to FPA and the
Selling Stockholders. The foregoing provisions for any such stockholder shall
also apply to any trust or other entity established by such stockholder. In no
event shall FPA be obligated to file more than one registration statement
pursuant to the terms of the registration rights agreement.
CONDITIONS TO CONSUMMATION OF THE MERGER
In addition to the approval and adoption of the Merger Agreement and the
terms of the Merger by the stockholders of AHI and FPA, the obligation of each
party to effect the Merger is subject to the fulfillment, at or prior to the
Closing, or where legally permissible, the waiver of, various conditions,
including: (i) the effectiveness of the Registration Statement and the absence
of any stop order suspending each such effectiveness or any proceedings for that
purpose being pending or threatened; (ii) the receipt of all state securities or
"Blue Sky" permits and other authorizations necessary to issue the FPA Common
Stock; (iii) the shares of FPA Common Stock issuable to AHI's stockholders in
the Merger in accordance with the Merger Agreement shall have been approved for
inclusion on Nasdaq; (iv) the expiration or termination of any waiting period
(and any extension thereof) under the HSR Act; (v) no court of competent
jurisdiction or other competent governmental or regulatory authority having
enacted, issued, promulgated, enforced or entered any law or order (whether
temporary, preliminary or permanent) which is in effect and has the effect of
making illegal or otherwise restricting, preventing or prohibiting consummation
of the Merger or the other transactions contemplated by the Merger Agreement;
(vi) the receipt of letters from Deloitte & Touche LLP and Ernst & Young LLP,
each dated the date of the Proxy Statement/Prospectus and confirmed in writing
at the Effective Time and addressed to FPA and AHI, respectively, stating that
the Merger will qualify as a "pooling of interests" transaction under APB No.
16; (vii) the delivery by AHI to FPA within thirty days after the date of the
Merger Agreement a letter identifying all persons who may be deemed affiliates
of AHI under
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Rule 145, including, without limitation, all directors and executive officers of
AHI; (viii) the delivery by AHI to each of the persons identified in the letter
referred to in subsection (vii) above, a notice of the resale restrictions
imposed by applicable securities laws, including Accounting Series Release No.
135 ("ASR 135"); and (ix) the receipt of all material consents, approvals and
notices from governmental or regulatory authorities or any other public or
private third parties required to consummate the Merger.
The obligation of FPA and Merger Sub to effect the Merger is further
subject to the fulfillment, at or prior to the Closing, of each of the following
conditions (all or any of which may be waived in whole or in part by FPA or
Merger Sub in their sole discretion): (i) AHI shall have performed each
agreement, covenant and obligation required by the Merger Agreement to be
performed or complied with by it on or prior to the Closing Date and the
representations and warranties of AHI in the Merger Agreement shall be true and
correct as of the Closing Date as though made on and as of the Closing Date or,
in the case of representations and warranties made as of a specified date
earlier than the Closing Date, on and as of such earlier date and AHI shall have
delivered to FPA a certificate, dated the Closing Date and executed on behalf of
AHI by its Chairman of the Board, President or any Senior Vice President, to
such effect; (ii) there shall not have been issued, enacted, promulgated or
deemed applicable to AHI, the Surviving Corporation, any of their respective
subsidiaries or the transactions contemplated by the Merger Agreement any order
or law of any governmental or regulatory authority which is then in effect and
which could be reasonably expected to result in a material diminution of the
benefits of the Merger to FPA; (iii) AHI and its subsidiaries shall have
received all consents (or in lieu thereof waivers) from parties to each contract
disclosed in the AHI Disclosure Letter; (iv) all proceedings to be taken on the
part of AHI in connection with the transactions contemplated by the Merger
Agreement and all documents incident thereto shall be reasonably satisfactory in
form and substance to FPA, and FPA shall have received copies of all such
documents and other evidences as FPA may reasonably request in order to
establish the consummation of such transactions and the taking of all
proceedings in connection therewith; (v) FPA shall have received the opinion of
counsel to AHI dated the Closing Date; and (vi) FPA subsidiaries shall have
received all consents (or in lieu thereof waivers) from parties to each contract
disclosed in the FPA Disclosure Letter.
The obligation of AHI to effect the Merger is further subject to the
fulfillment, at or prior to the Closing, of each of the following conditions
(all or any of which may be waived in whole or in part by AHI in its sole
discretion): (i) FPA and Merger Sub shall have performed each agreement,
covenant and obligation required by the Merger Agreement to be performed or
complied with by them on or prior to the Closing Date and the representations
and warranties of FPA and Merger Sub in the Merger Agreement shall be true and
correct as of the Closing Date as though made on and as of the Closing Date or,
in the case of representations and warranties made as of a specified date
earlier than the Closing Date, on and as of such earlier date and each of FPA
and Merger Sub shall have delivered to AHI certificates, dated the Closing Date
and executed on behalf of FPA and Merger Sub, as the case may be, by its
Chairman of the Board, President or any Executive or Senior Vice President, to
such effect; (ii) there shall not have been issued, enacted, promulgated or
deemed applicable to FPA or any of its respective subsidiaries or the
transactions contemplated by the Merger Agreement any order or law of any
governmental or regulatory authority which is then in effect and which could be
reasonably expected to result in a material diminution of the benefits of the
Merger to AHI; (iii) FPA shall have delivered a registration rights agreement to
the Selling Stockholders; (iv) the FPA Value shall not be below $10.00; (v) all
proceedings to be taken on the part of FPA in connection with the transactions
contemplated by the Merger Agreement and all documents incident thereto shall be
reasonably satisfactory in form and substance to AHI, and AHI shall have
received copies of all such documents and other evidences as AHI may reasonably
request in order to establish the consummation of such transactions and the
taking of all proceedings in connection therewith; and (vi) AHI shall have
received the opinion of counsel to FPA dated the Closing Date.
TERMINATION
The Merger Agreement may be terminated and the transactions contemplated
thereby may be abandoned whether prior to or after the approval of the
stockholders of either FPA or AHI: (i) by mutual written agreement of each of
FPA and AHI duly authorized by action taken by or on behalf of their Boards of
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<PAGE> 96
Directors; (ii) by either FPA or AHI upon written notice to non-terminating
party by the terminating party (A) at any time after April 30, 1997, if the
Merger has not been consummated on or prior to such date and such failure to
consummate the Merger was not caused by a breach of the Merger Agreement by the
terminating party, (B) if the AHI stockholders' approval or the FPA
stockholders' approval of the Merger Agreement has not been obtained, (C) if any
governmental or regulatory authority, the taking of action by which is a
condition to the obligations of either AHI or FPA to consummate the transactions
contemplated by the Merger Agreement, shall have determined not to take such
action and all appeals of such determination shall have been taken and have been
unsuccessful, (D) if there has been a material breach of any representation,
warranty, covenant or agreement on the part of the non-terminating party set
forth in the Merger Agreement, which breach has not been cured within five (5)
business days following receipt by the non-terminating party of notice of such
breach from the terminating party or assurance of such cure reasonably
satisfactory to the terminating party shall not have been given by or on behalf
of the non-terminating party within such five (5) business day period, or (E) if
any court of competent jurisdiction or other competent governmental or
regulatory authority has issued an order, judgment or decree making illegal or
otherwise restraining, preventing or prohibiting the Merger and such order,
judgment or decree shall have become final and nonappealable and such
terminating party has used all reasonable efforts to remove such order,
judgement or decree; and (iii) AHI may terminate the Merger Agreement if the AHI
Board concludes in good faith on the basis of advice from independent counsel
that such action is necessary or appropriate in order for the AHI Board to act
in a manner which is consistent with its fiduciary obligations under applicable
law.
EFFECT OF TERMINATION
If the Merger Agreement is validly terminated by either AHI or FPA pursuant
to the Merger Agreement, the Merger Agreement will forthwith become null and
void and there will be no liability or obligation on the part of either AHI or
FPA (or any of their respective Representatives or affiliates), except (i) that
certain provisions of the Merger Agreement will continue to apply following any
such termination and (ii) that nothing contained therein shall relieve any party
thereto from liability for wilful breach of its representations, warranties,
covenants or agreements contained in the Merger Agreement. AHI has agreed that
upon a termination by AHI pursuant to clause (iii) of the foregoing paragraph,
it will pay FPA liquidated damages in the amount of 2% of the value of FPA
Common Stock (based on the FPA Value) which would have been issued had the
Closing Date occurred on such date of termination.
AMENDMENT
The Merger Agreement may be amended, supplemented or modified by action
taken by or on behalf of the respective Boards of Directors of the parties
thereto at any time prior to the Effective Time, whether prior to or after
adoption of the Merger Agreement at the AHI Special Meeting or at the FPA
Special Meeting, but after such adoption and approval only to the extent
permitted by applicable law. No such amendment, supplement or modification shall
be effective unless set forth in a written instrument duly executed by or on
behalf of each party thereto.
WAIVER
At any time prior to the Effective Time any party to the Merger Agreement,
by action taken by or on behalf of its Board of Directors, may to the extent
permitted by applicable law (i) extend the time for the performance of any of
the obligations or other acts of the other parties thereto, (ii) waive any
inaccuracies in the representations and warranties of the other parties hereto
contained therein or in any document delivered pursuant thereto or (iii) waive
compliance with any of the covenants, agreements or conditions of the other
parties thereto contained therein. No such extension or waiver shall be
effective unless set forth in a written instrument duly executed by or on behalf
of the party extending the time of performance or waiving any such inaccuracy or
non-compliance. No waiver by any party of any term or condition of the Merger
Agreement, in any one or more instances, shall be deemed to be or construed as a
waiver of the same or any other term or condition of the Merger Agreement on any
future occasion.
88
<PAGE> 97
THE FOUNDATION TRANSACTION
Effective November 29, 1996, FPA acquired from Foundation all of the
outstanding stock of FHMS and the Holding Company. FHMS provides facilities
management and professional services to the Holding Company and its
subsidiaries, Foundation Health Medical Group, Inc. and Thomas-Davis Medical
Centers, P.C. (together with FHMS, the "Combined Foundation Companies"). The
Combined Foundation Companies provide services to approximately 242,000
enrollees in California and Arizona through approximately 188 primary care
physicians, and 2,300 specialty care physicians.
FHMS ACQUISITION
Pursuant to the Stock and Note Purchase Agreement dated June 28, 1996 (the
"Foundation Agreement"), effective November 29, 1996, FPA Medical Management of
California ("FPA California"), a wholly owned subsidiary of FPA, acquired from
Foundation all of the issued and outstanding capital stock of FHMS for aggregate
consideration valued at $197,000,000, consisting of (i) cash in the amount of $2
million, (ii) 4,076,087 shares of FPA Common Stock, (iii) promissory notes in
the principal amount of $34 million and (iv) the assumption of the indebtedness
of FHMS to Foundation and certain non-affiliated third parties in the aggregate
principal amount of approximately $86 million. The repayment of this
indebtedness is guaranteed by FPA.
HOLDING COMPANY ACQUISITION
Pursuant to the Foundation Agreement, Foundation assigned to a designee of
FPA's indirect subsidiary, FPA Independent Practice Association ("FPA IPA"), its
option (the "Option") to purchase all of the issued and outstanding stock of
Holding Company from Jonathan Scheff, M.D. ("Scheff"). Upon the exercise of the
Option, FPA IPA's designee transferred all of the issued and outstanding stock
of Holding Company to FPA IPA. In consideration of the Option, FPA IPA paid to
Foundation the sum of $15,000 and FPA California purchased the indebtedness of
Holding Company to Foundation as described above.
In connection with the Foundation Transaction, Foundation Health Medical
Group, Inc. and Thomas-Davis Medical Centers, P.C., the subsidiaries of the
Holding Company, and the Florida and Arizona IPAs previously acquired by FPA
(collectively, the "Medical Groups"), have entered into 30-year payor agreements
with Foundation. These Payor agreements include an obligation on the part of the
Medical Groups to guarantee, to the extent specified in the agreements, that the
enrollees of Foundation benefit plans have access to the providers and
facilities of the Medical Groups. These agreements commit the Medical Groups,
among other things, to contract with Foundation for all benefit programs and to
maintain sufficient medical personnel to provide reasonable and adequate access
to professional services for all benefit programs offered by Foundation, to keep
care centers open given specified levels of patients and to agree to certain
pricing and contracting parameters with Foundation. In consideration of such
services, Foundation has agreed to pay in the aggregate $55.0 million to the
Medical Groups.
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<PAGE> 98
APPROVAL OF AMENDMENT TO FPA MEDICAL MANAGEMENT, INC.
OMNIBUS STOCK OPTION PLAN
At the FPA Special Meeting, stockholders of FPA will be asked to approve an
amendment to the FPA Medical Management, Inc. Omnibus Stock Option Plan (the
"FPA Plan") which would, upon becoming effective, increase the total number of
shares of FPA Common Stock issuable upon exercise of options granted under such
plan from 5,000,000 to 6,500,000. The FPA Plan was approved by the FPA
stockholders in October 1994 and amendments to the FPA Plan were approved by the
FPA stockholders in July 1995, June 1996 and October 1996.
The proposal to approve the amendment to the FPA Plan will become effective
if it receives the affirmative vote of the holders of a majority of the shares
of FPA Common Stock present in person or by proxy at the FPA Special Meeting. In
the event the amendment is not approved by FPA stockholders, the amendment will
not become effective and the FPA Plan will remain in full force and effect in
its current form.
The FPA Plan currently provides for the issuance of up to 5,000,000 shares
of FPA Common Stock. As of December 31, 1996, options to purchase 5,000,000
shares of FPA Common Stock have been granted and are currently outstanding under
the FPA Plan and options to purchase an additional 718,895 shares of FPA Common
Stock have been granted subject to stockholder approval of an amendment to
increase the number of shares available for issuance under the FPA Plan. The
Board of Directors of FPA believes that it is advisable and in the best interest
of FPA to make additional shares available for the granting of options in the
future to officers and other key employees of FPA because options provide a
valuable incentive for such persons to remain with FPA and motivate them to
exert their best efforts on behalf of FPA. Accordingly, FPA's Board of Directors
recommends that the total number of shares issuable pursuant to the FPA Plan be
increased by 1,500,000.
FPA's Board of Directors recommends that you vote FOR the proposal to amend
the FPA Plan.
Set forth below is a summary of the FPA Plan, as proposed to be amended.
The purpose of the FPA Plan is to enable FPA to attract, retain and reward
employees and directors of, and consultants to, FPA and to strengthen the
mutuality of interests between such persons and FPA's stockholders. The FPA Plan
is administered by the Compensation Committee of the Board of Directors (the
"FPA Compensation Committee").
Under the FPA Plan, options to purchase shares of FPA Common Stock may be
granted to employees of, and consultants to, FPA and certain of its
subsidiaries. The FPA Plan provides for the grant of both incentive stock
options (options that satisfy the requirements of Section 422 of Internal
Revenue Code) and nonqualified options. Under the terms of the FPA Plan, the
option exercise price for incentive stock options may not be less than the fair
market value of the underlying stock at the time the option is granted. Both
incentive stock options and nonqualified options granted under the FPA Plan
expire upon the earlier of one month after the employee's termination, an
expiration date fixed by the FPA Compensation Committee and set forth in each
individual option agreement, or ten years from the date of grant. Options
granted pursuant to the FPA Plan will be exercisable at such times as the FPA
Compensation Committee shall determine. On December 31, 1996, the closing price
of FPA Common Stock on Nasdaq was $22.375. On December 31, 1996, FPA had
approximately 3,900 employees, 3,200 of whom were eligible to receive options
under the FPA Plan. After consummation of the Merger, FPA is expected to have
approximately 3,285 employees, all of whom will be eligible to receive options
under the FPA Plan.
The Plan has a provision which limits the number of shares of FPA Common
Stock for which options may be granted to any individual during any year. With
this provision, options granted under the FPA Plan qualify as performance-based
compensation for purposes of Section 162(m) of the Code and the regulations
thereunder, and FPA will be entitled to deduct the compensation paid to certain
executives pursuant to the FPA Plan, notwithstanding the deduction limit
contained in Section 162(m).
Under the FPA Plan, the price payable upon exercise of options may be paid
in cash or check acceptable to FPA, or by any other consideration that the FPA
Compensation Committee deems acceptable. The
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<PAGE> 99
exercise price may also be paid in shares of FPA Common Stock duly owned by the
optionee having a fair market value equal to the option price on the date of
exercise.
As of December 31, 1996, options to purchase 5,718,895 shares of FPA Common
Stock under the FPA Plan were outstanding. The individuals who receive options
and the number of shares of FPA Common Stock included in each grant are within
the discretion of the FPA Compensation Committee. The grants that were made
under the FPA Plan since the inception of the FPA Plan are shown below.
<TABLE>
<CAPTION>
SECURITIES UNDERLYING
OPTIONS GRANTED
NAME OR GROUP SINCE INCEPTION
------------------------------------------------------------------- ---------------------
<S> <C>
Seth Flam.......................................................... 781,000
Sol Lizerbram...................................................... 781,000
Stephen J. Dresnick................................................ 722,502
Steven M. Lash..................................................... 726,524
Howard Hassman..................................................... 413,000
Executive Officer Group............................................ 4,043,526
Non-Executive Officer Director Group............................... 0
Associates of Directors, Executive Officers or Nominees............ 0
Persons Who Received or Are to Receive 5% of Options............... 4,154,626
Non-Executive Officer and Employee Group........................... 1,675,369
</TABLE>
FEDERAL INCOME TAX CONSEQUENCES
Incentive Stock Options. It is intended that certain options granted under
the FPA Plan will qualify as "incentive stock options" to the degree possible
under the Code. This means that the optionee will not realize taxable income
upon the grant or exercise of the option. However, any excess of the fair market
value of the option stock on the date of exercise over the option price will
constitute an item of tax preference for purposes of the alternative minimum tax
and may cause the optionee to incur a liability for such tax in the year of
exercise.
If the optionee holds the stock purchased on exercise of the option until
at least (a) one year after it is purchased and (b) two years after the option
is granted, any profit or loss recognized on disposition of the stock will be
treated as a long-term capital gain or loss. If, however, the optionee disposes
of the stock within either the one or two-year period, the optionee generally
will be required to include in ordinary taxable income upon disposition of the
stock an amount equal to the lesser of (a) the amount, if any, by which the fair
market value of such stock on the date the option was exercised exceeded the
option price, or (b) the amount, if any, by which the amount realized from such
disposition exceeds the option price; any additional gain would be long-term or
short-term capital gain, depending upon how long the stock was held. But, for
certain dispositions of stock made within either the one- or two-year period by
way of gift or by way of sale to a person or entity related to the optionee, the
optionee may be required to include in ordinary taxable income the full amount
described in (a), regardless of the amount realized from such disposition.
The one- and two-year requirements do not apply to the disposition of stock
after an optionee's death by (a) the optionee's estate or (b) a person who
acquires the right to exercise the option by reason of the optionee's death. In
such cases, the stock may be disposed of any time after receipt and receive
preferential tax treatment subject to the general holding period rules for
capital gains.
Options granted under the FPA Plan may be exercised by the transfer to FPA
of shares of FPA Common Stock with a fair market value equal to the option's
exercise price. If the optionee transfers incentive stock option shares to FPA
before both the one- and two-year holding periods have expired, the transfer
will be treated as a disposition of such shares with the tax consequences
described above. If the shares so transferred are not incentive stock option
shares or, if they are such shares and both the one- and two-year periods have
expired, such transfer to FPA will not be a taxable event.
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<PAGE> 100
Generally, FPA will not be entitled to any tax deduction in connection with
the grant or exercise of an incentive stock option. If, however, the optionee
disposes of stock acquired upon exercise of an option before the one and
two-year periods have expired, FPA will be entitled to deduct, when the optionee
disposes of the stock, any amount the optionee is required to include in
ordinary taxable income.
Non-Qualified Stock Options. The grant by FPA of nonqualified stock
options is not a taxable event to the optionee. Generally, an optionee
recognizes ordinary income on the date option shares are issued to him or her
pursuant to the exercise of the option in an amount equal to the "spread" or the
excess of the fair market value of the shares on that date over the exercise
price. Any further gain or loss on disposition of the shares will be capital
gain or loss if the shares are held by the optionee for investment.
FPA will be entitled to deduct for federal income tax purposes any amount
the optionee is required to include in ordinary income at the time such amount
is so includable, provided that such amount is not deemed to be an "excess
parachute payment" (i.e., payment payable upon a change of control of FPA that
is in excess of reasonable compensation).
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<PAGE> 101
SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA
PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) OF
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
The following pro forma condensed consolidated balance sheet as of
September 30, 1996 and the pro forma condensed consolidated statements of
operations for the three years in the period ended December 31, 1995 and the
nine months ended September 30, 1996 give effect to the following consummated
and probable transactions.
Consummated Transactions
(1) The acquisitions of Gonzaba Management Organization (effective November
1, 1995), Arizona Managed Care Services and Affiliates (effective July 1, 1995),
and Grossmont Medical Clinic (effective May 18, 1995) (collectively referred to
as the "1995 FPA Acquisitions").
(2) The acquisition of Foundation Health IPA ("FHIPA") (effective January
31, 1996).
(3) The acquisition of Physicians First, Inc. ("PFI") (effective June 1,
1996).
(4) The acquisition of Foundation Health Medical Services and Affiliates
("FHMS") (effective November 29, 1996).
(5) The merger between FPA Medical Management, Inc. ("FPA") and Sterling
Healthcare Group, Inc. ("Sterling") (effective October 31, 1996) (referred to as
the "Sterling Merger.")
(6) Sterling's acquisitions of Medical Networks, Inc. (effective January
31, 1995) and Professional Emergency Physicians, P.A. (effective September 30,
1995) (collectively referred to as the "1995 Sterling Acquisitions").
Probable Transactions
(1) The proposed merger between FPA and AHI Healthcare Systems, Inc.
("AHI"). This merger is referred to as the AHI Merger.
The AHI merger, the FHMS acquisitions, and the Sterling Merger are
reflected as of September 30, 1996 for the pro forma condensed consolidated
balance sheet. The Consummated Transactions, except the Sterling Merger, are
reflected as of January 1, 1995 in the condensed consolidated statements of
operations. The Sterling Merger and the AHI Merger are reflected as of January
1, 1993 in the condensed consolidated statements of operations. The pro forma
information is based on the respective historical financial statements of the
Consummated Transactions and the Probable Transactions giving effect to the
Sterling Merger and the AHI Merger under the pooling of interests method of
accounting and all other acquisitions under the purchase method of accounting,
and the assumptions and adjustments described in the accompanying notes to the
pro forma condensed consolidated financial statements.
The pro forma condensed consolidated financial statements have been
prepared by the management of FPA based upon the unaudited financial statements
of FPA, Sterling, FHMS and AHI as of September 30, 1996 and for the nine months
then ended, the audited financial statements of FPA, FHMS, the 1996 FPA
Acquisitions, Sterling and AHI as of December 31, 1995 and for each of the three
years in the period then ended, and the unaudited results of operations for PFI,
1995 FPA Acquisitions and 1995 Sterling Acquisitions up to their respective
acquisition dates. Management of FPA cannot be sure that the estimated fair
values related to FHMS represent fair values that will ultimately be determined
upon completion of their valuation analysis. Consequently, such estimates are
subject to revision. Additionally, the Management of FPA believes that the AHI
Merger is probable.
Management of FPA does not believe that the pro forma condensed
consolidated financial statements are indicative of the results that actually
would have occurred if the combinations had been in effect on the dates
indicated or which may be obtained in the future. The pro forma condensed
consolidated financial statements should be read in conjunction with the
financial statements and notes of FPA, 1995 FPA Acquisitions, FHIPA, PFI, FHMS,
Sterling, 1995 Sterling Acquisitions, and AHI.
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<PAGE> 102
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
FOUNDATION
FPA MEDICAL HEALTH
MANAGEMENT, INC. MEDICAL
AND CONSUMMATED SERVICES,
STERLING TRANSACTIONS INC.
FPA MEDICAL HEALTHCARE PRO FORMA PRO FORMA AND
MANAGEMENT, INC. GROUP, INC. ADJUSTMENTS CONSOLIDATED AFFILIATES
---------------- ----------- ----------- ---------------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................... $ 2,526,679 $ 2,526,679
Marketable securities........................... 1,555,463 1,555,463
Accounts receivable -- net...................... 49,734,560 $40,799,245 90,533,805 $ 4,665,000
Current portion of notes receivable............. 650,953 650,953
Prepaid expenses and other assets............... 2,732,051 5,133,229 7,865,280 5,105,000
Deferred income tax asset....................... 1,011,018 3,097,318 4,108,336
------------ ----------- ------------ ------------ ------------
Total current assets............................ 58,210,724 49,029,792 107,240,516 9,770,000
Property and equipment -- net................... 17,004,108 2,846,092 19,850,200 91,055,000
Restricted cash and deposits.................... 7,804,728 7,804,728
Goodwill and intangibles -- net................. 95,428,971 38,221,561 133,650,532 12,115,000
Investments in GLHP............................. 4,994,900 4,994,900
Deposits and other assets....................... 1,816,136 562,541 2,378,677 5,408,000
------------ ----------- ------------ ------------ ------------
Total........................................... $185,259,567 $90,659,986 $ $275,919,553 $118,348,000
============ =========== ============ ============ ============
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC.
AND CONSUMMATED AHI
TRANSACTIONS HEALTHCARE POOLING OF
PRO FORMA PRO FORMA SYSTEMS, INTERESTS
ADJUSTMENTS CONSOLIDATED[S] INC. ADJUSTMENTS
------------ ----------------- ------------ -----------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents....................... $ (2,000,000)[A] $ 526,679 $ 17,176,000
Marketable securities........................... 1,555,463
Accounts receivable -- net...................... 95,198,805 13,956,000
Current portion of notes receivable............. 650,953
Prepaid expenses and other assets............... 12,970,280 558,000
Deferred income tax asset....................... 4,108,336 2,294,000
------------ ------------ ----------- -----------
Total current assets............................ (2,000,000) 115,010,516 33,984,000
Property and equipment -- net................... (72,182,000)[O] 38,723,200 5,553,000
Restricted cash and deposits.................... 7,804,728
Goodwill and intangibles -- net................. 209,672,000[B] 351,212,532 26,079,000
(4,225,000)[O]
Investments in GLHP............................. 4,994,900
Deposits and other assets....................... (1,687,000)[O] 6,099,677 339,000
------------ ------------ ----------- -----------
Total........................................... $129,578,000 $ 523,845,553 $ 65,955,000
============ ============ =========== ===========
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC.
PRO FORMA
CONSOLIDATED
----------------
ASSETS
Current assets:
Cash and cash equivalents....................... $ 17,702,679
Marketable securities........................... 1,555,463
Accounts receivable -- net...................... 109,154,805
Current portion of notes receivable............. 650,953
Prepaid expenses and other assets............... 13,528,280
Deferred income tax asset....................... 6,402,336
------------
Total current assets............................ 148,994,516
Property and equipment -- net................... 44,276,200
Restricted cash and deposits.................... 7,804,728
Goodwill and intangibles -- net................. 377,291,532
Investments in GLHP............................. 4,994,900
Deposits and other assets....................... 6,438,677
------------
Total........................................... $589,800,553
============
</TABLE>
94
<PAGE> 103
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
FOUNDATION
FPA MEDICAL HEALTH
MANAGEMENT, INC. MEDICAL
AND CONSUMMATED SERVICES,
STERLING TRANSACTIONS INC.
FPA MEDICAL HEALTHCARE PRO FORMA PRO FORMA AND
MANAGEMENT, INC. GROUP, INC. ADJUSTMENTS CONSOLIDATED AFFILIATES
---------------- ----------- ------------ ---------------- -------------
<S> <C> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable and accrued expenses...... $ 12,010,855 $10,283,937 $ 13,000,000[D] $ 35,294,792 $ 19,570,000
Claims payable, including incurred but not
reported claims........................... 47,474,955 47,474,955 12,990,000
Income taxes payable....................... 2,273,591 2,273,591
Long-term debt -- current portion.......... 48,439,279 3,833,747 52,273,026 156,818,000
Other liabilities.......................... 650,000 650,000 9,422,000
------------ ----------- ------------ ------------ ------------
Total current liabilities................. 110,198,680 14,767,684 13,000,000 137,966,364 198,800,000
------------ ----------- ------------ ------------ ------------
Long-term debt -- net of current portion... 12,761,989 10,801,342 23,563,331
Deferred income tax liability.............. 1,746,461 498,521 2,244,982
Other long-term liabilities................ 1,001,784 3,450,710 4,452,494 18,220,000
Stockholders' equity (deficit):
Common stock.............................. 25,084 852 15,344[C] 41,280 20,000
Additional paid in capital................ 53,683,603 53,710,737 (15,344)[C] 107,378,996 4,722,000
Stock payable............................. 493,100 493,100
Accumulated earnings (deficit)............ 5,348,866 7,674,570 (13,000,000)[D] 23,436 (103,414,000)
Less: deferred compensation -- stock
options................................. (244,430) (244,430)
Less: Due from stockholders...............
------------ ----------- ------------ ------------ ------------
Total stockholders' equity (deficit)....... 59,550,653 61,141,729 (13,000,000) 107,692,382 (98,672,000)
------------ ----------- ------------ ------------ ------------
Total...................................... $185,259,567 $90,659,986 $275,919,553 $ 118,348,000
============ =========== ============ ============ ============
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC.
AND CONSUMMATED AHI FPA MEDICAL
TRANSACTIONS HEALTHCARE POOLING OF MANAGEMENT, INC.
PRO FORMA PRO FORMA SYSTEMS, INTERESTS PRO FORMA
ADJUSTMENTS CONSOLIDATED[S] INC. ADJUSTMENTS CONSOLIDATED
------------- ---------------- ------------ ------------ ----------------
<S> <<C> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable and accrued expenses...... $ (2,903,000)[O] $ 51,961,792 $ 14,051,000 11,500,000[D] $ 77,512,792
Claims payable, including incurred but not
reported claims........................... 60,464,955 19,455,000 79,919,955
Income taxes payable....................... 2,273,591 2,273,591
Long-term debt -- current portion.......... $ (75,191,000)[O] 62,273,026 2,496,000 64,769,026
(71,627,000)[P]
Other liabilities.......................... 10,072,000 10,072,000
------------- ------------ ------------ ----------- ------------
Total current liabilities................. (149,721,000) 187,045,364 36,002,000 11,500,000 234,547,364
------------- ------------ ------------ ----------- ------------
Long-term debt -- net of current portion... 34,000,000[A] 129,190,331 1,094,000 130,284,331
71,627,000[P]
Deferred income tax liability.............. 2,244,982 2,244,982
Other long-term liabilities................ 22,672,494 22,672,494
Stockholders' equity (deficit):
Common stock.............................. (20,000) 49,532 145,000 (130,880)[M] 63,552
8,152[A]
Additional paid in capital................ (4,722,000) 182,370,844 47,753,000 130,880[M] 230,254,724
74,991,848[A]
Stock payable............................. 493,100 493,100
Accumulated earnings (deficit)............ 103,414,000 23,436 (18,574,000) (11,500,000)[D] (30,050,564)
Less: deferred compensation -- stock
options................................. (244,430) (50,000) (294,430)
Less: Due from stockholders............... (415,000) (415,000)
------------- ------------ ------------ ----------- ------------
Total stockholders' equity (deficit)....... 173,672,000 182,692,382 28,859,000 (11,500,000)[O] 200,051,382
------------- ------------ ------------ ----------- ------------
Total...................................... $ 129,578,000 $523,845,553 $ 65,955,000 -- $589,800,553
============= ============ ============ =========== ============
</TABLE>
95
<PAGE> 104
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC. FOUNDATION
AND CONSUMMATED HEALTH
STERLING PHYSICIANS TRANSACTIONS MEDICAL
FPA MEDICAL HEALTHCARE FIRST, PRO FORMA PRO FORMA SERVICES, INC.
MANAGEMENT, INC. GROUP, INC. INC.(E) ADJUSTMENTS CONSOLIDATED AND AFFILIATES
---------------- ------------ ----------- ----------- ---------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Managed care revenue............. $171,500,742 $14,870,833 $186,371,575 $ 99,056,000
Fee-for-service
revenue........................ 17,020,463 $100,749,819 4,176,018 121,946,300 15,732,000
------------ ------------ ----------- --------- ------------ -----------
Total operating revenue........ 188,521,205 100,749,819 19,046,851 308,317,875 114,788,000
------------ ------------ ----------- --------- ------------ -----------
Expenses:
Medical services............... 140,110,800 64,686,222 16,128,269 220,925,291 137,663,000
General and administrative..... 39,015,517 29,754,056 2,811,904 $ 160,134[F] 71,741,611 36,474,000
------------ ------------ ----------- --------- ------------ -----------
Total expenses................. 179,126,317 94,440,278 18,940,173 160,134 292,666,902 174,137,000
------------ ------------ ----------- --------- ------------ -----------
Income (loss) from operations.... 9,394,888 6,309,541 106,678 (160,134) 15,650,973 (59,349,000)
Other income (expense)
Interest and other income...... 343,881 99,190 83,940 527,011 5,672,000
Interest expense............... (2,032,358) (749,107) (15,382) (500,000)[G] (3,296,847) (6,855,000)
Other expense.................. (2,757,000)
------------ ------------ ----------- --------- ------------ -----------
Total other income (expense)... (1,688,477) (649,917) 68,558 (500,000) (2,769,836) (3,940,000)
------------ ------------ ----------- --------- ------------ -----------
Income (loss) before income
taxes.......................... 7,706,411 5,659,624 175,236 (660,134) 12,881,137 (63,289,000)
Income tax (expense) benefit..... (3,378,492) (2,218,081) (73,922) 264,054[I] (5,406,441) 16,800,000
------------ ------------ ----------- --------- ------------ -----------
Net income (loss)................ $ 4,327,919 $ 3,441,543 $ 101,314 $(396,080) $ 7,474,696 $ (46,489,000)
============ ============ =========== ========= ============ ===========
Pro forma net income (loss) per
share.......................... $ 0.34 $ 0.36
Weighted average shares.......... 12,613,385 21,017,416
<CAPTION>
FPA MEDICAL
MANAGEMENT,
INC.
AND CONSUMMATED FPA MEDICAL
TRANSACTIONS MANAGEMENT, INC.
PRO FORMA PRO FORMA AHI HEALTHCARE PRO FORMA
ADJUSTMENTS CONSOLIDATED[S] SYSTEMS, INC. CONSOLIDATED
------------ --------------- -------------- ----------------
<S> <<C> <C> <C> <C>
Managed care revenue............. $ 285,427,575 $ 89,202,000 $374,629,575
Fee-for-service
revenue........................ 137,678,300 137,678,300
----------- ------------ ------------ ------------
Total operating revenue........ 423,105,875 89,202,000 512,307,875
----------- ------------ ------------ ------------
Expenses:
Medical services............... 358,588,291 77,388,000 435,976,291
General and administrative..... $ 5,726,000[F] 113,942,411 28,718,000 142,660,411
----------- ------------ ------------ ------------
Total expenses................. 5,726,000 472,530,702 106,106,000 578,636,702
----------- ------------ ------------ ------------
Income (loss) from operations.... (5,726,000) (49,424,827) (16,904,000) (66,328,827)
Other income (expense)
Interest and other income...... 6,199,011 955,000 7,154,011
Interest expense............... (1,562,214)[G] (11,714,061) (123,000) (11,837,061)
Other expense.................. (2,757,000) (2,757,000)
----------- ------------ ------------ ------------
Total other income (expense)... (1,562,214) (8,272,050) 832,000 (7,440,050)
----------- ------------ ------------ ------------
Income (loss) before income
taxes.......................... (7,289,014) (57,696,877) (16,072,000) (73,768,877)
Income tax (expense) benefit..... 11,431,206[I] 22,824,765 497,000 23,321,765
----------- ------------ ------------ ------------
Net income (loss)................ $ 4,142,192 $ (34,872,112) $(15,575,000) $(50,447,112)
=========== ============ ============ ============
Pro forma net income (loss) per
share.......................... $ (1.39) $ (1.57)
Weighted average shares.......... 25,093,503 32,153,315
</TABLE>
96
<PAGE> 105
FPA MEDICAL MANAGEMENT INC. AND SUBSIDIARIES AND ACQUIRED BUSINESSES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
FPA MEDICAL STERLING 1995
MANAGEMENT, HEALTHCARE 1995 FPA STERLING FOUNDATION PHYSICIANS PRO FORMA
INC. GROUP, INC ACQUISITIONS ACQUISITIONS HEALTH IPA FIRST, INC.[E] ADJUSTMENTS
----------- ------------ ------------ ------------ ----------- -------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Managed care revenue....... $49,880,875 $25,090,938 $ 9,275,866 $ 34,313,695 $ 627,179[H]
Fee-for-service revenue.... 2,811,080 $115,659,527 1,289,937 $9,629,087 18,789 7,347,642
----------- ------------ ------------ ------------ ----------- -------------- -----------
Total operating revenue.... 52,691,955 115,659,527 26,380,875 9,629,087 9,294,655 41,661,337 627,179
----------- ------------ ------------ ------------ ----------- -------------- -----------
Expenses:
Medical services.......... 37,757,244 69,734,593 20,826,529 7,296,001 10,831,198 37,252,931
General and
administrative.......... 13,310,386 39,423,328 6,581,161 2,589,077 871,015 3,873,015 994,745[F]
(641,004)[L]
----------- ------------ ------------ ------------ ----------- -------------- -----------
Total expenses.......... 51,067,630 109,157,921 27,407,690 9,885,078 11,702,213 41,125,946 353,741
----------- ------------ ------------ ------------ ----------- -------------- -----------
Income (loss) from
operations................ 1,624,325 6,501,606 (1,026,815) (255,991) (2,407,558) 535,391 273,438
Other income (expense)
Interest and other
income.................. 543,973 65,324 41,125 13,980 28,893 119,166
Interest expense.......... (354,248) (1,823,695) (414,655) (21,649) (1,724,394)[G]
(245,416)[L]
----------- ------------ ------------ ------------ ----------- -------------- -----------
Total other income
(expense)............. 189,725 (1,758,371) (373,530) 13,980 28,893 97,517 (1,969,810)
----------- ------------ ------------ ------------ ----------- -------------- -----------
Income (loss) before income
taxes..................... 1,814,050 4,743,235 (1,400,345) (242,011) (2,378,665) 632,908 (1,696,372)
Income tax (expense)
benefit................... (811,588) (1,911,732) (62,503) 927,680 (267,562) 775,353[I]
----------- ------------ ------------ ------------ ----------- -------------- -----------
Net income (loss).......... $1,002,462 $ 2,831,503 $(1,462,848) $ (242,011) $(1,450,985) $ 365,346 $ (921,019)
============== ============= ============ ============ ============ ============== ===========
Pro forma net income (loss)
per share................. $ 0.13
Weighted average shares.... 7,676,402
<CAPTION>
FPA MEDICAL FPA MEDICAL
MANAGEMENT, FOUNDATION MANAGEMENT, FPA
INC. AND HEALTH INC. AND MEDICAL
CONSUMMATED MEDICAL CONSUMMATED MANAGEMENT,
TRANSACTIONS SERVICES, INC. TRANSACTIONS AHI INC.
PRO FORMA AND PRO FORMA PRO FORMA HEALTHCARE PRO FORMA
CONSOLIDATED AFFILIATES[Q] ADJUSTMENTS CONSOLIDATED[S] SYSTEMS, INC. CONSOLIDATED
------------ -------------- ------------ ------------- ------------- ------------
<S> <<C> <C> <C> <C> <C> <C>
Managed care revenue....... $119,188,553 $105,174,000 $224,362,553 $114,284,000 $338,646,553
Fee-for-service revenue.... 136,756,062 41,374,000 178,130,062 178,130,062
------------ -------------- ------------ ------------- ------------- ------------
Total operating revenue.... 255,944,615 146,548,000 -- 402,492,615 114,284,000 516,776,615
------------ -------------- ------------ ------------- ------------- ------------
Expenses:
Medical services.......... 183,698,496 104,723,000 288,421,496 88,997,000 377,418,496
General and
administrative.......... 67,001,723 101,907,000 $ 7,635,733[F] 176,544,456 29,597,000 206,141,456
------------ -------------- ------------ ------------- ------------- ------------
Total expenses.......... 250,700,219 206,630,000 7,635,733 464,965,952 118,594,000 583,559,952
------------ -------------- ------------ ------------- ------------- ------------
Income (loss) from
operations................ 5,244,396 (60,082,000) (7,635,733) (62,473,337) (4,310,000) (66,783,337)
Other income (expense)
Interest and other
income.................. 812,461 812,461 520,000 1,332,461
Interest expense.......... (4,584,057) (11,210,000) (2,110,873)[G] (17,904,930) (530,000) (18,434,930)
------------ -------------- ------------ ------------- ------------- ------------
Total other income
(expense)............. (3,771,596) (11,210,000) (2,110,873) (17,092,469) (10,000) (17,102,469)
------------ -------------- ------------ ------------- ------------- ------------
Income (loss) before income
taxes..................... 1,472,800 (71,292,000) (9,746,606) (79,565,806) (4,320,000) (83,885,806)
Income tax (expense)
benefit................... (1,350,352) 31,368,000 3,898,642[I] 33,916,291 1,219,000 35,135,291
------------ -------------- ------------ ------------- ------------- ------------
Net income (loss).......... $ 122,448 $(39,924,000) $ (5,847,964) $(45,649,515) $ (3,101,000) $(48,750,515)
============= ============= ============= =============== ============= =============
Pro forma net income (loss)
per share................. $ 0.01 $ (2.22) $ (1.77)
Weighted average shares.... 16,470,286 20,546,373 27,606,185
</TABLE>
97
<PAGE> 106
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC.
AND CONSUMMATED
STERLING TRANSACTIONS AHI
FPA MEDICAL HEALTHCARE PRO FORMA PRO FORMA HEALTHCARE
MANAGEMENT, INC. GROUP, INC. ADJUSTMENTS CONSOLIDATED SYSTEMS, INC.
---------------- ----------- ----------- ---------------- --------------
<S> <C> <C> <C> <C> <C>
Managed care revenue.................... $ 18,193,286 $ 18,193,286 $ 60,746,000
Fee-for-service revenue................. 242,591 $39,255,573 39,498,164
----------- ----------- --------- ----------- -----------
Total operating revenue................. 18,435,877 39,255,573 57,691,450 60,746,000
----------- ----------- --------- ----------- -----------
Expenses:
Medical services...................... 13,628,430 26,353,093 39,981,523 43,464,000
General and administrative............ 4,423,842 10,553,813 14,977,655 15,243,000
----------- ----------- --------- ----------- -----------
Total expenses...................... 18,052,272 36,906,906 54,959,178 58,707,000
----------- ----------- --------- ----------- -----------
Income from operations.................. 383,605 2,348,667 2,732,272 2,039,000
Other income (expense)
Interest and other income............. 115,191 71,764 186,955 447,000
Interest expense...................... (35,299) (152,065) (187,364) (210,000)
----------- ----------- --------- ----------- -----------
Total other income (expense)........ 79,892 (80,301) (409) 237,000
----------- ----------- --------- ----------- -----------
Income before income taxes.............. 463,497 2,268,366 2,731,863 2,276,000
Income tax expense...................... (75,184) (866,841) $(150,720)[J] (1,092,745) (725,000)
----------- ----------- --------- ----------- -----------
Net income.............................. $ 388,313 $ 1,401,525 $(150,720) $ 1,639,118 $ 1,551,000
=========== =========== ========= =========== ===========
Pro forma net income per share.......... $ 0.07 $ 0.19
Weighted average shares
outstanding[R]........................ 3,981,613 8,705,319
=========== ===========
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC.
AND CONSUMMATED/
PROBABLE
TRANSACTIONS
PRO FORMA PRO FORMA
ADJUSTMENTS CONSOLIDATED
----------- ----------------
<S> <<C> <C>
Managed care revenue.................... $ 78,939,286
Fee-for-service revenue................. 39,498,164
--------- ------------
Total operating revenue................. 118,437,450
--------- ------------
Expenses:
Medical services...................... 83,445,523
General and administrative............ 30,220,655
--------- ------------
Total expenses...................... 113,666,178
--------- ------------
Income from operations.................. 4,771,272
Other income (expense)
Interest and other income............. 633,955
Interest expense...................... (397,364)
--------- ------------
Total other income (expense)........ 236,591
--------- ------------
Income before income taxes.............. 5,007,863
Income tax expense...................... $(185,400)[J] (2,003,145)
--------- ------------
Net income.............................. $(185,400) 3,004,718
========= ============
Pro forma net income per share.......... $ 0.19
Weighted average shares
outstanding[R]........................ 15,765,130
============
</TABLE>
98
<PAGE> 107
FPA MEDICAL MANAGEMENT INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1993
<TABLE>
<CAPTION>
FPA MEDICAL
MANAGEMENT, INC.
AND CONSUMMATED/
FPA MEDICAL AHI PROBABLE TRANSACTIONS
MANAGEMENT, HEALTHCARE PRO FORMA PRO FORMA
INC. SYSTEMS, INC. ADJUSTMENTS CONSOLIDATED
--------------- -------------- ----------- ---------------------
<S> <C> <C> <C> <C>
Managed care revenues................. $13,987,914 $ 44,865,000 $58,852,914
Fee-for-service revenue............... -- -- --
----------- ----------- ----------- -----------
Total operating revenue..... 13,987,914 44,865,000 58,852,914
----------- ----------- ----------- -----------
Expenses:
Medical services.................... 10,347,804 30,998,000 41,345,804
General and administrative.......... 3,471,056 10,935,000 14,406,056
----------- ----------- ----------- -----------
Total expenses.............. 13,818,860 41,933,000 -- 55,751,860
----------- ----------- ----------- -----------
Income from operations................ 169,054 2,932,000 -- 3,101,054
Other income (expense)
Interest and other income........... 12,325 143,000 155,325
Interest expense.................... (3,058) (17,000) (20,058)
----------- ----------- ----------- -----------
Total other income
(expense)................. 9,267 126,000 -- 135,267
----------- ----------- ----------- -----------
Income before income taxes............ 178,321 3,058,000 -- 3,236,321
Income tax expense.................... -- (84,000) $(1,139,200)[J] (1,223,200)
----------- ----------- ----------- -----------
Net income (loss)..................... $ 178,321 $ 2,974,000 $(1,139,200) $ 2,013,121
=========== =========== =========== ===========
Pro forma net income per share........ $ 0.27 $ 0.20
Weighted average shares outstanding
[R]................................. 3,163,000 10,222,812
</TABLE>
99
<PAGE> 108
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FPA Medical Management, Inc. and Subsidiaries ("FPA") has consummated the
following transactions: purchased the business of Grossmont Medical Clinic
("Grossmont") effective May 18, 1995 for $2,385,000 in cash and debt; purchased
Arizona Managed Care Services and Affiliates ("AMCS") effective July 1, 1995 for
$1,850,000 in cash, FPA common stock and debt; purchased Gonzaba Management
Organization ("Gonzaba") effective November 1, 1995 for $21,512,824 in cash, FPA
common stock, and debt; purchased Foundation Health IPA effective January 31,
1996 for $10,063,654 in cash and debt; purchased Physicians First, Inc.
effective June 1, 1996 for $21,591,541 in cash, FPA common stock and debt;
merged with Sterling Healthcare Group, Inc. ("Sterling") in exchange for
8,097,781 shares of FPA common stock effective October 31, 1996 accounted for as
a pooling of interests, purchased Foundation Health Medical Services and
Affiliates ("FHMS") for $111,000,000 in cash, FPA common stock and debt:
(Grossmont, AMCS and Gonzaba are collectively referred to as the "1995 FPA
Acquisitions"). Also, during 1995, Sterling acquired Medical Networks, Inc. and
Professional Emergency Physicians, P.A. (collectively, the "1995 Sterling
Acquisitions"). These completed acquisitions by FPA and Sterling were accounted
for under the purchase method. Additionally, FPA proposes to merge with AHI by
issuing FPA common stock in exchange for substantially all of the outstanding
common stock of AHI. It is contemplated that the AHI Merger will be accounted
for as a pooling of interests. The following adjustments are necessary to
reflect the pro forma effects of the executed and proposed transactions.
Certain of the entities included in the pro forma financial statements are
professional corporations which FPA is unable to own a majority interest in
states which prohibit the corporate practice of medicine. Such entities are
included in the pro forma financial statements due to the fact FPA consolidates,
or will consolidate upon acquisition, these professional corporations in the
consolidated financial statements of FPA. These professional corporations are,
or will be, consolidated by FPA because FPA has, or will have, direct or
indirect unilateral and perpetual control over the assets and operations of the
professional corporations, other than by means of owning the majority of the
voting stock of the professional corporations. Also, FPA believes it will have
unilateral and perpetual control over the FHMS entities upon acquisition. The
shareholder/director of these professional corporations will enter into a
succession agreement which requires such shareholder/director to sell to a
designee of FPA such shareholder/director's shares of stock if such shareholder
director is terminated from FPA. This ensures unilateral and perpetual control
over these professional corporations by FPA. As such, due to the
parent-subsidiary relationship under generally accepted accounting principles,
FPA will consolidate the financial statements of these professional
corporations. FPA believes that consolidation of the financial statements of the
professional corporations is necessary to present fairly the financial position
and results of operations of the Company.
[A] Reflects the estimated $111,000,000 in FPA common stock, debt and cash to be
issued by FPA in connection with the acquisition of FHMS.
[B] Under purchase accounting, the assets and liabilities of the acquired entity
are required to be adjusted to their estimated fair values. For the
purposes of determining the pro forma effects of the FHMS acquisition on
the balance sheet of FPA, the estimated fair values of the assets and
liabilities of this acquisition have been preliminarily determined by the
management of FPA to be equal to the historically recorded amounts. A
valuation analysis will be performed by independent consultants and
consequently, such estimates are subject to revision. However, the
management of FPA does not expect the final classification and amortization
to materially differ from these estimates. Accordingly, the estimated
excess purchase price paid by FPA over the net assets of FHMS acquired in
the amount of $209,672,000 has been reflected as a pro forma adjustment to
goodwill and intangibles. The management of FPA has preliminarily
determined that substantially all of the excess purchase price in this
transaction will be allocated to the value of the managed care contract
acquired which has a term of 30 years.
100
<PAGE> 109
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
-- (CONTINUED)
[C] Reflects the exchange of each share of Sterling common stock for .951 shares
of FPA common stock based on FPA's average closing price of $24.1958 during
the measurement period as defined in the Merger Agreement. Based on
Sterling's 8,515,017 shares outstanding at October 31, 1996 (the effective
date of the Sterling Merger), the total FPA common stock issued was
8,097,781 shares.
[D] Nonrecurring costs estimated to be $13,000,000 will be recorded in
connection with the Sterling Merger and $11,500,000 will be recorded in
connection with the AHI Merger. These costs consist primarily of
professional fees and certain employee termination costs. Because such
costs are nonrecurring, they have not been recorded in the accompanying
unaudited pro forma condensed consolidated statements of operations.
However, such costs will be charged to income in the first period following
the consummation of the Mergers.
[E] As a result of FPA's acquisition, PFI will receive fully delegated
capitation revenue from Physicians Corporation of America, the seller,
based on the acquisition agreement with FPA, rather than primary care
capitation only as is reflected in the historical income statements of PFI.
The incremental revenue which PFI would have received under this fully
delegated contract was approximately $31 million for the five months ended
May 31, 1996 (up to acquisition) and approximately $67 million for the year
ended December 31, 1995. Additionally, there would have been a
corresponding increase in medical services expense and general and
administrative expense for the provision of hospital and specialty care
services under this fully delegated contract.
[F] For the purpose of determining the pro forma effects of the acquisitions of
the 1995 FPA Acquisitions, FHIPA, PFI and FHMS on FPA's statement of
operations, the following adjustments to increase (decrease) income have
been made:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
---------------------------------------------------------------
1995 FPA
ACQUISITIONS FHIPA PFI FHMS TOTAL
--------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Amortization over 4-15 years
of intangible
assets(1)(2)............... $(120,555) $(241,005) $ (820,000) $(1,181,560)
Amortization over 25 to 30
years of cost in excess of
net assets acquired
(goodwill)(2)(3)........... (728,123) $(402,546) (427,097) (6,815,733) (8,373,499)
Depreciation of additional
purchase cost assigned to
property and equipment..... (127,530) 283,780 156,250
Compensation under employment
agreements................. 768,331 768,331
--------- --------- --------- ----------- -----------
$(207,877) $(402,546) $(384,322) $(7,635,733) $(8,630,478)
========= ========= ========= =========== ===========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1996
-------------------------------------
PFI FHMS TOTAL
--------- ---------- ----------
<S> <C> <C> <C>
Amortization over 30 years of costs in excess of net
assets acquired (goodwill)(2)(3).................. $(177,957) $(5,111,800) $(5,289,757)
Amortization over 4-10 years of intangible
assets(1)(2)...................................... (100,419) (615,000) (715,419)
Depreciation of purchase cost assigned to property
and equipment..................................... 118,242 118,242
--------- ----------- -----------
$(160,134) $(5,726,800) $(5,886,934)
========= =========== ===========
</TABLE>
- ---------------
(1) The amortization period of the identifiable intangible assets is based
on the period of estimated future economic benefit as determined by FPA
in conjunction with independent valuation analysis.
101
<PAGE> 110
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
-- (CONTINUED)
(2) The total balance of the goodwill and intangibles would have been
approximately $250,432,371 and $8,364,019, respectively, related to the
1995 FPA Acquisitions, FHIPA, PFI and FHMS at January 1, 1995. The
total balance of the goodwill and intangibles would have been
approximately $242,058,872 and $7,182,459, respectively, related to PFI
and FHMS at January 1, 1996.
(3) It is expected that substantially all of the excess purchase price over
the net assets acquired in connection with the acquisition of the FHMS
entities will be allocated to the managed care contract which has a
life of 30 years. As the value of the managed care contract will be
amortized over 30 years, the same amortization period as goodwill, and
there would be no difference in the amortization expense, no amount has
been allocated between the goodwill and the managed care contract for
the purposes of the pro forma financial statements.
[G] Reflects the increase in interest expense as a result of the notes issued in
connection with the FPA acquisitions. The debt in the amount of
approximately $116,000,000 that would have been issued or assumed in
connection with the FHMS acquisition bears interest at LIBOR plus .45%. A
one-eighth percent change in the interest rate would have an impact to
interest expense of approximately $109,000 and $145,000 for the nine months
ended September 30, 1996 and the year ended December 31, 1995, respectively.
[H] Reflects the increase in revenues for FHIPA as a result of the new provider
agreement with Foundation, the seller, based on the acquisition agreement.
[I] Reflects the estimated income tax effects of the pro forma adjustments.
Additionally, for the year ended December 31, 1995, reflects income taxes as
if the 1995 FPA Acquisitions and the 1995 Sterling acquisitions were C
Corporations and had accounted for taxes in accordance with the provisions
of SFAS No. 109. No valuation allowance has been recognized related to the
pro forma tax benefits based on FPA Management's belief that it is more
likely than not, based on the assessment of future taxable income and
available tax planning strategies, that such benefit would be realized in
future periods. If FPA had incurred the losses before income taxes of
$73,768,877 and $83,885,806 for the nine months ended September 30, 1996 and
the year ended December 31, 1995, respectively, included in the pro forma
income statements, FPA would need to generate a comparable amount of future
taxable income over the next 15 years (net operating loss carryforward
period) in order to fully realize the benefit of these net operating losses.
[J] Reflects income taxes as if FPA and Sterling had been a C Corporation for
the periods presented.
[K] Not used.
[L] Reflects the reduction in stockholder compensation, bonuses and other
benefits that will not be paid in the future as a result of the 1995
Sterling Acquisitions and the employment contracts that Sterling entered
into, in conjunction with the 1995 Sterling Acquisitions. Additionally,
reflects the amortization of the excess of cost over net assets of
businesses acquired of $216,723, and the incremental interest of $245,416 in
conjunction with the 1995 Sterling Acquisitions. Interest is calculated
based on Sterling's 1995 effective borrowing rate of 8.0%. The excess of the
purchase price over the cost of the net assets of the 1995 Sterling
Acquisitions is being amortized on a straight-line basis over periods
ranging from 25 to 40 years. The 1995 Sterling Acquisitions resulted in
additional borrowings on Sterling's bank line of credit in the amount of
$15,100,000 during 1995.
[M] Reflects the issuance of 7,059,812 shares of FPA common stock in exchange
for 100% of the shares of outstanding AHI common stock based on the AHI
shares outstanding multiplied by $8.75 divided by the market value per share
of FPA common stock (assumed to be $18.00 per share).
102
<PAGE> 111
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
-- (CONTINUED)
[N] Not used.
[O] Reflects an adjustment for certain assets and liabilities, as defined in the
Stock and Note Purchase Agreement between Foundation and FPA (the "Purchase
Agreement"), to be distributed from FHMS to Foundation, the seller, prior to
the acquisition of FHMS by FPA. Such assets consist primarily of property
and equipment which FPA is not acquiring in the transaction and is being
transferred to Foundation with a corresponding decrease in the debt due to
Foundation.
[P] Reflects the reclassification of debt owed to Foundation to long-term as
defined in the Stock Purchase Agreement. The debt due to Foundation in
connection with this acquisition would have consisted of a note for
approximately $96,000,000 bearing interest at LIBOR plus .45%, as may be
adjusted from time to time pursuant to the note, with interest payable
monthly commencing on January 1, 1997 and principal payable in 59 monthly
installments commencing on February 1, 1999 and a final installment of the
remaining principal on December 31, 2003. Such principal payments are based
on a 13 year amortization schedule with a balloon payment at the end of
seven years. In the event FPA issues any debt or equity securities after
December 31, 1998, FPA must prepay the outstanding principal of such note
from the proceeds of such issuance in an amount equal to the lesser of (i)
25% of the amount of the net proceeds of such issuance and (ii) the
principal amount then outstanding under the note. In addition, there will be
a $22 million note issued due to Foundation bearing interest at LIBOR plus
.45% for approximately the first seven months and LIBOR plus 3.45%
thereafter maturing 25 months from the closing date, which will be paid down
with the proceeds from the issuance of the convertible subordinated
debentures issued in a private placement on December 18, 1996.
[Q] The FHMS amounts included in the pro forma condensed consolidated statement
of operations for the year ended December 31, 1995 represent the unaudited
results of operations of FHMS for the year ended March 31, 1996.
Accordingly, the FHMS income statement amounts for the three months ended
March 31, 1996 are included in the pro forma condensed consolidated income
statements for the year ended December 31, 1995 and the nine months ended
September 30, 1996.
[R] The weighted average shares outstanding was calculated based on the
historical weighted average shares outstanding of FPA giving effect to the
shares of FPA Common Stock issued in connection with the Sterling Merger (at
an exchange ratio of .951) and the estimated 7,059,812 shares of FPA common
stock to be issued in connection with the AHI Merger. In addition, for the
nine months ended September 30, 1996 and the year ended December 31, 1995,
the weighted average shares outstanding give effect to the estimated
4,076,087 shares of FPA Common Stock to be issued in connection with the
FHMS Acquisition, 525,000 shares of FPA Common Stock issued in connection
with the PFI Acquisition, and 225,475 shares of FPA Common Stock issued in
connection with the 1995 FPA Acquisitions.
[S] The FHMS Acquisition was consummated effective November 29, 1996.
103
<PAGE> 112
SELECTED PRO FORMA FINANCIAL DATA -- FPA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following are unaudited pro forma combined statements of operations
data and combined balance sheet data of FPA and Sterling, which give effect to
the Sterling Merger as a pooling of interests and should be read in conjunction
with such pro forma condensed consolidated financial statements (unaudited) and
the notes thereto included elsewhere herein. For purposes of the pro forma
operating data, FPA's consolidated financial statements for the five fiscal
years ended December 31, 1995, 1994, 1993, 1992 and 1991, and for the nine
months ended September 30, 1996 and 1995, have been combined with Sterling's
consolidated financial statements since June 1, 1994. The pro forma information
is presented for illustrative purposes only and is not necessarily indicative of
the operating results or financial position that would have occurred if the
Sterling Merger had been consummated at the beginning of the periods indicated,
nor is it necessarily indicative of future operating results or financial
position.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------------- -----------------------
1991 1992 1993 1994 1995 1995 1996
------ ------ --------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
COMBINED STATEMENTS OF
OPERATIONS:
Operating revenue............................. $1,321 $8,275 $ 13,988 $ 57,691 $ 168,352 $ 111,591 $ 289,271
Medical services expense...................... 995 6,423 10,348 39,981 107,492 70,891 204,797
------ ------ ---------- ---------- ---------- ---------- ----------
326 1,852 3,640 17,710 60,860 40,700 84,474
General and administrative expense............ 862 1,893 3,471 14,978 52,734 34,113 68,770
------ ------ ---------- ---------- ---------- ---------- ----------
Income (loss) from operations................. (536) (41) 169 2,732 8,126 6,587 15,704
Other income/(expense), net................... -- 10 9 -- (1,569) (1,261) (2,338)
------ ------ ---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes............. (536) (31) 178 2,732 6,557 5,326 13,366
Income tax (expense) benefit.................. -- -- -- (942) (2,723) (2,169) (5,597)
------ ------ ---------- ---------- ---------- ---------- ----------
Net income (loss)............................. $ (536) $ (31) $ 178 $ 1,790 $ 3,834 $ 3,157 $ 7,769
====== ====== ========== ========== ========== ========== ==========
PRO FORMA PER SHARE DATA:
Net income per share.......................... $ 0.27 $ 0.21 $ 0.24 $ 0.21 $ 0.38
Weighted average shares outstanding........... 3,163,000 8,705,319 15,774,183 15,229,191 20,711,166
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1996
----- ------ ------ ------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
COMBINED BALANCE SHEET DATA:
Cash and marketable securities.............................. -- $ 423 $ 610 $12,217 $ 11,401 $ 4,082
Working capital surplus (deficit)........................... $(535) (634) (600) 22,164 25,974 (17,726)
Total assets................................................ 107 1,026 1,632 45,052 152,407 275,920
Long-term liabilities....................................... -- -- 21 9,553 22,841 30,261
Stockholders' equity........................................ (515) (546) (358) 24,326 93,227 120,693
</TABLE>
104
<PAGE> 113
SELECTED FINANCIAL DATA -- AHI
The selected consolidated financial data set forth below as of and for each
of the five years in the period ended December 31, 1995 have been derived from
AHI's consolidated financial statements, which have been audited by Ernst &
Young LLP, independent auditors. The selected consolidated financial data as of
and for the nine months ended September 30, 1995 and 1996 have been derived from
the unaudited consolidated financial statements of AHI which, in the opinion of
management, include all adjustments (consisting of only normal recurring
adjustments) necessary for a fair presentation of the information set forth
herein. The results of operations for the nine months ended September 30, 1996
are not necessarily indicative of the results for the full year.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------ ------------------
1991 1992 1993 1994 1995 1995 1996
------- ------- ------- ------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Statements of Operations Data:
Total operating revenue.............................. $18,875 $31,684 $44,865 $60,746 $114,284 $84,307 $ 89,202
Cost of medical services............................. 12,400 22,054 30,998 43,464 88,997 66,158 77,388
Gross margin......................................... 6,475 9,630 13,867 17,282 25,287 18,149 11,814
Operating Expenses:
Medical network.................................... 741 883 1,250 2,883 6,717 4,736 7,111
General and administrative......................... 2,761 3,810 4,294 7,377 11,586 8,122 16,389
Depreciation and amortization...................... 325 451 448 760 2,167 1,552 1,959
Network development................................ 0 0 713 4,223 9,127 6,460 3,259
Stockholder compensation........................... 2,862 5,345 4,230 0 0 0 0
------- ------- ------- ------- ------- ------- --------
6,689 10,489 10,935 15,243 29,597 20,870 28,718
------- ------- ------- ------- ------- ------- --------
Operating income (loss).............................. (214) (859) 2,932 2,039 (4,310) (2,721) (16,904)
Interest expense................................... (23) (40) (17) (210) (530) (434) (123)
Interest income.................................... 118 102 143 115 520 50 955
------- ------- ------- ------- ------- ------- --------
Net interest (expense) income........................ 95 62 126 (95) (10) (384) 832
------- ------- ------- ------- ------- ------- --------
Income (loss) before income taxes and minority
interest........................................... (119) (797) 3,058 1,944 (4,320) (3,105) (16,072)
Minority interest.................................... 0 125 0 332 0 0 0
------- ------- ------- ------- ------- ------- --------
Income (loss) before income taxes.................... (119) (672) 3,058 2,276 (4,320) (3,105) (16,072)
Income tax (expense) benefit......................... 0 (10) (84) (725) 1,219 1,219 497
------- ------- ------- ------- ------- ------- --------
Net income (loss).................................... $ (119) $ (682) $ 2,974 $ 1,551 $ (3,101) $(1,886) $(15,575)
======= ======= ======= ======= ======= ======= ========
Net income (loss) per share.......................... $ (0.01) $ (0.05) $ 0.21 $ 0.13 $ (0.26) $ (0.17) $ (1.07)
======= ======= ======= ======= ======= ======= ========
Pro forma net income (loss)(1)....................... $ (129) $ (682) $ 1,934 $ 1,551 $ (3,363) $(2,148) $(15,575)
======= ======= ======= ======= ======= ======= ========
Pro forma net income (loss) per share(1)............. $ (0.01) $ (0.05) $ 0.14 $ 0.13 $ (0.29) $ (0.20) $ (1.07)
======= ======= ======= ======= ======= ======= ========
Weighted average number of common and common
equivalent shares outstanding:..................... 13,038 13,146 13,911 11,998 11,800 10,909 14,523
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
-------------------------------------------- ------------------
1991 1992 1993 1994 1995 1995 1996
------ ------ ------ ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents................................ $ 822 $3,119 $3,427 $ 655 $31,608 $ 755 $17,176
Working capital (deficit)................................ (186) (339) 519 (4,875) 16,547 (25,756) (2,018)
Total assets............................................. 4,870 6,684 9,910 20,704 76,256 44,316 65,955
Long-term debt, less current portion..................... 250 112 350 3,120 1,203 2,095 1,094
Stockholders' equity..................................... 792 671 1,359 2,910 44,388 1,036 28,859
</TABLE>
- ---------------
(1) Pro Forma net income (loss) and net income (loss) per share have been
determined assuming AHI and its affiliated physician networks had been
taxed as a C-corporation for all periods presented.
105
<PAGE> 114
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- AHI
OVERVIEW
AHI's physician networks contract directly with Payors to deliver covered
medical benefits and to coordinate all inpatient and outpatient care for
enrollees. Generally, the physician network receives a capitation payment from
the Payor for each enrollee who selects a primary care physician contracting
with the physician network as the enrollee's primary care provider. In addition,
such contracts typically provide for shared risk pools, which are incentive
payments to be paid by the Payor to the physician network to encourage the
efficient utilization of hospital and other medical services. All such medical
revenue is in turn assigned to AHI pursuant to an administrative, nonmedical
management services agreement between the physician network and AHI, but
excludes amounts that may not be assigned under applicable law.
For each of the nine months ended September 30, 1996 and fiscal year 1995,
approximately 97% of AHI's total operating revenue related to contracts under
which AHI's physician networks received a capitation payment for each covered
life in exchange for the responsibility for the provision of specific medical
services to assigned enrollees and bonuses under shared risk pools. Payors are
increasingly overseeing the provision of and the prices charged for medical
services with the goal of reducing costs and lowering reimbursement. AHI's
success therefore depends in large part on the effective management of health
care costs, including controlling utilization of specialty care physicians,
other ancillary providers, inpatient services and services from third-party
providers at competitive prices. Any adjustment downward in capitation payments
or shared risk pools caused by the increasing efforts by Payors to reduce their
costs could have a material adverse effect on AHI's operating results.
The physician networks contract with health care providers to deliver
medical services. The cost of medical services provided by the physician network
comprises payments to affiliated primary care, specialty care and ancillary
providers. Compensation for such health care providers varies typically
according to the type of provider. Primary care physicians are generally
compensated on a capitated basis, receiving a fixed monthly fee for each
enrollee selecting such physician, or discounted fee-for-service when enrollment
is small. Specialist and ancillary providers are typically compensated on a
discounted fee-for-service basis. Two of AHI's affiliated networks include
medical groups and the associated medical and non-medical costs of operating
these clinics are also included in the cost of medical services.
Medical network operating expenses consist primarily of salary related
expenses for the provision of medical management services to the physician
networks. The majority of costs associated with medical management services
fluctuate commensurate with enrollment and the number of contracted providers.
These costs consist primarily of claims administration, eligibility management,
quality and utilization management, credentialing and other costs related to
AHI's national service center.
Network development expenses include direct and indirect costs associated
with the strategic planning, corporate organization, provider and Payor
contracting and relationship building activities that are required to develop
and market a locally integrated managed health care system. Direct costs include
incremental costs of AHI personnel physically located in new markets prior to
commencement of operations and certain incremental administrative costs such as
legal, travel and facility expenses. Indirect costs consist of an allocation of
expenses associated with existing executive and corporate development staff
engaged early in the network development process to conduct market research and
assess the operational and strategic opportunities available in the market. AHI
defines a network as being "in development" once direct, incremental network
development costs have been incurred. Networks are considered operational once
network physicians begin accepting enrollees into the network.
AHI has also entered into new markets by acquiring existing physician
networks. In such acquisitions, AHI or an affiliate has principally purchased
the physician and Payor contracts that the network holds; it generally does not
purchase the assets or the practices of the independent physicians who contract
with the network. These contracts represent significantly all of the assets of
the physician network and, accordingly, result in the recording of goodwill on
AHI's balance sheet. See "RISK FACTORS -- Risks Relating to
106
<PAGE> 115
AHI -- Goodwill." In addition to the consideration paid in the acquisition, all
direct costs associated with these acquisitions are capitalized. In August 1994,
AHI acquired Camino Real Medical Group, Inc. ("CRMG") (which has been renamed
Health Service Alliance of Northern California) in Northern California (which
had approximately 28,000 prepaid covered lives at the date of acquisition) and
in February 1995, AHI acquired The Healthcare Partnership ("THP") in Houston,
Texas (which had approximately 40,600 prepaid covered lives at the date of
acquisition). In March 1996, AHI acquired Private Physician Group at Stanford in
Northern California (which had approximately 2,900 prepaid covered lives at the
date of acquisition). Although AHI continues to pursue acquisitions and other
opportunities, there can be no assurance that AHI will be able to capitalize
successfully on such opportunities or that such opportunities will be available
to AHI in the future.
AHI's acquisition and development strategy has had, and will continue to
have, significant revenue and cost implications. This is due to a number of
factors, including market conditions outside of AHI's base Southern California
market requiring more administrative costs, costs of building infrastructure and
the inherently delayed timing of revenue increases and cost decreases after
developing networks or acquiring networks with higher medical costs.
AHI's operating results are subject to quarter-to-quarter fluctuations.
Quarterly results may be affected by the timing and amount of costs associated
with AHI's development and acquisition of physician networks (as discussed
above), by adverse trends in professional and hospital-based medical costs, and
by other operational or external factors, including the movement of enrollees,
particularly during periods of open enrollment for HMOs. Quarterly results may
be affected by significant differences between actual and estimated amounts
receivable or payable related to Payor shared risk pool arrangements and
provider "incurred but not reported" claims ("IBNR"), which are adjusted
periodically as settlements are made in the case of shared risk pools or as
actual claims are paid in the case of IBNR. AHI has noted a recent industry
trend of increasing health care costs, particularly in fee-for-service
arrangements and hospital-based medical costs. AHI has also made acquisitions of
underperforming companies with significantly higher costs of medical services as
a percentage of revenue, and there can be no assurance that AHI's acquisitions,
including any future acquisitions, will not adversely affect AHI's results of
operations or cause significant quarterly fluctuations and/or adjustments.
Quarterly results have in the past been subject to fluctuations and, as a
result, the operating results for any quarter are not necessarily indicative of
results for any future period. See "RISK FACTORS -- Risks Relating to
AHI -- Fluctuations in Quarterly Operating Results." AHI expects to report a net
loss through at least the first quarter of 1997. See "RISK FACTORS -- Risks
Relating to AHI -- Recent Operating Losses."
On July 2, 1996, pursuant to discussions with the Department, the
regulatory body for managed care plans in the State of California, AHI, through
a wholly owned subsidiary, filed an application for restricted licensure as a
Knox-Keene health care service plan for its California operations. The
restricted license, if granted, would allow for the direct receipt of capitation
payments for hospital and medical professional services, but would not allow AHI
or its licensed subsidiary to market a health care service plan to employers and
subscribers. The Department granted FPA a restricted license in December 1996
and has granted AHI's request to suspend AHI's application pending the outcome
of the Merger. AHI may be required to restructure its California business
operations (which, if such license is not granted, could result in a significant
reduction of revenue) and/or incur additional administrative costs in the future
to meet applicable regulatory requirements, including the tangible net equity
requirements pursuant to Department regulations, which could restrict AHI's
ability to transfer funds and pay dividends. There can be no assurance that the
Department will not impose additional requirements adverse to AHI's business.
107
<PAGE> 116
RESULTS OF OPERATIONS
The following table sets forth consolidated statements of operations data
expressed as a percentage of total operating revenue for the nine months ended
September 30, 1996 and 1995 and the years ending December 31, 1995, 1994 and
1993.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------- ---------------
1993 1994 1995 1995 1996
----- ----- ----- ----- -----
(% OF TOTAL OPERATING REVENUE)
<S> <C> <C> <C> <C> <C>
Total operating revenue............................ 100.0 100.0 100.0 100.0 100.0
Cost of medical services........................... 69.1 71.6 77.9 78.5 86.8
----- ----- ----- ----- -----
Gross margin....................................... 30.9 28.4 22.1 21.5 13.2
Operating expenses:
Medical network.................................. 2.8 4.7 5.9 5.6 8.0
General and administrative....................... 9.6 12.1 10.1 9.6 18.4
Depreciation and amortization.................... 1.0 1.3 1.9 1.8 2.2
Network development.............................. 1.6 7.0 8.0 7.7 3.6
Stockholder compensation......................... 9.4 0.0 0.0 0.0 0.0
----- ----- ----- ----- -----
24.4 25.1 25.9 24.7 32.2
----- ----- ----- ----- -----
Operating income (loss)............................ 6.5 3.3 (3.8) (3.2) (19.0)
Interest income.................................... 0.3 0.2 0.0 0.0 1.1
Interest expense................................... 0.0 (0.3) 0.0 (0.5) (0.1)
----- ----- ----- ----- -----
Net interest income (expense)...................... 0.3 (0.1) 0.0 (0.5) 1.0
----- ----- ----- ----- -----
Income (loss) before income taxes and minority
interest......................................... 6.8 3.2 (3.8) (3.7) (18.0)
Minority Interest.................................. 0.0 0.5 0.0 0.0 0.0
----- ----- ----- ----- -----
Income (loss) before income taxes.................. 6.8 3.7 (3.8) (3.7) (18.0)
Historical and pro forma income tax (expense)
benefit.......................................... (2.5) (1.1) 0.8 1.2 .5
----- ----- ----- ----- -----
Pro forma net income (loss)(1)..................... 4.3 2.6 (3.0) (2.5) (17.5)
===== ===== ===== ===== =====
</TABLE>
- ---------------
(1) Pro forma net income (loss) has been determined assuming AHI and its
affiliated physician networks had been taxed as C-corporations for all
periods presented.
NINE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 1995
Total operating revenue increased 5.8% to $89.2 million for the first nine
months of 1996 from $84.3 million for the first nine months of 1995. The
increase in total operating revenue was primarily due to an increase in
capitation revenue. Average covered lives increased 24,625, or 15.2%, to 186,545
in the first nine months of 1996 compared to 161,920 in the corresponding period
of 1995. Of this increase, 17,828 average covered lives, or 11.0%, were a result
of increased enrollment in existing networks and acquired networks since
acquisition, and 6,797 average covered lives, or 4.2%, were in acquired networks
at the dates of acquisition. This increase in capitation revenue was offset by a
reduction in risk share revenue of approximately $2 million due to higher than
expected hospital-based costs under certain of AHI's Payor contracts. Because of
AHI's recent experience with higher than expected hospital-based costs under
certain Payor contracts, AHI recorded less risk share revenue in the first nine
months of 1996 compared to the corresponding period of 1995 and may record less
revenue under shared risk arrangements in the future.
Cost of medical services increased 17.0% to $77.4 million for the first
nine months of 1996 from $66.2 million for the first nine months of 1995. As a
percentage of total operating revenue, cost of medical services increased 8.3%
to 86.8% for the first nine months of 1996 from 78.5% for the corresponding
period of 1995. The increase in this percentage was principally due to the
aforementioned reduction in revenue relating to certain of AHI's risk share
arrangements, as well as an increase in medical costs of $3 million due to
revisions of claims reserves reflecting recent experience in physician claims
payment patterns. AHI and the managed
108
<PAGE> 117
care industry, in general, recently have experienced an increase in medical
costs. There can be no assurance that this recent trend in increasing medical
costs will not continue, and if it does, such trend could have a material
adverse effect on AHI's operating results in the future.
Medical network operating expenses increased 50.1% to $7.1 million for the
nine months ended September 30, 1996 from $4.7 million for the corresponding
period of 1995. As a percentage of total operating revenue, medical network
operating expenses increased 2.4% to 8.0% in the first nine months of 1996 from
5.6% in the corresponding period of 1995. AHI is experiencing higher claims
administration and medical management costs as it expands outside of its base
Southern California market. This is primarily related to different billing
patterns of physicians in other regions of the country due to a higher
percentage of primary care and specialty physicians being reimbursed on a
fee-for-service versus capitated basis prior to achieving critical mass.
Affiliated primary care and specialty physicians totaled 8,256 and 4,720 at
September 30, 1996 and 1995, respectively. In addition, AHI is continuing the
process of implementing new technologies in the areas of utilization management
and claims administration with the goal of making these processes more
efficient. In the near term, however, these new technologies have caused
additional costs to be incurred while these new technologies are phased into
AHI's operations. There can be no assurance that AHI's investment in new
technologies will result in future operating efficiencies.
General and administrative expenses increased 102% to $16.4 million for the
first nine months of 1996 from $8.1 million in the first nine months of 1995. As
a percentage of total operating revenue, general and administrative expenses
increased 8.8% to 18.4% for the nine months ended September 30, 1996 from 9.6%
for the corresponding period of 1995. The increase in these expenses as a
percentage of total operating revenue reflects higher costs relating to newly
operational markets before economies of scale are achieved and additional
investments in infrastructure in anticipation of AHI's future growth.
Operational networks totaled 50 at September 30, 1996 compared to 24 at
September 30, 1995. Until and if critical mass is achieved in these newly
operational markets, such increases will result in an increase in overall
general and administrative expenses as a percentage of revenue. In addition,
general and administrative expenses also increased due to regulatory compliance
and other costs associated with being a public company.
Depreciation and amortization increased 26.2% to $2.0 million for the nine
months of 1996 from $1.6 million for the same period of 1995. The increase in
these expenses was primarily due to additional depreciation related to recent
equipment purchases.
Network development expenses decreased 49.6% to $3.3 million for the first
nine months of 1996 from $6.5 million for the corresponding period of 1995. The
decrease in these expenses reflects AHI's emphasis on bringing previously
developmental networks into operation. Networks in development decreased to 44
at September 30, 1996 compared to 68 at September 30, 1995.
Net interest income was $832,000 for the first nine months of 1996 compared
with net interest expense of $384,000 for the corresponding period of 1995. AHI
realized net interest income in the first nine months of 1996 primarily due to
interest earned on the remaining net proceeds from its initial public offering.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Total operating revenue increased 88.1% to $114.3 million for the year
ended December 31, 1995, from $60.7 million for the year ended December 31,
1994. AHI operated and managed 18 additional physician networks and contracted
with approximately 2,900 additional physicians at December 31, 1995 compared to
December 31, 1994. As a result, average covered lives for the year increased
75.5% or 71,350 covered lives, to 165,905 during 1995 from 94,555 during 1994.
Of this increase, 56.0%, or 52,967 average covered lives were in acquired
networks at the date of acquisition, and 19.5%, or 18,383 average covered lives,
were the result of increased enrollment in existing networks and acquired
networks since acquisition. Year end covered lives at December 31, 1995
increased 51.7% to 179,558 from 118,328 at December 31, 1994. AHI's average
capitation revenue per covered life under commercial plans for the year ended
December 31, 1995 increased compared with 1994 due to higher premiums in new
markets, in spite of relatively stable premium rates in California. AHI
experienced an overall decrease in average capitation revenue per covered life
under Medicare plans during 1995 compared with 1994 due to a lower Medicare
reimbursement rate in Texas, which was partially
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offset by an increase in Medicare rates in California. AHI also experienced a
favorable product mix change which resulted in higher average capitation revenue
per covered life due to an increase in the percentage of senior covered lives as
a percentage of total covered lives in 1995 compared with 1994. AHI receives
substantially higher rates for senior covered lives compared with commercial and
Medicaid covered lives. Revenue derived from shared risk pools and other bonus
pools designed to encourage the efficient utilization of hospital and other
specialty care services as a percentage of total operating revenue decreased in
1995 compared with 1994. This percentage decrease was primarily a result of
higher inpatient utilization in the newly acquired THP operation. However,
during the eleven months since acquisition, AHI reduced THP's Medicare bed days
to 1,285 days per thousand for the eleven months from approximately 1,800 days
per thousand at acquisition.
Cost of medical services increased 105% to $89.0 million for the year ended
December 31, 1995 from $43.5 million for the year ended December 31, 1994. As a
percentage of total operating revenue, cost of medical services increased 6.3%,
to 77.9% for the year ended December 31, 1995 from 71.6% for the prior year
period. This increase primarily results from the newly acquired THP and CRMG
operations. Prior to acquisition, both THP and CRMG operated at significantly
lower gross margins than the gross margins for AHI's existing networks in
Southern California. For example, prior to its acquisition, THP's operations
incurred a cost of medical services that had historically been higher than total
operating revenue (approximately 121% in 1994). In the eleven months ended
December 31, 1995, AHI had reduced THP's cost of medical services as a
percentage of total operating revenue to approximately 86%. This reduction was a
result of AHI's ability to implement both inpatient and outpatient utilization
management systems into a network that was previously operating with minimal
medical management procedures. Immediate actions included the renegotiation of
contracts with certain affiliated THP physicians, implementation of systems and
procedures for managing inpatient and outpatient professional activity, and the
provision of training and education to affiliated physicians. Excluding THP's
and CRMG's operations and a non-recurring charge related to a change in
estimates of $910,000 at June 30, 1995 (See Note 10 to Notes to Consolidated
Financial Statements), cost of medical services as a percentage of total
operating revenue were the same in each of the two years ended December 31, 1995
and 1994.
Medical network operating expenses increased 133% to $6.7 million for the
year ended December 31, 1995 from $2.9 million for the year ended December 31,
1994. As a percentage of total operating revenue, medical network operating
expenses increased 1.2% to 5.9% for the year ended December 31, 1995, compared
to 4.7% for the year ended December 31, 1994, due to higher costs as a
percentage of revenue in newly operational markets prior to economies of scale
through critical mass being achieved in those markets. In addition, claims
administration costs in markets outside of Southern California are significantly
higher than those in Southern California due to different billing patterns of
the physicians in these markets and a higher proportion of primary care
physicians paid on a discounted fee-for-service basis versus capitation.
General and administrative expenses increased 57.1% to $11.6 million for
the year ended December 31, 1995 from $ 7.4 million for the year ended December
31, 1994. As a percentage of total operating revenue, general and administrative
expenses decreased 2.0% to 10.1% for the year ended December 31, 1995 from 12.1%
for the year ended December 31, 1994. In 1994, AHI recorded a $1.3 million
charge for an employment-related settlement. Excluding this charge, general and
administrative expenses as a percentage of revenue would have remained constant.
During the second half of 1995, AHI experienced an increase in the percentage of
general and administrative expenses compared with the first half of 1995,
primarily related to additional investment in infrastructure to support current
and future growth and costs associated with newly operational markets. As
markets become operational, there are additional general and administrative
expenses incurred to prepare for the new membership. Until critical mass is
achieved in these newly operational markets, such increases will result in an
increase in overall general and administrative expenses as a percentage of
revenue.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("SFAS 123"), which provides an alternative to APB Opinion No. 25,
Accounting for Stock Issued to Employees, in accounting for stock-based
compensation issued to employees. The Statement allows for a fair value based
method of accounting for
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employee stock options and similar equity instruments awarded after December 31,
1995. Companies will be allowed to elect to continue following the measurement
criteria under APB Opinion No. 25, or switch to the measurement criteria under
SFAS 123. For companies that continue to account for stock-based compensation
arrangements under Opinion No. 25, SFAS 123 requires disclosure of the pro forma
effect on net income and earnings per share of its fair value based accounting
for those arrangements. These disclosure requirements are effective for fiscal
years beginning after December 15, 1995. AHI is in the process of evaluating the
provisions of SFAS 123 and has not determined whether it will adopt the
recognition and measurement provisions of that Statement. If it does, AHI
expects it would result in increased compensation expense in future periods.
Network development expenses increased 116% to $9.1 million in the year
ended December 31, 1995 from $4.2 million in the year ended December 31, 1994.
This increase was primarily due to the additional 33 physician networks AHI was
developing in 1995 over the prior year period. Physician networks in development
totaled 65 at December 31, 1995 and 32 at December 31, 1994.
The costs in excess of net tangible book value of acquisitions are
generally amortized over 20 years. Depreciation and amortization increased 185%
to $2.2 million for the year ended December 31, 1995 from $760,000 for the year
ended December 31, 1994. This increase is primarily due to additional
amortization from the acquisitions made by AHI in the last half of 1994 and in
the first quarter of 1995.
Net interest expense decreased to $10,000 for the year ended December 31,
1995, from $95,000 for the year ended December 31, 1994 due to the repayment of
outstanding borrowings under AHI's Bank Facility in September 1995 from the
proceeds of AHI's public offering and the interest earned on the net invested
proceeds from the public offering. See "-- Liquidity and Capital Resources."
Minority interest represents the portion of subsidiary earnings not attributable
to the consolidated entity. Minority interest was eliminated for the year ended
December 31, 1995 due to AHI's March 1, 1995 acquisition of the minority
interest in one physician network.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
Total operating revenue increased 35.4% to $60.7 million in 1994 from $44.9
million in 1993. AHI operated and managed three additional physician networks
and contracted with 2,348 additional physicians at December 31, 1994 compared to
December 31, 1993. As a result, average covered lives for the year increased
38.2%, or 26,160 average covered lives to 94,555 at December 31, 1994 from
68,395 on December 31, 1993. Of this increase, 16.4%, or 11,250 average covered
lives, resulted from the acquisition of CRMG and 21.8%, or 14,910 average
covered lives, were the result of increased enrollment in existing markets and
increased enrollment in CRMG since acquisition. AHI's average capitation revenue
per covered life under commercial plans increased 6.0% in 1994 over the prior
year period while the average capitation revenue per covered life under Medicare
plans remained constant.
Cost of medical services increased 40.2% to $43.5 million for the year
ended December 31, 1994 from $31.0 million for the year ended December 31, 1993.
As a percentage of total operating revenue, cost of medical services increased
2.5% to 71.6% for the year ended December 31, 1994 from 69.1% for the prior
year. The increase in 1994 was primarily due to the formation of a new medical
group in September, 1993. Generally, the first year of operations following such
formation typically results in a higher cost of medical services than AHI's
average as AHI moves to implement its utilization management and administrative
systems in the new medical group.
Medical network operating expenses increased 131% to $2.9 million for the
year ended December 31, 1994 from $1.3 million for the year ended December 31,
1993. As a percentage of total operating revenue, medical network operating
expenses increased 1.9% to 4.7% for the year ended December 31, 1994 from 2.8%
for the prior year. The increase in 1994 was due to the expansion of AHI's
service center to enhance the quality and scope of management services provided.
General and administrative expenses increased 71.8% to $7.4 million for the
year ended December 31, 1994 from $4.3 million for the year ended December 31,
1993. As a percentage of total operating revenue, general and administrative
expenses increased 2.5% to 12.1% for the period ended December 31, 1994 from
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9.6% for the prior year period. The increase was primarily attributable to AHI's
expansion of its executive team and information systems management to
accommodate AHI's rapid growth during the period. In addition, the acquisition
of CRMG resulted in increased general and administrative costs as a percentage
of revenue due to the costs associated with operating its facilities and support
personnel in the new market. In addition, AHI made an employment related
settlement for $1.3 million during 1994. Excluding this cost, and on a
"same-store" basis, general and administrative expenses would have decreased as
a percentage of total operating revenue.
Depreciation and amortization increased 69.6% to $760,000 for the year
ended December 31, 1994 from $448,000 for the year ended December 31, 1993. This
increase was primarily due to additional amortization from the acquisition of
CRMG in August 1994.
Network development expense increased 492% to $4.2 million for the year
ended December 31, 1994 from $713,000 for the year ended December 31, 1993. This
increase was primarily due to the additional 28 physician networks AHI had under
development at December 31, 1994 versus the prior year. Physician networks under
development totaled 32 at December 31, 1994 and four at December 31, 1993.
Net interest expense for 1994 was $95,000 as compared to the net interest
income for 1993 of $126,000. This change resulted primarily from the acquisition
of CRMG which was partially financed and partially paid for in cash.
LIQUIDITY AND CAPITAL RESOURCES
AHI requires capital primarily to develop and acquire physician networks
and to fund working capital. Capitation arrangements positively impact AHI's
cash flow due to the fact that the physician networks receive capitation revenue
prior to incurring costs associated with services provided under Payor
agreements. Partially offsetting this, AHI's shared risk pool arrangements
negatively impact cash flow due to the fact that settlements in connection with
these arrangements are typically not collected until at least 150 days following
the end of the period in which they were accrued. Since inception through the
date AHI entered into the Bank Facility, AHI financed its operations primarily
through internally generated funds.
For the nine months ended September 30, 1996, AHI used $9.9 million in its
operating activities. The use of cash in operating activities resulted primarily
from (i) a net loss of $15.6 million, offset by $2.0 million of depreciation and
amortization, (ii) a $1.1 million increase in accounts receivable and (iii) a
$386,000 increase in recoverable and deferred income taxes, offset by (iv) a
$3.2 million increase in accrued medical claims, (v) a $1.6 million increase in
accounts payable and accrued expenses, and (vi) a $423,000 decrease in prepaid
expenses and other assets. For the first nine months of 1996, AHI's investing
activities included $3.0 million of cash used for equipment purchases and
technology implementation costs and its financing activities included $1.6
million of cash used for principal payments of notes payable.
For the year ended December 31, 1995, AHI used $6.6 million in its
operating activities. The use of cash in operating activities resulted primarily
from (i) a net loss of $3.1 million (including $9.1 million spent in network
development activities), offset by $2.2 million of depreciation and
amortization, (ii) a $4.3 million increase in accounts receivable primarily from
AHI's shared-risk arrangements, (iii) a $2.4 million decrease in accrued medical
claims resulting from a significant effort by AHI's Service Center to reduce the
payment period for all claims, (iv) a net increase of $2.2 million in income tax
balances, (v) a $596,000 increase in prepaid expenses and (vi) a $3.8 increase
in accounts payable and accrued expenses. For the year ended December 31, 1995,
AHI's investing activities included expenditures of approximately $2.5 million
for the acquisitions of THP and Primary Care Medical Group at Little Company of
Mary Hospital ("PCMG") and $2.1 million for equipment purchases.
AHI has a two-year revolving line of credit bank facility (the "Bank
Facility"), with a maximum borrowing limit of $15.0 million. As of September 30,
1996, AHI had $13.0 million available under the Bank Facility (represented by
the total Bank Facility less a $2.0 million letter of credit securing a
promissory note issued in connection with an acquisition). Interest is payable
on borrowings under the Bank Facility at the bank's prime rate plus 0.25% per
annum or, at AHI's option, LIBOR plus 2.50%. Borrowings under the Bank
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Facility are secured by AHI's accounts receivable and certain equipment and,
effective June 1996, are secured by an amount of qualifying investments equal to
the borrowing limit plus interest. The Bank Facility contains certain
restrictions on AHI's ability to engage in certain actions.
At September 30, 1995 and October 31, 1995 through December 31, 1995, AHI
was in default on its cash flow coverage ratio and obtained waivers from the
Bank Facility lenders on August 21, 1995 and February 20, 1996, respectively,
extending to all periods through March 30, 1996. Effective March 31, 1996, the
Bank Facility was amended to revise the definitions of cash flow and debt in the
computation of the cash flow coverage and debt coverage ratios. Effective June
30, 1996, the Bank Facility was again amended, deleting all financial covenants,
namely the cash flow coverage and debt coverage ratio covenants. AHI has been in
compliance with all remaining covenants since such time. As of December 31,
1996, AHI had no borrowings under the Bank Facility.
On July 2, 1996, pursuant to discussions with the Department, AHI, through
a wholly owned subsidiary, filed an application for restricted licensure as a
Knox-Keene health care service plan for its California operations. The
Department granted FPA a restricted license in December 1996 and has granted
AHI's request to suspend AHI's application pending the outcome of the Merger
with FPA. Pursuant to tangible net equity requirements under regulations
governing AHI's license application, AHI will be required, upon license, to
maintain cash reserves, initially expected to be at least $6 million.
Because of the Knox-Keene license cash reserve requirements (if such
license is granted), continued cash flow used in its operating activities and
future capital equipment requirements and technology implementation costs, AHI
believes that existing cash balances and amounts available under the Bank
Facility will not be sufficient to finance its operations through the next
twelve months. If AHI is unable to consummate its planned merger with FPA or is
unable to decrease its operating losses, AHI may find it necessary to dispose of
certain assets or undertake other actions to conserve its cash balances and
remain viable as a going concern. There can be no assurance these efforts would
be successful. See "RISK FACTORS -- Risks Relating to the Merger -- Inability to
Consummate Merger."
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BUSINESS OF AHI
OVERVIEW
AHI is a physician practice management company that develops integrated
health care delivery networks in selected geographic areas and provides managed
care infrastructure services. As of December 31, 1996, AHI had approximately
2,500 primary care and 6,500 specialty care affiliated physicians in its 51
operational networks and 40 networks in development. In total, these 51
operational networks managed 206,489 covered lives under approximately 250 payor
contracts as of December 31, 1996. AHI designs its networks to provide the
affiliated physicians with access to managed care contracts, to establish a "one
stop shop" for HMOs and other Payors to contract with complete, actively managed
physician networks with multiple access points, and to offer patients a
comprehensive range of medical care in convenient locations.
OPERATIONS
AHI's networks generally include primary and specialty care physicians and
other ancillary providers. While a primary care physician's affiliation and
compensation arrangements with the physician network may take one of several
forms, generally the primary care physician is an independent private
practitioner who enters into an independent contractor relationship with the
physician network to provide certain medical services on a capitated payment or
discounted fee-for-service basis to the networks' enrollees who are within the
physician's patient base. Primary care physicians who provide medical services
covered by an enrollee's benefits but which are outside the scope of the
capitated arrangements are reimbursed on a contractually discounted
fee-for-service basis. Specialty care providers contract with AHI's physician
networks to provide medical services to enrollees and generally are compensated
on a discounted fee-for-service, per diem, per case or capitated basis. Hospital
and affiliated medical facilities generally contract directly with the Payors to
provide both inpatient and outpatient services to enrollees on a
fee-for-service, per diem, per case or capitated basis.
AHI's physician networks contract to provide medical services to a wide
variety of HMOs and other Payors. The Payor contracts customarily obligate the
contracting physician network to deliver covered medical benefits and to
coordinate all inpatient and outpatient covered medical care for enrollees.
Generally, the physician network receives a capitation payment for each enrollee
who selects an affiliated primary care physician. Additionally, the Payor
contracts typically provide for bonuses to be paid to the physician network
derived from shared risk pools and other financial incentives ("shared risk
pools") to encourage the efficient utilization of hospital and other specialty
care services provided to enrollees. The physician networks assign all such
revenue to AHI pursuant to a management services agreement, except for amounts
that may not be assigned to AHI under applicable law, such as certain Medicare
payments. In exchange, AHI provides to the physician networks management
functions such as management information systems, utilization and quality
management systems, referral procedures, risk management programs, and
assistance in credentialing and contracting with Payors, as well as other
nonmedical management and administrative functions necessary or appropriate for
the physician network. AHI also provides certain other practice management
functions for its physician networks, such as administrative, accounting and
financial services.
NETWORK DEVELOPMENT AND MARKET EXPANSION
AHI's growth strategy is based on actively developing managed health care
delivery networks in both existing and new markets, and making selective
acquisitions and forming joint ventures in such markets. AHI develops existing
markets by: (i) adding new physicians to existing networks, (ii) capturing
additional revenues from existing practices as patients migrate from traditional
fee-for-service plans to capitated managed care programs, (iii) contracting with
additional Payors to expand the number of capitated lives within existing
physician networks and (iv) developing additional physician networks within the
market to provide Payors with additional access to actively managed physicians.
In addition, AHI seeks new markets to develop. In evaluating opportunities to
develop new markets, AHI primarily looks for evidence of a market's growth
potential, including markets undergoing commencement or strong growth of managed
care penetration, significant Payors seeking to enter or increase local market
share, and hospitals or other local health care
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providers intending to enhance their managed care business. Generally, AHI seeks
markets with a minimum population base ranging from 400,000 to 500,000 potential
enrollees, and a large percentage of Medicare beneficiaries. Other desirable
market characteristics are an adequate supply of primary care physicians and an
adequate presence of other health care facilities, including acute inpatient and
outpatient programs and services, non-acute inpatient facilities and
community-based resources and ancillary services.
Finally, AHI grows through the implementation of selected acquisitions and
joint ventures. In such acquisitions, AHI is principally acquiring a physician
network and the network's contracts with HMOs and other Payors and the medical
service contracts which the network holds with independent physicians and other
providers of care. AHI typically does not acquire the practices or assets of
physician providers who contract with the physician network. Physicians maintain
ownership of their practices and existing patient base, and are associated with
the network only when providing services to the network's members.
As of December 31, 1996, AHI had approximately 9,000 affiliated physicians
in its 51 operational networks and 40 networks in development. The operational
networks consist of 13 physician networks in California (ten in Southern
California and three in Northern California), 24 physician networks located in
Texas, eight physician networks located in Georgia and six physician networks in
South Florida. In total, these 51 operating networks represent contracts
covering 206,489 covered lives as of December 31, 1996, of which approximately
27,000 lives were acquired through the acquisition of CRMG in Northern
California, in August 1994, and approximately 40,600 lives were acquired through
the acquisition of THP in Houston, Texas, in February 1995. In March 1996, AHI
acquired Private Physician Group at Stanford in Northern California (which had
approximately 2,900 prepaid covered lives at the date of acquisition). Although
AHI continues to pursue acquisitions and other opportunities, there can be no
assurance that AHI will be able to capitalize successfully on such opportunities
or that such opportunities will be available to AHI in the future. In October
1996, AHI entered into a joint venture with a national hospital company to
jointly develop managed care networks in the Atlanta, Georgia metropolitan area.
In addition, AHI has entered into fee-based network development management
projects in Louisiana and New York.
AHI's strategy involves growth through the development of networks of
physicians in existing and new markets, as well as acquisitions and joint
ventures in such markets. There can be no assurance that AHI will be able to
grow in existing or new markets or successfully identify, complete or integrate
any acquisition. See "RISK FACTORS -- Risks Relating to AHI -- Ability to Manage
Growth." Certain of the acquired networks have not been financially successful
under prior management and there can be no assurance that AHI will be able to
improve the performance of such networks to an acceptable level or be able to
maintain such performance at an acceptable level. In addition, AHI's financial
results can be negatively affected as the costs associated with developing
networks do not immediately translate into revenues. Further, the infrastructure
required for expansion will continue to increase general and administrative
costs as a percentage of revenue until critical mass is achieved, and there can
be no assurance that AHI will be able to maintain and develop an adequate
infrastructure to support future growth or continue existing business
relationships, or that such critical mass will be achieved.
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, AHI competes with any entity that contracts with Payors for the
provision of prepaid health services (including, but not limited to, medical
groups, independent physician associations, independent private practice
physicians and physician-hospital organizations) and with hospitals and Payors
who own or operate health care delivery systems. See "RISK FACTORS -- Risks
Relating to AHI -- Competition." AHI also competes with other companies such as
management service organizations which provide management services to health
care providers. Such competitors may include local, regional and national
entities. A number of these companies provide traditional management services to
primary care, multi-specialty and specialty physician groups, while other
companies provide claims processing, utilization review and other more focused
management services. Certain competitors are significantly larger and better
capitalized than AHI and may have access to greater resources, provide a wider
variety of services, have greater experience in providing health care management
services and have
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longer established relationships with buyers of such services than does AHI. To
the extent that health care reform measures or any other factors make the
provision of prepaid managed medical care an attractive market to other
potential participants, AHI may encounter increased competition. Additionally,
since AHI is founded in part on the availability of primary care physicians to
contract with AHI's physician networks, the acquisition of physician practices
or practice assets currently being undertaken by a wide range of entities
(including hospitals, HMOs, management services organizations and medical
groups) could lead to significant competition for primary care physician
resources and could endanger the success or operating feasibility of AHI in one
or more markets or require AHI to orient its strategy toward acquiring primary
care physicians in selected markets.
CONTRACTUAL RELATIONSHIPS
The physician network provider contracts between the physicians and the
physician networks generally have terms of approximately one year, are
automatically renewable and are generally terminable upon between 30 and 90
days' notice by either party. Such contracts typically obligate a primary care
physician to provide certain services on a capitated payment or discounted
fee-for-services basis to network enrollees who are within the physician's
patient base. Specialist physicians are generally paid on a discounted
fee-for-service or per case basis. The compensation structures for physicians
are set to be competitive within the geographic area in which each physician is
located. AHI from time to time reviews physician compensation patterns and
programs and may adjust them upon renewal or during the term of the agreements
by mutual consent.
The physician network Payor contracts between the Payors and the physician
networks generally have terms of approximately one to three years, are
automatically renewable and are terminable upon between 30 and 180 days' notice
by either party. Such contracts generally obligate the contracting physician
network to provide on behalf of the Payor specified medical services and to
coordinate all specified inpatient and outpatient medical care for enrollees. To
encourage efficient utilization of hospital and related services, the Payor
contracts typically establish shared risk pools, which consist of a yearly
hospital budget fund against which all payments for hospitalization services are
credited. At the end of the period, the physician network is entitled to receive
a portion of any excess amounts in the fund which result from a lower level of
hospital expenditures. A significant percentage of the Payor contracts obligate
AHI's physician networks to bear a portion of any deficit in this fund.
Typically, such deficits are carried forward and offset against future surpluses
or reduction of future capitation payments. Additionally, some Payor contracts
contain similar arrangements with respect to other specialty care services.
In entering into or renewing Payor contracts, AHI considers a number of
specific factors which affect capitated rates, the shared risk pool and breadth
of covered benefits. These factors include, but are not limited to, the
demographic risk profile of the enrollee pool, prior financial experience,
availability of stop loss protection and an understanding of the fee-for-service
equivalent charges. In undertaking this process, AHI analyzes pertinent data in
order to assess the providers' contractual and economic opportunity and
exposure, and then conducts the negotiations on behalf of the physician
networks.
For the years ended December 31, 1996, 1995 and 1994, FHP, Inc. represented
approximately 17%, 22% and 35%, respectively, of AHI's total operating revenue,
and CareAmerica Southern California, Inc. represented approximately 6%, 11% and
22%, respectively, of AHI's total operating revenue. Upon completion of the THP
acquisition in February 1995, AHI's revenue from PacifiCare Health Systems, Inc.
represented approximately 33% and 28%, respectively, of AHI's total operating
revenue for the years ended December 31, 1996 and 1995. See "RISK
FACTORS -- Risks Relating to AHI -- Dependance on Certain Payors." On a pro
forma basis for each of fiscal years 1996 and 1995, after giving effect to the
potential merger between FHP, Inc. and PacifiCare Health Systems, Inc.,
approximately 50% of AHI's total operating revenue would have been attributable
to Payor agreements with the merged FHP/PacifiCare entity.
The physician network management agreements have terms of twenty years,
with automatic and perpetual renewals thereafter of ten years each, and may be
terminated by the physician network only for cause upon prior notice of 180
days. AHI may terminate the agreement without cause upon prior notice of 30
days. For purposes of the management agreements, "cause" is defined generally as
(i) a material breach of
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any provision of the management agreement and failure to cure such breach within
180 days after receipt of written notice, (ii) a violation of a federal, state,
or local statute or regulation which does or likely would result in material
adverse harm to either party and failure to cure such violation within 180 days
after receipt of written notice or (iii) dissolution or liquidation of a party.
As compensation for its services, AHI retains that portion of each physician
network's assigned revenue which equals (i) a reimbursement of all of its direct
and indirect costs, including an allocated portion of AHI's overhead expense,
(ii) a fixed monthly marketing fee, (iii) a percentage of the assigned gross
revenues and (iv) any and all profits earned in risk sharing pools between the
physician network, HMOs and hospitals. In addition, through its control over the
board of directors of the physician network, AHI has the right and ability to
cause the physician network to declare and pay a discretionary bonus to AHI.
This bonus is based in part on the cost savings AHI has generated, but is not
based on any predetermined formula. Consequently, this contractual arrangement
results in all profits of the physician network inuring to the benefit of AHI
and thus AHI has all of the interest in any residual profits of the physician
network. All other funds remaining after such compensation to AHI are remitted
to the physician network, from which the physician network is obligated to pay
the cost of all medical care services. Should such amount remitted not be
sufficient to pay the obligations of the physician network, AHI has the right
but not the obligation to loan funds to the physician network based upon terms
and conditions agreeable to both parties. Each physician network has agreed to
indemnify AHI for breaches of the agreement and for claims relating to the
performance of medical services.
Notwithstanding the services provided by AHI, the physician networks are
solely and exclusively in control of and responsible for all aspects of the
practice of medicine and the delivery of medical services, including but not
limited to diagnosis, treatment, referrals, quality assurance, utilization
management, surgery and therapy. AHI receives a limited power of attorney from
its physician networks for ease of administration in Payor and provider
contracting, but the physician network retains full authority of approval over
all provider and Payor contracts and credentialing.
In Florida, where general business corporations are permitted to own
medical practices, AHI's physician networks are owned by subsidiaries.
Approximately 1% of AHI's total medical revenues are derived from physician
networks located in such states. In states, such as California, Georgia and
Texas, that prohibit the corporate practice of medicine, physician networks are
owned by one or more physicians qualified under the laws of such states to hold
an ownership interest therein (a "Qualified Physician"). Of AHI's 47 physician
networks located in California, Georgia and Texas, all of the stock of 44
physician networks (representing approximately 94% of AHI's total medical
revenues) is owned solely by Qualified Physicians who are employees or
consultants of AHI. Of the three remaining physician networks located in
California (representing approximately 5% of AHI's total medical revenues) a
majority of the stock is owned by Qualified Physicians who are employees of AHI,
and other Qualified Physicians own minority interests. These minority interests
have no rights or ability to make decisions or prevent AHI from exercising its
unilateral control over the physician networks. Effective January 31, 1997, all
such minority interests have been acquired by AHI for consideration consisting
of approximately $200,000 of AHI Common Stock. Each of the Qualified Physicians
has entered into a succession agreement which requires such Qualified Physician
to sell to a designee of AHI all of such shareholder's stock for a nominal
amount upon the occurrence of specified events, including without limitation, if
such shareholder's employment or consulting relationship with AHI is terminated,
or otherwise in the sole discretion of AHI. These agreements thus ensure
unilateral and perpetual control over the physician networks by AHI.
Although AHI does not own the physician networks in the states which
prohibit the corporate practice of medicine, AHI has consolidated the financial
statements of these networks because of a parent-subsidiary relationship
recognized under generally accepted accounting principles resulting from its
unilateral and perpetual control over the physician networks for all periods
presented herein. See Note 1 of AHI Notes to Consolidated Financial Statements.
GOVERNMENTAL REGULATION
As a participant in the health care industry, AHI's operations and
relationships are subject to extensive and increasing regulation by a number of
governmental entities at the federal, state and local levels. AHI and
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<PAGE> 126
its subsidiaries and affiliates also are subject to laws and regulations
relating to business corporations in general. AHI believes its operations are in
material compliance with applicable laws as currently interpreted. Nevertheless,
because of the structure of AHI, many aspects of AHI's business operations fall
within the regulatory oversight of federal and state authorities, and there can
be no assurance that a review of AHI's business by courts or regulatory
authorities will not result in a determination that could adversely affect the
operations of AHI. There also can be no assurance that the regulatory
environment in which AHI operates will not change significantly in the future,
which change could restrict AHI's existing operations, expansion, financial
condition or opportunities for success. See "RISK FACTORS -- Risks Relating to
AHI -- Governmental Regulation."
In addition to current regulation, the public and state and federal
governments recently have focused significant attention on reforming the health
care system in the United States. Within the past two years, a broad range of
health care reform measures have been introduced in Congress and in certain
state legislatures. Additional health care reform measures have been brought
before the public in state voter initiatives. Among the proposals under
consideration are or were cost controls on hospitals, insurance market reforms
to increase the availability of group health insurance to small businesses,
requirements that all businesses offer health insurance coverage to their
employees and the creation of a single government health insurance plan at the
state or federal level that would cover all citizens. Legislative interest
recently has also focused on the role of HMOs in the provision of health care
and the effect of managed care reimbursement mechanisms on health care service
utilization and quality of service. It is not clear at this time what proposals,
if any, will be adopted or, if adopted what effect, if any, such proposals would
have on AHI's business. There can be no assurance that any proposals adopted
would be coordinated at the federal or state level, and therefore AHI, as a
national participant in the health care industry, is subject to varying state
regulatory environments. See "RISK FACTORS -- Risks Relating to AHI -- State
Laws Regarding Prohibition of Corporate Practice of Medicine." Certain
proposals, such as cutbacks in the Medicare and Medicaid programs, containment
of health care costs that could include a freeze on prices charged by
physicians, hospitals or other health care providers, and greater state
flexibility in the administration of Medicaid, could adversely affect AHI. There
can be no assurance that currently proposed or future health care legislation or
policies or other changes in the administration or interpretation of
governmental health care programs, laws, regulations or policies will not have a
material adverse effect on AHI's operating results. See "RISK FACTORS -- Risks
Relating to AHI -- State Laws Regarding Prohibition of Corporate Practice of
Medicine."
Continuing budgetary constraints at both the federal and state level and
the increasing costs of health care and reimbursement programs have led, and may
continue to lead, to relatively significant reductions in government and other
third party reimbursements for certain medical charges. The entities affiliated
with AHI which provide health care services are subject to the right of
governmental authorities to periodically audit their operations to determine the
adequacy of coding procedures and the reasonableness of charges, among other
items. All Medicare and Medicaid providers are subject to claims review, audits
and retroactive adjustments, recoupment, civil monetary penalties, criminal
fines and penalties, and/or suspension or exclusion from payment programs for
improper billing practices. Federal regulations also provide for withholding
payments to recoup amounts due to the programs.
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 or 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 recently 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 costs. 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 certain entities in which they have an
ownership or financial interest. Effective January 1, 1995, the federal
anti-referral legislation extends to entities that provide certain other
"designated health services." Many states, including those in which AHI
presently does business, have similar anti-kickback and anti-referral laws. In
addition, the health care reforms that were
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<PAGE> 127
proposed by the Clinton Administration contemplated expanding existing federal
anti-kickback and anti-referral laws so as to apply to all health care Payors,
and not just Medicare or Medicaid. 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 AHI's
business does not fall within certain of the current or proposed safe harbors,
AHI believes that its operations materially comply with such statutes and
regulations. AHI 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. A determination of liability under any such law could have a material
adverse effect on AHI's revenue or operating results. There can be no assurance
that such extension of such laws will not be enacted by Congress or by
regulation, and it is presently unclear how such changes would impact physician
networks within AHI or other types of managed care arrangements. Such changes,
however, could materially and adversely affect AHI's operating results.
AHI currently manages or is developing physician networks in California,
Texas, Florida, Kentucky, Arizona, Georgia, Tennessee, Louisiana and New York.
Except for Arizona, Florida and Louisiana, each of the foregoing states
prohibits the corporate practice of medicine except by professional medical
corporations or associations. In such states, all health care services are
provided by, and all contracts are held by, physician networks licensed as
health care providers in such states and AHI performs only nonmedical management
and administrative services, does not represent to the public or its clients
that it offers medical services and does not exercise influence or control over
the practice of medicine by the physicians with whom it contracts. Accordingly,
AHI believes that it is not in violation of applicable state laws relating to
the corporate practice of medicine. The laws in most states regarding the
corporate practice of medicine have been subjected to limited judicial and
regulatory interpretation and, therefore, no assurance can be given that AHI's
activities will be found to be in compliance, if challenged. In states that do
not prohibit the corporate practice of medicine, AHI, through its subsidiaries,
may employ physicians to practice medicine, may enter into contracts for medical
services with HMOs and other Payors and may take such other actions as are
necessary or appropriate to perform such agreements. In addition to prohibiting
the corporate practice of medicine, the laws of many states prohibit entities
like AHI from engaging in certain health care related activities, such as
splitting fees with non-physicians. AHI believes its current and planned
activities do not constitute fee-splitting as contemplated by these laws. There
can be no assurance, however, that interpretations or enforcement of such laws
will not require structural and organizational modifications of AHI's existing
relationships with its affiliated entities, physicians or with third parties.
Statutes or regulations in some states also could restrict expansion of AHI's
operations into those jurisdictions. See "RISK FACTORS -- Risks Relating to
AHI -- State Laws Regarding Prohibition of Corporate Practice of Medicine."
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 AHI 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 and utilization review agents.
In connection with its existing operations and its expansion into new markets,
AHI 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 change in the future or that additional
laws and regulations will not be enacted. The ability of AHI to operate
profitably will depend, in part, upon AHI and its affiliates, obtaining and
maintaining all necessary licenses, certificates of need and other approvals and
operating in compliance with applicable health care regulations.
Laws in all states regulate the business of insurance and the operation of
HMOs. Generally, the business of insurance is defined to include the acceptance
of financial risk and has not extended to physician networks. The Knox-Keene
Act, a California statute that applies to managed care health service plans,
requires all health care service plans to be licensed by the Department. Under
the Department's current interpretation of the Knox-Keene Act, the Department
could seek a ruling that AHI's operations in California, as currently
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conducted, are subject to the provisions of the Knox-Keene Act. After
discussions with the Department, AHI voluntarily commenced the process of
preparing an application, through a wholly owned subsidiary, for a restricted
Knox-Keene license that would allow AHI to maintain its California operations.
The restricted license, if granted, would allow for the receipt of capitation
payments for both hospital and medical professional services, but would not
allow AHI or its Subsidiary to market a health care service plan directly to
employers and subscribers. The Department granted FPA a restricted license in
December 1996 and has granted AHI's request to suspend the processing of AHI's
license application pending the outcome of the Merger. AHI may be required to
restructure its California business operations (which, if such license is not
granted, could result in a significant reduction of revenue) and/or incur
additional costs in the future to meet applicable regulatory requirements,
including the tangible net equity requirements pursuant to Department
regulations, which could restrict AHI's ability to transfer funds and pay
dividends. There can be no assurances the Department will not impose
requirements adverse to AHI's business. See "RISK FACTORS -- Risks Relating to
AHI -- Knox-Keene Act Compliance." In addition, there can be no assurance that
regulatory authorities in other states would not require AHI or its affiliates
to license their operations as an insurer, in an HMO or as a provider network.
There can be no assurance that future interpretations of insurance laws and
healthcare network laws by the regulatory authorities in these states or the
states into which AHI may expand will not require licensure or a restructuring
of some or all of the operations of AHI.
Because the affiliated provider entities within AHI remain separate legal
entities, they may be deemed competitors subject to a range of antitrust laws
that prohibit anti-competitive conduct, including price fixing, concerted
refusals to deal and division of market. If AHI provider entities are deemed by
regulatory authorities or courts to be part of a single entity or system, they
may be subject to antitrust laws that prohibit anti-competitive combinations or
activities in excess of an immaterial size. Recent guidelines promulgated by the
United States Department of Justice suggest that enforcement activity will not
be taken against exclusive joint venture health care entities with less than
twenty percent market share in a defined local geographic market or against
nonexclusive joint venture health care entities with less than thirty percent
market share in a defined local geographic market. AHI believes that it is
structured so as to fall within the nonexclusive joint venture definition and
that AHI's market share in each of its current markets falls below such
enforcement guideline thresholds, but there can be no assurance that AHI's
interpretation is consistent with that of federal or state authorities or courts
or that such circumstances will remain as AHI grows and matures and as further
regulation and interpretations are promulgated.
The physician networks contract with physicians and other health care
professionals to provide health care services to the contracting entity on an
independent contractor basis. Since AHI regards these professionals as
independent contractors, each such contracting entity within AHI does not
withhold federal or state income taxes, make federal or state unemployment tax
payments or provide workers' compensation insurance with respect to such
independent contractors. AHI believes that the classification by the physician
networks of these health care professionals is proper for federal and state tax
purposes. A contrary determination by taxing authorities or a change in existing
law could have a material adverse effect on AHI's operating results.
RISK MANAGEMENT PROGRAM
AHI's management services include the provision of professional liability
insurance coverage for its affiliates. AHI currently provides this coverage to
its managed physician networks through a professional liability policy in the
amount of $5,000,000 per claim. AHI maintains professional liability insurance
on a modified-occurrence basis in amounts deemed appropriate by management,
based upon historical claims and the nature and risks of its business. However,
there can be no assurance that a future claim or claims will not exceed the
limits of available insurance coverage, that any insurer will remain solvent and
able to meet its obligations to provide coverage for any claim or claims or that
coverage will continue to be available or available with sufficient limits on a
commercially reasonable basis to adequately insure the operations of AHI in the
future. See "RISK FACTORS -- Risks Relating to AHI -- Potential Exposure to
Professional Liability; Availability of Insurance." AHI has renewed its policy
through October 1, 1997. Since 1987,
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<PAGE> 129
substantially all claims have been made within twelve months of occurrence, and
no settlements have exceeded policy limits.
AHI generally requires physicians by contract to carry certain minimum
amounts of professional liability insurance coverage. These amounts generally
correspond to statutory or customary minimums in the physician's practice area.
AHI is not obligated to provide professional liability insurance coverage to
independent contractor physicians, but does provide such coverage to the limited
number of physicians employed by the physician network.
In recent years, participants in the health care industry have become
subject to an increasing number of lawsuits alleging medical malpractice and
related legal theories, including the withholding of approval for necessary
medical services. Often, such lawsuits seek large damage awards, forcing health
care professionals and other defendants to incur substantial defense costs. AHI
has significant operations in California, which recently was the jurisdiction
for a very large jury award against another company on a claim alleging
negligent or fraudulent withholding of approval for necessary medical services.
AHI monitors such cases in each jurisdiction and considers such litigation
possibilities in the review and implementation of its risk management programs.
Due to the nature of its business, AHI and its officers or directors from
time to time become involved as defendants in medical malpractice lawsuits, some
of which are currently ongoing, and are subject to the attendant risk of
substantial damage awards. A significant source of potential liability in this
regard is the negligence of health care professionals employed or contracted by
AHI and its affiliates.
EMPLOYEES
As of December 31, 1996, AHI had approximately 450 full-time employees.
None of AHI's employees are subject to a collective bargaining agreement.
Management believes that its employee relations are good.
PROPERTIES
AHI leases approximately 28,000 square feet in Downey, California for its
corporate headquarters and approximately 40,000 square feet in Long Beach,
California for its national service center. Monthly rental payments are
approximately $29,000 for the Downey Facility and $40,000 for the Long Beach
Facility, and the terms of the leases continue until January 31, 1999 and
February 28, 2001, respectively. Three medical group facilities are leased in
Southern California, with the leased space ranging from approximately 9,000
square feet to approximately 28,000 square feet. Monthly rental payments for
such clinics range from approximately $19,000 to $59,000. The expiration dates
of the medical office leases range from March 12, 1997 to October 1, 2004. AHI
also leases local and regional administrative offices in each state in which it
conducts business. Such leases generally are for approximately 1,000 to 4,500
square feet. The leases generally are short-term, ranging from less than
approximately one year to six years, and have monthly rents ranging from
approximately $1,000 to $7,000. AHI anticipates should it continue to grow,
expanded facilities may be required. AHI does not anticipate significant
difficulties in obtaining additional facilities.
LEGAL PROCEEDINGS
AHI and its affiliates are subject to certain legal actions arising in the
ordinary course of business, generally related to professional liability,
employment-related issues and other business related claims. In the opinion of
management, such actions are either adequately insured or will not have a
material adverse effect on AHI's financial position, operating results, or
working capital. See "RISK FACTORS -- Risks Relating to AHI -- Legal
Proceedings."
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
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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 including an
injunction of the Merger. AHI 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 the financial condition or results of operations of
AHI. See "RISK FACTORS -- Risks Relating to AHI -- Legal Proceedings."
MARKET FOR AHI'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information
AHI's Common Stock is listed for trading on the Nasdaq National Market
under the symbol "AHIS". AHI's Common Stock began trading on the Nasdaq National
Market on September 29, 1995. The following table sets forth for the periods
indicated the high and low bid prices per share of the Common Stock as reported
on the Nasdaq National Market:
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Fiscal Year Ended December 31, 1995
Third Quarter.............................................. 15 1/2 15
Fourth Quarter............................................. 15 1/2 5 1/2
Fiscal Year Ended December 31, 1996
First Quarter.............................................. 8 5 3/4
Second Quarter............................................. 6 3/4 5 3/4
Third Quarter.............................................. 6 3/4 4 1/4
Fourth Quarter............................................. 8 5/8 5 3/4
Fiscal Year Ended December 31, 1997
First Quarter (through February 7, 1997)................... 9 8 5/8
</TABLE>
(b) Holders of Common Stock
As of February 7, 1997, there were approximately 35 record holders of AHI's
Common Stock
(c) Dividends
AHI did not declare or pay any dividends on its Common Stock during the
years ended December 31, 1995 and 1996. Restrictions imposed by AHI's revolving
line of credit bank facility prohibit the payment of dividends by AHI. In
addition, the declaration and payment of dividends by AHI are subject to the
discretion of the AHI Board. It is the current policy of AHI to retain earnings,
if any, to finance the operations and expansion of AHI's business. Any
determination as to the payment of dividends in the future will depend upon,
among other things, general business conditions, AHI's earnings, financial
condition, capital needs and other factors deemed pertinent by AHI's Board,
including the limitations, if any, on the payment of dividends under state law
and under any existing AHI credit facility. See "AHI Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources".
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -- AHI
The following table sets forth certain information regarding beneficial
ownership as of December 31, 1996 (unless otherwise indicated) by (i) all of
AHI's directors and its Chief Executive Officer and four other most highly
compensated executive officers, (ii) each person known by AHI to be the
beneficial owner of more than 5% of the AHI Common Stock, and (iii) all
directors and executive officers of AHI as a group. Except as otherwise
indicated, the beneficial owners listed below have sole voting and investment
power with respect to all shares owned by them, except to the extent such power
is shared by a spouse under applicable law. The information presented is based
upon filings with the Commission and information furnished to AHI by certain of
its beneficial owners.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP PRO FORMA BENEFICIAL
OF AHI COMMON STOCK OWNERSHIP OF FPA
AS OF DECEMBER 31, COMMON STOCK AFTER
1996(1) THE MERGER(1)(13)
NAME AND ADDRESS OF --------------------- ---------------------
BENEFICIAL OWNER(1) NUMBER PERCENT NUMBER PERCENT
- --------------------------------------------------- --------- ------- --------- -------
<S> <C> <C> <C> <C>
Leonardo Berezovsky, M.D.(2)....................... 4,219,746 29.1% 1,649,920 5.4%
Jose Spiwak, M.D.(3)............................... 2,907,496 20.0 1,136,830 3.7%
Kawips Trust(4).................................... 801,581 5.5 313,418 1.0%
Kaushal Tamboli, M.D.(5)........................... 885,002 6.1 346,035 1.1%
Saul A. Honigstein(6).............................. 320,061 2.2 43,290 *
Charles H. Klieman, M.D.(7)........................ 198,436 1.4 67,577 *
Roy A. Wilkens(8).................................. 8,875 * 5,793 *
Edward F. Thompson(8).............................. 6,875 * 5,011 *
Luis M. Artime(9).................................. 12,357 * 2,269 *
Steven L. Posar, M.D.(10).......................... 276,108 1.9 75,567 *
Gary V. Sherlock(11)............................... 413,235 2.8 37,543 *
Executive Officers and Directors as a Group (13
persons)(12)..................................... 9,919,475 62.3 3,446,039 11.3%
</TABLE>
- ---------------
* Less than one percent
(1) Includes shares of Common Stock subject to options which may be exercised
within 60 days of December 31, 1996. Such shares are deemed to be
outstanding for the purposes of computing the percentage ownership of the
individual holding such shares, but are not deemed outstanding for purposes
of computing the percentage of any other person shown in the table. The
address of each of the stockholders named in this table, other than the
Kawips Trust, is: c/o AHI Healthcare Systems, Inc., 12620 Erickson Avenue,
Suite A, Downey, California 90241.
(2) Includes shares of AHI Common Stock held by Leonardo Berezovsky, M.D., as
Trustee of The Leonardo Berezovsky Irrevocable Trust Number Two, The
Leonardo Berezovsky, M.D. Charitable Trust and the Karen and Sonia
Berezovsky Charitable Trust.
(3) Includes shares are held by Dr. Jose and Sara Spiwak as Trustees of the
Spiwak Family Trust and the Jose and Sara Spiwak Charitable Remainder
Unitrust. This amount does not include 801,581 shares of AHI Common Stock
held by Peter Montgomery as Trustee of the Kawips Trust. See Note 4.
Includes 597,055 shares of Common Stock as to which Dr. Spiwak's brother,
Boris Spiwak, has an option to purchase pursuant to a stock option
agreement between Dr. Spiwak and Boris Spiwak dated March 4, 1988.
(4) These shares are held by Peter Montgomery as Trustee of the Kawips Trust,
an irrevocable trust created by a trust agreement dated August 2, 1993 by
Jose and Sara Spiwak for the benefit of their children. The address of the
Kawips Trust is 5951 Variel Avenue, Woodland Hills, California 91367. Does
not include 500,000 shares held by Peter Montgomery as Trustee of the
Kawips Charitable Remainder Unitrust, an irrevocable trust created by a
trust agreement dated November 8, 1996 by Jose and Sara Spiwak for the
benefit of their children. Dr. and Mrs. Spiwak disclaim beneficial
ownership of all such shares.
(5) Includes 115,000 shares held by Kaushal and Mona Tamboli as Trustees of the
VIKA Charitable Trust. Excludes 248,546 shares of Common Stock held by Mr.
T. Pooran as Trustee of the Tamboli Children's Trust, as to which shares
Dr. Tamboli disclaims beneficial ownership. The Tamboli Children's Trust is
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an irrevocable trust which was created by a trust agreement dated July 1,
1994 by Dr. Kaushal and Mona Tamboli for the benefit of their children.
(6) Consists of 320,061 shares of AHI Common Stock subject to options currently
exercisable.
(7) Includes 25,603 shares of AHI Common Stock subject to options currently
exercisable.
(8) Includes 1,875 shares of AHI Common Stock subject to options currently
exercisable.
(9) Includes 11,357 shares of AHI Common Stock subject to options currently
exercisable.
(10) Includes 145,948 shares of AHI Common Stock subject to options currently
exercisable.
(11) Includes 317,217 shares of AHI Common Stock subject to options currently
exercisable.
(12) Includes 1,397,202 shares of AHI Common Stock subject to options currently
exercisable.
(13) Pro forma amounts are based on an assumed FPA Value equal to $24.25, which
was the closing price of FPA Common Stock on February 7, 1997. At such
price, the Equivalent Value would be $9.48 and the Conversion Number would
be .391. Assumes conversion of qualified AHI options immediately prior to
the Effective Time and qualified options granted pursuant to AHI
Non-Employee Director Stock Option Plan. See "THE MERGER -- Merger
Consideration; Adjustments to Merger Consideration."
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SELECTED UNAUDITED PRO FORMA COMBINED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following are unaudited pro forma combined statements of operations
data and combined balance sheet data of FPA (giving effect to the Sterling
Merger) and AHI, which give effect to the AHI Merger as a pooling of interests
and should be read in conjunction with such pro forma condensed consolidated
financial statements (unaudited) and the notes thereto included elsewhere
herein. The pro forma combined financial data was derived from the historical
financial statements of FPA, Sterling and AHI. For purposes of the pro forma
operating data, FPA's consolidated financial statements for the five fiscal
years ended December 31, 1995, 1994, 1993, 1992 and 1991, and for the nine
months ended September 30, 1996 and 1995, have been combined with AHI's
consolidated financial statements. The pro forma information is presented for
illustrative purposes only and is not necessarily indicative of the operating
results or financial position that would have occurred if the AHI Merger had
been consummated at the beginning of the periods indicated, nor is it
necessarily indicative of future operating results or financial position.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------------------------- -------------------------
1991 1992 1993 1994 1995 1995 1996
------- ------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
COMBINED STATEMENTS OF
OPERATIONS:
Total operating
revenue............. $20,196 $39,959 $ 58,853 $ 118,437 $ 282,636 $ 195,898 $ 378,473
Medical services
expense............. 13,395 28,477 41,346 83,445 196,489 137,049 282,185
------- ------- ------- -------- -------- -------- --------
6,801 11,482 17,507 34,992 86,147 38,849 96,288
General and
administrative
expense............. 7,551 12,257 14,406 30,221 82,331 53,764 97,488
------- ------- ------- -------- -------- -------- --------
Income (loss) from
operations.......... (730) (775) 3,101 4,771 3,816 5,085 (1,200)
Other income
(expense), net...... 95 72 135 (237) (1,579) (1,645) (1,506)
------- ------- ------- -------- -------- -------- --------
Income (loss) before
income taxes........ (655) (703) 3,236 5,008 2,237 3,440 (2,706)
Income tax expense.... -- (10) (84) (1,667) (1,504) (2,169) (5,100)
------- ------- ------- -------- -------- -------- --------
Net income (loss)..... $ (655) $ (713) $ 3,152 $ 3,341 $ 733 $ 1,271 $ (7,806)
======= ======= ======= ======== ======== ======== ========
PRO FORMA PER SHARE
DATA:
Net income per
share............... $ 0.31 $ 0.21 $ 0.03 $ 0.06 $ (0.28)
Weighted average
shares
outstanding......... 10,222,812 15,765,130 22,833,995 22,288,983 27,770,978
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------ SEPTEMBER 30,
1991 1992 1993 1994 1995 1996
------ ------ ------- ------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
COMBINED BALANCE SHEET DATA:
Cash and marketable securities............. $ 822 $3,542 $ 4,037 $12,872 $ 43,009 $ 21,258
Working capital surplus (deficit).......... (721) (973) (81) 17,289 42,521 (19,744)
Total assets............................... 4,977 7,710 11,542 65,756 228,663 341,875
Long term liabilities...................... 250 112 371 12,673 24,044 31,355
Stockholders' equity....................... 277 125 1,001 27,236 137,615 149,551
</TABLE>
125
<PAGE> 134
APPROVAL OF ADJOURNMENT OR POSTPONEMENT OF SPECIAL MEETING
At the FPA Special Meeting, FPA stockholders will be asked to approve the
adjournment or postponement of the FPA Special Meeting in the event that such
adjournment or postponement is necessary in order to solicit additional votes
for the adoption of the Merger Agreement or approval of the amendment to the FPA
Plan.
The FPA Board recommends that you vote FOR this proposal.
At the AHI Special Meeting, AHI stockholders will be asked to approve the
adjournment or postponement of the AHI Special Meeting in the event that such
adjournment or postponement is necessary in order to solicit additional votes
for adoption of the Merger Agreement.
The AHI Board recommends that you vote FOR this proposal.
LEGAL MATTERS
The validity of the FPA Common Stock offered hereby will be passed upon for
FPA by Ballard Spahr Andrews & Ingersoll, Philadelphia, Pennsylvania. Certain
federal tax consequences of the Merger and certain legal matters in connection
with the Merger will be passed upon for AHI by Milbank, Tweed, Hadley & McCloy,
Los Angeles, California.
ADDITIONAL INFORMATION
Neither the FPA Board nor the AHI Board is aware of any business to be
acted upon at the Special Meetings other than as described herein. If, however,
other matters are properly brought before either of the Special Meetings, or any
adjournments or postponements thereof, the persons appointed as proxies will
have discretion to vote or act thereon according to their best judgment and
applicable rules of the Commission.
EXPERTS
The consolidated financial statements of FPA as of December 31, 1994 and
1995 and for each of the three years in the period ended December 31, 1995
appearing in the Form 10-K, as amended by Form 10-K/A, have been audited by
Deloitte & Touche LLP, independent auditors, as stated in their report appearing
therein, and have been incorporated herein by reference in reliance upon the
report of such firm given upon their authority as experts in accounting and
auditing.
The consolidated balance sheets as of December 31, 1995 and 1994 and the
consolidated statements of operations, stockholders' equity and cash flows for
the year ended December 31, 1995 and the period June 1, 1994 to December 31,
1994 of Sterling, have been audited by Coopers & Lybrand L.L.P., independent
accountants, given on the authority of that firm as experts in accounting and
auditing.
The Supplemental Consolidated Financial Statements of FPA as of December
31, 1994 and 1995 and for each of the three years in the period ended December
31, 1995 appearing herein have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report, and are included in reliance
upon the report of such firm given upon their authority as experts in accounting
and auditing.
The Consolidated Financial Statements of AHI Healthcare Systems, Inc. for
the years ended at December 31, 1995 and 1994 and for each of the three years in
the period ended December 31, 1995, appearing in this Joint Proxy
Statement/Prospectus and Registration Statement, have been audited by Ernst &
Young LLP, independent auditors, as set forth in their report thereon appearing
elsewhere herein, and are included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
The combined financial statements of Foundation Health Medical Services (a
wholly owned subsidiary of Foundation) and affiliates as of June 30, 1995 and
1996 and for each of the three years in the period ended June 30, 1996,
appearing herein have been audited by Deloitte & Touche LLP (except for the
December 31,
126
<PAGE> 135
1993 financial statements of Thomas-Davis Medical Centers, P.C.) as stated in
their report appearing herein (such report expresses an unqualified opinion and
includes an explanatory paragraph referring to significant related party
transactions). The financial statements of Thomas-Davis Medical Centers, P.C.
for the year ended December 31, 1993 (combined with those of Foundation Health
Medical Services (a wholly owned subsidiary of Foundation) and affiliates) have
been audited by Stevenson, Jones, Imig, Holmaas & Kleinhans, P.C., as stated in
their report appearing herein.
The financial statements of Foundation Health IPA as of December 31, 1995
and 1994 and for the year ended December 31, 1995 and for the period from June
7, 1994 (date of inception) to December 31, 1994, incorporated herein by
reference have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their report incorporated herein by reference (such report expresses
an unqualified opinion and includes an explanatory paragraph referring to
significant related party transactions and a subsequent event.)
127
<PAGE> 136
INDEX TO FINANCIAL STATEMENTS
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FPA Medical Management Inc. and Subsidiaries
Independent Auditors' Report........................................................ F-2
Report of Independent Accountants................................................... F-3
Supplemental Consolidated Balance Sheets............................................ F-4
Supplemental Consolidated Statements of Operations.................................. F-5
Supplemental Consolidated Statements of Stockholders' Equity........................ F-6
Supplemental Consolidated Statements of Cash Flows.................................. F-7
Notes to Supplemental Consolidated Financial Statements............................. F-9
Combined Financial Statements
Foundation Health Medical Services and Affiliates
Independent Auditors' Report........................................................ F-29
Combined Balance Sheets............................................................. F-30
Combined Statements of Operations................................................... F-31
Combined Statements of Shareholder's Deficit........................................ F-32
Combined Statements of Cash Flows................................................... F-33
Notes to Combined Financial Statements.............................................. F-35
Interim Financial Statements
Combined Balance Sheets............................................................. F-44
Combined Statement of Operations.................................................... F-45
Combined Statements of Shareholder's Deficit........................................ F-46
Combined Statements of Cash Flows................................................... F-47
Notes to Combined Financial Statements.............................................. F-48
Consolidated Financial Statements
AHI Healthcare Systems, Inc.
Independent Auditors' Report........................................................ F-50
Consolidated Balance Sheets......................................................... F-51
Consolidated Statements of Operations............................................... F-52
Consolidated Statements of Stockholders' Equity..................................... F-53
Consolidated Statements of Cash Flows............................................... F-54
Notes to Consolidated Financial Statements.......................................... F-56
</TABLE>
F-1
<PAGE> 137
INDEPENDENT AUDITORS' REPORT
To the Stockholders of FPA Medical Management, Inc.:
We have audited the supplemental consolidated balance sheets of FPA Medical
Management, Inc. and subsidiaries as of December 31, 1994 and 1995 and the
related supplemental consolidated statements of operations, changes in
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 1995. These supplemental 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 supplemental 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
supplemental consolidated financial statements. We did not audit the
consolidated balance sheets of Sterling Healthcare Group, Inc. as of December
31, 1994 and 1995 or the related consolidated statements of operations, changes
in stockholders' equity and cash flows of Sterling Healthcare Group, Inc. for
each of the two years in the period ended December 31, 1995, which statements
reflect total assets of $26,742,105 and $78,608,252 as of December 31, 1994 and
December 31, 1995, respectively, 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. Those 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 provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
such supplemental consolidated financial statements present fairly, in all
material respects, the financial position of FPA Medical Management, Inc. and
subsidiaries as of December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
March 8, 1996 (Except for the pooling of
interests with Sterling Healthcare Group, Inc.
as described in notes 1 and 22 for which
the date is October 31, 1996)
San Diego, California
F-2
<PAGE> 138
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 1994, 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 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, 1994 and 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.
COOPERS & LYBRAND L.L.P.
Miami, Florida
March 15, 1996
F-3
<PAGE> 139
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1994 AND SEPTEMBER 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1994 1995 1996
------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................... $ 2,136,870 $ 2,071,173 $ 2,526,679
Marketable securities.............................................. 10,079,811 9,329,840 1,555,463
Accounts receivable -- net......................................... 16,890,026 40,229,995 76,292,294
Accounts receivable -- other....................................... 2,199,046 4,636,973 14,241,511
Current portion of note receivable from FPASD...................... 18,601 300,086 650,953
Prepaid expenses................................................... 371,977 656,003 6,894,980
Income tax receivable.............................................. 163,560 1,227,949 970,300
Deferred income tax asset.......................................... 1,370,885 2,861,898 4,108,336
----------- ------------ ------------
Total current assets......................................... 33,230,776 61,313,917 107,240,316
PROPERTY AND EQUIPMENT -- net........................................ 3,141,343 9,591,799 19,850,200
RESTRICTED CASH AND DEPOSITS......................................... 3,285,000 7,804,728
GOODWILL -- net of accumulated amortization of $112,818 and
$1,724,606 in 1994 and 1995, respectively.......................... 7,672,401 69,498,404 127,029,623
INTANGIBLE ASSETS -- net of accumulated amortization of $11,976 and
$249,682 in 1994 and 1995, respectively............................ 282,840 5,988,579 6,620,909
NOTE RECEIVABLE FROM FPASD -- net of current portion................. 66,939
INVESTMENT IN GLHP................................................... 1,994,900 4,994,900
OTHER ASSETS......................................................... 657,207 733,937 2,378,677
----------- ------------ ------------
Total assets................................................. $45,051,506 $152,406,536 $275,919,553
=========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses.............................. $ 6,894,855 $14,851,559 $ 19,091,901
Claims payable, including incurred but not reported claims......... 1,284,806 10,247,476 47,474,955
Accrued payroll and related liabilities............................ 207,686 1,363,304 3,202,891
Borrowings on line of credit....................................... 788,325
Current portion of accrued liability for professional liability
claims........................................................... 475,100 610,000 650,000
Current portion of long-term debt.................................. 976,258 7,042,635 52,273,026
Income taxes payable............................................... 1,228,488 436,775 2,273,591
----------- ------------ ------------
Total current liabilities.................................... 11,067,193 35,340,074 124,966,364
BANK LINE OF CREDIT.................................................. 2,662,242 10,000,000 10,000,000
LONG-TERM DEBT -- net of current portion............................. 2,987,348 9,012,552 13,563,331
ACCRUED LIABILITY FOR PROFESSIONAL LIABILITY CLAIM, net of current
portion............................................................ 2,013,400 2,440,000 2,475,000
DEFERRED INCOME TAX LIABILITY........................................ 1,894,903 1,989,770 1,746,461
OTHER LONG TERM PAYABLES............................................. 100,000 392,275 2,476,015
MINORITY INTEREST.................................................... 4,900
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value per share, 2,000,000 shares
authorized, no shares outstanding................................
Common stock, $.002 par value, 18,000,000 shares authorized,
14,723,351 and 19,198,825 shares issued and outstanding at
December 31, 1994 and 1995, respectively......................... 29,447 38,398 41,280
Additional paid-in capital......................................... 23,237,532 87,650,858 107,378,995
Stock subscriptions receivable..................................... (14,227)
Stock payable...................................................... 567,000 493,100
Accumulated earnings............................................... 1,420,010 5,253,975 13,023,437
Less: Deferred Compensation -- stock options....................... (346,342) (283,266) (244,430)
----------- ------------ ------------
Total stockholders' equity................................... 24,326,420 93,226,965 120,692,382
----------- ------------ ------------
Total........................................................ $45,051,506 $152,406,536 $275,919,553
=========== ============ ============
</TABLE>
See notes to financial statements.
F-4
<PAGE> 140
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 31,
---------------------------------------- ---------------------------
1993 1994 1995 1995 1996
----------- ----------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Managed care revenue.................. $13,987,914 $18,193,286 $ 49,880,875 $ 28,878,594 $171,500,742
Fee-for-service revenue, net of
contractual allowances.............. 39,498,164 118,470,607 82,712,463 117,770,282
----------- ----------- ------------ ------------ ------------
Operating revenue..................... 13,987,914 57,691,450 168,351,482 111,591,057 289,271,024
Medical services -- Professional
Corporations........................ 3,748,153 4,173,204 7,234,374 4,120,715 15,971,210
Medical services -- others............ 6,599,651 35,808,319 100,257,463 66,770,586 188,825,812
----------- ----------- ------------ ------------ ------------
3,640,110 17,709,927 60,859,645 40,699,756 84,474,002
General and administrative expense.... 3,471,056 14,977,655 52,733,714 34,111,833 68,769,573
----------- ----------- ------------ ------------ ------------
Income from operations................ 169,054 2,732,272 8,125,931 6,587,923 15,704,429
OTHER INCOME (EXPENSE):
Interest and other income........... 12,325 186,955 609,297 389,490 443,071
Interest expense.................... (3,058) (187,364) (2,177,943) (1,650,854) (2,781,465)
----------- ----------- ------------ ------------ ------------
Total other income
(expense)................. 9,267 (409) (1,568,646) (1,261,364) (2,338,394)
----------- ----------- ------------ ------------ ------------
INCOME BEFORE INCOME TAXES............ 178,321 2,731,863 6,557,285 5,326,559 13,366,035
PROVISION FOR INCOME TAXES............ 942,025 2,723,320 2,169,433 5,596,573
----------- ----------- ------------ ------------ ------------
NET INCOME............................ $ 178,321 $ 1,789,838 $ 3,833,965 3,157,126 7,769,462
=========== =========== ============ ============ ============
NET INCOME PER SHARE.................. $.24 $.21 $.38
============ ============ ============
PRO FORMA (Note 1):
Adjustment for employment
agreements....................... $ 1,228,004
Adjustment to income tax expense.... (562,530) $ (110,235)
----------- -----------
Net income.......................... 843,795 1,679,603
=========== ===========
Net income per common share......... $.27 $.19
=========== ===========
</TABLE>
See notes to financial statements.
F-5
<PAGE> 141
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
STOCK DEFERRED
ADDITIONAL SUBSCRIPTIONS ACCUMULATED COMPENSATION
COMMON PAID-IN (RECEIVABLE) EARNINGS STOCK
STOCK CAPITAL PAYABLE (DEFICIT) OPTIONS TOTAL
------- ----------- ------------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, JANUARY 1, 1993..................... $2,188 $ 9,812 $ (10,000) $ (548,149) $ (546,149)
Receipt of payment for stock
subscription.............................. 10,000 10,000
Net income for the year ended December 31,
1993...................................... 178,321 178,321
------- ----------- ------------- ----------- ------------
BALANCES, DECEMBER 31, 1993................... 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 to former director for
services rendered......................... 30 239,970 240,000
Common stock subscribed..................... 6 49,994 (50,000)
Receipt of payment for stock
subscriptions............................. 35,773 35,773
Common stock issued through initial public
offering
for cash, net of costs (including tax
benefit of $160,924)...................... 2,795 11,574,068 11,576,863
Common stock issued in connection with
PrimeCare, Inc. acquisition............... 313 1,953,250 1,953,563
Stock warrants issued for cash.............. 43,365 43,365
Amortization of deferred compensation....... 22,658 22,658
Net income for the year ended December 31,
1994...................................... 1,789,838 1,789,838
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
Stock options and warrants exercised........ 156,000 156,000
Receipt of payments for stock
subscriptions............................. 14,227 14,227
Common stock payable........................ 567,000 567,000
Amortization and termination of deferred
compensation options...................... (25,000) 63,076 38,676
Net income for the year ended December 31,
1995...................................... 3,833,965 3,883,965
------- ----------- ------------- ----------- ------------ ------------
BALANCES, DECEMBER 31, 1995................... $38,398 $87,650,858 $ 567,000 $5,253,975 $ (283,266) $ 93,226,965
Stock options and warrants exercised
(unaudited)............................... 515 9,059,920 9,060,435
Shares issued in connection with
acquisitions (unaudited).................. 231 657,023 657,254
Shares issued in connection with the
conversion of debt (unaudited)............ 1,086 3,498,914 3,500,000
Shares issued in connection with PFI
acquisition (unaudited)................... 1,050 6,524,280 6,525,330
Termination of deferred compensation options
(unaudited)............................... (12,000) (12,000)
Amortization of deferred compensation
(unaudited)............................... 38,836 38,836
Issuance of shares for stock payable
(unaudited)............................... (73,900) (73,900)
Net income for the nine month period ended
September 30, 1996 (unaudited)............ -- -- -- 7,769,462 -- 7,769,462
------- ----------- ------------- ----------- ------------ ------------
BALANCES, SEPTEMBER 30, 1996 (unaudited)...... 41,280 107,378,995 493,100 13,023,437 (244,430) 120,692,382
======== ========== ============ =========== ============ ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE> 142
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------- ----------------------------
1993 1994 1995 1995 1996
--------- ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income......................................... $ 178,321 $ 1,789,838 $ 3,833,965 $ 3,157,126 $ 7,769,462
---------- ------------ ------------ ------------ ------------
Adjustments to reconcile net income to net cash
provided by (used by) operating activities:
Depreciation and amortization.................... 50,943 570,733 3,419,060 2,102,874 6,240,009
Imputed interest on notes payable................ 132,489 98,023
Loss on disposal of business..................... 772,875
Deferred compensation stock options.............. 22,658 38,076 29,132 26,835
Impairment of goodwill........................... 434,602
Changes in assets and liabilities, net of effects
of acquisitions:
Accounts receivable............................ (259,784) (4,448,976) (17,983,548) (11,085,533) (43,535,978)
Income tax receivable.......................... (163,560) (1,064,389) (1,087,850) 3,525,022
Deferred income taxes.......................... 40,000 (205,580) 591,545 (234,875) 633,085
Accounts payable and accrued expenses.......... 42,653 850,558 469,485 (825,630) (1,639,891)
Claims payable, including IBNR................. 153,522 (315,194) 5,348,274 3,499,051 37,227,479
Accrued liability for professional claims
liabilities.................................. (124,216) (738,500) (188,500) (375,000)
Accrued payroll and related liabilities........ 196,638 (7,157) 336,625 109,901 1,839,587
Prepaid expenses and other assets.............. (27,453) (129,057) (507,908) (360,858) (6,278,445)
---------- ------------ ------------ ------------ ------------
Total adjustments............................ 196,519 (3,949,791) (8,751,314) (8,042,288) (2,239,274)
---------- ------------ ------------ ------------ ------------
Net cash provided (used) by operating
activities................................. 374,840 (2,159,953) (4,917,349) (4,855,162) 5,530,188
---------- ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment................. (40,011) (971,053) (4,808,619) (2,035,181) (3,894,872)
Payments for intangible assets..................... (270,621) (1,703,570) (858,930) (2,323,849)
Net payment (to) from FPASD........................ (129,912) 44,372 (214,546) 12,257 (350,867)
Investment in GLHP................................. (1,994,900) (1,994,900) (3,000,000)
Net sale (purchase) of marketable securities....... (10,079,811) 749,971 7,209,053 7,774,377
Acquisitions, net of cash acquired................. (3,713,133) (38,529,816) (22,713,070) (13,276,035)
Payments escrowed for acquisition.................. (3,285,000) 1,143,526 (4,519,728)
Proceeds from sale of businesses................... 1,600,000
Other.............................................. (46,212)
---------- ------------ ------------ ------------ ------------
Net cash used by investing activities........ (169,923) (14,990,246) (48,232,692) (21,524,297) (19,590,975)
---------- ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from merger, net.......................... 109,117 5,699,870
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 subordinated notes
payable.......................................... 1,000,000
Proceeds from issuance of stock warrants........... 43,365
Proceeds from exercise of stock options and
warrants......................................... 156,000 156,000 8,057,854
Issuance of notes payable.......................... 47,802,427
Net borrowings under bank line of credit........... 207,242 7,814,781 29,644,059 469,116
Receipt of payment for stock subscriptions......... 10,000 35,773 14,227 12,782
Payments on long-term debt......................... (2,724) (922,779) (5,302,072) (4,192,641) (41,813,105)
Deferred public offering costs..................... (25,665) (420,454)
---------- ------------ ------------ ------------ ------------
Net cash provided by financing activities.... 90,728 18,567,994 53,084,344 25,199,746 14,516,292
---------- ------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH...................... 295,645 1,417,795 (65,697) (1,209,713) 455,505
CASH, AND CASH EQUIVALENTS BEGINNING OF PERIOD....... 423,430 719,075 2,136,870 2,136,870 2,071,174
---------- ------------ ------------ ------------ ------------
CASH, END OF PERIOD.................................. $ 719,075 $ 2,136,870 $ 2,071,173 $ 927,157 $ 2,526,679
========== ============ ============ ============ ============
</TABLE>
See notes to financial statements.
F-7
<PAGE> 143
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------- ----------------------------
1993 1994 1995 1995 1996
--------- ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Supplemental cash flow information:
Cash paid for interest............................. $ 3,502 $ 117,400 $ 1,957,194 $ 47,090 $ 1,819,130
Cash paid for income taxes......................... $ 800 $ 1,840,296 $ 4,781,045 $ 9,350 $ 870,382
Equipment acquired under capital leases............ $ 27,702 $ 155,361 $ 438,643 $ 270,776 $ 1,137,712
Common stock issued in connection with
acquisitions..................................... $ -- $ 4,741,976 $ 13,889,870 $ 8,535,359 $ 8,941,657
Common stock to former director for services
rendered......................................... $ -- $ 240,000 $ -- $ -- $ --
</TABLE>
See notes to financial statements.
F-8
<PAGE> 144
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION -- The merger of FPA Medical Management, Inc. and
Subsidiaries ("FPA") and Sterling Healthcare Group, Inc. ("Sterling") has been
accounted for as a pooling of interests and, accordingly, the accompanying
supplemental consolidated financial statements have been prepared on a basis
that includes the accounts of FPA and Sterling (Sterling amounts are included
from June 1, 1994, the date of inception). Information concerning common stock
and per share data has been restated on an equivalent share basis. There were no
material adjustments to the accounts of Sterling as a result of adopting the
same Accounting Principles of the Company.
GENERAL -- FPA Medical Management, Inc., a Delaware corporation
incorporated in 1994, is a national health care management service organization
which, through its network of primary care physicians and affiliated
professional corporations ("Professional Corporations"), contracts with health
maintenance organizations ("HMOs") and other prepaid health insurance plans
(collectively, "Payors") to provide and manage physician and related health care
services to their enrollees who select FPA network primary care physicians. In
March 1994, two predecessor entities of FPA, Family Practice Medical Management
Corp., a California corporation incorporated in 1986, and FPA Medical
Management, Inc., a California corporation incorporated in 1992, were merged
into FPA. The accompanying supplemental financial statements present the
financial position and results of operations of FPA and the predecessor
entities, including the accounts of the FPA subsidiaries, certain Professional
Corporations, and Sterling (collectively, the "Company").
FPA and its subsidiaries currently manage the provision of prepaid health
care services for networks of primary care physicians in California, Arizona,
Texas, Florida, Delaware, Michigan, and New Jersey. The "FPA Network" consists
of Professional Corporations and various independent practitioners.
The Professional Corporations contract with Payors to provide for the
delivery of health care services on a capitation basis (i.e., a fixed payment
per enrollee per month). Through administrative services agreements (see Note
2), 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.
The Company through Sterling provides physician contract management for
hospital emergency and anesthesia departments in 20 states at December 31, 1995.
The Company also operates six primary care medical facilities at December 31,
1995 in three states. The Company also has a physician recruiting and medical
management consulting division and publishes a monthly magazine. Contractual
arrangements with hospitals are primarily fee-for-service whereby hospitals
agree to authorize the Company and its contracted health care professionals to
contract directly with the patients. Therefore, the Company bills and collects
directly from the patient or third party payor for the professional component of
the charges for medical services rendered by the Company's contracted health
care professionals. The Company contracts, on an independent contractor basis,
directly with the physicians who provide such medical services. The physicians
are compensated based on an hourly rate in accordance with independent
contractor agreements.
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
Corporation. 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.
However, due to a parent-subsidiary relationship
F-9
<PAGE> 145
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
under generally accepted accounting principles as described above, FPA has
consolidated the financial statements of the following 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 all of the following subsidiaries and
Professional Corporations since they were acquired, were incorporated, or
entered into an administrative services agreement with FPA or one of its
subsidiaries.
- Arizona Managed Care Services, Inc.
- Arizona Managed Care Physicians, IPA, Inc.
- Family and Senior Care, Inc.
- FPA Medical Management of Michigan, Inc.
- FPA Medical Management of South Carolina, Inc.
- FPA Gonzaba Management Services Organization, Inc.
- OPSU, Inc.
- PrimeCare, Inc.
- Family Practice Associates of San Diego, Inc., an Osteopathic corporation
- FPA Medical Group of California, an Osteopathic corporation
- FPA Medical Group of New Jersey, a professional corporation
- FPA Medical Group of Pennsylvania, a medical corporation
- Arizona Managed Care Providers Ltd.
- William Gonzaba, M.D., a professional, d/b/a Gonzaba Medical Group
- FPA Independent Practice Association, an Osteopathic corporation
- FPA Medical Group of South Carolina, P.C.
- VIP IPA
- Foundation Health IPA
- Century Family Medical Group, Inc.
- Physicians First, Inc.
- Family First Medical Centers, Inc.
- Physicians Medical Group of Florida, Inc.
- FPA Family Pharmacy, Inc.
- FPA Acquisition Corporation
- FPA Medical Management of California, Inc.
- FPA Medical Group of Delaware, P.A.
- Family Practice Associates of Southern California, an Osteopathic Medical
Corporation
F-10
<PAGE> 146
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
- FPA Medical Group of Texas, a Texas Professional Association
- FHC IPA, Inc.
- Sterling Healthcare Group, Inc.
- Sterling Mednet Administrative Services, Inc.
- Sterling Sub Texas, Inc.
- Sterling Medical Group, Inc.
- Sterling Physicians Services of America, Inc.
- Sterling Miami, Inc.
- Sterling Anesthesia, Inc.
- Sterling Regional Emergency Services, Inc.
- Sterling Mednet Emergency Services, Inc.
- Sterling Billing Services Corp.
- Sterling Physicians Group of Texas, Inc.
- Sterling Medical Group of Michigan, Inc.
- Sterling Real Property Melbourne, Inc.
- Sterling Medical Group of Florida, Inc.
- Sterling Professional Emergency Physicians, LLC
- Sterling Healthcare of Texas, a Texas professional association
- FPA Acquisition Corp.
REVENUES AND ACCOUNTS RECEIVABLE -- 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 three years, with automatic renewal periods, terminable on prior
notice (generally between 30 and 180 days).
The Company has two types of Payor contracts: contracts for both inpatient
and outpatient services ("global capitation" contracts) and those limited to
outpatient services ("outpatient capitation" contracts). Additionally, under
global capitation contracts, the Company receives a fixed monthly amount per
enrollee after 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
after 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 amounts pre-established by the Payor in excess of
inpatient cost.
As a result of physician acquisitions, FPA has historically also generated
fee-for-service revenues through the Professional Corporations. These revenues
are presented net of contractual deductions.
F-11
<PAGE> 147
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
Fee for service revenue from patient services, primarily Sterling's, is
reported on the accrual basis, net of Estimated third-party contractual
adjustments. Further adjustments are recorded to reflect amounts estimated to be
uncollectible based upon individual contract experience. The allowance
considered necessary to cover contractual adjustments and uncollectibles 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. The Company has arrangements to
supplement patient revenues not achieving specified levels or to cover front-end
staffing and insurance costs.
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. The Company does not require collateral relating to
accounts or subsidy receivables. Sterling's revenues received directly from
governmental agencies made up approximately 26.8% and 30.2% of net operating
revenue for the years ended December 31, 1994 and 1995.
MEDICAL SERVICES EXPENSE -- Through the Professional Corporations, 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. The costs of referrals to specialty care physicians
are paid on either a discounted fee-for-service or capitation basis. The
majority of 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), 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.
FPA purchases stoploss insurance protection which provides thresholds or
"attachment points," generally $100,000 for inpatient services and $25,000 for
outpatient services, both policies on a per member per year basis, at which
point substantially all financial exposure for an enrollee beyond such
thresholds is contractually shifted to the insurer up to a specified level, at
which point the risk for loss returns to the Company.
CASH AND CASH EQUIVALENTS -- Cash equivalents are defined as highly liquid
financial instruments with maturities of 90 days or less from the date of
purchase and so near maturity that there is insignificant risk of changes in
value because of interest changes. The Company maintains its cash and cash
equivalents with high quality financial institutions. At times, such balances
may be in excess of the federally insured limit of $100,000. A substantial
portion of FPA's cash is deposited in four 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 represent the invested
proceeds of the FPA's public offerings of Common Stock and consist of U.S.
Treasury and government agency obligations, corporate debt securities, and money
market funds. 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 reported.
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 estimated useful lives of the assets,
generally three to thirty years. Equipment under capital leases is amortized
using the straight-line method over the shorter period of the lease term or the
estimated useful life of the equipment. Maintenance and repairs are charged to
expense as incurred. Significant renewals or betterments are
F-12
<PAGE> 148
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
capitalized. When property and equipment are retired, or otherwise disposed of,
the cost and related accumulated depreciation are removed from their respective
accounts and any relating gain or loss is reflected in earnings.
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. At
December 31, 1995, $3,000,000 of this balance relates to a pending acquisition
(see Note 20).
GOODWILL -- The Company has classified as goodwill the excess of the
purchase price over the fair value of the assets of entities acquired. Goodwill
is being amortized on a straight-line basis over the estimated periods of future
benefit of 15 to 40 years. At each balance sheet date, the Company evaluates the
recoverability of goodwill and based upon such evaluation, management believes
that no material impairment of goodwill has occurred. 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. 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, 1995.
INTANGIBLE ASSETS -- Intangible assets consist primarily 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 five to fifteen years. Intangible assets also consist of
unamortized loan costs, which are comprised of costs incurred on obtaining
financing, and are amortized over the term of the related debt.
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 11).
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, based on an
actuarial valuation, of its liabilities for claims incurred but not reported.
Such liabilities are not discounted.
PRO FORMA INFORMATION -- The pro forma net income and net income per share
information in the accompanying consolidated statements of operations reflect
the effects on historical results as if (i) compensation to certain of FPA's
officers had been consistent with the employment agreements entered into as of
January 1, 1994 and (ii) 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 PER COMMON SHARE -- Net income per common share is computed
based on the weighted average number of shares outstanding, giving retroactive
effect to all stock splits, including a one-for-one stock dividend effective
March 1, 1995. Common equivalent shares consist of the dilutive effect of
outstanding options and warrants calculated using the treasury stock method.
STOCK OPTIONS -- The Company follows the practice of recording amounts
received upon the exercise of options by crediting common stock and additional
paid-in capital. To the extent that the Company realizes an income tax benefit
from the exercise or early disposition of certain stock options, this benefit
results in a decrease in current income taxes payable and an increase in
additional paid-in capital.
NEW ACCOUNTING STANDARDS -- In March 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" which was effective for the Company beginning
F-13
<PAGE> 149
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
January 1, 1996. SFAS No. 121 requires that long-lived and certain intangible
assets held and used by the Company be reviewed for impairment. In October 1995,
the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," which
will be 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 will continue to apply APB Opinion
No. 25 to its stock-based compensation awards to employees and will disclose the
required pro forma effect on net income and earnings per share.
RECLASSIFICATIONS -- Certain reclassifications have been made to prior
years' financial statements to conform to current year classifications.
ACCOUNTING ESTIMATES -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
UNAUDITED FINANCIAL INFORMATION -- The consolidated financial information
for the nine months ended September 30, 1996 and 1995 included in the
supplemental consolidated financial statements and notes thereto are unaudited.
In the opinion of management, such information contains all adjustments,
consisting only of normal recurring accruals, necessary for a fair presentation
of such information. Information for the nine months ended September 30, 1996 is
not necessarily indicative of the results to be expected for the entire year.
2. ADMINISTRATIVE SERVICES AGREEMENTS
Under administrative services agreements with the Professional
Corporations, FPA and its subsidiaries provide administrative and operational
services such as contract management, marketing, financial reporting,
utilization review, case management, claims processing and payment, and quality
assurance. Pursuant to the agreements, the Professional Corporations assign to
FPA and its subsidiaries as agent all capitation revenues and substantially all
shared risk pool revenues they are entitled to receive under contracts with
Payors for prepaid medical services. In their capacities as agents for the
Professional Corporations, FPA and its subsidiaries remit a portion of the
capitation payments to the primary care physicians in the FPA Network based on
the number of enrollees each physician covers and disburses funds required to
discharge obligations arising from the Payor agreements. As compensation for
services rendered under the agreement, FPA and its subsidiaries generally retain
all revenue in excess of its costs, as defined in the agreement.
The administrative services agreements, except for the agreement with
FPASD, also provide for the assignment of all fee-for-service revenues in
exchange for expanded management services, including the provision of
facilities, non-medical staff and medical supplies for the Professional
Corporation's medical offices, billing for services performed on a
fee-for-service basis, and other services. Because the administrative services
agreement with FPASD does not assign all of its revenues to FPA and does not
obligate FPA to provide FPASD the expanded management services described above,
unilateral and perpetual control does not exist. The operations of FPASD have
not been consolidated into these financial statements.
For the years ended December 31, 1993, 1994 and 1995, total revenues
assigned to FPA and its subsidiaries under these agreements were $13,987,914,
$18,435,877 and $52,691,955, respectively, and
F-14
<PAGE> 150
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
medical services expenses to the Professional Corporations totaled $3,748,153,
$4,173,204, and $7,234,374, respectively. Additionally, prior to January 1,
1994, FPA paid FPASD fixed monthly fees for certain other medical services
provided for the Company.
The administrative services agreements between FPA or its subsidiaries and
the Professional Corporations generally expire in 2003, 2004 or 2005, subject to
renewal for an additional ten years at the option of FPA or its subsidiaries.
Thereafter, the agreements renew for successive ten-year periods unless notice
of intent to let the agreements expire is given by either party.
3. MARKETABLE SECURITIES
Marketable securities at December 31 include the following (at cost which
approximates fair value):
<TABLE>
<CAPTION>
1994 1995
----------- ----------
<S> <C> <C>
U.S. Treasury and government agency obligations.... $ 4,989,820
Corporate debt securities.......................... 4,694,270 $8,228,788
Money market funds................................. 395,721 1,101,052
----------- ----------
Total.................................... $10,079,811 $9,329,840
=========== ==========
</TABLE>
The marketable securities held by the Company at December 31, 1995 have
contractual maturities through March 1998.
4. RELATED PARTY TRANSACTIONS
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, 1994 and 1995, the balance was $85,540 and $300,086, respectively. The
entire outstanding balance, including accrued interest at 7%, is due on demand.
In connection with a note between FPASD and a hospital ("Hospital"), FPA
agreed that it will delay receipt of its shared risk pool revenue payments
related to two Payor agreements until FPASD pays off the note, which is due
September 30, 1996. FPA will earn interest at prime plus 1% on the earned shared
risk pool revenue until it is received. Further, until the note payment is made,
the Company has agreed not to enter into capitated agreements with other
hospitals in San Diego, unless Hospital first elects not to participate in any
such agreement. FPA and FPASD have agreed that FPA will receive certain
additional shared risk pool funds until the note is paid in full.
GMSO leases from an officer of GMSO its main facility, certain leasehold
improvements, and certain medical and office equipment 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.
F-15
<PAGE> 151
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31:
<TABLE>
<CAPTION>
1994 1995
---------- ----------
<S> <C> <C>
Land........................................................ $ 25,000 $ 25,000
Building.................................................... 139,825 139,825
Computer hardware and software.............................. 317,885 1,730,733
Furniture, fixtures and equipment, including medical
equipment................................................. 3,760,154 7,519,444
Leasehold improvements...................................... 101,457 1,479,653
---------- ----------
4,344,321 10,894,655
Accumulated depreciation and amortization................... (1,231,698) (2,576,385)
---------- ----------
3,112,623 8,318,270
Capitalized software development costs...................... 28,720 1,273,529
---------- ----------
Property and equipment, net................................. $3,141,343 $9,591,799
========== ==========
</TABLE>
6. DEBT
CONVERTIBLE SUBORDINATED NOTES PAYABLE -- On October 5, 1994, FPA sold
$1,000,000 of convertible subordinated notes to representatives of the
underwriters of FPA's initial public offering. The notes bear interest at 6%,
payable semiannually, with principal due October 1999. The notes are convertible
into Common Stock of FPA at the option of the holders at any time prior to
maturity at a conversion price of $5.00 per share, subject to certain
antidilution provisions. These notes were converted during 1996.
CONVERTIBLE PROMISSORY NOTE -- In connection with the acquisition of GMSO
on November 1, 1995 FPA issued a 36-month, $2,500,000 9% convertible promissory
note with payments of interest only due for the first 24 months and principal
and interest monthly thereafter. These notes were paid off during 1996.
LINES OF CREDIT -- At December 31, 1995, GMSO maintained agreements with a
financial institution providing lines of credit totaling $1,400,000. Interest
and amounts borrowed under these lines are payable monthly at the prime rate
(8.5% at December 31, 1995). Borrowings under the lines of credit at December
31, 1995 were $788,325. In January 1996, the balance was repaid in full.
On December 31, 1994, Sterling had a $25,000,000 revolving credit facility
with an outstanding balance of $2,662,242 which was replaced on August 31, 1995
with a $50,000,000 revolving credit facility. At December 31, 1995, borrowings
under the line of credit were $10,000,000. On October 31, 1996, this facility
was repaid and terminated.
Sterling total outstanding borrowings on October 1, 1997 will convert to a
term loan payable in 20 equal quarterly installments of principal plus accrued
interest. The extent of the credit facility is available at the Sterling's
option, provided that total outstanding borrowings under the facility plus other
permitted senior indebtedness shall not exceed a multiple of 3 times (2.75 times
as of July 31, 1996 and 2.5 times as of July 31, 1997) the Company's
consolidated annual cashflow, as defined. At December 1, 1995, $17,000,000 in
additional borrowings was available under the revolving credit facility. The
line is collateralized by (i) the capital stock of all existing and future
subsidiaries, (ii) intercompany notes executed by all subsidiaries, and (iii)
all personal property of Sterling. The revolving credit facility contains
covenants that among other things, require Sterling to maintain certain
financial ratios and impose certain limitations with respect to additional
indebtedness, mergers and acquisitions, liens and encumbrances, disposition of
assets, transactions with related parties, investments and the payment of
dividends. Sterling was in compliance with the terms of the revolving credit
facility at December 31, 1995.
F-16
<PAGE> 152
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
The interest rate is determined based on Sterling's ratio of senior debt to
annualized cash flow, as defined, and accrues at the bank's prime rate plus .25%
to .75%, payable quarterly, or the LIBOR rate plus 1.50% to 2.25%, payable at
the end of each interest period, at Sterling's option. As of December 31, 1994
and 1995, the interest rate was 8.75% and 8.125%, respectively. The weighted
average interest rate on short term borrowings was 6.8% and 8.4% for the years
ended December 31, 1994 and 1995, respectively.
Based upon the amount outstanding at December 31, 1995 under the revolving
credit facility, maturities for each of the next five years and thereafter would
be as follows, assuming conversion to a note payable on October 1, 1997:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
----------------------------------------------------------------
<S> <C>
1997............................................................ $ 500,000
1998............................................................ 2,000,000
1999............................................................ 2,000,000
2000............................................................ 2,000,000
Thereafter...................................................... 3,500,000
-----------
$10,000,000
===========
</TABLE>
CAPITAL LEASES -- The Company leases equipment under capital leases which
expire at various dates through the year 2000.
NOTES PAYABLE -- In connection with certain acquisitions, the Company has
entered into various additional notes payable.
The following is a summary of long-term debt:
<TABLE>
<CAPTION>
1994 1995
---------- ----------
<S> <C> <C>
Notes payable, interest ranging from 7% to 8.5% and principal due
through January 1, 2002........................................... $ 259,565 $5,270,421
Note payable, interest at 9% and principal due November 9, 1997..... 2,500,000
Convertible note payable, interest at 9% and principal due
November 9, 1998.................................................. 2,500,000
Notes payable to former shareholders of Sterling Health Care, Inc.
interest at rates ranging from 5% to 5.54%, payable in 60 monthly
installments to maturity, January 1998............................ 2,056,464 1,372,895
Notes payable to former shareholder of Emergency Physicians Group,
interest at prime, payable in two equal installments in December
1996 and 1997..................................................... 1,200,000
6% convertible subordinated notes, interest payable April 5th and
October 5th through 1999, principal due October 5, 1999........... 1,000,000 1,000,000
Notes payable to a financial institution, interest ranging from 7%
to 8.5%, paid in full in January 1996............................. 714,858
Notes payable to former shareholder of MedNet, payable in January
1996.............................................................. 266,761
Other............................................................... 647,577 1,230,252
---------- ----------
Total..................................................... 3,963,606 16,055,187
Less current portion................................................ 976,258 7,042,635
---------- ----------
Long-term debt, net of current portion.............................. $2,987,348 $9,012,552
========== ==========
</TABLE>
F-17
<PAGE> 153
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
At December 31, 1995, future payments on long-term debt are as follows:
<TABLE>
<CAPTION>
NOTES PAYABLE CAPITAL
AND OTHER LEASES
------------- -----------
<S> <C> <C>
1996...................................................... $ 6,638,759 $ 500,895
1997...................................................... 4,298,023 328,896
1998...................................................... 2,900,966 139,596
1999...................................................... 1,130,518 29,241
2000...................................................... 134,027 3,458
Thereafter................................................ 111,419
----------- -----------
$ 15,213,712 1,002,086
===========
Less amount representing minimum interest due on capital
leases.................................................. (160,611)
-----------
Present value of net minimum capital lease payments....... 841,475
Notes payable and other................................... 15,213,712
-----------
Total long-term debt...................................... $16,055,187
===========
</TABLE>
The fair market value of the Company's debt approximates its reported
carrying value.
7. MAJOR CUSTOMERS
In 1993, FPA had four Payors which accounted for 38%, 12%, 11% and 10%,
respectively, of FPA's operating revenue, assigned from Professional
Corporations. In 1994, FPA had two Payors which accounted for 33% and 10%,
respectively, of FPA's operating revenue, assigned from Professional
Corporations. In 1995, FPA had two Payors which accounted for 26% and 15%,
respectively, of FPA's operating revenue, assigned from Professional
Corporations. The foregoing percentages exclude the effects of the Sterling
Merger.
8. 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.
On September 21, 1991, FPASD and five founding directors of FPA were named
as defendants in a civil suit in the United States District Court of California
brought under the provisions of the Federal Civil False Claims Act. The
complaint sets forth numerous allegations of improper conduct by the defendants
concerning unsubstantiated billing, improper record keeping and other related
infractions. The Department of Justice conducted an investigation and, at
present, has declined to intervene in the case. FPASD and the five founding
directors of the Company believe the case to be without merit and intend to
defend the action vigorously. In December 1995, FPA was named as an additional
defendant in the suit and in February 1996 was dismissed from the suit.
F-18
<PAGE> 154
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
The Company is a party to certain facilities leases which terminate at
various dates through October 2009. Future minimum lease payments required under
all operating leases are as follows:
<TABLE>
<CAPTION>
RENTS
RECEIVABLE
OPERATING UNDER
LEASES SUBLEASES
----------- ----------
<S> <C> <C>
1996....................................................... $ 4,572,567 $ 283,776
1997....................................................... 4,206,795 264,288
1998....................................................... 3,825,767 254,400
1999....................................................... 3,117,026 254,400
2000....................................................... 2,434,131 256,944
Thereafter................................................. 8,562,389 674,150
----------- ----------
Total............................................ $26,718,675 $1,987,958
=========== ==========
</TABLE>
For 1993, 1994 and 1995, total expense under these non-cancelable operating
leases was $504,503, $844,094 and $2,966,964, respectively.
9. STOCKHOLDERS' EQUITY
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, the stockholders authorized an increase in the total number of
shares which may be granted under the plan to 1,500,000. 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 approved the 1995 Non-Employee 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.
F-19
<PAGE> 155
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
Stock option transactions and prices are summarized as follows:
<TABLE>
<CAPTION>
1995
NON-EMPLOYEE
1994 DIRECTORS'
PHYSICIAN NON-QUALIFIED
OMNIBUS STOCK STOCK OPTION STOCK OPTION
OPTION PLAN PLAN 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
========= ======= ======
Average option price per share:
At December 31, 1994...................... $ 5.11 N/A N/A
At December 31, 1995...................... $ 7.72 $ 7.05 $ 8.40
Options exercisable:
At December 31, 1994...................... 100,000
At December 31, 1995...................... 213,832 31,500
</TABLE>
WARRANTS -- In connection with FPA's initial public offering, FPA sold for
$43,290 to the representatives of the underwriters warrants to purchase up to
260,000 shares of Common Stock. The warrants are exercisable through October 20,
1999 at $6.00 per share, subject to certain anti-dilution provisions.
Additionally, FPA granted to one of the representatives of the underwriters
warrants to purchase an additional 15,000 shares of FPA's Common Stock in
exchange for certain advisory services and $75. The warrants are exercisable
through November 22, 1999 at $6.00 per share, subject to certain anti-dilution
provisions.
10. COMPENSATION AGREEMENTS
The Company has employment agreements with its executive officers, which
expire at various dates through 2001. Such agreements, which have been revised
from time to time, provide for minimum salary levels, adjusted annually for
cost-of-living changes and merit increases, as well as for incentive bonuses
which are payable if specified management goals are attained. The aggregate
commitment for future salaries at December 31, 1995, excluding bonuses, exceeds
$10,000,000.
11. 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 at
the date it became a taxable enterprise.
F-20
<PAGE> 156
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
The components of the income tax expense as of December 31 are as follows:
<TABLE>
<CAPTION>
1994 1995
--------- ----------
<S> <C> <C>
Federal expense:
Current................................................... $ 974,870 $2,190,978
Deferred.................................................. (181,312) 204,808
--------- ----------
State expense:
Current................................................... 171,936 348,882
Deferred.................................................. (23,469) (21,348)
--------- ----------
$ 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 the
effect of the following items:
<TABLE>
<CAPTION>
1994 1995
---- ----
<S> <C> <C>
Tax expense at U.S. statutory rate..................................... 34% 34%
Revocation of FPA S Corporation status................................. (4.9)
State taxes, net of Federal income tax benefit......................... 3.2 3.7
Goodwill amortization.................................................. 1.7
Other.................................................................. 2.2 2.1
---- ----
Total income tax expense..................................... 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 liability at December 31 are as follows:
<TABLE>
<CAPTION>
1994 1995
---------- -----------
<S> <C> <C>
Deferred tax assets:
Allowance for uncollectible accounts............................. $1,123,154 $ 2,307,580
Accrued liability for professional liability claims.............. 362,308 321,256
Net operating losses............................................. 173,667 296,511
Other............................................................ 28,534 50,392
---------- -----------
Total deferred tax assets................................ 1,687,663 2,975,739
Deferred tax liabilities:
Geographic expansion costs....................................... (101,068) (179,893)
Acquisition costs currently deductible........................... (231,498)
Fixed assets..................................................... (351,833)
Deferred compensation............................................ (57,565)
Depreciation and amortization.................................... (106,458) (656,625)
---------- -----------
Total deferred tax liabilities........................... (207,526) (1,477,414)
Net deferred tax assets (liability)................................ $1,480,137 $ 1,498,325
========== ===========
</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.
F-21
<PAGE> 157
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
12. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practical to estimate
that value:
- The carrying amount of cash and cash equivalents approximates fair value
because of the short maturities of those instruments.
- The carrying amount of debt outstanding under the revolving credit
facility approximates fair market value because the interest rate is
variable, based upon prime or LIBOR.
- The carrying amount of notes payable in the aggregate at December 31,
1995 approximates fair value.
13. NEW JERSEY ACQUISITION
On November 7, 1994, the Company acquired substantially all of the
outstanding capital stock of PrimeCare, Inc. ("PrimeCare"), an independent
practice association of physicians operating in southern New Jersey, for 312,570
shares of FPA's Common Stock, valued at $1,953,563. Additionally, the Company
capitalized $307,133 in costs related to the acquisition. The acquisition was
accounted for under the purchase method. Goodwill recorded as a result of the
acquisition of PrimeCare is being amortized over 15 years on a straight-line
basis.
Under the terms of the PrimeCare acquisition, each former PrimeCare
shareholder has agreed, for a period of 18 months following the PrimeCare
closing (if PrimeCare has not entered into contracts with Payors in the southern
New Jersey region for the provision of all outpatient medical services covering
at least 25,000 members (the "Enrollment Date") during the 18 months following
the PrimeCare closing) or four years following the PrimeCare closing (if
Enrollment Date has occurred during the 18 months following the PrimeCare
closing), not to join or affiliate with, or offer any medical services through
any management services organization or similar organization that contracts with
Payors with which the Company or its affiliated entities currently contract.
Additionally, if the Company contracts with Payors whose members are then being
serviced by physicians who are former PrimeCare shareholders, such physicians
will use their best efforts to convert such members to the Company's network.
Each such physician has also granted to the Company, for an identical period of
time, a right of first refusal to purchase such physician's interest in his or
her practice.
14. MICHIGAN SUBSIDIARY
On April 10, 1995, the Company signed an exclusive agreement to provide
management services through a majority-owned subsidiary, QualNet, with Great
Lakes Health Plan, Inc. ("GLHP") headquartered in Southfield, Michigan. GLHP was
licensed as a health maintenance organization from the Michigan Department of
Insurance in 1996. GLHP expects to service Medicaid enrollees in four counties
which currently have over 50,000 eligible Medicaid recipients. GLHP also expects
to market to commercial members following the initial Medicaid enrollment. In
connection with this transaction, the Company invested $2,000,000 in GLHP and
QualNet. QualNet began limited start-up operations on April 10, 1995. Included
in intangible assets at December 31, 1995 are $266,034 in start-up costs related
to activity in Michigan. These costs are being amortized over five years,
beginning when operations commence in Michigan.
15. ARIZONA ACQUISITIONS
Effective July 1, 1995, the Company acquired all of the outstanding shares
of AMCS and WMPS. The purchase price (including direct costs) was $1,911,511
consisting of $1,250,000 in cash, $350,000 in Common
F-22
<PAGE> 158
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
Stock (50,378 shares), a $250,000 three-year note payable, and $61,511 in direct
costs. In connection with this acquisition, $3,100,330 was recorded as goodwill,
which is being amortized over 25 years, and $300,000 was recorded as the value
of a covenant not to compete, which is being amortized over the 11 year
contractual obligation of the physician not to compete. The acquisition was
recorded under the purchase method of accounting. AMCS, WMPS and AMCP serve
approximately 13,000 managed care enrollees in the Phoenix metropolitan area.
During 1995, the Company acquired the assets and certain liabilities of two
physician practices. The aggregate purchase price of these practices was
$2,492,500 of which $1,817,731 was classified as goodwill which is being
amortized over 25 years, and $295,000 was recorded as the value of covenants not
to compete, which is being amortized over the contractual obligation of the
physicians not to compete, ranging from 10 to 13 years. These acquisitions were
accounted for under the purchase method of accounting.
16. TEXAS ACQUISITIONS
Effective November 1, 1995, the Company acquired all of the outstanding
stock of GMSO and OPSU in San Antonio, Texas. The purchase price was
$21,512,824, consisting of $14,710,404 in cash, $1,571,496 in Common Stock
(175,097 shares), $5,000,000 in notes payable, and $230,924 in direct costs. The
Company also loaned to two key employees of GMG and GMSO a total of $660,000 to
be repaid over three years. In connection with this acquisition, $19,983,491 was
recorded as goodwill, which is being amortized over 25 years, and $1,900,000 was
recorded as the value of a covenant not to compete, which is being amortized
over the 15 year contractual obligation of the physician not to compete. The
acquisition was recorded under the purchase method of accounting. GMSO, OPSU,
and GMG serve approximately 38,000 managed care enrollees in the San Antonio
area.
17. CALIFORNIA ACQUISITIONS
During 1995, the Company acquired the assets and certain liabilities of 14
physician practices, and a Professional Corporation concurrently employed 22
additional physicians. The aggregate purchase price (including direct costs) of
these practices was $8,434,701 of which $6,121,916 was classified as goodwill,
which is being amortized over 25 years, and $1,743,000 was recorded as the value
of covenants not to compete, which is being amortized over the contractual
obligation of the physicians not to compete, ranging from five to 11 years.
These acquisitions were accounted for under the purchase method of accounting.
18. STERLING HEALTHCARE GROUP, INC. ("STERLING") ACQUISITIONS
Sterling consummated the following acquisitions in 1994 and 1995 which have
been accounted for using the purchase method of accounting for financial
reporting purposes. Accordingly, the assets and liabilities of the acquired
entities are recorded at their estimated fair values at the date of the
acquisitions. In addition, the results of operations of the companies acquired
have been included in the results of operations of Sterling from the date of
acquisition.
In January 1995, the Sterling acquired the assets of the Skylark Outpatient
Clinic from Patient Services of America, Inc. ("Skylark"). In addition to the
acquisition, Sterling entered into a consulting agreement with one of Skylark's
shareholders. In consideration for the acquisition and consulting agreement,
Sterling issued an aggregate of 154,305 shares of Sterling's Common Stock,
valued at $1.5 million and $1.5 million in cash. Skylark, headquartered in
Ocala, Florida operates a primary care medical facility at that location. The
excess purchase price over the estimated fair value of the net assets acquired
was recorded as goodwill in the amount of $3.0 million and is being amortized on
a straight-line basis over 17 years.
F-23
<PAGE> 159
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
In January 1995, Sterling consummated the acquisition of Medical Networks,
Inc. ("MedNet"). The purchase price consisted of Sterling issuing an aggregate
of 692,114 shares of Sterling's Common Stock valued at $6.7 million, $12 million
in cash, and the issuance of $3.4 million of notes payable. Sterling also
granted a former MedNet shareholder options to purchase 75,000 shares of common
stock at $12.00 per share vesting over a three year period. The excess purchase
price over the estimated fair value of the net assets acquired was recorded as
goodwill in the amount of $20.1 million and is being amortized on a
straight-line basis over 40 years. MedNet, headquartered in Houston, Texas, is a
medical management company contracting with 15 hospitals to provide emergency
department services. MedNet also owns and operates three primary care facilities
under the trade name MedStop.
In September 1995, Sterling consummated the acquisition of Professional
Emergency Physicians, P.A. ("PEP"). PEP, located in Baltimore, Maryland is a
medical management company contracting with 5 hospitals to provide emergency
department services. The purchase price consisted of Sterling Common Stock
valued at $3,100,000 and $3,100,000 in cash. Additional consideration will be
issued or paid in fiscal 1996 in consideration for the adjusted equity of PEP as
defined, on the acquisition date. The agreement also allows for contingent
consideration on the two year anniversary date as defined in the agreement.
Sterling also granted to certain PEP shareholders options to purchase Sterling
Common Stock. The excess purchase price over the estimated fair value of the net
assets acquired was recorded as goodwill in the amount of $6,600,000 and is
being amortized on a straight-line basis over 25 years.
In July 1994, Sterling acquired Regional Emergency Services, Inc.
("Regional"), a Birmingham, Alabama based company engaged in providing physician
contract management services to 14 hospital emergency departments located in
Alabama, Mississippi, and Tennessee. The purchase price consisted of Sterling
Common Stock valued at $1,400,000 and $400,000 in cash. The excess purchase
price over the estimated fair values of the net assets acquired was recorded as
goodwill in the amount of $1,900,000 and is being amortized on a straight-line
basis over 25 years.
In November 1994, Sterling consummated the acquisition of Physician
Services, Inc. dba Physician Services of America and Brightstar Communications,
Inc. (collectively "PSA"). The purchase price consisted Sterling Common Stock
valued at $1,400,000 and $1,600,000 in cash. The excess purchase price over the
estimated fair value of the net assets acquired was recorded as goodwill in the
amount of $2,600,000 and is being amortized on a straight-line basis over 40
years. Sterling also granted to certain PSA shareholders options to purchase
shares of Sterling's Common Stock vesting over a period of two years. PSA,
headquartered in Louisville, Kentucky, provides physician recruitment and
medical management consulting to hospitals, group practices, HMO's, integrated
delivery systems and insurance companies. PSA has also developed a recruiting
service bureau used by hospitals to develop recruiting programs. In addition,
PSA publishes Life in Medicine magazine which focuses on career opportunities
for physicians.
19. LICENSURE
In February 1995, following a dialogue with the California Department of
Corporations (the "Department") regarding whether the Company's operations
classified it as a health care service plan within the meaning of California
law, the Company, on behalf of one of its wholly-owned subsidiaries, FSC, filed
a restricted license application with the Department. Upon licensure, all of the
Company's managed care activity in the State of California is expected to occur
through this subsidiary. Based on discussion with the Department and the advice
of its California regulatory counsel, the Company believes that it will be able
to meet the requirements for licensure. Notwithstanding the foregoing, there can
be no assurance that the Company's license application will be approved by the
Department. The failure to receive such licensure
F-24
<PAGE> 160
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
would cause the Company to alter the way the Company conducts business in the
State of California and could have a material adverse effect on the future
operations of the Company in the State of California.
20. UNUSUAL ITEMS
In the fourth quarter of 1995, Sterling recorded unusual charges of $1.6
million. This amount includes a $43,000 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 the fourth quarter of 1995,
Sterling sold 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 $3.7 million in revenue and generated an operating loss (including
the unusual items) of $2.1 million for the year.
21. SEGMENT INFORMATION
FPA merged with Sterling, a publicly traded company based in Florida, on
October 31, 1996 (See Note 22). 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 Room").
The activities related to the Primary Care Segment and the Emergency Room
Segment are as follows:
<TABLE>
<CAPTION>
EMERGENCY ROOM PRIMARY CARE CONSOLIDATED
-------------- ------------ ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
SEPTEMBER 30, 1996
Net revenues................................... $100,749 $188,522 $289,271
Operating income............................... 6,309 9,395 15,704
Assets employed at year-end.................... 90,659 185,261 275,920
Depreciation and amortization.................. 2,342 3,898 6,240
Capital expenditures........................... 412 3,483 3,895
DECEMBER 31, 1995
Net 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
Net revenues................................... $ 39,256 $ 18,435 $ 57,691
Operating income............................... 2,349 383 2,732
Assets employed at year-end.................... 26,742 18,310 45,052
Depreciation and amortization.................. 438 133 571
Capital expenditures........................... 499 472 971
DECEMBER 31, 1993
Net revenues................................... $ 13,988 $ 13,988
Operating income............................... 169 169
Assets employed at year-end.................... 1,632 1,632
Depreciation and amortization.................. 51 51
Capital expenditures........................... 40 40
</TABLE>
F-25
<PAGE> 161
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
22. SUBSEQUENT EVENTS
The following significant events have occurred subsequent to the December
31, 1995 balance sheet date:
CREDIT AGREEMENT -- On January 29, 1996, the Company entered into a
$15,000,000 credit, security, guarantee and pledge agreement ("Credit
Agreement") with two financial institutions. Permitted Borrowings, as defined in
the Credit Agreement, generally include acquisitions and capital expenditures.
Fees of $150,000 were paid in connection with the Credit Agreement. On August
31, 1996, the Amended and Restated Credit, Security, Guarantee and Pledge
Agreement (the "Amended Credit Agreement") was executed, pursuant to which fees
of $900,000 were paid. The Amended Credit Agreement allows for borrowings up to
$45,000,000. Borrowings bear interest at rates ranging from either LIBOR plus
2 1/2%, 2 3/8% or 3%, or prime rate plus 1%, 1 1/4%, or 1 1/2%, as defined by
the Amended Credit Agreement. The balance outstanding is due on the earlier of
December 31, 1996 or the consummation of the acquisition of FHMS and Holding
Company, as hereinafter defined. Periodic payments of accrued interest are due
during the term of the Amended Credit Agreement. Additionally, the financial
institutions were granted a security interest in substantially all of the assets
of the Company (excluding those of Gonzaba Management Services Organization,
Inc., FPA Medical Management of Michigan, Inc. d/b/a QualNet, Inc., and OPSU,
Inc., d/b/a Gonzaba Surgery Center), and the stock of certain subsidiaries of
FPA and Professional Corporations was pledged. The debt is also guaranteed by
the Professional Corporations. In connection with the Amended 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 50,000 shares of Common Stock at $9.125 per share exercisable prior to
February 2, 2001, subject to certain anti-dilution provisions. At September 30,
1996, the Company had borrowed $18,421,756 under the Amended Credit Agreement.
On June 28, 1996, FPA borrowed $8,507,760 from a third financial
institution pursuant to a promissory note due on December 31, 1996 and bearing
interest per annum at the higher of the interbank Federal funds rate as
announced by such institution and the base rate of interest announced from time
to time by such institution. Payments under such promissory note were guaranteed
by Foundation Health Corporation.
CALIFORNIA ACQUISITIONS -- Effective January 31, 1996, a Professional
Corporation acquired the stock of three independent practice associations in new
regions in California. All three were stock acquisitions and were financed
through notes payable issued by the Company. In connection with these
transactions, the Company obtained funding from the Credit Agreement for a
cumulative amount of $6,400,000. The purchase price of the first acquisition,
Century IPA, was $7,177,331 ($3,900,000 in cash and the remainder through a
ten-year note payable) and provides the FPA Network access to the Los Angeles,
California, market. The second acquisition, VIP IPA, was made for $6,159,015
($500,000 in cash and the remainder through a ten-year note payable) and
provides the FPA Network access to the Ventura County, California market. The
purchase price of the third acquisition, FHIPA, was $10,063,654 ($7,000,000 in
cash and the remainder through a ten-year note payable) and provides the FPA
Network access to the Sacramento, California, market.
In connection with these acquisitions, the Company opened new
administrative offices in the Los Angeles and Sacramento areas in January, 1996.
These acquisitions will be accounted for using the purchase method of
accounting. The excess of the purchase price over the fair value of tangible
assets acquired will be treated as goodwill and amortized over the expected
periods of future benefit to the Company.
Effective November 29, 1996, FPA acquired all of the outstanding stock of
Foundation Health Medical Services, a California corporation ( "FHMS") and
FHMG/TDMC Medical Group, a California Professional Corporation ("Holding
Company") from Foundation Health Corporation and certain of its affiliates
(collectively, "Foundation"). FHMS provides facilities management, non-physician
health care professionals
F-26
<PAGE> 162
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
and other administrative and management services to Holding Company and its
subsidiaries. Holding Company holds the stock of Foundation Health Medical
Group, Inc., a California Professional Corporation and Thomas-Davis Medical
Centers, P.C., an Arizona Professional Corporation. As consideration for the
acquisitions, FPA paid approximately $200 million, comprised of $5 million in
cash, $75 million in FPA Common Stock and $120 million in notes. The acquisition
has accounted for using the purchase method of accounting.
Effective July 1, 1996, the Company acquired an IPA with approximately
14,000 enrollees in Arizona for $4.0 million ($600,000 in cash and the remainder
through a twelve-month note payable). The transaction has been accounted for
using the purchase method of accounting.
Effective October 1, 1996, a Professional Corporation assumed substantially
all of the assets and liabilities of FPASD, owned by officers of the Company,
for approximately $4.1 million. No cash was exchanged pursuant to this
acquisition. The purchase price was supported by an independent valuation.
FLORIDA ACQUISITIONS -- Effective June 1, 1996, FPA acquired all of the
outstanding stock of Physicians First, Inc., a wholly owned subsidiary of
Physician Corporation of America, operating 40 primary care clinics in Florida.
The clinics have approximately 125 primary care physicians which provide
services to approximately 80,000 enrollees. As consideration for the acquisition
and a related agreement not to compete, FPA paid approximately $21,600,000,
comprised of a $15,000,000 note payable by FPA, 525,000 shares of common stock
and warrants to purchase up to 250,000 shares of FPA Common Stock. The
acquisition has been accounted for using the purchase method of accounting.
The following unaudited pro forma financial information presents the
consolidated results of operations if the acquisition of Physicians First, Inc.
had occurred as of the beginning of the periods presented, after including the
impact of certain adjustments, such as amortization of intangibles.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ ------------
<S> <C> <C>
Revenues................................................ $210,012,819 $308,317,575
Net income.............................................. 2,614,989 7,474,696
Net income per share.................................... .16 .36
</TABLE>
Effective July 1, 1996, the Company acquired an IPA with approximately
6,000 enrollees for $16.0 million ($2.4 million in cash and the remainder
through a twelve-month note payable). The transaction has been accounted for
using the purchase method of accounting.
GLHP -- On March 7, 1996, FPA made an additional capital contribution of
$3,000,000 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 17,000 Medicaid enrollees.
BUSINESS COMBINATION -- On October 31, 1996, FPA and Sterling consummated a
business combination ("the Combination"). As a result of the Combination, each
outstanding share of Sterling $.0001 par value common shares was converted to
.951 shares of FPA, $.002 par value common stock. Sterling's shareholders were
issued approximately 8,097,781 shares of FPA, representing approximately 37% of
the total issued and outstanding shares of FPA after the Combination. The
Combination has been accounted for as a pooling of interests and, accordingly,
the accompanying supplemental consolidated financial statements have been
prepared on a basis that includes the accounts of Sterling since June 1, 1994.
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.
F-27
<PAGE> 163
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO SUPPLEMENTAL FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
1994 1995
----------- ------------
<S> <C> <C>
Revenues:
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>
F-28
<PAGE> 164
INDEPENDENT AUDITORS' REPORT
Foundation Health Medical Services and Affiliates
We have audited the accompanying combined balance sheets of Foundation
Health Medical Services (a wholly-owned subsidiary of Foundation Health
Corporation) and its affiliates Foundation Health Medical Group, Inc. and
Thomas-Davis Medical Centers, P.C. (collectively the "Combined Companies"), as
of June 30, 1995 and 1996, and the related combined statements of operations,
shareholders' deficit, and cash flows for each of the three years in the period
ended June 30, 1996. These financial statements are the responsibility of the
Combined Companies' management. Our responsibility is to express an opinion on
these financial statements based on our audits. We did not audit the financial
statements of Thomas-Davis Medical Centers, P.C., for the year ended December
31, 1993, which statements reflect total revenues from operations of
$100,625,000 (which revenues have been included in the accompanying combined
statement of operations for the year ended June 30, 1994, as discussed in Note 2
to the combined financial statements). Those financial statements of
Thomas-Davis Medical Centers, P.C. were audited by other auditors whose report
has been furnished to us, and our opinion insofar as it relates to the amounts
included for Thomas-Davis Medical Centers, P.C., for the year ended June 30,
1994, is based solely on the report of the 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 financial statements present fairly, in all material respects, the combined
financial position of the Combined Companies as of June 30, 1995 and 1996, and
the combined results of their operations and their combined cash flows for each
of the three years in the period ending June 30, 1996 in conformity with
generally accepted accounting principles.
As discussed in Note 11 to the combined financial statements, the Combined
Companies receive a significant portion of their operating revenues from, and
have significant related party transactions with, two affiliated health
maintenance organizations and their Parent.
DELOITTE & TOUCHE LLP
Sacramento, California
September 30, 1996
F-29
<PAGE> 165
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED BALANCE SHEETS
JUNE 30, 1995 AND 1996
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------
1995 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 1,566,000 $ --
Patient receivables, net of allowance for uncollectible
accounts of $3,988,000 and $3,654,000...................... 6,778,000 4,828,000
Accounts receivable from related parties...................... 2,869,000 387,000
Other current assets.......................................... 2,979,000 3,722,000
------------ ------------
Total current assets.................................. 14,192,000 8,937,000
Property and equipment, net..................................... 109,985,000 93,367,000
Goodwill and other intangible assets, net....................... 9,135,000 12,755,000
Other assets.................................................... 2,810,000 3,520,000
------------ ------------
Total assets.......................................... $136,122,000 $118,579,000
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Reserves for claims payable................................... $ 7,701,000 $ 15,900,000
Accounts payable and accrued expenses......................... 10,708,000 14,128,000
Accounts payable to related party............................. -- 625,000
Intercompany payables......................................... 6,154,000 10,396,000
Intercompany accrued interest................................. 2,326,000 2,303,000
Intercompany notes payable.................................... 129,251,000 133,036,000
Current portion of bonus payable.............................. 1,983,000 2,813,000
Deferred compensation......................................... 8,315,000 9,333,000
Current portion of intercompany lease obligations............. 701,000 595,000
Current portion of other liabilities.......................... 1,530,000 974,000
Current portion of other notes payable........................ 332,000 259,000
------------ ------------
Total current liabilities............................. 169,001,000 190,362,000
Noncurrent portion of bonus payable............................. 9,269,000 6,229,000
Noncurrent portion of other notes payable....................... 258,000 124,000
Intercompany lease obligations.................................. 1,465,000 862,000
Other liabilities............................................... 5,468,000 2,597,000
------------ ------------
Total liabilities..................................... 185,461,000 200,174,000
------------ ------------
Shareholders' deficit:
Common stock.................................................. 20,000 20,000
Contributed capital........................................... 4,722,000 4,722,000
Accumulated deficit........................................... (54,081,000) (86,337,000)
------------ ------------
Total shareholders' deficit........................... (49,339,000) (81,595,000)
------------ ------------
Total liabilities and shareholders' deficit........... $136,122,000 $118,579,000
============ ============
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-30
<PAGE> 166
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenue:
Capitation revenue -- related party.................. $ 82,777,000 $ 80,281,000 $119,639,000
Patient service revenue, net......................... 21,777,000 29,222,000 19,001,000
Patient service revenue, net -- related party........ 3,215,000 5,560,000 5,638,000
Gain on sale of specialty practices.................. 2,338,000 -- 3,577,000
Other income......................................... 596,000 3,233,000 5,907,000
------------ ------------ ------------
Total revenue................................ 110,703,000 118,296,000 153,762,000
------------ ------------ ------------
Expenses:
Salaries and benefits................................ 72,800,000 97,147,000 114,076,000
Health care services................................. 22,770,000 22,793,000 54,249,000
Selling, general and administrative.................. 22,925,000 31,578,000 42,349,000
General and administrative -- related party.......... -- 986,000 4,143,000
Depreciation and amortization........................ 3,373,000 6,393,000 9,179,000
Interest expense -- intercompany..................... 830,000 5,758,000 9,963,000
Interest expense..................................... 2,065,000 1,668,000 416,000
Other................................................ 921,000 1,680,000 --
------------ ------------ ------------
Total expenses............................... 125,684,000 168,003,000 234,375,000
------------ ------------ ------------
Loss before income taxes............................... (14,981,000) (49,707,000) (80,613,000)
Benefit for income taxes............................... 3,786,000 4,366,000 48,357,000
------------ ------------ ------------
Net loss............................................... $(11,195,000) $(45,341,000) $(32,256,000)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-31
<PAGE> 167
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF SHAREHOLDERS' DEFICIT
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
COMMON STOCK
------------------ CONTRIBUTED ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------- ------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at July 1, 1993............ 10,200 $20,000 $2,064,000 $ 7,988,000 $ 10,072,000
Net loss........................... (11,195,000) (11,195,000)
TDMC net loss for six months
ended June 30, 1994 (Note 2)..... (5,533,000) (5,533,000)
------ ------- ---------- ------------ ------------
Balance at June 30, 1994........... 10,200 20,000 2,064,000 (8,740,000) (6,656,000)
Net assets transferred from parent
(Note 1)......................... 2,658,000 2,658,000
Net loss........................... (45,341,000) (45,341,000)
------ ------- ---------- ------------ ------------
Balance at June 30, 1995........... 10,200 20,000 4,722,000 (54,081,000) (49,339,000)
Net loss........................... (32,256,000) (32,256,000)
------ ------- ---------- ------------ ------------
Balance at June 30, 1996........... 10,200 $20,000 $4,722,000 $(86,337,000) $(81,595,000)
====== ======= ========== ============ ============
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-32
<PAGE> 168
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................. $(11,195,000) $(45,341,000) $(32,256,000)
Adjustments to reconcile net loss to net cash used
for operating activities:
Depreciation....................................... 2,768,000 3,911,000 6,893,000
Amortization....................................... 605,000 2,482,000 2,286,000
Equity in income of unconsolidated subsidiary...... -- (248,000) (289,000)
Gain on sale of specialty practices................ (2,338,000) -- (3,577,000)
Provision for uncollectible patient receivables.... 393,000 666,000 (334,000)
Credit for income taxes applied against
intercompany debt............................... -- -- (48,357,000)
Changes in assets and liabilities:
Patient receivables............................. 828,000 108,000 2,284,000
Account receivable from related parties......... (1,496,000) 2,320,000 2,482,000
Other current assets............................ (1,459,000) 7,017,000 (743,000)
Accounts payable and accrued expenses........... 3,676,000 (11,924,000) 2,935,000
Accounts payable to related party............... -- -- 625,000
Reserve for claims payable...................... -- 7,701,000 8,199,000
Other current liabilities....................... 21,000 11,252,000 (2,210,000)
Interest payable to related party............... (4,000) -- --
Intercompany payables and accrued interest...... (4,251,000) 7,479,000 4,219,000
Deferred compensation........................... 5,107,000 7,719,000 1,018,000
------------ ------------ ------------
Net cash used for operating activities............... (7,345,000) (6,858,000) (56,825,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in cash overdraft........................... -- -- 485,000
Acquisition of property and equipment................ (29,812,000) (48,926,000) (27,734,000)
Proceeds from disposition of property and
equipment.......................................... -- -- 5,384,000
Increase in intangible assets........................ (2,952,000) (1,972,000) (3,108,000)
Proceeds from sale of specialty practices............ 3,012,000 -- 4,012,000
Purchase of interest in unconsolidated subsidiary.... -- (5,980,000) --
Decrease (increase) in other assets.................. (1,833,000) 1,394,000 (525,000)
Decrease in notes receivable from related parties.... 278,000 -- --
Proceeds from interest in unconsolidated
subsidiary......................................... -- 257,000 104,000
------------ ------------ ------------
Net cash provided/(used) for investing activities.... (31,307,000) (55,277,000) (21,382,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Paydown of notes payable to related parties.......... (391,000) -- --
Use of restricted funds for construction............. 970,000 -- --
Paydown of other long-term obligations............... (38,000) (15,280,000) --
Paydown of other notes payable....................... (893,000) (10,679,000) (325,000)
Proceeds from intercompany notes payable............. 32,675,000 106,357,000 80,984,000
Paydown of intercompany notes payable................ -- (14,401,000) --
Paydown of other liabilities......................... (1,058,000) (3,427,000) (4,136,000)
Proceeds from other notes payable.................... 3,204,000 -- 118,000
Proceeds from line of credit with FHC................
------------ ------------ ------------
Net cash flows provided by financing activities...... 34,469,000 62,570,000 76,641,000
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents........................................ (4,183,000) 485,000 (1,566,000)
</TABLE>
F-33
<PAGE> 169
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH AND CASH EQUIVALENTS:
Beginning of period.................................. 5,264,000 1,081,000 1,566,000
------------ ------------ ------------
End of period........................................ $ 1,081,000 $ 1,566,000 $ --
============ ============ ============
SUPPLEMENTAL DISCLOSURE:
Cash paid during the year for:
Interest........................................ $ 2,913,000 $ 5,321,000 $ 9,986,000
============ ============ ============
Effect of intercompany transfers (Note 1):
Assets, net of cash............................. $ -- $ 48,225,000 $ --
============ ============ ============
Liabilities..................................... $ -- $ 45,567,000 $ --
============ ============ ============
Noncash investing and financing transactions:
Issuance of notes payable to acquire intangible
assets........................................ $ 521,000 $ 316,000 $ --
============ ============ ============
Property and equipment acquired through trade
payables...................................... $ 4,083,000 $ 2,584,000 $ --
============ ============ ============
Transfer of property and equipment for reduction
of intercompany debt.......................... $ $ $ 28,842,000
============ ============ ============
Transfer of receivables for reduction of
intercompany debt............................. $ $ $ 48,357,000
============ ============ ============
Assumption of liabilities in conjunction with
acquisition of physician practice............. $ -- $ -- $ 3,045,000
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-34
<PAGE> 170
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
AND THREE MONTHS ENDED SEPTEMBER 30, 1995 AND
1996 "UNAUDITED"
NOTE 1 -- NATURE OF OPERATIONS
Foundation Health Medical Services ("FHMS") is a wholly-owned subsidiary of
Foundation Health Corporation ("FHC"), and was incorporated on September 2,
1992. FHMS, headquartered in Sacramento, California, is a health care management
service organization which provides facilities, administrative and operational
services, including claims processing, accounting and financial reporting
(collectively "services") to two affiliated professional medical corporations
(the "Medical Groups"), one each located in California (Foundation Health
Medical Group, Inc. ("FHMG")) and Arizona (Thomas-Davis Medical Centers, P.C.
("TDMC")). FHMS' subsidiary, Catalina Professional Recruiters, Inc. ("CPR"),
provides temporary and permanent physician placement services.
On April 2, 1996, the Shareholder of FHMG and TDMC transferred his
interests in FHMG and TDMC to a holding company, FHMG/TDMC Medical Group (the
"Holding Company"), a professional corporation in exchange for 100% of the
Holding Company's common stock.
FHMG, a California professional corporation, was incorporated on August 14,
1992, FHMG provides primary health care services and employs 110 providers at 17
health care centers in California as of June 30, 1996. FHMG is wholly-owned
through the Holding Company by a physician (the "Shareholder"), who is an
employee of an FHC subsidiary. FHC has the right to cause ownership of the
Holding Company to be transferred to another shareholder of its designation who
would be qualified to own the stock of a California medical corporation.
TDMC, an Arizona professional corporation, was incorporated on October 13,
1994. TDMC provides primary and specialty health care services and employs 217
providers at 18 health care centers in Arizona as of June 30, 1996. In November
1994, TDMC entered into physician employment contracts with a majority of the
physicians of a professional medical corporation which merged with FHC effective
November 1, 1994 and is deemed for financial reporting purposes to be a
predecessor company of TDMC. Concurrently, TDMC entered into provider contracts
with several of the payors formerly served by the predecessor company of TDMC.
TDMC is wholly-owned by the Holding Company. FHC has the right to cause
ownership of the Holding Company to be transferred to another shareholder of its
designation who would be qualified to own the stock of an Arizona professional
medical corporation.
During the year ended June 30, 1995, the net assets of Foundation Health
Real Estate Services, a wholly-owned subsidiary of FHC, amounting to $2,141,000
and a portion of the net assets of the predecessor company of TDMC amounting to
$517,000 were transferred to FHMS at their recorded book value.
On June 28, 1996 the Shareholder of the Holding Company and FHC entered
into an agreement with FPA Medical Management, Inc., FPA Medical Management of
California, Inc. and FPA Independent Practice Association, an Osteopathic
Medical Corporation ("FPA IPA") to sell all of the outstanding stock of the
Holding Company to FPA IPA and all of the outstanding stock of FHMS to FPA
subject to regulatory approval and customary closing conditions.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Combination and basis of presentation
The combined financial statements include the accounts of FHMS, FHMG and
TDMC (collectively the "Combined Companies"). The combined statement of
operations for the year ended June 30, 1994 includes
F-35
<PAGE> 171
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
the financial results of the predecessor company of TDMC for the year ended
December 31, 1993. All significant intercompany transactions have been
eliminated in combination. The net loss of the predecessor company of TDMC for
the six months ended June 30, 1994 has been reflected as an addition to the
accumulated deficit as of June 30, 1994.
Cash and cash equivalents
Cash and cash equivalents consist of cash and cash equivalents with
original maturities of three months or less when acquired.
Goodwill and other intangible assets
Goodwill and other intangible assets consist primarily of goodwill and
other intangibles related to the Combined Companies acquisition of various
medical practices and deferred direct and incremental preoperating costs related
to the opening of health care centers. Preoperating costs are deferred prior to
the commencement of significant operations at which time the Combined Companies
begin amortizing such costs. Fully amortized intangible assets and related
accumulated amortization are removed from the accounts. The Combined Companies
evaluate the carrying value of their intangible assets at each balance sheet
date.
Goodwill and other intangible assets are amortized as follows:
<TABLE>
<CAPTION>
LIFE METHOD
-------------------------- --------------
<S> <C> <C>
Goodwill..................................... 40 years Straight line
Organization and preoperating costs.......... 3 years Straight line
Noncompetition and employment agreements..... Term of related agreement Straight line
</TABLE>
Goodwill of $6,737,000 and $10,368,000 at June 30, 1995 and 1996, net of
accumulated amortization of $163,000 and $375,000, is included in goodwill and
other intangible assets.
Revenue recognition
Capitation revenue from payors is recognized in the month in which the
related enrollees are entitled to services. Agreements with payors may also
contain provisions for incentive payments if the Medical Groups achieve or
exceed certain utilization levels.
Patient service revenue is reported at the estimated realizable amounts
from patients, third-party payors and others for services rendered. Revenue
under certain third-party payor agreements is subject to audit and retroactive
adjustments. Provisions for estimated third-party payor settlements and
adjustments are estimated in the period the related services are rendered and
are adjusted in future periods as final settlements are determined.
FHMG has contracts with various managed care organizations and indemnity
insurers to provide physician services based on negotiated fee schedules. In May
1995, FHMG entered into a primary care capitation contract with Foundation
Health, a California Health Plan (the "Health Plan"). Under the contract FHMG is
at risk for primary care services provided by its physician employees.
Capitation payments are received to cover all primary care services provided to
the Health Plan members linked to FHMG physicians. In November 1995 FHMG
renegotiated its capitation contract with the Health Plan. This new agreement
provides for a fixed payment per member per month for all primary and specialty
professional medical services rendered for Health Plan members linked to FHMG
physicians.
F-36
<PAGE> 172
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
TDMC has contracts with various managed care organizations and indemnity
insurers to provide physician services based on negotiated fee schedules. TDMC
has contracted with Intergroup Prepaid Health Services of Arizona, Inc.
("Intergroup"). Under the contract TDMC is at risk for primary and specialty
health care services.
Reserves for claims payable
Reserves for claims and health care expenses are based upon the
accumulation of cost estimates for unpaid claims reported prior to the close of
the accounting period, together with a provision for the current estimate of the
probable cost of claims that have occurred but have not yet been reported. Such
estimates are based on many variables including individual cases for reported
claims, estimates of unreported claims using historical and statistical
information and other factors. The methods for making the estimates and for
establishing the resulting reserves are continually reviewed and updated, and
any adjustments resulting therefrom are reflected in current operations. Given
the inherent variability of such estimates, the actual liability could differ
significantly from the amounts provided. While the ultimate amount of claims and
the related expenses paid are dependent on future developments, management is of
the opinion that the reserves for claims is adequate to cover such claims. These
liabilities are reduced by estimated amounts receivable from third-parties for
subrogation.
Property and equipment
Property and equipment is recorded at cost. Depreciation is provided using
the straight-line method for all assets over their estimated useful lives as
follows:
<TABLE>
<S> <C>
Buildings and improvements............................................... 5-40 years
Furniture and equipment.................................................. 3-10 years
</TABLE>
Expenditures for maintenance and repairs are expensed as incurred. Major
improvements which increase the estimated useful life of an asset are
capitalized. Upon the sale or retirement of assets, recorded cost and related
accumulated depreciation are removed from the accounts, and any gain or loss on
disposal is reflected in operations.
Income taxes
The Combined Companies account for income taxes using the liability method.
Deferred income tax assets and liabilities result from temporary differences
between the tax basis of assets and liabilities and their reported amounts in
the combined financial statements that will result in taxable or deductible
amounts in future years. Pursuant to a tax allocation agreement with FHC, the
Combined Companies reflect a provision/ benefit for income taxes under the
liability method as if they were to file separate federal and state tax returns
(Note 8).
Fair Value of Financial Instruments
The carrying amount of financial instruments reported in the combined
balance sheets for cash and cash equivalents, accounts receivable, accounts
payable and short-term debt approximates fair value because of the short-term
maturity of these financial instruments. The carrying amount for intercompany
revolving credit approximates fair value.
The fair values of fixed rate notes payable and other long-term liabilities
are estimated by discounting future cash flows using current discount rates that
reflect the risks associated with similar types of loans. At
F-37
<PAGE> 173
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
June 30, 1996 the estimated fair values of the Combined Companies' notes payable
and other long-term liabilities approximate the carrying value.
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Recently issued accounting pronouncements
The Combined Companies intend to adopt Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of ("SFAS No. 121") during the year ending June
30, 1997. Adoption of SFAS No. 121 is not expected to have a significant effect
on the Combined Companies' financial statements.
NOTE 3 -- PROPERTY AND EQUIPMENT
Property and equipment comprised the following:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------
1995 1996
------------ ------------
<S> <C> <C>
Land.................................................... $ 14,700,000 $ 10,624,000
Construction in progress................................ 8,192,000 2,722,000
Buildings and improvements.............................. 69,972,000 65,484,000
Furniture and equipment................................. 32,848,000 35,816,000
------------ ------------
125,712,000 114,646,000
Less: Accumulated depreciation.......................... (15,727,000) (21,279,000)
------------ ------------
$109,985,000 $ 93,367,000
============ ============
</TABLE>
Included in property and equipment at June 30, 1995 and 1996 is $1,662,000
and $1,861,000 of capitalized interest. During the years ended June 30, 1994,
1995 and 1996, the Combined Companies capitalized $628,000, $1,034,000, and
$199,000 of its interest expense.
Depreciation expense on property and equipment was $2,768,000, $3,911,000,
and $6,893,000 for the years ended June 30, 1994, 1995 and 1996.
NOTE 4 -- INTERCOMPANY NOTES PAYABLE
Intercompany notes payable comprised the following:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------------
1995 1996
------------ ------------
<S> <C> <C>
Notes payable, secured by land and building............. $ 42,526,000 $ 19,994,000
Unsecured revolving line of credit...................... 86,725,000 113,042,000
------------ ------------
$129,251,000 $133,036,000
============ ============
</TABLE>
F-38
<PAGE> 174
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
The secured notes payable to the Health Plan bears interest at 7.75% and
are payable on demand with interest payable quarterly. The revolving credit
agreement is with FHC and restricts the ability of the Combined Companies to pay
dividends and bonuses, acquire assets, enter into liens, incur additional
indebtedness or to otherwise merge, sell or dispose of assets. The credit
agreement bears interest at 7.75%, payable quarterly. Principal and interest is
due June 30, 1997 subject to automatic one-year extensions of the maturity date
unless FHC provides written notice of intent to terminate the agreement. The
amount outstanding under the unsecured revolving line of credit was reduced by
$48,357,000 for net income tax benefits generated by the Combined Companies.
NOTE 5 -- BONUS PAYABLE
Certain physician retention bonus obligations are payable to selected TDMC
physicians over a period of four to six years, subject to the physician's
continued employment. Amounts forfeited by participating physicians remain in
the bonus pool and are distributed to the remaining participants. The estimated
present value of future bonus payments was $11,252,000 and $9,042,000 at June
30, 1995 and 1996.
NOTE 6 -- OTHER LIABILITIES
Other liabilities at June 30, 1995 and 1996 comprised the following:
<TABLE>
<CAPTION>
1995 1996
----------- ----------
<S> <C> <C>
Stock Redemption Notes bearing an average interest rate of
5.87% with maturity dates through December 2020.......... $ 655,000 $ 423,000
Notes payable, secured by building, bearing an interest
rate of 9% due April 1997................................ 400,000 400,000
Notes payable, secured by land and building, bearing an
interest rate of 6.08%, due on dates through December
2004..................................................... 2,878,000 2,647,000
Capital lease obligations.................................. 3,065,000 101,000
----------- ----------
6,998,000 3,571,000
Current portion............................................ (1,530,000) (974,000)
----------- ----------
$ 5,468,000 $2,597,000
========== =========
Intercompany lease obligations............................. $ 2,166,000 1,457,000
Current portion............................................ (701,000) (595,000)
----------- ----------
$ 1,465,000 $ 862,000
========== =========
</TABLE>
The Combined Companies lease certain of their equipment under capital
leases that provide for purchase options. Property and equipment under capital
leases was $9,286,000 and the related accumulated depreciation was $4,897,000 at
June 30, 1995. The amount of equipment leased under capital leases at June 30,
1996 was not material.
F-39
<PAGE> 175
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
Future minimum payments under capital leases at June 30, 1996 are as
follows:
<TABLE>
<S> <C>
1997..................................................................... $ 716,000
1998..................................................................... 459,000
1999..................................................................... 389,000
2000..................................................................... 176,000
2001..................................................................... --
----------
1,740,000
Less: Amount representing interest....................................... 182,000
----------
$1,558,000
=========
</TABLE>
NOTE 7 -- COMMON STOCK
Common stock at June 30, 1995 and 1996 is comprised of the common stock of
FHMS, FHMG and TDMC as follows:
<TABLE>
<S> <C>
FHMS, no par value, 100 shares authorized, issued and outstanding.......... $ 5,000
FHMG, no par value, 100 shares authorized, issued and outstanding.......... 5,000
TDMC, $1 par value, 10,000 shares authorized, issued and outstanding....... 10,000
-------
$20,000
=======
</TABLE>
NOTE 8 -- INCOME TAXES
For income tax purposes, the operating results of FHMS have been included
in FHC's consolidated tax return for all years. In December 1995, TDMC and FHMG
entered into a similar tax sharing agreement with FHC. As a result, the losses
of TDMC and FHMG will be included in FHC's consolidated tax return as filed, or
as amended, for all years. The tax benefit of the net operating losses of TDMC
since inception in November 1994 and the net operating losses of FHMG for all
years is provided in the tax provision for the year ended June 30, 1996, the
period in which the tax sharing agreement was signed.
The Combined Companies' benefit for income taxes for the years ended June
30, 1994, 1995 and 1996 were comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------
1994 1995 1996
---------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal............................................ $3,837,000 $ 6,088,000 $43,189,000
State.............................................. 848,000 1,477,000 7,570,000
---------- ----------- -----------
Total current.............................. 4,685,000 7,565,000 50,759,000
---------- ----------- -----------
Deferred:
Federal............................................ (731,000) (2,610,000) (2,128,000)
State.............................................. (168,000) (589,000) (274,000)
---------- ----------- -----------
Total deferred............................. (899,000) (3,199,000) (2,402,0000
---------- ----------- -----------
Total benefit for income taxes....................... $3,786,000 $ 4,366,000 $48,357,000
========== =========== ===========
</TABLE>
F-40
<PAGE> 176
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
At June 30, 1994, 1995 and 1996 the Combined Companies had no income taxes
currently payable. All deferred taxes are held at FHC and settled through the
intercompany payable account.
NOTE 9 -- EMPLOYEE BENEFIT PLANS
Substantially all of FHMS' employees are eligible to participate in the
Foundation Health Corporation Profit sharing and 401(k) Plan ("FHC Plan").
Generally, employees may contribute up to 10% of their annual compensation to
the FHC Plan on a pre-tax basis and up to 10% on an after-tax basis. Under the
FHC Plan, FHMS makes matching contributions of up to a maximum of 50% of the
first 6% of each participating employee's base salary. FHMS' contributions, to
the FHC Plan totaled $15,000, $332,000 and $236,000 for the years ended June 30,
1994, 1995 and 1996.
FHMG and TDMC physician employees may participate in the FHMG 401(k) Plan.
Generally, participating employees may contribute up to 10% of their annual
compensation to the plan on a pre-tax basis and up to an additional 10% on an
after-tax basis. Under the plan, FHMG and TDMC make matching contributions of up
to 6% of each participating employee's base salary. FHMG and TDMC contributions
to the plan totaled $223,000, $1,204,000 and $2,160,000 for the years ended June
30, 1994, 1995 and 1996.
Deferred Compensation Plan
Certain FHMS employees are eligible to participate in the FHC deferred
compensation plan. Under the FHC deferred compensation plan, certain members of
management and highly compensated employees may defer payment of up to 90% of
their compensation. FHMS makes matching contributions subject to a vesting
schedule, of up to 10% of an employee participant's compensation if the
participant's base salary is at least $100,000. The deferred compensation,
together with FHMS matching amounts and accumulated interest which is accrued
but unfunded, is distributable in cash by lump sum or in monthly quarterly or
annual installments (not exceeding 20 years) upon the earlier of the date of
distribution elected by the participant or termination of employment. FHMS'
expense under the plan totaled $32,000, $89,000 and $205,000 for the years ended
June 30, 1994, 1995 and 1996. The Combined Companies' liability under the plan
amounted to $23,000 and $207,000 at June 30, 1995 and 1996. Such amount has been
included in accounts payable and accrued expenses.
During 1995, FHC amended the FHC deferred compensation plan by increasing
the interest rate paid to participants to 140% of Moody's corporate bond rate
and by allowing participants to receive 90% of vested funds before scheduled
distributions by irrevocably forfeiting the remaining 10%.
During the year ended June 30, 1995, the Combined Companies recorded a
liability relating to the deferred compensation plan of the predecessor company
of TDMC. Under the terms of the plan, interest accrues at the Citibank base rate
plus .25%. At June 30, 1995 and 1996, the liability recorded by the Combined
Companies related to this plan was $6,784,000 and $5,703,000. The Combined
Companies' expense under the plan totaled $394,000 and $516,000 for the years
ended June 30,1995 and 1996.
Certain FHMG and TDMC employees may participate in FHMG's deferred
compensation plan and defer payment of up to 90% of their compensation. The
deferred compensation, together with the accumulated interest which is accrued,
but unfunded, is distributable in cash by lump sum or in monthly, quarterly, or
annual installments (not exceeding 20 years) upon the earlier of the date of
distribution elected by the participant or termination of employment. Under the
terms of the plan, interest accrues at the Citibank's base rate plus .25%. The
liability under this plan amounted to $1,531,000 and $3,423,000 as of June 30,
1995 and
F-41
<PAGE> 177
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
1996. The Combined Companies' expense under the plan totaled $23,000, $75,000
and $229,000 for the years ended June 30, 1994, 1995, and 1996.
NOTE 10 -- ACQUISITIONS
During 1994, the Combined Companies acquired 16 physician practices. The
aggregate purchase price, including direct costs, of these practices was
$1,210,000 of which $650,000 was classified as goodwill, which is being
amortized over 40 years and $560,000 was recorded as the value of covenants not
to compete, which is being amortized over the contractual obligation of the
physicians not to compete of three years.
During 1995, the Combined Companies acquired 24 physician practices. The
aggregate purchase price, including direct costs of these practices was $571,000
which was classified as goodwill and is being amortized over 40 years.
In August 1995, FHMS and TDMC purchased Tucson Medical Associates, Ltd., a
medical group of 25 primary care physicians, for consideration of approximately
$6,145,000. Goodwill of $5,038,000 was recorded in connection with the
transaction. This acquisition and the acquisitions described above were
accounted for under the purchase method of accounting.
NOTE 11 -- INTERCOMPANY RELATED PARTY TRANSACTIONS
The Combined Companies are involved in the following transactions with
their affiliates:
- FHMS received certain oversight and administrative services under the
terms of administrative service agreements with FHC and affiliates.
Fees for these services were waived by FHC and its affiliates for the
years ended June 30, 1994, 1995 and 1996.
- The administration and payment of certain general and administrative
expenses are provided by FHC and various affiliates and such costs are
charged back to the appropriate affiliates. These transactions arise
in the normal course of business and are payable on the same terms as
equivalent transactions with nonaffiliates. At June 30, 1995 and 1996,
FHMS had amounts due of $6,154,000 and $10,396,000 related to these
transactions.
- FHMS has a revolving credit agreement to obtain financing from FHC and
an affiliate (Note 4). At June 30, 1995 and 1996 the Combined
Companies owed $2,326,000 and $2,303,000 in accrued interest related
to borrowings under these agreements. The Medical Groups have incurred
operating losses since their inception and are dependent upon
borrowings from FHC and their affiliates to finance their operations.
FHC intends to continue to finance the Combined Companies' operations subject to
the transfer of ownership discussed in Note 1.
- The Combined Companies have a tax allocation agreement with FHC (Note
8).
- During 1994, 1995, and 1996, FHMG contracted with the Health Plan to
provide health care services to its members at FHMS' health care
centers in California. During the years ended June 30, 1994, 1995, and
1996 revenues for medical services provided by the Combined Companies
to Health Plan's members totaled approximately $3,215,000, $6,839,000,
and $35,142,000. As of June 30, 1995 and 1996 the Combined Companies
have a receivable from the Health Plan for such services of
$1,380,000, and $387,000.
F-42
<PAGE> 178
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED JUNE 30, 1994, 1995 AND 1996
- The Combined Companies contract with Intergroup to provide health care
services to Intergroup's members at FHMS' care centers in Arizona.
Intergroup is a wholly-owned subsidiary of FHC. During the period
ended June 30, 1994, 1995, and 1996 revenues for medical services
provided by the Combined Companies to Intergroup's enrollees totaled
$82,777,000, $79,002,000 and $90,135,000. As of June 30, 1995 and
1996, the Combined Companies have a receivable from (payable to)
Intergroup for such services of $1,489,000 and $(625,000).
- Certain of the physician employees of the Medical Groups have been
granted options to purchase FHC common stock under the FHC 1993
Nonstatutory Stock Option Plan. The options are granted at the
discretion of the Compensation and Organizational Committee of the
Board of Directors of FHC; however, options to purchase 600,000 shares
of FHC common stock were reserved for issuance to TDMC's physicians in
conjunction with the merger of the predecessor company of TDMC with
FHC. Options are granted at an exercise price equal to the fair market
value of the stock at the date of grant. Under the Plan, options to
purchase 424,149 and 384,075 shares of FHC common stock were granted
to physician employees of the Medical Groups during the years ended
June 30, 1995 and 1996.
NOTE 12 -- COMMITMENTS AND CONTINGENCIES
During the year ended June 30, 1995, FHMS entered into a $60 million tax
retention operating lease (the "TROL agreement") for the construction of health
care centers and corporate facilities.
Under the TROL agreement, rental payments commence with the completion of
construction of facilities. Rental payments are based on the outstanding
property cost multiplied by the 30-day London Interbank Offering Rate (LIBOR)
plus .445%. At June 30, 1995 and 1996, the outstanding property cost was
$5,400,000 and $22,500,000 and LIBOR was 6.125% and 5.844%. FHC, as guarantor,
of FHMS' obligations under the TROL agreement has provided the lessor with a
guarantee of 87% of the residual value of the properties leased at the end of
the lease term. After the initial five-year noncancelable lease term, the lease
may be extended by agreement of the parties or FHC must purchase or arrange for
the sale of the leased properties.
FHMG and TDMC have certain insurance with respect to general liability and
medical malpractice risks on a claims made basis. Management is not aware of any
claims against the Medical Groups in excess of their policy limits. It is the
opinion of management that the ultimate resolution of any unasserted claims will
not have a material adverse effect on the financial position or operating
results of the Combined Companies.
TDMC and FHC have been named as defendants in several lawsuits relating to
FHC's acquisition of the predecessor company of TDMC. FHC has agreed to
indemnify the Combined Companies for their share of losses, if any, related to
these lawsuits; accordingly, no provision for any loss has been recorded in the
accompanying financial statements.
F-43
<PAGE> 179
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED BALANCE SHEETS
SEPTEMBER 30, 1995 AND 1996
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------------
1995 1996
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................... $ 9,617,000 $ --
Patient receivables, net of allowance for uncollectible
accounts.................................................. 7,688,000 4,665,000
Accounts receivable from related parties..................... 2,346,000
Other current assets......................................... 3,518,000 5,105,000
------------ ------------
Total current assets................................. 23,169,000 9,770,000
Property and equipment, net.................................... 87,382,000 91,055,000
Goodwill and other intangible assets, net...................... 13,532,000 12,115,000
Other assets................................................... 2,836,000 5,408,000
------------ ------------
Total assets......................................... $126,919,000 $ 118,348,000
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Reserves for claims payable.................................. $ 7,002,000 $ 12,990,000
Accounts payable and accrued expenses........................ 22,638,000 19,570,000
Accounts payable to related party............................ 2,371,000
Intercompany payables........................................ 7,958,000 7,925,000
Intercompany notes payable................................... 137,319,000 156,818,000
Current portion of other liabilities......................... 1,422,000 1,497,000
------------ ------------
Total current liabilities............................ 178,710,000 198,800,000
Noncurrent portion of other notes payable...................... 238,000
Other liabilities.............................................. 13,882,000 18,220,000
------------ ------------
Total liabilities.................................... 192,830,000 217,020,000
------------ ------------
Shareholder's deficit:
Common stock................................................. 20,000 20,000
Contributed capital.......................................... 4,722,000 4,722,000
Accumulated deficit.......................................... (70,653,000) (103,414,000)
------------ ------------
Total shareholder's deficit.......................... (65,911,000) (98,672,000)
------------ ------------
Total liabilities and shareholder's deficit.......... $126,919,000 $ 118,348,000
============ ============
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-44
<PAGE> 180
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996
UNAUDITED
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Revenue:
Capitation revenue -- related party........................... $ 19,618,000 $ 32,919,000
Patient service revenue, net.................................. 7,858,000 4,175,000
Patient service revenue, net -- related party................. 1,156,000 1,422,000
Other income.................................................. 1,186,000 745,000
------------ ------------
Total revenue......................................... 29,818,000 39,261,000
------------ ------------
Expenses:
Salaries and benefits......................................... 26,716,000 24,281,000
Health care services.......................................... 4,671,000 17,150,000
Selling, general and administrative........................... 9,009,000 8,500,000
General and administrative -- related party................... 944,000 675,000
Depreciation and amortization................................. 2,219,000 2,429,000
Interest expense -- intercompany.............................. 3,067,000 2,647,000
------------ ------------
Total expenses........................................ 46,626,000 55,682,000
------------ ------------
Loss before income taxes........................................ (16,808,000) (16,421,000)
Benefit (provision) for income taxes............................ 235,000 (656,000)
------------ ------------
Net loss........................................................ $(16,573,000) $(17,077,000)
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-45
<PAGE> 181
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF SHAREHOLDER'S DEFICIT
THREE MONTHS ENDED SEPTEMBER 30, 1996
UNAUDITED
<TABLE>
<CAPTION>
COMMON STOCK
----------------- CONTRIBUTED ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------- ------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at July 1, 1995.......... 10,200 $20,000 $4,722,000 $ (86,337,000) $ (81,595,000)
Net loss......................... (17,077,000) (17,077,000)
------ ------- ---------- ------------ ------------
Balance at September 30, 1996.... 10,200 $20,000 $4,722,000 $(103,414,000) $ (98,672,000)
====== ======= ========== ============ ============
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-46
<PAGE> 182
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
1995 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................................ $(16,573,000) $(17,077,000)
Adjustments to reconcile net loss to net cash used for operating
activities:
Depreciation.................................................. 2,219,000 2,461,000
Changes in assets and liabilities:
Patient receivables........................................ (910,000) 163,000
Account receivable from related parties.................... 523,000
Other current assets....................................... (539,000) (3,400,000)
Accounts payable and accrued expenses...................... 3,614,000 4,817,000
Accounts payable to related party.......................... 387,000
Reserve for claims payable................................. (699,000) (2,910,000)
Other current liabilities.................................. (1,274,000) (17,251,000)
------------ ------------
Net cash used for operating activities.......................... (13,639,000) (32,810,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment........................... (9,657,000) 491,000
Proceeds from transfer of property and equipment to related
party......................................................... 8,123,000
Increase in intangible assets................................... (1,574,000)
Proceeds from sale of specialty practices.......................
Decrease (increase) in other assets............................. (26,000) 129,000
------------ ------------
Net cash provided (used) for investing activities............... (3,134,000) 620,000
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Paydown of other notes payable.................................. (5,385,000)
Proceeds from other notes payable............................... 8,408,000
Proceeds from intercompany notes payable........................ 30,209,000 23,782,000
------------ ------------
Net cash flows provided by financing activities................. 24,824,000 32,190,000
------------ ------------
Net increase (decrease) in cash and cash equivalents............ 8,051,000 0
CASH AND CASH EQUIVALENTS:
Beginning of period............................................. 1,566,000 0
------------ ------------
End of period................................................... 9,617,000 0
============ ============
SUPPLEMENTAL DISCLOSURE:
Cash paid during the year for:
Interest................................................... $ 2,326,000 $ 2,303,000
============ ============
Noncash investing and financing transactions:
Assumption of liabilities in conjunction with acquisition
of physician practice.................................... $ 3,045,000 $ --
============ ============
Transfer of property and equipment to related party for
reduction of intercompany debt........................... $ 22,140,000 $ --
============ ============
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-47
<PAGE> 183
FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY-OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
THREE MONTHS ENDED SEPTEMBER 30, 1995 AND 1996
UNAUDITED
NOTE 1 -- BASIS OF PRESENTATION
The combined balance sheets at September 30, 1995 and 1996 and the combined
statements of operations and cash flows for the three months ended September 30,
1995 and 1996, and the statement of shareholder's deficit for the three months
ended September 30, 1996 are unaudited. In the opinion of management, these
statements have been prepared on the same basis as the audited combined
financial statements, and include all adjustments (all of which consist solely
of normal, recurring adjustments) necessary for a fair statement of the results
for the interim periods presented. See Note 3 concerning the termination of the
tax sharing agreement with FHC. Operating results for the interim periods
presented are not necessarily indicative of the results that may be expected for
any other interim period or for the year as a whole.
NOTE 2 -- TRANSFER OF INTERESTS
FHMG/TDMC Medical Group (the "Holding Company") is a professional
corporation which owns Foundation Health Medical Group, Inc. (FHMG) and
Thomas-Davis Medical Centers, P.C. ("TDMC"). On June 28, 1996 the shareholder of
the Holding Company entered into an agreement to sell all of the outstanding
stock of the Holding Company to an independent practice association. Effective
November 29, 1996 the transaction was consummated.
NOTE 3 -- INCOME TAXES
In December 1995 FHMG and TDMC entered into a tax sharing agreement with
FHC. Contingent upon the sale of the stock of the Holding Company (Note 2), such
agreement was terminated effective July 1, 1996. Accordingly, the tax provision
for the three months ended September 30, 1996 does not include the tax benefit
of the net operating losses of TDMC or FHMG for such period.
NOTE 4 -- RELATED PARTY TRANSACTIONS
It is suggested that these interim financial statements be read in
connection with the annual financial statements of Foundation Health Medical
Services and affiliates included elsewhere herein. As disclosed in such
financial statements, Foundation Health Medical Services and affiliates have
material related party transactions.
F-48
<PAGE> 184
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
AHI Healthcare Systems, Inc.
Report of Independent Auditors..................................................... F-50
Consolidated Balance Sheets........................................................ F-51
Consolidated Statements of Operations.............................................. F-52
Consolidated Statements of Stockholders' Equity.................................... F-53
Consolidated Statements of Cash Flows.............................................. F-54
Notes to Consolidated Financial Statements......................................... F-56
</TABLE>
F-49
<PAGE> 185
REPORT OF INDEPENDENT AUDITORS
STOCKHOLDERS AND BOARD OF DIRECTORS
AHI HEALTHCARE SYSTEMS, INC.
We have audited the accompanying consolidated balance sheets of AHI
Healthcare Systems, Inc. as of December 31, 1995 and 1994, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1995. 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.
Since the date of completion of our audit of the accompanying financial
statements and initial issuance of our report thereon dated February 22, 1996,
the Company, as discussed in Note 9, has experienced substantial losses and
decreased liquidity. Note 9 describes management's plans to address these
issues.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of AHI Healthcare
Systems, Inc. at December 31, 1995 and 1994, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
February 22, 1996, except for
Notes 1 and 9, which date is
January 31, 1997
Los Angeles, California
F-50
<PAGE> 186
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- SEPTEMBER 30,
1994 1995 1996
----------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 655,000 $31,608,000 $ 17,176,000
Accounts receivable, net of allowances................ 8,069,000 12,639,000 13,797,000
Due from related parties.............................. 295,000 177,000 159,000
Prepaid expenses...................................... 278,000 880,000 558,000
Recoverable income taxes (Note 3)..................... 39,000 1,050,000 1,423,000
Deferred income taxes (Note 3)........................ 463,000 858,000 871,000
----------- ----------- -----------
Total current assets.......................... 9,799,000 47,212,000 33,984,000
Equipment and leasehold improvements:
Equipment............................................. 3,753,000 5,738,000 8,503,000
Leasehold improvements................................ 992,000 1,168,000 1,378,000
----------- ----------- -----------
4,745,000 6,906,000 9,881,000
Less: accumulated depreciation and amortization....... (2,461,000) (3,412,000) (4,328,000)
----------- ----------- -----------
2,284,000 3,494,000 5,553,000
Deposits and other assets............................... 264,000 422,000 339,000
Goodwill and other intangible assets, net............... 8,357,000 25,128,000 26,079,000
----------- ----------- -----------
Total assets.................................. $20,704,000 $76,256,000 $ 65,955,000
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accrued medical claims................................ $ 6,989,000 $15,442,000 $ 19,455,000
Accounts payable and accrued expenses................. 4,476,000 11,526,000 14,051,000
Notes payable and capital lease obligations, current
portion (Note 5)................................... 1,249,000 3,364,000 2,496,000
Unsecured notes payable to stockholders, current
portion (Note 4)................................... 1,150,000 333,000 --
Income taxes payable (Note 3)......................... 810,000 -- --
----------- ----------- -----------
Total current liabilities..................... 14,674,000 30,665,000 36,002,000
Notes payable and capital lease obligations (Note 5).... 3,120,000 1,203,000 1,094,000
Contingencies (Note 8)
Stockholders' equity:
8% cumulative convertible voting preferred stock, $.01
par value, 25,000,000 shares authorized, none
issued............................................. -- -- --
Common stock, $.01 par value, 75,000,000 shares
authorized, issued and outstanding: 10,891,000 at
December 31, 1994 and 14,523,000 at December 31,
1995 and September 30, 1996, respectively (Notes 2
and 6)............................................. 109,000 145,000 145,000
Additional paid-in capital............................ 2,742,000 47,753,000 47,753,000
Retained earnings (deficit)........................... 160,000 (2,999,000) (18,574,000)
Unamortized deferred compensation expense............. (101,000) (61,000) (50,000)
Due from stockholder.................................. -- (450,000) (415,000)
----------- ----------- -----------
2,910,000 44,388,000 28,859,000
----------- ----------- -----------
Total liabilities and stockholders' equity.... $20,704,000 $76,256,000 $ 65,955,000
=========== =========== ===========
</TABLE>
See accompanying notes.
F-51
<PAGE> 187
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------- --------------------------
1993 1994 1995 1995 1996
----------- ----------- ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Total operating revenue....... $44,865,000 $60,746,000 $114,284,000 $84,307,000 $ 89,202,000
Cost of medical services...... 30,998,000 43,464,000 88,997,000 66,158,000 77,388,000
----------- ----------- ------------ ----------- ------------
Gross margin.................. 13,867,000 17,282,000 25,287,000 18,149,000 11,814,000
----------- ----------- ------------ ----------- ------------
Operating expenses:
Medical network............. 1,250,000 2,883,000 6,717,000 4,736,000 7,111,000
General and
administrative........... 4,294,000 7,377,000 11,586,000 8,122,000 16,389,000
Depreciation and
amortization............. 448,000 760,000 2,167,000 1,552,000 1,959,000
Network development......... 713,000 4,223,000 9,127,000 6,460,000 3,259,000
Stockholder compensation.... 4,230,000 -- -- -- --
----------- ----------- ------------ ----------- ------------
10,935,000 15,243,000 29,597,000 20,870,000 28,718,000
----------- ----------- ------------ ----------- ------------
Operating income (loss)....... 2,932,000 2,039,000 (4,310,000) (2,721,000) (16,904,000)
Interest income............... 143,000 115,000 520,000 50,000 955,000
Interest expense.............. (17,000) (210,000) (530,000) (434,000) (123,000)
----------- ----------- ------------ ----------- ------------
Net interest income
(expense)................... 126,000 (95,000) (10,000) (384,000) 832,000
----------- ----------- ------------ ----------- ------------
Income (loss) before income
(taxes) benefit and minority
interest.................... 3,058,000 1,944,000 (4,320,000) (3,105,000) (16,072,000)
Minority interest............. -- 332,000 -- -- --
----------- ----------- ------------ ----------- ------------
Income (loss) before income
taxes....................... 3,058,000 2,276,000 (4,320,000) (3,105,000) (16,072,000)
Income (taxes) benefit........ (84,000) (725,000) 1,219,000 1,219,000 497,000
----------- ----------- ------------ ----------- ------------
Net income (loss)............. $ 2,974,000 $ 1,551,000 $ (3,101,000) $(1,886,000) $(15,575,000)
=========== =========== ============ =========== ============
Historical net income (loss)
per share................... $ .21 $ .13 $ (.26) $ (0.17) $ (1.07)
=========== =========== ============ =========== ============
Pro forma information:
Historical net income
(loss)................... $ 2,974,000 $ 1,551,000 $ (3,101,000) $(1,886,000) $(15,575,000)
Charge in lieu of income
taxes for Subchapter S
Corporations (Note 3).... (1,040,000) -- (262,000) (262,000) --
----------- ----------- ------------ ----------- ------------
Pro forma net income (loss)... $ 1,934,000 $ 1,551,000 $ (3,363,000) $(2,148,000) $(15,575,000)
=========== =========== ============ =========== ============
Pro forma net income (loss)
per share................... $ .14 $ .13 $ (.29) $ (0.20) $ (1.07)
=========== =========== ============ =========== ============
Weighted average shares
outstanding................. 13,911,000 11,998,000 11,800,000 10,909,000 14,523,000
</TABLE>
See accompanying notes.
F-52
<PAGE> 188
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNAMORTIZED
COMMON STOCK ADDITIONAL RETAINED DEFERRED
--------------------- PREFERRED PAID-IN EARNINGS COMPENSATION DUE FROM
SHARES AMOUNT STOCK CAPITAL (DEFICIT) EXPENSE STOCKHOLDER TOTAL
---------- -------- --------- ----------- ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December
31, 1992............ 13,146,000 $132,000 $ -- $ 497,000 $ 42,000 $ -- $ -- $ 671,000
Issuance of common
stock............. 130,000 1,000 255,000 (140,000) 116,000
Net income.......... 2,974,000 2,974,000
Dividends paid...... (2,402,000) (2,402,000)
---------- -------- -------- ----------- ----------- --------- ----------- -----------
Balance at December
31, 1993............ 13,276,000 133,000 -- 752,000 614,000 (140,000) -- 1,359,000
Issuance of common
stock in
acquisition....... 192,000 2,000 1,980,000 1,982,000
Repurchase and
cancellation of
common stock...... (2,577,000) (26,000) 26,000 (1,483,000) (1,483,000)
Issuance of common
stock for
stockholder
notes............. 2,577,000 26,000 2,974,000 (3,000,000) --
Exchange of common
stock for Series T
preferred stock... (2,577,000) (26,000) 26,000 --
Redemption of Series
T preferred
stock............. (26,000) (2,974,000) 3,000,000 --
Other equity
transactions...... (16,000) (16,000)
Amortization........ 39,000 39,000
Net income.......... 1,551,000 1,551,000
Dividends paid...... (522,000) (522,000)
---------- -------- -------- ----------- ----------- --------- ----------- -----------
Balance at December
31, 1994............ 10,891,000 109,000 -- 2,742,000 160,000 (101,000) -- 2,910,000
Undistributed
S-Corporation
earnings
reclassified to
additional paid-in
capital........... 58,000 (58,000) --
Issuance of common
stock to a related
party............. 32,000 450,000 (450,000) --
Issuance of common
stock in initial
public offering... 3,600,000 36,000 44,503,000 44,539,000
Amortization........ 40,000 40,000
Net loss............ (3,101,000) (3,101,000)
---------- -------- -------- ----------- ----------- --------- ----------- -----------
Balance at December
31, 1995............ 14,523,000 145,000 -- 47,753,000 (2,999,000) (61,000) (450,000) 44,388,000
Payments on note
receivable from
stockholders...... 35,000 35,000
Amortization........ 11,000 11,000
Net loss............ (15,575,000) (15,575,000)
---------- -------- -------- ----------- ----------- --------- ----------- -----------
Balance at September
30, 1996
(unaudited)......... 14,523,000 $145,000 $ -- $47,753,000 $(18,574,000) $ (50,000) $ (415,000) $28,859,000
========== ======== ======== =========== =========== ========= =========== ===========
</TABLE>
See accompanying notes.
F-53
<PAGE> 189
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------- ---------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)........................... $ 2,974,000 $ 1,551,000 $(3,101,000) $ (1,886,000) $(15,575,000)
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization............. 448,000 760,000 2,167,000 1,552,000 1,959,000
Amortization of deferred compensation
expense................................ 116,000 23,000 40,000 5,000 11,000
Severance settlement financed through
issuance of debt....................... -- 1,200,000 -- -- --
Minority interest in income of
consolidated subsidiary................ -- (332,000) -- -- --
Changes in operating assets and
liabilities:
Accounts receivable.................... (2,568,000) (2,380,000) (4,253,000) (3,356,000) (1,058,000)
Due from related parties............... (38,000) 37,000 118,000 (40,000) 18,000
Prepaid expenses....................... (176,000) (44,000) (596,000) (1,154,000) 322,000
Recoverable income taxes............... (53,000) 18,000 (1,011,000) (1,011,000) (373,000)
Deferred income taxes.................. 4,000 (417,000) (395,000) (351,000) (13,000)
Deposits and other assets.............. (58,000) (121,000) (139,000) 1,000 83,000
Accrued medical claims................. 803,000 (233,000) (2,448,000) (2,326,000) 3,163,000
Accounts payable and accrued
expenses............................. 1,446,000 1,027,000 3,785,000 3,664,000 1,608,000
Income taxes payable................... 58,000 744,000 (810,000) (810,000) --
----------- ----------- ----------- ------------ ------------
Net cash provided by (used in) operating
activities................................ 2,956,000 1,833,000 (6,643,000) (5,712,000) (9,855,000)
INVESTING ACTIVITIES
Purchase of equipment and leasehold
improvements.............................. (468,000) (1,597,000) (2,140,000) (1,722,000) (2,975,000)
Acquisition of affiliates, net of cash
acquired.................................. -- (1,238,000) (2,481,000) (2,764,000) --
----------- ----------- ----------- ------------ ------------
Net cash used in investing activities....... (468,000) (2,835,000) (4,621,000) (4,486,000) (2,975,000)
FINANCING ACTIVITIES
Proceeds from issuance of notes payable and
Bank Facility borrowings.................. 350,000 222,000 12,065,000 12,960,000 --
Cash received on note receivable from
stockholder............................... -- -- -- -- 35,000
Principal payments on notes payable, capital
lease obligation and Bank Facility
borrowings................................ (138,000) (237,000) (14,387,000) (2,669,000) (1,637,000)
Dividends paid.............................. (2,402,000) (522,000) -- -- --
Issuance of common stock.................... 10,000 20,000 44,539,000 7,000 --
Purchase of treasury shares................. -- (1,253,000) -- -- --
----------- ----------- ----------- ------------ ------------
Net cash provided by (used in) financing
activities................................ (2,180,000) (1,770,000) 42,217,000 10,298,000 (1,602,000)
----------- ----------- ----------- ------------ ------------
Increase (decrease) in cash and cash
equivalents............................... 308,000 (2,772,000) 30,953,000 100,000 (14,432,000)
Cash and cash equivalents at beginning of
period.................................... 3,119,000 3,427,000 655,000 655,000 31,608,000
----------- ----------- ----------- ------------ ------------
Cash and cash equivalents at end of
period.................................... $ 3,427,000 $ 655,000 $31,608,000 $ 755,000 $ 17,176,000
=========== =========== =========== ============ ============
</TABLE>
F-54
<PAGE> 190
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------- ------------------------
1994 1995 1995 1996
----------- ----------- ----------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Stockholder note receivable issued in
connection with common stock issuance... $ -- $ 450,000 $ 450,000 $ --
Issuance of promissory note for severance
settlement.............................. 1,200,000 -- -- --
Issuance of common stock for stockholder
notes................................... 3,000,000 -- -- --
Exchange of common stock for Series T
preferred stock......................... (3,000,000) -- -- --
Issuance of common stock for Series T
preferred stock......................... 3,000,000 -- -- --
Redemption of Series T preferred stock..... (3,000,000) -- -- --
Issuance of promissory note for repurchase
and cancellation of common stock........ 230,000 -- -- --
DETAILS OF BUSINESSES ACQUIRED IN PURCHASE
TRANSACTIONS:
Fair value of assets acquired.............. $ 9,895,000 $19,305,000 $17,196,000 $2,053,000
Less:
Issuance of notes payable............... 3,193,000 1,703,000 70,000 327,000
Other liabilities assumed............... 3,197,000 14,166,000 13,413,000 1,726,000
Common stock issued..................... 1,962,000 -- --
----------- ----------- ----------- ----------
Cash paid for acquisitions................. (1,543,000) (3,436,000) (3,713,000) --
Cash of acquired businesses................ 305,000 955,000 949,000 --
----------- ----------- ----------- ----------
Net cash paid.............................. $(1,238,000) $(2,481,000) $(2,764,000) $ --
=========== =========== =========== ==========
</TABLE>
There were no non-cash transactions in 1993.
See accompanying notes.
F-55
<PAGE> 191
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND BASIS OF PRESENTATION
AHI Healthcare Systems, Inc., a Delaware corporation ("AHI" or the
"Company") is a health care management services organization which integrates
individual and small groups of primary care physicians and specialists into
local managed health care delivery systems ("Physician Networks" or
"Affiliates"), for which AHI provides medical management systems and services.
AHI currently manages the provision of prepaid health care services for 10
Physician Networks in Southern California, two in Northern California, 12 in
Texas, and four in Florida. AHI is developing additional Physician Networks in
several other states.
In states, such as Florida, where general business corporations are
permitted to own medical practices, the Company's Physician Networks are owned
by wholly-owned subsidiaries. In states, such as California and Texas, that
prohibit the corporate practice of medicine, the Physician Networks are owned by
one or more physicians qualified under the laws of such states to hold an
ownership interest therein (a "Qualified Physician"). Qualified Physicians
typically are providers of medical services to the Physician Network in which
they hold an ownership interest and also may have other contractual, employment,
or independent contractor relationships with the Company and its Affiliates. In
some of the Company's Southern California Physician Networks, for all periods
presented, minority interests exist in such networks. These minority interests
have no rights or ability to make decisions or prevent the Company from
exercising its unilateral control over the Physician Networks. For the networks
where a minority interest exists, at least a majority ownership interest in each
Physician Network is held by at least one or more Qualified Physicians who are
also officers, directors and significant stockholders of the Company. Effective
January 31, 1997, all such minority interests have been acquired by the
applicable Physician Network for aggregate consideration consisting of
approximately $200,000 of AHI common stock.
Effective January 1, 1994, two of the Affiliates, and January 1, 1995, the
remaining Affiliates, entered into a Management Agreement (the "Agreements")
with AHI. The Agreements codify the Company's previously existing unilateral and
perpetual control over the business enterprise of the Affiliates. Such
Agreements reflect the intent and operating practices of the Company and the
Affiliates during all periods prior to the execution of the Agreements. The
Agreements have terms of 20 years, which renew automatically and perpetually for
successive 10 year periods, and may only be terminated for cause by the
Affiliate. The Company may unilaterally terminate the Agreements without cause.
Under the Agreements, in return for the assignment of revenue of the Physician
Networks, AHI has agreed to provide financial management, information systems,
marketing and public relations, risk management, and administrative support for
claims processing, utilization review and quality of care. As compensation for
its services, AHI retains that portion of each Physician Network's assigned
revenue which equals (i) a reimbursement of all of its direct and indirect
costs, including an allocated portion of AHI's overhead expense, (ii) a fixed
monthly marketing fee, (iii) a percentage of the assigned gross revenues and
(iv) any and all profits earned in risk sharing pools between the Physician
Network, HMOs and hospitals. In addition, through its control over the board of
directors of the Physican Network, AHI has the right and ability to cause the
Physician Network to declare and pay a discretionary bonus to the Company. This
bonus is based in part on the cost savings AHI has generated, but is not based
on any predetermined formula. Consequently, the above contractual arrangement
results in all profits of the Physician Network inuring to the benefit of AHI,
and thus AHI has all of the interst in any residual profits of the Physician
Network. All other funds remaining after such compensation to AHI are remitted
to the Physician Network, from which the Physician Network is obligated to pay
the costs of all medical care services. Should such amount remitted not be
sufficient to pay the obligations of the Physician Network, AHI has the right
but not the obligation to loan funds to the Physician Network based upon terms
(including interest rate) and conditions agreeable to both parties.
Most states within which the Company operates prohibit the Company from
owning an organization which engages in the practice of medicine. Therefore,
notwithstanding the aforementioned services provided
F-56
<PAGE> 192
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
by the Company, the Physician Networks are solely responsible for the practice
of medicine and delivery of medical services, including but not limited to
diagnosis, treatment, referrals, quality assurance, utilization management,
surgery and therapy. Additionally, the Physician Networks retain full authority
of approval over all provider and payor contracts and physician credentialing.
At its cost, AHI has assumed the obligations for all facilities, medical and
non-medical supplies, and the employment of non-physician personnel. Also, the
Company has the right to sell, purchase and encumber all assets of the
Affiliates.
AHI has direct or indirect unilateral and perpetual control over the assets
and operations of each of the Physician Networks for all periods presented by
means other than owning the majority of the voting stock of those Physician
Networks that are required under state law to be owned by Qualified Physicians.
In such states, Qualified Physician shareholders have entered into a succession
or similar agreement which requires such shareholders to sell to a designee of
AHI such shareholders' shares of stock for a nominal amount if such
shareholders' employment or other contractual relationship with AHI is
terminated or otherwise in the sole discretion of AHI. This ensures unilateral
and perpetual control over the Physician Networks by AHI. Moreover, AHI's
determination that it has unilateral and perpetual control over the Physician
Networks is supported by the significant level of responsibilities delegated to
AHI by the Physician Networks through the Agreements as well as the terms of
these Agreements. By virtue of the Agreements, each of AHI's Physician Networks
operates exclusively on behalf of AHI and conducts no business nor holds any
assets other than the contracts it has with AHI, HMOs and independent
physicians. AHI controls each of the Physician Networks' business enterprise by
structuring, negotiating and executing all of their physician, payor and
management contracts, by operating as the single source of all business
decisions made on behalf of the Physician Network, by employing significantly
all of the personnel which operate the Physician Networks, and by unilaterally
controlling the purchase, sale, maintenance and risk management of all Physician
Network assets, including the leveraging of such assets, as is demonstrated with
the Bank Facility agreement (see Note 5). Additionally, as described above,
because of the management fee arrangement between the Company and the Physician
Network, and due to the Company's unilateral control of the Physician Networks,
there is no residual interest in the Physician Networks which inures to the
benefit of the shareholders of the Physician Networks from profits of the
Physician Networks, or a disposition of the Physician Networks by the Company,
should a disposition occur. Therefore, notwithstanding the lack of legal
majority ownership in the states which prohibit the corporate practice of
medicine, but due to a parent-subsidiary relationship under generally accepted
accounting principles, as described above, AHI has consolidated the financial
statements of the Physician Networks. It is AHI's belief that consolidation of
the financial statements of the Physician Networks is necessary to present
fairly the financial position and results of operations of AHI. All significant
inter-entity transactions have been eliminated in consolidation.
The Company consolidates all majority-owned subsidiaries through ownership
of voting stock. All significant intercompany transactions have been eliminated
in consolidation.
AHI managed health care services for prepaid covered lives under contract
with various health plans as follows:
<TABLE>
<CAPTION>
DECEMBER 31
1995 1994 1993
-------- -------- -------
<S> <C> <C> <C>
Commercial........................... 147,982 104,839 66,245
Senior............................... 24,048 10,857 10,296
Medicaid............................. 7,528 2,632 --
------- ------- ------
179,558 118,328 76,541
======= ======= ======
</TABLE>
RISKS AND UNCERTAINTIES
The preparation of the consolidated 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.
F-57
<PAGE> 193
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash equivalents are considered to be liquid investments with a maturity of
three months or less when purchased.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist of cash and cash equivalents, shared-risk
receivables and stop-loss receivables. Cash and cash equivalents are invested in
an investment fund of a financial institution. The Company's credit risk with
respect to shared-risk and stop-loss receivables is limited since amounts are
generally due from large HMOs or insurance companies.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated on the basis of cost.
Depreciation of equipment is provided using the straight-line method over the
estimated useful lives of the assets, and amortization of leasehold improvements
is provided using the straight-line basis over the shorter of the lease period
or the estimated useful lives of the leasehold improvements. Capitalized lease
obligations are amortized over the life of the lease. Lease amortization is
included in depreciation expense.
GOODWILL
Goodwill totaling $26,494,000 arose as the result of several acquisitions
in 1995 and 1994. This amount represents the excess of the consideration paid
and liabilities assumed over the fair value of the assets acquired. Such
acquisitions are discussed in Note 2 following. At each reporting period, the
Company reviews the carrying value of goodwill to determine if facts and
circumstances exist which would suggest that goodwill may be impaired, or that
the amortization period needs to be modified. Among the factors considered by
the Company in making the evaluation are changes in the Company's payor or
physician contracts, local market developments, changes in regulations, national
health care trends, changes in third party payment patterns and other factors.
Using these factors, if indicators are present which may indicate impairment is
probable, the Company will prepare a projection of the undiscounted cash flows
of the acquired enterprise and determine if goodwill is recoverable based on
these undiscounted cash flows. If an impairment is indicated, then an adjustment
will be made. Because substantially all of the acquisitions by AHI have not
included acquisitions of other long-lived assets, the adjustment will be equal
to the difference between the carrying value of the goodwill balance and the
undiscounted cash flows. Based on the factors considered above, the Company does
not believe that there are any current factors indicating any impairment of
goodwill as of December 31, 1995 which would require an adjustment.
A significant portion of the Company's goodwill acquired resulted from the
acquisition of The Healthcare Partnership ("THP"), in Houston, Texas, which had
a deficiency in its assets at the acquisition date. The Company has made
modifications to the payor and physician contracts, and increased administrative
efficiencies to address the operating deficiencies at THP. Because of these
changes, the Company estimates that it will be able to recover the goodwill
acquired in the THP transaction.
Goodwill has been recorded at cost and is being amortized on the
straight-line method over 20 years. Accumulated amortization was $1,365,000 and
$168,000 at December 31, 1995 and 1994, respectively.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121 (SFAS No. 121) "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
which was effective for the Company beginning January 1, 1996. SFAS No. 121
requires that long-lived assets and certain intangible assets associated with
those assets be reviewed for impairment. None of the Company's goodwill
described above is associated with any other long-lived
F-58
<PAGE> 194
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
assets. The adoption of this statement had no significant impact on the
Company's financial statements when adopted.
STOCK OPTIONS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 ("SFAS 123") "Accounting for
Stock-Based Compensation," which becomes effective for fiscal years beginning
after December 15, 1995. SFAS 123 establishes new financial accounting and
reporting standards for stock-based compensation plans. Entities will be allowed
to elect to continue following the measurement criteria under APB Opinion No.
25, or switch to measurement criteria under SFAS 123. Entities electing to
remain under APB Opinion No. 25 measurement criteria will be required to
disclose pro forma net income and earnings per share as if SFAS 123 had been
adopted. The Company is in the process of evaluating the statement, and
determination of the effect of adopting the new standard has not yet been made.
The Company must adopt the disclosure provisions of SFAS 123 by December 31,
1996.
DEFERRED COMPENSATION EXPENSE
Upon the consummation of employment agreements with certain physician
employees, the Company sold such employees shares at a price below fair value.
Differences between the purchase price of shares sold and the fair value of AHI
shares at the date of sale were recorded as deferred compensation expense. The
deferred compensation expense is amortized on the straight-line method over the
related employment periods.
MEDICAL REVENUES AND COST RECOGNITION
Operating revenue of the Company consists primarily of fees for medical
services provided by the Affiliates under capitated contracts with various
managed care payors including health maintenance organizations (HMOs). During
the year ended December 31, 1995, the Company generated approximately 28%, 22%
and 11% of its capitation revenue from contracts with three HMOs -- Pacificare,
FHP and CareAmerica, respectively. Capitation revenue under HMO contracts is
prepaid monthly to the Affiliates (and assigned to AHI) based on the number of
enrollees electing any one of the Affiliates as their health care provider. HMO
contracts also include provisions to share in the risk for hospitalization
whereby AHI can earn additional incentive revenue or incur penalties based upon
the utilization of hospital services. Estimated shared-risk amounts receivable
from the HMOs are recorded based upon hospital utilization and associated costs
incurred by assigned HMO enrollees, compared to budgeted costs. Differences
between actual contract settlements and estimated receivables relating to HMO
risk-sharing arrangements are recorded in the year of final settlement. Included
in accounts receivable as of December 31, 1995 and 1994 are $6,624,000 and
$4,056,000, respectively, of estimated amounts due under these arrangements.
In connection with providing services to HMO enrollees, the Physician
Network is responsible for the medical services its affiliated physicians
provide to assigned HMO enrollees. The cost of health services is recognized in
the period in which it is provided and includes an estimate of the cost of
services which have been incurred but not yet reported. The estimate for accrued
medical costs is based on actuarial projections of costs using historical
studies of claims paid. Estimates are continually monitored and reviewed and, as
settlements are made or estimates adjusted, differences are reflected in current
operations.
The Physician Network participates in reinsurance protection programs which
limit the amount of risk they ultimately bear by providing reimbursement
payments once medical services provided to an individual enrollee exceed an
agreed-upon amount. Estimates of reinsurance recoveries are included in accounts
receivable in the accompanying financial statements and, in the opinion of
management, adjustments, if any, would not have a material effect on the
consolidated financial position of the Company.
F-59
<PAGE> 195
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MEDICAL MALPRACTICE LIABILITY INSURANCE
Certain Affiliates maintain claims-made basis medical malpractice insurance
coverage for their employed physicians of $1,000,000 per incident and $3,000,000
in the aggregate on an annual basis. Claims-made coverage covers only those
claims reported during the policy period. An estimate of losses, if any, for
incurred but unreported claims is recorded based upon historical experience. In
March 1996, AHI caused its affiliates to renew their existing policies and
expects to be able to continue to obtain coverage in future years. Further, it
has been the Company's experience that substantially all claims are reported
within a year of the incident date.
The individual physicians who contract with the Physician Networks carry
their own medical malpractice insurance.
In addition to the above coverages, the Affiliates maintain comprehensive
health care liability insurance on a modified occurrence basis with total
coverage of $5,000,000 per claim.
MEDICAL NETWORK OPERATING EXPENSES
Medical network operating expenses consist primarily of salary-related
expenses for the provision of medical management services to the physician
networks. The majority of costs associated with medical management services
fluctuate commensurate with enrollment and the number of contracted providers,
and consist primarily of claims administration, eligibility management, quality
and utilization management, credentialing and other costs related to the
Company's service center.
NETWORK DEVELOPMENT EXPENSES
Network development costs are expensed as incurred.
INCOME TAXES
AHI and all of the Affiliates (except Camino Real Medical Group, Inc. which
is a C-Corporation) operated as Subchapter S Corporations through December 31,
1993. Effective January 1, 1994, AHI elected to operate as a C-Corporation,
while the Affiliates continued to elect S-Corporation status through December
31, 1994. Effective January 1, 1995, all except two of the Affiliates elected
C-Corporation status. As a result of the S-Corporation status, the Affiliates
and AHI through December 31, 1993, were not subject to federal income taxes;
however, the Affiliates through December 31, 1994 (and AHI through December 31,
1993) were subject to California franchise tax at a reduced rate of 2.5%.
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109),
under which deferred income tax assets and liabilities are recognized for the
differences between financial and income tax reporting bases of assets and
liabilities based on enacted tax rates and laws. The cumulative effect of
adopting SFAS No. 109 was not significant, and the impact on the combined
results of operations for the three years ended December 31, 1995 also was not
significant. Income taxes have been provided using the liability method in
accordance with SFAS No. 109.
EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is based on the weighted average number of common
shares and common equivalent shares for stock options and a warrant (when
dilutive) outstanding during the period for which the calculation is made,
giving retroactive effect to the November 1994 122:1 stock split, the June 1995
1.36004:1 stock split, and the September 1995 reverse stock split of .78444:1.
The stock options and warrants were anti-dilutive for the year ended December
31, 1995 and were dilutive for the years ended December 31, 1994 and 1993.
F-60
<PAGE> 196
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PRO FORMA NET INCOME (LOSS) PER SHARE
Pro forma net income (loss) and pro forma net income (loss) per share have
been determined assuming the Company had been taxed as a C-Corporation for all
periods presented.
RECLASSIFICATIONS
Certain reclassifications of 1994 and 1993 amounts have been made to
correspond with the 1995 presentation.
UNAUDITED FINANCIAL INFORMATION
The consolidated financial information as of September 30, 1996 and the
nine month periods ended September 30, 1995 and 1996 included in the
consolidated financial statements and notes thereto are unaudited. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the nine months ended September 30, 1996 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1996.
2. ACQUISITIONS
During the years ended December 31, 1995 and 1994, AHI made acquisitions as
set forth below, each of which has been accounted for as a purchase. The
information presented below includes certain purchase price adjustments recorded
in 1995. The consolidated financial statements include the operating results of
each business from the date of acquisition.
PRIMARY CARE MEDICAL GROUP AT LITTLE COMPANY AT MARY HOSPITAL, INC. ("PCMG")
On February 28, 1995, AHI, through its stockholders, purchased the entire
50% minority interest from five minority stockholders of PCMG for cash
consideration totaling $2,000,000. Each of the five minority stockholders also
entered into a covenant not-to-compete with AHI for $29,000 per stockholder per
year for 10 years, payable in quarterly installments of approximately $7,000 per
stockholder beginning June 1, 1995. In addition, AHI entered into provider
agreements with each minority stockholder for a period of ten-years, which
contain certain minimum payment guarantees. The purchase price in excess of
assets acquired was $4,119,000.
SOUTHWEST MEDICAL CARE, INC., DBA THE HEALTHCARE PARTNERSHIP ("THP")
On February 1, 1995, AHI, through its stockholder, purchased substantially
all assets and assumed certain liabilities of THP, a medical group operating in
Texas for $1,138,000 in cash and $35,000 in a note. The acquisition price in
excess of assets acquired was $12,474,000.
INTEGRATED MEDICAL MANAGEMENT SYSTEMS, INC. AND
INTEGRATED MEDICAL MARKETING SYSTEMS, INC. (COLLECTIVELY, "IMMS")
On December 12, 1994, the Company issued approximately 192,000 of AHI
common stock and notes payable of $303,000 in exchange for the outstanding
common stock of IMMS. Based on valuation of the common stock issued at $10.22
per share, the purchase price totaled $2,265,000 and resulted in goodwill of
$2,493,000.
Concurrent with the acquisition, non-qualified stock options to purchase
942,413 shares of AHI common stock at an exercise price of $14.06 per share were
granted under the LT Plan to two former stockholders of IMMS, who became Senior
Officers of the Company. In addition, options to purchase an additional 71,113
shares of AHI common stock at $14.06 per share under the LT Plan were granted to
these Senior Officers.
F-61
<PAGE> 197
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CAMINO REAL MEDICAL GROUP, INC. ("CRMG")
Effective August 1, 1994, AHI, through a physician stockholder, purchased
CRMG for consideration totaling $4,250,000, consisting of $1,360,000 in cash and
a promissory note of $2,890,000 bearing interest at the applicable Federal
short-term rate payable quarterly over three years. Principal is due in two
installments of $850,000 and $2,040,000 in February 1996 and July 1997,
respectively (see Note 5). In a series of transactions to effect the purchase,
AHI advanced the medical group $1,360,000. The acquisition resulted in goodwill
of $7,141,000.
Summarized below are the unaudited pro forma consolidated results of
operations for AHI as if the acquisitions of the above mentioned businesses had
taken place as of January 1, 1994. Such pro forma results are not necessarily
indicative of what the actual consolidated results of operations might have been
if the acquisitions had been effective at the beginning of each year.
<TABLE>
<CAPTION>
1995 1994
------------ ------------
<S> <C> <C>
Total operating revenues.................. $117,341,000 $ 97,915,000
Net loss.................................. (3,502,000) (6,651,000)
Loss per share............................ $ (.30) $ (.57)
</TABLE>
3. INCOME TAXES
Deferred income taxes arise principally from the use of different asset
lives for income tax purposes than for financial statement purposes.
The components of the provision for income taxes (benefit) are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1995 1994 1993
----------- ---------- -------
<S> <C> <C> <C>
Current:
Federal............................... $ -- $ 922,000 $ --
State................................. 20,000 220,000 75,000
----------- ---------- -------
20,000 1,142,000 75,000
Deferred:
Federal............................... (960,000) (358,000) --
State................................. (279,000) (59,000) 9,000
----------- ---------- -------
(1,239,000) (417,000) 9,000
Total:
Federal............................... (960,000) 564,000 --
State................................. (259,000) 161,000 84,000
----------- ---------- -------
$(1,219,000) $ 725,000 $84,000
=========== ========== =======
</TABLE>
Temporary differences and carryforwards that result in deferred income tax
assets as of December 31 are as follows:
<TABLE>
<CAPTION>
1995 1994
---------- ---------
<S> <C> <C>
Deferred income tax assets:
Depreciation and amortization..................... $ 22,000 $ 42,000
Net operating loss carryforward................... 895,000 537,000
Accrued expenses.................................. 434,000 377,000
---------- ---------
1,351,000 956,000
Valuation allowance............................... (493,000) (493,000)
---------- ---------
Net deferred income taxes........................... $ 858,000 $ 463,000
========== =========
</TABLE>
F-62
<PAGE> 198
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The differences between the provision for income tax expense at the federal
statutory rate of 34% and that showing in the Consolidated Statements of
Operations are summarized as follows for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994 1993
----------- --------- -----------
<S> <C> <C> <C>
Tax provision (credit) at statutory rate..... $(1,469,000) $ 774,000 $ 1,040,000
State taxes, net of federal benefit.......... (259,000) 123,000 76,000
Effect of S-Corporation elections and
revocations................................ -- (121,000) (1,040,000)
Goodwill amortization........................ 498,000 53,000 --
Benefit of NOL carryforward.................. -- (57,000) --
Other........................................ 11,000 (47,000) 8,000
----------- --------- -----------
$(1,219,000) $ 725,000 $ 84,000
=========== ========= ===========
</TABLE>
Effective January 1, 1995, all but two of the Affiliates revoked their
S-Corporation status. As a result, approximately $750,000 of net operating
losses are not available to offset future California income otherwise taxable at
1.5%.
AHI and certain of the Affiliates have a combined maximum amount of net
operating loss carryforwards of approximately $2,200,000 which may be utilized
in future years before expiring between 2007 and 2010. Of this amount,
approximately $1,200,000 arose from pre-acquisition losses of an acquired
Affiliate, the use of which is limited to future taxable income of this
Affiliate.
Taxes paid totaled approximately $1,253,000, $363,000 and $68,000 in 1995,
1994 and 1993, respectively, and $166,000 and $953,000 for the nine months ended
September 30, 1996 and 1995, respectively.
4. RELATED PARTY TRANSACTIONS
AHI entered into an employment agreement with Leonardo A. Berezovsky, M.D.,
AHI's Chairman and Chief Executive Officer, effective November 1, 1994. The
agreement provides for an initial base salary of $250,000 per annum, which may
be increased or decreased (but not below the initial base salary) in subsequent
years by the Compensation Committee of the Board of Directors based upon such
Committee's review of Dr. Berezovsky's performance. Dr. Berezovsky is also
eligible to receive, at the discretion of the Compensation Committee and based
upon performance, a bonus of up to 50% of his base salary. The agreement is for
a term of six years and, every 12 months during the term, automatically renews
for an additional 12 months. The agreement may only be terminated for cause and,
in the event of a "change of control" (as defined in the agreement), Dr.
Berezovsky is entitled to a lump sum payment equal to the sum of his annual base
salary through the remaining term of the agreement plus the value of his bonus
compensation, other incentive awards and benefits received in the year prior to
the change of control multiplied by the remaining years of the term of the
agreement.
In May 1995, the Company entered into an employment agreement with a
Director of the Company for a term of seven years, expiring in May 2002, which
provides for annual compensation of $25,000. Additionally, this Director's
medical corporation entered into consulting agreements with three of the
Physician Networks for the same period, with each agreement providing
compensation of approximately $50,000 annually.
In connection with the purchase of IMMS, the Company assumed the obligation
to repay certain working capital loans totaling $299,000 plus accrued interest
of $17,000 to the former owners of IMMS, who became stockholders and officers of
AHI. These notes bear interest at 8% and were paid in January 1996. Interest
expense on these notes totaled $23,000 and $1,000 in 1995 and 1994,
respectively. Additionally, the Company leases certain property from a trust of
a former owner of IMMS. Annual rental payments totaled approximately $75,000 in
1995 and $-0- in 1994. The lease expires in April 2001, unless renewed by the
Company for up to an additional ten years.
F-63
<PAGE> 199
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In addition, the Company issued promissory notes to the former stockholders
of IMMS in the amount of $303,000 as part of the purchase price. These notes are
non-interest bearing and have monthly installments ranging from $17,000 to
$30,000. The balance of these notes were paid in full as of February 1996.
Through December 31, 1993, three stockholders of AHI collectively advanced
$475,000 to an Affiliate for operations. Of these advances, $125,000 was repaid
in 1994 and the remaining $350,000 was paid in 1995. Interest expense on these
notes totaled $16,000, $41,000, and $15,000 in 1995, 1994, and 1993,
respectively.
The Affiliates have capitated and fee-for-service provider contracts with
physician professional corporations owned by physician stockholders of the
Company and the Affiliates. Medical costs incurred totaled approximately
$760,000, $391,000 and $340,000 for 1995, 1994, and 1993, respectively.
In August 1994, the Company issued shares of common stock to two of its
directors, one of which is an officer, in exchange for promissory notes, each in
the amount $1,500,000. The promissory notes were secured by other shares in the
Company held by these directors. The common stock was exchanged by the Company
for an equal number of shares of Series T preferred stock issued by the Company
in November 1994. These shares of preferred stock were redeemed by the Company
on December 31, 1994, in exchange for cancellation by the Company of the
outstanding obligations under the promissory notes.
Effective January 1, 1994, the Company entered into a consulting agreement
with one of its directors to assist the Company in analyzing claims and related
procedures. The consulting agreement provides for monthly payments of $7,500 and
can be terminated without cause by the Company. In exchange for services
provided, the Company paid $90,000 in 1995 and 1994, respectively.
5. NOTES PAYABLE
Notes payable consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1995 1994
---------- ----------
<S> <C> <C>
Note payable for the acquisition of Camino Real Medical Group,
interest at the applicable Federal short-term rate (6.08% and
5.89% at December 31, 1995 and 1994, respectively), payable
quarterly with principal due in two installments in February 1996
and July 1997. Note is collateralized by a letter of credit....... $2,890,000 $2,890,000
Note payable to certain physicians in connection with acquisition of
the remaining minority interest in Affiliate for covenant not to
compete, payable quarterly through March 2005. Payment is
guaranteed by a certain Affiliate................................. 1,349,000
Note payable to former stockholder, interest at 4.51% annually, with
principal due in full in January 1996. Payment is guaranteed by
certain Affiliates................................................ 230,000 230,000
Note payable to former stockholder, interest at prime rate (ranging
from 7.75% to 10.00%), payable monthly, principal due in three
installments of $400,000 in May through July 1995................. 1,200,000
Other notes payable................................................. 98,000 49,000
---------- ----------
4,567,000 4,369,000
Less current portion................................................ 3,364,000 1,249,000
---------- ----------
$1,203,000 $3,120,000
========== ==========
</TABLE>
The Company has a revolving line of credit with two banks (the "Bank
Facility") totaling $15,000,000 at December 31, 1995 ($4,750,000 at December 31,
1994). Borrowings under the line of credit bear interest at either the bank's
prime rate plus 0.25% per annum or LIBOR plus 2.50%. The line of credit has a
sublimit of $7,500,000 ($4,000,000 in 1994) available for issuance of standby
letters of credit at an annual fee of 2% of the amount issued. The line of
credit expires on May 15, 1997, and is guaranteed by certain of the Affiliates.
The
F-64
<PAGE> 200
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
line is collateralized by AHI and the guarantor's accounts receivable and
unencumbered equipment. The line of credit is also subject to financial
covenants, including maintaining profitability, minimum cash flow and other
financial covenants.
The Company is currently in full compliance with all financial covenants
under the Bank Facility. However, at June 30, 1995, and from October 31, 1995
through December 31, 1995, the Company was in default on its cash flow coverage
ratio covenant and obtained waivers from the Bank Facility lenders on August 21,
1995 and February 20, 1996, respectively, extending to all periods through March
30, 1996. The Company has amended the Bank Facility effective March 31, 1996
(see Note 9).
At December 31, 1995 and 1994, the Company had no indebtedness under the
line of credit agreement, except for a $2,890,000 letter of credit outstanding
issued in connection with the acquisition of CRMG.
Interest paid on all obligations totaled $427,000, $59,000, and $0, in
1995, 1994, and 1993, respectively and $123,000 and $434,000 for the nine months
ended September 30, 1996 and 1995, respectively.
6. STOCKHOLDERS' EQUITY
STOCK SPLITS
All share amounts have been adjusted to reflect the November 1994 122:1
stock split, the June 1995 1.36004:1 stock split and the September 1995 reverse
stock split of .78444:1.
STOCK TRANSACTIONS
Effective September 28, 1995, the Company completed an initial public
offering (the "Offering") of its common stock. The Company sold 3,600,000 shares
and the selling stockholders sold an additional 863,000 shares for $14.00 per
share. Proceeds from the Offering and the delivery of the related securities
occurred on October 4, 1995. Net proceeds to the Company totaled $44,539,000,
after deducting underwriting discounts and commissions and Offering costs.
In May 1995, a Director of AHI purchased 32,000 shares of the Company's
common stock for $450,000 by delivery of a note which is receivable in monthly
installments commencing from January 1996 through May 2002. The note is secured
by the purchased shares and is included in Due from Stockholder. In addition,
the Company granted this Director 42,675 stock options exercisable in
installments over a seven year period at $14.06 per share.
In August 1994, the Company issued shares of its common stock to two of its
stockholders in exchange for promissory notes totaling $3,000,000. The shares
were exchanged for the Company's Series T Preferred Stock which was subsequently
redeemed in exchange for cancellation of the promissory notes.
On June 28, 1994, AHI entered into a stock repurchase and mutual release
agreement with a former director and stockholder. Pursuant to this agreement,
such stockholder's entire equity interest was repurchased by AHI for $153,000 in
cash and a note payable of $230,000. The note bears interest at the rate of
4.51% per annum, with interest payable annually and principal and all accrued
but unpaid interest due and payable on January 31, 1996. The promissory note is
guaranteed by certain of the Affiliates.
On May 5, 1994, AHI and certain of the Affiliates entered into a stock
repurchase and mutual release agreement (the Agreement) with a former officer of
AHI. Under the terms of the Agreement, AHI agreed to purchase the former
officer's entire equity interest representing approximately 19% of all AHI
outstanding stock at the time of repurchase for $1.1 million and to settle all
outstanding employment-related disputes for $1.3 million. The settlement
payments were made in cash ($1.2 million) and a note payable ($1.2 million),
which was paid in full in 1995. The Company incurred $59,000 and $69,000 in
interest expense in 1995 and
F-65
<PAGE> 201
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1994, respectively. This former officer also received an additional $300,000
upon the completion of the Company's initial public offering in connection with
the Agreement.
AHI, in connection with a key officer's employment agreement, issued
130,000 shares of AHI stock at an aggregate price of $1 in 1993. The value of
such stock at the time of issuance was determined to be approximately $60,000.
STOCK OPTIONS
The Company has adopted four stock option plans, the AHI Executive Stock
Option Plan (the "Executive Plan"), the 1994 and 1995 AHI Long-Term Incentive
Plan (the "LT Plans"), and the 1995 Non-Employee Directors Stock Option Program.
In November 1993, the options granted under the Executive Plan were exchanged by
the optionholders for 1,075,404 options under the 1994 LT Plan.
Under the LT Plans, awards of options of AHI common stock or other stock
may be granted to employees and consultants as determined by the Compensation
Committee. The LT Plans also contain provisions permitting awards of restricted
stock. The terms of any awards of options and restricted stock will be specified
in each agreement as determined by the Compensation Committee, including, but
not limited to, the purchase price, term, exercise, vesting, restrictions and
employment termination. These options are exercisable ratably over periods up to
five years. Vested options can be subject to a two-year holding period. The LT
Plans and any awards thereunder terminate no later than ten years from date of
grant. A total of 3,028,222 options have been reserved for issuance under the LT
Plans.
On August 1, 1995 the Company adopted the 1995 Non-Employee Directors Stock
Option Program (the "Directors' Plan"). A total of 39,222 shares of Common Stock
have been reserved for issuance under the Directors' Plan. The Directors' Plan
authorizes the initial grant of options to purchase up to 7,500 shares of common
stock to each Non-Employee Director and authorizes an additional 1,000 option
grant annually. The option exercise price is determined by the average of the
fair market value of common stock for the fifth through ninth Nasdaq National
Market trading days following the grant. The term of each option is ten years
from the date of grant and vests over a four year period.
Following is a summary of stock option activity:
<TABLE>
<CAPTION>
1995
LONG-TERM NON-EMPLOYEE
INCENTIVE DIRECTORS
PLANS PLAN
--------- ------------
<S> <C> <C>
Outstanding at December 31, 1992.................... --
Granted........................................... 1,075,404
Exercised......................................... --
Canceled.......................................... --
---------
Outstanding at December 31, 1993.................... 1,075,404
Granted........................................... 1,013,526
Exercised......................................... --
Canceled.......................................... --
---------
Outstanding at December 31, 1994.................... 2,088,930 --
Granted........................................... 707,615 15,000
Exercised......................................... -- --
Canceled.......................................... (74,757) --
--------- ------
Outstanding at December 31, 1995.................... 2,721,788 15,000
========= ======
</TABLE>
F-66
<PAGE> 202
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
WARRANTS
In connection with the Company's revolving line of credit agreement (see
Note 5), AHI granted a warrant to the bank to purchase 53,343 shares of its
common stock at $14.06 per share which expires on May 18, 2000. The warrant may
be converted to shares of common stock equal to the aggregate fair value of
issuable shares less the total exercise price divided by the fair value per
share on the conversion date.
Prior to March 31, 1996, the Company may, at its option, purchase the
warrant at $6.46 per issuable share and to repurchase any common shares issued
thereunder at $20.52 per share.
7. COMMITMENTS
The Company leases its office facilities and various types of equipment
under operating leases. Lease terms generally range from three to 10 years with
renewal options. Many of the leases provide that the Company pay for taxes,
maintenance, insurance and other expenses, and contain rent escalation clauses.
Future minimum rental payments required under operating leases that have
initial or remaining noncancelable lease terms in excess of one year as of
December 31, 1995, are as follows:
<TABLE>
<S> <C>
1996............................................ $ 2,854,000
1997............................................ 2,497,000
1998............................................ 1,918,000
1999............................................ 1,260,000
2000............................................ 1,054,000
Thereafter...................................... 2,743,000
-----------
$12,326,000
===========
</TABLE>
Total rent expense was $2,377,000 in 1995, $910,000 in 1994, and $598,000
in 1993.
8. CONTINGENCIES
The Company and its Affiliates are subject to certain legal actions arising
in the ordinary course of business, generally related to professional liability,
employment-related issues and other business-related claims. In the opinion of
management, such actions are either adequately insured or will not have a
material adverse effect on the Company's financial position or results of
operations.
The Company is a defendant in a class action securities lawsuit, which
asserts that the Company, among other things, artificially inflated the price of
its common stock by misleading securities analysts and by failing to disclose in
its initial public offering prospectus alleged difficulties it was having with
the acquisition of Lakewood Health Plan, Inc. and with two of the Company's
contracts with FHP, Inc. The Company intends to vigorously defend this lawsuit.
The Company believes that it is adequately insured and does not expect that the
outcome of this lawsuit will have a material adverse effect on the financial
condition or results of operations of the Company.
9. SUBSEQUENT EVENTS AND CURRENT LIQUIDITY ISSUES
Effective March 31, 1996, the Bank Facility was amended to revise the
definitions of cash flow and debt in the computation of cash flow and debt
coverage ratio requirements which are included in the Bank Facility's financial
covenants. With such amendments, the Company is currently in compliance with all
covenants. On July 2, 1996, pursuant to discussions with the California
Department of Corporations ("DOC"), the regulatory body for managed care plans
in the State of California, the Company, through a wholly owned subsidiary,
filed an application for restricted licensure as a Knox-Keene health care
service plan for its California operations. The restricted license, if granted,
would allow for the direct receipt of capitation
F-67
<PAGE> 203
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
payments for hospital and medical professional services, but would not allow AHI
or its licensed subsidiary to market a health care service plan to employers and
subscribers. The Company may be required to restructure its California business
operations (which, if such license is not granted, could result in a significant
reduction of revenue) and/or incur additional administrative costs in the future
to meet applicable regulatory requirements. Pursuant to tangible net equity
requirements under regulations governing the Company's license application, the
Company will be required to maintain cash reserves, initially expected to be at
least $6 million, which could restrict the Company's ability to transfer funds
and pay dividends. Although the Company does not expect the licensure process to
have a material impact on its operations, there can be no assurance that the DOC
will not impose requirements adverse to the Company's business.
Effective June 1996, the Bank Facility was secured by an account of
qualifying investments equal to the borrowing limit plus interest. The Bank
Facility contains certain restrictions on the Company's ability to engage in
certain actions. The Bank Facility was also amended, deleting all financial
covenants, namely the cash flow coverage and debt coverage ratio covenants. AHI
has been in compliance with all remaining covenants since such date. As of
December 31, 1996, the Company had no borrowings under the Bank Facility.
In August 1995, the Company signed a non-binding letter of intent whereby
an affiliate of the Company intended to purchase Lakewood Health Plan, Inc., A
Medical Group ("LHP"), a California independent physician association, for total
consideration of $2,500,000, subject to, among other contingencies, execution of
definitive agreements. In January 1996, the Company announced that acquisition
discussions with LHP had terminated.
On November 8, 1996, the Company entered into an Agreement and Plan of
Merger ("Merger Agreement") with FPA Medical Management, Inc. ("FPA") of San
Diego, California. Under the terms of the Merger Agreement, which has been
approved by the Board of Directors of each company, each outstanding share of
the Company's common stock would be exchanged for $8.75 worth of shares of FPA's
common stock, subject to adjustment in the event that the average value of FPA's
common stock during a defined period immediately prior to the merger is less
than $14.38 or equal to or greater than $22.38 per share. Based on the closing
price of FPA's common stock on November 8, 1996, FPA expects to issue
approximately 6.1 million shares of its common stock for 100% of the outstanding
common stock of the Company. The transaction will be accounted for as a
pooling-of-interests. The merger is subject to regulatory and stockholder
approvals and certain conditions precedent and is expected to be completed in
early 1997. However, because of these conditions precedent, there can be no
assurance in this regard. FPA is a national healthcare management service
organization that organizes and manages primary care physician networks to
contract with health maintenance organizations and other prepaid health
insurance plans to provide physician and related healthcare services.
AHI and its directors are also named as defendants in a purported class
action lawsuit filed by Joshua Chopp, a stockholder of AHI, in the Delaware
Court of Chancery on November 12, 1996. 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 Agreement without undertaking
steps to accurately ascertain AHI's market value. The plaintiff seeks, on behalf
of all AHI common stockholders, to enjoin the Merger as well as rescissory and
compensatory damages. FPA is also named as a defendant in the lawsuit. AHI
intends to vigorously defend this lawsuit and does not expect that the outcome
of this lawsuit will have a material adverse effect.
Because of the Knox-Keene licensure cash reserve requirements (if such
license is granted), continued cash flow used in its operating activities and
future capital equipment requirements and technology implementation costs, the
Company believes that existing cash balances and amounts available under the
Bank Facility will not be sufficient to finance its operations through the end
of 1997. If the Company is unable to consummate its planned merger with FPA or
is unable to decrease its operating losses, the Company may
F-68
<PAGE> 204
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
find it necessary to dispose of certain assets or undertake other actions to
conserve its cash balances and remain viable as a going concern.
10. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The unaudited consolidated quarterly financial data for the years ended
December 31, 1995 and 1994 have been prepared in accordance with generally
accepted accounting principles for interim financial information. In the opinion
of management, all adjustments considered necessary for a fair presentation,
have been included.
The following interim financial information should be read in conjunction
with the consolidated financial statements for the years ended December 31, 1995
and 1994.
Quarterly financial data are summarized as follows (amounts in thousands,
except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1995
Total operating revenue....................... $24,947 $29,494 $ 29,866 $29,977
Gross margin.................................. 5,844 5,406 6,899 7,138
Loss from operations.......................... (424) (1,722) (575) (1,589)
Net loss...................................... (327) (789) (770) (1,215)
Net loss per share............................ $ (.03) $ (.07) $ (.07) $ (.08)
1994
Total operating revenue....................... $12,645 $13,287 $ 15,809 $19,005
Gross margin.................................. 3,193 4,044 3,978 6,067
Income (loss) from operations................. 801 (156) 336 1,058
Net income (loss)............................. 484 (35) 434 668
Earnings (loss) per share..................... $ .04 $ (.00) $ .04 $ .06
</TABLE>
During the quarter ended June 30, 1995, the Company recorded a charge to
operations of $910,000 relating to a change in accounting estimates. Of this
amount, $460,000 relates to an increase in the allowance for doubtful accounts
for certain 1994 health plan receivables, primarily as a result of disputes
which arose in 1995. The remaining $450,000 relates to an increase in estimated
accrued medical claims.
During the quarter ended June 30, 1994, a $1,300,000 charge was recorded in
general and administrative expenses reflecting an employment-related settlement.
See Note 6 for further discussion.
F-69
<PAGE> 205
APPENDIX I
AGREEMENT AND PLAN OF MERGER
DATED AS OF NOVEMBER 8, 1996
BY AND AMONG
FPA MEDICAL MANAGEMENT, INC.,
FPA ACQUISITION CORP.
AND
AHI HEALTHCARE SYSTEMS, INC.
<PAGE> 206
TABLE OF CONTENTS
This Table of Contents is not part of the Agreement to which it is attached
but is inserted for convenience only.
<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C> <C>
ARTICLE I
THE MERGER
1.01 The Merger....................................................................... 1
1.02 Effective Time................................................................... 1
1.03 Closing.......................................................................... 1
1.04 Certificate of Incorporation and Bylaws of the Surviving Corporation............. 1
1.05 Directors and Officers of the Surviving Corporation.............................. 1
1.06 Effects of the Merger............................................................ 2
1.07 Further Assurances............................................................... 2
ARTICLE II
CONVERSION OF SHARES
2.01 Conversion of Capital Stock...................................................... 2
2.02 Exchange of Certificates......................................................... 3
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
3.01 Organization and Qualification................................................... 5
3.02 Capital Stock.................................................................... 5
3.03 Authority Relative to this Agreement............................................. 6
3.04 Non-Contravention; Approvals and Consents........................................ 6
3.05 SEC Reports and Financial Statements............................................. 7
3.06 Absence of Certain Changes or Events............................................. 8
3.07 Absence of Undisclosed Liabilities............................................... 8
3.08 Legal Proceedings................................................................ 8
3.09 Information Supplied............................................................. 8
3.10 Taxes............................................................................ 9
3.11 Employee Benefit Plans; ERISA.................................................... 9
3.12 Vote Required.................................................................... 11
3.13 Accounting Matters............................................................... 11
3.14 Company Not an Interested Stockholder or an Acquiring Person..................... 11
3.15 Section 203 of the DGCL Not Applicable........................................... 11
3.16 Title to Assets.................................................................. 11
3.17 Permits, Etc. ................................................................... 11
</TABLE>
i
<PAGE> 207
<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C> <C>
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF PARENT AND SUB
4.01 Organization and Qualification................................................... 12
4.02 Capital Stock.................................................................... 12
4.03 Authority Relative to this Agreement............................................. 13
4.04 Non-Contravention; Approvals and Consents........................................ 13
4.05 SEC Reports and Financial Statements............................................. 14
4.06 Absence of Certain Changes or Events............................................. 14
4.07 Absence of Undisclosed Liabilities............................................... 14
4.08 Legal Proceedings................................................................ 15
4.09 Information Supplied............................................................. 15
4.10 Taxes............................................................................ 15
4.11 Employee Benefit Plans; ERISA.................................................... 16
4.12 Vote Required.................................................................... 17
4.13 Accounting Matters............................................................... 17
4.14 Parent Not an Interested Stockholder or an Acquiring Person...................... 17
4.15 Section 203 of the DGCL Not Applicable........................................... 17
4.16 Title to Assets.................................................................. 17
4.17 Permits, Etc. ................................................................... 18
ARTICLE V
COVENANTS
5.01 Covenants of the Company and Parent.............................................. 18
ARTICLE VI
ADDITIONAL AGREEMENTS
6.01 Access to Information; Confidentiality........................................... 20
6.02 Preparation of Registration Statement and Proxy Statement........................ 20
6.03 Approval of Stockholders......................................................... 21
6.04 Inclusion of Shares on The Nasdaq National Market................................ 21
6.05 [Reserved]....................................................................... 21
6.06 Regulatory and Other Approvals................................................... 21
6.07 Employee Benefit Plans........................................................... 22
6.08 [Reserved]....................................................................... 22
6.09 Directors' and Officers' Indemnification and Insurance........................... 22
6.10 Expenses......................................................................... 23
6.11 Pooling of Interests............................................................. 23
6.12 Brokers or Finders............................................................... 23
6.13 Standstill....................................................................... 24
6.14 Notice and Cure.................................................................. 24
6.15 Fulfillment of Conditions........................................................ 24
6.16 No Solicitations................................................................. 24
6.17 Irrevocable Proxies.............................................................. 25
</TABLE>
ii
<PAGE> 208
<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C> <C>
ARTICLE VII
CONDITIONS
7.01 Conditions to Each Party's Obligation to Effect the Merger....................... 25
7.02 Conditions to Obligation of Parent and Sub to Effect the Merger.................. 26
7.03 Conditions to Obligation of the Company to Effect the Merger..................... 27
ARTICLE VIII
TERMINATION, AMENDMENT AND WAIVER
8.01 Termination...................................................................... 28
8.02 Effect of Termination............................................................ 28
8.03 Amendment........................................................................ 29
8.04 Waiver........................................................................... 29
ARTICLE IX
GENERAL PROVISIONS
9.01 Non-Survival of Representations, Warranties, Covenants and Agreements............ 29
9.02 Knowledge........................................................................ 29
9.03 Notices.......................................................................... 29
9.04 Entire Agreement................................................................. 30
9.05 Public Announcements............................................................. 30
9.06 No Third Party Beneficiary....................................................... 30
9.07 No Assignment; Binding Effect.................................................... 30
9.08 Headings......................................................................... 31
9.09 Invalid Provisions............................................................... 31
9.10 Governing Law.................................................................... 31
9.11 Counterparts..................................................................... 31
</TABLE>
iii
<PAGE> 209
GLOSSARY OF DEFINED TERMS
The following terms, when used in this Agreement, have the meanings
ascribed to them in the corresponding Sections of this Agreement listed below:
<TABLE>
<S> <C>
"Alternative Proposal" Section 6.16
"Antitrust Division" Section 6.06
"ASR 135" Section 6.11
"Average Price of Parent Common Stock Section 2.01(c)
"Certificate of Merger" Section 1.02
"Certificates" Section 2.02(b)
"Closing" Section 1.03
"Closing Date" Section 1.03
"Code" Section 3.10
"Combined Results" Section 6.11
"Company" Preamble
"Company Common Stock" Section 2.01(b)
"Company Disclosure Letter" Section 3.01
"Company Employee Benefit Plan" Section 3.11(c)(i)
"Company Financial Statements" Section 3.05
"Company Option Plan" Section 2.01(e)
"Company Preferred Stock" Section 3.02(a)
"Company SEC Reports" Section 3.05
"Company Stockholders' Approval" Section 6.03(b)
"Company Stockholders' Meeting" Section 6.03(b)
"Constituent Corporations" Section 1.01
"Contracts" Section 3.04(a)
"Conversion Number" Section 2.01(c)
"DGCL" Section 1.01
"Dissenting Share" Section 2.01(d)
"Effective Time" Section 1.02
"ERISA" Section 3.11(a)(i)
"Exchange Act" Section 3.04(b)
"Exchange Agent" Section 2.02(a)
"Exchange Fund" Section 2.02(a)
"FTC" Section 6.06
"GAAP" Section 3.10
"Governmental or Regulatory Authority" Section 3.04(a)
"HSR Act" Section 3.04(b)
"IRS" Section 3.10
"Indemnified Parties" Section 6.09(a)
"Laws" Section 3.04(a)
"Lien" Section 3.02(b)
"material" Section 3.01
"material adverse effect" Section 3.01
"materially adverse" Section 3.01
"Merger" Preamble
"Options" Section 3.02(a)
"Orders" Section 3.04(a)
</TABLE>
iv
<PAGE> 210
<TABLE>
<S> <C>
"Parent" Preamble
"Parent Common Stock" Section 2.01(c)
"Parent Disclosure Letter" Section 4.01
"Parent Employee Benefit Plan" Section 4.11(c)
"Parent Financial Statements" Section 4.05
"Parent Option Plans" Section 4.02
"Parent Preferred Stock" Section 4.02(a)
"Parent SEC Reports" Section 4.05
"Parent Stockholders' Approval" Section 6.03(a)
"Parent Stockholders' Meeting Section 6.03(a)
"Parent Warrants" Section 4.02
"PBGC" Section 3.11(a)(iii)
"Plan" Section 3.11(c)(ii)
"Proxy Statement" Section 3.09
"Registration Statement" Section 4.09
"Representative" Section 6.01(a)
"Rule 144" Section 7.03(e)
"Rule 145" Section 7.01(f)
"SEC" Section 3.04(b)
"Sales Price of Parent Common Stock" Section 2.01(c)
"Secretary of State" Section 1.02
"Securities Act" Section 3.04(b)
"Selling Stockholders" Section 7.03(e)
"Stockholders' Meetings" Section 6.03(b)
"Sub" Preamble
"Sub Common Stock" Section 2.01(a)
"Subsidiary" Section 2.01(b)
"Surviving Corporation" Section 1.01
"Surviving Corporation Common Stock" Section 2.01(a)
"Trading Day" Section 2.01(c)
</TABLE>
v
<PAGE> 211
This AGREEMENT AND PLAN OF MERGER dated as of November 8, 1996 is made and
entered into by and among FPA Medical Management, Inc., a Delaware corporation
("Parent"), FPA Acquisition Corp., a Delaware corporation wholly owned by Parent
("Sub"), and AHI Healthcare Systems, Inc., a Delaware corporation (the
"Company").
WHEREAS, the Boards of Directors of Parent, Sub and the Company have each
determined that it is advisable and in the best interests of their respective
stockholders to consummate, and have approved, the business combination
transaction provided for herein in which Sub would merge with and into the
Company and the Company would become a wholly-owned Subsidiary of Parent (the
"Merger"); and
WHEREAS, Parent, Sub and the Company desire to make certain
representations, warranties and agreements in connection with the Merger and
also to prescribe various conditions to the Merger;
NOW, THEREFORE, in consideration of the mutual covenants and agreements set
forth in this Agreement, and for other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto
agree as follows:
ARTICLE I
THE MERGER
1.01 The Merger. At the Effective Time (as defined in Section 1.02), upon
the terms and subject to the conditions of this Agreement, Sub shall be merged
with and into the Company in accordance with the General Corporation Law of the
State of Delaware (the "DGCL"). The Company shall be the surviving corporation
in the Merger (the "Surviving Corporation"). Sub and the Company are sometimes
referred to herein as the "Constituent Corporations". As a result of the Merger,
the outstanding shares of capital stock of the Constituent Corporations shall be
converted or canceled in the manner provided in Article II.
1.02 Effective Time. At the Closing (as defined in Section 1.03), a
certificate of merger (the "Certificate of Merger") shall be duly prepared and
executed by the Surviving Corporation and thereafter delivered to the Secretary
of State of the State of Delaware (the "Secretary of State") for filing, as
provided in Section 251 of the DGCL, on, or as soon as practicable after, the
Closing Date (as defined in Section 1.03). The Merger shall become effective at
the time provided in the Certificate of Merger (the date and time so provided in
the Certificate of Merger being referred to herein as the "Effective Time").
1.03 Closing. The closing of the Merger (the "Closing") will take place
at the offices of Milbank, Tweed, Hadley & McCloy, 601 South Figueroa Street,
Los Angeles, California 90017, or at such other place as the parties hereto
mutually agree, on a date and at a time to be specified by the parties, which
shall in no event be later than 10:00 a.m., local time, on the day of
satisfaction of the condition set forth in Section 7.01(a), provided that the
other closing conditions set forth in Article VII have been satisfied or, if
permissible, waived in accordance with this Agreement, or on such other date as
the parties hereto mutually agree (the "Closing Date"). At the Closing there
shall be delivered to Parent, Sub and the Company the certificates and other
documents and instruments required to be delivered under Article VII.
1.04 Certificate of Incorporation and Bylaws of the Surviving
Corporation. At the Effective Time, (i) the Certificate of Incorporation of Sub
as in effect immediately prior to the Effective Time shall be the Certificate of
Incorporation of the Surviving Corporation until thereafter amended as provided
by law and such Certificate of Incorporation, and (ii) the Bylaws of Sub as in
effect immediately prior to the Effective Time shall be the Bylaws of the
Surviving Corporation until thereafter amended as provided by law, the
Certificate of Incorporation of the Surviving Corporation and such Bylaws.
1.05 Directors and Officers of the Surviving Corporation. The directors
of Sub and the officers of Sub immediately prior to the Effective Time shall,
from and after the Effective Time, be the directors and officers, respectively,
of the Surviving Corporation until their successors shall have been duly elected
or appointed and qualified or until their earlier death, resignation or removal
in accordance with the Surviving Corporation's Certificate of Incorporation and
Bylaws.
<PAGE> 212
1.06 Effects of the Merger. Subject to the foregoing, the effects of the
Merger shall be as provided in the applicable provisions of the DGCL.
1.07 Further Assurances. Each party hereto will execute such further
documents and instruments and take such further actions as may reasonably be
requested by one or more of the others to consummate the Merger, to vest the
Surviving Corporation with full title to all assets, properties, rights,
approvals, immunities and franchises of either of the Constituent Corporations
or to effect the other purposes of this Agreement.
ARTICLE II
CONVERSION OF SHARES
2.01 Conversion of Capital Stock. At the Effective Time, by virtue of the
Merger and without any action on the part of the holder thereof:
(a) Capital Stock of Sub. Each issued and outstanding share of the
common stock, par value $.01 per share, of Sub ("Sub Common Stock") shall
be converted into and become one fully paid and nonassessable share of
common stock, par value $.01 per share, of the Surviving Corporation
("Surviving Corporation Common Stock"). Each certificate representing
outstanding shares of Sub Common Stock shall at the Effective Time
represent an equal number of shares of Surviving Corporation Common Stock.
(b) Cancellation of Treasury Stock and Stock Owned by Parent and
Subsidiaries. All shares of common stock, par value $0.01 per share, of
the Company ("Company Common Stock") that are owned by the Company as
treasury stock and any shares of Company Common Stock owned by Parent, Sub
or any other wholly-owned Subsidiary (as hereinafter defined) of Parent
shall be canceled and retired and shall cease to exist and no stock of
Parent or other consideration shall be delivered in exchange therefor. As
used in this Agreement, "Subsidiary" means, with respect to any party, any
corporation or other organization, whether incorporated or unincorporated,
(i) of which more than fifty percent (50%) of either the equity interests
in, or the voting control of, such corporation or other organization is,
directly or indirectly through Subsidiaries or otherwise, beneficially
owned by such party or (ii) which is a professional corporation owned by at
least one physician who (x) is an officer and director of such party and is
qualified under the laws of such professional corporation's state of
incorporation to hold an ownership interest therein or (y) has executed a
succession or similar stockholder agreement with such party.
(c) Exchange Ratio for Company Common Stock. Each issued and
outstanding share of Company Common Stock (other than shares to be canceled
in accordance with Section 2.01(b) and other than Dissenting Shares (as
defined in Section 2.01(d))) shall be converted into the right to receive a
number of shares (the "Conversion Number") of fully paid and nonassessable
shares of common stock, par value $0.002 per share, of Parent ("Parent
Common Stock") determined as follows:
(i) if the Average Price of Parent Common Stock (as defined below)
is less than $14.38, the Conversion Number shall be 0.609;
(ii) if the Average Price of Parent Common Stock is equal to or
greater than $14.38 and less than $22.38, the Conversion Number shall be
equal to the result obtained by dividing $8.75 by the Average Price of
Parent Common Stock (and rounding the result to three decimal places);
(iii) if the Average Price of Parent Common Stock is equal to or
greater than $22.38 and less than $25.38, the Conversion Number shall be
0.391; and
(iv) if the Average Price of Parent Common Stock is equal to or
greater than $25.38, the Conversion Number shall be equal to the result
obtained by dividing $9.92 by the Average Price of Parent Common Stock
(and rounding the result to three decimal places).
The "Average Price of Parent Common Stock" shall be equal to the arithmetic
average of the Sales Price of Parent Common Stock (as hereinafter defined)
on each of the last ten (10) Trading Days (as
2
<PAGE> 213
hereinafter defined) preceding the second day before the date of the
Company Stockholders' Meeting. The term "Sales Price of Parent Common
Stock" shall mean, on any Trading Day, the average of the closing bid and
ask prices of Parent Common Stock on The Nasdaq National Market on such
Trading Day. The term "Trading Day" shall mean any day on which Parent
Common Stock is traded on The Nasdaq National Market. If, after the date
hereof and prior to the Effective Time, Parent shall pay a dividend in,
subdivide, combine into a smaller number of shares or issue by
reclassification of its shares, any shares of Parent Common Stock, the
Conversion Number shall be multiplied by a fraction, the numerator of which
shall be the number of shares of Parent Common Stock outstanding
immediately after, and the denominator of which shall be the number of such
shares outstanding immediately before, the occurrence of such event, and
the resulting product shall from and after the date of such event be the
Conversion Number, subject to further adjustment in accordance with this
sentence. All shares of Company Common Stock shall no longer be outstanding
and shall automatically be canceled and retired and shall cease to exist,
and each holder of a certificate representing any such shares shall cease
to have any rights with respect thereto, except the right to receive the
shares of Parent Common Stock and any cash in lieu of fractional shares of
Parent Common Stock to be issued or paid in consideration therefor
(determined in accordance with Section 2.02(e)), upon the surrender of such
certificate in accordance with Section 2.02, without interest.
(d) Dissenting Shares. (i) If applicable, notwithstanding any
provision of this Agreement to the contrary, each outstanding share of
Company Common Stock the holder of which has not voted in favor of the
Merger, has perfected such holder's right to an appraisal of such holder's
shares in accordance with the applicable provisions of the DGCL and has not
effectively withdrawn or lost such right to appraisal (a "Dissenting
Share"), shall not be converted into or represent a right to receive shares
of Parent Common Stock pursuant to Section 2.01(c), but the holder thereof
shall be entitled only to such rights as are granted by the applicable
provisions of the DGCL; provided, however, that any Dissenting Share held
by a person at the Effective Time who shall, after the Effective Time,
withdraw the demand for appraisal or lose the right of appraisal, in either
case pursuant to the DGCL, shall be deemed to be converted into, as of the
Effective Time, the right to receive shares of Parent Common Stock pursuant
to Section 2.01(c).
(ii) The Company shall give Parent (x) prompt notice of any written
demands for appraisal, withdrawals of demands for appraisal and any other
instruments served pursuant to the applicable provisions of the DGCL
relating to the appraisal process received by the Company and (y) the
opportunity to direct all negotiations and proceedings with respect to
demands for appraisal under the DGCL. The Company will not voluntarily make
any payment with respect to any demands for appraisal and will not, except
with the prior written consent of Parent, settle or offer to settle any
such demands.
(e) Company Option Plans. The Company shall provide for immediate
vesting of, and cancellation at the Effective Time of, all outstanding
options to the extent permitted under the terms of the Company's 1995
Non-Employee Directors Stock Option Program, 1994 Long-Term Incentive Plan,
1995 Long-Term Incentive Plan (collectively, the "Company Option Plans")
and the stock option agreements executed pursuant thereto.
2.02 Exchange of Certificates.
(a) Exchange Agent. On the Closing Date, Parent shall make available to
the Surviving Corporation for deposit with a bank or trust company designated
before the Effective Date by Parent and reasonably acceptable to the Company
(the "Exchange Agent"), certificates representing the number of duly authorized
whole shares of Parent Common Stock issuable in connection with the Merger plus
an amount of cash equal to the aggregate amount payable in lieu of fractional
shares in accordance with Section 2.02(e), to be held for the benefit of and
distributed to such holders in accordance with this Section. The Exchange Agent
shall agree to hold such shares of Parent Common Stock and funds (such shares of
Parent Common Stock and funds, together with earnings thereon, being referred to
herein as the "Exchange Fund") for delivery as contemplated by this Section and
upon such additional terms as may be agreed upon by the Exchange Agent, the
Company and Parent before the Effective Time. If for any reason (including
losses) the amount of cash in the Exchange Fund is inadequate to pay the cash
amounts to which holders of shares of Company Common Stock shall be
3
<PAGE> 214
entitled pursuant to Section 2.02(e), Parent shall make available to the
Surviving Corporation additional funds for the payment thereof.
(b) Exchange Procedures. As soon as reasonably practicable after the
Effective Time, Parent shall cause the Exchange Agent to mail to each holder of
record of a certificate or certificates which immediately prior to the Effective
Time represented outstanding shares of Company Common Stock (the "Certificates")
whose shares are converted pursuant to Section 2.01(c) into the right to receive
shares of Parent Common Stock (i) a letter of transmittal (which shall specify
that delivery shall be effected, and risk of loss and title to the Certificates
shall pass, only upon delivery of the Certificates to the Exchange Agent and
shall be in such form and have such other provisions as Parent may reasonably
specify) and (ii) instructions for use in effecting the surrender of the
Certificates in exchange for certificates representing shares of Parent Common
Stock and cash in lieu of fractional shares. Upon surrender of a Certificate for
cancellation to the Exchange Agent, together with such letter of transmittal
duly executed and completed in accordance with its terms, the holder of such
Certificate shall be entitled to receive in exchange therefor a certificate
representing that number of whole shares of Parent Common Stock, plus the cash
amount payable in lieu of fractional shares in accordance with Section 2.02(e),
which such holder has the right to receive pursuant to the provisions of this
Article II, and the Certificate so surrendered shall forthwith be canceled. In
no event shall the holder of any Certificate be entitled to receive interest on
any funds to be received in the Merger. In the event of a transfer of ownership
of Company Common Stock which is not registered in the transfer records of the
Company, a certificate representing that number of whole shares of Parent Common
Stock, plus the cash amount payable in lieu of fractional shares in accordance
with Section 2.02(e), may be issued to a transferee if the Certificate
representing such Company Common Stock is presented to the Exchange Agent
accompanied by all documents required to evidence and effect such transfer and
by evidence that any applicable stock transfer taxes have been paid. Until
surrendered as contemplated by this Section 2.02(b), each Certificate shall be
deemed at any time after the Effective Time for all corporate purposes of
Parent, except as limited by paragraph (c) below, to represent ownership of the
number of shares of Parent Common Stock into which the number of shares of
Company Common Stock shown thereon have been converted as contemplated by this
Article II.
(c) Distributions with Respect to Unexchanged Shares. No dividends or
other distributions declared or made after the Effective Time with respect to
Parent Common Stock with a record date on or after the Effective Time shall be
paid to the holder of any unsurrendered Certificate with respect to the shares
of Parent Common Stock represented thereby and no cash payment in lieu of
fractional shares shall be paid to any such holder pursuant to Section 2.02(e)
until the holder of record of such Certificate shall surrender such Certificate
in accordance with this Section. Subject to the effect of applicable laws,
following surrender of any such Certificate, there shall be paid to the record
holder of the certificates representing whole shares of Parent Common Stock
issued in exchange therefor, without interest, (i) at the time of such
surrender, the amount of dividends or other distributions, if any, with a record
date on or after the Effective Time which theretofore became payable, but which
were not paid by reason of the immediately preceding sentence, with respect to
such whole shares of Parent Common Stock, and (ii) at the appropriate payment
date, the amount of dividends or other distributions with a record date on or
after the Effective Time but prior to surrender and a payment date subsequent to
surrender payable with respect to such whole shares of Parent Common Stock.
(d) No Further Ownership Rights in Company Common Stock. All shares of
Parent Common Stock issued upon the surrender for exchange of Certificates in
accordance with the terms hereof (including any cash paid pursuant to Section
2.02(e)) shall be deemed to have been issued at the Effective Time in full
satisfaction of all rights pertaining to the shares of Company Common Stock
represented thereby. From and after the Effective Time, the stock transfer books
of the Company shall be closed and there shall be no further registration of
transfers on the stock transfer books of the Surviving Corporation of the shares
of Company Common Stock which were outstanding immediately prior to the
Effective Time. If, after the Effective Time, Certificates are presented to the
Surviving Corporation for any reason, they shall be canceled and exchanged as
provided in this Section.
(e) No Fractional Shares. No certificate or scrip representing fractional
shares of Parent Common Stock will be issued in the Merger upon the surrender
for exchange of Certificates, and such fractional share
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interests will not entitle the owner thereof to vote or to any rights of a
stockholder of Parent. In lieu of any such fractional shares, each holder of
Company Common Stock who would otherwise have been entitled to a fraction of a
share of Parent Common Stock in exchange for Certificates pursuant to this
Section shall receive from the Exchange Agent a cash payment in lieu of such
fractional share determined by multiplying (A) last sales price of a whole share
of Parent Common Stock on The Nasdaq National Market on the last Trading Day
immediately preceding the Closing Date by (B) the fractional share interest to
which such holder would otherwise be entitled.
(f) Termination of Exchange Fund. Any portion of the Exchange Fund which
remains undistributed to the stockholders of the Company for twelve (12) months
after the Effective Time shall be delivered to Parent, upon demand, and any
stockholders of the Company who have not theretofore complied with this Article
II shall thereafter look only to Parent (subject to abandoned property, escheat
and other similar laws) as general creditors for payment of their claim for
Parent Common Stock, any cash in lieu of fractional shares of Parent Common
Stock and any dividends or distributions with respect to Parent Common Stock.
Neither Parent nor the Surviving Corporation shall be liable to any holder of
shares of Company Common Stock for shares of Parent Common Stock (or dividends
or distributions with respect thereto) or cash payable in respect of fractional
share interests delivered to a public official pursuant to any applicable
abandoned property, escheat or similar law.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to Parent and Sub as follows:
3.01 Organization and Qualification. Each of the Company and its
Subsidiaries is a corporation duly organized, validly existing and in good
standing under the laws of its jurisdiction of incorporation and has full
corporate power and authority to conduct its business as and to the extent
now conducted and to own, use and lease its assets and properties, except
(in the case of any Subsidiary) for such failures to be so organized,
existing and in good standing or to have such power and authority which,
individually or in the aggregate, are not having and could not be
reasonably expected to have a material adverse effect on the Company and
its Subsidiaries taken as a whole. Each of the Company and its Subsidiaries
is duly qualified, licensed or admitted to do business and is in good
standing in each jurisdiction in which the ownership, use or leasing of its
assets and properties, or the conduct or nature of its business, makes such
qualification, licensing or admission necessary, except for such failures
to be so qualified, licensed or admitted and in good standing which,
individually or in the aggregate, are not having and could not be
reasonably expected to have a material adverse effect on the Company and
its Subsidiaries taken as a whole. As used in this Agreement, any reference
to any event, change or effect being "material" or "materially adverse" or
having a "material adverse effect" on or with respect to an entity (or
group of entities taken as a whole) means such event, change or effect is
material or materially adverse, as the case may be, to the business,
condition (financial or otherwise), properties, assets (including
intangible assets), liabilities (including contingent liabilities), or
results of operations of such entity (or, if with respect thereto, of such
group of entities taken as a whole). Section 3.01 of the letter dated the
date hereof and delivered to Parent and Sub by the Company concurrently
with the execution and delivery of this Agreement (the "Company Disclosure
Letter") sets forth the name and jurisdiction of incorporation of each
Subsidiary of the Company. Except as disclosed in Section 3.01 of the
Company Disclosure Letter, the Company does not directly or indirectly own
any equity or similar interest in, or any interest convertible into or
exchangeable or exercisable for, any equity or similar interest in, any
corporation, partnership, joint venture or other business association or
entity.
3.02 Capital Stock. (a) The authorized capital stock of the Company
consists solely of 75,000,000 shares of Company Common Stock and 25,000,000
shares of preferred stock, par value $0.01 per share ("Company Preferred
Stock"). As of September 30, 1996, 14,523,041 shares of Company Common
Stock were issued and outstanding, no shares were held in the treasury of
the Company and 3,067,444 shares were reserved for issuance under the
Company Option Plans. There has been no change
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in the number of issued and outstanding shares of Company Common Stock or
shares of Company Common Stock held in treasury or reserved for issuance
since such date. As of the date hereof, no shares of Company Preferred
Stock are issued and outstanding. All of the issued and outstanding shares
of Company Common Stock are, and all shares reserved for issuance will be,
upon issuance in accordance with the terms specified in the instruments or
agreements pursuant to which they are issuable, duly authorized, validly
issued, fully paid and nonassessable. Except pursuant to this Agreement and
except as set forth in Section 3.02 of the Company Disclosure Letter or the
Company SEC Reports (as defined in Section 3.05), there are no outstanding
subscriptions, options, warrants, rights (including "phantom" stock
rights), preemptive rights or other contracts, commitments, understandings
or arrangements, including any right of conversion or exchange under any
outstanding security, instrument or agreement (together, "Options"),
obligating the Company or any of its Subsidiaries to issue or sell any
shares of capital stock of the Company or to grant, extend or enter into
any Option with respect thereto, and there are no rights to register any of
the Company's securities under the Securities Act.
(b) Except as disclosed in Section 3.02 of the Company Disclosure
Letter, all of the outstanding shares of capital stock of each Subsidiary
of the Company are duly authorized, validly issued, fully paid and
nonassessable and are owned, beneficially and of record, by the Company or
a Subsidiary wholly owned, directly or indirectly, by the Company, free and
clear of any liens, claims, mortgages, encumbrances, pledges, security
interests, equities and charges of any kind (each a "Lien"). Except as
disclosed in Section 3.02 of the Company Disclosure Letter or in the
Company SEC Reports, there are no (i) outstanding Options obligating the
Company or any of its Subsidiaries to issue or sell any shares of capital
stock of any Subsidiary of the Company or to grant, extend or enter into
any such Option or (ii) voting trusts, proxies or other commitments,
understandings, restrictions or arrangements in favor of any person other
than the Company or a Subsidiary wholly owned, directly or indirectly, by
the Company with respect to the voting of or the right to participate in
dividends or other earnings on any capital stock of any Subsidiary of the
Company.
(c) Except as disclosed in Section 3.02 of the Company Disclosure
Letter or in the Company SEC Reports, there are no outstanding contractual
obligations of the Company or any Subsidiary of the Company to repurchase,
redeem or otherwise acquire any shares of Company Common Stock or any
capital stock of any Subsidiary of the Company or to provide funds to, or
make any investment (in the form of a loan, capital contribution or
otherwise) in, any Subsidiary of the Company or any other person.
3.03 Authority Relative to this Agreement. The Company has full
corporate power and authority to enter into this Agreement, to perform its
obligations hereunder and, subject to obtaining the Company Stockholders'
Approval (as defined in Section 6.03(b)), to consummate the transactions
contemplated hereby. The execution, delivery and performance of this
Agreement by the Company and the consummation by the Company of the
transactions contemplated hereby have been duly and validly approved by the
Board of Directors of the Company, the Board of Directors of the Company
has recommended adoption of this Agreement by the stockholders of the
Company and directed that this Agreement be submitted to the stockholders
of the Company for their consideration, and no other corporate proceedings
on the part of the Company or its stockholders are necessary to authorize
the execution, delivery and performance of this Agreement by the Company
and the consummation by the Company of the transactions contemplated
hereby, other than obtaining the Company Stockholders' Approval. This
Agreement has been duly and validly executed and delivered by the Company
and constitutes a legal, valid and binding obligation of the Company
enforceable against the Company in accordance with its terms, except as
enforceability may be limited by bankruptcy, insolvency, reorganization,
moratorium or other similar laws affecting the enforcement of creditors'
rights generally and by general equitable principles (regardless of whether
such enforceability is considered in a proceeding in equity or at law).
Consummation of the transactions contemplated hereby is subject to the
obtaining of the Company Stockholders' Approval.
3.04 Non-Contravention; Approvals and Consents.
(a) The execution and delivery of this Agreement by the Company do
not, and the performance by the Company of its obligations hereunder and
the consummation of the transactions contemplated hereby
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will not, conflict with, result in a violation or breach of, constitute
(with or without notice or lapse of time or both) a default under, result
in or give to any person any right of payment or reimbursement,
termination, cancellation, modification or acceleration of, or result in
the creation or imposition of any Lien upon any of the assets or properties
of the Company or any of its Subsidiaries under, any of the terms,
conditions or provisions of (i) the certificates or articles of
incorporation or bylaws (or other comparable charter documents) of the
Company or any of its Subsidiaries, or (ii) subject to the obtaining of the
Company Stockholders' Approval and the taking of the actions described in
paragraph (b) of this Section, (x) any statute, law, rule, regulation or
ordinance (together, "Laws"), or any judgment, decree, order, writ, permit
or license (together, "Orders"), of any court, tribunal, arbitrator,
authority, agency, commission, official or other instrumentality of the
United States or any state, county, city or other political subdivision (a
"Governmental or Regulatory Authority"), applicable to the Company or any
of its Subsidiaries or any of their respective assets or properties, or (y)
any note, bond, mortgage, security agreement, indenture, license,
franchise, permit, concession, contract, lease or other instrument,
obligation or agreement of any kind (together, "Contracts") to which the
Company or any of its Subsidiaries is a party or by which the Company or
any of its Subsidiaries or any of their respective assets or properties is
bound, excluding from the foregoing clauses (x) and (y) conflicts,
violations, breaches, defaults, terminations, modifications, accelerations
and creations and impositions of Liens which, individually or in the
aggregate, could not be reasonably expected to have a material adverse
effect on the Company and its Subsidiaries taken as a whole or on the
ability of the Company to consummate the transactions contemplated by this
Agreement.
(b) Except (i) for the filing of a premerger notification report by
the Company under the Hart-Scott-Rodino Antitrust Improvements Act of 1976,
as amended, and the rules and regulations thereunder (the "HSR Act"), (ii)
for the filing of the Proxy Statement (as defined in Section 3.09) and
Registration Statement (as defined in Section 4.09) with the Securities and
Exchange Commission (the "SEC") pursuant to the Securities Exchange Act of
1934, as amended, and the rules and regulations thereunder (the "Exchange
Act"), and the Securities Act of 1933, as amended, and the rules and
regulations thereunder (the "Securities Act"), the declaration of the
effectiveness of the Registration Statement by the SEC and filings with any
state securities authorities that are required in connection with the
transactions contemplated by this Agreement, (iii) for the filing of the
Certificate of Merger and other appropriate merger documents required by
the DGCL with the Secretary of State and appropriate documents with the
relevant authorities of other states in which the Constituent Corporations
are qualified to do business, and (iv) as disclosed in Section 3.04 of the
Company Disclosure Letter, no consent, approval or action of, filing with
or notice to any Governmental or Regulatory Authority or other public or
private third party is necessary or required under any of the terms,
conditions or provisions of any Law or Order of any Governmental or
Regulatory Authority or any Contract to which the Company or any of its
Subsidiaries is a party or by which the Company or any of its Subsidiaries
or any of their respective assets or properties is bound for the execution
and delivery of this Agreement by the Company, the performance by the
Company of its obligations hereunder or the consummation of the
transactions contemplated hereby, other than such consents, approvals,
actions, filings and notices which the failure to make or obtain, as the
case may be, individually or in the aggregate, could not be reasonably
expected to have a material adverse effect on the Company and its
Subsidiaries taken as a whole or on the ability of the Company to
consummate the transactions contemplated by this Agreement.
3.05 SEC Reports and Financial Statements. The Company delivered to
Parent prior to the execution of this Agreement a true and complete copy of
each form, report, schedule, registration statement, definitive proxy
statement and other document (together with all amendments thereof and
supplements thereto) filed by the Company or any of its Subsidiaries with
the SEC since September 28, 1995 (as such documents have since the time of
their filing been amended or supplemented, the "Company SEC Reports"),
which are all the documents (other than preliminary material) that the
Company and its Subsidiaries were required to file with the SEC since such
date. As of their respective dates, the Company SEC Reports (i) complied as
to form in all material respects with the requirements of the Securities
Act or the Exchange Act, as the case may be, and (ii) did not contain any
untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary in
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order to make the statements therein, in light of the circumstances under
which they were made, not misleading. The audited consolidated financial
statements and unaudited interim consolidated financial statements
(including, in each case, the notes, if any, thereto) included in the
Company SEC Reports (the "Company Financial Statements") complied as to
form in all material respects with the published rules and regulations of
the SEC with respect thereto, were prepared in accordance with generally
accepted accounting principles applied on a consistent basis during the
periods involved (except as may be indicated therein or in the notes
thereto and except with respect to unaudited statements as permitted by
Form 10-Q of the SEC) and fairly present (subject, in the case of the
unaudited interim financial statements, to normal, recurring year-end audit
adjustments which are not expected to be, individually or in the aggregate,
materially adverse to the Company and its Subsidiaries taken as a whole)
the consolidated financial position of the Company and its consolidated
Subsidiaries as at the respective dates thereof and the consolidated
results of their operations and cash flows for the respective periods then
ended. Except as set forth in Section 3.05 of the Company Disclosure
Letter, each Subsidiary of the Company is treated as a consolidated
Subsidiary of the Company in the Company Financial Statements for all
periods covered thereby.
3.06 Absence of Certain Changes or Events. Except as disclosed in
the Company SEC Reports filed prior to the date of this Agreement, since
September 30, 1996, there has not been any change, event or development
having, individually or in the aggregate, a material adverse effect on the
Company and its Subsidiaries taken as a whole, other than those occurring
as a result of general economic or financial conditions or other
developments which are not unique to the Company and its Subsidiaries but
also generally affect other persons who participate or are engaged in the
lines of business in which the Company and its Subsidiaries participate or
are engaged.
3.07 Absence of Undisclosed Liabilities. Except for matters
reflected or reserved against in the balance sheet for the period ended
September 30, 1996 included in the Company Financial Statements or as
disclosed in Section 3.07 of the Company Disclosure Letter, neither the
Company nor any of its Subsidiaries had at such date, or has incurred since
that date, any liabilities or obligations (whether absolute, accrued,
contingent, fixed or otherwise, or whether due or to become due) of any
nature that would be required by generally accepted accounting principles
to be reflected on a consolidated balance sheet of the Company and its
consolidated Subsidiaries (including the notes thereto), except liabilities
or obligations (i) which were incurred in the ordinary course of business
consistent with past practice or (ii) which have not been, and could not be
reasonably expected to be, individually or in the aggregate, materially
adverse to the Company and its Subsidiaries taken as a whole.
3.08 Legal Proceedings. Except as disclosed in the Company SEC
Reports filed prior to the date of this Agreement or in Section 3.08 of the
Company Disclosure Letter, (i) there are no actions, suits, arbitrations or
proceedings pending or, to the knowledge of the Company and its
Subsidiaries, threatened against, relating to or affecting, nor to the
knowledge of the Company and its Subsidiaries are there any Governmental or
Regulatory Authority investigations or audits pending or threatened
against, relating to or affecting, the Company or any of its Subsidiaries
or any of their respective assets and properties which, individually or in
the aggregate, could be reasonably expected to have a material adverse
effect on the Company and its Subsidiaries taken as a whole or on the
ability of the Company to consummate the transactions contemplated by this
Agreement, (ii) neither the Company nor any of its Subsidiaries is subject
to any Order of any Governmental or Regulatory Authority which,
individually or in the aggregate, is having or could be reasonably expected
to have a material adverse effect on the Company and its Subsidiaries taken
as a whole or on the ability of the Company to consummate the transactions
contemplated by this Agreement and (iii) there are no material Medicare,
Medicaid or other managed care recoupment or recoupments of any third-party
payor being sought, threatened, requested or claimed against the Company or
any of its Subsidiaries.
3.09 Information Supplied. The joint proxy statement relating to the
Stockholders' Meetings (as defined in Section 6.03(b)), as amended or
supplemented from time to time (as so amended and supplemented, the "Proxy
Statement"), and any other documents to be filed by the Company with the
SEC or any other Governmental or Regulatory Authority in connection with
the Merger and the other
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transactions contemplated hereby will (in the case of the Proxy Statement
and any such other documents filed with the SEC under the Exchange Act or
the Securities Act) comply as to form in all material respects with the
requirements of the Exchange Act and the Securities Act, respectively, and
will not, on the date of its filing or, in the case of the Proxy Statement,
at the date it is mailed to stockholders of the Company and of Parent, at
the times of the Stockholders' Meetings and at the Effective Time, contain
any untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they are made, not
misleading, except that no representation is made by the Company with
respect to information supplied in writing by or on behalf of Parent or Sub
expressly for inclusion therein and information incorporated by reference
therein from documents filed by Parent or any of its Subsidiaries with the
SEC.
3.10 Taxes. The Company and each of its Subsidiaries has filed all
tax returns that are required to have been filed by it in any jurisdiction
for all periods ending on or prior to the Effective Time and such tax
returns are true, correct and complete in all material respects, and the
Company and each of its Subsidiaries has paid all taxes shown to be due and
payable on such returns and all other taxes and assessments payable by it
to the extent the same have become due and payable and before they have
become delinquent, except for any taxes and assessments the amount,
applicability or validity of which is currently being contested in good
faith by appropriate proceedings and with respect to which the Company has
set aside on its books reserves (segregated to the extent required by
generally accepted accounting principles, consistently applied throughout
the specified period and in the immediately comparable period ("GAAP"))
deemed by it in its reasonable discretion to be adequate. The Company has
no knowledge of any proposed material tax assessment, obligation or other
claim against the Company or any of its Subsidiaries, and in the opinion of
the Company all tax liabilities of the Company and its Subsidiaries are
adequately provided for on the books of the Company. There are no material
liens for taxes upon any property or assets of the Company or any
Subsidiary thereof, except for liens for taxes not yet due. There are no
unresolved issues of law or fact arising out of a notice of deficiency,
proposed deficiency or assessment from the Internal Revenue Service ("IRS")
or any other governmental taxing authority with respect to taxes of the
Company or any of its Subsidiaries which, if decided adversely, singly or
in the aggregate, would have a material adverse effect on the business,
operations, properties, assets, condition (financial or other) or results
of operations of the Company and its Subsidiaries, taken as a whole.
Neither the Company nor any of its Subsidiaries is a party to any agreement
providing for the allocation or sharing of taxes with any entity that is
not, directly or indirectly, a wholly-owned corporate Subsidiary of Company
other than agreements the consequences of which are adequately reserved for
in the Company Financial Statements. Neither the Company nor any of its
corporate Subsidiaries has, with regard to any assets or property held,
acquired or to be acquired by any of them, filed a consent to the
application of Section 341(f) of the Internal Revenue Code of 1986, as
amended (the "Code").
3.11 Employee Benefit Plans; ERISA.
(a) Except as disclosed in the Company SEC Reports filed prior to the
date of this Agreement or as set forth in Section 3.11 of the Company
Disclosure Letter:
(i) to the knowledge of the Company and its Subsidiaries, no
prohibited transaction within the meaning of Section 406 or 407 of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"),
or Section 4975 of the Code with respect to any Company Employee Benefit
Plan (as defined below) has occurred during the five-year period
preceding the date of this Agreement;
(ii) there is no outstanding liability (except for premiums due)
under Title IV of ERISA with respect to any Company Employee Benefit
Plan;
(iii) neither the Pension Benefit Guaranty Corporation (the
"PBGC"), the Company nor any of its Subsidiaries has instituted
proceedings to terminate any Company Employee Benefit Plan;
(iv) full payment has been made of all amounts which the Company or
any of its Subsidiaries were required to have paid as a contribution to
the Company Employee Benefit Plans as of the last
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day of the most recent fiscal year of each of the Company Employee
Benefit Plans ended prior to the date of this Agreement, and none of the
Company Employee Benefit Plans has incurred any "accumulated funding
deficiency" (as defined in Section 302 of ERISA and Section 412 of the
Code), whether or not waived, as of the last day of the most recent
fiscal year of each such Company Employee Benefit Plan ended prior to
the date of this Agreement;
(v) the value on a termination basis of accrued benefits under each
of the Company Employee Benefit Plans which is subject to Title IV of
ERISA, based upon the actuarial assumptions used for funding purposes in
the most recent actuarial report prepared by such Company Employee
Benefit Plan's actuary with respect to each such Company Employee
Benefit Plan, did not, as of its latest valuation date, exceed the then
current value of the assets of such Company Employee Benefit Plan;
(vi) each of the Company Employee Benefit Plans which is intended
to be "qualified" within the meaning of Section 401(a) of the Code has
been determined by the IRS to be so qualified and such determination has
not been modified, revoked or limited;
(vii) each of the Company Employee Benefit Plans is, and its
administration is and has been during the five-year period preceding the
date of this Agreement in all material respects in compliance with, and
none of the Company nor any of its Subsidiaries has received any claim
or notice that any such Company Employee Benefit Plan is not in
compliance with, all applicable laws and orders and prohibited
transaction exemptions, including, without limitation, the requirements
of ERISA;
(viii) to the knowledge of the Company and its Subsidiaries, there
are no material pending, threatened or anticipated claims involving any
of the Company Employee Benefit Plans other than claims for benefits in
the normal course;
(ix) to the knowledge of the Company and its Subsidiaries, during
the five-year period preceding the date of this Agreement, none of the
Company or any of its Subsidiaries has entered into any transaction
which could subject such entity to liability under Section 302(c)(ii),
4062, 4063, 4064, or 4069 of ERISA and no "reportable event" within the
meaning of Section 4043 of ERISA has occurred with respect to any
Company Employee Benefit Plan;
(x) none of the Company or any of its Subsidiaries is in default in
performing any of its contractual obligations under any of the Company
Employee Benefit Plans or any related trust agreement or insurance
contract;
(xi) there are no material outstanding liabilities of any Company
Employee Benefit Plan other than liabilities for benefits to be paid to
participants in such Company Employee Benefit Plan and their
beneficiaries in accordance with the terms of such Company Employee
Benefit Plan; and
(xii) none of the Company or any of its Subsidiaries maintains or
is obligated to provide benefits under any life, medical or health plan
which provides benefits to retirees or other terminated employees other
than benefit continuation rights under the Consolidated Omnibus
Reconciliation Act of 1985, as amended.
(b) Except as set forth in Section 3.11 of the Company Disclosure
Letter, neither the execution and delivery of this Agreement nor the
consummation of the transactions contemplated hereby will accelerate
benefits under any Company Employee Benefit Plan.
(c) As used herein:
(i) "Company Employee Benefit Plan" means any Plan entered into,
established, maintained, contributed to or required to be contributed to
by the Company or any of its Subsidiaries and existing on the date of
this Agreement or at any time subsequent thereto and on or prior to the
Effective Time and, in the case of a Plan which is subject to Part 3 of
Title I of ERISA, Section 412 of the Code or Title IV of ERISA, at any
time during the five-year period preceding the date of this Agreement;
and
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(ii) "Plan" means any employment, bonus, incentive compensation,
deferred compensation, pension, profit sharing, retirement, stock
purchase, stock option, stock ownership, stock appreciation rights,
phantom stock, leave of absence, layoff, vacation, day or dependent
care, legal services, cafeteria, life, health, medical, accident,
disability, workmen's compensation or other insurance, severance,
separation, termination, change of control or other benefit plan,
agreement, practice, policy or arrangement of any kind, whether written
or oral, including, but not limited to any "employee benefit plan"
within the meaning of Section 3(3) of ERISA.
3.12 Vote Required. Assuming the accuracy of the representation and
warranty contained in Section 4.12, the affirmative vote of the holders of
record of at least a majority of the outstanding shares of Company Common
Stock with respect to the adoption of this Agreement is the only vote of
the holders of any class or series of the capital stock of the Company
required to adopt this Agreement and approve the Merger and the other
transactions contemplated hereby.
3.13 Accounting Matters. Neither the Company nor any of its
affiliates has taken or agreed to take any action that (without giving
effect to any action taken or agreed to be taken by Parent or any of its
affiliates) would prevent Parent from accounting for the business
combination to be effected by the Merger as a pooling of interests.
3.14 Company Not an Interested Stockholder or an Acquiring
Person. Neither the Company nor, to the knowledge of the Company, any of
its affiliates or associates (as such terms are defined in Section 203 of
the DGCL) is an "interested stockholder" (as such term is defined in
Section 203 of the DGCL) with respect to Parent.
3.15 Section 203 of the DGCL Not Applicable. The provisions of
Section 203 of the DGCL will not, assuming the accuracy of the
representation and warranty contained in Section 4.14 (without giving
effect to the knowledge qualification thereof), apply to this Agreement,
the Merger or the other transactions contemplated hereby.
3.16 Title to Assets. The Company and its Subsidiaries are in
possession of and have good title to, or have valid leasehold interests in
or valid rights under Contract to use, all of their respective properties
and assets primarily used in their respective businesses and material to
the condition (financial or other) of such businesses taken as a whole,
free and clear of all mortgages, liens, pledges, charges or encumbrances of
any nature whatsoever, except (i) the lien for current taxes, payments of
which are not yet delinquent, (ii) such imperfections in title and
easements and encumbrances, if any, as are not substantial in character,
amount or extent and do not materially detract from the value of or
interfere with the present use of the property subject thereto or affected
thereby, or otherwise materially impair the Company's business operations
(in the manner presently carried on by the Company) or (iii) as disclosed
in the Company SEC Reports, and except for such matters which, singly or in
the aggregate, would not materially and adversely affect the business,
operations, properties, assets, condition (financial or other) or results
of operations of the Company and its Subsidiaries, taken as a whole. All
leases under which the Company leases any substantial amount of real or
personal property have been made available to Parent and are in good
standing, valid and effective in accordance with their respective terms,
and there is not, under any of such leases, any existing default or event
which with notice or lapse of time or both would become a default other
than defaults under such leases which in the aggregate would not materially
and adversely affect the condition of the Company and its Subsidiaries,
taken as a whole.
3.17 Permits, Etc. The Company and its Subsidiaries own or validly
hold all licenses, permits, certificates of authority, registrations,
franchises and similar consents granted or issued by any applicable
Governmental or Regulatory Authority, used or held for use which are
required to conduct and material to the condition of their respective
businesses taken as a whole.
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ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF PARENT AND SUB
Parent and Sub represent and warrant to the Company as follows:
4.01 Organization and Qualification. Each of Parent and its
Subsidiaries (including Sub) is a corporation duly organized, validly
existing and in good standing under the laws of its jurisdiction of
incorporation and has full corporate power and authority to conduct its
business as and to the extent now conducted and to own, use and lease its
assets and properties, except (in the case of any Subsidiary) for such
failures to be so organized, existing and in good standing or to have such
power and authority which, individually or in the aggregate, are not having
and could not be reasonably expected to have a material adverse effect on
Parent and its Subsidiaries taken as a whole. Sub was formed solely for the
purpose of engaging in the transactions contemplated by this Agreement, has
engaged in no other business activities and has conducted its operations
only as contemplated hereby. Each of Parent and its Subsidiaries is duly
qualified, licensed or admitted to do business and is in good standing in
each jurisdiction in which the ownership, use or leasing of its assets and
properties, or the conduct or nature of its business, makes such
qualification, licensing or admission necessary, except for such failures
to be so qualified, licensed or admitted and in good standing which,
individually or in the aggregate, are not having and could not be
reasonably expected to have a material adverse effect on Parent and its
Subsidiaries taken as a whole. Section 4.01 of the letter dated the date
hereof and delivered by Parent and Sub to the Company concurrently with the
execution and delivery of this Agreement (the "Parent Disclosure Letter")
sets forth the name and jurisdiction of incorporation of each Subsidiary of
Parent. Except as disclosed in Section 4.01 of the Parent Disclosure
Letter, Parent does not directly or indirectly own any equity or similar
interest in, or any interest convertible into or exchangeable or
exercisable for, any equity or similar interest in, any corporation,
partnership, joint venture or other business association or entity.
4.02 Capital Stock. (a) The authorized capital stock of Parent
consists solely of 98,000,000 shares of Parent Common Stock and 2,000,000
shares of preferred stock, par value $0.002 per share ("Parent Preferred
Stock"). As of October 31, 1996, 20,673,133 shares of Parent Common Stock
were issued and outstanding, no shares were held in the treasury of Parent,
5,200,000 shares were reserved for issuance under the Parent's Amended and
Restated Omnibus Stock Option Plan, 1994 Physician Stock Option Plan and
1995 Non-Employee Director's Non-Qualified Stock Option Plan (collectively,
the "Parent Option Plans") and 365,000 shares were reserved for issuance
pursuant to the exercise of outstanding warrants ("Parent Warrants"). There
has been no change in the number of issued and outstanding shares of Parent
Common Stock or shares of Parent Common Stock held in treasury or reserved
for issuance since such date other than as a result of the exercise of
Options pursuant to the Parent Option Plans or the exercise of Parent
Warrants. As of the date hereof, no shares of Parent Preferred Stock are
issued and outstanding. All of the issued and outstanding shares of Parent
Common Stock are, and all shares reserved for issuance will be, upon
issuance in accordance with the terms specified in the instruments or
agreements pursuant to which they are issuable (including pursuant to this
Agreement), duly authorized, validly issued, fully paid and nonassessable.
Except pursuant to this Agreement and except as set forth in Section 4.02
of the Parent Disclosure Letter or in the Parent SEC Reports (as defined in
Section 4.05), there are no outstanding Options obligating Parent or any of
its Subsidiaries to issue or sell any shares of capital stock of Parent or
to grant, extend or enter into any Option with respect thereto, and there
are no rights to register any of Parent's securities under the Securities
Act.
(b) Except as disclosed in Section 4.02 of the Parent Disclosure
Letter or in the Parent SEC Reports, all of the outstanding shares of
capital stock of each Subsidiary of Parent are duly authorized, validly
issued, fully paid and nonassessable and are owned, beneficially and of
record, by Parent or a Subsidiary wholly owned, directly or indirectly, by
Parent, free and clear of any Liens. Except as disclosed in Section 4.02 of
the Parent Disclosure Letter or in the Parent SEC Reports, there are no (i)
outstanding Options obligating Parent or any of its Subsidiaries to issue
or sell any shares of capital stock of any Subsidiary of Parent or to
grant, extend or enter into any such Option or (ii) voting trusts,
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proxies or other commitments, understandings, restrictions or arrangements
in favor of any person other than Parent or a Subsidiary wholly owned,
directly or indirectly, by Parent with respect to the voting of or the
right to participate in dividends or other earnings on any capital stock of
any Subsidiary of Parent.
(c) Except as disclosed in Section 4.02 of the Parent Disclosure
Letter or in the Parent SEC Reports there are no outstanding contractual
obligations of Parent or any Subsidiary of Parent to repurchase, redeem or
otherwise acquire any shares of Parent Common Stock or any capital stock of
any Subsidiary of Parent or to provide funds to, or make any investment (in
the form of a loan, capital contribution or otherwise) in, any Subsidiary
of Parent or any other person.
4.03 Authority Relative to this Agreement. Each of Parent and Sub
has full corporate power and authority to enter into this Agreement, to
perform its obligations hereunder and, subject to obtaining the Parent
Stockholders' Approval (as defined in Section 6.03(a)), to consummate the
transactions contemplated hereby. The execution, delivery and performance
of this Agreement by each of Parent and Sub and the consummation by each of
Parent and Sub of the transactions contemplated hereby have been duly and
validly approved by its Board of Directors and by Parent in its capacity as
the sole stockholder of Sub, the Board of Directors of Parent has adopted a
resolution declaring the advisability of issuance of the Parent Common
Stock in connection with the Merger and the adoption of this Agreement by
the stockholders of Parent, and no other corporate proceedings on the part
of either of Parent or Sub or their stockholders are necessary to authorize
the execution, delivery and performance of this Agreement by Parent and Sub
and the consummation by Parent and Sub of the transactions contemplated
hereby, other than obtaining the Parent Stockholders' Approval. This
Agreement has been duly and validly executed and delivered by each of
Parent and Sub and constitutes a legal, valid and binding obligation of
each of Parent and Sub enforceable against each of Parent and Sub in
accordance with its terms, except as enforceability may be limited by
bankruptcy, insolvency, reorganization, moratorium or other similar laws
affecting the enforcement of creditors' rights generally and by general
equitable principles (regardless of whether such enforceability is
considered in a proceeding in equity or at law). Consummation of the
transactions contemplated hereby is subject to the obtaining of the Parent
Stockholders' Approval.
4.04 Non-Contravention; Approvals and Consents.
(a) The execution and delivery of this Agreement by each of Parent and
Sub do not, and the performance by each of Parent and Sub of its
obligations hereunder and the consummation of the transactions contemplated
hereby will not, conflict with, result in a violation or breach of,
constitute (with or without notice or lapse of time or both) a default
under, result in or give to any person any right of payment or
reimbursement, termination, cancellation, modification or acceleration of,
or result in the creation or imposition of any Lien upon any of the assets
or properties of Parent or any of its Subsidiaries under, any of the terms,
conditions or provisions of (i) the certificates or articles of
incorporation or bylaws (or other comparable charter documents) of Parent
or any of its Subsidiaries, or (ii) subject to the obtaining of the Parent
Stockholders' Approval and the taking of the actions described in paragraph
(b) of this Section, (x) any Laws or Orders of any Governmental or
Regulatory Authority applicable to Parent or any of its Subsidiaries or any
of their respective assets or properties, or (y) any Contracts to which
Parent or any of its Subsidiaries is a party or by which Parent or any of
its Subsidiaries or any of their respective assets or properties is bound,
excluding from the foregoing clauses (x) and (y) conflicts, violations,
breaches, defaults, terminations, modifications, accelerations and
creations and impositions of Liens which, individually or in the aggregate,
could not be reasonably expected to have a material adverse effect on
Parent and its Subsidiaries taken as a whole or on the ability of Parent
and Sub to consummate the transactions contemplated by this Agreement.
(b) Except (i) for the filing of a premerger notification report by
Parent under the HSR Act, (ii) for the filing of the Proxy Statement and
Registration Statement with the SEC pursuant to the Exchange Act and the
Securities Act, the declaration of the effectiveness of the Registration
Statement by the SEC and filings with any state securities authorities that
are required in connection with the transactions contemplated by this
Agreement, (iii) for the filing of the Certificate of Merger and other
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appropriate merger documents required by the DGCL with the Secretary of
State and appropriate documents with the relevant authorities of other
states in which the Constituent Corporations are qualified to do business,
and (iv) as disclosed in Section 4.04 of the Parent Disclosure Letter, no
consent, approval or action of, filing with or notice to any Governmental
or Regulatory Authority or other public or private third party is necessary
or required under any of the terms, conditions or provisions of any Law or
Order of any Governmental or Regulatory Authority or any Contract to which
Parent or any of its Subsidiaries is a party or by which Parent or any of
its Subsidiaries or any of their respective assets or properties is bound
for the execution and delivery of this Agreement by each of Parent and Sub,
the performance by each of Parent and Sub of its obligations hereunder or
the consummation of the transactions contemplated hereby, other than such
consents, approvals, actions, filings and notices which the failure to make
or obtain, as the case may be, individually or in the aggregate, could not
be reasonably expected to have a material adverse effect on Parent and its
Subsidiaries taken as a whole or on the ability of Parent and Sub to
consummate the transactions contemplated by this Agreement.
4.05 SEC Reports and Financial Statements. Parent delivered to the
Company prior to the execution of this Agreement a true and complete copy
of each form, report, schedule, registration statement, definitive proxy
statement and other document (together with all amendments thereof and
supplements thereto) filed by Parent or any of its Subsidiaries with the
SEC since October 20, 1994 (as such documents have since the time of their
filing been amended or supplemented, the "Parent SEC Reports"), which are
all the documents (other than preliminary material) that Parent and its
Subsidiaries were required to file with the SEC since such date. As of
their respective dates, the Parent SEC Reports (i) complied as to form in
all material respects with the requirements of the Securities Act or the
Exchange Act, as the case may be, and (ii) did not contain any untrue
statement of a material fact or omit to state a material fact required to
be stated therein or necessary in order to make the statements therein, in
light of the circumstances under which they were made, not misleading. The
audited consolidated financial statements and unaudited interim
consolidated financial statements (including, in each case, the notes, if
any, thereto) included in the Parent SEC Reports (the "Parent Financial
Statements") complied as to form in all material respects with the
published rules and regulations of the SEC with respect thereto, were
prepared in accordance with generally accepted accounting principles
applied on a consistent basis during the periods involved (except as may be
indicated therein or in the notes thereto and except with respect to
unaudited statements as permitted by Form 10-Q of the SEC) and fairly
present (subject, in the case of the unaudited interim financial
statements, to normal, recurring year-end audit adjustments which are not
expected to be, individually or in the aggregate, materially adverse to
Parent and its Subsidiaries taken as a whole) the consolidated financial
position of Parent and its consolidated Subsidiaries as at the respective
dates thereof and the consolidated results of their operations and cash
flows for the respective periods then ended. Except as set forth in Section
4.05 of the Parent Disclosure Letter, each Subsidiary of Parent is treated
as a consolidated Subsidiary of Parent in the Parent Financial Statements
for all periods covered thereby.
4.06 Absence of Certain Changes or Events. Except as disclosed in
the Parent SEC Reports filed prior to the date of this Agreement, since
June 30, 1996 there has not been any change, event or development having,
individually or in the aggregate, a material adverse effect on Parent and
its Subsidiaries taken as a whole.
4.07 Absence of Undisclosed Liabilities. Except for matters
reflected or reserved against in the balance sheet for the period ended
June 30, 1996 included in the Parent Financial Statements or as disclosed
in Section 4.07 of the Parent Disclosure Letter, neither Parent nor any of
its Subsidiaries had at such date, or has incurred since that date, any
liabilities or obligations (whether absolute, accrued, contingent, fixed or
otherwise, or whether due or to become due) of any nature that would be
required by GAAP to be reflected on a consolidated balance sheet of Parent
and its consolidated Subsidiaries (including the notes thereto), except
liabilities or obligations (i) which were incurred in the ordinary course
of business consistent with past practice or (ii) which have not been, and
could not be reasonably expected to be, individually or in the aggregate,
materially adverse to Parent and its Subsidiaries taken as a whole.
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4.08 Legal Proceedings. Except as disclosed in the Parent SEC
Reports filed prior to the date of this Agreement or in Section 4.08 of the
Parent Disclosure Letter, (i) there are no actions, suits, arbitrations or
proceedings pending or, to the knowledge of Parent and its Subsidiaries,
threatened against, relating to or affecting, nor to the knowledge of
Parent and its Subsidiaries are there any Governmental or Regulatory
Authority investigations or audits pending or threatened against, relating
to or affecting, Parent or any of its Subsidiaries or any of their
respective assets and properties which, individually or in the aggregate,
could be reasonably expected to have a material adverse effect on Parent
and its Subsidiaries taken as a whole or on the ability of Parent and Sub
to consummate the transactions contemplated by this Agreement, (ii) neither
Parent nor any of its Subsidiaries is subject to any Order of any
Governmental or Regulatory Authority which, individually or in the
aggregate, is having or could be reasonably expected to have a material
adverse effect on Parent and its Subsidiaries taken as a whole or on the
ability of Parent and Sub to consummate the transactions contemplated by
this Agreement and (iii) there are no material Medicare, Medicaid or other
managed care recoupment or recoupments of any third-party payor being
sought, threatened, requested or claimed against Parent or any of its
Subsidiaries.
4.09 Information Supplied. The Proxy Statement and the Registration
Statement on Form S-4 to be filed with the SEC by Parent in connection with
the Stockholders' Meetings and the issuance of shares of Parent Common
Stock in the Merger, as amended or supplemented from time to time (as so
amended and supplemented, the "Registration Statement"), and any other
documents to be filed by the Company with the SEC or any other Governmental
or Regulatory Authority in connection with the Merger and the other
transactions contemplated hereby will (in the case of the Proxy Statement
and the Registration Statement and any such other documents filed with the
SEC under the Securities Act or the Exchange Act) comply as to form in all
material respects with the requirements of the Exchange Act and the
Securities Act, respectively, and will not, on the date of its filing or,
in the case of the Proxy Statement and the Registration Statement, at the
time it becomes effective under the Securities Act, at the date the Proxy
Statement is mailed to stockholders of the Company and of Parent, at the
times of the Stockholders' Meetings and at the Effective Time, contain any
untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they are made, not
misleading, except that no representation is made by Parent or Sub with
respect to information supplied in writing by or on behalf of the Company
expressly for inclusion therein and information incorporated by reference
therein from documents filed by Parent or any of its Subsidiaries with the
SEC.
4.10 Taxes. Parent and each its Subsidiaries has filed all tax
returns that are required to have been filed by it in any jurisdiction, for
all periods ending on or prior to the Effective Time and such tax returns
are true, correct and complete in all material respects, and Parent and
each of its Subsidiaries has paid all taxes shown to be due and payable on
such returns and all other taxes and assessments payable by it to the
extent the same have become due and payable and before they have become
delinquent, except for any taxes and assessments the amount, applicability
or validity of which is currently being contested in good faith by
appropriate proceedings and with respect to which Parent has set aside on
its books reserves (segregated to the extent required by GAAP) deemed by it
in its reasonable discretion to be adequate. Parent has no knowledge of any
proposed material tax assessment, obligation or other claim against Parent
or any of its Subsidiaries, and in the opinion of Parent all tax
liabilities of Parent and its Subsidiaries are adequately provided for on
the books of Parent. There are no material liens for taxes upon any
property or assets of Parent or any Subsidiary thereof, except for liens
for taxes not yet due. There are no unresolved issues of law or fact
arising out of a notice of deficiency, proposed deficiency or assessment
from the IRS or any other governmental taxing authority with respect to
taxes of Parent or any of its Subsidiaries which, if decided adversely,
singly or in the aggregate, would have a material adverse effect on the
business, operations, properties, assets, condition (financial or other) or
results of operations of Parent and its Subsidiaries, taken as a whole.
Neither Parent nor any of its Subsidiaries is a party to any agreement
providing for the allocation or sharing of taxes with any entity that is
not, directly or indirectly, a wholly-owned corporate Subsidiary of Parent
other than agreements the consequences of which are adequately reserved for
in Parent Financial Statements. Neither Parent nor any of its corporate
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Subsidiaries has, with regard to any assets or property held, acquired or
to be acquired by any of them, filed a consent to the application of
Section 341(f) of the Code.
4.11 Employee Benefit Plans; ERISA.
(a) Except as disclosed in the Parent SEC Reports filed prior to the
date of this Agreement or as set forth in Section 4.11 of the Parent
Disclosure Letter:
(i) to the knowledge of Parent and its Subsidiaries, no prohibited
transaction within the meaning of Section 406 or 407 of ERISA, or
Section 4975 of the Code with respect to any Parent Employee Benefit
Plan (as defined below) has occurred during the five-year period
preceding the date of this Agreement;
(ii) there is no outstanding liability (except for premiums due)
under Title IV of ERISA with respect to any Parent Employee Benefit
Plan;
(iii) neither the PBGC, Parent nor any of its Subsidiaries has
instituted proceedings to terminate any Parent Employee Benefit Plan;
(iv) full payment has been made of all amounts which Parent or any
of its Subsidiaries were required to have paid as a contribution to the
Parent Employee Benefit Plans as of the last day of the most recent
fiscal year of each of the Parent Employee Benefit Plans ended prior to
the date of this Agreement, and none of the Parent Employee Benefit
Plans has incurred any "accumulated funding deficiency" (as defined in
Section 302 of ERISA and Section 412 of the Code), whether or not
waived, as of the last day of the most recent fiscal year of each such
Parent Employee Benefit Plan ended prior to the date of this Agreement;
(v) the value on a termination basis of accrued benefits under each
of the Parent Employee Benefit Plans which is subject to Title IV of
ERISA, based upon the actuarial assumptions used for funding purposes in
the most recent actuarial report prepared by such Parent Employee
Benefit Plan's actuary with respect to each such Parent Employee Benefit
Plan, did not, as of its latest valuation date, exceed the then current
value of the assets of such Parent Employee Benefit Plan;
(vi) each of the Parent Employee Benefit Plans which is intended to
be "qualified" within the meaning of Section 401(a) of the Code has been
determined by the IRS to be so qualified and such determination has not
been modified, revoked or limited;
(vii) each of the Parent Employee Benefit Plans is, and its
administration is and has been during the five-year period preceding the
date of this Agreement in all material respects in compliance with, and
none of Parent nor any of its Subsidiaries has received any claim or
notice that any such Parent Employee Benefit Plan is not in compliance
with, all applicable laws and orders and prohibited transaction
exemptions, including, without limitation, the requirements of ERISA;
(viii) to the knowledge of Parent and its Subsidiaries, there are
no material pending, threatened or anticipated claims involving any of
the Parent Employee Benefit Plans other than claims for benefits in the
normal course;
(ix) to the knowledge of Parent and its Subsidiaries, during the
five-year period preceding the date of this Agreement, none of Parent or
any of its Subsidiaries has entered into any transaction which could
subject such entity to liability under Section 302(c)(ii), 4062, 4063,
4064, or 4069 of ERISA and no "reportable event" within the meaning of
Section 4043 of ERISA has occurred with respect to any Parent Employee
Benefit Plan;
(x) none of Parent or any of its Subsidiaries is in default in
performing any of its contractual obligations under any of Parent
Employee Benefit Plans or any related trust agreement or insurance
contract;
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(xi) there are no material outstanding liabilities of any Parent
Employee Benefit Plan other than liabilities for benefits to be paid to
participants in such Parent Employee Benefit Plan and their
beneficiaries in accordance with the terms of such Parent Employee
Benefit Plan; and
(xii) none of Parent or any of its Subsidiaries maintains or is
obligated to provide benefits under any life, medical or health plan
which provides benefits to retirees or other terminated employees other
than benefit continuation rights under the Consolidated Omnibus
Reconciliation Act of 1985, as amended.
(b) Except as set forth in Section 4.11 of the Parent Disclosure
Letter, neither the execution and delivery of this Agreement nor the
consummation of the transactions contemplated hereby constitutes a change
in control or has or will accelerate benefits under any Parent Employee
Benefit Plan.
(c) As used herein "Parent Employee Benefit Plan" means any Plan
entered into, established, maintained, contributed to or required to be
contributed to by Parent or any of its Subsidiaries and existing on the
date of this Agreement or at any time subsequent thereto and on or prior to
the Effective Time and, in the case of a Plan which is subject to Part 3 of
Title I of ERISA, Section 412 of the Code or Title IV of ERISA, at any time
during the five-year period preceding the date of this Agreement.
4.12 Vote Required. Assuming the accuracy of the representation and
warranty contained in Section 3.12, the affirmative vote of the holders of
record of at least a majority of the outstanding shares of Parent Common
Stock with respect to the approval of the issuance of Parent Common Stock
and adoption of this Agreement in connection with the Merger is the only
vote of the holders of any class or series of the capital stock of Parent
required to approve the Merger and the other transactions contemplated
hereby.
4.13 Accounting Matters. To the knowledge of Parent, neither Parent
nor any of its affiliates has taken or agreed to take any action that
(without giving effect to any action taken or agreed to be taken by the
Company or any of its affiliates) would prevent Parent from accounting for
the business combination to be effected by the Merger as a pooling of
interests.
4.14 Parent Not an Interested Stockholder or an Acquiring
Person. Neither Parent nor, to the knowledge of Parent, any of its
affiliates or associates (as such terms are defined in Section 203 of the
DGCL) is an "interested stockholder" (as such term is defined in Section
203 of the DGCL) with respect to the Company.
4.15 Section 203 of the DGCL Not Applicable. The provisions of
Section 203 of the DGCL will not, assuming the accuracy of the
representation and warranty contained in Section 3.14 (without giving
effect to the knowledge qualification thereof), apply to this Agreement,
the Merger or the other transactions contemplated hereby.
4.16 Title to Assets. Parent and its Subsidiaries are in possession
of and have good title to, or have valid leasehold interests in or valid
rights under Contract to use, all of their respective properties and assets
primarily used in their respective businesses and material to the condition
(financial or other) of such businesses taken as a whole, free and clear of
all mortgages, liens, pledges, charges or encumbrances of any nature
whatsoever, except (i) the lien for current taxes, payments of which are
not yet delinquent, (ii) such imperfections in title and easements and
encumbrances, if any, as are not substantial in character, amount or extent
and do not materially detract from the value of or interfere with the
present use of the property subject thereto or affected thereby, or
otherwise materially impair Parent's business operations (in the manner
presently carried on by Parent) or (iii) as disclosed in the Parent SEC
Reports, and except for such matters which, singly or in the aggregate,
would not materially and adversely affect the business, operations,
properties, assets, condition (financial or other) or results of operations
of Parent and its Subsidiaries, taken as a whole. All leases under which
Parent leases any substantial amount of real or personal property have been
made available to the Company and are in good standing, valid and effective
in accordance with their respective terms, and there is not, under any of
such leases, any existing default or event which with notice or lapse of
time or both would become a default other than defaults
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under such leases which in the aggregate would not materially and adversely
affect the condition of Parent and its Subsidiaries, taken as a whole.
4.17 Permits, Etc. Parent and its Subsidiaries own or validly hold
all licenses, permits, certificates of authority, registrations, franchises
and similar consents granted or issued by any applicable Governmental or
Regulatory Authority, used or held for use and material to the condition of
their respective businesses taken as a whole.
ARTICLE V
COVENANTS
5.01 Covenants of the Company and Parent. At all times from and after the
date hereof until the Effective Time, the Company and Parent each covenants and
agrees as to itself and its Subsidiaries that (except as expressly contemplated
or permitted by this Agreement, or to the extent that the other party shall
otherwise consent in writing):
(a) Ordinary Course. Each party and each of its Subsidiaries shall
conduct their respective businesses only in, and none of the Company,
Parent and such Subsidiaries shall take any action except in, the ordinary
course consistent with past practice.
(b) Without limiting the generality of paragraph (a) of this Section,
except as otherwise disclosed in the Parent Disclosure Letter or the
Company Disclosure Letter, as applicable, (i) each party and its
Subsidiaries shall use all commercially reasonable efforts to preserve
intact in all material respects their present business organizations and
reputation, to keep available the services of their key officers and
employees, to maintain their assets and properties in good working order
and condition, ordinary wear and tear excepted, to maintain insurance on
their tangible assets and businesses in such amounts and against such risks
and losses as are currently in effect, to preserve their relationships with
customers and suppliers and others having significant business dealings
with them and to comply in all material respects with all Laws and Orders
of all Governmental or Regulatory Authorities applicable to them, and (ii)
neither party shall, nor shall it permit any of its Subsidiaries to:
(A) amend or propose to amend its certificate or articles of
incorporation or bylaws (or other comparable corporate charter
documents);
(B) (w) declare, set aside or pay any dividends on or make other
distributions in respect of any of its capital stock, except for the
declaration and payment of dividends by a wholly-owned Subsidiary solely
to its parent corporation, (x) split, combine, reclassify or take
similar action with respect to any of its capital stock or issue or
authorize or propose the issuance of any other securities in respect of,
in lieu of or in substitution for shares of its capital stock, (y) adopt
a plan of complete or partial liquidation or resolutions providing for
or authorizing such liquidation or a dissolution, merger, consolidation,
restructuring, recapitalization or other reorganization or (z) directly
or indirectly redeem, repurchase or otherwise acquire any shares of its
capital stock or any Option with respect thereto;
(C) issue, deliver or sell, or authorize or propose the issuance,
delivery or sale of, any shares of its capital stock or any Option with
respect thereto (other than (x) the issuance of options by Parent
pursuant to the Parent Option Plans, in accordance with their present
terms, (y) the issuance of shares of Company Common Stock and Parent
Common Stock, as the case may be, upon exercise of previously granted
options pursuant to the Company Option Plans and the Parent Option
Plans, in each case in accordance with their present terms or the Parent
Warrants, and (z) the issuance by a wholly-owned Subsidiary of its
capital stock to its parent corporation), or modify or amend any right
of any holder of outstanding shares of capital stock or Options with
respect thereto;
(D) other than acquisitions by Parent in accordance with its
ongoing acquisition program, acquire (by merging or consolidating with,
or by purchasing a substantial equity interest in or a substantial
portion of the assets of, or by any other manner) any business or any
corporation,
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partnership, association or other business organization or division
thereof or otherwise acquire or agree to acquire any assets which are
material, individually or in the aggregate, to such party and its
Subsidiaries taken as a whole;
(E) other than dispositions of assets which are not, individually
or in the aggregate, material to such party and its Subsidiaries taken
as a whole, sell, lease, grant any security interest in or otherwise
dispose of or encumber any of its assets or properties;
(F) except to the extent required by applicable law, (x) permit any
material change in (A) any pricing, marketing, purchasing, investment,
accounting, financial reporting, inventory, credit, allowance or tax
practice or policy or (B) any method of calculating any bad debt,
contingency or other reserve for accounting, financial reporting or tax
purposes or (y) make any material tax election or settle or compromise
any material income tax liability with any Governmental or Regulatory
Authority;
(G) (x) incur (which shall not be deemed to include entering into
credit agreements, lines of credit or similar arrangements until
borrowings are made under such arrangements) any indebtedness for
borrowed money or guarantee any such indebtedness other than in the
ordinary course of its business consistent with past practice in an
aggregate principal amount exceeding $5,000,000 with respect to the
Company and its Subsidiaries and $250,000,000 with respect to Parent and
its Subsidiaries (in each case net of any amounts of any such
indebtedness discharged during such period), or (y) voluntarily
purchase, cancel, prepay or otherwise provide for a complete or partial
discharge in advance of a scheduled repayment date with respect to, or
waive any right under, any indebtedness for borrowed money other than in
the ordinary course of its business consistent with past practice in an
aggregate principal amount exceeding $5,000,000 with respect to the
Company and its Subsidiaries and $250,000,000 with respect to Parent and
its Subsidiaries;
(H) enter into, adopt, amend in any material respect (except as may
be required by applicable law) or terminate any Company Employee Benefit
Plan or Parent Employee Benefit Plan, as the case may be, or other
agreement, arrangement, plan or policy between such party or one of its
Subsidiaries and one or more of its directors, officers or employees,
or, except for normal increases in the ordinary course of business
consistent with past practice that, in the aggregate, do not result in a
material increase in benefits or compensation expense to such party and
its Subsidiaries taken as a whole, increase in any manner the
compensation or fringe benefits of any director, officer or employee or
pay any benefit not required by any plan or arrangement in effect as of
the date hereof;
(I) enter into any contract or amend or modify any existing
contract, or engage in any new transaction, outside the ordinary course
of business consistent with past practice or not on an arm's length
basis, with any affiliate of such party or any of its Subsidiaries;
(J) make any capital expenditures or commitments for additions to
plant, property or equipment constituting capital assets except in the
ordinary course of business consistent with past practice in an
aggregate amount exceeding $5,000,000 with respect to the Company and
its Subsidiaries and $15,000,000 with respect to Parent and its
Subsidiaries;
(K) make any change in the lines of business in which it
participates or is engaged; or
(L) enter into any contract, agreement, commitment or arrangement
to do or engage in any of the foregoing.
(c) Advice of Changes. Each party shall confer on a regular and
frequent basis with the other with respect to its business and operations
and other matters relevant to the Merger, and shall promptly advise the
other, orally and in writing, of any change or event, including, without
limitation, any complaint, investigation or hearing by any Governmental or
Regulatory Authority (or communication indicating the same may be
contemplated) or the institution or threat of litigation, having, or which,
insofar as can be reasonably foreseen, could have, a material adverse
effect on the Company or Parent, as the case may be,
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and its Subsidiaries taken as a whole or on the ability of the Company or
Parent, as the case may be, to consummate the transactions contemplated
hereby.
ARTICLE VI
ADDITIONAL AGREEMENTS
6.01 Access to Information; Confidentiality. (a) Each of the Company and
Parent shall, and shall cause each of its Subsidiaries to, throughout the period
from the date hereof to the Effective Time, (i) provide the other party and its
directors, officers, employees, legal, investment, banking and financial
advisors, accountants and any other agents and representatives (collectively,
"Representatives") with full access, upon reasonable prior notice and during
normal business hours, to all officers, employees, agents and accountants of the
Company or Parent, as the case may be, and its Subsidiaries and their respective
assets, properties, books and records, but only to the extent that such access
does not unreasonably interfere with the business and operations of the Company
or Parent, as the case may be, and its Subsidiaries, and (ii) furnish promptly
to such persons (x) a copy of each report, statement, schedule and other
document filed or received by the Company or Parent, as the case may be, or any
of its Subsidiaries pursuant to the requirements of federal or state securities
laws or filed with any other Governmental or Regulatory Authority, and (y) all
other information and data (including, without limitation, copies of Contracts,
Company Employee Benefit Plans or Parent Employee Benefit Plans, as the case may
be, and other books and records) concerning the business and operations of the
Company or Parent, as the case may be, and its Subsidiaries as the other party
or any of such other persons reasonably may request. No investigation pursuant
to this paragraph or otherwise shall affect any representation or warranty
contained in this Agreement or any condition to the obligations of the parties
hereto.
(b) Each party will hold, and will use its best efforts to cause its
Representatives to hold, in strict confidence, unless (i) compelled to disclose
by judicial or administrative process or by other requirements of applicable
Laws of Governmental or Regulatory Authorities (including, without limitation,
in connection with obtaining the necessary approvals of this Agreement or the
transactions contemplated hereby of Governmental or Regulatory Authorities), or
(ii) disclosed in an action or proceeding brought by a party hereto in pursuit
of its rights or in the exercise of its remedies hereunder, all documents and
information concerning the other party and its Subsidiaries furnished to it by
such other party or its Representatives in connection with this Agreement or the
transactions contemplated hereby, except to the extent that such documents or
information can be shown to have been (x) previously known by the Company or
Parent, as the case may be, or its Representatives, (y) in the public domain
(either prior to or after the furnishing of such documents or information
hereunder) through no fault of the Company or Parent, as the case may be, and
its Representatives or (z) later acquired by the Company or Parent, as the case
may be, or its Representatives from another source if the recipient is not aware
that such source is under an obligation to the Company or Parent, as the case
may be, to keep such documents and information confidential. In the event that
this Agreement is terminated without the transactions contemplated hereby having
been consummated, upon the request of the Company or Parent, as the case may be,
the other party will, and will cause its Representatives to, promptly (and in no
event later than five (5) days after such request) redeliver or cause to be
redelivered all copies of documents and information furnished by the Company or
Parent, as the case may be, or its Representatives to such party and its
Representatives in connection with this Agreement or the transactions
contemplated hereby and destroy or cause to be destroyed all notes, memoranda,
summaries, analyses, compilations and other writings related thereto or based
thereon prepared by the Company or Parent, as the case may be, or its
Representatives.
6.02 Preparation of Registration Statement and Proxy Statement. The
Company and Parent shall prepare and file with the SEC as soon as reasonably
practicable after the date hereof the Proxy Statement and Parent shall prepare
and file with the SEC as soon as reasonably practicable after the date hereof
the Registration Statement, in which the Proxy Statement will be included as the
prospectus. Parent and the Company shall use their best efforts to have the
Registration Statement declared effective by the SEC as promptly as practicable
after such filing. Parent shall also take any action (other than qualifying as a
foreign
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corporation or taking any action which would subject it to service of process in
any jurisdiction where Parent is not now so qualified or subject) required to be
taken under applicable state blue sky or securities laws in connection with the
issuance of Parent Common Stock in connection with the Merger. If at any time
prior to the Effective Time any event shall occur that should be set forth in an
amendment of or a supplement to the Registration Statement, Parent shall prepare
and file with the SEC such amendment or supplement as soon thereafter as is
reasonably practicable. Parent, Sub and the Company shall cooperate with each
other in the preparation of the Registration Statement and the Proxy Statement
and any amendment or supplement thereto, and each shall notify the other of the
receipt of any comments of the SEC with respect to the Registration Statement or
the Proxy Statement and of any requests by the SEC for any amendment or
supplement thereto or for additional information, and shall provide to the other
promptly copies of all correspondence between Parent or the Company, as the case
may be, or any of its Representatives with respect to the Registration Statement
or the Proxy Statement. Parent shall give the Company and its counsel the
opportunity to review the Registration Statement and all responses to requests
for additional information by and replies to comments of the SEC before their
being filed with, or sent to, the SEC. Each of the Company, Parent and Sub
agrees to use its best efforts, after consultation with the other parties
hereto, to respond promptly to all such comments of and requests by the SEC and
to cause the Registration Statement to be declared effective by the SEC, and the
Proxy Statement to be mailed to the holders of Company Common Stock and Parent
Common Stock entitled to vote at the meetings of the stockholders of the Company
and Parent at the earliest practicable time.
6.03 Approval of Stockholders.
(a) Parent shall, through its Board of Directors, duly call, give notice
of, convene and hold a meeting of its stockholders (the "Parent Stockholders'
Meeting") for the purpose of voting on the adoption of this Agreement and the
issuance of Parent Common Stock in the Merger (the "Parent Stockholders'
Approval"). Parent shall, through its Board of Directors, include in the Proxy
Statement the recommendation of the Board of Directors of Parent that it is in
the best interest of the stockholders that the stockholders of Parent adopt this
Agreement, and shall use its best efforts to obtain such adoption.
(b) The Company shall, through its Board of Directors, duly call, give
notice of, convene and hold a meeting of its stockholders (the "Company
Stockholders' Meeting" and, together with the Parent Stockholders' Meeting, the
"Stockholders' Meetings") for the purpose of voting on the adoption of this
Agreement (the "Company Stockholders' Approval") as soon as reasonably
practicable after the date hereof. Subject to the exercise of fiduciary
obligations under applicable law as advised by independent counsel, the Company
shall, through its Board of Directors, include in the Proxy Statement the
recommendation of the Board of Directors of the Company that it is in the best
interest of the stockholders that the stockholders of the Company adopt this
Agreement, and shall use its best efforts to obtain such adoption. At such
meeting, Parent shall, and shall cause its Subsidiaries to, cause all shares of
Company Common Stock then owned by Parent or any such Subsidiary to be voted in
favor of the adoption of this Agreement.
(c) Parent and the Company shall coordinate and cooperate with respect to
the timing of the Stockholders' Meetings and shall use their best efforts to
cause the Stockholders' Meetings to be held on the same day and as soon as
practicable after the date hereof.
6.04 Inclusion of Shares on The Nasdaq National Market. Parent shall use
its best efforts to cause the shares of Parent Common Stock to be issued in the
Merger in accordance with this Agreement to be approved for inclusion on The
Nasdaq National Market, subject to official notice of issuance, prior to the
Closing Date.
6.05 [Reserved]
6.06 Regulatory and Other Approvals. Subject to the terms and conditions
of this Agreement and without limiting the provisions of Sections 6.02 and 6.03,
each of the Company and Parent will proceed diligently and in good faith and
will use all commercially reasonable efforts to do, or cause to be done, all
things necessary, proper or advisable to, as promptly as practicable, (a) obtain
all consents, approvals or actions of, make all filings with and give all
notices to Governmental or Regulatory Authorities or any other public or private
third parties required of Parent, the Company or any of their Subsidiaries to
consummate the
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Merger and the other matters contemplated hereby, and (b) provide such other
information and communications to such Governmental or Regulatory Authorities or
other public or private third parties as the other party or such Governmental or
Regulatory Authorities or other public or private third parties may reasonably
request in connection therewith. In addition to and not in limitation of the
foregoing, each of the parties will (x) take promptly all actions necessary to
make the filings required of Parent and the Company or their affiliates under
the HSR Act, (y) comply at the earliest practicable date with any request for
additional information received by such party or its affiliates from the Federal
Trade Commission (the "FTC") or the Antitrust Division of the Department of
Justice (the "Antitrust Division") pursuant to the HSR Act, and (z) cooperate
with the other party in connection with such party's filings under the HSR Act
and in connection with resolving any investigation or other inquiry concerning
the Merger or the other matters contemplated by this Agreement commenced by
either the FTC or the Antitrust Division or state attorneys general.
6.07 Employee Benefit Plans. (a) Parent shall allow retained employees of
the Company and its Subsidiaries to participate, effective as of the Closing
Date, under the terms of the Parent Employee Benefit Plans, including without
limitation its health, medical, disability, life or other insurance, retirement,
401(k) or severance plans, as employees of similar salary and position at Parent
or its Subsidiaries as if such employees had been employees of Parent or its
Subsidiaries during their employment by the Company and its Subsidiaries.
Nothing herein shall (i) obligate Parent to offer employment to or to continue
to employ any person employed by the Company prior to the Effective Time or (ii)
prevent Parent from reducing or discontinuing any benefit for all of its
employees, including those employed by the Company prior to the Effective Time.
Any employee of the Company or its Subsidiaries retained by Parent shall be an
"at will" employee, unless otherwise provided by agreement between Parent and
such employee.
(b) Parent will, and will cause the Surviving Corporation to, honor without
modification all employee severance plans (or policies) and employment and
severance agreements of the Company or any of its Subsidiaries in existence on
the date hereof as such agreements shall be in effect in accordance with the
terms of this Agreement at the Effective Time, as set forth in the plans and
agreements specified in Section 6.07(i) of the Company Disclosure Letter. Parent
hereby notifies and agrees with the Company that upon the Effective Time, the
employees designated in Section 6.07(ii) of the Company Disclosure Letter are
terminated and entitled to severance for termination upon a change of control as
set forth in their employment agreements with the Company, are not subject to
any noncompetition agreement, and their severance shall be paid by the Company
in one lump sum at the Closing, or such other payment arrangement as may be
agreed upon by Parent and such terminated employee.
6.08 [Reserved]
6.09 Directors' and Officers' Indemnification and Insurance. (a) Except
to the extent required by law, until the fifth anniversary of the Effective
Time, Parent will not take any action so as to amend, modify or repeal the
provisions for indemnification of directors, officers, stockholders, employees
or agents contained in the certificates or articles of incorporation or bylaws
(or other comparable charter documents) of the Surviving Corporation and its
Subsidiaries (which as of the Effective Time shall be no less favorable to such
individuals than those maintained by the Company and its Subsidiaries on the
date hereof) in such a manner as would materially and adversely affect the
rights of any individual who shall have served as a director, officer,
stockholder, employee or agent of the Company or any of its Subsidiaries prior
to the Effective Time (each an "Indemnified Party") to be indemnified by such
corporations in respect of their serving in such capacities prior to the
Effective Time. Parent shall indemnify all directors, officers, employees, and
stockholders who are officers or directors of the Company against any liability
or losses (including attorney's fees for counsel who are reasonably acceptable
to Parent) any of them may incur because of any claim brought against them prior
to or within five years from the Effective Time as officers, directors,
employees, agents or stockholders of the Company, and in connection therewith,
shall advance attorney's fees to them to defend any such claim; provided that
Parent shall be entitled to cooperate in the defense of any such matter; and
provided, further, that Parent shall not be liable for any settlement effected
without its written consent (which consent shall not be unreasonably withheld);
and provided, further, that Parent shall not be obligated pursuant to this
Section to pay the fees and disbursements of more than one counsel for all
Indemnified Parties in any single action,
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except to the extent that, in the opinion of counsel for the Indemnified
Parties, two or more of such Indemnified Parties have conflicting interests in
the outcome of such action. Parent may obtain directors' and officers' liability
insurance covering its obligations under this Section.
(b) The Company shall purchase prior to the Effective Time, and Parent and
the Surviving Corporation shall maintain, until September 28, 1999, the policies
of directors' and officers' liability insurance maintained by the Company and
its Subsidiaries as of the date hereof (or policies of at least the same
coverage and amounts containing terms that are no less advantageous to the
insured parties) with respect to claims arising from facts or events that
occurred on or prior to the Effective Time.
(c) The provisions of this Section are intended to be for the benefit of,
and shall be enforceable by, each Indemnified Party and each party entitled to
insurance coverage under paragraph (b) above, respectively, and his or her heirs
and legal representatives, and shall be in addition to any other rights an
Indemnified Party may have under the certificate or articles of incorporation or
bylaws of the Surviving Corporation or any of its Subsidiaries, under the DGCL
or otherwise.
(d) In the event the Parent or the Surviving Corporation or any of their
respective successors or assigns (i) consolidates with or merges into any other
person and shall not be the continuing or surviving corporation or entity of
such consolidation or merger or (ii) transfers all or substantially all of its
properties and assets to any person, then, and in each such case, proper
provision shall be made so that the successors and assigns of the Parent or the
Surviving Corporation, as the case may be, or at Parent's option, Parent, shall
assume the obligations set forth in paragraphs (a) and (b) of this Section.
6.10 Expenses. Whether or not the Merger is consummated, all costs and
expenses incurred in connection with this Agreement and the transactions
contemplated hereby shall be paid by the party incurring such cost or expense,
except (i) that expenses incurred in connection with printing and mailing the
Proxy Statement and the Registration Statement, as well as any filing fees
relating thereto, shall be shared equally by Parent and the Company and (ii) the
fee, if applicable, set forth in the last sentence of Section 8.02 shall be paid
by the Company.
6.11 Pooling of Interests. From and after the date hereof and until the
Effective Time, neither Parent nor the Company nor any of their respective
Subsidiaries or other affiliates shall knowingly take any action, or knowingly
fail to take any action, that would jeopardize the treatment of Parent's
acquisition of the Company as a "pooling of interests" for accounting purposes.
Following the Effective Time, Parent shall use its best efforts to conduct the
business of the Surviving Corporation, and shall cause the Surviving Corporation
to use its best efforts to conduct its business, in a manner that would not
jeopardize the characterization of the Merger as a "pooling of interests" for
accounting purposes. The Parent agrees that on or prior to the later of February
28, 1997 or sixty (60) days after the Effective Time, Parent shall cause
publication of the combined results of operations of Parent, Sub and the Company
for a period of the first 30 days of combined operations of the Company and the
Parent (the "Combined Results"). For purposes of this Section 6.11, the term,
"publication" shall have the meaning provided in SEC Accounting Series Release
No. 135 ("ASR 135").
6.12 Brokers or Finders. Each of Parent and the Company represents, as to
itself and its affiliates, that no agent, broker, investment banker, financial
advisor or other firm or person is or will be entitled to any broker's or
finder's fee or any other commission or similar fee in connection with any of
the transactions contemplated by this Agreement, except Smith Barney Inc., whose
fees and expenses will be paid by the Company in accordance with the Company's
agreement with such firm (a true and complete copy of which has been delivered
by the Company to Parent prior to the execution of this Agreement), and Needham
& Company, Inc., whose fees and expenses will be paid by Parent in accordance
with Parent's agreement with such firm (a true and complete copy of which has
been delivered by Parent to the Company prior to the execution of this
Agreement), and each of Parent and the Company shall indemnify and hold the
other harmless from and against any and all claims, liabilities or obligations
with respect to any other such fee or commission or expenses related thereto
asserted by any person on the basis of any act or statement alleged to have been
made by such party or its affiliate.
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6.13 Standstill. Each of Parent and the Company agrees that until the
expiration of three years from the date of termination of this Agreement,
without the prior written consent of the other, it will not (a) in any manner
acquire, agree to acquire or make any proposal to acquire, directly or
indirectly (i) a substantial portion of the assets of the other and its
Subsidiaries taken as a whole or (ii) any of the issued and outstanding shares
of stock of the other (b) make or in any way participate, directly or
indirectly, in any "solicitation" of "proxies" (as such terms are used in the
proxy rules of the SEC) to vote, or seek to advise or influence any person with
respect to the voting of, any voting securities of the other or any of its
Subsidiaries or (c) form, join or in any way participate in a "group" (within
the meaning of Section 13(d) of the Exchange Act) with respect to any voting
securities of the other or any of its Subsidiaries.
6.14 Notice and Cure. Each of Parent and the Company will notify the
other in writing of, and contemporaneously will provide the other with true and
complete copies of any and all information or documents relating to, and will
use best efforts to cure before the Closing, any event, transaction or
circumstance, as soon as practical after it becomes known to such party,
occurring after the date of this Agreement that causes or will cause any
covenant or agreement of Parent or the Company, as the case may be, under this
Agreement to be breached or that renders or will render untrue any
representation or warranty of Parent or the Company, as the case may be,
contained in this Agreement as if the same were made on or as of the date of
such event, transaction or circumstance. Each of Parent and the Company also
will notify the other in writing of, and will use best efforts to cure, before
the Closing, any violation or breach, as soon as practical after it becomes
known to such party, of any representation, warranty, covenant or agreement made
by Parent or the Company, as the case may be, in this Agreement, whether
occurring or arising prior to, on or after the date of this Agreement. No notice
given pursuant to this Section shall have any effect on the representations,
warranties, covenants or agreements contained in this Agreement for purposes of
determining satisfaction of any condition contained herein.
6.15 Fulfillment of Conditions. Subject to the terms and conditions of
this Agreement, each of Parent and the Company will take or cause to be taken
all steps necessary or desirable and proceed diligently and in good faith to
satisfy each condition to the other's obligations contained in this Agreement
and to consummate and make effective the transactions contemplated by this
Agreement, and neither Parent nor the Company will, nor will it permit any of
its Subsidiaries to, take or fail to take any action that could be reasonably
expected to result in the nonfulfillment of any such condition.
6.16 No Solicitations. Prior to the Effective Time, the Company agrees
(a) that neither it nor any of its Subsidiaries shall, and it shall use its best
efforts to cause their respective Representatives not to, initiate, solicit or
encourage, directly or indirectly, any inquiries or the making or implementation
of any proposal or offer (including, without limitation, any proposal or offer
to its stockholders) with respect to a merger, consolidation or other business
combination including the Company or any of its Subsidiaries or any acquisition
or similar transaction (including, without limitation, a tender or exchange
offer) involving the purchase of (i) all or any significant portion of the
assets of the Company and its Subsidiaries taken as a whole, (ii) 20% or more of
the outstanding shares of Company Common Stock or (iii) 20% or more of the
outstanding shares of the capital stock of any Subsidiary of the Company (any
such proposal or offer being hereinafter referred to as an "Alternative
Proposal"), or engage in any negotiations concerning, or provide any
confidential information or data to, or have any discussions with, any person or
group relating to an Alternative Proposal (excluding the transactions
contemplated by this Agreement), or otherwise facilitate any effort or attempt
to make or implement an Alternative Proposal; (b) that it will notify Parent
immediately if any such inquiries, proposals or offers are received by, any such
information is requested from, or any such negotiations or discussions are
sought to be initiated or continued with, it or any such person or group; and
(c) that it will, prior to accepting any Alternative Proposal, (i) receive a
determination from an independent financial advisor that such Alternative
Proposal is more favorable (from a financial point of view) to the Company's
stockholders than the Merger, (ii) determine in the exercise of its fiduciary
obligations under applicable law as advised by independent counsel that such
Alternative Proposal is more favorable to the Company's stockholders than the
Merger, and (iii) deliver to Parent a definitive agreement of such Alternative
Proposal or a description of the material terms thereof and, except as would
violate a fiduciary or contractual obligation, a copy of any information
provided by such person or group, including the identity of such person or
group,
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and give Parent at least three (3) days to offer a counterproposal prior to
executing such definitive agreement; provided, however, that nothing contained
in this Section 6.16 shall prohibit the Board of Directors of the Company from
(1) furnishing information to or entering into discussions or negotiations with
any person or group that makes an unsolicited bona fide Alternative Proposal,
if, and only to the extent that, (A) the Board of Directors of the Company,
based upon the written opinion of outside counsel (a copy of which shall be
provided promptly to Parent), determines in good faith that such action is
required or appropriate for the Board of Directors to comply with its fiduciary
duties to stockholders imposed by law, (B) the Board of Directors has reasonably
concluded in good faith that the person or group making such Alternative
Proposal will have adequate sources of financing to consummate such Alternative
Proposal and that such Acquisition Proposal is more favorable to the Company's
stockholders than the Merger and (C) prior to furnishing such information to, or
entering into discussions or negotiations with, such person or group, the
Company provides written notice to Parent to the effect that it is furnishing
information to, or entering into discussions or negotiations with, such person
or group; and (2) to the extent applicable, complying with Rule 14e-2
promulgated under the Exchange Act with regard to an Alternative Proposal.
6.17 Irrevocable Proxies. Upon the execution hereof, each of Parent and
the Company will use its best efforts to cause its officers and employee
directors to execute and deliver to the other party to this Agreement
irrevocable proxies in a form reasonably acceptable to the parties hereto
authorizing the other party to vote all shares of Company Common Stock and
Parent Common Stock, as the case may be, which such executive officers and
directors are entitled to vote in favor of the Merger. Such proxies shall be
revocable in the event that this Agreement is terminated.
ARTICLE VII
CONDITIONS
7.01 Conditions to Each Party's Obligation to Effect the Merger. The
respective obligation of each party to effect the Merger is subject to the
fulfillment, at or prior to the Closing, of each of the following conditions:
(a) Stockholder Approvals. This Agreement shall have been adopted by
the stockholders of the Company. This Agreement shall have been adopted by
the stockholders of the Parent.
(b) Registration Statement; State Securities Laws. The Registration
Statement shall have become effective in accordance with the provisions of
the Securities Act with respect to all the shares being issued in
connection with the Merger, and no stop order suspending such effectiveness
shall have been issued and remain in effect and no proceeding seeking such
an order shall be pending or threatened. Parent shall have received all
state securities or "Blue Sky" permits and other authorizations, if any,
necessary to issue the Parent Common Stock pursuant to this Agreement after
the Merger.
(c) Inclusion of Shares on The Nasdaq National Market. The shares of
Parent Common Stock issuable to the Company's stockholders in the Merger in
accordance with this Agreement shall have been approved for inclusion on
The Nasdaq National Market, upon official notice of issuance.
(d) HSR Act. Any waiting period (and any extension thereof)
applicable to the consummation of the Merger under the HSR Act shall have
expired or been terminated.
(e) No Injunctions or Restraints. No court of competent jurisdiction
or other competent Governmental or Regulatory Authority shall have enacted,
issued, promulgated, enforced or entered any Law or Order (whether
temporary, preliminary or permanent) which is then in effect and has the
effect of making illegal or otherwise restricting, preventing or
prohibiting consummation of the Merger or the other transactions
contemplated by this Agreement.
(f) Pooling and Affiliate Letters. Parent and the Company shall have
received letters from Deloitte & Touche LLP and Ernst & Young, each dated
the date of the Proxy Statement and confirmed in writing at the Effective
Time and addressed to Parent and the Company, respectively, stating that
the Merger will qualify as a pooling of interests transaction under Opinion
16 of the Accounting Principles
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Board. Within thirty (30) days after the date of this Agreement, (i) the
Company shall deliver to Parent a letter identifying all persons who may be
deemed affiliates of the Company under Rule 145 promulgated under the
Securities Act ("Rule 145"), including, without limitation, all directors
and executive officers of the Company, and (ii) the Company shall advise
the persons identified in such letter of the resale restrictions imposed by
applicable securities laws, including ASR 135. Each of the Company and
Parent shall use its reasonable best efforts to obtain as soon as
practicable after the date hereof from affiliates of the Company and Parent
an agreement that such persons will comply with the provisions of ASR 135.
(g) Governmental and Regulatory Consents and Approvals. Other than
the filing provided for by Section 1.02, all consents, approvals and
actions of, filings with and notices to any Governmental or Regulatory
Authority or any other public or private third parties required of Parent,
the Company or any of their Subsidiaries to consummate the Merger and the
other matters contemplated hereby, the failure of which to be obtained or
taken could be reasonably expected to have a material adverse effect on
Parent and its Subsidiaries or the Surviving Corporation and its
Subsidiaries, in each case taken as a whole, or on the ability of Parent
and the Company to consummate the transactions contemplated hereby shall
have been obtained.
7.02 Conditions to Obligation of Parent and Sub to Effect the Merger. The
obligation of Parent and Sub to effect the Merger is further subject to the
fulfillment, at or prior to the Closing, of each of the following additional
conditions (all or any of which may be waived in whole or in part by Parent and
Sub in their sole discretion):
(a) Representations and Warranties. Each of the representations and
warranties made by the Company in this Agreement shall be true and correct
in all material respects as of the Closing Date as though made on and as of
the Closing Date or, in the case of representations and warranties made as
of a specified date earlier than the Closing Date, on and as of such
earlier date, and the Company shall have delivered to Parent a certificate,
dated the Closing Date and executed on behalf of the Company by its
Chairman of the Board, President or any Executive or Senior Vice President,
to such effect.
(b) Performance of Obligations. The Company shall have performed and
complied with, in all material respects, each agreement, covenant and
obligation required by this Agreement to be so performed or complied with
by the Company at or prior to the Closing, and the Company shall have
delivered to Parent a certificate, dated the Closing Date and executed on
behalf of the Company by its Chairman of the Board, President or any
Executive or Senior Vice President, to such effect.
(c) Orders and Laws. There shall not have been issued, enacted,
promulgated or deemed applicable to the Company, the Surviving Corporation,
any of their respective Subsidiaries or the transactions contemplated by
this Agreement any Order or Law of any Governmental or Regulatory Authority
which is then in effect and which could be reasonably expected to result in
a material diminution of the benefits of the Merger to Parent, and there
shall not be pending or threatened on the Closing Date any action, suit or
proceeding in, before or by any Governmental or Regulatory Authority which
could be reasonably expected to result in any such issuance, enactment,
promulgation or deemed applicability of any such Order or Law or of any
Order or Law referred to in Section 7.01(e).
(d) Contractual Consents. The Company and its Subsidiaries shall have
received all consents (or in lieu thereof waivers) from parties to each
Contract disclosed pursuant to Section 3.04(b).
(e) [Reserved]
(f) Proceedings. All proceedings to be taken on the part of the
Company in connection with the transactions contemplated by this Agreement
and all documents incident thereto shall be reasonably satisfactory in form
and substance to Parent, and Parent shall have received copies of all such
documents and other evidences as Parent may reasonably request in order to
establish the consummation of such transactions and the taking of all
proceedings in connection therewith.
(g) Opinion of Counsel. Parent shall have received the opinion of
Milbank, Tweed, Hadley & McCloy, counsel to the Company, dated the Closing
Date, in form reasonably acceptable to Parent.
26
<PAGE> 237
(h) Contractual Consents. Parent and its Subsidiaries shall have
received all consents (or in lieu thereof waivers) from parties to each
Contract disclosed pursuant to Section 4.04.
7.03 Conditions to Obligation of the Company to Effect the Merger. The
obligation of the Company to effect the Merger is further subject to the
fulfillment, at or prior to the Closing, of each of the following additional
conditions (all or any of which may be waived in whole or in part by the Company
in its sole discretion):
(a) Representations and Warranties. Each of the representations and
warranties made by Parent and Sub in this Agreement shall be true and
correct in all material respects as of the Closing Date as though made on
and as of the Closing Date or, in the case of representations and
warranties made as of a specified date earlier than the Closing Date, on
and as of such earlier date, and Parent and Sub shall each have delivered
to the Company a certificate, dated the Closing Date and executed on behalf
of Parent by its Chairman of the Board, President or any Executive or
Senior Vice President and on behalf of Sub by its Chairman of the Board,
President or any Vice President, to such effect.
(b) Performance of Obligations. Parent and Sub shall have performed
and complied with, in all material respects, each agreement, covenant and
obligation required by this Agreement to be so performed or complied with
by Parent or Sub at or prior to the Closing, and Parent and Sub shall each
have delivered to the Company a certificate, dated the Closing Date and
executed on behalf of Parent by its Chairman of the Board, President or any
Executive or Senior Vice President and on behalf of Sub by its Chairman of
the Board, President or any Vice President, to such effect.
(c) Orders and Laws. There shall not have been issued, enacted,
promulgated or deemed applicable to the Parent, its Subsidiaries or the
transactions contemplated by this Agreement any Order or Law of any
Governmental or Regulatory Authority which is then in effect and which
could be reasonably expected to result in a material diminution of the
benefits of the Merger to the Company, and there shall not be pending or
threatened on the Closing Date any action, suit or proceeding in, before or
by any Governmental or Regulatory Authority which could be reasonably
expected to result in any such issuance, enactment, promulgation or deemed
applicability of any such Order or Law or of any Order or Law referred to
in Section 7.01(e).
(d) [Reserved]
(e) Registration Rights. Parent shall have entered into a
Registration Rights Agreement with the Selling Stockholders (as defined
below) providing that if, during the three month period following the date
on which the Combined Results are published, any of Leonardo Berezovsky,
Jose Spiwak and Kaushal Tamboli (the "Selling Stockholders") was or would
have been unable to sell at least 850,000 shares of the Parent Common Stock
received in the Merger in accordance with the provisions of Rule 144
promulgated under the Securities Act ("Rule 144"), Parent shall use its
best efforts to file a registration statement with the SEC to register on
behalf of any such Selling Stockholder a number of shares of Parent Common
Stock received in the Merger equal to three (3) times the amount by which
850,000 exceeds the number of shares such Selling Stockholder sold, or
would have been able to sell under Rule 144 during such three-month period.
Additionally, the registration rights agreement shall provide that, in the
event no registration statement was filed at the end of the initial
three-month period for any such Selling Stockholder and, during the
six-month period following the date on which the Combined Results are
published, any such Selling Stockholder was or would have been unable to
sell at least 1,700,000 shares of Parent Common Stock received in the
Merger in accordance with Rule 144, Parent shall use its best efforts to
file a registration statement with the SEC to register on behalf of any
such Selling Stockholder a number of shares of Parent Common Stock equal to
two (2) times the amount by which 1,700,000 exceeds the number of shares
such Selling Stockholder sold, or would have been able to sell under Rule
144 during such six-month period. Notwithstanding anything in this
Agreement to the contrary, any registration rights granted in the
registration rights agreement are subordinate to and shall not contravene
any registration rights granted by Parent prior to the date hereof. Such
registration rights agreement shall contain such other terms as are
customary and reasonably acceptable to Parent and Selling Stockholders. The
foregoing provisions for any such stockholder shall also apply to any trust
or
27
<PAGE> 238
other entity established by such stockholder. In no event shall Parent be
obligated to file more than one registration statement pursuant to the
terms of the registration rights agreement.
(f) The Average Price shall not be below $10.00.
(g) Proceedings. All proceedings to be taken on the part of Parent
and Sub in connection with the transactions contemplated by this Agreement
and all documents incident thereto shall be reasonably satisfactory in form
and substance to the Company, and the Company shall have received copies of
all such documents and other evidences as the Company may reasonably
request in order to establish the consummation of such transactions and the
taking of all proceedings in connection therewith.
(h) [Reserved]
(i) Opinion of Counsel. The Company shall have received the Opinion
of Ballard Spahr Andrews & Ingersoll, counsel to Parent, dated the Closing
Date, in form reasonably acceptable to the Company.
ARTICLE VIII
TERMINATION, AMENDMENT AND WAIVER
8.01 Termination. This Agreement may be terminated, and the transactions
contemplated hereby may be abandoned, at any time prior to the Effective Time,
whether prior to or after the Company Stockholders' Approval or the Parent
Stockholders' Approval:
(a) by mutual written agreement of the parties hereto duly authorized
by action taken by or on behalf of their respective Boards of Directors;
(b) by either the Company or Parent upon notification to the
non-terminating party by the terminating party:
(i) at any time after April 30, 1997 if the Merger shall not have
been consummated on or prior to such date and such failure to consummate
the Merger is not caused by a breach of this Agreement by the
terminating party;
(ii) if the Company Stockholders' Approval or the Parent
Stockholders' Approval shall not be obtained by reason of the failure to
obtain the requisite vote upon a vote held at a meeting of such
stockholders, or any adjournment thereof, called therefor;
(iii) if any Governmental or Regulatory Authority, the taking of
action by which is a condition to the obligations of either the Company
or Parent to consummate the transactions contemplated hereby, shall have
determined not to take such action and all appeals of such determination
shall have been taken and have been unsuccessful;
(iv) if there has been a material breach of any representation,
warranty, covenant or agreement on the part of the non-terminating party
set forth in this Agreement which breach has not been cured within five
(5) business days following receipt by the non-terminating party of
notice of such breach from the terminating party or assurance of such
cure reasonably satisfactory to the terminating party shall not have
been given by or on behalf of the non-terminating party within such five
(5) business day period; or
(v) if any court of competent jurisdiction or other competent
Governmental or Regulatory Authority shall have issued an Order making
illegal or otherwise restricting, preventing or prohibiting the Merger
and such Order shall have become final and nonappealable; or
(c) by the Company if the Board of Directors of the Company concludes
in good faith on the basis of advice from independent counsel that such
action is necessary or appropriate in order for such Board of Directors to
act in a manner which is consistent with its fiduciary obligations under
applicable law.
8.02 Effect of Termination. If this Agreement is validly terminated by
either the Company or Parent pursuant to Section 8.01, this Agreement will
forthwith become null and void and there will be no liability or obligation on
the part of either the Company or Parent (or any of their respective
Representatives or
28
<PAGE> 239
affiliates), except (i) that the provisions of Sections 6.01(b), 6.10, 6.12 and
6.13 will continue to apply following any such termination and (ii) that nothing
contained herein shall relieve any party hereto from liability for wilful breach
of its representations, warranties, covenants or agreements contained in this
Agreement. Notwithstanding the foregoing and the provisions of Section 6.10,
upon a termination by the Company pursuant to subsection (c) of Section 8.01,
the Company shall pay Parent liquidated damages in the amount of two percent
(2%) of the Average Price of the Parent Common Stock which would have been
issued hereunder had the Closing Date occurred on such date of termination.
8.03 Amendment. This Agreement may be amended, supplemented or modified
by action taken by or on behalf of the respective Boards of Directors of the
parties hereto at any time prior to the Effective Time, whether prior to or
after adoption of this Agreement at the Company Stockholders' Meeting or at the
Parent Stockholders' Meeting, but after such adoption and approval only to the
extent permitted by applicable law. No such amendment, supplement or
modification shall be effective unless set forth in a written instrument duly
executed by or on behalf of each party hereto.
8.04 Waiver. At any time prior to the Effective Time any party hereto, by
action taken by or on behalf of its Board of Directors, may to the extent
permitted by applicable law (i) extend the time for the performance of any of
the obligations or other acts of the other parties hereto, (ii) waive any
inaccuracies in the representations and warranties of the other parties hereto
contained herein or in any document delivered pursuant hereto or (iii) waive
compliance with any of the covenants, agreements or conditions of the other
parties hereto contained herein. No such extension or waiver shall be effective
unless set forth in a written instrument duly executed by or on behalf of the
party extending the time of performance or waiving any such inaccuracy or
non-compliance. No waiver by any party of any term or condition of this
Agreement, in any one or more instances, shall be deemed to be or construed as a
waiver of the same or any other term or condition of this Agreement on any
future occasion.
ARTICLE IX
GENERAL PROVISIONS
9.01 Non-Survival of Representations, Warranties, Covenants and
Agreements. The representations, warranties, covenants and agreements contained
in this Agreement or in any instrument delivered pursuant to this Agreement
shall not survive the Merger but shall terminate at the Effective Time, except
for the agreements contained in Article II and in Sections 6.01(b), 6.05, 6.07,
6.09, 6.10, 6.11, and 6.12, which shall survive the Effective Time.
9.02 Knowledge. With respect to any representations or warranties
contained herein which are made to the knowledge of the Company or Parent or any
of their respective Subsidiaries, as the case may be, the knowledge of the
officers, directors and employees of the Company or Parent, as the case may be,
and of the officers, directors and employees of its respective Subsidiaries,
shall be imputed to the Company or Parent, as the case may be, and such
Subsidiaries.
9.03 Notices. All notices, requests and other communications hereunder
must be in writing and will be deemed to have been duly given only if delivered
personally or by facsimile transmission or mailed (first class postage prepaid)
to the parties at the following addresses or facsimile numbers:
If to Parent or Sub, to:
FPA Medical Management, Inc.
2878 Camino del Rio South, Suite 301
San Diego, California 92108
Attn: James A. Lebovitz, Esq.
Facsimile No.: (619) 299-0708
29
<PAGE> 240
with a copy to:
Ballard Spahr Andrews & Ingersoll
1735 Market Street, 51st Floor
Philadelphia, Pennsylvania 19103-7599
Attn: Justin P. Klein, Esq.
Facsimile No.: (215) 864-8999
If to the Company, to:
AHI Healthcare Systems, Inc.
12620 Erickson Avenue, Suite A
Downey, California 90240
Attn: Chief Executive Officer
Facsimile No.: (310) 803-4373
with a copy to:
Milbank, Tweed, Hadley & McCloy
601 South Figueroa Street, 30th Floor
Los Angeles, California 90017
Attn: Eric H. Schunk, Esq.
Facsimile No.: (213) 629-5063
All such notices, requests and other communications will (i) if delivered
personally to the address as provided in this Section, be deemed given upon
delivery, (ii) if delivered by facsimile transmission to the facsimile number as
provided in this Section, be deemed given upon receipt, and (iii) if delivered
by mail in the manner described above to the address as provided in this
Section, be deemed given upon receipt (in each case regardless of whether such
notice, request or other communication is received by any other person to whom a
copy of such notice, request or other communication is to be delivered pursuant
to this Section). Any party from time to time may change its address, facsimile
number or other information for the purpose of notices to that party by giving
notice specifying such change to the other parties hereto.
9.04 Entire Agreement. This Agreement, together with the Registration
Rights Agreement, supersedes all prior discussions and agreements among the
parties hereto with respect to the subject matter hereof and contains the sole
and entire agreement among the parties hereto with respect to the subject matter
hereof.
9.05 Public Announcements. Except as otherwise required by law or the
rules of The Nasdaq National Market, so long as this Agreement is in effect,
Parent and the Company will not, and will not permit any of their respective
Representatives to, issue or cause the publication of any press release or make
any other public announcement with respect to the transactions contemplated by
this Agreement without the consent of the other party, which consent shall not
be unreasonably withheld. Parent and the Company will cooperate with each other
in the development and distribution of all press releases and other public
announcements with respect to this Agreement and the transactions contemplated
hereby, and will furnish the other with drafts of any such releases and
announcements as far in advance as practicable.
9.06 No Third Party Beneficiary. The terms and provisions of this
Agreement are intended solely for the benefit of each party hereto and their
respective successors or permitted assigns, and except as provided in Sections
2.01, 2.02, 6.07 and 6.09 (which are intended to be for the benefit of the
persons entitled to therein, and may be enforced by any of such persons), it is
not the intention of the parties to confer third-party beneficiary rights upon
any other person.
9.07 No Assignment; Binding Effect. Neither this Agreement nor any right,
interest or obligation hereunder may be assigned by any party hereto without the
prior written consent of the other parties hereto and any attempt to do so will
be void, except that Sub may assign any or all of its rights, interests and
obligations hereunder to another direct or indirect wholly-owned Subsidiary of
Parent, provided that any such Subsidiary agrees in writing to be bound by all
of the terms, conditions and provisions contained herein.
30
<PAGE> 241
Subject to the preceding sentence, this Agreement is binding upon, inures to the
benefit of and is enforceable by the parties hereto and their respective
successors and assigns.
9.08 Headings. The headings used in this Agreement have been inserted for
convenience of reference only and do not define or limit the provisions hereof.
9.09 Invalid Provisions. If any provision of this Agreement is held to be
illegal, invalid or unenforceable under any present or future law, and if the
rights or obligations of any party hereto under this Agreement will not be
materially and adversely affected thereby, (i) such provision will be fully
severable, (ii) this Agreement will be construed and enforced as if such
illegal, invalid or unenforceable provision had never comprised a part hereof,
(iii) the remaining provisions of this Agreement will remain in full force and
effect and will not be affected by the illegal, invalid or unenforceable
provision or by its severance herefrom and (iv) in lieu of such illegal, invalid
or unenforceable provision, there will be added automatically as a part of this
Agreement a legal, valid and enforceable provision as similar in terms to such
illegal, invalid or unenforceable provision as may be possible.
9.10 Governing Law. This Agreement shall be governed by and construed in
accordance with the laws of the State of Delaware applicable to a contract
executed and performed in such State, without giving effect to the conflicts of
laws principles thereof.
9.11 Counterparts. This Agreement may be executed in any number of
counterparts, each of which will be deemed an original, but all of which
together will constitute one and the same instrument.
IN WITNESS WHEREOF, each party hereto has caused this Agreement to be
signed by its officer thereunto duly authorized as of the date first above
written.
<TABLE>
<C> <S>
Attest: FPA MEDICAL MANAGEMENT, INC.
/s/ JAMES A. LEBOVITZ, ESQ. By: /s/ STEVEN M. LASH
- --------------------------------------------- -----------------------------------------
Secretary Steven M. Lash
Executive Vice President
Attest: FPA ACQUISITION CORP.
/s/ JAMES A. LEBOVITZ, ESQ. By: /s/ STEVEN M. LASH
- --------------------------------------------- -----------------------------------------
Secretary Steven M. Lash
Executive Vice President
Attest: AHI HEALTHCARE SYSTEMS, INC.
/s/ JOSE SPIWAK, M.D. By: /s/ LEONARDO BEREZOVSKY, M.D.
- --------------------------------------------- -----------------------------------------
Secretary Name: Leonardo Berezovsky, M.D.
Title: Chairman and
Chief Executive Officer
</TABLE>
31
<PAGE> 242
AMENDMENT NO. 1 TO AGREEMENT
AND PLAN OF MERGER
This Amendment No. 1 dated as of February 5, 1997 to the Agreement and Plan
of Merger, dated as of November 8, 1996 (the "Agreement"), is made and entered
into by and among FPA Medical Management, Inc., a Delaware corporation
("Parent"), FPA Acquisition Corp., a Delaware corporation and a wholly owned
subsidiary of Parent ("Sub"), and AHI Healthcare Systems, Inc., a Delaware
corporation (the "Company"). Capitalized terms used herein and not otherwise
defined shall have the meanings ascribed to such terms in the Agreement.
WITNESSETH:
WHEREAS, Parent, Subsidiary and the Company executed, delivered and entered
into the Agreement;
WHEREAS, Parent, Subsidiary and the Company desire to amend certain terms
of the Agreement.
NOW THEREFORE, in consideration of the premises and the representations,
warranties, covenants and agreements contained herein and in the Agreement, the
parties hereto, intending to be legally bound, agree as follows:
1. The following section is hereby added immediately after Section
3.17 of the Agreement:
3.18 Tax-Free Reorganization. The Company has not taken and has
not agreed to take any action that would interfere with the ability of
Parent to treat the Merger as a tax-free reorganization within the
meaning of Section 368(a)(1)(A) and Section 368(a)(2)(E), and
368(a)(1)(B) of the Code.
2. The following section is hereby added immediately after Section
4.17 of the Agreement:
4.18 Tax-Free Reorganization. Neither Parent nor Sub has taken or
agreed to take any action that would interfere with the ability of
Parent to treat the Merger as a tax-free reorganization within the
meaning of Section 368(a)(1)(A) and Section 368(a)(2)(E), and
368(a)(1)(B) of the Code.
3. Section 5.01(b)(ii) is hereby amended by adding at the end the
following:
(M) take any action to cause the Merger not to be treated as a
tax-free reorganization within the meaning of Section 368(a)(1)(A) and
Section 368(a)(2)(E), and Section 368(a)(1)(B) of the Code.
4. Section 7.03 is hereby amended by adding at the end the following:
(j) Opinion of Tax Counsel. The Company shall have received an
opinion of Milbank, Tweed, Hadley & McCloy, counsel to the Company, in
form and substance reasonably satisfactory to the Company, effective as
of the date the opinion was delivered and based on representations of
the Company and Parent, to the effect that (i) the Merger of Sub with
and into the Company pursuant to the Merger Agreement and applicable
state law will be treated for U.S. federal income tax purposes as a
reorganization within the meaning of Section 368(a) of the Code; (ii)
Parent, Sub and Company will each be a party to the reorganization
within the meaning of Section 368(b) of the Code; and (iii) the
stockholders of the Company will not recognize gain or loss upon receipt
of Parent Common Stock in the Merger, except that stockholders will
recognize any gain realized in the Merger to the extent such
stockholders receive cash in lieu of fractional shares. This opinion
will be delivered prior to the date the Proxy Statement is first mailed
to stockholders of the Company and Parent.
5. Terms of the Agreement other than those amended hereby shall
remain in full force and effect.
6. This Amendment No. 1 to the Agreement and Plan of Merger may be
executed in any number of counterparts, each of which will be deemed an
original, but all of which together will constitute one and the same
instrument.
<PAGE> 243
IN WITNESS WHEREOF, Parent, Sub and the Company have caused this Amendment
No. 1 to the Agreement and Plan of Merger to be signed by their respective
officers as of the date first written above.
FPA MEDICAL MANAGEMENT, INC.
By: /s/ JAMES A. LEBOVITZ
------------------------------------
Name: James A. Lebovitz
Title: Senior Vice President,
General Counsel, and Secretary
FPA ACQUISITION CORP.
By: /s/ JAMES A. LEBOVITZ
------------------------------------
Name: James A. Lebovitz
Title: Senior Vice President,
General Counsel, and Secretary
AHI HEALTHCARE SYSTEMS, INC.
By: /s/ LEONARDO BEREZOVSKY, M.D.
------------------------------------
Name: Leonardo Berezovsky, M.D.
Title: Chairman and Chief Executive
Officer
2
<PAGE> 244
Appendix II
[NEEDHAM & COMPANY, INC. LETTERHEAD]
November 8, 1996
The Board of Directors
FPA Medical Management, Inc.
2878 Camino del Rio South
Suite 301
San Diego, CA 92108
Gentlemen:
We understand that FPA Medical Management, Inc. ("FPA"), FPA
Acquisition Corp., a wholly-owned subsidiary of FPA ("Merger Sub"), and AHI
Healthcare Systems, Inc. ("AHI") propose to enter into an Agreement and Plan of
Merger (the "Merger Agreement") pursuant to which Merger Sub will be merged
with and into AHI and AHI will become a wholly owned subsidiary of FPA (the
"Merger"). The terms of the Merger will be set forth more fully in the Merger
Agreement.
Pursuant to the proposed Merger Agreement, we understand that at the
Effective Time (as defined in the Merger Agreement), each outstanding share of
common stock, par value $0.01 per share, of AHI will be converted into the
right to receive a number of shares (the "Conversion Number") of Common Stock,
par value $0.002 per share, of FPA ("FPA Common Stock") determined as follows:
(i) if the arithmetic average of the average of the closing bid and ask prices
of FPA Common Stock on the Nasdaq National Market on any day which FPA Common
Stock is traded on the Nasdaq National Market ("Trading Day") on each of the
last ten Trading Days preceding the second day before the date of the AHI
stockholders' meeting ("Average Price") is less than $14.38, the Conversion
Number shall be 0.609; (ii) if the Average Price of FPA Common Stock is equal
to or greater than $14.38 and less than $22.38, the Conversion Number shall be
equal to the result obtained by dividing $8.75 by the Average Price of FPA
Common Stock (and rounding the result to three decimal places); (iii) if the
Average Price of FPA Common Stock is equal to or greater than $22.38 and less
than $25.38, the Conversion Number shall be 0.391; and (iv) if the Average Price
of FPA Common Stock is equal to or greater than $25.38, the Conversion Number
shall be equal to the result obtained by dividing $9.92 by the Average Price of
FPA Common Stock (and rounding the result to three decimal places).
You have asked us to advise you as to the fairness, from a financial
point of view, to the stockholders of FPA of the proposed consideration to be
paid by FPA to AHI in the Merger. Needham & Company, Inc., as part of its
investment banking business, is regularly engaged in the valuation of
businesses and their securities in connection with mergers and acquisitions,
negotiated underwritings, secondary distributions of securities, private
placements and other purposes. We have acted as financial advisor to FPA in
connection with the Merger. We will receive a fee for our services as financial
advisor, a portion of which is contingent upon the consummation of the Merger,
and FPA has agreed to
<PAGE> 245
indemnify us for certain liabilities arising from our role as financial advisor
and out of the rendering of this opinion.
For purposes of this opinion we have, among other things: (i) reviewed
a draft of the Merger Agreement dated November 8, 1996; (ii) reviewed certain
other documents related to the Merger; (iii) reviewed certain publicly
available information covering FPA and AHI and certain other relevant
financial and operating data of FPA and AHI made available from the internal
records of FPA and AHI; (iv) visited certain locations of AHI's facilities; (v)
held discussions with members of senior management of FPA and AHI concerning
their current and future business prospects; (vi) reviewed certain financial
forecasts and projections prepared by FPA's and AHI's respective managements;
(vii) compared certain publicly available financial data of certain companies
whose securities are traded in the public markets, which we deemed generally
comparable to AHI, to similar data for AHI; (viii) reviewed the financial terms
of certain other business combinations that we deemed generally relevant; (ix)
reviewed the premiums/discounts paid by acquirors in certain other business
combinations that we deemed generally relevant; (x) performed an
accretion/dilution analysis and reviewed the impact of the Merger on FPA's
projected operating results; (xi) reviewed current and historical market
closing prices and trading data for AHI's and FPA's Common Stock; and (xii)
performed and/or considered such other studies, analyses, inquiries and
investigations as we deemed appropriate.
In connection with our review and in arriving at our opinion, we have
not assumed any responsibility to independently verify any of the foregoing
information, have relied on such information, and have assumed that all such
information is complete and accurate in all material respects. In addition, we
have assumed, with your consent and in the case of (i) below, without
independent verification the accuracy of the advice and conclusion of FPA's
accountants, that (i) the Merger will be accounted for under the
pooling-of-interests for financial reporting purposes; (ii) any material
liabilities (contingent or otherwise, known or unknown) of FPA and AHI are set
forth in the consolidated financial statements of FPA and AHI, respectively;
(iii) the terms set forth in the executed Merger Agreement will not differ
materially from the proposed terms provided to us in the draft Merger Agreement
dated November 8, 1996; (iv) that all conditions to the closing of the Merger
will be satisfied without waiver; and (v) the Merger would be consummated on a
timely basis in the manner contemplated in the Merger Agreement. With respect
to FPA's and AHI's financial forecasts provided to us by their respective
managements, we have assumed for purposes of our opinion that such forecasts
have been reasonably prepared on bases reflecting the best currently available
estimates and judgments of such managements, at the time of preparation, of the
future operating and financial performance of FPA and AHI. We have not assumed
any responsibility for or made or obtained an independent evaluation,
appraisal or physical inspection of the assets or liabilities of FPA and AHI.
Further, our opinion is based on economic, monetary and market conditions
existing as of the date hereof, and in rendering this opinion, we have relied
without independent verification on the accuracy, completeness and fairness of
all historical financial and other information which was either publicly
available or furnished to us by FPA and AHI. Our opinion as expressed herein is
limited to the fairness, from a financial point of view, to the stockholders of
FPA of the consideration to be paid by FPA and AHI in the Merger and does not
address FPA's underlying business decision to engage in the Merger. Our
opinion does not constitute a recommendation to any stockholder of FPA as to how
such stockholder should vote on the proposed Merger.
We are not expressing any opinion as to what the value of FPA Common
Stock will be when issued pursuant to the Merger or the price at which FPA
Common Stock will trade at any time.
In the ordinary course of our business, we may actively trade the
equity securities of FPA for our own account and for the accounts of customers
and, accordingly, may at any time hold a long or short position in such
securities.
<PAGE> 246
This letter and the opinion expressed herein are provided at the
request and for the information of the Board of Directors of FPA and may not be
quoted or referred to or used for any other purpose without our prior written
consent, except that this letter may be disclosed in connection with any
registration statement or proxy statement used in connection with the Merger so
long as this letter is quoted in full in such registration statement or proxy
statement.
Based upon and subject to the foregoing, it is our opinion that, as of
the date hereof, the consideration to be paid by FPA and AHI in the Merger is
fair to the stockholders of FPA from a financial point of view.
Very truly yours,
/s/ Needham & Company, Inc.
------------------------------------
NEEDHAM & COMPANY, INC.
<PAGE> 247
APPENDIX III
[SMITH BARNEY LETTERHEAD]
November 8, 1996
The Board of Directors
AHI Healthcare Systems, inc.
12620 Erickson Avenue
Downey, California 90241
Members of the Board:
You have requested our opinion as to the fairness, from a financial point of
view, the holders of the common stock of AHI Healthcare Systems, Inc. ("AHI")
pursuant to the terms and subject to the conditions forth in the Agreement and
Plan of Merger, dated as of November 8, 1996 (the "Merger Agreement"), by and
among FPA Medical Management, Inc. ("FPA"), FPA Acquisition Corp., a wholly
owned subsidiary of FPA ("Sub"), and AHI. As more fully described in the
Merger Agreement, (i) Sub will be merged with and into AHI (the "Merger") and
(ii) each outstanding share of the common stock, par value $0.01 per share, of
AHI (the "AHI Common Stock") will be converted into the right to receive (i)
0.609 of a share of the common stock, par value $0.0902 per share, of FPA (the
"FPA Common Stock"), if the arithmetic average of the closing bid and ask
prices of FPA Common Stock on The Nasdaq National Market on each of the last 10
trading days preceding the second day prior to the date of AHI's stockholders'
meeting in respect of the Merger (the "Average Price") is less than $14.38,
(ii) that number of shares of FPA Common Stock equal to the result obtained by
dividing $8.75 by the Average Price, if the Average Price is equal to or
greater than $22.38, (iii) 0.391 of a share of FPA Common Stock, if the Average
Price is equal to or greater than $22.38 and less than $25.38 or (iv) that
number of shares of FPA Common Stock equal to the result obtained by dividing
$9.92 by the Average Price, if the Average Price is equal to or greater than
$25.38 (the number of shares of FPA Common stock into which shares of AHI
Common Stock will be so converted, the "Conversion Number").
In arriving at our opinion, we reviewed the Merger Agreement and held
discussions with certain senior officers, directors and other representatives
and advisors of AHI and certain senior officers and other representatives of
FPA concerning the businesses, operations and prospects of AHI and FPA. We
examined certain publicly available business and financial information relating
to AHI and FPA as well as certain financial forecasts and other information and
date for AHI and FPA which were provided to or otherwise discussed with us by
the respective managements of AHI and FPA, including information relating to
certain strategic implications and operational benefits anticipated to result
from the Merger. We reviewed the financial terms of the Merger as set forth in
the Merger Agreement in relation to, among other things: current and historical
market prices and trading volumes of AHI Common Stock and FPA Common Stock; the
historical and projected earnings and other operating data of AHI and FPA; and
the capitalization and financial condition of AHI and FPA. We considered, to the
extent publicly available, the financial terms of similar transactions recently
effected which we considered relevant in evaluating the Merger and analyzed
certain financial, stock market and other publicly available information
relating to the businesses of other companies whose operations we considered
relevant in evaluating those of AHI and FPA. We also evaluated the potential
pro forma financial impact of the Merger on FPA. In addition to the foregoing,
we conducted such other analyses and examinations and considered such other
financial, economic and market criteria as we deemed appropriate in arriving at
our opinion.
In rendering our opinion, we have assumed and relied, without independent
verification upon the accuracy and completeness of all financial and other
information and data publicly available or
<PAGE> 248
The Board of Directors
AHI Healthcare Systems, Inc.
November 8, 1996
Page 2
furnished to or otherwise reviewed by or discussed with us. With respect to
financial forecasts and other information and data provided to or otherwise
reviewed by or discussed with us, we have been advised by the managements of
AHI and FPA that such forecasts and other information and data were prepared on
bases reflecting reasonable estimates and judgments of the managements of AHI
and FPA as to the future financial performance of AHI and FPA and the strategic
implications and operational benefits anticipated to result from the Merger. We
have assumed, with your consent, that the Merger will be treated as a pooling
of interests in accordance with generally accepted accounting principles. Our
opinion, as set forth herein, relates to the relative values of AHI and FPA. We
are not expressing any opinion as to what the value of the FPA Common Stock
actually will be when issued to AHI stockholders pursuant to the Merger or the
price at which the FPA Common Stock will trade subsequent to the Merger. We
have not made or been provided with an independent evaluation or appraisal of
the assets or liabilities (contingent or otherwise) of AHI or FPA nor have we
made any physical inspection of the properties or assets of AHI or FPA. In
connection with our engagement, we were requested to approach, and held
discussions with, third parties to solicit indications of interest in a
possible acquisition of AHI. Our opinion is necessarily based upon information
available to us, and financial, stock market and other conditions and
circumstances existing and disclosed to us, as of the date hereof.
Smith Barney has been engaged to render financial advisory services to AHI in
connection with the proposed Merger and will receive a fee for such services, a
significant portion of which is contingent upon the consummation of the Merger.
We also will receive a fee upon the delivery of this opinion. In the ordinary
course of our business, we and our affiliates may actively trade or hold the
securities of AHI and FPA for our own account or for the account of our
customers and, accordingly, may at any time hold a long or short position in
such securities. We have in the past provided services to AHI unrelated to the
proposed Merger, for which services we have received compensation, and also
have provided services to FPA from time to time. In addition, we and our
affiliates (including Travelers Group Inc. and its affiliates) may maintain
relationships with AHI and FPA.
Our advisory services and the opinion expressed herein are provided for the
information of the Board of Directors of AHI in its evaluation of the proposed
Merger, and our opinion is not intended to be and does not constitute a
recommendation to any stockholder as to how such stockholder should vote on the
proposed Merger. Our opinion may not be published or otherwise used or referred
to, nor shall any public reference to Smith Barney be made, without our prior
written consent; provided, that our opinion may be included in its entirety in
the Joint Proxy Statement/Prospectus of AHI and FPA relating to the proposed
Merger.
Based upon and subject to the foregoing, our experience as investment bankers,
our work as described above and other factors we deemed relevant, we are of the
opinion that, as of the date hereof, the Conversion Number is fair, from a
financial point of view, to the holders of AHI Common Stock.
Very truly yours,
/s/ Smith Barney Inc.
SMITH BARNEY INC.
