<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 29, 1997.
REGISTRATION NO. 333-32687
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2 TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
FPA MEDICAL MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 8049 33-0604264
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
3636 NOBEL DRIVE
SUITE 200
SAN DIEGO, CALIFORNIA 92122
(619) 453-1000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
JAMES A. LEBOVITZ, ESQ.
SENIOR VICE PRESIDENT, GENERAL
COUNSEL AND SECRETARY
3636 NOBEL DRIVE
SUITE 200
SAN DIEGO, CALIFORNIA 92122
(619) 453-1000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
Copies to:
<TABLE>
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DAVID R. SNYDER, ESQ. BRUCE D. MEYER, ESQ.
PILLSBURY MADISON & SUTRO LLP GIBSON, DUNN & CRUTCHER LLP
101 WEST BROADWAY, SUITE 1800 333 SOUTH GRAND AVENUE
SAN DIEGO, CALIFORNIA 92101 LOS ANGELES, CALIFORNIA 90071-3197
(619) 234-5000 (213) 229-7000
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effectiveness of this Registration Statement and the
effective time of the merger (the "Merger") of FPA Acquisition Corp., a wholly
owned subsidiary of FPA Medical Management, Inc., with and into Health Partners,
Inc. as described in the Agreement and Plan of Merger dated as of July 1, 1997
(the "Merger Agreement"), attached as Appendix A to the Proxy
Statement/Prospectus forming a part of this Registration Statement.
If the securities being registered on this form are being offered in
connection with the formation of a holding company and are in compliance with
General Instruction G, check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
================================================================================
<PAGE> 2
FPA MEDICAL MANAGEMENT, INC.
CROSS-REFERENCE SHEET
(Pursuant to Item 501(b) of Regulation S-K)
<TABLE>
<CAPTION>
FORM S-4
ITEM NO. CAPTION LOCATION IN PROXY STATEMENT/PROSPECTUS
- -------- ---------------------------------------------- ----------------------------------------------
<C> <S> <C>
A. INFORMATION ABOUT THE TRANSACTION.
1. Forepart of Registration Statement and Outside
Front Cover Page of Prospectus................ Facing Page; Cross-Reference Sheet; Outside
Front Cover Page
2. Inside Front and Outside Back Cover Pages of
Prospectus.................................... Available Information; Incorporation of
Certain Documents by Reference; Table of
Contents
3. Risk Factors, Ratio of Earnings to Fixed
Charges and Other Information................. Summary; Risk Factors
4. Terms of the Transaction...................... Summary; The Merger; The Merger Agreement; The
Payments; Board of Directors and Management of
FPA Following the Merger; Comparison of Rights
of Holders of HPI and FPA Common Stock
5. Pro Forma Financial Information............... Summary; Selected Historical and Pro Forma
Information; Selected Historical Financial
Data -- FPA
6. Material Contracts with the Company Being
Acquired...................................... Summary; The Merger; The Merger Agreement
7. Additional Information Required for Reoffering
by Persons and Parties Deemed to be
Underwriters.................................. *
8. Interests of Named Experts and Counsel........ *
9. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities................................... *
B. INFORMATION ABOUT THE REGISTRANT.
10. Information With Respect to S-3 Registrants... Available Information; Summary; Description of
FPA Common Stock; Selected Historical
Financial Data -- FPA
11. Incorporation of Certain Information by
Reference..................................... *
12. Information With Respect to S-2 or S-3
Registrants................................... *
13. Incorporation of Certain Information by
Reference..................................... *
14. Information With Respect to Registrants Other
Than S-2 or S-3 Registrants................... FPA's Annual Report on Form 10-K/A for the
year ended December 31, 1996; FPA's Quarterly
Report on Form 10-Q for the quarter ended
March 31, 1997; FPA's Current Report on Form
8-K/A dated March 17, 1997; FPA's Current
Report on Form 8-K/A dated July 31, 1997;
FPA's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997; The audited
combined balance sheets of Foundation Health
Medical Services (a wholly owned subsidiary of
Foundation Health Corporation) and affiliates
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.
</TABLE>
<PAGE> 3
<TABLE>
<CAPTION>
FORM S-4
ITEM NO. CAPTION LOCATION IN PROXY STATEMENT/PROSPECTUS
- -------- ---------------------------------------------- ----------------------------------------------
<C> <S> <C>
C. INFORMATION ABOUT THE COMPANY BEING ACQUIRED.
15. Information With Respect to S-3 Companies..... *
16. Information With Respect to S-2 or S-3
Companies..................................... *
17. Information With Respect to Companies Other
Than S-2 or S-3 Companies..................... Summary; Selected Consolidated Financial
Data -- HPI; Management's Discussion and
Analysis of Financial Condition and Results of
Operations -- HPI; Business of HPI; Security
Ownership of Certain HPI Beneficial Owners and
Management; Executive Officers of HPI; HPI
Executive Officer and Director Compensation;
Index to HPI's Consolidated Financial
Statements
D. VOTING AND MANAGEMENT INFORMATION.
18. Information if Proxies, Consents or
Authorizations are to be Solicited............ Summary; The Merger; The HPI Special Meeting
19. Information if Proxies, Consents or
Authorizations are not be to Solicited or in
an Exchange Offer............................. *
</TABLE>
- ---------------
* Not Applicable.
<PAGE> 4
HEALTH PARTNERS, INC.
800 CONNECTICUT AVENUE
NORWALK, CONNECTICUT 06854
September , 1997
Dear Stockholder:
You are cordially invited to attend a Special Meeting of Stockholders of
Health Partners, Inc. ("HPI"), which, as you have previously been notified, will
be held at 10:00 a.m., local time, on , 1997 at HPI's corporate
headquarters, 800 Connecticut Avenue, Norwalk, Connecticut, and any adjournments
or postponements thereof (the "HPI Special Meeting").
At the HPI Special Meeting, holders of HPI's common stock and preferred
stock will be asked to consider and vote upon a proposal to approve and adopt
the Agreement and Plan of Merger dated as of July 1, 1997 (the "Merger
Agreement") by and among FPA Medical Management, Inc. ("FPA"), FPA Acquisition
Corp., a wholly owned subsidiary of FPA ("Merger Sub"), and HPI. A copy of the
Merger Agreement is included as Appendix A to the attached Proxy
Statement/Prospectus. On the terms and subject to the conditions of the Merger
Agreement, Merger Sub will be merged with and into HPI (the "Merger"), and HPI
will continue in existence as a wholly owned subsidiary of FPA.
THE BOARD OF DIRECTORS OF HPI, AFTER CAREFUL CONSIDERATION, HAS UNANIMOUSLY
APPROVED THE MERGER AGREEMENT AND DETERMINED THAT THE MERGER IS FAIR TO, AND IN
THE BEST INTERESTS OF, HPI AND ITS STOCKHOLDERS AND RECOMMENDS THAT YOU VOTE FOR
APPROVAL OF THE MERGER AGREEMENT.
At the HPI Special Meeting, you will also be asked to consider and vote
upon a proposal to approve certain payments and benefits (the "Payments") to be
paid to or received by the undersigned. The Board of Directors of HPI has
approved the Payments (with the undersigned abstaining) and recommends that you
vote FOR approval of the Payments.
Upon consummation of the Merger, each outstanding share of HPI common stock
will be converted into the right to receive a number of shares of FPA common
stock equal to the Exchange Ratio, which is based on a formula set forth in the
Merger Agreement and described in the attached Proxy Statement/Prospectus. Based
on such formula, management of HPI believes that the Exchange Ratio will fall
between .43 and .55 shares of FPA common stock for each share of HPI common
stock, assuming a range of FPA Value, as defined in the Proxy
Statement/Prospectus, of $15.65 to $25.00 and based on the number of shares of
HPI common stock and substitute options to purchase HPI common stock issued in
connection with the completion of the Roll-Up Transactions, as described in the
Proxy Statement/Prospectus. STOCKHOLDERS OF HPI WILL BE ABLE TO OBTAIN THE
EXCHANGE RATIO BEGINNING AT THE END OF THE SECOND BUSINESS DAY PRECEDING THE HPI
SPECIAL MEETING BY CALLING (888) XXX-XXXX.
PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN THE ACCOMPANYING PROXY EVEN
IF YOU ARE PLANNING TO ATTEND THE MEETING. A RETURN ENVELOPE IS ENCLOSED FOR
YOUR USE AND NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES. If you do
attend the HPI Special Meeting and wish to vote in person, you may revoke your
proxy at that time.
Very truly yours,
Charles G. Berg
President and Chief Executive Officer
<PAGE> 5
HEALTH PARTNERS, INC.
800 CONNECTICUT AVENUE
NORWALK, CONNECTICUT 06854
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON , 1997
To Our Stockholders:
FURTHER NOTICE IS HEREBY GIVEN that a Special Meeting of Stockholders of
Health Partners, Inc., a Delaware corporation ("HPI"), will be held at 10:00
a.m., local time, at HPI's corporate headquarters, 800 Connecticut Avenue,
Norwalk, Connecticut, and any adjournments or postponements thereof (the "HPI
Special Meeting"). The HPI Special Meeting is called for the purpose of
considering and voting upon:
1. A proposal to approve and adopt the Agreement and Plan of Merger dated
as of July 1, 1997 (the "Merger Agreement") by and among FPA Medical Management,
Inc. ("FPA"), FPA Acquisition Corp. ("Merger Sub") and HPI. Pursuant to the
Merger Agreement (i) Merger Sub will be merged with and into HPI, with HPI as
the surviving corporation and (ii) each outstanding share of HPI common stock
(subject to the exceptions and limitations set forth in the Merger Agreement and
including shares of HPI common stock issued upon conversion of HPI preferred
stock) at the Effective Time (as defined herein) will be converted into the
right to receive a number of shares of FPA common stock equal to the Exchange
Ratio as set forth in the Merger Agreement and as described in the attached
Proxy Statement/Prospectus. A copy of the Merger Agreement is included as
Appendix A to the attached Proxy Statement/Prospectus. STOCKHOLDERS OF HPI WILL
BE ABLE TO OBTAIN THE EXCHANGE RATIO BEGINNING AT THE END OF THE SECOND BUSINESS
DAY PRECEDING THE HPI SPECIAL MEETING BY CALLING (888) XXX-XXXX. The proposed
merger and other related matters are more fully described in the attached Proxy
Statement/Prospectus and the Appendices thereto.
2. A proposal to approve certain payments and benefits to the President and
Chief Executive Officer of HPI.
3. To transact such other business as may properly come before the HPI
Special Meeting.
The close of business on September 4, 1997 has been fixed as the record
date for determination of stockholders entitled to notice of, and to vote at,
the HPI Special Meeting. Only stockholders of record at the close of business on
the record date are entitled to vote at the HPI Special Meeting.
In connection with the proposed merger, dissenters' rights will be
available to those stockholders of HPI who meet and comply with the requirements
of Section 262 of the Delaware General Corporation Law (the "Delaware Act"), a
copy of which is included as Appendix C to the attached Proxy
Statement/Prospectus. Reference is made to the section entitled "THE
MERGER -- Rights of Dissenting Stockholders" in the attached Proxy
Statement/Prospectus for a discussion of the procedures to be followed in
asserting dissenters' rights in connection with the proposed merger under
Section 262 of the Delaware Act.
PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN THE ACCOMPANYING PROXY EVEN
IF YOU ARE PLANNING ON ATTENDING THE HPI SPECIAL MEETING. A RETURN ENVELOPE IS
ENCLOSED FOR YOUR USE AND NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES.
If you do attend the HPI Special Meeting and wish to vote in person, you may
revoke your proxy at that time.
In accordance with the Delaware Act, a complete list of the stockholders of
HPI entitled to vote at the HPI Special Meeting will be open to examination,
during ordinary business hours, at HPI's executive offices for 10 days preceding
the HPI Special Meeting by any HPI stockholder for any purpose germane to the
HPI Special Meeting.
By Order of the Board of Directors,
Charles G. Berg
President and Chief Executive Officer
[date]
<PAGE> 6
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
<TABLE>
<S> <C>
FPA MEDICAL MANAGEMENT, INC.
HEALTH PARTNERS, INC. PROSPECTUS
PROXY STATEMENT 6,388,889 SHARES
COMMON STOCK
</TABLE>
This Proxy Statement/Prospectus ("Proxy Statement/Prospectus") is being
furnished to the stockholders of Health Partners, Inc., a Delaware Corporation
("HPI"), in connection with the solicitation of proxies by the Board of
Directors of HPI (the "HPI Board") for use at a Special Meeting of stockholders
to be held at HPI's corporate headquarters, 800 Connecticut Avenue, Norwalk,
Connecticut on , 1997, at 10:00 a.m. local time (the "HPI Special
Meeting") to (i) approve the Agreement and Plan of Merger dated as of July 1,
1997 (the "Merger Agreement") by and among HPI, FPA Medical Management, Inc., a
Delaware corporation ("FPA"), and FPA Acquisition Corp., a Delaware corporation
and wholly owned subsidiary of FPA ("Merger Sub"), relating to the merger
("Merger") of Merger Sub with and into HPI and (ii) approve certain payments and
benefits (the "Payments") to Charles G. Berg, President and Chief Executive
Officer of HPI. APPROVAL OF THE PAYMENTS IS NOT A CONDITION TO THE CONSUMMATION
OF THE MERGER. As a result of the Merger, HPI will become a wholly owned
subsidiary of FPA. In connection with the Merger, each outstanding share of HPI
Common Stock, par value $.001 per share ("HPI Common Stock"), will be exchanged
for the right to receive a number of shares of FPA Common Stock, par value $.002
per share ("FPA Common Stock"), equal to the "Exchange Ratio." The holders of
HPI Preferred Stock have agreed to convert their shares of HPI Preferred Stock
to HPI Common Stock prior to the Effective Time. See "THE MERGER
AGREEMENT -- The Merger." A copy of the Merger Agreement is included in the
Proxy Statement/Prospectus as Appendix A.
The Exchange Ratio depends on the relationship among (i) the total issued and
outstanding shares of HPI Common Stock (the "Outstanding HPI Stock") immediately
prior to the time at which the Merger becomes effective (the "Effective Time")
(including the total number of shares of HPI Common Stock issuable pursuant to
the Roll-up Transactions (as described in this Proxy Statement/Prospectus) and
the conversion of all of the shares of HPI Preferred Stock), (ii) the fair value
of vested and unvested options to purchase HPI Common Stock (the "HPI Options")
outstanding immediately prior to the Effective Time (including HPI Options
issuable in the Roll-up Transactions) which will be converted in the Merger into
fully paid shares of FPA Common Stock (the "FPA Option Shares"), (iii) the
presumed transaction value of $115 million and (iv) the FPA Value. The FPA Value
will be the average of the closing prices of FPA Common Stock on the Nasdaq
National Market System ("Nasdaq") for the ten consecutive trading days ending on
the date that is two trading days prior to the date of consummation of the
Merger (the "Closing Date"). The "Adjusted FPA Value" will equal the FPA Value,
except that if the FPA Value is less than $18, the Adjusted FPA Value will be
$18 and if the FPA Value is greater than $22, the Adjusted FPA Value will be
$22. Consequently, the Adjusted FPA Value may differ from the actual market
price of FPA Common Stock reported by Nasdaq on the date of the HPI Special
Meeting, the Closing Date or the date the HPI stockholders actually receive
their shares of FPA Common Stock after the Merger is completed. See "THE
MERGER -- Merger Consideration," "THE MERGER AGREEMENT -- Roll-Up Transactions"
and "-- Treatment of Stock Options." STOCKHOLDERS OF HPI WILL BE ABLE TO OBTAIN
THE EXCHANGE RATIO BEGINNING AT THE END OF THE SECOND BUSINESS DAY PRECEDING THE
HPI SPECIAL MEETING BY CALLING (888) XXX-XXXX.
The Exchange Ratio can be represented by the following formula:
<TABLE>
<S> <C>
Exchange Ratio = ($115 Million / Adjusted FPA Value) - FPA Option Shares
---------------------------------------------------------
Outstanding HPI Stock
</TABLE>
HPI believes that the Exchange Ratio will likely fall between .43 and .55
resulting in the issuance of between 5,227,273 and 6,388,889 shares of FPA
Common Stock (assuming a range of FPA Value of $15.65 to $25.00, respectively).
If the FPA Value is less than $15.65, HPI may terminate the Merger Agreement. In
the event that the FPA Value is below $15.65, the Board of Directors of HPI, in
exercise of its fiduciary duties, would consider whether to terminate the Merger
Agreement based on whether the stockholders of HPI would receive fair
consideration for their HPI Common Stock and whether consummation of the Merger
would be in the best interests of the stockholders. If the Board of Directors of
HPI determines that the HPI stockholders would receive fair consideration for
their HPI Common Stock and that consummation of the Merger would be in their
best interests, FPA and HPI will amend this Proxy Statement/Prospectus and HPI
will resolicit stockholder votes to the extent required by law. See "THE MERGER
- -- Termination." Except as more fully described in the accompanying Proxy
Statement/Prospectus, in no event will the number of shares of FPA Common Stock
issuable in the Merger exceed 6,388,889. The calculation of the Exchange Ratio
is described more fully in the accompanying Proxy Statement/Prospectus. See "THE
MERGER -- Merger Consideration" and "-- Adjustments to Merger Consideration."
The fair value of the HPI Options will be determined two days prior to the
consummation of the Merger. The conversion of the HPI Options into fully paid
shares of FPA Common Stock will not require the option holder to pay the
exercise price of the option, since the exercise price is considered in the
determination of the fair value. Since the FPA Option Shares are deducted from
the FPA Common Stock issued in determining the Exchange Ratio, any increase in
the fair value of the HPI Options will decrease the Exchange Ratio and any
decrease in the fair value of such options will increase the Exchange Ratio. HPI
Option holders will be able to obtain information regarding the fair value of
their options beginning at the end of the second business day preceding the
consummation of the Merger by calling (888) xxx-xxxx. Officers and directors of
HPI own options to purchase 468,212 shares of HPI Common Stock and based on an
FPA Value of $ , the last reported sale price of FPA Common Stock on
September , 1997, the fair value of these options would be $ .
Shares of FPA Common Stock are traded on Nasdaq under the symbol "FPAM." On
, 1997, the last trading day prior to the date of this Proxy
Statement/Prospectus, the last reported sale price of FPA Common Stock was
$ per share. Based on this closing price, and assuming the FPA Value were
$ , the dollar value of the Merger Consideration, as defined in this Proxy
Statement/Prospectus, per share of HPI Common Stock would be $ and the
aggregate Merger Consideration would be $ , Upon conversion of the HPI
Preferred Stock into HPI Common Stock WellPoint Development Company, Inc.
("WellPoint") and Oxford Health Plans, Inc. ("Oxford")will own 3,299,982 and
4,700,043 shares of HPI Common Stock respectively, and based on the
aforementioned assumptions, would receive and shares of FPA Common
Stock, respectively, with a market value of and , respectively.
The Merger Consideration for HPI Common Stockholders other than WellPoint and
Oxford would be shares of FPA Common Stock with a market value of
.
This Proxy Statement/Prospectus and the accompanying forms of proxy are first
being mailed to stockholders of HPI on or about , 1997.
The Payments will be made to Mr. Berg pursuant to his current employment
agreement (the "HPI Employment Agreement") with HPI which will be terminated at
the Effective Time. Stockholder approval of the Payments is required for such
payments to be tax deductible expenses of HPI and to avoid a 20% nondeductible
excise tax to Mr. Berg on such Payments. See "THE PAYMENTS" and "THE
MERGER -- Interests of Certain Persons in the Merger."
To the extent that FPA or HPI waives compliance with material provisions of
or conditions to consummation of the Merger, FPA and HPI will amend this Proxy
Statement/Prospectus, and HPI will resolicit stockholder votes to the extent the
same may be required by law.
In addition, this Proxy Statement/Prospectus also constitutes the Prospectus
of FPA filed as part of a Registration Statement on Form S-4 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") under
the Securities Act of 1933, as amended (the "Securities Act"), relating to the
shares of FPA Common Stock to be issued to stockholders of HPI in the Merger.
SEE "RISK FACTORS" BEGINNING AT PAGE 26 FOR A DISCUSSION OF CERTAIN
CONSIDERATIONS IN EVALUATING THE MERGER AND FPA.
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 HPI. 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 HPI 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
HPI has been furnished by HPI.
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 , 1997.
<PAGE> 7
AVAILABLE INFORMATION
FPA is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith,
files 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 Common Stock are traded on the Nasdaq
National Market System under the symbol FPAM.
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
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 Effective Time of the Merger 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.
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. The safe harbor provisions of the
Private Securities Litigation Reform Act of 1995 do not apply to forward looking
statements made by HPI. Although FPA and HPI 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 HPI'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."
2
<PAGE> 8
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
AVAILABLE INFORMATION................................................................. 2
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE....................................... 2
GLOSSARY OF CERTAIN DEFINED TERMS..................................................... 6
SUMMARY............................................................................... 9
FPA MEDICAL MANAGEMENT, INC......................................................... 9
HEALTH PARTNERS, INC................................................................ 12
THE MERGER.......................................................................... 13
THE HPI SPECIAL MEETING............................................................. 22
FPA AND HPI COMPARATIVE PER SHARE DATA.............................................. 24
MARKET PRICE AND DIVIDEND DATA...................................................... 25
RISK FACTORS.......................................................................... 26
Risks Relating to FPA............................................................... 26
Risks Relating to HPI............................................................... 36
Risks Relating to the Merger........................................................ 38
THE HPI SPECIAL MEETING............................................................... 40
Date, Time and Place................................................................ 40
Purpose of the HPI Special Meeting.................................................. 40
Revocation of Proxies............................................................... 40
Quorum.............................................................................. 40
Vote Required....................................................................... 40
Record Date; Stock Entitled to Vote................................................. 41
Voting of Proxies................................................................... 41
Solicitation of Proxies............................................................. 41
Stockholders' Right of Appraisal.................................................... 41
Security Ownership of Certain HPI Owners and Management............................. 42
THE MERGER............................................................................ 44
Effects of the Merger............................................................... 44
Merger Consideration................................................................ 44
Adjustments to Merger Consideration................................................. 46
Conversion of Shares; Procedures for Exchange of Certificates; Fractional Shares.... 46
Nasdaq Listing...................................................................... 47
Background of the Merger............................................................ 47
Recommendation of the HPI Board of Directors and Reasons for the Merger............. 50
Opinion of HPI's Financial Advisor.................................................. 52
Effective Time of the Merger........................................................ 56
Interests of Certain Persons in the Merger.......................................... 56
Certain Federal Income Tax Consequences............................................. 59
Accounting Treatment................................................................ 60
Resale of FPA Common Stock by Affiliates............................................ 61
Certain Regulatory Matters.......................................................... 61
Rights of Dissenting Stockholders................................................... 61
THE PAYMENTS.......................................................................... 63
BOARD OF DIRECTORS AND MANAGEMENT OF FPA FOLLOWING THE MERGER......................... 64
Board of Directors of FPA Following the Merger...................................... 64
Executive Officers of FPA Following the Merger...................................... 65
DESCRIPTION OF FPA COMMON STOCK....................................................... 65
</TABLE>
3
<PAGE> 9
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
COMPARISON OF RIGHTS OF HOLDERS OF HPI AND FPA COMMON STOCK........................... 66
Preferred Stock..................................................................... 66
Board of Directors.................................................................. 66
Bylaws.............................................................................. 67
Stockholder Meetings................................................................ 67
Indemnification..................................................................... 67
Stockholder Voting Requirements..................................................... 68
Action by Consent................................................................... 68
THE MERGER AGREEMENT.................................................................. 69
The Merger.......................................................................... 69
Effective Time...................................................................... 69
Fractional Shares................................................................... 70
Surrender and Payment............................................................... 70
Treatment of Stock Options.......................................................... 70
Certain Representations and Warranties.............................................. 70
Conduct of Business Pending the Merger.............................................. 71
Certain Additional Agreements....................................................... 72
Roll-up Transactions................................................................ 75
Conditions to Consummation of the Merger............................................ 75
Termination......................................................................... 76
Effect of Termination............................................................... 77
Amendment........................................................................... 77
Waiver.............................................................................. 77
SELECTED HISTORICAL AND PRO FORMA INFORMATION......................................... 78
SELECTED HISTORICAL FINANCIAL DATA -- FPA............................................. 87
SELECTED CONSOLIDATED FINANCIAL DATA -- HPI........................................... 88
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- HPI........................................................ 89
Overview............................................................................ 89
Results of Operations............................................................... 92
Liquidity and Capital Resources..................................................... 94
BUSINESS OF HPI....................................................................... 96
Administrative Services Agreements.................................................. 97
SECURITY OWNERSHIP OF CERTAIN HPI BENEFICIAL OWNERS AND MANAGEMENT.................... 98
EXECUTIVE OFFICERS OF HPI............................................................. 99
HPI EXECUTIVE OFFICER AND DIRECTOR COMPENSATION....................................... 99
Executive Officer Compensation...................................................... 99
LEGAL MATTERS......................................................................... 101
ADDITIONAL INFORMATION................................................................ 101
EXPERTS............................................................................... 102
INDEX TO HPI'S CONSOLIDATED FINANCIAL STATEMENTS...................................... F-1
</TABLE>
4
<PAGE> 10
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C> <C>
APPENDIX A -- AGREEMENT AND PLAN OF MERGER DATED AS OF JULY 1, 1997 BY AND AMONG
FPA, MERGER SUB AND HPI............................................... A-1
APPENDIX B -- OPINION OF SMITH BARNEY INC........................................... B-1
APPENDIX C -- DELAWARE GENERAL CORPORATION LAW SECTION 262.......................... C-1
APPENDIX D -- FPA'S ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDED DECEMBER 31,
1996.................................................................. D-1
APPENDIX E -- FPA'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH 31,
1997.................................................................. E-1
APPENDIX F -- FPA'S CURRENT REPORT ON FORM 8-K/A DATED MARCH 17, 1997............... F-1
APPENDIX G -- FPA'S CURRENT REPORT ON FORM 8-K/A DATED JULY 31, 1997................ G-1
APPENDIX H -- FPA's QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30,
1997.................................................................. H-1
APPENDIX I -- THE AUDITED COMBINED BALANCE SHEETS OF FOUNDATION HEALTH MEDICAL
SERVICES (A WHOLLY OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION)
AND AFFILIATES 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............. I-1
</TABLE>
5
<PAGE> 11
GLOSSARY OF CERTAIN DEFINED TERMS
<TABLE>
<S> <C>
Adjusted FPA Value........................... The FPA Value as adjusted pursuant to the
terms of the Merger Agreement and used in
determining the Exchange Ratio.
APB No. 16................................... Accounting Principles Board Opinion No. 16, as
amended.
Capitation................................... A per enrollee per month amount paid pursuant
to Payor contracts in exchange for which the
PPM or physician group is financially
responsible to provide the enrollee with all
necessary medical care specified by the
capitation arrangement.
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......................................... The Internal Revenue Code of 1986, as amended.
Commission................................... The Securities and Exchange Commission.
Delaware Act................................. Delaware General Corporation Law.
Department................................... The California Department of Corporations.
DOJ.......................................... The United States Department of Justice.
Effective Time............................... The time at which the Merger will become
effective as provided for in the Certificate
of Merger or such other time as to which FPA,
HPI and Merger Sub shall agree.
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.
Exchange Ratio............................... The number of shares of FPA Common Stock
issuable in exchange for each share of HPI
Common Stock in connection with the Merger.
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.
FPA Network.................................. Professional Corporations, other providers of
medical services and Payors affiliated with
FPA.
FPA Option Shares............................ The number of fully paid shares of FPA Common
Stock to be issued in respect of HPI Options.
</TABLE>
6
<PAGE> 12
<TABLE>
<S> <C>
FPA Value.................................... The average closing price 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 Closing Date.
Global Capitation............................ A capitation arrangement whereby the PPM or
physician group is financially responsible to
provide enrollees with all necessary inpatient
and outpatient medical care.
HMO.......................................... Health Maintenance Organization.
HPI.......................................... Health Partners, Inc.
HPI Board.................................... The Board of Directors of Health Partners,
Inc.
HPI Common Stock............................. Health Partners, Inc. Common Stock, $.001 par
value per share.
HPI Options.................................. Options to purchase shares of HPI Common Stock
(including substitute HPI Options issued in
connection with the completion of the Roll-up
Transactions).
HPI Preferred Stock.......................... Health Partners, Inc. Series A Convertible
Preferred Stock, $.001 par value per share,
and Health Partners, Inc. Series B Convertible
Preferred Stock, $.001 par value per share.
HPI Special Meeting.......................... The Special Meeting of stockholders of HPI to
be held on at 10:00 a.m. local time
at 800 Connecticut Avenue, Norwalk,
Connecticut, as the same may be adjourned or
postponed.
HPI Subsidiaries............................. Direct and indirect subsidiaries of HPI.
HPI Voting Securities........................ The outstanding shares of HPI Common Stock and
HPI Preferred Stock.
HSR Act...................................... Hart-Scott-Rodino Antitrust Improvements Act
of 1976, as amended.
IPA.......................................... Independent practice association.
Merger....................................... The merger of Merger Sub and HPI.
Merger Agreement............................. The Agreement and Plan of Merger dated as of
July 1, 1997 by and among FPA, Merger Sub and
HPI.
Merger Consideration......................... The aggregate consideration to be issued to
HPI stockholders in the Merger.
Merger Sub................................... FPA Acquisition Corp.
Nasdaq....................................... The Nasdaq National Market System.
1994 Securities Purchase Agreement........... The Securities Purchase Agreement by and among
HPI, Foxfield Venture, Inc. (now WellPoint),
Oxford and certain individual investors dated
as of May 18, 1994.
Outstanding HPI Stock........................ The total number of issued and outstanding
shares of HPI Common Stock (including the
total number of shares of HPI Common Stock
issuable in the Roll-up Transactions and the
conversion of all of the shares of HPI
Preferred Stock).
Oxford....................................... Oxford Health Plans, Inc.
</TABLE>
7
<PAGE> 13
<TABLE>
<S> <C>
PPM.......................................... Physician practice management company.
Payments..................................... Certain payments and benefits to be paid to or
received by Mr. Berg in connection with the
Merger.
Payors....................................... HMOs and other prepaid health insurance plans
which provide physician and related health
care services to enrollees.
Professional Corporations.................... Professional corporations affiliated with FPA.
Proxy Statement/Prospectus................... This proxy statement/prospectus relating to
the Merger and the Payments.
Record Date.................................. September 4, 1997
Registration Statement....................... The registration statement filed under the
Securities Act of which this Proxy
Statement/Prospectus forms a part.
Roll-up Transactions......................... The acquisition by HPI of the minority
interests in its subsidiaries which will occur
immediately prior to the Effective Time.
Rule 144..................................... Rule 144 promulgated under the Securities Act.
Rule 145..................................... Rule 145 promulgated under the Securities Act.
Securities Act............................... Securities Act of 1933, as amended.
Smith Barney................................. Smith Barney Inc., financial advisor to HPI
with respect to the Merger.
Surviving Corporation........................ HPI after the Merger.
WellPoint.................................... WellPoint Development Company, Inc.
WellPoint Parent............................. WellPoint Health Networks Inc., the ultimate
corporate parent of WellPoint.
</TABLE>
8
<PAGE> 14
SUMMARY
The following is a summary of certain information contained elsewhere or
incorporated by reference 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 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 physicians and owned primary care physician groups. FPA manages all
covered primary and specialty medical care for each enrollee in exchange for
monthly capitation payments pursuant to Payor contracts. Including the effects
of the Merger, FPA will be affiliated with approximately 7,580 primary care
physicians (including obstetrician-gynecologists who contract with HealthCap,
Inc. ("HealthCap") as primary care physicians, the "ob-gyn physicians") and
15,322 specialty care physicians (excluding specialists who contract with
HealthCap), who provide services to approximately 1,316,800 enrollees (including
HealthCap ob-gyn direct access enrollees) of 42 health maintenance organizations
("HMOs") or other prepaid health insurance plans (collectively, "Payors") in 27
states. FPA, through its subsidiary Sterling Healthcare Group, Inc.
("Sterling"), is also affiliated with approximately 1,300 emergency department
physicians and manages the emergency departments of 107 hospitals in 20 states.
FPA's strategy is to increase enrollment by adding new Payor relationships
and new providers to the existing FPA Network and by expanding the FPA Network
into new geographic areas where the penetration of managed healthcare is
growing. FPA believes new Payor and provider relationships are possible because
of its ability to manage the cost of health care without sacrificing quality.
FPA seeks to control the two "gatekeeping" points of entry into the managed
health care delivery system -- the primary care physician's office and the
emergency room -- thereby giving FPA a platform for coordinating all aspects of
patient care under global capitation Payor contracts. FPA is also pursuing
national and multi-state Payor contracts, which facilitate more rapid
development of provider networks in new markets and thus should enable FPA to
increase enrollment in an accelerated manner. FPA has recently entered into
several multi-state Payor agreements, including agreements with (i) Aetna/U.S.
Healthcare ("Aetna") whereby Aetna managed care members in 12 states may access
the FPA Network as specific arrangements are negotiated and approved in each of
such states; (ii) Healthsource, Inc. ("Healthsource") whereby Healthsource
managed care members in three states may utilize the FPA Network; and (iii)
PacifiCare Health Systems, Inc. ("PacifiCare") whereby the FPA Network will be
available to PacifiCare managed care members in certain agreed upon markets. FPA
has recently entered into a letter of intent with Foundation Health Systems,
Inc. ("Foundation") to negotiate long-term global capitation contracts in a
number of states where FPA and Foundation mutually do business.
FPA's relationships with its subsidiaries and affiliated professional
corporations (the "Professional Corporations"), other providers of medical
services and Payors (collectively, the "FPA Network") offer physicians the
opportunity to participate more effectively in managed care programs by
organizing physician groups within geographic areas to contract with Payors. FPA
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
9
<PAGE> 15
physicians to retain control of their own practices while gaining access to more
patients through participation in a managed care program.
Except where otherwise permitted by law or regulation, FPA does not engage
in the practice of medicine. Due to the constraints of the corporate practice of
medicine doctrine, FPA cannot own the majority of shares of the voting stock of
the Professional Corporations in most states. FPA has direct or indirect
unilateral and perpetual control over the assets and operations of the
Professional Corporations through the ownership of such Professional
Corporations by certain physicians who are employees of FPA or one of its
subsidiaries. Each shareholder/director of such Professional Corporations has
entered into a succession agreement with FPA which requires such
shareholder/director to sell to a designee of FPA such shareholder/director's
shares of stock in the relevant Professional Corporation for a nominal amount if
such shareholder/director is terminated from employment with FPA.
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. In the states where the corporate practice of
medicine prohibits the ownership of professional corporations other than by
physicians or physician-owned professional corporations, in most cases the
capitation payments are received by the Professional Corporations and are
generally assigned to FPA pursuant to administrative services agreements. Where
subsidiaries of FPA contract directly with Payors, such subsidiaries receive the
capitation payments.
The FPA Network manages all covered primary and specialty medical care for
each enrollee in exchange for 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
pre-authorization 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, some of the costs 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 health care costs.
FPA recruits physicians and contracts for their services to provide
staffing of emergency departments. FPA also assists its hospital clients in such
areas as physician scheduling, operations support, quality assurance and
departmental accreditation as well as billing and record keeping. In addition,
FPA has expanded its hospital-based services to include the management of
anesthesiology departments, correctional institutional health facilities and
rural health care clinics.
The future growth of FPA is largely dependent on a continued increase in
the number of new enrollees in the FPA Network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
serving enrollees of Payors in the FPA Network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations or
subsidiaries of FPA have contracts and whose members are patients of physicians
in the FPA Network or (iii) agreements with Payors, physicians and hospitals in
other geographic markets. The process of identifying and consummating suitable
acquisitions of, or affiliations with, physician groups can be lengthy and
complex. The environment for such acquisitions and affiliations is subject to
increasing competitive pressures. There can be no assurance that FPA will be
successful in identifying, acquiring or affiliating with additional physician
groups or hospitals or that the Professional Corporations or subsidiaries of FPA
will be able to contract with new Payors. In addition, there can be no assurance
that 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 entities may have a material
adverse effect on FPA's results of operations and financial condition. FPA's
ability to expand is also dependent upon its ability to comply with legal and
regulatory requirements in the jurisdictions in which it operates or will
operate and to obtain necessary regulatory approvals, certificates and licenses.
FPA is regularly in discussions with potential 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.
10
<PAGE> 16
The health care industry is subject to extensive federal and state
legislation and regulation. Changes in the regulations or interpretations of
existing regulations could significantly affect the business of FPA.
FPA's executive offices are located at 3636 Nobel Drive, Suite 200, San
Diego, California 92122 and its telephone number is (619) 453-1000.
Additional Information with Respect to FPA
Description of Business. Reference is made to the section entitled "Item 1.
Business" of FPA's Annual Report on Form 10-K/A for the year ended December 31,
1996 a copy of which is included as Appendix D to this Proxy
Statement/Prospectus (the "FPA Form 10-K/A").
Description of Property. Reference is made to the section entitled "Item 2.
Properties" of the FPA Form 10-K/A.
Legal Proceedings. Reference is made to the section entitled "Item 3. Legal
Proceedings" of the FPA Form 10-K/A.
Market Price of and Dividends on FPA's Common Equity and Related
Stockholder Matters. See "MARKET PRICE AND DIVIDEND DATA."
Selected Financial Data. See "SELECTED HISTORICAL FINANCIAL DATA -- FPA."
Supplementary Financial Information. Reference is made to the section
entitled "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Quarterly Results" of the FPA Form 10-K/A; "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Quarterly Results" of FPA's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997 a copy of which is included as Appendix E to this
Proxy Statement/Prospectus; and "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Quarterly Results" of FPA's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 a copy of
which is included as Appendix H to this Proxy Statement/Prospectus.
Management's Discussion and Analysis of Financial Condition and Results of
Operations. Reference is made to the section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations" of FPA's Current
Report on Form 8-K/A dated July 31, 1997 a copy of which is included as Appendix
G to this Proxy Statement/Prospectus; and "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations" of FPA's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1997 a copy of which is
included as Appendix H to this Proxy Statement/Prospectus.
FPA Recent Developments. On September 2, 1997, FPA acquired Emergency
Medical Care Incorporated ("EMC") for cash and shares of FPA Common Stock with
an aggregate value of $18 million, subject to adjustment based on certain
performance criteria. The acquisition will be accounted for as a purchase. EMC
is a physician practice management company ("PPM") engaged in the business of
providing contract management and support services primarily to hospital-based
emergency departments. EMC recruits physicians and contracts for their services
to provide staffing of emergency departments. As of September 2, 1997, EMC
provided PPM services on a contract basis to 17 hospital-based emergency
departments and one radiology department in two states. EMC is currently
affiliated with approximately 125 physicians who provide medical care to
approximately 250,000 patients annually.
On June 30, 1997, FPA acquired HealthCap in a stock-for-stock merger
accounted for as a pooling of interests in which 2,300,000 shares of FPA Common
Stock were issued in exchange for all of the outstanding shares of HealthCap
(including shares covered by HealthCap vested options and outstanding warrants
at the closing of the merger) and FPA assumed certain outstanding HealthCap
options. HealthCap is a PPM that provides management services to physician
networks, including IPAs and professional corporations, which are paid pursuant
to capitation arrangements. HealthCap operates in California, Florida, Georgia,
Missouri and Nevada. As of March 31, 1997, HealthCap had a network of
approximately 1,540 primary care physicians which provided health care services
to approximately 50,000 HMO enrollees under 12 Payor contracts.
11
<PAGE> 17
On March 17, 1997, FPA acquired AHI Healthcare Systems, Inc. ("AHI") in a
stock-for-stock merger accounted for as a pooling of interests in which
5,678,509 shares of FPA Common Stock were issued in exchange for all of the
outstanding shares of AHI. AHI develops integrated health care delivery networks
and provides managed care infrastructure services primarily in California,
Florida and Texas. As of March 17, 1997, AHI had approximately 9,000 affiliated
physicians (including both primary care and specialist physicians) in 51
operational and 40 developing networks, which provided health care services to
approximately 200,000 enrollees under approximately 22 Payor contracts.
HEALTH PARTNERS, INC.
HPI is a physician practice management company which invests in and manages
multi-specialty physician group practices ("Affiliated Practices") and IPAs.
While HPI does not directly engage in the practice of medicine, certain of HPI's
direct and indirect subsidiaries (the "HPI Subsidiaries") or its affiliated
medical groups or IPAs contract with HMOs and other Payors on a capitated or
global fee basis in selected metropolitan markets to provide services to
assigned enrollees. HPI's strategy is to affiliate with physicians who are
seeking a partner to assist the medical group or network in transitioning from a
fee-for-service oriented health care system to a managed care system. In each
market, HPI seeks to affiliate with a locally prominent medical group or IPA and
assist the medical group or IPA in building a managed care infrastructure and
developing a high quality, geographically strong network of physicians. The
network is designed to increase the number of available primary care physicians,
which provides an opportunity to increase the number of patients served under a
capitated or global fee contract. HPI believes this approach enables physicians
to provide high-quality, cost-effective health care, is highly desirable to both
Payors and patients and is more likely to assist physicians in successfully
adapting to a managed care environment. HPI has targeted major metropolitan
markets with lower HMO penetration. HPI should benefit as managed health care
grows in these geographic markets by an increase in new Payor and physician
relationships.
Since its inception in September 1993, HPI has affiliated with eight
physician group practices and six IPAs representing 1,722 physicians in five
geographic markets, including the New York City metropolitan area, northern
Virginia, Washington, D.C., northern Kentucky and San Antonio, Texas. HPI's
affiliated medical groups and IPAs currently serve approximately 138,000
patients under capitated or global fee arrangements. HPI believes it is the New
York metropolitan area's largest PPM with approximately 1,331 affiliated
physicians and approximately 104,000 patients under capitated or global fee
arrangements.
As of the Record Date, Oxford Health Plans, Inc. ("Oxford") and WellPoint
Development Company, Inc. ("WellPoint") beneficially own approximately 82.7% of
HPI's outstanding voting securities and each has elected two directors to HPI's
five person Board of Directors. See "THE HPI SPECIAL MEETING -- Security
Ownership of Certain HPI Beneficial Owners and Management."
HPI's executive offices are located at 800 Connecticut Ave, Norwalk,
Connecticut 06854 and its telephone number is (203) 851-2600.
12
<PAGE> 18
THE MERGER
Effects of the Merger...... Pursuant to the Merger, Merger Sub will merge with
and into HPI, HPI will continue as the surviving
corporation (sometimes referred to as the
"Surviving Corporation") and HPI will become a
wholly owned subsidiary of FPA. At the Effective
Time (as defined below): (i) each outstanding share
of HPI Common Stock, except as provided below, will
be exchanged for the right to receive a number of
shares of FPA Common Stock equal to the Exchange
Ratio; (ii) each share of HPI Common Stock and HPI
Preferred Stock held in HPI's treasury will be
canceled and extinguished and will cease to exist
and no consideration will be delivered with respect
thereto; (iii) if applicable, each outstanding
share of HPI Common Stock and HPI Preferred Stock,
the holder of which is eligible for dissenters'
rights to appraisal in accordance with the Delaware
General Corporation Law ("Delaware Act"), will not
be converted into a right to receive shares of FPA
Common Stock, but such holder will be entitled to
only such rights as are granted under the
applicable provisions of the Delaware Act (see "THE
MERGER -- Rights of Dissenting Stockholders"); and
(iv) each share of capital stock of Merger Sub
issued and outstanding immediately prior to the
Effective Time will be converted into and exchanged
for one share of common stock of the Surviving
Corporation.
The Exchange Ratio will depend on the relationship
among (i) the total issued and outstanding shares
of HPI Common Stock (the "Outstanding HPI Stock")
immediately prior to the Effective Time which will
equal 10,545,222, assuming no holders of options to
purchase shares of HPI Common Stock ("HPI Options")
exercise such options between the date hereof and
the Effective Time, which number includes the
8,000,025 shares of HPI Common Stock to be issued
upon conversion of the HPI Preferred Stock and the
871,697 shares of HPI Common Stock to be issued in
the Roll-up Transactions, (ii) the fair value of
options to purchase HPI Options immediately prior
to the Effective Time (including HPI Options issued
in the Roll-up Transactions) which will be
converted in the Merger into shares of FPA Common
Stock (the "FPA Option Shares"), (iii) the presumed
transaction value of $115 million and (iv) the FPA
Value. The FPA Value will be the average of the
closing prices of FPA Common Stock on Nasdaq for
the ten consecutive trading days ending on the date
that is two trading days prior to the date of
consummation of the Merger (the "Closing Date").
The "Adjusted FPA Value" will equal the FPA Value,
except that if the FPA Value is less than $18, the
Adjusted FPA Value will be $18 and if the FPA Value
is greater than $22, the Adjusted FPA Value will be
$22. Consequently, the Adjusted FPA Value may
differ from the actual market price of FPA Common
Stock reported by Nasdaq on the date of the HPI
Special Meeting, the Closing Date or the date the
HPI stockholders actually receive their shares of
FPA Common Stock after the Merger is completed. See
"THE MERGER -- Merger Consideration," "THE MERGER
AGREEMENT -- Roll Up Transactions" and
"-- Treatment of Stock Options."
The Exchange Ratio can be represented by the
following formula:
<TABLE>
<S> <C>
Exchange Ratio = ($115 Million / Adjusted FPA Value) -- FPA Option Shares
---------------------------------------------------------
Outstanding HPI Stock
</TABLE>
13
<PAGE> 19
The following table sets forth the range of the
number of shares of FPA Common Stock that may be
issued in the Merger depending upon the FPA Value:
<TABLE>
<CAPTION>
SHARES OF
FPA COMMON STOCK
FPA VALUE TO BE ISSUED
-------------------------------------------- ----------------
<S> <C>
less than or equal to $18.00................ 6,388,889
$19.00...................................... 6,052,631
$20.00...................................... 5,750,000
$21.00...................................... 5,476,190
greater than or equal to $22.00............. 5,227,273
</TABLE>
Except as more fully described in this Proxy
Statement/Prospectus, in no event will the number
of shares of FPA Common Stock issuable in the
Merger exceed 6,388,889.
The following table sets forth the Exchange Ratio
depending upon the FPA Value and FPA Option Shares
to be issued:
<TABLE>
<CAPTION>
FPA EXCHANGE
FPA VALUE OPTION SHARES RATIO
---------------------------------------- ------------- --------
<S> <C> <C>
less than or equal to $18.00............
$19.00..................................
$20.00..................................
$21.00..................................
greater than or equal to $22.00.........
</TABLE>
HPI believes that the Exchange Ratio will fall
between .43 and .55 (assuming a range of FPA Value
of $15.65 to $25.00, respectively).
The adjustments to the Exchange Ratio are described
more fully in this Proxy Statement/Prospectus. IF
THE FPA VALUE IS LESS THAN $15.65, HPI MAY
TERMINATE THE MERGER AGREEMENT. STOCKHOLDERS OF HPI
WILL BE ABLE TO OBTAIN THE EXCHANGE RATIO BEGINNING
AT THE END OF THE SECOND BUSINESS DAY PRECEDING THE
HPI SPECIAL MEETING BY CALLING (888) XXX-XXXX. See
"THE MERGER -- Merger Consideration,"
"-- Adjustments to Merger Consideration" and "THE
MERGER AGREEMENT -- Termination."
The actual market price of the FPA Common Stock may
vary, which may cause a change in the Exchange
Ratio and the aggregate Merger Consideration. Each
HPI stockholder is urged to obtain updated FPA
market information.
During the 90 day period ending September 15, 1997,
the market price of FPA Common Stock ranged from a
low of $16.75 to a high of $32.00 per share. FPA's
stock price may be affected by a number of factors,
including announcements of new legislative
proposals or legislation affecting the managed care
industry, the performance of, and investor
expectations for, FPA, analysts' comments regarding
the managed care industry generally and FPA in
particular, announcements by FPA of pending
transactions and general economic and market
conditions. As one factor in determining the
Exchange Ratio is the FPA Value, a risk to the HPI
stockholders of such FPA stock price volatility is
that a significant change in the price of FPA
Common Stock could occur between the last day of
the period for which the Adjusted FPA Value is
14
<PAGE> 20
determined (the second business day preceding the
date of the HPI Special Meeting) and the Effective
Time (which is expected to occur on the date of the
HPI Special Meeting).
Since the Exchange Ratio cannot be calculated until
the second business day immediately preceding the
date of the HPI Special Meeting, the number of
shares of FPA Common Stock to be issued to the
holders of HPI Voting Securities, may differ from
the estimates provided in this Proxy
Statement/Prospectus.
No fractional shares of FPA Common Stock will be
issued in connection with the Merger, and in lieu
of any such fractional share, each holder of HPI
Common Stock who would otherwise have been entitled
to a fraction of a share of FPA Common Stock will
be entitled to receive a cash payment equal to such
fraction multiplied by the FPA Value.
Recommendation of HPI's
Board of Directors......... The HPI Board believes that the terms of the Merger
are fair to and in the best interests of the
holders of the HPI Common Stock and HPI Preferred
Stock and has unanimously approved the Merger
Agreement and the related transactions. The HPI
Board unanimously recommends that HPI stockholders
approve the Merger Agreement. See "THE
MERGER -- Recommendation of the HPI Board of
Directors and Reasons for the Merger."
The HPI Board considered a number of material
factors, favorable, neutral and adverse, in its
evaluation of the Merger, each of which is
described at "THE MERGER -- Recommendation of the
HPI Board of Directors and Reasons for the Merger."
See "RISK FACTORS."
Certain officers and all directors of HPI have
certain interests in the Merger that are in
addition to their interests as stockholders of HPI
generally. These interests arise from, among other
things, certain employment agreements, management
retention programs, indemnification arrangements,
registration rights and other matters which FPA
will assume or has agreed to provide after the
Merger. For a discussion and quantification of
these interests, see "THE MERGER -- Interests of
Certain Persons in the Merger." Oxford and
WellPoint have certain interests in the Merger that
are in addition to their interests as stockholders
of HPI generally. In connection with the Merger,
Oxford and HPI have agreed to establish certain
strategic principles under which they will enter
into partnership agreements in the future in
existing and new markets (the "Strategic
Agreement"). WellPoint Health Networks Inc., the
ultimate corporate parent of WellPoint ("WellPoint
Parent"), and FPA have agreed to develop a
strategic relationship with respect to servicing
the enrollees of WellPoint Parent's subsidiary
health plans (the "Memorandum of Understanding").
In addition, Oxford, WellPoint and certain officers
and directors will be parties to a registration
rights agreement pursuant to which FPA will file
and keep effective a registration statement for the
shares of FPA Common Stock received in the Merger.
For a discussion of these interests, see "THE
MERGER -- Interests of Certain Persons in the
Merger." Oxford and WellPoint each appoint two
directors to the five person HPI Board. The other
director is Mr. Berg, the President and Chief
Executive Officer of HPI. Therefore, all of the
directors on the HPI Board are interested directors
and the
15
<PAGE> 21
HPI Board did not appoint a special committee of
disinterested directors to evaluate the Merger.
The HPI Board of Directors was aware of all of
these interests and considered them, among other
matters, in approving the Merger Agreement and in
formulating its recommendations to the stockholders
of HPI that they approve the Merger Agreement and
the transactions contemplated therein. See "RISK
FACTORS" and "THE MERGER -- Background of the
Merger."
Opinion of HPI's Financial
Advisor.................... Smith Barney Inc. ("Smith Barney") has acted as
financial advisor to HPI in connection with the
Merger and has delivered to the HPI Board a written
opinion dated July 1, 1997 to the effect that, as
of the date of such opinion and based upon and
subject to certain matters stated therein, the
Merger Consideration was fair, from a financial
point of view, to the holders of HPI Common Stock.
The full text of the written opinion of Smith
Barney dated July 1, 1997, which sets forth the
assumptions made, matters considered and
limitations on the review undertaken, is attached
as Appendix B to this Proxy Statement/Prospectus
and should be read carefully in its entirety. The
opinion of Smith Barney is directed to the HPI
Board and relates only to the fairness of the
Merger Consideration 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 HPI
Special Meeting. See "THE MERGER -- Opinion of
HPI'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 of the Merger (the "Closing"). It is
anticipated that the Closing will occur on the date
of the HPI Special Meeting.
Conditions to the Merger... The obligations of FPA and HPI to consummate the
Merger are subject to certain conditions including
(i) obtaining the approval of the stockholders of
HPI, (ii) the effectiveness of the Registration
Statement of which this Proxy Statement/Prospectus
is a part, (iii) the approval for inclusion on
Nasdaq 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) the absence
of any preliminary or permanent injunction or other
order or decree prevents the consummation of the
Merger, (vi) the receipt by each party of various
legal opinions 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 performance in all
material respects of all agreements, covenants and
obligations by each party. Additionally, the
obligation of HPI to consummate the Merger is
subject to the conditions that (i) FPA shall have
entered into an agreement to provide registration
rights to
16
<PAGE> 22
certain HPI stockholders, (ii) FPA shall have
entered into certain employment agreements and have
taken certain employee-related actions and (iii)
the FPA Value shall be not less than $15.65. The
obligation of FPA to consummate the Merger is
subject to the conditions that (i) the resignation
of the directors of HPI immediately prior to the
Effective Time shall have occurred, (ii) HPI and
Oxford Health Plans, Inc. shall have entered into a
Master Strategic Agreement pursuant to which the
parties shall have agreed to certain strategic
principles for ongoing relationships between
Oxford's health plan subsidiaries and HPI's
subsidiaries and professional corporations, (iii)
FPA and WellPoint Health Networks Inc. ("WellPoint
Parent") shall have entered into a Memorandum of
Understanding pursuant to which the parties shall
have agreed to develop a strategic relationship to
further the delivery of quality cost-effective
health care to enrollees of WellPoint Parent's
health plan subsidiaries, (iv) there shall be no
HPI Preferred Stock outstanding as of the Effective
Time, (v) stock option acknowledgments shall have
been executed by holders representing no less than
80% of the shares of HPI Common Stock issuable upon
exercise of all HPI stock options and (vi) each
Roll-up Transaction shall be complete or the
parties thereto shall have entered into escrow
agreements which will set aside an agreed upon
maximum number of shares of FPA Common Stock which
may be issued in the Roll-up Transactions. Either
FPA or HPI 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 HPI will amend this Proxy
Statement/Prospectus, and HPI will resolicit
stockholder votes to the extent required by
applicable law. In the event the FPA Value is less
than $15.65, HPI's decision to complete the Merger
will depend upon the HPI Board's reconsideration
of, among other things, the factors set forth under
"THE MERGER -- Recommendation of the HPI Board of
Directors and Reasons for the Merger." See "THE
MERGER -- Certain Regulatory Matters" and "THE
MERGER AGREEMENT -- Conditions to Consummation of
the Merger."
Termination, Amendment and
Waiver..................... The Merger Agreement may be terminated at any time
prior to the Effective Time by mutual consent of
FPA and HPI, or, generally, by either party if,
among other things, (i) the Merger shall not have
been completed by October 28, 1997, (ii) HPI does
not obtain stockholder approval, (iii) any required
governmental or regulatory approval is not
obtained, (iv) either party materially breaches any
of its representations, warranties or covenants
under the Merger Agreement or (v) the Merger is
prohibited by court order. In the event that the
FPA Value is below $15.65, the HPI Board, in the
exercise of its fiduciary duties, would consider
whether to terminate the Merger Agreement based on
whether the stockholders of HPI would receive fair
consideration for their HPI Common Stock and
whether consummation of the Merger would be in the
best interests of the HPI stockholders. Each of FPA
and HPI may terminate the Merger Agreement if the
respective conditions to each
17
<PAGE> 23
such party's obligations have not been satisfied or
waived on or prior to the Closing Date. See "THE
MERGER AGREEMENT -- Termination," "-- Amendment"
and "-- Waiver."
Rights of HPI
Stockholders............... Both FPA and HPI are Delaware corporations and the
rights of their respective stockholders are
governed by the Delaware Act and their respective
Certificates of Incorporation and Bylaws. In
addition, the rights of the HPI stockholders are
affected by a Securities Purchase Agreement among
HPI, Foxfield Ventures, Inc. (now WellPoint),
Oxford and certain management investors dated as of
May 18, 1994 ("1994 Securities Purchase
Agreement"). If the Merger is consummated, HPI'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 HPI's Certificate of Incorporation and Bylaws
and FPA's Certificate of Incorporation and Bylaws.
The material differences include the rights of each
corporation's preferred stockholders; the
procedures for (i) nominating, electing and
removing each corporation's directors, (ii)
amending each corporation's bylaws and (iii)
calling special meetings of each corporation's
stockholders; the rights of each corporation's
officers and directors to indemnification; and each
corporation's stockholder voting requirements. See
"COMPARISON OF RIGHTS OF HOLDERS OF HPI AND FPA
COMMON STOCK."
Treatment of Stock
Options.................... HPI has granted options to purchase 1,353,203
shares of to be issued HPI Common Stock (including
options to purchase 169,703 shares to be issued in
connection with the completion of the Roll-Up
Transactions) of which options to purchase 468,212
shares are held by officers of HPI and options to
purchase 884,991 shares are held by employees of
HPI and certain HPI Subsidiaries. Pursuant to the
Merger Agreement, each HPI Option, whether or not
vested, shall be canceled at the Effective Time in
exchange for a number of shares of fully paid FPA
Common Stock with a market value equal to the fair
value of such HPI Option as determined by applying
a variation of the Black-Scholes option pricing
model by an investment banking firm. The conversion
of the HPI Options into fully paid shares of FPA
Common Stock will not require the option holder to
pay the exercise price of the option, since the
exercise price is considered in the determination
of the fair value of the HPI Options. See "THE
MERGER AGREEMENT -- Treatment of Stock Options."
The HPI Options will include substitute HPI Options
issued in connection with the completion of the
Roll-up Transactions in exchange for options to
acquire Minority Shares (as defined herein) in HPI
Subsidiaries which will be canceled in connection
with the Roll-up Transactions. See "THE MERGER
AGREEMENT -- Roll-up Transactions." HPI Options are
held by officers and employees of HPI and certain
HPI Subsidiaries. See "THE MERGER -- Interests of
Certain Persons in The Merger."
Roll-up Transactions....... HPI has affiliated with group practices and IPAs
through the HPI Subsidiaries. The physician-owners
of the group practices or IPAs own shares in HPI
Subsidiaries ("Minority Shares") with which they
contract to provide health care services. In each
case, such shares represent less than a 30%
interest in such subsidiary. Such physician-owners
and other employees also have been granted stock
options in HPI Subsidiar-
18
<PAGE> 24
ies (the "Minority Options"). HPI has the right to
exchange the Minority Shares and Minority Options
for HPI Common Stock and HPI Options of equal value
(the "Roll-up Transactions"). HPI has exercised its
right in connection with the Merger. Pursuant to
the Roll-up Transactions, 871,697 shares of HPI
Common Stock will be issued and options to purchase
170,287 shares of HPI Common Stock will be issued
immediately prior to the Effective Time. See "THE
MERGER AGREEMENT -- Roll-up Transactions."
Following the Roll-up Transactions, the holders of
such newly issued HPI Common Stock and HPI Options
will have the right to receive shares of FPA Common
Stock on the same terms and conditions as other
holders of HPI Common Stock and HPI Options at the
Effective Time. See "THE MERGER -- Merger
Consideration" and "THE MERGER
AGREEMENT -- Treatment of Stock Options." The
holders of such newly issued HPI Common Stock will
not have the right to vote such shares in
connection with the Merger as such shares will be
issued subsequent to the Record Date. Only holders
of record of HPI Common Stock and HPI Preferred
Stock at the close of business on September 4, 1997
are entitled to vote at the HPI Special Meeting.
See "THE HPI SPECIAL MEETING -- Record Date; Stock
Entitled to Vote."
Dissenters' Rights......... Holders of HPI Common Stock and HPI Preferred Stock
who exercise dissenters' rights with respect to the
Merger in accordance with the procedures prescribed
in Section 262 of the Delaware Act will be entitled
to receive cash for their HPI Common Stock if such
stockholders (i) deliver to HPI's Secretary before
the vote on the Merger Agreement at the HPI Special
Meeting a written demand for appraisal, (ii)
continuously hold their shares from the date the
appraisal demand is made through the Effective
Time, (iii) neither vote in favor of the Merger nor
consent thereto in writing and (iv) file a petition
in the Delaware Court of Chancery within 120 days
of the Effective Time demanding a determination of
the "fair value" of their shares. Failure to take
any of the steps required under Section 262 of the
Delaware Act on a timely basis may result in the
loss of appraisal rights. A copy of Section 262 of
the Delaware Act relating to dissenters' rights is
attached to this Proxy Statement/Prospectus as
Appendix C. See "THE MERGER -- Rights of Dissenting
Stockholders."
HSR Act Filing............. FPA and HPI made their respective filings under the
HSR Act with the Federal Trade Commission ("FTC")
on July 29, 1997, and the waiting period of their
respective HSR Act filings has expired.
Notwithstanding the expiration of the waiting
period of the HSR Act filings, the FTC, Department
of Justice ("DOJ") or others could take action
under antitrust laws, before or after the Effective
Time, seeking the divestiture by FPA of all or any
part of the assets of HPI 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. See "THE MERGER -- Certain Regulatory
Matters."
Material Federal Income Tax
Consequences............... The Merger is intended to qualify for federal
income tax purposes as a reorganization within the
meaning of Section 368(a) of the Internal
19
<PAGE> 25
Revenue Code of 1986, as amended (the "Code").
Assuming the Merger so qualifies as a
reorganization within the meaning of Section 368(a)
of the Code, in general, no gain or loss will be
recognized by holders of HPI Common Stock with
respect thereto on the surrender of their HPI
Common Stock in exchange for FPA Common Stock,
except with respect to cash received in lieu of
fractional shares, and no gain or loss will be
recognized by FPA or HPI. Each of FPA and HPI has
received an opinion of its respective counsel to
the effect that the Merger will constitute a
reorganization within the meaning of Section 368(a)
of the Code and that each of HPI, FPA and Merger
Sub will be a party to the reorganization within
the meaning of Section 368(b) of the Code. For a
further discussion of the federal income tax
consequences of the Merger see "THE
MERGER -- Certain Federal Income Tax Consequences."
Accounting Treatment....... The Merger will be treated as a "pooling of
interests" for accounting and financial reporting
purposes. See "THE MERGER -- Accounting Treatment."
Interests of Certain
Persons in the Merger;
Possible Conflicts of
Interest................... In considering the recommendations of the HPI Board
with respect to the Merger Agreement and the
transactions contemplated thereby, HPI stockholders
should be aware that certain members of HPI
management and the HPI Board have interests in the
Merger that are in addition to the interests of the
stockholders of HPI generally. These interests
arise from, among other things, certain employment
agreements, management retention programs,
indemnification arrangements, registration rights
and other matters which FPA will assume or has
agreed to provide after the Merger. FOR A
DISCUSSION AND QUANTIFICATION OF THESE INTERESTS,
SEE "THE MERGER -- INTERESTS OF CERTAIN PERSONS IN
THE MERGER."
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; risks of
financial leverage; difficulty in maintaining
growth; risks related to intangible assets;
difficulty in controlling health care costs,
capitated nature of revenue; risks related to full
risk capitation; risks related to fee-for-service
contracts; dependence on government and other third
party payors; reliance on certain payors;
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 and certain employment contracts; risk of
dilution and additional capital needs; shares
eligible for future sale; and anti-takeover effect
of certain provisions. Risks relating to HPI
include risks related to PPM business generally;
HPI's limited operating history and losses; risks
associated with growth strategy; control by certain
stockholders; concentration of payors; limitations
on reimbursement; and goodwill and other
20
<PAGE> 26
intangibles. Risks relating to the Merger include
the impact on FPA's financial statements; no
assurance of successful integration of certain
operations; exchange ratio may not fully reflect
changes in the price of FPA Common Stock; need for
additional capital; possible loss of business;
rights of HPI stockholders following the Merger;
federal income tax consequences; and certain
conflicts of interest.
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 HPI Common
Stock. CERTIFICATES FOR SHARES OF HPI 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 HPI
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 HPI or FPA at the
time of the Special Meeting 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."
Payments................... Pursuant to the terms of his employment agreement
dated September 1, 1993 with HPI and in connection
with the termination of such employment agreement
which will occur as a result of the Merger as of
the Effective Time, Charles G. Berg, the President
and Chief Executive Officer of HPI, will receive
certain payments and benefits (the "Payments")
which could be considered "parachute payments"
under Section 280G of the Code. See "THE
MERGER -- Interests of Certain Persons in the
Merger -- Berg Employment Agreement." These
potential "parachute payments" include (i) a lump
sum cash payment to Mr. Berg of $350,000 by HPI,
(ii) the acceleration of the vesting of Mr. Berg's
unvested HPI options to purchase 239,150 shares of
HPI Common Stock, the value of which vesting
acceleration is estimated to be approximately
$460,000 and (iii) all or a portion of the amount
of $300,000 to be paid to Mr. Berg by FPA at the
Effective Time in consideration for entering into a
new employment agreement with FPA. Based on Section
280G of the Code and the proposed regulations
thereto ("Section 280G"), HPI may not be able to
deduct all or a portion of the Payments and Mr.
Berg may be subject to a nondeductible 20% excise
tax with respect thereto unless stockholders
representing 75% or more of the HPI Common Stock
and HPI Preferred Stock (other than securities
owned or controlled by Mr. Berg and certain of his
family members) approve the Payments and approval
of the Payments is made a condition of the receipt
of such Payments. At the HPI Special Meeting, the
HPI stockholders will be asked to approve the
Payments. Unless the Payments are approved by HPI
stockholders in accordance with Section 280G, such
Payments will be forfeited. THE HPI BOARD (WITH MR.
BERG ABSTAINING) HAS APPROVED THE PAYMENTS AND
RECOMMENDS A VOTE FOR THE APPROVAL OF THE PAYMENTS.
SEE "THE PAYMENTS."
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<PAGE> 27
THE HPI SPECIAL MEETING
Special Stockholder
Meeting.................... The special meeting of stockholders of HPI (the
"HPI Special Meeting") will be held on
, 1997 at 10:00 a.m. local time at HPI's offices
located at 800 Connecticut Avenue, Norwalk,
Connecticut 06854.
Matters to be Considered at
the HPI Special Meeting.... At the HPI Special Meeting, stockholders will be
asked (i) to approve and adopt the Merger Agreement
and (ii) to approve the Payments to the President
and Chief Executive Officer of HPI.
HPI'S BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE
FOR EACH PROPOSAL.
Quorum; Vote Required...... The presence in person or by proxy of the holders
of a majority of the issued and outstanding shares
of HPI Common Stock and HPI Preferred Stock (the
"HPI Voting Securities") at the HPI Special Meeting
is necessary to constitute a quorum at the meeting.
For purpose of constituting a quorum and for all
matters to be voted upon at the HPI Special
Meeting, the HPI Preferred Stock shall be treated
on an as-converted basis. Approval of the Merger
Agreement requires the affirmative vote of 60% of
the HPI Voting Securities. Approval of the possible
adjournment or postponement of the HPI Special
Meeting requires the affirmative vote of a majority
of the HPI Voting Securities present either in
person or by proxy at the HPI Special Meeting.
Approval of the Payments requires the affirmative
vote of at least 75% of the HPI Voting Securities,
excluding shares that are owned by the President
and Chief Executive Officer of HPI and certain of
his family members. See "THE HPI SPECIAL
MEETING -- Vote Required" and "THE MERGER
AGREEMENT -- Conditions to Consummation of the
Merger."
Record Date; Outstanding
HPI Stock.................. Only stockholders of record of HPI Common Stock and
HPI Preferred Stock at the close of business on
September 4, 1997 are entitled to notice of and to
vote at the HPI Special Meeting. On that date,
there were 1,673,500 shares of HPI Common Stock
outstanding, 25,000 shares of HPI Series A
Convertible Preferred Stock outstanding and 25,000
shares of HPI Series B Convertible Preferred Stock
outstanding, with each share of HPI Common Stock
entitled to one vote per share, each share of HPI
Series A Convertible Preferred Stock entitled to
132 votes per share and each share of HPI Series B
Convertible Preferred Stock entitled to 188 votes
per share, with respect to all matters to be
considered at the HPI Special Meeting.
Security Ownership of HPI
Management............... As of the record date, the directors and named
executive officers of HPI as a group owned
approximately 10.60% of the voting power
represented by the HPI Voting Securities.
Stockholders of HPI with the collective power to
vote approximately 82.70% of the HPI Voting
Securities have entered into voting agreements and
given their irrevocable proxies to FPA, providing
that their shares shall be voted in favor of the
Merger Agreement. Accordingly, approval of the
Merger by the HPI stockholders is assured. See "THE
MERGER -- Interests of Certain Persons in
22
<PAGE> 28
the Merger" and "SECURITY OWNERSHIP OF CERTAIN HPI
BENEFICIAL OWNERS AND MANAGEMENT."
Reasons for the Merger..... The Board of Directors of HPI, after careful
consideration, has unanimously approved the Merger
Agreement and the transactions contemplated thereby
and determined that the Merger is fair to, and in
the best interests of, HPI and its stockholders and
recommends a vote FOR the approval and adoption of
the Merger Agreement.
The HPI Board believes the Merger offers HPI an
attractive opportunity to strengthen its
competitive position and enhance its profile with
physicians and Payors. Furthermore, the Merger will
allow HPI to align with a leading PPM in a
consolidating industry while at the same time
affording stockholders enhanced liquidity due to
the developed market for FPA's publicly traded
shares. Disadvantages include the possibility that
FPA will not be able to integrate successfully
recent acquisitions, the possibility that FPA will
not be able to sustain its growth strategy and
FPA's leveraged balance sheet. See "THE
MERGER -- Recommendation of the HPI Board of
Directors and Reasons for the Merger."
23
<PAGE> 29
FPA AND HPI COMPARATIVE PER SHARE DATA
The following table sets forth certain historical per share data of FPA and
combined per share data of FPA and HPI on an unaudited pro forma basis, based on
the assumption that the Merger occurred at the beginning of the earliest period
presented and was accounted for as a pooling of interests. Historical financial
data of FPA has been restated to include the effects of the October 1996 merger
with Sterling and the March 1997 merger with AHI, both of which were accounted
for as a "pooling of interests." Historical net earnings per common share of HPI
have not been presented as HPI is a nonpublic company. The pro forma comparative
per share data gives effect to the Merger assuming the issuance of 5,227,273
shares of FPA Common Stock in the Merger. See "THE MERGER -- Adjustments to
Merger Consideration."
HISTORICAL EARNINGS PER SHARE DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------- SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
----- ----- ------ ------------------
<S> <C> <C> <C> <C>
FPA $0.29 $0.03 $(2.56) $(0.40)
</TABLE>
FPA AND HPI PRO FORMA COMBINED EARNINGS PER SHARE DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------- SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
------ ------ ------ ------------------
<S> <C> <C> <C> <C>
Pro forma combined per FPA share $(0.09) $(0.31) $(3.61) $(0.38)
Pro forma equivalent per HPI share (0.04) (0.15) (1.69) (0.18)
</TABLE>
BOOK VALUE PER COMMON SHARE
<TABLE>
<CAPTION>
DECEMBER 31,
1996 JUNE 30, 1997
------------ -------------
<S> <C> <C> <C> <C>
FPA -- Historical $ 4.39 $ 3.68
HPI -- Historical(1) 2.73 2.77
Pro forma combined per FPA share 4.27
Pro forma equivalent per HPI share 2.00
</TABLE>
(1) Assumes the conversion of HPI Preferred Stock into HPI Common Stock as of
June 30, 1997.
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<PAGE> 30
MARKET PRICE AND DIVIDEND DATA
FPA Common Stock is listed on Nasdaq under the symbol "FPAM." The HPI
Common Stock and HPI Preferred Stock are not traded on any securities market or
exchange.
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>
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.................................... 28 1/2 18 1/4
Second Quarter................................... 24 1/2 14 7/8
Third Quarter (through September 26, 1997)....... 33 3/8 22 7/8
</TABLE>
- ---------------
(1) Prices have been adjusted to reflect a 100% stock dividend of FPA Common
Stock effected April 1995.
The closing price of FPA Common Stock on Nasdaq on July 1, 1997, the last
full trading day prior to the public announcement of the Merger Agreement, was
$23.875 and on , 1997 was $ .
FPA declared no cash dividends during 1995, 1996 or 1997 and has no plans
to declare cash dividends in the foreseeable future. FPA's Credit Agreement with
Lehman Commercial Paper, Inc. and the lenders parties thereto and FPA's 6 1/2%
Convertible Subordinated Debentures limit the ability of FPA to pay cash
dividends.
As of the HPI record date, there were 19 holders of record of HPI Common
Stock, one holder of record of HPI's Series A Convertible Preferred Stock and
one holder of record of HPI's Series B Convertible Preferred Stock.
HPI declared and paid a dividend on its Series A Convertible Preferred
Stock in May 1994 in connection with its exchange into Series B Convertible
Preferred Stock. Also, HPI had a stock split distributed as a dividend to its
common stockholders in May 1994. See note 9 of Notes to HPI's Consolidated
Financial Statements contained elsewhere in this Proxy Statement/Prospectus.
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<PAGE> 31
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 HPI Special Meeting.
RISKS RELATING TO FPA
No Assurance of Successful Integration of Acquisitions; Expanded Service
Offering. Over the last two and one-half years, FPA has pursued an aggressive
growth strategy. FPA's growth has been achieved primarily through acquisitions,
several of which have been completed during the last six months. Several of
these acquisitions 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, including cost savings, will be realized. Furthermore, there
can be no assurance that any cost savings which are realized will not be offset
by increases in other expenses or operating losses. FPA will encounter similar
uncertainties and risks with respect to any future acquisitions it may make.
Failure to effectively accomplish the integration of acquired companies could
have a material adverse effect on FPA's results of operations and financial
condition.
Certain of the companies recently acquired by FPA have recently or
historically operated at a loss. Other acquired companies have experienced
fluctuations in quarter-to-quarter operating results. See "Fluctuations in
Quarterly Results." FPA has commenced the institution of certain measures
intended to reduce these losses and quarterly fluctuations and to operate the
acquired businesses profitably. However, there can be no assurance that FPA will
reverse these trends or operate these entities profitably. If there are
continuing operating losses at the acquired companies, FPA may need additional
capital to fund its business, and there can be no assurance that such additional
capital can be obtained or, if obtained, it will be on terms acceptable to FPA.
FPA is regularly in discussions with potential acquisition candidates and
may from time to time enter into letters of intent or definitive agreements with
respect to the acquisition of such businesses. No assurance can be given as to
FPA's ability to compete successfully at favorable prices for available
acquisition candidates or to complete future acquisitions, or as to the
financial effect on FPA of any acquired business. Future acquisitions by FPA may
involve the issuance of additional shares of common stock, which could have a
dilutive effect on earnings per share, or could involve significant cash
expenditures and may result in increased indebtedness and interest and
amortization expenses or decreased operating income, which could have an adverse
impact on FPA's future operating results.
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 recent acquisitions of Sterling and EMC,
FPA manages and supports 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.
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<PAGE> 32
There can be no assurance that FPA will be successful in developing and
integrating Sterling's and EMC's operations and services.
Risks of Financial Leverage. FPA's indebtedness is significant in relation
to its stockholders' equity. Giving effect to amounts drawn down pursuant to
FPA's $275 Million Credit Agreement (including the term loan) with BankBoston,
N.A., as Administrative Agent for the Lenders parties thereto, dated June 30,
1997 (the "Credit Agreement"), and the issuance of FPA's 6 1/2% Convertible
Subordinated Debentures due 2001 (the "Debentures") in December 1996, FPA's
indebtedness accounts for approximately 240% of FPA's stockholders' equity as of
June 30, 1997. 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.
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
subsidiaries and Professional Corporations will be able to contract with new
Payors. In addition, 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 entities may have a material adverse effect on FPA's
results of operations and financial condition. FPA's ability to expand is also
dependent upon its ability to comply with legal and regulatory requirements in
the jurisdictions in which it operates or will operate and to obtain necessary
regulatory approvals, certificates and licenses.
Risks Related to Intangible Assets. As a result of FPA's various
acquisition transactions, intangible assets of approximately $328.6 million have
been recorded as of June 30, 1997 on FPA's balance sheet. Such intangible assets
totaled approximately 271% of FPA's stockholders' equity as of June 30, 1997.
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 $15.8 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
specific underlying facts and circumstances of each such acquisition. 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. In the past, FPA has recorded charges for impairment of
goodwill, including (i) in 1995, $434,000 related to the sale and closing of
primary care centers and (ii) in 1996, $4.1 million relating to a 1995
acquisition in Arizona (as a result of continuing losses in the acquired entity)
and $14.8 million related to certain emergency room department contracts (which
were terminated after acquisition of the contracting entity). Although at June
30, 1997 the net unamortized balance of intangible assets acquired was not
considered to be impaired, any future determination, based on reevaluation of
the underlying facts and circumstances, 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 business
and results of operations.
27
<PAGE> 33
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 subsidiaries and 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 with such shared risk arrangements be assumed by FPA,
thereby reducing 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 require more
specialty care than anticipated or 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 per year, at which substantially all
financial exposure for inpatient services of an enrollee beyond such threshold
is contractually shifted to the insurer up to a specified level (generally $1
million), at which point 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 stoploss attachment points in the future.
Risks Related to 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 subsidiaries
and 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 18.8% and 18.3% of FPA's total operating
revenue for the year ended December 31, 1996 and the six months ended June 30,
1997, respectively, was generated from contracts in which the subsidiaries and
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
subsidiaries and Professional Corporations or (ii) the subsidiaries and
Professional Corporations are unable to control effectively the utilization of
these services, FPA could experience material adverse effects on its results of
operations.
Risks Related to Fee-for-Service Contracts. Sterling provides physician
practice management services to hospitals under fee-for-service contracts and
flat-rate contracts. In general, under fee-for-service contracts, Sterling's
revenues are 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. As a result of the
Sterling acquisition, a significant portion of FPA's operating revenue will be
derived from payments made by government-sponsored
28
<PAGE> 34
health care programs as well as from other third party payors. For the year
ended December 31, 1996 and the six months ended June 30, 1997, approximately
34% and 27%, respectively, of FPA's revenue was derived from government Payors.
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.
The Balanced Budget Act of 1997, which becomes effective October 1, 1997,
includes, among other matters, Medicare and Medicaid reform legislation. The
Medicare legislation will, among other things, (i) reduce Medicare payments to
managed care plans and alter the payment structure; (ii) require managed care
plans to make medically necessary care available 24 hours a day; (iii) prohibit
plans from restricting provider advice about medical care or treatment ("gag
clauses"); (iv) eliminate the 50/50 enrollment rule and replace it with enhanced
quality and outcome measures; (v) authorize provider-sponsored organizations to
contract directly with Medicare; and (vi) establish a medical savings account
demonstration project. The Medicaid legislation will, among other things, (i)
enable states to require Medicaid beneficiaries to enroll in managed care plans
without receiving federal waivers; (ii) repeal the 75/25 enrollment rule and
replace it with quality assurance standards; (iii) ban "gag clauses"; and (iv)
provide states with greater discretion to set reimbursement rates. FPA cannot
predict the effect that this legislation or current and future proposals
regarding government funded programs would have on its operations. Additionally,
Resource Based Relative Value Scale ("RBRVS"), a system of reimbursement
designed to reallocate medical reimbursement among medical specialties, took
effect on January 1, 1992 and has been 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 results of operations of FPA.
Reliance on Certain Payors. For the year ended December 31, 1994,
CareAmerica of Southern California, Inc. ("CareAmerica") accounted for 11.3% of
FPA's operating revenue. For the year ended December 31, 1995, Foundation Health
Systems, Inc. ("Foundation") accounted for 26.2% of FPA's operating revenue. For
the year ended December 31, 1996, Foundation and PCA Qualicare accounted for
16.1% and 11.3%, respectively, of FPA's operating revenue. For the six months
ended June 30, 1997, Foundation and PCA Qualicare accounted for 19.4% and 12.7%,
respectively, of FPA's operating revenue.
Terminability of Payor Contracts. Contracts with Payors generally provide
for terms of one to thirty years, may be terminated earlier without cause, upon
notice and upon renewal or in a number of other circumstances 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, a number of Sterling's hospital services
agreements have been terminated as a result of
29
<PAGE> 35
nonrenewal, 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's results of operations.
As of June 30, 1997, approximately 33% of FPA's membership was pursuant to
Payor agreements with Foundation. The terms of these Payor agreements are thirty
years with automatic five-year renewal periods. These agreements commit certain
Professional Corporations to, among other things, 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, keep care centers open given specified levels of patients
and agree to certain pricing and contracting parameters with Foundation. 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. A
significant modification to or termination of such agreements would have a
material adverse effect on FPA's results of operations.
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
ability to add new and retain existing hospital clients.
On December 5, 1996, the Thomas-Davis Medical Centers, P.C. ("TDMC")
physicians located in Tucson, Arizona (the "petitioners") voted to be
represented by the Federation of Physicians and Dentists (the "Union"). On
February 13, 1997, the TDMC employees located in Tucson voted to be represented
by the Union of Health and Hospital Care Employees. On September 24, 1997, the
District Court Judge for the United States District Court for the District of
Arizona granted a temporary injunction and ordered, among other things, FPA and
TDMC to recognize the Union as the exclusive bargaining agent for the
petitioners and to refrain from making unilateral changes in the terms and
conditions of employment, and upon request of the Union (which request was made
on September 26, 1997), to recognize and bargain in good faith with the Union as
the exclusive collective bargaining agent of the petitioners concerning wages,
hours and other terms and conditions of employment. TDMC and FPA are in the
process of appealing certain aspects related to such representation; however,
there can be no assurance as to the outcome of such appeals. 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.
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's results of operations will be
materially and adversely affected and FPA may be subject to retroactive taxes
and penalties.
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<PAGE> 36
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 set forth in Appendix D, 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 modifications of such organization or
arrangements may be required, which could have an adverse effect on FPA's
business and results of operations.
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 results of operations.
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 applicable
membership criteria. Such laws could limit the flexibility of managed care
organizations, such as FPA, 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
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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.
Furthermore, 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.
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 of 1975, as
amended (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 determined that physician management companies like FPA must apply for and
operate under a restricted Knox-Keene license. FPA's restricted license
application was approved by the Department in December 1996. The loss or
revocation of such license would have a material adverse effect on FPA's
business and results of operations.
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 among
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 or the effects such compliance could have
on FPA's operations.
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Antitrust Regulation. FPA's affiliated IPAs and Professional Corporations
are separate legal entities due to legal and regulatory requirements; if they
are deemed to be competitors in specified markets, they may be subject to
various laws which prohibit anti-competitive conduct, including price fixing,
concerted refusals to deal and division of market. Alternatively, if FPA's
affiliated IPAs and Professional Corporations, although separate entities, are
deemed to be part of a single entity or system, they may be subject to laws that
prohibit anti-competitive combinations or activities if the number of affiliated
physicians in specified markets exceeds certain thresholds. 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 are promulgated and interpretations thereof issued.
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
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 such
Professional Corporations or eliminate shared risk arrangements in which the
Professional Corporations are currently participating, such actions could have a
material adverse effect on FPA's results of operations.
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 has been named as a party in certain 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. There can be no assurance that insurance coverage
for lawsuits brought or which may be brought against FPA will 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's financial condition and results of
operations. Furthermore, 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. The Texas
legislature has enacted legislation effective September 1, 1997 which provides
that a health insurance carrier, health maintenance organization or managed care
entity has the duty to exercise ordinary care when making health care treatment
decisions and is liable for damages for harm to an insured or enrollee
proximately caused by its failure to exercise such ordinary care or proximately
caused by treatment decisions made by its employees, agents, ostensible agents
or representatives acting on its behalf and over whom it exercises influence or
control. Given the recent enactment of this legislation and the lack of judicial
interpretation thereof, FPA cannot assess the impact this legislation may have
on its operations in Texas; however, if the legislation is utilized by patients
to bring successful malpractice actions against managed care entities such as
FPA, the cost of providing health care as well as the cost of insurance coverage
against such
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actions could increase, which could have an adverse impact on FPA's results of
operations. 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
parties to lawsuits alleging fraudulent billing practices under the federal
Civil False Claims Act. The Civil False Claims Act permits a person (generally
an employee or former employee 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.
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 (i)
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 (ii) 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. FPA intends to vigorously defend this lawsuit and does not expect
that the outcome of this lawsuit will have a material adverse effect on FPA's
results of operation.
Fluctuations in Quarterly Results. FPA's financial statements (including
interim financial statements) contain accruals which are calculated quarterly
for estimates of amounts assigned by certain FPA subsidiaries and 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, these FPA subsidiaries and 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 these subsidiaries,
Professional Corporations and Payors are unable to reconcile such 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
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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 market 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.
Risk of Dilution and Additional Capital Needs. 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 FPA Common Stock, or securities convertible into or exercisable
for the purchase of 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 of FPA 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.
Furthermore, 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, after conversion of the Debentures, or otherwise, or
the perception that such sales could occur, may adversely affect prevailing
market prices of the FPA Common Stock. As of September 19, 1997, 33,789,827
shares of FPA Common Stock were issued and outstanding. In addition, as of
September 24, 1997, FPA had granted options or warrants to purchase, or
securities (excluding the Debentures) convertible into, approximately 7,881,838
shares of FPA Common Stock and 3,107,900 shares of FPA Common Stock were
issuable upon conversion of the Debentures. In addition to the registration
rights to be granted to certain stockholders of HPI in connection with the
Merger covering approximately shares of FPA Common Stock (assuming an FPA
Value of $ ), approximately 950,000 shares of outstanding FPA Common
Stock are subject to registration rights agreements which obligate FPA to
register such shares. In addition, FPA has granted registration rights to
certain former AHI stockholders in the event that such stockholders are unable
to sell a specified number of shares in accordance with the provisions of Rule
144, although FPA does not believe a registration statement regarding such
shares will need to be filed. All remaining FPA shares are freely tradeable,
without restriction under the Securities Act.
Anti-Takeover Effect of Certain Provisions. FPA's Certificate of
Incorporation, as amended, and Bylaws 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 of Directors without the
approval of the stockholders to issue preferred stock. The rights of the holders
of FPA 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
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the effect of discouraging a person from acquiring a majority of the outstanding
FPA 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 Agreement, FPA may not enter into any merger or
consolidation arrangement or purchase any securities of or any assets
constituting a business unit of another person except, among other things, for
Permitted Acquisitions (as defined in the Credit Agreement). These provisions
could serve to impede or prevent a change of control of FPA or have a depressive
effect on FPA's stock price. FPA has obtained the consent of the Lenders under
the Credit Agreement to the Merger and the waiver of any violation of provisions
of the Credit Agreement which would be violated by the Merger.
RISKS RELATING TO HPI
HPI and FPA are engaged in similar businesses, and thus HPI is subject to
many of the risks described with respect to FPA under the headings
"-- Difficulty in Controlling Health Care Costs; Capitated Nature of Revenue,"
"-- Risks Related to Full Risk Capitation," "-- Risks Related to Fee-for-Service
Contracts," "-- Dependence on Government and Other Third Party Payors,"
"-- 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" and "-- Potential
Liabilities." In addition, HPI is also subject to the following risks:
HPI Limited Operating History and Losses. HPI was incorporated in September
1993 and has a limited operating history. From September 15, 1993 (inception of
operations) to December 31, 1993, for the years ended December 31, 1994, 1995
and 1996 and for the six months ended June 30, 1997, HPI experienced net losses
of $1.2 million, $4.4 million, $7.2 million, $9.5 million and $.9 million,
respectively, and there can be no assurance that HPI will achieve profitability.
See "SELECTED CONSOLIDATED FINANCIAL DATA -- HPI" and the Consolidated Financial
Statements of HPI included elsewhere herein.
Risks Associated with Growth Strategy. To date HPI's strategy has involved
growth through the acquisition of the assets of, and affiliation with,
Affiliated Practices and IPAs, and development of managed care networks around
these physician organizations. HPI is subject to various risks associated with
such a growth strategy, including the risk that HPI will be unable to retain
personnel or acquire other resources necessary to service such growth
adequately. Consequently, there can be no assurance that continued rapid growth
would not impair HPI's ability to provide its management services efficiently to
its Affiliated Practices or IPAs and to assure that its managed care network
retains its members. Furthermore, expenses arising from HPI's efforts to
complete or integrate acquisitions, expand existing or develop new managed care
networks or otherwise increase its market penetration could have a material
adverse effect on HPI. In addition, there can be no assurance that HPI will be
able to identify and recruit suitable affiliation candidates in the future or to
integrate and manage the Affiliated Practices and IPAs profitably. The growth of
HPI has also been largely dependent on HPI's ability to form networks of
physicians around the Affiliated Practices and IPAs, to manage and control costs
and to realize economies of scale. Any failure of HPI to implement economically
feasible affiliations may have a material adverse effect on HPI's operating
results. There can be no assurance that (i) HPI will be able to achieve and
manage planned growth, (ii) the assets of physician group practices or other
health care providers will continue to be available for acquisition, (iii) the
liabilities assumed by HPI in any acquisition will not have a material adverse
effect on HPI or (iv) the addition of physician group practices or health care
providers will be profitable for HPI.
HPI's expansion strategy also requires substantial capital investment.
Capital is needed not only for the acquisition of physician group practice
assets, but also for the effective integration and operation of the Affiliated
Practices. HPI also requires capital for marketing, development and operation of
managed care networks. There can be no assurance that HPI will obtain sufficient
capital for its requirements.
Control by Certain Stockholders. Oxford and Wellpoint beneficially own
approximately 82% of HPI's outstanding voting securities and each has elected
two directors to HPI's five person Board of Directors.
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Accordingly, if Oxford and Wellpoint were to act in concert, they would control
HPI's Board of Directors and therefore the business, policies and affairs of
HPI.
Concentration of Payors. HPI derives net revenue of consolidated and
unconsolidated affiliated medical corporations and IPAs from contracts between
its Affiliated Practices and IPAs 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. A substantial majority of HPI's revenues to date has been derived
from payor contracts with Oxford. For the years ended December 31, 1994, 1995
and 1996 and the six months ended June 30, 1997, Oxford accounted for
approximately 68% (pursuant to two contracts), 62% (pursuant to four contracts),
69% (pursuant to seven contracts), and 74% (pursuant to seven contracts) of
HPI's net revenue of consolidated and unconsolidated affiliated medical
corporations and IPAs, respectively. There can be no assurance that the number
of assigned enrollees under any payor contract will remain constant or increase.
The loss of the Oxford contracts or the failure to retain such Oxford covered
members would have a material adverse effect on HPI. In connection with the
Merger, Oxford and HPI have agreed to establish certain strategic principles
under which they will enter into partnership agreements in the future in
existing and new markets. See "THE MERGER -- Interests of Certain Persons in the
Merger -- Master Strategic Arrangement for Private Practice Partnerships."
Limitations on Reimbursement. For each of the years ended December 31,
1994, 1995 and 1996 and the six months ended June 30, 1997, approximately, 41%,
52% and 51%, respectively, of HPI's net revenues of consolidated and
unconsolidated affiliated medical corporations and IPAs were derived from
Medicare and Medicaid programs. Reflecting a trend in the health care industry,
these third party payors increasingly are negotiating with health care
providers, such as HPI, concerning the prices charged for medical services, with
the goal of lowering reimbursement and/or capitation rates. There can be no
assurance that any further reduction in reimbursement or capitation rates would
be offset through enhancement of operating efficiencies, or that any such
enhancement of operating efficiencies will occur. Third party payors may also
deny reimbursement for a variety of reasons, including if they determine that a
treatment was not performed in accordance with the cost-effective treatment
methods established by such payors. In addition, funding for governmental
programs, such as Medicare and Medicaid, is under increased scrutiny. In
addition, HPI faces a significant concentration of payors in many of the local
markets that it serves. While HPI has not been adversely affected by this in the
past, this concentration may allow payors with significant market share to lower
reimbursement or capitation rates. Any loss of revenue caused by these trends in
the health care industry toward cost containment and oversight could have a
material adverse effect on HPI's business and results of operations.
Goodwill and Other Intangibles. As a result of HPI's acquisitions during
1994, 1995 and 1996, goodwill and other intangibles increased from approximately
$9.3 million as of January 1, 1995 to approximately $23.3 million as of December
31, 1996, resulting in amortization expense on an annualized basis at December
31, 1996 of approximately $.9 million per year. Goodwill is amortized over
twenty to thirty years using the straight-line method as described in the Notes
to HPI's Consolidated Financial Statements included elsewhere in this Proxy
Statement/Prospectus. Such amortization is expected to affect significantly
HPI's results of operations. In addition, future acquisitions by HPI will likely
increase goodwill. Consummation of the Roll-up Transactions will also generate
goodwill to the extent the fair value of HPI's Common Stock issued in connection
with such acquisitions exceed recorded minority interest. See "THE MERGER
AGREEMENT -- Roll-up Transactions." As required under generally accepted
accounting principles, HPI reviews the carrying value of goodwill and other
intangibles at each reporting period to determine if facts or circumstances
exist which suggest that goodwill and other intangibles may be impaired. If
impairment is determined to have occurred, HPI will recognize an impairment
loss. There can be no assurance that impairment of goodwill and other
intangibles with respect to HPI's acquisitions will not occur. Recognition of an
impairment loss, if required, could have a material adverse effect on the
operating results of HPI in the period recognized. See note 2 of Notes to HPI's
Consolidated Financial Statements included elsewhere in this Proxy
Statement/Prospectus. Although FPA does not expect there to be a material
adjustment to the carry value of HPI's goodwill following the Merger upon
consummation of the Merger, in accordance with its policies, FPA will review the
carrying value of the goodwill previously recorded by HPI to determine if facts
or
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circumstances exist which would suggest that HPI's goodwill may be impaired and
that the results of such impairment would have a material adverse effect on the
operating results in the period recorded. Prior to the consummation of the AHI
and Sterling mergers, FPA was unable to estimate the amount of restructuring
charges to be recognized in connection with those mergers. Following the
consummation of the AHI and Sterling mergers, FPA recognized restructuring
charges of $24.7 million and $3.8 million, respectively. Management of FPA does
not anticipate that restructuring charges in addition to the $15.5 million in
merger related charges set forth in the Pro Forma Condensed Consolidated
Financial Statements included herein, will be reorganized following the Merger.
RISKS RELATING TO THE MERGER
Impact on FPA's Financial Statements. FPA expects to incur non-recurring
costs in connection with the Merger aggregating approximately $15.5 million
relating primarily to certain employee termination costs, financial advisory
fees, professional fees and restructuring costs, which costs will be expensed in
the first quarter after the Closing. See "SELECTED HISTORICAL AND PRO FORMA
INFORMATION."
No Assurance of Successful Integration of Certain Operations. FPA and HPI
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. 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 and operations. 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.
Exchange Ratio May Not Fully Reflect Changes in FPA Stock Price. The FPA
Value at the Effective Time may vary significantly from the FPA stock price 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, market assessments of the
likelihood that the Merger will be consummated and the timing thereof and
general market and economic conditions. Since the actual number of shares of FPA
Common Stock issuable to HPI stockholders in the Merger depends on the FPA
Value, the fair value of the HPI Options and the issuance of HPI Common Stock in
the Roll-up Transactions, there is no guarantee as to the number of shares or
value of the FPA Common Stock that HPI stockholders will receive. Each HPI
stockholder is urged to obtain updated FPA market information. HPI stockholders
will be able to obtain the Exchange Ratio at the end of the second business day
preceding the HPI Special Meeting by calling (888) xxx-xxxx. See "THE
MERGER -- Adjustments to Merger Consideration."
Need for Additional Capital. Upon consummation of the Merger, FPA will be a
larger company and may therefore require additional capital in order to continue
to expand its operations. Failure to secure additional capital could have an
adverse effect on FPA's results of operations.
Possible Loss of Business. Despite the efforts of each of FPA and HPI,
current key independent contractor physicians, employees or clients of HPI may
not continue to contract with HPI or FPA following the Merger. The loss of a
material number of independent contractor physicians, employees or clients could
adversely affect the operations of HPI and FPA. Neither FPA nor HPI is aware
that any of their respective physicians, employees or clients intend to end
their relationship with FPA or HPI, as the case may be, following the
consummation of the Merger. As of June 30, 1997, Oxford represented 74% of HPI's
net
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revenue of consolidated and unconsolidated affiliated medical corporations and
IPAs and on a combined pro forma basis would have represented approximately 14%
of FPA's revenue as of such date. The termination of the Oxford payor agreements
or a significant reduction in revenues from Oxford could adversely affect the
results of operations of FPA after the Merger.
Rights of HPI Stockholders Following the Merger. Following the Merger,
holders of HPI Common Stock and HPI Preferred Stock will become holders of FPA
Common Stock. Certain differences exist between the rights of the HPI
stockholders under the HPI Certificate of Incorporation and Bylaws and the 1994
Securities Purchase Agreement, and the rights of FPA stockholders under the FPA
Certificate of Incorporation and Bylaws. Among other things, the differences
include a classified board of directors in the case of FPA, different procedures
for calling special meetings of stockholders, different procedures for
nomination of directors and supermajority vote requirements for certain
provisions in the case of HPI.
Federal Income Tax Consequences. The Merger is intended to qualify for
federal income tax purposes as a tax-free reorganization under the Code. If for
any reason the Merger does not qualify as a reorganization, then among other
effects, the HPI stockholders may recognize gain or loss in such transaction and
FPA and HPI will amend this Proxy Statement/Prospectus and HPI will resolicit
stockholder votes to the extent required by law. No ruling from the Internal
Revenue Service has been requested regarding the federal income tax consequences
of the Merger. See "THE MERGER -- Certain Federal Income Tax Consequences."
Certain Conflicts of Interest. Certain officers and all the directors of
HPI have certain interests in the Merger that are in addition to their interests
as stockholders of HPI generally. These interests are as follows: (i) Mr. Berg,
a director and the President and Chief Executive Officer of HPI, will receive,
subject to stockholder approval, certain cash payments in connection with the
termination of his existing employment agreement with HPI and as consideration
for entering into a new employment agreement with FPA and, subject to
stockholder approval, all of Mr. Berg's unvested stock options shall vest; (ii)
each of HPI's three executive officers, Messrs. Berg, Phillips and Conlin, has
been granted HPI Options which, pursuant to the Merger Agreement, whether or not
vested, will be canceled at the Effective Time in exchange for shares of fully
paid FPA Common Stock; (iii) Messrs. Phillips and Conlin have existing
employment agreements with HPI and HPI has committed to pay Messrs. Phillips and
Conlin certain amounts at the Effective Time; (iv) FPA has agreed to cause the
Surviving Corporation to make payments to certain key employees of HPI, subject
to certain conditions, at the first anniversary of the Effective Time; (v) FPA
has agreed to make available a pool of options to purchase shares of FPA Common
Stock to key employees of HPI; (vi) HPI has agreed to enter into a registration
rights agreement with Oxford, WellPoint and certain individuals; (vii) FPA has
agreed to indemnify HPI directors and officers for a period of six years
following the Effective Time and maintain liability insurance with respect
thereto; (viii) Oxford and HPI have agreed to enter into a Strategic Agreement;
and (ix) WellPoint Parent and FPA have agreed to enter into a Memorandum of
Understanding. For a discussion and quantification of these interests, see "THE
MERGER -- Interests of Certain Persons in the Merger." To the extent these
interests led to more consideration being paid to the interested parties in
their capacities other than as stockholders of HPI generally, the aggregate
Merger Consideration may be less than would have been obtained absent these
interests. The non-affiliated HPI stockholders, therefore may receive less
consideration for their shares than would otherwise have been the case.
If Oxford and WellPoint were to act in concert, they would control HPI's
Board of Directors and therefore the business, policies and affairs of HPI. As a
result, Oxford and WellPoint could preclude any unsolicited acquisition of HPI.
Such concentration of ownership could adversely affect the price of HPI's Common
Stock and could force an acquiror to pay a control premium to such stockholders
to the detriment of the other HPI stockholders. However, as described above,
Oxford and WellPoint have each granted an irrevocable proxy to vote in favor of
the Merger Agreement without any control premium for their HPI securities. In
connection with the Merger, Oxford and HPI have agreed to establish certain
strategic principles under which they will enter into partnership agreements in
the future in existing and new markets and WellPoint Parent and FPA have agreed
to develop a strategic relationship in the future. If such future relationships
unfairly benefit Oxford and WellPoint, it could have negative consequences to
FPA's stockholders. See "THE MERGER -- Interests of Certain Persons in the
Merger."
39
<PAGE> 45
THE HPI SPECIAL MEETING
This Proxy Statement/Prospectus is being furnished to the stockholders of
HPI in connection with the solicitation of proxies by and on behalf of the Board
of Directors for use at the HPI Special Meeting. This Proxy Statement/Prospectus
and the related form of proxy for HPI are first being mailed to HPI stockholders
on or about , 1997.
DATE, TIME AND PLACE
The HPI Special Meeting will be held on , 1997 at 10:00 a.m.,
local time, at HPI's offices located at 800 Connecticut Ave., Norwalk,
Connecticut.
PURPOSE OF THE HPI SPECIAL MEETING
At the HPI Special Meeting, the stockholders of HPI 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 HPI, with HPI
surviving the Merger as a wholly owned subsidiary of FPA. Pursuant to the
Merger, each outstanding share of HPI Common Stock will be exchanged for the
right to receive a number of shares of FPA Common Stock equal to the Exchange
Ratio. The Exchange Ratio will vary based on the FPA Value, the Outstanding HPI
Stock and the number of FPA Option Shares. Based upon 10,545,222 shares of
Outstanding HPI Stock (assuming no exercises of HPI Options between the date
hereof and the Effective Time), FPA Option Shares and assuming an FPA
Value equal to $ , which was the closing price of FPA Common Stock on
, 1997, the Exchange Ratio would be . Based upon such
assumptions, HPI's stockholders and option holders would be issued an aggregate
of approximately shares of FPA Common Stock, representing
approximately % of the total issued and outstanding shares of FPA Common Stock
after the Merger. See "THE MERGER -- Adjustments to Merger Consideration."
The HPI Board has unanimously approved the Merger Agreement and recommends
a vote FOR approval and adoption of the Merger Agreement.
At the HPI Special Meeting, the stockholders of HPI will also be asked to
consider and vote upon a proposal to approve the Payments to Charles G. Berg,
the President and Chief Executive Officer of HPI. The HPI Board has approved the
Payments (with Mr. Berg abstaining) and recommends a vote FOR approval of the
Payments. See "THE PAYMENTS."
REVOCATION OF PROXIES
Except for those HPI Stockholders who have executed irrevocable proxies,
any holder of HPI Voting Securities has the unconditional right to revoke his or
her proxy at any time prior to the voting thereof at the HPI Special Meeting by
(i) filing a written revocation with the Secretary of HPI prior to the voting of
such proxy, (ii) giving a duly executed proxy bearing a later date or (iii)
attending the HPI Special Meeting and voting in person. Attendance by a
stockholder at the HPI Special Meeting will not itself revoke his or her proxy.
QUORUM
The presence, in person or by proxy, of the holders of a majority of the
HPI Voting Securities (with the HPI Preferred Stock weighted on an as-converted
basis) at the HPI Special Meeting is necessary to constitute a quorum at the HPI
Special Meeting. Abstentions and non-votes will be included in determining the
presence of a quorum.
VOTE REQUIRED
For purposes of voting at the HPI Special Meeting, the shares of HPI
Preferred Stock will be weighted on an as-converted basis. The affirmative vote
of the holders of at least 60% of the HPI Voting Securities, voting together as
a class, either in person or by proxy, at the HPI Special Meeting is required to
approve the
40
<PAGE> 46
Merger Agreement. The affirmative vote of the holders of a majority of the HPI
Voting Securities present, either in person or by proxy, at the HPI Special
Meeting is required to approve the possible adjournment or postponement of the
HPI Special Meeting.
The affirmative vote of the holders of at least 75% of the HPI Voting
Securities, voting together as a class, either in person or by proxy, excluding
shares owned by Mr. Berg or certain of his family members, is required to
approve the Payments. Approval of the Payments is not a condition to the Merger.
RECORD DATE; STOCK ENTITLED TO VOTE
The HPI Board has established September 4, 1997 (the "Record Date") as the
date to determine those record holders of HPI Voting Securities entitled to
notice of and to vote at the HPI Special Meeting. On that date, there were
1,673,500 shares of HPI Common Stock outstanding, 25,000 shares of Series A
Convertible Preferred Stock outstanding and 25,000 shares of Series B
Convertible Preferred Stock outstanding. Each share of HPI Common Stock is
entitled to one vote, each share of Series A Convertible Preferred stock is
entitled to 132 votes and each share of Series B Convertible Preferred stock is
entitled to 188 votes with respect to all matters to be voted upon at the HPI
Special Meeting.
In the event the Merger is not approved and adopted by the stockholders of
HPI, the Merger Agreement may be terminated in accordance with its terms. See
"THE MERGER AGREEMENT -- Termination."
VOTING OF PROXIES
At the HPI Special Meeting, abstentions and non-votes will have the effect
of a vote against adoption of the Merger Agreement and against approval of the
Payments. Because abstentions are treated as shares present and entitled to vote
at the HPI Special Meeting, they will have the effect of a vote against approval
of the possible adjournment or postponement of the HPI Special Meeting.
Non-votes are not allowed to vote at the HPI Special Meeting and will have no
effect on the outcome of a proposal to approve the possible adjournment or
postponement of the HPI Special Meeting.
If a holder of HPI Voting Securities does not return a signed proxy card
and does not attend the meeting and vote in person, his or her shares will not
be voted. Shares not voted will have the effect of a vote against the Merger
Agreement and against the Payments at the HPI Special Meeting.
SOLICITATION OF PROXIES
Solicitation of proxies for use at the HPI Special Meeting may be made in
person or by mail, telephone, telecopy or telegram. HPI will conduct the
solicitation of proxies for the HPI 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 HPI may solicit
proxies from HPI stockholders by telephone or telegram or in person. Such
directors, officers and employees will not be compensated for such solicitation.
STOCKHOLDERS' RIGHT OF APPRAISAL
Holders of HPI Voting Securities as of the Record Date have the right to
demand judicial appraisal of, and obtain a cash payment for, the "fair value" of
their shares (exclusive of any element of value arising from the accomplishment
or expectation of the Merger) pursuant to Section 262 of the Delaware Act. In
order to exercise such rights, such holders of HPI Voting Securities must
perfect their right to exercise the right of appraisal. To perfect this right,
HPI stockholders must (i) deliver to HPI's Secretary before the vote on the
Merger Agreement at the HPI Special Meeting a written demand for appraisal, (ii)
continuously hold their shares from the date the appraisal demand is made
through the Effective Time, (iii) neither vote in favor of the Merger nor
consent thereto in writing and (iv) file a petition in the Delaware Court of
Chancery within 120 days of the Effective Time demanding a determination of the
"fair value" of their shares of HPI Common Stock. The full text of Section 262
of the Delaware Act is attached hereto as Appendix C, and any holder of HPI
Voting Securities desiring to exercise dissenters' rights of appraisal in
connection with the Merger should consult with legal counsel prior to taking any
action in order to ensure that the stockholder complies with the
41
<PAGE> 47
applicable statutory provision. Failure to take any of the steps required under
Section 262 of the Delaware Act on a timely basis may result in the loss of
appraisal rights. See "THE MERGER -- Rights of Dissenting Stockholders" and
Appendix C hereto.
SECURITY OWNERSHIP OF CERTAIN HPI OWNERS AND MANAGEMENT
As of the Record Date, directors and executive officers of HPI named in the
Summary Compensation Table had the right to vote approximately 10.60% of the HPI
Voting Securities (treating the HPI Preferred Stock on an as-converted basis).
As provided by the terms of the relevant Certificate of Designations, each share
of HPI Series A Convertible Preferred Stock is convertible into and votes the
equivalent of approximately 132 shares of HPI Common Stock and each share of HPI
Series B Convertible Preferred Stock is convertible into and votes the
equivalent of approximately 188 shares of HPI Common Stock. WellPoint owns all
25,000 outstanding shares of the Series A Convertible Preferred Stock,
representing approximately 34.11% of the HPI Voting Securities. Oxford owns all
25,000 outstanding shares of Series B Convertible Preferred Stock, representing
approximately 48.59% of the HPI Voting Securities. As a result, as of the Record
Date, Oxford and WellPoint beneficially own approximately 82.7% of HPI's
outstanding voting securities. In addition, Oxford and WellPoint have each
elected two directors to HPI's five person Board of Directors. On July 1, 1997,
Oxford and WellPoint entered into a stockholders agreement and related proxy in
which they each granted an irrevocable proxy to FPA to vote their HPI securities
in favor of the Merger Agreement and the transactions contemplated thereby and
to convert their shares of HPI Preferred Stock into shares of HPI Common Stock
prior to the Effective Time. In accordance with HPI's Certificate of
Incorporation, cumulative unpaid dividends at the time of conversion of HPI
Preferred Stock will be canceled.
The following table sets forth certain information regarding beneficial
ownership of HPI's securities as of June 30, 1997 by: (i) each of HPI's
directors (other than David B. Snow Jr., Thomas C. Geiser and Max Brown, who do
not own any securities of HPI) and executive officers, (ii) all directors and
named executive officers of HPI as a group and (iii) each person known to HPI to
be a beneficial owner of 5% or more of any class of HPI's voting securities.
<TABLE>
<CAPTION>
NUMBER OF SHARES
NAME AND ADDRESS OF HPI CLASS OF HPI SECURITIES BENEFICIALLY
SECURITIES HOLDERS CURRENTLY OWNED OWNED(1) PERCENT OF CLASS
- ------------------------------------------- ----------------------- ------------------- ----------------
<S> <C> <C> <C>
Directors and Executive Officers:
Charles G. Berg(2) Common Stock 834,000 42.61%
800 Connecticut Ave.
Norwalk, CT 06854
Charles D. Phillips(3)(1)(7) Common Stock 12,500 7.4%
800 Connecticut Ave.
Norwalk, CT 06854
Paul Conlin(4)(7) Common Stock 25,000 14.7%
800 Connecticut Ave.
Norwalk, CT 06854
Stephen F. Wiggins(5)(7) Common Stock 475,000 28.38%
800 Connecticut Ave.
Norwalk, CT 06854
All Directors and Named Executive Officers Common Stock 1,346,500 67.49%
as a Group (4 persons)(6)
5% Stockholders:
Oxford Health Plans, Inc. Series B Preferred 25,000 100%
800 Connecticut Ave. Stock
Norwalk, CT 06854
WellPoint Development Company, Inc. Series A Preferred 25,000 100%
21555 Oxnard Street Stock
Woodland Hills, CA 91367
</TABLE>
- ---------------
(1) Includes shares of HPI Common Stock subject to options which may be
exercised within 60 days of June 30, 1997. Such shares are deemed to be
outstanding for the purposes of computing the percentage
42
<PAGE> 48
ownership of the individual holding such shares, but are not deemed
outstanding for purposes of computing the percentage of any other person
shown in this table.
(2) The number of shares of HPI Common Stock for Mr. Berg includes vested HPI
Options to purchase 44,850 shares of HPI Common Stock and unvested HPI
Options to purchase 239,150 shares of HPI Common Stock which will vest at
the Effective Time pursuant to the termination of the HPI Employment
Agreement.
(3) The number of shares of HPI Common Stock for Mr. Phillips represents vested
HPI Options to purchase 12,500 shares of HPI Common Stock.
(4) The number of shares of HPI Common Stock for Mr. Conlin represents vested
HPI Options to purchase 25,000 shares of HPI Common Stock.
(5) Mr. Wiggins serves as Chairman of Oxford. Mr. Wiggins disclaims beneficial
ownership of the shares of HPI Preferred Stock owned by Oxford.
(6) Includes HPI Options to purchase 321,500 shares of HPI Common Stock.
(7) HPI Preferred Stock and HPI Common Stock vote together as a class; thus,
Messrs. Phillips, Conlin and Wiggins do not hold in excess of 5% of HPI
Voting Securities.
See "SECURITY OWNERSHIP OF CERTAIN HPI BENEFICIAL OWNERS AND MANAGEMENT."
If Oxford and WellPoint were to act in concert, they would control HPI's
Board of Directors and therefore the business, policies and affairs of HPI. As a
result, Oxford and WellPoint could preclude any unsolicited acquisition of HPI.
Such concentration of ownership could adversely affect the price of HPI's Common
Stock and could force an acquiror to pay a control premium to such stockholders
to the detriment of the other HPI stockholders. However, as described above,
Oxford and WellPoint have each granted an irrevocable proxy to vote in favor of
the Merger Agreement without any control premium for their HPI securities. In
connection with the Merger, Oxford and HPI have agreed to establish certain
strategic principles under which they will enter into partnership agreements in
the future in existing and new markets and WellPoint Parent and FPA have agreed
to develop a strategic relationship in the future. If such future relationships
unfairly benefit Oxford and WellPoint, it could have negative consequences to
FPA's stockholders. See "RISK FACTORS -- Risks Relating to the Merger" and "THE
MERGER -- Interests of Certain Persons in the Merger."
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<PAGE> 49
THE MERGER
EFFECTS OF THE MERGER
The Merger Agreement provides that the Merger will be consummated promptly
following approval by the holders of HPI Voting Securities 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 HPI, and HPI, as the
Surviving Corporation, will be a wholly owned subsidiary of FPA. Stockholders of
HPI will become stockholders of FPA and their rights will be governed by the
Certificate of Incorporation and Bylaws of FPA.
MERGER CONSIDERATION
Pursuant to the Merger Agreement, at the Effective Time, Merger Sub will
merge with and into HPI and each share of HPI Common Stock issued and
outstanding immediately prior to the Effective Time (other than shares of HPI
Common Stock owned by HPI as treasury stock and shares of HPI Common Stock owned
by FPA, Merger Sub or any wholly owned subsidiary of FPA or HPI to be cancelled
in accordance with the Merger Agreement) shall be converted into the right to
receive a number of shares of FPA Common Stock equal to the Exchange Ratio. The
holders of HPI Preferred Stock have agreed to convert their shares of HPI
Preferred Stock to HPI Common Stock prior to the Effective Time.
The Exchange Ratio will depend on the relationship among (i) the total
issued and outstanding shares of HPI Common Stock (the "Outstanding HPI Stock")
immediately prior to the Effective Time which will equal 10,545,222, assuming no
exercises of options to purchase HPI Common Stock ("HPI Options") between the
date hereof and the Effective Time (including the 8,000,025 shares of HPI Common
Stock to be issued upon conversion of the HPI Preferred Stock and the 871,697
shares of HPI Common Stock to be issued in the Roll-up Transactions), (ii) the
fair value of options to purchase HPI Common Stock immediately prior to the
Effective Time (including substitute HPI Options issued in the Roll-up
Transactions) which will be converted in the Merger into shares of FPA Common
Stock (the "FPA Option Shares"), (iii) the presumed transaction value of $115
million and (iv) the FPA Value. The FPA Value will be the average of the closing
prices of FPA Common Stock on Nasdaq for the ten consecutive trading days ending
on the date that is two trading days prior to the Closing Date. The "Adjusted
FPA Value" will equal the FPA Value, except that if the FPA Value is less than
$18, the Adjusted FPA Value will be $18 and if the FPA Value is greater than
$22, the Adjusted FPA Value will be $22. Consequently, the Adjusted FPA Value
may differ from the actual market price of FPA Common Stock reported by Nasdaq
on the date of the HPI Special Meeting, the Closing Date or the date the HPI
stockholders actually receive their shares of FPA Common Stock after the Merger
is completed. See "THE MERGER -- Merger Consideration," "THE MERGER
AGREEMENT -- Roll Up Transactions" and "-- Treatment of Stock Options."
The Exchange Ratio can be represented by the following formula:
<TABLE>
<S> <C>
Exchange Ratio = ($115 Million / Adjusted FPA Value) - FPA Option Shares
---------------------------------------------------------
Outstanding HPI Stock
</TABLE>
The following table sets forth the range of the number of shares of FPA
Common Stock that may be issued in the Merger depending upon the FPA Value:
<TABLE>
<CAPTION>
SHARES OF
FPA COMMON STOCK
FPA VALUE TO BE ISSUED
----------------------------------------------------------- ----------------
<S> <C>
less than or equal to $18.00............................... 6,388,889
$19.00..................................................... 6,052,631
$20.00..................................................... 5,750,000
$21.00..................................................... 5,476,190
greater than or equal to $22.00............................ 5,227,273
</TABLE>
Except as more fully described in this Proxy Statement/Prospectus, in no
event will the number of shares of FPA Common Stock issuable in the Merger
exceed 6,388,889.
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<PAGE> 50
The following table sets forth the Exchange Ratio depending upon the FPA
Value and FPA Option Shares to be issued:
<TABLE>
<CAPTION>
FPA EXCHANGE
FPA VALUE OPTION SHARES RATIO
------------------------------------------------------- ------------- --------
<S> <C> <C>
less than or equal to $18.00...........................
$19.00.................................................
$20.00.................................................
$21.00.................................................
greater than or equal to $22.00........................
</TABLE>
HPI believes that the Exchange Ratio will fall between .43 and .55
(assuming a range of FPA Value of $15.65 to $25.00, respectively).
The fair value of the HPI Options will be determined two days prior to the
consummation of the Merger. The conversion of the HPI Options into fully paid
shares of FPA Common Stock will not require the option holder to pay the
exercise price of the option, since the exercise price is considered in the
determination of the fair value. HPI Option holders will be able to obtain the
fair value of their options beginning at the end of the second business day
preceding the consummation of the Merger by calling (888) xxx-xxxx.
On , 1997 the closing price of FPA Common Stock was
$ . Assuming an FPA Value equal to such price, 10,545,222 shares of
Outstanding HPI Stock (including conversion of all outstanding shares of HPI
Preferred Stock and the 871,697 shares of HPI Common Stock to be issued in
connection with the completion of the Roll-up Transactions) and FPA
Option Shares, the Exchange Ratio would have been . Based upon these
assumptions, HPI's stockholders and option holders would be issued approximately
shares of FPA Common Stock, representing approximately % of the
shares of FPA Common Stock to be issued and outstanding after the Merger. The
holders of HPI Preferred Stock, which shares will be converted into shares into
HPI Common Stock immediately prior to the Merger, would receive approximately
% of the aggregate Merger Consideration based on these assumptions.
IF THE FPA VALUE IS LESS THAN $15.65, HPI MAY TERMINATE THE MERGER
AGREEMENT. STOCKHOLDERS OF HPI WILL BE ABLE TO OBTAIN THE EXCHANGE RATIO
BEGINNING AT THE END OF THE SECOND BUSINESS DAY PRECEDING THE HPI SPECIAL
MEETING BY CALLING (888) XXX-XXXX. See "THE MERGER AGREEMENT -- Termination."
The actual market price of the FPA Common Stock may vary, which may cause a
change in the Exchange Ratio and the aggregate Merger Consideration. Each HPI
stockholder is urged to obtain updated FPA market information.
During the 90 day period ending September 15, 1997, the market price of FPA
Common Stock has ranged from a low of $16.75 to a high of $32.00 per share.
FPA's stock price may be affected by a number of factors, including
announcements of new legislative proposals or legislation affecting the managed
care industry, the performance of, and investor expectations for, FPA, analysts'
comments regarding the managed care industry generally and FPA in particular,
announcements by FPA of pending transactions and general economic and market
conditions. As one factor in determining the Exchange Ratio is the FPA Value, a
risk to the HPI stockholders of such FPA stock price volatility is that a
significant change in the price of FPA Common Stock could occur between the last
day of the period for which the Adjusted FPA Value is determined (the second
business day preceding the date of the HPI Special Meeting) and the Effective
Time (which is expected to occur on the date of the HPI Special Meeting).
Since the Exchange Ratio cannot be calculated until the second business day
immediately preceding the date of the HPI Special Meeting, the number of shares
of FPA Common Stock to be issued to the holders of HPI Voting Securities, may
differ from the estimates provided in this Proxy Statement/Prospectus.
FPA Option Shares will be issued in exchange for the cancellation of
1,183,500 outstanding HPI Options and 170,287 substitute HPI Options issued in
connection with the completion of the Roll-Up Transactions. The HPI Options will
be exchanged for a number of fully paid shares of FPA Common Stock equal to the
quotient which results when the "Fair Market Value" of such option at the
Effective Time is divided by the
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<PAGE> 51
FPA Value. The Fair Market Value of the HPI Options will be determined by an
investment banking firm, selected by HPI and acceptable to FPA, by applying a
variation of the Black-Scholes option pricing model. The FPA Option Shares will
not affect the Exchange Ratio when the FPA Value is between $18.00 and $22.00.
As the FPA Value exceeds $22.00, the Exchange Ratio will decrease as the result
of an increase in the Fair Market Value of the HPI Options which results from an
increase in the value of HPI Common Stock with a fixed number of shares of FPA
Common Stock. As the FPA Value falls below $18.00, the Exchange Ratio will
increase as a result of a decrease in the Fair Market Value of the HPI Options
which results from a decrease in the value of HPI Common Stock with a fixed
number of shares of FPA Common Stock.
The actual market price of the FPA Common Stock may vary from the FPA
value, which may cause a change in the Exchange Ratio and the aggregate Merger
Consideration (as defined below). Each HPI stockholder is urged to obtain
updated FPA market information. STOCKHOLDERS OF HPI WILL BE ABLE TO OBTAIN THE
EXCHANGE RATIO BEGINNING AT THE END OF THE SECOND BUSINESS DAY PRECEDING THE HPI
SPECIAL MEETING BY CALLING (888) XXX-XXXX.
ADJUSTMENTS TO MERGER CONSIDERATION
The consideration to be issued to each HPI stockholder in the Merger will
be that number of shares of FPA Common Stock which is determined by multiplying
the Exchange Ratio by the number of shares of HPI Common Stock held by such HPI
stockholder on the Closing Date (the "Merger Consideration"). As described in
the previous section, the Exchange Ratio will vary based on the FPA Value. The
FPA Value may differ from the actual market price of FPA Common Stock reported
by Nasdaq on the date of the HPI Special Meeting, the Closing Date or the date
the HPI stockholders actually receive their shares of FPA Common Stock after the
Merger is completed. The Merger Agreement may be terminated by HPI if the FPA
Value is less than $15.65. If, prior to the Effective Time, the announcement of
a transaction by FPA requires the amendment of the Registration Statement of
which this Proxy Statement/Prospectus is a part, and, as a result of such
amendment, the Closing occurs later than September 29, 1997 and the FPA Value is
below $18.00, for purposes of determining the Exchange Ratio, there will be no
adjustment to the FPA Value. Except as a result of events described in the
previous sentence, in no event will the number of shares of FPA Common Stock
issuable in the Merger exceed 6,388,889. Since the actual number of shares of
FPA Common Stock issuable to HPI stockholders in the Merger depends on the FPA
Value, the number of shares of Outstanding HPI Common Stock and the number of
FPA Option Shares, there is no guarantee as to the number of shares or value of
the FPA Common Stock that HPI stockholders will receive.
CONVERSION OF SHARES; PROCEDURES FOR EXCHANGE OF CERTIFICATES; FRACTIONAL SHARES
The conversion of HPI Common Stock into the right to receive 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 HPI, in its capacity as exchange agent (the "Exchange Agent"),
will send a transmittal form to each HPI stockholder of record. The transmittal
form will contain instructions with respect to the surrender of certificates
representing HPI Common Stock to be exchanged for FPA Common Stock.
HPI STOCKHOLDERS SHOULD NOT FORWARD HPI STOCK CERTIFICATES TO THE EXCHANGE
AGENT UNTIL THEY HAVE RECEIVED TRANSMITTAL FORMS. HPI STOCKHOLDERS SHOULD NOT
RETURN STOCK CERTIFICATES WITH THE ENCLOSED PROXY.
Until the certificates representing HPI 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
exchanged. When such certificates are surrendered, any unpaid dividends will be
paid without interest. For all other purposes, however, each certificate which
represents shares of HPI Common Stock at the Effective Time will be deemed to
evidence ownership of the shares of FPA Common Stock into which those shares are
entitled to be exchanged by virtue of the Merger.
All shares of FPA Common Stock issued upon the exchange of shares of HPI
Common Stock shall be deemed to have been issued in full satisfaction of all
rights pertaining to such shares of HPI Common Stock.
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<PAGE> 52
No fractional shares of FPA Common Stock will be issued to any HPI
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 FPA Value.
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 inclusion on Nasdaq.
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 several recent
acquisitions. 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. The FPA Board determined that the Merger would enhance
FPA by extending its geographic coverage, especially to the New York
metropolitan area, and by the strategic relationships with Oxford and WellPoint
Parent being developed as a result of the Merger and the transactions
contemplated thereby.
HPI raised $50.0 million under the 1994 Securities Purchase Agreement,
which proceeds were utilized to fund HPI's business plan. In July 1996, HPI
began exploring an initial public offering of HPI Common Stock to raise
additional capital to fund its acquisition and growth plans. In October 1996,
HPI decided not to pursue an initial public offering due to adverse market
conditions in the PPM sector and retained Smith Barney to assist HPI in
exploring other strategic alternatives. HPI did not consider other financial
advisors as Smith Barney is an internationally recognized investment banking
firm selected by HPI based on Smith Barney's experience and expertise in
advising health care and PPM companies. See "THE MERGER -- Opinion of HPI's
Financial Advisor." In analyzing the strategic alternatives, HPI evaluated (i)
additional equity placements with Oxford and WellPoint Parent, (ii) equity
placements with venture capital firms, (iii) debt and bridge financing and (iv)
a merger with a strategic buyer. In evaluating these alternatives, HPI
considered the potential valuation which would be placed on HPI, the return on
investment for current stockholders, the potential dilutive effect on existing
stockholders and the availability of future financings. Management of HPI
concluded a strategic buyer would provide the greatest stockholder return,
provide a higher likelihood that HPI would achieve its projected growth and
provide current stockholders with liquidity. The HPI Board concurred with the
conclusions reached by management. Thus, at the direction of HPI, Smith Barney
initially contacted five potential buyers (the "Potential Buyers") consisting of
four publicly traded strategic buyers, including FPA, and one financial sponsor
as a potential partner. Between November 1 and November 7, 1996, each of the
parties contacted entered into a confidentiality agreement with HPI and received
a confidential memorandum relating to HPI.
Throughout November 1996, Mr. Berg and Smith Barney held discussions with
each of the Potential Buyers relating to the operations of HPI. These
discussions focused on the managed care contracts held by HPI Subsidiaries, its
Affiliated Practices or IPAs, the terms and conditions of its administrative
services agreements with the Affiliated Practices and IPAs and the markets in
which HPI had operations.
Between December 2 and December 10, 1996, HPI received preliminary
indications of interest from three strategic buyers (including FPA and two other
entities which will be referred to herein as "Strategic Buyer Two" and
"Strategic Buyer Three"). At such time, the remaining Potential Buyers elected
not to continue discussions with HPI. On December 10, 1996, Mr. Berg held
discussions with Smith Barney concerning the preliminary indications of interest
and to discuss strategies for proceeding. During December 1996, interested
parties conducted their financial and operational due diligence with respect to
HPI. On December 19, 1996, Mr. Berg held discussions with Strategic Buyer Two
and on December 18 and 26, 1996 Mr. Berg held discussions with Strategic Buyer
Three to respond to business due diligence questions and begin
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discussions as to the terms of a possible transaction. On December 30 and 31,
Strategic Buyer Two conducted a business due diligence review at HPI's offices.
The business diligence and these preliminary discussions continued with both
Strategic Buyer Two and Strategic Buyer Three through the second week of January
1997. Mr. Berg held similar discussions with FPA on January 7, 1997 and again on
January 23, 1997.
On January 27, 1997, Mr. Berg again met with Smith Barney to discuss the
various proposals and to strategize. On January 30, 1997, Mr. Berg spoke with
both FPA and Strategic Buyer Three concerning the terms of a possible
transaction. In early February, Mr. Berg held numerous discussions with FPA
concerning the terms of a possible transaction including the consideration to be
paid, the role of management after the combination and the pricing.
On February 18, 1997, Strategic Buyer Two notified HPI that it was no
longer interested in pursuing a transaction with HPI. For the remainder of
February and March, both FPA and Strategic Buyer Three held discussions with Mr.
Berg and other members of HPI management to answer questions and discuss HPI's
current and projected results of operations.
On April 1, 1997, Mr. Berg held a meeting with Strategic Buyer Number Three
to discuss the terms of a possible transaction, the role of management in the
combined entity, pricing issues and consideration. These discussions were
followed up with several telephone conversations over the next week or so. On
April 10, 1997, HPI received a revised term sheet from Strategic Buyer Three.
From April 10, 1997 through June 11, 1997, HPI continued to negotiate offers
with FPA and Strategic Buyer Three. On May 5 and May 14, Mr. Berg and
representatives of Oxford met with the Chief Financial Officer and Chief
Executive Officer, respectively, of Strategic Buyer Three and FPA, respectively,
to discuss the continuing business of Oxford with HPI and the impact of a
transaction on such business. On May 21, 1997, Mr. Berg and Mr. Phillips spent
the day at FPA reviewing the transaction terms and performing certain due
diligence on FPA. Over the next week, Mr. Berg held numerous calls with
Strategic Buyer Three and FPA to resolve the final terms of a transaction. Upon
review of the two negotiated offers, HPI's management determined that HPI's
stockholders would, in the end, receive greater value from a transaction with
FPA due to its strategic fit, its complementary business plan and FPA's market
capitalization and liquidity. On June 12, 1997, HPI terminated discussions with
Strategic Buyer Three and negotiated solely with FPA. The rejected offer, while
proposing an aggregate consideration for HPI in the same form and within the
same range offered by FPA and ultimately agreed upon, was not as attractive to
HPI's stockholders and management when considering the structure, terms and
conditions, the acquiring company's capitalization and stock trading liquidity.
From June 16, 1997 through July 1, 1997, legal and financial advisors to
HPI and executive officers of HPI and FPA held further discussions and
negotiations and finalized the Merger Agreement. During its negotiations with
FPA, management of HPI kept the HPI Board apprised of the parameters of a
transaction with FPA.
At the June 27, 1997 meeting of the HPI Board, Smith Barney reviewed
various financial analyses with the HPI Board and orally rendered to the HPI
Board an oral opinion (subsequently confirmed by delivery of a written opinion
dated July 1, 1997, the date of execution of the Merger Agreement) to the effect
that, as of such date and based upon and subject to certain matters described in
its written opinion, the Merger Consideration was fair from a financial point of
view to the holders of HPI Common Stock. See "THE MERGER -- Opinion of HPI's
Financial Advisor." The HPI Board unanimously concluded in its June 27, 1997
meeting that the transaction was fair and in the best interests of HPI's
stockholders and unanimously approved the transaction. See "-- Recommendation of
the HPI Board of Directors and Reasons for the Merger."
The determination of the Exchange Ratio was based on negotiations between
the managements of HPI and FPA. In negotiations, HPI considered FPA's Common
Stock price, a presumed transaction value for HPI and the objectives of HPI's
principal stockholders. The objectives of HPI's principal stockholders were to
(i) maximize the valuation of HPI, (ii) provide for valuation protection given
the volatility in the general
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stock market and FPA's Common Stock price, (iii) provide appreciation if the
transaction were viewed favorably by the stockholders of FPA and (iv) provide
for sufficient liquidity for all HPI stockholders. Management of HPI believes
the Exchange Ratio achieves these objectives.
Using a $ price for FPA Common Stock, the closing price of FPA Common
Stock on September , 1997, the aggregate Merger Consideration would be
$ . The actual market price for FPA Common Stock may vary, which may
cause a change in the aggregate Merger Consideration and the Exchange Ratio.
In considering the overall impact of the proposed Merger, the HPI Board
also considered the background of the Roll-up Transactions and the effects of
the Merger thereon. In connection with each HPI Subsidiary's affiliations with
Affiliated Practices and IPAs, the physician-owners of the group practices and
IPAs own Minority Shares in HPI Subsidiaries with which they contract to provide
health care services. Certain of the HPI Subsidiaries have also granted Minority
Options to purchase shares of common stock of such HPI Subsidiary to certain of
such subsidiary's employees. At the time of issuance of the Minority Shares,
each HPI Subsidiary entered into a shareholders agreement with the holders of
the Minority Shares which provided that HPI had the right to exchange the
Minority Shares for shares of HPI Common Stock. Each shareholders agreement
further provides that the exchange is to be based on the fair value of such HPI
Subsidiary as determined by a willing buyer and a willing seller without giving
effect to the relationship between HPI and such HPI Subsidiary. Each HPI
Subsidiary's stock option plan provides for the cancellation of subsidiary
options in the event HPI exercises its exchange right and the options are to be
exchanged for substitute HPI Options based on the exchange ratio determined in
the Roll-Up Transaction for such HPI Subsidiary. Both the shareholders
agreements and the HPI Subsidiary option plans provide the mechanism for which
the Roll-Up Transactions and exchanges are to occur. See "THE MERGER -- Roll-Up
Transactions."
Finally, the HPI Board considered the effects the Merger would have on its
senior executives both from a financial and operational perspective. The HPI
Board considered contractual and other obligations to its senior management and
the importance of retaining these senior executives to operate HPI effectively
after the Merger. In light of these factors, the HPI Board approved certain
transactions relating to its President and Chief Executive Officer subject to
stockholder approval (See "THE PAYMENTS") and FPA agreed to provide (i) a
severance plan to be implemented for a period of one year subsequent to the
Effective Time, (ii) a management retention and bonus program and (iii) a pool
of stock options for the senior management of HPI.
Each of the directors of HPI has certain interests in the Merger that are
in addition to the interests of HPI stockholders generally. See "-- Interests of
Certain Persons in the Merger." Accordingly, the HPI Board determined not to
appoint a special committee of independent directors for purposes of considering
the Merger Agreement and the transactions contemplated thereby. The HPI Board
was aware of each of these conflicts and considered them, among other matters,
in approving the Merger Agreement and in formulating its recommendation to the
stockholders of HPI that they approve the Merger Agreement and the transactions
contemplated therein. These interests arise from, among other things, certain
employment agreements, management retention programs, indemnification
arrangements, registration rights, and other matters which FPA will assume or
has agreed to provide after the Merger. For a discussion and quantification of
these interests, see "THE MERGER -- Interests of Certain Persons in the Merger."
If Oxford and WellPoint were to act in concert, they would control HPI's
Board of Directors and therefore the business, policies and affairs of HPI. As a
result, Oxford and WellPoint could preclude any unsolicited acquisition of HPI.
Such concentration of ownership could adversely affect the price of HPI's Common
Stock and could force an acquiror to pay a control premium to such stockholders
to the detriment of the other HPI stockholders. However, as described above,
Oxford and WellPoint have each granted an irrevocable proxy to vote in favor of
the Merger Agreement without any control premium for their HPI securities. In
connection with the Merger, Oxford and FPA agreed to establish certain strategic
principles with regard to existing business between HPI and Oxford and under
which they will enter into partnership agreements in the future in existing and
new markets. WellPoint Parent and FPA have agreed to develop a strategic
relationship in the future. If such future relationships unfairly benefit Oxford
and WellPoint, it could
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have negative consequences to FPA's stockholders. See "RISK FACTORS -- Risk
Relating to the Merger" and "THE MERGER -- Interests of Certain Persons in the
Merger."
RECOMMENDATION OF THE HPI BOARD OF DIRECTORS AND REASONS FOR THE MERGER
On June 27, 1997, the HPI Board, after consultation with its management and
financial and legal advisors, unanimously determined that the terms of the
Merger Agreement and the transactions contemplated thereby are in the best
interests of HPI and its stockholders. The HPI Board focused on the impact of
the Merger on its stockholders and determined, among other things, that the
Merger Consideration was fair to the holders of HPI Common Stock from a
financial point of view (which was affirmed by an opinion of Smith Barney
delivered to the HPI Board (see "THE MERGER -- Opinion of HPI's Financial
Advisor")) and provided them with liquidity for their holdings, including
registration rights for affiliates of HPI. In determining whether the Merger was
in the best interests of HPI's stockholders and of HPI itself, the HPI Board
also considered the impact of the Merger on HPI in light of current market
conditions, the relative strengths and weaknesses of HPI and FPA and the
potential for savings and increased profits of the combined entities. The HPI
Board considered the following factors (which represent all of the material
factors considered by the HPI Board):
Merger Consideration. Of primary concern to the HPI Board in considering
the Merger was treatment of its stockholders as a whole, without distinguishing
between holders of HPI Preferred Stock and holders of HPI Common Stock. The HPI
Board sought advice from its financial and legal advisors as to the customary
and appropriate methods for determining an exchange ratio. The Exchange Ratio
provides that HPI stockholders will receive, in the aggregate, (i) an adjustable
amount of shares of FPA Common Stock determined by dividing $115 million by the
FPA Value if the FPA Value falls within the target range of $18 and $22 which
causes an agreed upon amount of consideration to be paid to the HPI
stockholders, (ii) a fixed Exchange Ratio if the FPA Value is above $22, which
provides additional consideration to the HPI stockholders to the extent the FPA
Value exceeds $22 and (iii) a number of shares of FPA Common Stock if the FPA
Value is below $18 which provides reduced consideration to the HPI stockholders
to the extent the FPA Value is less than $18. However, the HPI Board may elect
to terminate the Merger Agreement without liability if the FPA Value is below
$15.65. See "-- Merger Consideration."
The HPI Board, in consultation with its financial advisor, determined that
the Merger Consideration, realized through the Exchange Ratio, offered the HPI
stockholders a fair price for their shares, particularly in light of the fact
that the HPI Board could terminate the Merger Agreement if the FPA Value were to
drop below $15.65. See "-- Opinion of HPI's Financial Advisor."
Competitive Position of HPI and Industry Consolidation. A significant
objective of the HPI Board was to strengthen HPI's competitive position and
enhance its profile among physicians and Payors. The HPI Board felt that a
combination with FPA would accelerate HPI's ability to achieve these goals. The
HPI Board was concerned with the increasingly competitive pressures within the
managed care sector of the health care industry and noted the resulting trend
towards consolidation among Payors, providers and PPMs. The HPI Board determined
that HPI would be in a much stronger position if it were part of a larger
entity, which would enable it to compete more effectively in this consolidating
environment. The HPI Board felt that it was the appropriate time to utilize the
strength and resources of a larger entity rather than continue trying to compete
on its own.
Benefits of the Merger with FPA. The HPI Board focused on the specific
benefits to be obtained in combining with FPA. The HPI Board determined that a
combined FPA and HPI, would, as one of the largest national physician practice
management companies, be able to operate more effectively and profitably based
on the size, geographic scope and expertise of the combined entity. In addition,
the HPI Board believed that there would be considerable cost savings and
synergies achieved by merging the companies by combining duplicative operations
and eliminating overlapping development activities in the same markets.
Likelihood of Consummation of the Merger. The HPI Board determined that it
would only enter into an agreement which offered a high likelihood of timely
consummation. On balance, after reviewing the various
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termination provisions provided in the Merger Agreement, the HPI Board believed
that the Merger would be consummated in a timely manner. See "-- Termination."
Contributions of Management. The HPI Board believed that one key to its
success has been the contribution of its management team. Therefore, the Board
felt that it was pivotal that management support the Merger and that FPA support
the HPI management team after consummation of the Merger. The provisions in the
Merger Agreement which provide both severance arrangements and management
retention and bonus programs were important to the HPI Board in satisfying these
concerns.
The HPI Board realized that certain members of management had certain
interests in the Merger beyond that of other HPI stockholders. These interests
arise from, among other things, certain employment agreements, management
retention programs, indemnification arrangements, registration rights, and other
matters which FPA will assume or has agreed to provide after the Merger. For a
discussion and quantification of these interests, see "-- Interests of Certain
Persons in the Merger." The HPI Board believed that the payments and inducements
to management, including the Payments to Mr. Berg which the HPI stockholders are
being asked to approve at the HPI Special Meeting, (i) acted to align the
interests of management with those of HPI in negotiating and effectuating the
Merger, (ii) provided the necessary incentives for the key members of HPI's
management team to continue with HPI and FPA after the Merger is consummated and
(iii) after consultation with its advisors, are reasonable based on the size of
HPI and FPA and industry standards. See "THE PAYMENTS."
Desire to Complete Roll-up Transactions. It has been a goal of the HPI
Board (and the holders of Minority Shares and/or Minority Options (the "Minority
Holders")) to eliminate the Minority Shares and Minority Options under the right
circumstances. The HPI Board believes that the Merger represents such a
situation. By completing the Roll-up Transactions and subsequently the Merger,
the Minority Holders would receive freely tradable shares of FPA Common Stock in
place of their restricted minority interests. In addition, because HPI can
compel the Roll-up Transactions, the HPI Board did not believe that the efforts
needed to consummate such transactions would cause any delay in the timing of
the Merger.
Termination Rights. In the event the FPA Value is below $15.65, the HPI
Board may terminate the Merger Agreement without penalty. The HPI Board noted
that having the ability to terminate the Merger Agreement in such a circumstance
without penalty would protect the HPI stockholders from any adverse consequences
caused by a decrease in the FPA Value below such level.
Interests of Non-Affiliated Stockholders. The Merger Consideration and
liquidity afforded the non-affiliated stockholders favorably impacted the HPI
Board's decision to approve the Merger.
Potential Merger Risks. In analyzing a combination with FPA, the HPI Board
generally considered the matters set forth under "RISK FACTORS" including:
(a) the effect of FPA's recent acquisitions of Sterling, Foundation,
AHI and HealthCap on FPA's ability to integrate HPI's operations
efficiently into FPA following consummation of the Merger;
(b) the ability of FPA to maintain its current growth strategy; and
(c) the amount of FPA's indebtedness in relation to its stockholders'
equity.
The HPI Board reviewed these risk factors in their totality as well as the
interests of certain officers and all directors of HPI in the Merger that are in
addition to their interests as stockholders of HPI generally, without focusing
on any one individual factor, and concluded that on balance, despite such
factors, HPI would be better positioned to face those underlying risks as well
as accomplish its business plan if it combined with FPA. The HPI Board also
believes that FPA is capable of addressing the issues raised by the integration
of HPI operations following consummation of 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 HPI Board in the evaluation of the
Merger. The HPI 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 HPI Board determined that the factors adverse
to the Merger were not sufficient to negate the incentives for pursuing, and
potential benefits of, the
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Merger. The HPI Board unanimously determined that the Merger was fair to and in
the best interest of the HPI stockholders and that HPI should proceed with the
Merger.
ACCORDINGLY, THE HPI BOARD UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS OF
HPI VOTE "FOR" APPROVAL OF THE PROPOSAL TO ADOPT THE MERGER AGREEMENT.
STOCKHOLDERS SHOULD BE AWARE THAT CERTAIN MEMBERS OF THE HPI BOARD AND
MANAGEMENT HAVE CERTAIN INTERESTS IN THE MERGER THAT MAY CONFLICT WITH AND ARE
IN ADDITION TO THOSE OF OTHER HPI STOCKHOLDERS. THESE INTERESTS ARISE FROM,
AMONG OTHER THINGS, CERTAIN EMPLOYMENT AGREEMENTS, MANAGEMENT RETENTION
PROGRAMS, INDEMNIFICATION ARRANGEMENTS, REGISTRATION RIGHTS AND OTHER MATTERS
WHICH FPA WILL ASSUME OR HAS AGREED TO PROVIDE AFTER THE MERGER. FOR A
DISCUSSION AND QUANTIFICATION OF THESE INTERESTS, SEE "INTERESTS OF CERTAIN
PERSONS IN THE MERGER."
OPINION OF HPI'S FINANCIAL ADVISOR
Smith Barney was retained by HPI to act as its financial advisor in
connection with the proposed Merger. In connection with such engagement, HPI
requested that Smith Barney evaluate the fairness, from a financial point of
view, to the holders of HPI Common Stock of the consideration to be received by
such holders in the Merger. On June 27, 1997, at a meeting of the Board of
Directors of HPI held to evaluate the proposed Merger, Smith Barney delivered to
the Board of Directors of HPI an oral opinion (which opinion was subsequently
confirmed by delivery of a written opinion dated July 1, 1997, the date of
execution of the Merger Agreement) to the effect that, as of the date of such
opinion and based upon and subject to certain matters stated therein, the Merger
Consideration was fair, from a financial point of view, to the holders of HPI
Common Stock.
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 HPI and certain senior officers and other
representatives of FPA concerning the business, operations and prospects of HPI
and FPA. Smith Barney examined certain business and financial information
relating to HPI and certain publicly available business and financial
information relating to FPA as well as certain financial forecasts and other
information and data for HPI and FPA which were provided to or otherwise
discussed with Smith Barney by the respective managements of HPI and FPA,
including information relating to certain strategic implications and operations
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 FPA Common Stock; the historical and projected earnings and other operating
data of HPI and FPA; and the capitalization and financial condition of HPI and
FPA. Smith Barney 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 HPI and FPA. Smith Barney also evaluated the potential pro
forma financial impact of the Merger on FPA. In connection with its engagement,
Smith Barney was requested to approach on a limited basis, and held discussions
with, certain third parties to solicit indications of interest in a possible
acquisition of HPI. (See "THE MERGER -- Background of the Merger"). 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 provided to or otherwise reviewed by or discussed
with Smith Barney, the managements of HPI and FPA advised Smith Barney that such
forecasts and other information and data were reasonably prepared on bases
reflecting the currently available estimates and judgments of the managements of
HPI and
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FPA as to the future financial performance of HPI and FPA and the strategic
implications and operational benefits anticipated to result from the Merger.
Smith Barney assumed, with the consent of the HPI Board, that the Merger will be
treated as a pooling of interests in accordance with generally accepted
accounting principles and as a tax-free reorganization for federal income tax
purposes. Smith Barney also assumed, with the consent of the HPI Board, and took
into account to the extent relevant to its analysis, that prior to the
consummation of the Merger all outstanding shares of the Series A Convertible
Preferred Stock and Series B Convertible Preferred Stock of HPI and outstanding
minority interests in subsidiaries of HPI will be converted into shares of HPI
Common Stock. Smith Barney did not express any opinion as to what the value of
the FPA Common Stock actually will be when issued to HPI 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 HPI or FPA nor did Smith Barney make any physical inspection of
the properties or assets of HPI or FPA. Although Smith Barney evaluated the
Merger Consideration 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 HPI and FPA. No other limitations
were imposed by HPI 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 JULY 1, 1997,
WHICH SETS FORTH THE ASSUMPTIONS MADE, MATTERS CONSIDERED AND LIMITATIONS ON THE
REVIEW UNDERTAKEN, IS ATTACHED HERETO AS APPENDIX B AND IS INCORPORATED HEREIN
BY REFERENCE. HOLDERS OF HPI COMMON STOCK ARE URGED TO READ THIS OPINION
CAREFULLY IN ITS ENTIRETY. SMITH BARNEY HAS CONSENTED TO THE INCLUSION OF ITS
OPINION LETTER AS APPENDIX B HERETO. IN GIVING SUCH CONSENT, SMITH BARNEY DOES
NOT ADMIT THAT IT COMES WITHIN THE CATEGORY OF PERSONS WHOSE CONSENT IS REQUIRED
UNDER SECTION 7 OF THE SECURITIES ACT, OR THE RULES AND REGULATIONS OF THE
COMMISSION THEREUNDER, NOR DOES IT THEREBY ADMIT THAT IT IS AN EXPERT WITH
RESPECT TO ANY PART OF THE REGISTRATION STATEMENT OF WHICH THIS PROXY
STATEMENT/PROSPECTUS IS A PART WITHIN THE MEANING OF THE TERM "EXPERTS" AS USED
IN THE SECURITIES ACT, OR THE RULES AND REGULATIONS OF THE COMMISSION
THEREUNDER. THE OPINION OF SMITH BARNEY IS DIRECTED TO THE HPI BOARD AND RELATES
ONLY TO THE FAIRNESS OF THE MERGER CONSIDERATION 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 HPI 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
comparable analyses, including those described below. The summary of such
analyses does not purport to be a complete description of the analyses
underlying Smith Barney's 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 opinion. In its analyses, Smith Barney made
numerous assumptions with respect to HPI, FPA, industry performance, general
business, economic, market and financial conditions and other matters, many of
which are beyond the control of HPI 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 Board of
Directors of HPI in its evaluation of the Merger and should not be viewed as
determinative of the views of the Board of Directors or management of HPI with
respect to the Merger Consideration or the proposed Merger.
Selected Company Analysis. Using publicly available information, Smith
Barney analyzed, among other things, the market values and trading multiples of
the following selected publicly traded companies in the PPM industry, consisting
of: (i) Contract Hospital-Based PPM Companies: EmCare Holdings Inc.; and
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Sheridan Healthcare, Inc.; (ii) Multi-Specialty/Primary Care PPM Companies: FPA;
MedPartners, Inc.; PHP HealthCare Corporation; PhyCor, Inc.; PhyMatrix
Corporation; and Promedco Management (the "Multi-Specialty/Primary Care PPM
Companies"); and (iii) Single Specialty PPM Companies: American Oncology
Resources, Inc.; MedCath Incorporated; OccuSystems Inc.; Orthodontic Centers of
America, Inc.; Pedatrix Medical, Group Inc.; Physician Reliance Network, Inc.;
Physicians Resource Group, Inc.; and Specialty Care Network, Inc. (collectively,
the "Selected Companies"). With respect to the Selected Companies analyzed,
Smith Barney focused primarily on the Multi-Specialty/Primary Care PPM
Companies, the operations of which Smith Barney considered to be the most
comparable to HPI. Smith Barney compared market values as a multiple of, among
other things, estimated calendar 1997 and 1998 net income, and adjusted market
values (equity market value, plus debt, less cash) as a multiple of, among other
things, latest 12 months earnings before interest, taxes, depreciation and
amortization ("EBITDA"). All multiples were based on closing stock prices as of
June 25, 1997. Net income estimates for FPA and the Selected Companies were
based on estimates of selected investment banking firms and net income estimates
for HPI were based on internal estimates of the management of HPI (excluding
growth estimates for potential acquisitions). Applying a range of multiples
(excluding outliers) for the Multi-Specialty/Primary Care PPM Companies of
estimated calendar 1997 and 1998 net income of 18.8x to 26.1x (with a mean of
22.3x) and 13.3x to 19.3x (with a mean of 16.4x), respectively, and latest 12
months EBITDA of 12.6x to 19.8x (with a mean of 14.6x) to HPI estimated calendar
1997 and 1998 net income and estimated calendar 1997 EBITDA, respectively,
resulted in an equity reference range for HPI of approximately $74.4 million to
$110.1 million, as compared to the equity value implied by the Merger
Consideration of approximately $119.0 million based on a closing stock price of
FPA Common Stock on June 25, 1997.
Selected Merger and Acquisition Transactions Analysis. Using publicly
available information, Smith Barney analyzed the purchase price and implied
transaction value multiples paid in selected transactions in the PPM industry,
consisting of (acquiror/target): MedPartners, Inc./InPhyNet Medical Management;
Physicians Resource Group, Inc./American Ophthalmic Inc.; FPA/AHI Healthcare
Systems, Inc.; FPA/Sterling Healthcare Group Inc.; Physicians Resource Group,
Inc./EyeCorp, Inc.; MedPartners, Inc./Pacific Physician Services Inc.;
MedPartners, Inc./Mullikin Medical Enterprises, L.P.; Coastal Healthcare Group,
Inc./Health Enterprises, Inc.; Caremark International Inc./Friendly Hills
Healthcare Network; and Foundation Health Corporation/Thomas-Davis Medical
Centers, P.C. (collectively, the "Selected Transactions"). Smith Barney
compared, among other things, the purchase prices in the Selected Transactions
as a multiple of latest 12 months net income, and transaction values as
multiples of latest 12 months earnings before interest and taxes ("EBIT") and
EBITDA. All multiples for the Selected Transactions were based on information
available at the time of announcement of the transaction. Applying a range of
multiples (excluding outliers) for the Selected Transactions of latest 12 months
net income, EBIT and EBITDA of 18.7x to 39.1x (with a mean of 28.8x and a median
of 22.3x), 13.5x to 22.9x (with a mean of 18.6x and a median of 17.2x) and 8.8x
to 17.3x (with a mean of 12.9x and a median of 12.0x), respectively, to
corresponding financial data for HPI resulted in an equity reference range for
HPI of approximately $56.9 million to $105.9 million, as compared to the equity
value implied by the Merger Consideration of approximately $119.0 million based
on a closing stock price of FPA Common Stock on June 25, 1997.
No company, transaction or business used in the "Selected Company Analysis"
or "Selected Merger and Acquisition Transactions Analysis" as a comparison is
identical to HPI, FPA or the Merger. 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, Selected Transactions or the
business segment, company or transaction to which they are being compared.
Contribution Analysis. Smith Barney analyzed the respective contributions
of HPI and FPA to the estimated revenue, EBITDA, EBIT and net income of the
combined company for fiscal years 1997 through 2000, based on internal estimates
of the managements of FPA and HPI (excluding, in the case of HPI, growth
estimates for potential acquisitions), without giving effect to certain costs
savings and other potential synergies and transaction costs anticipated by the
managements of HPI and FPA to result from the Merger. This analysis indicated
that HPI would contribute approximately 15.8% of revenue, 8.3% of EBITDA, 5.9%
of EBIT and 7.7% of net income of the combined company in fiscal year 1997,
approximately 17.5% of revenue,
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12.7% of EBITDA, 11.5% of EBIT and 12.9% of net income of the combined company
in fiscal year 1998, approximately 17.8% of revenue, 12.6% of EBITDA, 11.4% of
EBIT and 12.2% of net income of the combined company in fiscal year 1999, and
approximately 18.3% of revenue, 12.6% of EBITDA, 10.7% of EBIT and 11.1% of net
income of the combined company in fiscal year 2000. Based on the Exchange Ratio,
current stockholders of HPI would own approximately 14.2% of the equity value of
the combined company, on a fully diluted basis, upon consummation of the Merger,
and HPI would constitute approximately 11.5% of the enterprise value of the
combined company.
Discounted Cash Flow Analysis. Smith Barney performed a discounted cash
flow analysis of the projected free cash flow of HPI for fiscal years 1997
through 2000, based on internal estimates of the management of HPI (excluding
growth estimates for potential acquisitions) for fiscal 1997 and fiscal 1998 and
extrapolated for fiscal years 1999 through 2000 assuming annual revenue growth
rates in such years of 15% and 20%. The stand-alone discounted cash flows
analysis of HPI was determined by (i) adding (x) the present value of projected
free cash flows over the three and one-half year period from 1997 to 2000 and
(y) the present value of HPI's estimated terminal value in year 2000 and (ii)
subtracting the current net debt of HPI. The range of estimated terminal values
for HPI at the end of the three and one-half year period was calculated by
applying terminal multiples of 9.0x to 11.0x to HPI's projected 2000 EBITDA,
representing HPI's estimated value beyond the year 2000. The cash flows and
terminal values of HPI were discounted to present value using discount rates
ranging from 15% to 20%. Utilizing such discount rates and terminal values, this
analysis resulted in an equity reference range for HPI of approximately $110.3
million to $150.6 million (assuming a 15% annual revenue growth rate in fiscal
years 1999 through 2000) and approximately $119.4 million to $163.3 million
(assuming a 20% annual revenue growth rate in fiscal years 1999 through 2000),
as compared to the equity value implied by the Merger Consideration of
approximately $119.0 million based on a closing stock price of FPA Common Stock
on June 25, 1997.
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 the projected earnings per share ("EPS") of FPA for the fiscal years
ended 1997 through 2000, based on internal estimates of the managements of FPA
and HPI (excluding, in the case of HPI, growth estimates for potential
acquisitions). The results of the pro forma merger analysis suggested that the
Merger could be dilutive to FPA's EPS in fiscal year 1997 and accretive to FPA's
EPS in fiscal years 1998 through 2000, assuming certain cost savings and other
potential synergies anticipated by the management of HPI to result from the
Merger were achieved. The actual results achieved by the combined company may
vary from projected results and the variations may be material.
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) indications of interest
received from third parties other than FPA; (ii) FPA's and HPI's historical and
projected financial results; (iii) the history of trading prices and volume for
FPA Common Stock and the relationship between movements in FPA Common Stock,
movements in the common stock of comparable companies and movements in the S&P
500 Index; and (iv) selected published analysts' reports on FPA, including
analysts' estimates as to the earnings growth potential of FPA.
Pursuant to the terms of Smith Barney's engagement, HPI has agreed to pay
Smith Barney for its services in connection with the Merger an aggregate
financial advisory fee equal to 1.25% of the total consideration (including
certain liabilities assumed) payable in connection with the Merger. HPI has also
agreed to reimburse Smith Barney for reasonable 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
federal securities laws, arising out of Smith Barney's engagement.
Smith Barney has advised HPI that, in the ordinary course of business,
Smith Barney and its affiliates may actively trade or hold the securities of 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 investment banking services to FPA unrelated to the proposed
Merger, for which services Smith
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Barney has received compensation. In addition, Smith Barney and its affiliates
(including Travelers Group, Inc. and its affiliates) may maintain relationships
with HPI and FPA.
Smith Barney is an internationally recognized investment banking firm and
was selected by HPI based on Smith Barney's experience and expertise. Smith
Barney regularly engages in the valuation of businesses and their securities in
connection with mergers and acquisitions, negotiated underwriting, 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, Merger Sub will be
merged with and into HPI at the Effective Time. The Merger will become effective
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 Closing Date, at the offices of
Pillsbury Madison & Sutro LLP, 101 West Broadway, Suite 1800, San Diego,
California, unless another date or place is agreed to by the parties. See "THE
MERGER AGREEMENT -- Conditions to Consummation of the Merger."
INTERESTS OF CERTAIN PERSONS IN THE MERGER
Certain officers and all of the directors of HPI have certain interests in
the Merger that are in addition to their interests as stockholders of HPI
generally. The HPI Board was aware of these interests and considered them, among
other matters, in approving the Merger Agreement and in formulating its
recommendation to the stockholders of HPI that they approve the Merger Agreement
and the transactions contemplated therein. Each of these interests is set forth
below.
Berg Employment Agreements. Mr. Berg is subject to an existing employment
agreement dated September 1, 1993 with HPI (the "HPI Employment Agreement").
Under the HPI Employment Agreement, Mr. Berg is entitled to receive certain
payments and benefits (the "Payments") following the termination of such
agreement, if the termination resulted from a material alteration in Mr. Berg's
duties. The HPI Board has determined that the Merger will cause such a material
alteration. Therefore, at the Effective Time, the HPI Employment Agreement will
be terminated and Mr. Berg will be entitled to receive the Payments, subject to
stockholder approval of the same. As a result of such termination, pursuant to
the terms of the HPI Employment Agreement, Mr. Berg will be entitled to receive
from HPI a cash payment equal to $350,000 (consisting of severance and related
benefits of $250,000 and $100,000 in accrued bonus) and all of his outstanding
unvested HPI Options will vest. See "THE PAYMENTS." The aggregate number of
shares of HPI Common Stock underlying the unvested portion of Mr. Berg's HPI
Options is 239,150, of which 69,300 are scheduled to vest in 1998, 69,300 in
1999, 69,300 in 2000 and 31,250 in 2001. The exercise prices for such options
range from $.001 per share to $4.25 per share.
Upon consummation of the Merger, Mr. Berg will enter into a new employment
agreement with FPA (the "FPA Employment Agreement"). The FPA Employment
Agreement will have a term of three years and provide a base salary of $240,000
per year (which may be increased but not decreased at annual reviews) and an
annual performance bonus opportunity of up to 50% of his then current base
salary. In addition, Mr. Berg will receive a payment at the Effective Time of
$300,000 (in consideration for entering into the FPA Employment Agreement). Mr.
Berg is entitled to a payment of $365,000 as consideration for a covenant not to
compete contained in the FPA Employment Agreement. Such amount will be paid upon
expiration or termination of the FPA Employment Agreement and the commencement
of the non-compete period. Mr. Berg will be granted a nonqualified option to
purchase 75,000 shares of FPA Common Stock with a per share exercise price equal
to the fair market value of a share of FPA Common Stock on the date of grant.
The term of the option will be ten years from the date of grant unless
terminated earlier pursuant to the terms of the stock option agreement. Subject
to certain terms and conditions, options to purchase up to 30,000 shares of FPA
Common Stock are scheduled to vest on each of the first two anniversaries of the
date of grant (5,000 will vest automatically each year and up to 25,000 may vest
each year if certain performance criteria are
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satisfied) and options to purchase 5,000 shares of FPA Common Stock are
scheduled to vest (automatically) on each of the next three anniversaries of
such date. Pursuant to the FPA Employment Agreement, following a termination of
Mr. Berg's employment for "Cause" (as defined in the FPA Employment Agreement)
or if Mr. Berg terminates his employment unrelated to a "Good Reason Event" (as
defined in the FPA Employment Agreement), Mr. Berg is entitled to his then
effective base salary and benefits through such termination date. If Mr. Berg is
terminated without Cause or if he terminates his employment in conjunction with
a Good Reason Event, then (i) Mr. Berg will be entitled to his then effective
base salary and benefits through the date of termination and for a period of
eighteen months thereafter and (ii) all of Mr. Berg's outstanding options will
vest and remain outstanding until the expiration of their original terms.
Other Employment Agreements. Pursuant to the Merger Agreement and except as
described with respect to Mr. Berg, all of the existing HPI employment
agreements shall remain in full force and effect following the Effective Time.
Messrs. Charles D. Phillips and Paul Conlin have existing employment agreements
which, unless renewed, are scheduled to expire on December 31, 1998 and May 31,
1999, respectively. The employment agreements provide for base salaries for
Messrs. Phillips and Conlin of $165,000 and $156,000 respectively and an annual
bonus opportunity of up to fifty percent of their then current base salary. The
agreements contain severance provisions which provide for payments of base
salary and benefits for a period of twelve months and nine months, respectively,
following a termination without Cause (as defined in the agreements). In
addition, HPI has committed to pay to each of Messrs. Phillips and Conlin
amounts equal to $50,000 and $25,000, respectively, as of the Effective Time.
Treatment of Stock Options. HPI has granted HPI Options to officers and
employers of HPI and certain HPI Subsidiaries. Pursuant to the Merger Agreement,
the HPI Options, including HPI Options granted to Messrs. Berg, Phillips and
Conlin, whether or not vested, will be canceled at the Effective Time in
exchange for a number of shares of fully paid FPA Common Stock, decreased to the
nearest whole share, equal to the quotient which results when the "Fair Market
Value" of such HPI Options at the Effective Time is divided by the FPA Value.
The Fair Market Value of the HPI Options will be determined by an investment
banking firm, selected by HPI and acceptable to FPA, by applying a variation of
the Black-Scholes option pricing model. See "THE MERGER AGREEMENT -- Treatment
of Stock Options." The HPI Options held by executive officers of HPI which will
be converted into FPA Common Stock are shown in the following table:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF NUMBER OF SHARES OF ESTIMATED
HPI COMMON STOCK HPI COMMON STOCK NUMBER OF SHARES OF
EXERCISE UNDERLYING UNVESTED UNDERLYING VESTED FPA COMMON STOCK
EXECUTIVE DATE OF GRANT PRICE PORTION OF OPTION(1) PORTION OF OPTION(2) TO BE ISSUED(3)
- -------------------- ------------------- -------- -------------------- -------------------- -------------------
<S> <C> <C> <C> <C> <C>
Charles G. Berg(4) May 16, 1995 $ .001 -- 34,000
January 29, 1996 $ 3.25 -- 125,000
January 6, 1997 $ 4.25 -- 125,000
Charles D.
Phillips(5) September 26, 1995 $ 4.75 11,337 2,884
January 29, 1996 $ 3.25 37,500 12,500
January 6, 1997 $ 4.25 40,000 --
Paul Conlin January 29, 1996 $ 3.25 25,000 25,000
January 6, 1997 $ 4.25 30,000 --
</TABLE>
- ---------------
(1) These numbers of shares were determined as of August 30, 1997, except as
described in footnote 4.
(2) These numbers of shares were determined as of August 30, 1997, except as
described in footnote 4.
(3) The estimated number of shares of FPA Common Stock to be issued is based on
an estimate of the Fair Market Value of the HPI Options and an FPA Value of
$ . A description of how the Fair Market Value of the HPI Options is
calculated is described above. The actual Fair Market Value of the HPI
Options will most likely differ from the estimate based on these
calculations, and the number of shares of FPA Common Stock issuable in
exchange for such options will depend on the actual FPA Value.
(4) Mr. Berg's HPI Options are considered vested for purposes of this table
because such options will accelerate and become fully exercisable at the
Effective Time, subject to stockholder approval, as a result of the
termination of the HPI Employment Agreement.
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(5) The September 26, 1995 option grant to Mr. Phillips was made by an HPI
Subsidiary to purchase shares in such subsidiary. These options are subject
to the Roll-up Transactions. The table reflects the number of substitute HPI
Options to be issued to Mr. Phillips in connection with the completion of
the Roll-up Transactions.
Based on the aforementioned number of FPA Common Shares to be issued to
executive officers of HPI, assuming a FPA Value of $ , the last trading
price of FPA Common Stock on September , 1997, the aggregate fair value of the
HPI option is , and for Messrs. Berg, Phillips and
Conlin, respectively. No directors hold or have held options to purchase shares
of HPI Common Stock.
Management Retention Program. Pursuant to an agreement reached between HPI
and FPA, FPA will cause the Surviving Corporation to make payments to certain
key employees of the Surviving Corporation based on their continued employment
and performance during the period from the Effective Time through the first
anniversary of the Effective Time. In order to be entitled to the payment, the
employee must be employed by the Surviving Corporation, a subsidiary thereof or
FPA at the time of the first anniversary of the Effective Time, unless such
employment is earlier terminated at the request of the Surviving Corporation, a
subsidiary thereof or FPA. Also, HPI and FPA have agreed that if any of the
aforementioned key employees who do not have employment contracts are terminated
without cause at any time prior to the first anniversary of the Effective Time,
such employee will be entitled to receive six months severance and be provided
with thirty days notice of termination. Under this program, Messrs. Phillips and
Conlin are entitled to receive payments on the first anniversary of the
Effective Time in amounts equal to $90,000 and $80,000, respectively. No payment
will be made to Mr. Berg under this program.
Equity Incentive Plan. FPA has agreed to make available a pool of options
to purchase FPA Common Stock to key employees of HPI. Option grants will be
determined after the Closing and will be consistent in amount to those received
by other FPA employees with similar responsibilities. Mr. Berg will recommend
allocations of the pool among HPI key employees which will be approved in the
same manner as other FPA option grants.
Registration Rights Agreement. In the Merger Agreement, FPA has agreed to
enter into a registration rights agreement (the "Registration Rights Agreement")
with Oxford, WellPoint and Messrs. Berg, Phillips and Conlin and Stephen F.
Wiggins (collectively, the "Selling Stockholders"), pursuant to which FPA will
file a registration statement with the Commission as soon as practicable after
the Closing Date covering the shares of FPA Common Stock received in the Merger
by the Selling Stockholders (and no other shares of FPA Common Stock) and will
use its reasonable efforts to cause such registration statement to be declared
effective on or prior to 90 days after the Closing Date (but no earlier than 60
days following the Closing Date). FPA has agreed to use its reasonable efforts
to keep the registration statement effective for the period ending two years
after the Closing Date or such shorter period as necessary. See "THE MERGER
AGREEMENT -- Certain Additional Agreements -- Registration Rights Agreement."
Indemnification of Directors and Officers. FPA has agreed to indemnify,
defend and hold harmless, for a period of six years commencing at the Effective
Time, all current and former directors and officers of HPI and its subsidiaries
against all losses, claims, damages and liabilities, costs or expenses,
judgments, fines, penalties and amounts paid in settlement arising out of any
acts or omissions or alleged acts or omissions by them in their capacities as
such. Also, the Merger Agreement requires FPA to purchase, immediately following
the Effective Time, and maintain or cause the Surviving Corporation to maintain
for a period of six years thereafter directors' and officers' liability
insurance covering each person who was a director or officer of HPI at any time
prior to the Effective Time. See "THE MERGER AGREEMENT -- Certain Additional
Agreements."
Master Strategic Arrangement for Private Practice Partnerships. Certain
health plan subsidiaries of Oxford ("Oxford health plans") and certain HPI
Subsidiaries, affiliated professional corporations and an IPA ("HPI MSOs") are
parties to partnership agreements which govern the relationship between the
Oxford health plans and the providers, including provisions regarding the
compensation payable to providers for the provision of comprehensive medical
care to Oxford health plan enrollees. In connection with the Merger, Oxford and
HPI have agreed to establish certain strategic principles under which they will
enter into
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partnership agreements in the future in existing and new markets (the "Strategic
Agreement"). The terms of the Strategic Agreement include, among others, (i) the
partnership agreements in existence between Oxford health plans and HPI MSOs
shall remain in effect in accordance with their terms; (ii) if Oxford and HPI
agree that an HPI MSO should become a provider for an Oxford health plan, that
provider and Oxford health plan will enter into partnership agreements
containing mutually satisfactory provisions and will become subject to the
Strategic Agreement; (iii) under certain delineated circumstances, the Oxford
health plan may advise the HPI MSO of its intention to change the compensation
level payable to providers servicing health plan enrollees; the parties have
agreed to negotiate in good faith the intended compensation changes with
specified remedies if agreement is not reached; (iv) HPI MSOs must meet certain
specified conditions in order to add physicians to provider groups which are
parties to existing partnership agreements; and (v) if HPI develops physician
networks in markets where Oxford health plans operate, the parties agree to
negotiate in good faith to enter into partnership agreements in such areas,
which agreements will be in accordance with the terms of the Strategic
Agreement. The Strategic Agreement has a term of ten years with additional five
year terms upon mutual agreement of the parties and includes specified events of
termination.
WellPoint Parent Memorandum of Understanding. WellPoint Parent and FPA have
agreed to develop a strategic relationship to further the delivery of quality,
cost-effective health care to enrollees of WellPoint Parent's subsidiary health
plans. The strategic relationship will focus on markets served by WellPoint
Parent's subsidiary health plans and will include possible expansion of current
contractual relationships between WellPoint Parent's health plans and FPA and
entering into new contractual relationships. The memorandum of understanding
contemplates various activities that WellPoint Parent and FPA may jointly pursue
in meeting the objectives of the relationship. The memorandum does not obligate
either party to alter any existing contractual relationship or to enter into any
definitive agreement regarding the terms of the memorandum.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following summary discusses the material federal income tax
consequences of the Merger. The summary is based upon the Code, applicable
Treasury Regulations thereunder and administrative rulings and judicial
authority as of the date hereof. All of the foregoing are subject to change,
possibly with retroactive effect, and any such change could affect the
continuing validity of the discussion. The discussion assumes that holders of
shares of HPI Common Stock hold such shares as a capital asset. Further, the
discussion does not address the tax consequences that may be relevant to a
particular stockholder subject to special treatment under certain federal income
tax laws, such as dealers in securities, banks, insurance companies, tax-exempt
organizations, non-United States persons, stockholders who acquired shares of
HPI Common Stock through the exercise of options or otherwise as compensation or
through a tax-qualified retirement plan, and holders of options granted under
HPI's benefit plans. This discussion does not address any consequences arising
under the laws of any state, locality or foreign jurisdiction or the tax
consequences of transactions effected prior to or after the Merger (whether or
not such transactions are in connection with the Merger), except to the extent,
if at all, that such prior or subsequent transactions would affect the tax
treatment of the Merger.
Neither HPI nor FPA has requested a ruling from the Internal Revenue
Service ("IRS") with regard to any of the federal income tax consequences of the
Merger and the opinions of counsel as to such federal income tax consequences
set forth below will not be binding on the IRS.
General. As of the date hereof, it is intended that the Merger will
constitute a reorganization pursuant to Section 368(a) of the Code and that for
federal income tax purposes no gain or loss will be recognized by FPA, HPI or
Merger Sub. The respective obligations of the parties to consummate the Merger
are conditioned on (i) the receipt by FPA of an opinion of Pillsbury Madison &
Sutro LLP confirming that the Merger will qualify as a reorganization within the
meaning of Section 368(a) of the Code and that each of FPA, HPI and Merger Sub
will be a party to the reorganization within the meaning of Section 368(b) of
the Code and (ii) the receipt by HPI of an opinion of Gibson, Dunn & Crutcher
LLP confirming that the Merger will qualify as a reorganization within the
meaning of Section 368(a) of the Code and that each of FPA, HPI and Merger Sub
will be a party to the reorganization within the meaning of Section 368(b) of
the Code. Such opinions will be based upon, among other things, (i)
representations of HPI, FPA and certain stockholders of HPI customarily given in
transactions of this type and (ii) the assumption that the Merger will be
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consummated in accordance with the terms of the Merger Agreement.Assuming the
representations of HPI, FPA and certain stockholders of HPI referred to in the
preceding sentence are true and correct at the time the Merger is consummated,
and assuming further that the Merger is consummated in accordance with the terms
of the Merger Agreement, then in the opinions of Pillsbury Madison & Sutro LLP
and Gibson, Dunn & Crutcher LLP, the Merger will qualify as a reorganization
within the meaning of Section 368(a) of the Code and will have the material
federal income tax consequences described below.
Consequences to HPI Stockholders. Under the reorganization provisions of
the Code, no gain or loss will be recognized by holders of HPI Common Stock with
respect thereto as a result of the surrender of their shares of HPI Common Stock
in exchange for shares of FPA Common Stock pursuant to the Merger (except as
discussed below with respect to cash received in lieu of fractional shares). The
aggregate tax basis of the shares of FPA Common Stock received in the Merger
(including any fractional shares of FPA Common Stock deemed received) will be
the same as the aggregate tax basis of the shares of HPI Common Stock
surrendered in exchange therefor in the Merger. The holding period of the shares
of FPA Common Stock received (including the holding period of fractional shares
of FPA Common Stock deemed received) will include the holding period of shares
of HPI Common Stock surrendered in exchange therefor.
Fractional Shares. If a holder of shares of HPI Common Stock receives cash
in lieu of a fractional share interest in FPA Common Stock in the Merger, such
fractional share interest will be treated as having been distributed to the
holder, and such cash amount will be treated as received in redemption of the
fractional share interest. Under Section 302 of the Code, if such redemption is
"not essentially equivalent to a dividend" after giving effect to the
constructive ownership rules of the Code, the holder will generally recognize
capital gain or loss equal to the cash amount received for the fractional share
of FPA Common Stock reduced by the portion of the holder's tax basis in shares
of HPI Common Stock surrendered that is allocable to the fractional share
interest in FPA Common Stock. Under these rules, a stockholder of HPI should
recognize capital gain or loss on the receipt of cash in lieu of a fractional
share interest in FPA Common Stock. For non-corporate holders of HPI Voting
Securities, such capital gain will be taxed at ordinary income tax rates if the
holder's holding period in the fractional share interest is 12 months or less,
at a maximum federal income tax rate of 28% if the holder's holding period in
the fractional share interest is more than 12 months and not more than 18
months, and at a maximum federal income tax rate of 20% if the holder's holding
period in such fractional share interest is more than 18 months.
Consequences to HPI, FPA and Merger Sub. None of HPI, FPA or Merger Sub
will recognize gain or loss as a result of the Merger.
THE PRECEDING DISCUSSION DOES NOT PURPORT TO BE A COMPLETE ANALYSIS OR
DISCUSSION OF ALL POTENTIAL TAX EFFECTS RELEVANT TO THE MERGER. THUS, HPI
STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX
CONSEQUENCES TO THEM OF THE MERGER, INCLUDING TAX RETURN REPORTING REQUIREMENTS,
THE APPLICABILITY AND EFFECT OF FEDERAL, STATE, LOCAL, AND OTHER APPLICABLE TAX
LAWS AND THE EFFECT OF ANY PROPOSED CHANGES IN THE TAX LAWS.
ACCOUNTING TREATMENT
The Merger will be accounted for using the "pooling of interests" method of
accounting pursuant to Accounting Principles Board Opinion No. 16, as amended
("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 "SELECTED HISTORICAL AND PRO FORMA INFORMATION -- PRO
FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OF FPA MEDICAL
MANAGEMENT, INC. AND SUBSIDIARIES." It is a condition to the Merger that each of
FPA and HPI receive letters from their respective independent auditors stating
that the Merger will qualify as a "pooling of interests" for accounting and
financial reporting purposes.
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RESALE OF FPA COMMON STOCK BY AFFILIATES
The FPA Common Stock to be issued to stockholders of HPI in connection with
the Merger has been registered under the Securities Act pursuant to the
Registration Statement of which this Proxy Statement/Prospectus forms a part.
The FPA Common Stock received by the stockholders of HPI 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 HPI or FPA within the meaning of Rule 145 promulgated under the Securities
Act ("Rule 145"). Affiliates are generally defined as persons who control, are
controlled by, or are under common control with HPI or FPA at the time of the
HPI Special Meeting (generally, directors, certain executive officers and major
stockholders). Affiliates of HPI 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 one year
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 promulgated 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 one-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. One year 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. Two years after the Effective Time, an Affiliate would be able to sell such
shares of FPA Common Stock without any restrictions, provided that 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 FPA Common Stock issued to affiliates of HPI may not be resold by them
until combined results of operations of FPA and HPI 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 HPI.
See "THE MERGER -- Interests of Certain Persons in the Merger -- Registration
Rights Agreement."
CERTAIN REGULATORY MATTERS
FPA and HPI intend to resist vigorously any assertion that the Merger
violates the federal antitrust laws. Any such resistance could delay
consummation of the Merger, perhaps for a considerable period of time. FPA and
HPI made their respective filings with the FTC and the DOJ with respect to the
Merger on July 29, 1997 and the waiting period of their respective HSR filings
has expired. Notwithstanding the expiration of the waiting period of the HSR
filings, the FTC, DOJ or others could take action under the antitrust laws,
before or after the Effective Time, seeking the divestiture by FPA of all or any
part of the assets of HPI 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 states' 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. HPI does not intend 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.
RIGHTS OF DISSENTING STOCKHOLDERS
Holders of HPI Voting Securities as of the Record Date (the "Record
Holders") are entitled to appraisal rights under Section 262 of the Delaware Act
("Section 262") for such securities. The following discussion
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represents a summary of the material provisions of Section 262. For additional
information, reference is made to the full text of Section 262, which is
reprinted in its entirety as Appendix C to this Proxy Statement/Prospectus. A
person having a beneficial interest in HPI Voting Securities as of the Record
Date held of record in the name of another person, such as a nominee, must act
promptly to cause the record holder to follow the steps summarized below
properly and in a timely manner to perfect the appraisal rights provided under
Section 262.
Under Section 262, where a merger is to be submitted for approval at a
meeting of stockholders, as in the case of the HPI Special Meeting, not less
than 20 days prior to the meeting, a constituent corporation must notify each of
the holders of its stock for which appraisal rights are available that such
appraisal rights are available and include in each such notice a copy of Section
262. THIS PROXY STATEMENT/PROSPECTUS SHALL CONSTITUTE SUCH NOTICE TO THE RECORD
HOLDERS OF HPI COMMON STOCK AND HPI PREFERRED STOCK. ANY SUCH STOCKHOLDER WHO
WISHES TO EXERCISE SUCH APPRAISAL RIGHTS SHOULD REVIEW THE FOLLOWING DISCUSSION
AND APPENDIX C CAREFULLY BECAUSE FAILURE TO TIMELY AND PROPERLY COMPLY WITH THE
PROCEDURES SPECIFIED WILL RESULT IN THE LOSS OF APPRAISAL RIGHTS UNDER THE
DELAWARE ACT.
Under the Delaware Act, a Record Holder of HPI Voting Securities who makes
the demand described below with respect to such shares, who continuously is the
record holder of such shares through the Effective Time, who otherwise complies
with the statutory requirements set forth in Section 262 and who neither votes
in favor of approval of the Merger Agreement and the Merger nor consents thereto
in writing will be entitled to have his or her HPI Voting Securities appraised
by the Delaware Court of Chancery and to receive payment of the "fair value" of
such shares as described below. Such holders are, in such circumstances,
entitled to appraisal rights because they hold shares of a constituent
corporation to the Merger and may be required by the Merger Agreement to accept
the Merger Consideration.
A Record Holder of HPI Voting Securities wishing to exercise his or her
appraisal rights must deliver to the Secretary of HPI, before the vote on the
Merger Agreement at the HPI Special Meeting, a written demand for appraisal of
his or her HPI Voting Securities. Merely voting or delivering a proxy directing
a vote against approval of the Merger Agreement and the Merger will not
constitute a demand for appraisal. A written demand is essential. Such written
demand must reasonably inform HPI of the identity of the Record Holder and that
such holder intends thereby to demand appraisal of the holder's shares. All
written demands for appraisal of HPI Voting Securities should be sent or
delivered to HPI at 800 Connecticut Avenue, Norwalk, Connecticut 06854,
Attention: Corporate Secretary. In addition, a Record Holder of HPI Voting
Securities wishing to exercise his or her appraisal rights must hold such shares
of record on the date the written demand for appraisal is made and must hold
such shares continuously through the Effective Time. Stockholders who hold their
HPI Voting Securities in nominee form and who wish to exercise appraisal rights
must take all necessary steps in order that a demand for appraisal is made by
the record holder of such shares and are urged to consult with their nominee to
determine the appropriate procedures for the making of a demand for appraisal by
the record holder.
Within ten days after the Effective Time of the Merger, HPI, as the
surviving corporation in the Merger, must send a notice as to the effectiveness
of the Merger to each person who has satisfied the appropriate provisions of
Section 262 and who is entitled to appraisal rights under Section 262. Within
120 days after the Effective Time, any Record Holder of HPI Voting Securities
who has complied with the requirements for exercise of appraisal rights will be
entitled, upon written request, to receive from the Surviving Corporation a
statement setting forth (i) the aggregate number of shares of HPI Common Stock
and HPI Preferred Stock not voted in favor of the Merger Agreement and with
respect to which demands for appraisal have been received and (ii) the aggregate
number of holders of such shares. Any such statement must be mailed within ten
days after a written request therefor has been received by the Surviving
Corporation.
Within 120 days after the Effective Time, but not thereafter, the Surviving
Corporation or any Record Holder of HPI Voting Securities who has complied with
the foregoing procedures and who is entitled to appraisal rights under Section
262 may file a petition in the Delaware Court of Chancery demanding a
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determination of the "fair value" of such shares. The Surviving Corporation is
not under any obligation to file a petition with respect to the appraisal of the
"fair value" of the HPI Voting Securities and neither FPA nor HPI presently
intends that the Surviving Corporation file such a petition. Accordingly, it is
the obligation of the stockholders to initiate all necessary action to perfect
their appraisal rights within the time prescribed in Section 262. A Record
Holder of HPI Voting Securities will fail to perfect, or effectively lose, his
or her right to appraisal if no petition for appraisal of shares of HPI Voting
Securities is filed within 120 days after the Effective Time.
If a petition for an appraisal is timely filed, after a hearing on such
petition, the Delaware Court of Chancery will determine the holders of HPI
Voting Securities entitled to appraisal rights and will appraise the "fair
value" of the HPI Voting Securities, exclusive of any element of value arising
from the accomplishment or expectation of the Merger. Stockholders considering
seeking appraisal should be aware that the "fair value" of their HPI Voting
Securities as determined under Section 262 could be more than, the same as, or
less than the value of the Merger Consideration they would have received if they
did not seek appraisal. The Delaware Supreme Court has stated that "proof of
value by any techniques or methods which are generally considered acceptable in
the financial community and otherwise admissible in court" should be considered
in the appraisal proceedings. In addition, Delaware courts have decided that the
statutory appraisal remedy, depending on factual circumstances, may or may not
be a dissenter's exclusive remedy.
The Delaware Court of Chancery will determine the amount of interest, if
any, to be paid upon the amounts to be received by persons whose HPI Voting
Securities have been appraised. The costs of the action may be determined by
such court and taxed upon the parties as the court deems equitable. The Delaware
Court of Chancery may also order that all or a portion of the expenses incurred
by any holder of HPI Voting Securities in connection with an appraisal,
including without limitation, reasonable attorneys' fees and the fees and
expenses of experts utilized in the appraisal proceeding, be charged pro rata
against the value of all of the HPI Voting Securities entitled to appraisal.
If any Record Holder of HPI Voting Securities who demands appraisal of his
or her shares under Section 262 fails to perfect, or effectively withdraws or
loses, his or her right to appraisal, as provided in the Delaware Act, the HPI
Voting Securities of such stockholder will be deemed to receive Merger
Consideration in accordance with the Merger Agreement. A holder may withdraw his
or her demand for appraisal by delivering to the Surviving Corporation a written
withdrawal of his or her demand for appraisal and acceptance of the Merger,
except that any such attempt to withdraw made more than 60 days after the
Effective Time will require the written approval of the Surviving Corporation.
Failure to follow the steps required by Section 262 of the Delaware Act for
perfecting appraisal rights may result in the loss of such rights.
Any Record Holder of HPI Voting Securities who has duly demanded an
appraisal in compliance with Section 262 will not, after the Effective Time, be
entitled to vote the HPI Voting Securities subject to such demand for any
purpose or be entitled to the payment of dividends or other distributions on
those shares (except dividends or other distributions payable to holders of
record of shares of HPI Voting Securities as of a date prior to the Effective
Time).
THE PAYMENTS
The following is a summary of certain payments and benefits (the
"Payments") that will be paid to and received by Charles G. Berg, President and
Chief Executive Officer of HPI, in connection with the termination at the
Effective Time of the HPI Employment Agreement.
Under the HPI Employment Agreement, Mr. Berg is entitled to receive the
following Payments upon the termination of such agreement, if such termination
results from a material alteration of Mr. Berg's duties, which the HPI Board has
determined will occur as a result of the Merger: (a) a lump-sum cash payment of
$350,000 and (b) the acceleration of the vesting of his unvested HPI Options to
purchase 239,150 shares of HPI Common Stock. The value of such vesting
acceleration is estimated to be approximately $460,000. See "THE
MERGER -- Interests of Certain Persons in the Merger." By voting FOR approval of
the Payments, HPI stockholders will be approving the payment of all of the
Payments to Mr. Berg.
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Section 280G of the Code and the proposed regulations promulgated
thereunder ("Section 280G") will disallow the deduction by HPI of any portion of
the Payments characterized as an "excess parachute payment" as described below.
Also, Section 4999 of the Code will impose a 20% nondeductible excise tax on Mr.
Berg with respect to any portion of the Payments characterized as an "excess
parachute payment." To be considered parachute payments, the Payments must (i)
be in the nature of compensation, (ii) be contingent on a change in ownership of
HPI and (iii) have a present value, when combined with all other such payments
(the "Total Payments"), that equals or exceeds three times the average annual
compensation paid to Mr. Berg by HPI over the term of his employment with HPI
(the "Employment Period"). The Total Payments may include all or a portion of
the $300,000 payment to Mr. Berg to be made by FPA pursuant to the FPA
Employment Agreement. See "THE MERGER -- Interests of Certain Persons in the
Merger."
If the Total Payments are considered parachute payments, they will be
treated as "excess parachute payments" to the extent the present value of such
payments exceeds the average annual compensation paid to Mr. Berg over the
Employment Period.
The Payments appear to be in the nature of compensation to Mr. Berg. A
change in ownership of HPI will occur as a result of the Merger, a necessary
precondition to Mr. Berg's right to receive the Payments, and the present value
of the Payments, when combined with all other such payments to Mr. Berg, will
exceed three times the average annual compensation paid to Mr. Berg over the
Employment Period. Accordingly, a portion of the Payments may constitute excess
parachute payments unless exempted in the manner described below.
The adverse federal income tax consequences to HPI and to Mr. Berg under
Sections 280G and 4999 of the Code may be avoided if the Payments are approved
by a separate vote of disinterested stockholders owning in excess of 75% of the
HPI Voting Securities, voting together, not held, directly or indirectly, by Mr.
Berg or certain members of his family, after adequate disclosure to all such
stockholders of all material facts concerning the Payments. If approved, the
Payments are no longer includable in the calculation of the Total Payments and,
as a result, the maximum Total Payments will be reduced to a level below the
threshold such that none of the Total Payments could be considered a parachute
payment. The disclosure set forth in this Proxy Statement/Prospectus is intended
as adequate disclosure to all HPI stockholders of all material facts concerning
the Payments.
For purposes of the stockholder vote discussed above, any stockholder of
HPI who is not an individual may exercise its vote through any person authorized
by the entity to vote such shares. However, if a substantial portion of the
assets of such entity consists of HPI Common Stock or HPI Preferred Stock, in
general, approval of the Payments must be made by a separate vote of the persons
who hold, immediately before consummation of the Merger, in excess of 75% of the
voting power of such entity. If the Payments are not approved by the HPI
stockholders, such Payments will be forfeited.
THE BOARD OF HPI HAS APPROVED THE PAYMENTS TO MR. BERG (WITH MR. BERG
ABSTAINING), SUBJECT TO STOCKHOLDER APPROVAL, AND RECOMMENDS A VOTE "FOR" THE
PROPOSAL TO PAY THE PAYMENTS TO MR. BERG.
BOARD OF DIRECTORS AND MANAGEMENT OF
FPA FOLLOWING THE MERGER
BOARD OF DIRECTORS OF FPA FOLLOWING THE MERGER
Upon consummation of the Merger, Seth Flam, Sol Lizerbram, Sheldon Derezin,
Stephen J. Dresnick, Kevin Ellis, Howard Hassman and Herbert A. Wertheim, each
of whom is currently a director of FPA, will continue to serve as directors of
FPA.
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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 49 Chairman of the Board of Directors
Dr. Seth Flam 39 President, Chief Executive Officer and Director
Dr. Stephen J. Dresnick 46 Vice Chairman of the Board of Directors and President,
Sterling Healthcare Group, Inc.
Steven M. Lash 43 Executive Vice President, Chief Financial Officer and
Treasurer
James A. Lebovitz 39 Senior Vice President, General Counsel and Secretary
</TABLE>
DESCRIPTION OF FPA COMMON STOCK
FPA's authorized capital stock consists of 98,000,000 shares of Common
Stock, $.002 par value per share, and 2,000,000 shares of Preferred Stock, $.001
par value per share. As of September 24, 1997, there were 33,789,827 shares of
FPA Common Stock and no shares of FPA Preferred Stock issued and outstanding.
Holders of FPA Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Holders of FPA Common Stock do not
have cumulative voting rights and, therefore, holders of a majority of the
shares voting for the election of FPA directors can elect all of the directors.
In such event, the holders of the remaining shares will not be able to elect any
directors.
Holders of the FPA Common Stock are entitled to receive such dividends as
may be declared from time to time by the Board of Directors out of funds legally
available therefor, subject to the terms of any agreement governing FPA's
indebtedness. FPA does not anticipate paying cash dividends in the foreseeable
future. In the event of the liquidation, dissolution or winding up of FPA, the
holders of FPA Common Stock are entitled to share ratably in all assets
remaining after payment of liabilities.
Holders of the FPA Common Stock have no preemptive, conversion or
redemption rights and are not subject to further calls or assessments by FPA.
All of the outstanding shares of FPA Common Stock are validly issued, fully paid
and nonassessable.
The transfer agent and registrar for FPA Common Stock is American Stock
Transfer & Trust Company.
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COMPARISON OF RIGHTS OF HOLDERS OF HPI
AND FPA COMMON STOCK
Both FPA and HPI are Delaware corporations and the rights of their
respective stockholders are governed by the Delaware Act and their Certificates
of Incorporation and Bylaws. In addition, the rights of the HPI stockholders are
affected by the 1994 Securities Purchase Agreement. If the Merger is
consummated, HPI 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 HPI
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, HPI's Certificate of Incorporation and Bylaws and the
1994 Securities Purchase Agreement.
PREFERRED STOCK
The Boards of Directors of FPA and HPI 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; HPI currently has authorized 50,000 shares of preferred
stock, $.001 par value. FPA has not authorized or issued any shares of preferred
stock. HPI has issued and outstanding 25,000 shares of Series A Convertible
Preferred Stock and 25,000 shares of Series B Convertible Preferred Stock. A
condition to the consummation of the Merger is the conversion, prior to the
Effective Time, of the issued and outstanding shares of HPI Preferred Stock into
HPI Common Stock, which HPI Common Stock will subsequently be converted into FPA
Common Stock. Each of WellPoint and Oxford has agreed to convert its outstanding
shares of HPI Preferred Stock to HPI Common Stock prior to the Effective Time.
As a result of these transactions, the current holders of HPI Preferred Stock
will no longer enjoy the special dividend, voting and liquidation preferences
and rights set forth in the HPI Certificate of Incorporation. Also, upon
conversion, the cumulative unpaid dividends on the HPI Preferred Stock will be
canceled with no additional shares of HPI Common Stock issued as consideration
for the cancellation.
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. Currently, the FPA Board consists of seven
members. HPI's Certificate of Incorporation provides that the number of
directors on the HPI Board shall be specified in HPI's Bylaws. The HPI Bylaws
provide that the Board shall have one or more members as determined by a
majority of the Board. Currently, the HPI Board consists of five members. The
1994 Securities Purchase Agreement provides that so long as each of Oxford and
WellPoint beneficially owns at least 20% of the outstanding shares of HPI Common
Stock (assuming conversion of the outstanding shares of HPI Preferred Stock
beneficially owned by such stockholder), each of Oxford and WellPoint will be
entitled to nominate two directors to the HPI Board. In addition, for so long as
certain individual investors collectively own at least 10% of the outstanding
shares of HPI Common Stock, the representative of a majority in interest of the
individual investors (the "Representative") shall be entitled to nominate one
director to the HPI Board. Currently, each of Oxford and WellPoint beneficially
owns in excess of 20%, and the individual investors collectively own in excess
of 10%, of the HPI Common Stock, so that these provisions are in effect.
FPA's and HPI's Bylaws provide that any or all 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. HPI's Bylaws also provide that a director may
be removed for cause by vote of a majority of the HPI Board. The 1994 Securities
Purchase Agreement provides that if any of Oxford, WellPoint or the
Representative notifies the HPI stockholders that (i) such person or
Representative wishes to remove a director nominated by it or (ii) if any of
such stockholders no longer owns the requisite percentage of shares required to
maintain such nomination rights, all such stockholders shall vote their shares
in favor of such removal if a vote is otherwise required.
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HPI's Bylaws provide that a vacancy on the HPI 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. HPI's Bylaws also provide that a vacancy created by
the removal of a director may be filled by a vote of the holders of a majority
of the outstanding shares of capital stock of HPI 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.
HPI's Bylaws provide that directors shall be elected by a plurality of
votes cast at annual meetings of stockholders (and holders of HPI's Preferred
Stock shall have the same right to vote as holders of HPI's Common Stock on an
as-converted basis) with each director serving until the next annual meeting of
stockholders and until his successor is duly elected and qualified or until his
earlier death, resignation or removal or as described above pursuant to the 1994
Securities Purchase Agreement. FPA's Bylaws provide for a staggered Board of
Directors, with the directors of FPA divided into three classes, as nearly equal
in number as possible. Each director on the FPA Board is elected to serve a term
of three years and until his successor is duly elected and qualified.
BYLAWS
FPA's Certificate of Incorporation grants the FPA Board the power to
repeal, alter, amend or rescind FPA's Bylaws. FPA's Bylaws permit FPA's
stockholders to alter, amend, repeal or adopt the same. HPI's Certificate of
Incorporation provides that the HPI Board may adopt, repeal, alter, amend or
rescind HPI's Bylaws, subject to the right of the holders of a majority of the
outstanding stock of HPI, by vote at an annual or special meeting, to amend,
alter or repeal any Bylaw made by the Board.
STOCKHOLDER MEETINGS
HPI's Bylaws provide that special meetings of stockholders may be called by
the HPI Board. FPA's Bylaws provide that special meetings of stockholders may be
called by the President. Furthermore, FPA's Bylaws provide that such special
meeting 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.
The 1994 Securities Purchase Agreement further provides that if any party
to the 1994 Securities Purchase Agreement fails to vote its shares for directors
as required therein, each other stockholder to such Agreement shall have an
irrevocable, perpetual proxy, exercisable by any of them individually, to vote
such shares of HPI securities in accordance with the 1994 Securities Purchase
Agreement.
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 (i)
expenses (including attorneys' fees) and certain amounts paid in settlement and
(ii) 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 and HPI's Bylaws require 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 ("Indemnitees") for actions undertaken
in an official capacity or any other capacity.
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FPA's Certificate of Incorporation and HPI's Bylaws provide for the
continuation of indemnification for Indemnitees no longer employed by the
respective company (where the conduct at issue occurred while the Indemnitee was
employed by such company). FPA's Certificate of Incorporation and HPI's Bylaws
also provide for the benefits of indemnification to inure to the heirs,
executors and administrators of the Indemnitee. Furthermore, FPA's Certificate
of Incorporation and HPI's Bylaws require, as a prerequisite to indemnification
in connection with a suit initiated by the Indemnitee, that the Indemnitee
receive authorization from the Board prior to initiating the suit.
FPA's Certificate of Incorporation and HPI's Bylaws grant Indemnitees the
right to receive an advance of funds from their respective company 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 Indemnitee may
be required to deliver an undertaking to his respective company to the effect
that the Indemnitee will repay all amounts advanced should the Indemnitee
ultimately be determined not to be entitled to indemnification.
FPA's Certificate of Incorporation provides that if an 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 Indemnitee may sue FPA
for the unpaid amount. If the 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 such failure to meet the standard of conduct for indemnification as a
defense. FPA may not offer as a defense to the advancement of funds that it has
not yet determined whether the Indemnitee has met the appropriate standard of
conduct. Neither HPI's Bylaws nor its Certificate of Incorporation contains
comparable provisions.
STOCKHOLDER VOTING REQUIREMENTS
Under the Delaware Act, unless otherwise provided for 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.
HPI's Certificate of Incorporation contains provisions requiring the
affirmative vote of the holders of at least 80% or more of HPI Voting Securities
to amend, alter or repeal or adopt any provision inconsistent with the current
provision of the Bylaws providing that HPI's directors shall not be liable to
HPI or its stockholders for monetary damages for breach of fiduciary duty as a
director. In addition, until there are less than 5,000 shares of HPI Preferred
Stock outstanding, the approval of at least 60% of the issued and outstanding
shares of HPI Common Stock and HPI Preferred Stock, voting as a class, is
required to sell, abandon, transfer, lease or otherwise dispose of all or
substantially all of its properties or assets, merge or consolidate with or into
another corporation, voluntarily dissolve, liquidate or wind-up, authorize,
create, issue or sell any class of capital stock of HPI ranking prior to or on a
parity with the HPI Preferred Stock, alter or change the designations, rights
and preferences of the HPI Preferred Stock in any manner or authorize any
employee stock option plan or program except plans relating to not in excess of
1,450,000 shares of HPI Common Stock.
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 stockholders 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. Both FPA's and HPI's
Bylaws permit action by such written consent.
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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 A 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.
THE MERGER
The Merger Agreement provides that, subject to the approval and adoption of
the Merger Agreement by the stockholders of HPI and the satisfaction or waiver
of other conditions to the Merger, Merger Sub will be merged with and into HPI
in accordance with the Delaware Act, whereupon the separate existence of Merger
Sub will cease and HPI will be the Surviving Corporation and a wholly owned
subsidiary of FPA.
At the Effective Time:
(i) Each issued and outstanding share of HPI Common Stock, except as
provided for below, will be exchanged for the right to receive a number of
shares of FPA Common Stock equal to the Exchange Ratio. For a discussion of
the Exchange Ratio, see "THE MERGER -- Merger Consideration."
(ii) Each share of HPI Common Stock and HPI Preferred Stock held in
HPI's treasury will be canceled and extinguished and will cease to exist
and no consideration will be delivered with respect thereto.
(iii) If applicable, each outstanding share of HPI Common Stock and
HPI Preferred Stock, the holder of which (a) has not voted in favor of the
Merger, (b) has perfected such holder's dissenters' rights to appraisal in
accordance with the pertinent provisions of the Delaware Act and (c) has
not effectively withdrawn or lost such rights to appraisal, will not be
converted into a right to receive shares of FPA Common Stock, but such
holder shall be entitled only to such rights as are granted under the
applicable provisions of the Delaware Act. See "THE MERGER -- Rights of
Dissenting Stockholders."
(iv) Each share of capital stock of Merger Sub issued and outstanding
immediately prior to the Effective Time will be converted into and
exchanged for one validly issued, fully paid and nonassessable share of
common stock of the Surviving Corporation.
Immediately prior to the Effective Time, HPI shall use its reasonable best
efforts to cause each issued and outstanding share of HPI Preferred Stock to be
converted into shares of HPI Common Stock in accordance with the provisions of
the relevant Certificate of Designations for such HPI Preferred Stock, and such
shares of HPI Common Stock will be converted into the right to receive shares of
FPA Common Stock as described above in subparagraph (i) of this section. The
holders of HPI Preferred Stock have agreed to convert their shares of HPI
Preferred Stock to HPI Common Stock prior to the Effective Time. Upon conversion
of the HPI Preferred Stock into HPI Common Stock, cumulative unpaid dividends
will be canceled with no additional shares of HPI Common Stock issued as
consideration for the cancellation.
At the Effective Time, present holders of HPI Common Stock and HPI
Preferred Stock will cease to have any rights as holders of such shares, other
than, if applicable, dissenters' rights to appraisal, but will have the right to
receive shares of FPA Common Stock and cash in lieu of any fractional shares of
FPA Common Stock.
The Certificate of Incorporation and Bylaws of Merger Sub will be the
Certificate of Incorporation and Bylaws of the Surviving Corporation. The
directors of Merger Sub serving immediately prior to the Effective Time will be
the initial directors of the Surviving Corporation, in each case until their
respective successors are duly elected or appointed and qualified.
EFFECTIVE TIME
The Merger will become effective on such date as the duly prepared and
executed Certificate of Merger is filed with the Secretary of State of Delaware
in accordance with the Delaware Act. The filing of the
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Certificate of Merger will be made simultaneously with or as soon as practicable
after the second business day immediately following the date on which all
conditions contemplated by the Merger Agreement have been fulfilled or waived or
such other time as agreed between the parties.
FRACTIONAL SHARES
No certificates or scrip for fractional shares of FPA Common Stock will be
issued in connection with the Merger. In lieu of any such fractional share, each
holder of HPI Common Stock who would otherwise have been entitled to a fraction
of a share of FPA Common Stock upon surrender of certificates for exchange will
be entitled to receive from the Exchange Agent a cash payment equal to such
fraction multiplied by the FPA Value.
SURRENDER AND PAYMENT
From and after the Effective Time, as required by the Merger Agreement, FPA
will make available to the Exchange Agent certificates representing the
appropriate number of shares of FPA Common Stock and cash to be paid in lieu of
fractional shares of FPA Common Stock issuable in connection with the Merger.
Promptly after the Effective Time, the Exchange Agent shall mail to each holder
of a certificate or certificates that immediately prior to the Effective Time
represented HPI Common Stock ("HPI Certificates") a letter of transmittal and
instructions for surrendering the HPI Certificates, and each holder thereof will
be entitled to receive, upon surrender to the Exchange Agent of one or more HPI
Certificates, certificates representing the number of whole shares of FPA Common
Stock into which such shares are converted in the Merger and cash in
consideration of fractional shares of FPA Common Stock, as described above.
TREATMENT OF STOCK OPTIONS
As of September , 1997, there were outstanding options to purchase
1,183,000 shares of HPI Common Stock. HPI expects to issue options to purchase
approximately 170,287 shares of HPI Common Stock in the Roll-up Transactions. At
the Effective Time, each of the outstanding options to purchase shares of HPI
Common Stock ("HPI Options") granted under the HPI 1994 Stock Option Plan (the
"HPI Option Plan"), whether or not vested, including the substitute HPI Options
issuable to holders of Minority Options in connection with the completion of the
Roll-up Transactions, will be canceled in exchange for a number of Shares of
fully paid FPA Common Stock (the "FPA Option Shares"), decreased to the nearest
whole share, equal to the quotient which results when the "Fair Market Value" of
such option at the Effective Time is divided by the FPA Value (the "Option
Exchange"). The Fair Market Value of the HPI Options will be determined by an
investment banking firm, selected by HPI and acceptable to FPA, by applying a
variation of the Black-Scholes option pricing model. HPI estimates that an
aggregate of FPA Option Shares will be issued in the Merger.
HPI and FPA believe that HPI has the right under the HPI Option Plan to
undertake the Option Exchange without seeking the consent of the holders of HPI
Options. However, HPI has agreed to use its reasonable best efforts to cause the
holders of HPI Options to execute prior to the Closing Date a form of
acknowledgement reasonably acceptable to FPA regarding their acceptance of the
treatment of HPI Options set forth in the Merger Agreement and described above
(the "Stock Option Acknowledgements"). FPA can terminate the Merger Agreement if
HPI does not enter into Stock Option Acknowledgment Agreements with holders of
HPI Options representing at least 80% of the total number of HPI Options.
CERTAIN REPRESENTATIONS AND WARRANTIES
The Merger Agreement contains various customary representations and
warranties of each of FPA, Merger Sub and HPI (which are subject, in certain
cases, to specified exceptions, and all of which terminate at the Effective
Time) relating to, among other things, the following: (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
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documents and reports filed by FPA 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) HPI's stockholders' vote to approve the Merger;
(xiv) accounting matters relating to "pooling of interests;" (xv) title to
assets; and (xvi) permits.
CONDUCT OF BUSINESS PENDING THE MERGER
At all times from and after the date of the Merger Agreement until the
Effective Time, HPI 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 its business
only in the ordinary course consistent with past practice; (ii) use its
reasonable best efforts to keep available the services of its key officers and
employees; (iii) maintain insurance on its tangible assets and businesses in
such amounts and against such risks and losses consistent with past practice;
and (iv) preserve its relationships with customers and others having business
dealings with them.
At all times from and after the date of the Merger Agreement until the
Effective Time, each of FPA, Merger Sub and HPI has agreed that it will not
permit any of its respective 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; (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, except in the case of
FPA with respect to certain potential acquisitions as disclosed to HPI; (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) HPI may grant options to the extent required to be granted automatically
under the HPI Option Plans or pursuant to written employment agreements, may
issue shares of HPI Common Stock upon conversion of HPI Preferred Stock and may
issue shares of HPI Common Stock and HPI Options to effect the Roll-up
Transactions and (B) FPA may issue shares upon exercise of options or upon
conversion of the FPA Debentures and in connection with potential acquisitions
as disclosed to HPI; (vii) (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;
(viii) 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 HPI and its subsidiaries and $300,000,000 with respect to FPA and its
subsidiaries (in each case net of any amounts of any such indebtedness
discharged during such period); (ix) 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 HPI and its subsidiaries and $300,000,000 with respect to FPA and its
subsidiaries; (x) with respect to HPI, enter into, adopt or amend (except as may
be required by applicable law) any bonus, profit sharing, compensation, stock
option, pension, retirement, deferred compensation, health care, employment or
other employee benefit plan, agreement, trust, fund or arrangement for the
benefit or welfare of any employee or retiree or enter into or amend any
employment, severance, special pay arrangement with respect to termination of
employment or other similar arrangements or agreements with any directors,
officers or key
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employees, except in the ordinary course and consistent with past; (xi) with
respect to HPI, make any acquisitions of assets in excess of $250,000 and with
respect to FPA and its subsidiaries, 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;
(xii) knowingly take or fail to take any action which action or failure to take
action would cause HPI or its stockholders to recognize gain or loss for federal
income tax purposes as a result of the consummation of the Merger; (xiii)
knowingly take any action which would jeopardize the treatment of the Merger as
a pooling of interests; or (xiv) fail to use all commercially reasonable efforts
to preserve intact in all material respects their present business organizations
and reputation.
At all times from and after the date of the Merger Agreement until the
Effective Time, each of FPA and HPI has further agreed that prior to the
Effective Time 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) 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 give notice to the other and use their
respective best efforts to prevent or promptly remedy (i) the occurrence or
failure to occur or the impending or threatened occurrence or failure to occur,
of any event which occurrence or failure to occur would be likely to cause any
of its representations or warranties to be untrue or inaccurate in any material
respect and (ii) any material failure on its part to comply with or satisfy any
covenant, condition or agreement to be complied with or satisfied by it.
CERTAIN ADDITIONAL AGREEMENTS
Pursuant to the Merger Agreement, FPA and HPI have made the following
additional agreements.
Access to Information. Each of FPA and HPI shall, and shall cause each of
its subsidiaries, throughout the period commencing on the date of the Merger
Agreement and ending at the Effective Time, to: (i) provide the other party and
its legal and financial advisors, accountants and any other agents and
representatives (collectively, "Advisors") with full access, upon reasonable
prior notice and during normal business hours, to 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 HPI, 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 HPI, 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 HPI, 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 HPI, as the case may be, the other party will, and will cause its
Advisors to, promptly redeliver or cause to be redelivered all copies of
documents and information furnished by FPA or HPI, as the case may be, or its
Advisors to such party and its Advisors 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 HPI, as the case may be, or
its Advisors.
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.
Regulatory and Other Approvals. Subject to the terms and conditions of the
Merger Agreement, each of HPI 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, (i)
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, HPI or any of their subsidiaries to consummate
the Merger and the other matters contemplated hereby and (ii) 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
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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 HPI 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 the FTC, the DOJ or
any state attorney general.
Employee Benefit Plans. In the Merger Agreement, FPA agreed that, for one
year after the Effective Time, FPA shall, or shall cause the Surviving
Corporation to, provide employee benefit plans and programs for the benefit of
employees and former employees of HPI ("HPI Employees"), which, in the
aggregate, are no less favorable than the HPI employee benefit plans and
programs in effect immediately prior to the Effective Time. FPA further agreed
that, for the two year period beginning on the date one year following the
Effective Time, FPA shall, or shall cause the Surviving Corporation to, provide
HPI Employees with employee benefit plans and programs that are no less
favorable in the aggregate to those provided from time to time to FPA employees
of comparable status and seniority. Except as specified in the Merger Agreement,
with respect to such benefits, past service, compensation and expense credits of
such HPI Employees shall be recognized, whenever reasonably possible, consistent
with the terms of such plans and programs, for all purposes under such plans and
each employee or fringe benefit plan or program available to HPI Employees as
contemplated hereby shall be applied to such HPI Employees.
FPA agreed to honor, and agreed to cause the Surviving Corporation to
honor, without modification, all existing employment, severance, consulting and
salary continuation agreements between HPI and any current or former officer,
director, employee or consultant to HPI.
Directors' and Officers' Indemnification and Insurance. FPA agreed to
purchase and maintain, for a period of six years following the Effective Time,
policies of directors' and officers' liability insurance covering current and
former directors, officers and employers of HPI with respect to claims arising
from facts or events that occurred on or prior to the Effective Time, providing
at least the same coverage and amounts and containing terms that are no less
advantageous to the insured parties as those in effect immediately prior to the
Effective Time for officers and directors of FPA. FPA agreed to indemnify all
past or present directors, officers, employees, trustees and agents of HPI
against any liability or 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 six years from the Effective Time as officers,
directors, employees, trustees or agents of HPI, and in connection therewith,
agreed to advance attorney's fees to them to defend any such claim; provided
that FPA shall be entitled to direct the defense of any such matter; 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 to cover these obligations.
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.
Pooling of Interests. FPA and HPI agreed that from and after the date of
the Merger Agreement and until the Effective Time, neither FPA nor HPI 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 HPI as a "pooling of interests" for financial
and 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.
Brokers or Finders. Each of FPA and HPI represented that no broker, finder
or investment banker is entitled to any broker's, finder's or other fee or
commission in connection with any of the transactions
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contemplated by the Merger Agreement, except Smith Barney, whose fees and
expenses will be paid by HPI in accordance with HPI's agreement with such firm.
Fulfillment of Conditions. Subject to the terms and conditions of the
Merger Agreement, each of FPA and HPI 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 HPI 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, HPI agreed that (a) neither
it nor any of its subsidiaries shall, and it shall use its best efforts to cause
its 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
HPI 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 portion of the assets of HPI and its subsidiaries
taken as a whole, (ii) any of the outstanding shares of HPI Common Stock or
Preferred Stock or (iii) any of the outstanding shares of the capital stock of
any subsidiary of HPI (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 and (b) 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 except for the Roll-up Transactions.
HPI Stockholder Agreements. FPA, HPI, Oxford and WellPoint are parties to a
Stockholder Agreement whereby Oxford and WellPoint have delivered irrevocable
proxies to FPA to vote all of their HPI Voting Securities for the approval and
adoption of the Merger Agreement and the transactions contemplated thereby.
FPA and HPI Affiliates. Each of FPA and HPI has delivered a letter to the
other identifying all persons who may be deemed to be affiliates for purposes of
Accounting Series Release 135 ("ASR 135"). On or prior to a date that is five
days prior to the Closing Date, (i) HPI will deliver a letter to FPA identifying
all persons who may be deemed affiliates of HPI under Rule 145, including,
without limitation, all directors and executive officers of HPI, and (ii) it
shall advise the persons identified in such letter of the resale restrictions
imposed by applicable securities laws. Each of FPA and HPI has obtained from its
respective affiliates an agreement that such persons will comply with the
provisions of ASR 135 and will not sell shares of FPA Common Stock or HPI Common
Stock and Preferred Stock in an amount which would contravene the provisions of
ASR 135 until combined results of operations of FPA and HPI covering at least 30
days of combined operations are made public. FPA has agreed to keep current its
filings under the Exchange Act for purposes of reliance upon the resale
provisions of Rule 145.
Registration Rights Agreement. In the Merger Agreement, FPA agreed to enter
into the Registration Rights Agreement with Oxford, WellPoint, and Messrs. Berg,
Phillips, Conlin and Wiggins (the "Selling Stockholders") pursuant to which FPA
will file a registration statement with the Commission as soon as practicable
after the Closing Date covering the shares received in the Merger by the Selling
Stockholders (and no other shares of FPA Common Stock) and use its reasonable
efforts to cause such registration statement to be declared effective on or
prior to 90 days after the Closing Date (but no earlier than 60 days following
the Closing Date). FPA has agreed to use its reasonable efforts to keep the
registration statement effective for the period ending two years after the
Closing Date or such shorter period as may be necessary in order for the Selling
Stockholders to freely sell the registered shares. In no event shall FPA be
obligated to file more than one registration statement pursuant to the terms of
the Registration Rights Agreement.
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ROLL-UP TRANSACTIONS
HPI has affiliated with group practices and IPAs through subsidiaries (the
"HPI Subsidiaries"). The physician-owners of the group practices and IPAs own
shares in HPI Subsidiaries with which they contract to provide health care
services. In each case, the physician-owners own less than a 30% interest in
such Minority Shares. Each of the HPI Subsidiaries has also granted Minority
Options to certain of its employees." Shareholder agreements with the
physician-owners and the stock option plans for each HPI Subsidiary grant HPI
the right to exchange the Minority Shares and Minority Options for HPI Common
Stock and HPI Options, respectively, of equal value (the "Roll-up
Transactions").
In the Merger Agreement, HPI agreed to exercise its right and deliver
roll-up notices to each of the Minority Holders, which notices serve to inform
the Minority Holders of HPI's intention to undertake the Roll-up Transactions.
The Roll-up Transactions contemplate the exchange, immediately prior to the
Effective Time, of the Minority Shares and Minority Options with respect to each
HPI Subsidiary for HPI Common Stock and substitute HPI Options based on the fair
value of such stock and options (the "Subsidiary Value"). HPI has delivered such
notices and has reached agreement with the Minority Holders of each HPI
Subsidiary with regard to the Subsidiary Value of each such HPI Subsidiary. As a
result of such valuations, HPI will issue in connection with the Roll-up
Transactions, immediately prior to the Effective Time, 871,697 shares of HPI
Common Stock and substitute HPI Options to purchase 170,287 shares of HPI Common
Stock. The acquisition of the Minority Shares shall be treated under the
purchase method of accounting with the difference between the fair value of the
HPI Common Stock issued and the fair value of the assets and liabilities
recorded as goodwill.
At the Effective Time, holders of such newly issued shares of HPI Common
Stock and substitute HPI Options will have the right to receive shares of FPA
Common Stock on the same terms and conditions as other holders of HPI Common
Stock and HPI Options at the Effective Time. See "THE MERGER -- Merger
Consideration" and "THE MERGER AGREEMENT -- Treatment of Stock Options."
CONDITIONS TO CONSUMMATION OF THE MERGER
In addition to the approval and adoption of the Merger Agreement by the
stockholders of HPI, 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 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 HPI's stockholders in the Merger 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 preliminary
or permanent injunction or other order or decree by any federal or state court
which prevents the consummation of the Merger shall have been issued and remain
in effect (each party agreeing to use its reasonable efforts to have any such
injunction, order or decree lifted); (vi) the receipt of letters from Deloitte &
Touche LLP and KPMG Peat Marwick LLP, each dated not more than two business days
prior to the Effective Time and addressed to FPA and HPI, respectively, stating
that the Merger will qualify as a "pooling of interests" transaction under APB
No. 16; (vii) the delivery by HPI to FPA on or prior to the date which is five
days prior to the Closing Date of a letter identifying all persons who may be
deemed affiliates of HPI under Rule 145, including, without limitation, all
directors and executive officers of HPI; (viii) the delivery by HPI 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; and
(ix) the receipt of all 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) HPI shall have performed in all
material respects each agreement, covenant and obligation required by the Merger
Agreement to be performed or complied with by it
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on or prior to the Closing Date and the representations and warranties of HPI in
the Merger Agreement shall be true and correct in all material respects (except
for such representations and warranties that are qualified by their terms by a
referral to materiality, which representations and warranties as so qualified
shall be true in all respects) on and as of the date made and as of the Closing
Date as though made on and as of the Closing and HPI shall have delivered to FPA
a certificate, dated the Closing Date and executed on behalf of HPI by its
President and Chief Executive Officer or a Vice President, to such effect; (ii)
HPI and its subsidiaries shall have received all consents (or, in lieu thereof,
waivers) from parties to each contract disclosed in the HPI Disclosure Letter;
(iii) FPA shall have received the opinion of counsel to HPI dated the Closing
Date; (iv) FPA shall have received an opinion from Pillsbury Madison & Sutro LLP
stating that the Merger will be treated for federal income tax purposes as a
tax-free reorganization; (v) FPA shall have received the resignations of the
members of the board of directors of HPI; (vi) FPA and Oxford shall have
executed the Master Strategic Agreement; (vii) FPA and WellPoint shall have
executed the Memorandum of Understanding; (viii) there shall be no HPI Preferred
Stock outstanding; (ix) Stock Option Acknowledgments shall have been executed
and delivered by the holders of no less than 80% of the HPI Options; (x) each
Roll-up Transaction shall either be complete by the Effective Time or escrow
agreements shall have been executed; and (xi) FPA shall have received the
Denominator Certificate from HPI.
The obligation of HPI 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 HPI in its sole
discretion): (i) FPA and Merger Sub shall have performed in all material
respects 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 in all material respects (except for such
representations and warranties that are qualified by their terms by a referral
to materiality, which representations and warranties as so qualified shall be
true in all respects) on and as of the date made and on and as of the Closing
Date as though made on and as of the Closing and each of FPA and Merger Sub
shall have delivered to HPI certificates, dated the Closing Date and executed on
behalf of FPA by its Chairman of the Board and Chief Executive Officer, the
President or a Vice President of FPA and of the President and Chief Executive
Officer or a Vice President of Merger Sub, to such effect; (ii) FPA shall have
delivered a registration rights agreement to the Selling Stockholders; (iii) HPI
shall have received an opinion from Gibson, Dunn & Crutcher LLP stating that the
Merger will be treated for federal income tax purposes as a tax-free
reorganization; (iv) the Smith Barney opinion shall not have been withdrawn; (v)
FPA shall have entered into employment agreements and have taken such other
employee related matters as agreed to by the parties to the Merger Agreement;
(vi) the FPA Value shall not be below $15.65; and (vii) HPI shall have received
the opinion of counsel to FPA dated the Closing Date.
To the extent that FPA or HPI waives compliance with any material
provisions of or conditions to the consummation of the Merger, including 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 HPI will amend this Proxy Statement/Prospectus, and HPI
will resolicit stockholder votes to the extent required by applicable law.
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 HPI: (i) by either FPA or HPI upon written notice to the
non-terminating party by the terminating party at any time after October 28,
1997, if the Merger has not been consummated on or prior to such date otherwise
than on account of delay or default on the part of the terminating party, except
that the non-terminating party may extend such date for an additional 30 days if
all required statutory approvals have not been obtained and, in the event FPA is
the non-terminating party, if the Roll-up Transactions have not been concluded;
(ii) if any condition to closing the Merger is not satisfied, other than as a
result of the conduct of the party whose obligation it was to obtain such
condition; (iii) 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 30 days
following receipt by the non-terminating party of notice of such breach from the
terminating party; (iv) if the
76
<PAGE> 82
Merger is enjoined by a final, unappealable court order not entered at the
request of or with the support of FPA or any of its 5% stockholders, in the case
of FPA, or HPI or any or its 5% stockholders, in the case of HPI; and (v) HPI
may terminate the Merger Agreement if the FPA Value is less than $15.65.
As described above, HPI may terminate the Merger Agreement if the FPA Value
is less than $15.65. The number of shares of FPA Common Stock issuable in the
Merger in exchange for each share of HPI Common Stock is determined by the
Exchange Ratio. See "THE MERGER -- Merger Consideration." In the event that the
FPA Value is below $15.65, the HPI Board, in exercise of its fiduciary duties,
would consider whether to terminate the Merger Agreement based on whether the
stockholders of HPI would receive fair consideration for their HPI Common Stock
and whether consummation of the Merger would be in the best interests of the
stockholders.
EFFECT OF TERMINATION
If the Merger Agreement is validly terminated by either HPI or FPA pursuant
to the Merger Agreement, the Merger Agreement will forthwith become void and
there will be no further obligation on the part of either HPI 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 willful breach or a knowing violation by such party
of its representations, warranties, covenants or agreements contained in the
Merger Agreement.
AMENDMENT
The Merger Agreement may not be amended except by action taken by or on
behalf of the respective boards of directors of the parties thereto or duly
authorized committees thereof and then only by a written instrument duly
executed by or on behalf of each party thereto and in compliance with applicable
law.
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 thereto
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, except that after the vote of HPI
stockholders with respect to the Merger Agreement, the formula for determining
the Exchange Ratio shall not be changed from that provided in the Merger
Agreement. 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.
77
<PAGE> 83
SELECTED HISTORICAL AND PRO FORMA INFORMATION
PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) OF
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
The following pro forma condensed consolidated balance sheet of FPA as of
June 30, 1997 and the pro forma condensed consolidated statements of operations
for the three fiscal years ended December 31, 1994, 1995 and 1996 and the six
months ended June 30, 1997 give effect, to the extent set forth below, to the
following consummated and probable transactions.
Consummated Transactions:
(1) The acquisition of Physicians First, Inc. ("PFI") (effective June 1,
1996).
(2) The acquisition of Foundation Health Medical Services and Affiliates
("FHMS") (effective November 29, 1996).
Probable Transaction:
(1) The proposed merger of FPA and HPI (the "Merger").
The Merger is reflected as of June 30, 1997 for the pro forma condensed
consolidated balance sheet. The Consummated Transactions are reflected as of
January 1, 1996 in the pro forma condensed consolidated statements of
operations. The Roll-up Transactions and the conversion of HPI Preferred Stock
into HPI Common Stock are reflected as of January 1, 1996 in the pro forma
condensed consolidated statements of operations and as of June 30, 1997 in the
pro forma condensed consolidated balance sheet. The Merger is reflected as of
January 1, 1994 in the pro forma condensed consolidated statements of
operations. The pro forma information is based on the respective historical
financial statements of the companies involved in the Consummated Transactions
and the Merger, giving effect to the Merger under the pooling of interests
method of accounting and the Consummated Transactions 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 and HPI as of June 30, 1997 and for the six months then ended, the
audited financial statements of FPA and HPI as of December 31, 1996 and for each
of the three years in the period then ended, and the unaudited results of
operations for PFI and FHMS up to their respective acquisition dates.
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
separate historical consolidated financial statements and accompanying notes of
FPA, HPI, PFI and FHMS.
78
<PAGE> 84
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
JUNE 30, 1997
ASSETS
<TABLE>
<CAPTION>
HEALTH
PARTNERS, FPA MEDICAL
INC. HEALTH MANAGEMENT, INC.
FPA MEDICAL HEALTH PRO FORMA PARTNERS, INC. PRO FORMA PRO FORMA
MANAGEMENT, INC. PARTNERS, INC. ADJUSTMENTS PRO FORMA ADJUSTMENTS CONSOLIDATED
---------------- -------------- ------------ -------------- ------------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Current assets:
Cash and cash
equivalents..... $ 12,648,662 $ 7,880,000 $ 7,880,000 $ 20,528,662
Marketable
securities...... 24,619,747 24,619,747
Accounts
receivable -- net... 186,781,243 1,518,000 1,518,000 188,299,243
Amounts due from
unconsolidated
affiliated
medical
corporations and
IPAs............ 7,707,000 7,707,000 7,707,000
Prepaid expenses
and other
assets.......... 8,610,274 1,497,000 1,497,000 10,107,274
Deferred income
tax asset....... 6,158,892 6,158,892
------------ ----------- ------------ ----------- ------------ ------------
Total
current
assets.... 238,818,818 18,602,000 18,602,000 257,420,818
Property and
equipment -- net... 39,123,772 8,384,000 8,384,000 47,507,772
Restricted cash and
deposits.......... 500,000 500,000
Goodwill and
intangibles -- net... 306,406,814 23,380,000 $ 7,993,000(I) 31,373,000 337,779,814
Investments in
GLHP.............. 4,994,900 4,994,900
Deferred income tax
asset............. 3,689,058 3,689,058
Deposits and other
assets............ 19,708,636 640,000 640,000 20,348,636
------------ ----------- ------------ ----------- ------------ ------------
Total....... $613,241,998 $ 51,006,000 $ 7,993,000 $ 58,999,000 $ $ 672,240,998
============ =========== ============ =========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable
and accrued
expenses........ $ 62,998,028 $ 7,829,000 $ 7,829,000 $ 15,500,000(A) $ 86,327,028
Claims payable,
including
incurred but not
reported
claims.......... 124,044,354 7,022,000 7,022,000 131,066,354
Long-term
debt -- current
portion......... 12,416,613 2,151,000 2,151,000 14,567,613
Current portion of
accrued
liability for
professional
liability
claims.......... 585,668 585,668
Other
liabilities..... 920,000 2,389,000 2,389,000 3,309,000
------------ ----------- ------------ ----------- ------------ ------------
Total
current
liabilities... 200,964,663 19,391,000 19,391,000 15,500,000 235,855,663
------------ ----------- ------------ ----------- ------------ ------------
Long-term
debt -- net of
current
portion......... 271,099,787 3,844,000 3,844,000 274,943,787
Accrued liability
for professional
liability
claims, net of
current
portion......... 3,195,912 3,195,912
Other long-term
liabilities..... 16,758,033 194,000 194,000 16,952,033
Minority
interests....... 746,000 (746,000)(I)
Stockholders'
equity:
Preferred
stock......... 50,000,000 (50,000,000)(J)
Common stock.... 65,933 2,000 23,000(I)(J) 25,000 (25,000)(F) 76,388
10,455(F)
Additional paid
in capital.... 209,292,915 58,716,000(I)(J) 58,716,000 (58,716,000)(F) 268,023,460
58,730,545(F)
Stock payable... 534,600 534,600
Accumulated
deficit....... (88,242,845) (23,171,000) (23,171,000) (15,500,000)(A) (126,913,845)
Less: Due from
stockholders... (427,000) (427,000)
------------ ----------- ------------ ----------- ------------ ------------
Total
stockholders'
equity........ 121,223,603 26,831,000 8,739,000 35,570,000 (15,500,000) 141,293,603
------------ ----------- ------------ ----------- ------------ ------------
Total....... $ 51,006,000 $ 51,006,000 $ 7,993,000 $ 58,999,000 $ $ 672,240,998
============ =========== ============ =========== ============ ============
</TABLE>
See accompanying notes to pro forma condensed consolidated financial statements.
79
<PAGE> 85
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
HEALTH
PARTNERS, FPA MEDICAL
INC. MANAGEMENT, INC.
FPA MEDICAL HEALTH PRO FORMA HEALTH PARTNERS, INC. PRO FORMA
MANAGEMENT, INC. PARTNERS, INC.(H) ADJUSTMENTS PRO FORMA CONSOLIDATED
---------------- ----------------- ----------- --------------------- ----------------
<S> <C> <C> <C> <C> <C>
Managed care revenue........... $337,816,319 $60,803,000 $60,803,000 $398,619,319
Fee-for-service revenue........ 137,752,525 137,752,525
Management services revenue.... 12,349,000 12,349,000 12,349,000
------------ ----------- -------- ------------ ------------
Total operating
revenue............ 475,568,844 73,152,000 73,152,000 548,720,844
------------ ----------- -------- ------------ ------------
Expenses:
Medical services............. 340,833,454 53,379,000 53,379,000 394,212,454
General and administrative... 109,904,940 20,949,000 $ 146,000(K) 21,095,000 130,999,940
Merger, restructuring and
other unusual charges..... 38,004,841 38,004,841
------------ ----------- -------- ------------ ------------
Total expenses....... 488,743,235 74,328,000 146,000 74,474,000 563,217,235
------------ ----------- -------- ------------ ------------
Loss from operations........... (13,174,391) (1,176,000) (146,000) (1,322,000) (14,496,391)
Other income (expense):
Interest and other income.... 4,778,925 425,000 425,000 5,203,925
Interest expense............. (8,865,929) (266,000) (266,000) (9,131,929)
Minority interests' share in
net losses................ 169,000 (169,000)(L)
------------ ----------- -------- ------------ ------------
Total other income
(expense).......... (4,087,004) 328,000 (169,000) 159,000 (3,928,004)
------------ ----------- -------- ------------ ------------
Loss before income taxes....... (17,261,395) (848,000) (315,000) (1,163,000) (18,424,395)
Income tax expense (benefit)... (3,351,782) 14,000 14,000 (3,337,782)
------------ ----------- -------- ------------ ------------
Net loss....................... $(13,909,613) $ (862,000) $(315,000) $(1,177,000) $(15,086,613)
============ =========== ======== ============ ============
Pro forma net loss per share... $ (0.40) $ (0.38)
Weighted average shares
outstanding(G)............... 34,510,257 39,737,530
</TABLE>
See accompanying notes to pro forma condensed consolidated financial statements.
80
<PAGE> 86
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
FOUNDATION FPA MEDICAL
HEALTH MANAGEMENT,
MEDICAL INC. AND
SERVICES, CONSUMMATED
FPA MEDICAL PHYSICIANS INC. TRANSACTIONS
MANAGEMENT, FIRST, AND PRO FORMA PRO FORMA HEALTH
INC. INC.(B) AFFILIATES ADJUSTMENTS CONSOLIDATED PARTNERS, INC.(H)
------------ ----------- ------------ ----------- ------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Managed care revenue.... $386,427,917 $14,870,833 $121,214,187 $ 522,512,937 $ 45,741,000
Fee-for-service
revenue............... 172,676,696 4,176,018 19,251,147 196,103,861
Management services
revenue............... 28,826,000
------------ ----------- ------------ ----------- ------------- ------------
Total operating
revenue....... 559,104,613 19,046,851 140,465,334 718,616,798 74,567,000
------------ ----------- ------------ ----------- ------------- ------------
Expenses:
Medical services...... 431,617,608 16,128,269 166,950,333 614,696,210 50,328,000
General and
administrative...... 139,646,319 2,811,904 44,210,000 $6,510,814 (C) 193,179,037 34,529,000
Merger, restructuring
and other unusual
charges............. 52,571,868 52,571,868
------------ ----------- ------------ ----------- ------------- ------------
Total
expenses...... 623,835,795 18,940,173 211,160,333 6,510,814 860,447,115 84,857,000
------------ ----------- ------------ ----------- ------------- ------------
Income (loss) from
operations............ (64,731,182) 106,678 (70,694,999) (6,510,814) (141,830,317) (10,290,000)
Other income (expense):
Interest and other
income.............. 1,991,288 83,940 6,168,667 8,243,895 677,000
Interest expense...... (6,164,532) (15,382) (8,619,667) (2,406,837) (D) (17,206,418) (539,000)
Other expense......... (2,757,000) (2,757,000)
Minority interests'
share in net
losses.............. 866,000
------------ ----------- ------------ ----------- ------------- ------------
Total other
income
(expense)..... (4,173,244) 68,558 (5,208,000) (2,406,837) (11,719,523) 1,004,000
------------ ----------- ------------ ----------- ------------- ------------
Income (loss) before
income taxes.......... (68,904,426) 175,236 (75,902,999) (8,917,651) (153,549,840) (9,286,000)
Income tax (expense)
benefit............... (1,080,000) (73,922) 16,362,667 17,565,593 (E) 32,774,338 (185,000)
------------ ----------- ------------ ----------- ------------- ------------
Net income (loss)....... $(69,984,426) $ 101,314 $(59,540,332) $8,647,942 $(120,775,502) $ (9,471,000)
============ =========== ============ =========== ============= ============
Pro forma net loss per
share................. $ (2.56) $ (3.84)
Weighted average shares
outstanding(G)........ 27,381,279 31,423,942
<CAPTION>
FPA
MEDICAL
HEALTH MANAGEMENT
PARTNERS, INC. INC.
PRO FORMA HEALTH PARTNERS, INC. PRO FORMA
ADJUSTMENTS PRO FORMA CONSOLIDATED
-------------- --------------------- -------------
<S> <C> <C> <C>
Managed care revenue.... $ 45,741,000 $ 568,253,937
Fee-for-service
revenue............... 196,103,861
Management services
revenue............... 28,826,000 28,826,000
----------- ------------ -------------
Total operating
revenue....... 74,567,000 793,183,798
----------- ------------ -------------
Expenses:
Medical services...... 50,328,000 665,024,210
General and
administrative...... $ 291,000(K) 34,820,000 227,999,037
Merger, restructuring
and other unusual
charges............. 52,571,868
----------- ------------ -------------
Total
expenses...... 291,000 85,148,000 945,595,115
----------- ------------ -------------
Income (loss) from
operations............ (291,000) (10,581,000) (152,411,317)
Other income (expense):
Interest and other
income.............. 677,000 8,920,895
Interest expense...... (539,000) (17,745,418)
Other expense......... (2,757,000)
Minority interests'
share in net
losses.............. (866,000)(L)
----------- ------------ -------------
Total other
income
(expense)..... (866,000) 138,000 (11,581,523)
----------- ------------ -------------
Income (loss) before
income taxes.......... (1,157,000) (10,443,000) (163,992,840)
Income tax (expense)
benefit............... (185,000) 32,589,338
----------- ------------ -------------
Net income (loss)....... $ (1,157,000) $ (10,628,000) $(131,403,502)
=========== ============ =============
Pro forma net loss per
share................. $ (3.61)
Weighted average shares
outstanding(G)........ 36,440,693
</TABLE>
See accompanying notes to pro forma condensed consolidated financial statements.
81
<PAGE> 87
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
FPA MEDICAL
FPA MEDICAL MANAGEMENT, INC.
MANAGEMENT, HEALTH PRO FORMA PRO FORMA
INC. PARTNERS, INC.(H) ADJUSTMENTS CONSOLIDATED
------------ ------------------ ----------- ----------------
<S> <C> <C> <C> <C>
Managed care revenue............. $164,164,875 $ 16,340,000 $180,504,875
Fee-for-service revenue.......... 118,470,607 118,470,607
Management services revenue...... 15,636,000 15,636,000
------------ ----------- ----------- ------------
Total operating
revenue.............. 282,635,482 31,976,000 314,611,482
------------ ----------- ----------- ------------
Expenses:
Medical services............... 202,739,878 14,719,000 217,458,878
General and administrative..... 74,489,765 25,207,000 99,696,765
Merger, restructuring and other
unusual charges............. 1,589,908 1,589,908
------------ ----------- ----------- ------------
Total expenses......... 278,819,551 39,926,000 318,745,551
------------ ----------- ----------- ------------
Income (loss) from operations.... 3,815,931 (7,950,000) (4,134,069)
Other income (expense):
Interest and other income...... 1,129,297 387,000 1,516,297
Interest expense............... (2,707,943) (116,000) (2,823,943)
Minority interests' share in
net losses.................. 683,000 683,000
------------ ----------- ----------- ------------
Total other income
(expense)............ (1,578,646) 954,000 (624,646)
------------ ----------- ----------- ------------
Income (loss) before income
taxes.......................... 2,237,285 (6,996,000) (4,758,715)
Income tax expense............... (1,504,320) (175,000) (1,679,320)
------------ ----------- ----------- ------------
Net income (loss)................ $ 732,965 $ (7,171,000) $ $ (6,438,035)
============ =========== =========== ============
Pro forma
Adjustment to income tax
expense(M).................. (262,000)
------------ ----------- ----------- ------------
Net income (loss)................ $ 470,965 $ (7,171,000) $ $ 6,700,035
============ =========== =========== ============
Pro forma net income (loss) per
share.......................... $ 0.03 $ (0.31)
Weighted average shares
outstanding(G)................. 18,306,992 21,277,698
</TABLE>
See accompanying notes to pro forma condensed consolidated financial statements.
82
<PAGE> 88
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.
FPA MEDICAL HEALTH PRO FORMA PRO FORMA
MANAGEMENT, INC. PARTNERS, INC. (H) ADJUSTMENTS CONSOLIDATED
---------------- ------------------ ----------- ----------------
<S> <C> <C> <C> <C>
Managed care revenue............ $ 78,939,286 $ 2,497,000 $ 81,436,286
Fee-for-service revenue......... 39,498,164 39,498,164
Management Services Revenue..... 8,468,000 8,468,000
------------ ----------- -------- ------------
Total operating
revenue............. 118,437,450 10,965,000 129,402,450
------------ ----------- -------- ------------
Expenses:
Medical services.............. 84,816,105 2,584,000 87,400,105
General and administrative.... 28,850,073 13,289,000 42,139,073
------------ ----------- -------- ------------
Total expenses........ 113,666,178 15,873,000 129,539,178
------------ ----------- -------- ------------
Income (loss) from operations... 4,771,272 (4,908,000) (136,728)
Other income (expense):
Interest and other income..... 633,955 446,000 1,079,955
Interest expense.............. (397,364) (254,000) (651,364)
Minority interests' share in
net losses................. 367,000 367,000
------------ ----------- -------- ------------
Total other income.... 236,591 559,000 795,591
------------ ----------- -------- ------------
Income (loss) before income
taxes......................... 5,007,863 (4,349,000) 658,863
Income tax expense.............. (1,667,025) (40,000) (1,707,025)
------------ ----------- -------- ------------
Net income (loss)............... $ 3,340,838 $ (4,389,000) $ $ (1,048,162)
============ =========== ======== ============
Pro forma
Adjustment to income tax
expense(M)................. (110,235)
------------ ----------- -------- ------------
Net income (loss)............... $ 3,230,603 $ (4,389,000) $ $ (1,158,397)
============ =========== ======== ============
Pro forma net income (loss) per
share......................... $ 0.29 $ (0.09)
Weighted average shares
outstanding(G)................ 11,271,046 13,343,522
</TABLE>
See accompanying notes to pro forma condensed consolidated financial statements.
83
<PAGE> 89
FPA NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
FPA consummated the purchase of PFI effective June 1, 1996 for $21,591,541
consisting of cash, FPA Common Stock and debt and FHMS effective November 29,
1996 for $111,000,000 consisting of cash, FPA Common Stock and debt. These
completed acquisitions by FPA were accounted for under the purchase method. The
merger of Sterling with FPA was consummated in October 1996 and the merger of
AHI with FPA was consummated in March 1997. Both of these mergers were accounted
for as a pooling of interests and FPA's financial statements have been restated
to take into account financial information and data of Sterling and AHI for all
periods presented. Additionally, FPA proposes to merge with HPI by issuing FPA
common stock in exchange for all of the outstanding common stock of HPI. It is
contemplated that the Merger will be accounted for as a pooling of interests.
The following adjustments are necessary to reflect the pro forma effects of the
FPA consummated and probable transactions.
Certain of the entities included in the pro forma condensed consolidated
financial statements are professional corporations in which FPA is unable to own
a majority interest due to certain state laws which prohibit the corporate
practice of medicine. Such entities are included in the pro forma condensed
consolidated financial statements due to the fact FPA consolidates these
professional corporations in the consolidated financial statements of FPA. These
professional corporations are consolidated by FPA because FPA has 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. The shareholder/director of each
of these professional corporations which are affiliated with FPA 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 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 consolidates the financial statements of these 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 FPA.
(A) Nonrecurring costs estimated to be $15,500,000 will be recorded in
connection with the Merger. These costs consist primarily of certain
employee termination costs, financial advisory fees, professional fees
and restructuring 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 expensed in the period the Merger is consummated.
(B) As a result of FPA's acquisition, PFI receives fully delegated
capitation revenue from Physicians Corporation of America, the seller,
based on the acquisition agreement with FPA, rather than only primary
care capitation as is reflected in this historical statement of
operations of PFI. The incremental revenue which PFI would have
received under this fully delegated contract, which is not included in
the pro forma condensed consolidated statement of operations, was
approximately $31,000,000 for the five months ended May 31, 1996 (date
of acquisition). 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, which is not included in the pro
forma condensed consolidated statement of operations.
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<PAGE> 90
(C) For the purpose of determining the pro forma effects of the
acquisitions of 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, 1996
-----------------------------------------
PFI FHMS TOTAL
--------- ----------- -----------
<S> <C> <C> <C>
Amortization over 4-15 years of
intangible assets(1)(2)............ $(100,419) $ (751,667) $ (852,086)
Amortization over 30 years of cost in
excess of net assets acquired
(goodwill)(2)(3)................... (177,957) (5,599,013) (5,776,970)
Depreciation of additional purchase
cost assigned to property and
equipment.......................... 118,242 118,242
--------- ----------- ---------
$(160,134) $(6,350,680) $(6,510,814)
========= =========== =========
</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
analyses.
(2) The total balance of the goodwill and intangibles at January 1, 1996
would have been approximately $196,053,338 and $6,164,019,
respectively, related to PFI and FHMS.
(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 Foundation Payor
agreements which have terms of 30 years. As the value of the Payor
agreements 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 Payor agreements for the purposes of the pro forma
condensed consolidated financial statements.
(D) Reflects the increase in interest expense as a result of the notes
issued in connection with the acquisitions of PFI and FHMS. The debt
in the amount of approximately $116,000,000 that was 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 had
an impact to interest expense of approximately $145,000 for the year
ended December 31, 1996.
(E) Reflects the estimated income tax effects of the pro forma
adjustments. 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 $153,549,840 for the year ended December 31, 1996
included in the pro forma condensed consolidated statement of
operations, FPA would need to generate a comparable amount of future
taxable income over the next 15 years (the net operating loss
carryforward period) in order to fully realize the benefit of these
net operating losses.
(F) Reflects the effects of the assumed issuance of 5,227,272 shares of
FPA Common Stock in exchange for 100% of the shares of outstanding HPI
Voting Securities and HPI Options based on an assumed Adjusted FPA
Value of $22 per share.
(G) The weighted average shares outstanding was calculated based on the
historical weighted average shares outstanding of FPA giving effect to
the assumed 5,227,272 shares of FPA Common Stock to be issued in
connection with the Merger. In addition, for the year ended December
31, 1996 the weighted average shares outstanding give effect to the
4,076,087 shares of FPA Common Stock issued in connection with the
FHMS acquisition and the 525,000 shares of FPA Common Stock issued in
connection with the PFI acquisition.
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<PAGE> 91
(H) The HPI consolidated financial statements have been presented to
conform with FPA's consolidation policies. Accordingly, only the
amounts associated with the consolidated IPA's of HPI have been
presented in the pro forma condensed consolidated statements of
operations. In order to present pro forma medical service expense in
accordance with FPA's classification of medical service expense, a
portion of HPI's clinic salaries, medical malpractice and medical
supplies have been classified as medical service expense in the pro
forma condensed consolidated statement of operations. The following
amounts included in the HPI financial statements have been classified
as medical service expense in the pro forma condensed consolidated
statement of operations, with the remainder being classified as
general and administrative expense.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
------------------------ SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
-------- ------ ------ ----------------
<S> <C> <C> <C> <C>
Clinic salaries, wages and benefits............. 1,022 2,253 2,152 1,289
Network operating expenses...................... 1,091 1,959 2,797 1,834
</TABLE>
(I) Reflects the effect of the issuance of HPI Common Stock valued at an
aggregate of approximately $8,739,000 in connection with the Roll-up
Transactions.
(J) Reflects the conversion of the HPI Preferred Stock into 8,000,025
shares of HPI Common Stock.
(K) The acquisition of minority interests shall be treated under the
purchase method of accounting with the difference between the fair
value of the HPI Common Stock issued and the fair value of the assets
and liabilities recorded as goodwill. This adjustment reflects the
amortization of goodwill incurred as a result of the Roll-up
Transactions.
(L) Reflects the elimination of the minority interests share in net losses
as a result of the Roll-up Transactions.
(M) The pro forma net income (loss) and net income (loss) per share
information in the 1994 and 1995 pro forma condensed consolidated
statement of operations reflect the effect on historical results as if
FPA had been a C Corporation rather than an S Corporation for income
tax purposes, and no tax benefit arose as a result of the change in
tax status.
86
<PAGE> 92
SELECTED HISTORICAL FINANCIAL DATA -- FPA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected historical financial data of FPA set forth below for the years
ended December 31, 1994, 1995 and 1996 which give effect to the merger with AHI,
accounted for as a pooling of interests, have been derived from FPA's audited
Consolidated Financial Statements included elsewhere in this Proxy
Statement/Prospectus. The Selected Historical Financial Data for the years ended
December 31, 1993 and 1992 and the six months ended June 30, 1997 and 1996 are
unaudited. In the opinion of FPA's management, all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of FPA's
financial position and results of operations for such unaudited periods, have
been included. Operating results for the six months ended June 30, 1997 are not
necessarily indicative of the results that may be expected for any other interim
period or for the year. The data set forth below should be read in conjunction
with FPA's Consolidated Financial Statements and the notes thereto included
elsewhere in this Proxy Statement/Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
-------------------------------------------------------- -----------------------
1992 1993 1994 1995 1996 1996 1997
------- ------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
COMBINED STATEMENTS OF
OPERATIONS:
Operating revenue............. $39,959 $58,853 $ 118,437 $ 282,636 $ 559,105 $ 237,201 $ 475,569
Medical services expense...... 28,477 41,346 84,816 202,740 431,618 177,675 340,833
------- ------- -------- -------- -------- -------- --------
11,482 17,507 33,621 79,896 127,487 59,526 134,736
General and administrative
expense..................... 12,382 14,406 28,850 74,490 139,646 59,293 109,905
Merger, restructuring and
other unusual charges....... 1,590 52,572 38,005
------- ------- -------- -------- -------- -------- --------
Income (loss) from
operations.................. (900) 3,101 4,771 3,816 (64,731) 233 (13,174)
Other income (expense), net... 197 135 237 (1,579) (4,173) (667) (4,087)
------- ------- -------- -------- -------- -------- --------
Income (loss) before income
taxes....................... (703) 3,236 5,008 2,237 (68,904) (434) (17,261)
Income tax (expense)
benefit..................... (10) (84) (1,667) (1,504) (1,080) (3,175) 3,351
------- ------- -------- -------- -------- -------- --------
Net income (loss)............. $ (713) $ 3,152 $ 3,341 $ 733 $ (69,984) $ (3,609) $ (13,910)
------- ------- -------- -------- -------- -------- --------
PRO FORMA PER SHARE DATA:
Net income (loss) per share... $ 0.37 $ 0.29 $ 0.03 $ (2.56) $ (0.13) $ (0.40)
Weighted average shares
outstanding................. 8,602,201 11,271,046 18,306,992 27,381,279 27,660,452 34,510,257
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------- JUNE 30,
1992 1993 1994 1995 1996 1997
------ ------- ------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
COMBINED BALANCE SHEET DATA:
Cash and marketable securities........ $3,542 $ 4,037 $12,872 $ 43,009 $ 55,472 $ 37,268
Working capital surplus (deficit)..... (973) (81) 17,289 42,521 (38,092) 37,854
Total assets.......................... 7,710 11,543 65,756 228,663 579,664 613,242
Long-term liabilities................. 112 371 12,270 24,043 194,432 291,054
Stockholders' equity (deficit)........ 125 (1,001) 27,236 137,615 134,374 121,224
</TABLE>
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<PAGE> 93
SELECTED CONSOLIDATED FINANCIAL DATA -- HPI
(IN THOUSANDS)
The selected consolidated financial data set forth below for the period
September 15, 1993 (date of inception of operations) to December 31, 1993 and
for the years ended December 31, 1994, 1995 and 1996 have been derived from
HPI's consolidated financial statements which have been audited by KPMG Peat
Marwick LLP, independent auditors. The selected consolidated financial data as
of and for the six months ended June 30, 1996 and 1997 have been derived from
unaudited financial statements of HPI. In the opinion of HPI's management, all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of HPI's financial position and results of operations for such
unaudited periods, have been included. Operating results for the six months
ended June 30, 1997 are not necessarily indicative of the results that may be
expected for any other interim period or for the fiscal year. The data set forth
below are qualified in their entirety by, and should be read in conjunction
with, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS-HPI," HPI's consolidated financial statements and the notes
thereto and the other financial and statistical information included elsewhere
in this Proxy Statement/Prospectus.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
----------------------------------------- --------------------------
1993(1) 1994 1995 1996 1996 1997
------- ------- ------- -------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net Revenue:
Net revenue of consolidated IPAs.......... $ 441 $ 2,497 $16,340 $ 45,741 $20,125 $ 60,803
Amounts associated with unconsolidated
entities:
Net revenue of unconsolidated affiliated
medical corporations.................. 425 17,675 36,910 53,677 25,200 21,906
Net revenue of unconsolidated IPAs...... -- -- 34,027 40,456 20,310 21,680
Cost of affiliated physician services... (317) (4,579) (12,327) (16,419) (7,876) (10,747)
Medical claims of unconsolidated
affiliated medical corporations....... (108) (4,628) (9,829) (10,389) (5,709) --
Medical claims of unconsolidated IPAs... -- -- (33,145) (38,499) (19,401) (20,490)
------- ------- ------- -------- ------- -------
Management services revenue............... -- 8,468 15,636 28,826 12,524 12,349
Other revenue............................. 10 36 165 255 101 247
------- ------- ------- -------- ------- -------
Net revenue........................ 451 11,001 32,141 74,822 32,750 73,399
------- ------- ------- -------- ------- -------
Operating Expenses:
Clinic salaries, wages and benefits....... 445 5,743 11,457 13,995 6,229 9,362
Medical claims of consolidated IPAs....... -- 471 10,507 45,379 21,133 50,256
Network operating expenses................ -- 897 2,889 4,676 2,010 2,503
Other clinic expenses..................... 862 4,745 9,797 13,371 6,092 7,598
General corporate expenses................ 329 2,152 3,904 4,974 2,314 2,896
Depreciation and amortization............. 20 1,865 1,372 2,462 1,132 1,713
Net interest expense (income)............. (10) (156) (106) 117 68 88
------- ------- ------- -------- ------- -------
Total operating expenses........... 1,646 15,717 39,820 84,974 38,978 74,416
Loss before minority interests and
provision for income taxes.............. (1,195) (4,716) (7,679) (10,152) (6,228) (1,017)
Minority interests........................ -- 367 683 866 352 169
Provision for income taxes................ -- (40) (175) (185) (56) (14)
------- ------- ------- -------- ------- -------
Net loss.................................. $(1,195) $(4,389) $(7,171) $ (9,471) $(5,932) $ (862)
======= ======= ======= ======== ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
----------------------------------------- --------------------------
1993 1994 1995 1996 1996 1997
------- ------- ------- -------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash...................................... $ 3,543 $ 4,734 $ 4,473 $ 7,823 $ 2,902 $ 7,880
Working capital (deficit)................. 3,125 4,200 (170) (1,836) (3,228) (789)
Total assets.............................. 6,308 19,747 30,653 56,719 32,480 51,006
Long-term debt............................ 0 719 696 670 683 657
Stockholders' equity...................... 3,810 12,335 17,164 25,193 16,232 26,831
</TABLE>
- ---------------
(1) For the period September 15, 1993 (date of inception of operations) through
December 31, 1993.
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<PAGE> 94
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS -- HPI
The discussion and analysis set forth below is qualified in its entirety,
and should be read in conjunction with, HPI's Consolidated Financial Statements
and notes thereto and the other financial and business information related to
HPI included elsewhere in this Proxy Statement/Prospectus.
OVERVIEW
HPI was incorporated and commenced operations in September 1993 and
completed its first affiliation with a physician group practice in November
1993. Through June 30, 1997, HPI has entered into administrative services
agreements with a total of eight physician group practices representing 150
physicians and six IPAs representing 1,572 physicians. As a result of HPI's
limited period of affiliation with the group practices and IPAs, as well as the
significant number of acquisitions made by HPI, HPI does not believe that the
period to period comparisons and percentage relationships within periods set
forth below are meaningful. The following table sets forth information regarding
HPI's physician group practice and IPA affiliations and capitated patients under
risk contracts as of April 1, 1997:
<TABLE>
<CAPTION>
DATE OF NUMBER OF NUMBER OF PRIMARY NUMBER OF NUMBER OF
AFFILIATED PRACTICE/IPA AFFILIATION PHYSICIANS CARE PHYSICIANS SPECIALISTS CAPITATED PATIENTS
- ----------------------------- -------------- --------- ----------------- --------- ------------------
<S> <C> <C> <C> <C> <C>
PHYSICIAN GROUPS
Mednet Healthcare Group November 1993 13 10 3 6,700
Brooklyn, New York
Virginia Medical Associates August 1994 42 27 15 16,500
Northern Virginia
Manhattan Primary Care October 1994 7 7 0 6,700
Manhattan, New York
Patient First Physicians July 1995 28 22 6 8,000
Group
Northern Kentucky
Vento Medical Services June 1996 13 7 6 2,000
Brooklyn, New York
Clarkstown Pediatric July 1996 21 21 0 6,500
Associates
Rockland County, New York
Primary Care Associates October 1996 14 14 0 4,000
Northern Kentucky
Gerald Family Care November 1996 12 12 0 14,000
Washington, DC
IPAS
Mednet Healthcare Group November 1993 248 42 206 1,900
Brooklyn, New York
Medica August 1994 285 91 194 10,900
Brooklyn, New York
Manhattan Primary Care October 1994 156 48 108 16,300
Manhattan, New York
Brooklyn Physician Associates January 1995 253 71 182 24,500
Brooklyn, New York
Health One Associates August 1995 252 77 175 28,000
Brooklyn, New York
San Antonio Network of June 1996 295 85 210 6,000
Physicians
San Antonio, Texas
Vento Medical Group June 1996 83 4 79 0
Brooklyn, New York
</TABLE>
HPI has affiliated with physician group practices and IPAs through
Subsidiaries. Each HPI Subsidiary acquires the property, medical and office
equipment of a group practice and simultaneously enters into an exclusive
administrative services agreement with a newly formed professional corporation.
The administrative
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<PAGE> 95
services agreement requires the HPI Subsidiary to provide the professional
corporation with management systems and services, non-physician health care
personnel and equipment. While HPI does not directly engage in the practice of
medicine, the HPI Subsidiary may also contract with Payors and enter into a
provider services agreement with the professional corporation. The newly formed
professional corporation contracts with physician, other professional medical
corporations and/or contracts with Payors. Certain HPI Subsidiaries provide
similar services to IPAs, except such subsidiaries do not provide non-physician
health care personnel and equipment to the IPAs; however, they do provide
certain medical management service to the IPAs. The HPI Subsidiaries do not
purchase the property, medical and office equipment of the IPAs, but may
purchase contractual relationships with Payors and other providers. See
"BUSINESS OF HPI -- Administrative Services Agreements." In connection with
affiliations with medical groups and IPAs, HPI has issued the physician-owners
of the group practice or IPA shares of the relevant HPI Subsidiary, which
represents a minority interest in that HPI Subsidiary. In connection with the
minority interests, HPI has entered into shareholders agreements with all
minority shareholders which require that, at the closing of the Merger, the
holders of the minority interests exchange their stock and options in HPI
subsidiaries for HPI Common Stock with an equal value. These exchanges are
referred to in this Proxy Statement/Prospectus as the "Roll-up Transactions."
HPI and the shareholder representative for each HPI Subsidiary have reached
agreement on valuation. See "THE MERGER AGREEMENT -- Roll-up Transactions."
Net revenue of consolidated IPAs, net revenue of unconsolidated affiliated
medical corporations and net revenue of unconsolidated IPAs is derived from
affiliated group practices which earn revenue from providing medical services to
enrollees of HMOs and Payors, on both a capitated and fee-for-service basis, and
from affiliations with IPAs, which earn revenue by providing medical services to
enrollees of HMOs and Payors on a capitated basis. While HPI does not directly
engage in the practice of medicine, certain HPI Subsidiaries, affiliated group
practices and affiliated IPAs contract directly with HMOs and managed care
Payors for the provision of specified medical services and to coordinate all
inpatient and outpatient care for the assigned enrollees. Generally, HPI or an
affiliated group practice or IPA receives a capitation payment from the Payor
for members of the Payor who select one of the affiliated group practice's or
IPA's primary care physicians as the member's primary care provider. The
capitation payment may be either a fixed amount or a percentage of the premium
related to the enrollee. The determination of whether the capitation payment is
based on a percentage of premium or a fixed amount depends upon the Payor's
policies relating to the establishment of capitation rates and the current
market trends in reimbursement methodology. The percentage of premium or the
fixed amount is negotiated based on the medical loss ratio of the Payor,
historical medical loss ratios of the group practice or IPA and the covered
benefits under the risk contract. In addition, such contracts provide for the
establishment of shared risk pools, which represent an annual hospital budget
fund against which all payments for hospital services are credited. Under the
Payor contracts, the networks are entitled to receive a portion of any surplus
remaining in the hospital funds at the end of specified periods. Some of the
Payor contracts obligate the networks to bear a portion of any deficits in the
hospital funds. The percentage sharing in the surplus or deficits of hospital
funds will depend on the contractual terms of the Payor contract. If an HPI
Subsidiary contracts with an HMO in a shared risk arrangement, the HPI
Subsidiary bears the ultimate financial risk under the shared risk contract.
Typically, the HPI Subsidiary has shared its risk with the contracting
physicians and would be required to pay to or collect from the physicians any
applicable surplus or deficits. If an Affiliated Practice or IPA contracts with
an HMO in a shared risk arrangement and the HPI Subsidiary has entered into an
agreement to share certain surpluses and deficits as part of its administrative
services agreement, the HPI Subsidiary would either be entitled to or be
obligated for its portion of the surplus or deficit. For those affiliated
medical corporations and IPAs where HPI does not exercise control but has a net
profits interest, HPI includes the net revenue of such entities in net revenue
of unconsolidated affiliated medical corporations and net revenue of
unconsolidated IPAs. Cost of affiliated physician services, medical claims
expenses for unconsolidated affiliated medical corporations and medical claims
of unconsolidated IPAs are deducted from the net revenue of unconsolidated
affiliated medical corporations and net revenue of unconsolidated IPAs.
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<PAGE> 96
The following table sets forth the percentage of net revenue of all
affiliated medical corporations and IPAs (regardless or whether the entity is
consolidated) derived from capitation and fee-for-service billings for the three
years ended December 31, 1996 and the six months ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
-------------------------- -----------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Capitation............................ 71% 79% 76% 78% 79%
Fee-for-service....................... 29% 21% 24% 22% 21%
</TABLE>
The cost of medical services provided by the affiliated group practices,
IPAs and independent contracting physicians, includes 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 compensated on a capitated basis, in which they
receive a fixed monthly fee for each enrollee selecting such physician, or on a
fee-for-service basis. Specialist and ancillary providers are typically
compensated on a fee-for-service basis. Hospitals are typically compensated on a
per diem basis.
The nature of affiliated group practices affects the cost of affiliated
physician services, clinic salaries, wages and benefits, medical claims of
unconsolidated affiliated medical corporations (if the affiliated group practice
has capitation arrangements), other clinic expenses and depreciation and
amortization. These expenses as a percentage of net revenues of unconsolidated
medical corporations will vary based upon the mix of primary care and specialist
providers, the percentage of net revenue of unconsolidated medical corporations
received on a capitated basis and the scope of the risk of providing health care
services undertaken in a particular capitation agreement.
The nature of the IPAs affects the costs of medical claims of consolidated
IPAs or medical claims of unconsolidated IPAs, network operating expenses and
depreciation and amortization. These expenses as a percentage of net revenues of
consolidated IPAs or medical claims of unconsolidated IPAs will vary based upon
the scope of risk of providing medical care undertaken in a specific capitation
agreement and the underlying variations in margin for commercial, Medicaid and
Medicare contracts and the growth in enrollment for these product lines.
Net revenue of unconsolidated affiliated medical corporations also includes
fee-for-service revenue generated by physicians employed by the affiliated group
practices. Fee-for-service revenue is reduced by provisions for contractual
adjustments which arise under the terms of certain reimbursement arrangements
and managed care contracts, and represent the difference between charges at the
established rates and estimated reimbursable amounts. Contractual adjustments
are recognized in the period services are rendered.
Cost of affiliated physician services, medical claims of unconsolidated
affiliated medical corporations and medical claims or unconsolidated IPAs are
deducted from net revenue of unconsolidated affiliated medical corporations and
net revenue of unconsolidated IPAs. Management services revenue is equivalent to
the net profits interest and is calculated as net revenue of unconsolidated
medical corporations plus net revenue of unconsolidated IPAs less cost of
affiliated physician services less medical claims of unconsolidated affiliated
medical corporations less medical claims of unconsolidated IPAs.
Cost of affiliated physician services includes amounts paid to physicians
employed by the affiliated group practices under various compensation plans at
each professional corporation. The physician compensation plans are intended to
encourage clinical efficiency and productivity and are based on factors such as
the amount of prepaid revenue, the mix between primary care and specialty
physicians in the group and community standards for physician compensation.
Clinic salaries, wages and benefits includes all amounts paid to
non-provider personnel employed at the affiliated group practices. The personnel
includes clinical, administrative and management personnel.
Medical claims of consolidated IPAs, medical claims of unconsolidated
affiliated medical corporations and medical claims of unconsolidated IPAs
includes the cost of services rendered by network providers as well as by
non-network providers for which the affiliated group practices and IPAs are
financially responsible under capitated agreements. These amounts are paid by
either a subsidiary of HPI, the affiliated group practices, IPAs or the Payor
depending on the terms of the Payor contract. In certain contracts, funds are
advanced to an
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<PAGE> 97
affiliated group practice or IPA which is responsible for the payment of the
claims. Under other contracts, the Payor pays the claims and performs periodic
settlements pursuant to which surpluses are paid to the affiliated group
practice or IPA or deficits are offset against future payments.
Network operating expenses includes all the administrative costs, including
salaries, wages and benefits associated with subsidiaries who provide service to
IPAs.
Other clinic expenses include all other operating expenses attributable to
affiliated group practices except for costs of affiliated physician services,
clinic salaries, wages and benefits, medical claims (if applicable), and
depreciation and amortization, interest income and expense and provision for
income taxes. These costs typically include occupancy costs, professional
liability insurance and medical and pharmaceutical supplies, among others.
Minority interests represent the proportionate share of the net income or
loss of each subsidiary attributable to the minority shareholders of such
subsidiaries. If the equity in net losses exceeded the minority interests' share
in the equity, HPI recognized all losses in the consolidated statements of
operations.
HPI's profitability depends upon effectively managing the cost and quality
of providing care in a prepaid environment, and enhancing the efficiency of
group practice and IPA operations.
HPI's quarterly operating results are subject to fluctuations resulting
from the timing and amount of costs associated with HPI's development and
acquisition of group practices and IPAs, by trends in medical costs and by other
operational or external factors. Additionally, quarterly results may be affected
by significant differences between the actual and estimated amounts receivable
from or payable to Payors relating to capitation arrangements and incurred but
not reported medical claims. Such payables and receivables are settled
periodically, and the timing of the settlements vary by Payor and are governed
by the terms of the capitation agreement. In addition, changes in enrollment
from one Payor to another, particularly during the periods of open enrollment
for employer groups, could impact quarterly results.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996.
For the six months ended June 30, 1997, net revenue of consolidated IPAs
increased $40.7 million to $60.8 million from $20.1 million in 1996. Due to a
change in the risk sharing percentages of certain contracts with Oxford,
consolidated IPAs recorded an additional $25.0 million of net revenue. These
increases are offset by the cancellation of a risk contract with Oxford which
decreased net revenue of consolidated IPAs by $4.0 million. An increase of $10.4
million in net revenue of consolidated IPAs is attributable to certain risk
contract which were transferred to HPI Subsidiaries, with the remaining increase
was attributable to growth in membership and providers for existing IPAs
consolidated by HPI.
Net revenue of unconsolidated affiliated medical corporations decreased
$3.3 million or 13% to $21.9 million from $25.2 million in 1996. A decrease of
$10.4 million is attributable to certain risk contracts which were transferred
to HPI's subsidiaries and consolidated into net revenue of consolidated IPAs.
This decrease is offset by an increase of $7.1 million for new affiliations with
affiliated medical corporations.
Costs of affiliated physician services increased $2.8 million or 37% to
$10.7 million from $7.9 million in 1996. This increase is attributable to three
new affiliations with group practices which contributed $2.3 million.
Medical claims of unconsolidated affiliated medical corporations decreased
$5.7 million in 1995 which resulted from the transfer of risk sharing contracts
held by affiliated group practices to HPI Subsidiaries.
Clinic salaries, wages and benefits increased $3.2 million or 52% to $9.4
million from $6.2 million in 1996. due to the three new affiliations with group
practices and contributed $3.0 million.
Medical claims of consolidated IPAs increased $29.1 million or 137% to
$50.3 million from $21.1 million in 1996. Due to a change in risk sharing
percentages of certain contracts with Oxford, the affiliated group practices and
IPAs recorded an additional $25.0 million in medical claims expense. This
increase is offset by the cancellation of a risk contract with Oxford which had
previously contributed $4.0 million. The remaining increase is attributable to
growth in membership and providers.
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<PAGE> 98
General corporate expenses increased in gross dollars as HPI has continued
to expand its management team, corporate office and install and operate its
information systems. General corporate expenses as a percentage of net revenue
has decreased while it has increased in gross dollars. HPI expects to continue
this trend as it grows and affiliates with additional group practices and IPAs.
FISCAL 1996 COMPARED TO FISCAL 1995.
For the year ended December 31, 1996, net revenue of consolidated IPAs
increased $29.4 million or 180% to $45.7 million from $16.3 million in 1995.
Full year results of operations of a consolidated IPAs contributed net revenues
of $15.3 million. The remaining increase in net revenue of consolidated IPAs is
attributable to increases in enrollment of capitated membership and an increase
in the number of primary care physicians in the managed care network.
Net revenues of unconsolidated affiliated medical corporations increased
$16.8 million or 45% to $53.7 million from $36.9 million in 1995. The increase
resulted from full year results of the operations of an affiliated group
practice acquired in 1995 which contributed an additional $7.7 million. Also,
four new affiliations with group practices contributed an additional $4.7
million. Finally, affiliated group practices portion of surpluses from risk
sharing settlements increased by $1.7 million.
Net revenues of unconsolidated IPAs increased $6.4 million or 19% to $40.4
million from $34.0 million in 1995. The increase resulted from growth in
providers and corresponding enrollees for three IPAs which contributed an
additional $10.6 million. Also, a new affiliation with an IPA contributed an
additional $.9 million. These increases are offset by a $6.0 million decrease
which resulted from the transfer of a risk contract held by an IPA to an HPI
Subsidiary.
Cost of affiliated physician services increased $4.1 million or 33% to
$16.4 million from $12.3 million in 1995. The increase resulted from four new
affiliations with group practices which contribute $2.0 million and full year
results of the affiliated group practice acquired in 1995 contributed an
additional $2.1 million in 1996. This increase was offset by a $.4 million
decrease attributable to a reduction in the number of employed physicians at a
group practice. The growth in cost of affiliated physician services has not
increased in proportion to net revenue of unconsolidated affiliated medical
corporations since HPI has experienced a higher level of revenue growth in
capitation revenue.
Medical claims of unconsolidated IPAs increased $5.4 million or 16% to
$38.5 million from $33.5 million in 1995. This increase is attributable to
growth in new providers and corresponding enrollees for three IPAs which
contributed an additional $10.6 million. Also, a new affiliation with an IPA
contributed an additional $.9 million. These increases are offset by a $6.0
million decrease which resulted from the transfer of a risk sharing contract
held by an affiliated IPA to an HPI Subsidiary.
Clinic salaries, wages and benefits increased to $14.0 million or 22% from
$11.5 million in 1995. The increase is primarily attributable to the four new
affiliations with group practices which contributed $1.5 million.
Medical claims of consolidated IPAs increased $34.9 million to $45.4
million for 1996 from $10.5 million in 1995. The increase is attributable to the
full year results of an IPA which affiliated with HPI in August 1995 which
contributed $17.0 million. The remaining increase is primarily attributable to
an increase in enrollment of capitated members in New York.
Other clinic expenses increased $3.6 million or 36% to $13.4 million from
$9.8 million in 1995. The increase is attributable to the new group practice
affiliations which contributed $1.3 million in 1996. Full year results for the
group practice acquired in 1995 contributed $2.1 million.
For the year ended December 31, 1996, general corporate expenses were $5.0
million, an increase of $1.1 million or 27% from $3.9 million in 1995. HPI
continued to expand its management team and infrastructure to manage its
acquisitions and growth strategy. HPI expects general corporate expenses to
increase in gross dollars but not in proportion to growth in revenue and other
expenses.
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<PAGE> 99
FISCAL 1995 COMPARED TO FISCAL 1994.
For the year ended December 31, 1995, net revenue of consolidated IPAs
increased $13.8 million to $16.3 million from $2.5 million for 1994. The
increase is attributable to the full year results of the operations of the IPAs
with which HPI affiliated in 1994.
Net revenue of unconsolidated affiliated medical corporations increased
$19.2 million or 115% to $36.9 million from $17.7 million in 1994. This increase
is attributable to the full year results of the operations of affiliated medical
groups acquired in 1994 which contributed an additional $11.2 million. Also, an
increase resulted from a new affiliation with a medical group which contributed
$5.5 million.
Net revenue of unconsolidated IPAs was $34.0 million for 1995. During 1995,
HPI affiliated with two new IPAs which had existing membership in January and
August 1995 and previously affiliated IPAs experienced their first enrollment
during 1995.
Cost of affiliated physician services increased to $12.3 million for the
year ended December 31, 1995 from $4.6 million for 1994. This increase is
attributable to affiliations with additional affiliated group practices in 1995,
which cost approximately $2.1 million and the full year results of affiliation
with additional affiliated group practices in 1994, which cost approximately
$5.1 million.
Medical claims of unconsolidated IPAs were $33.1 million for 1995, when HPI
affiliated with two new IPAs which had existing membership in January and August
1995. Also, previously affiliated IPAs experienced their first enrollment during
1995.
Clinic salaries, wages and benefits increased $5.8 million or 100% to $11.5
million for the year ended December 31, 1995 from $5.7 million for 1994. The
increase is attributable to new affiliations with additional group practices and
the full year results for affiliation with additional group practices in 1994.
Clinic salaries, wages and benefits decreased as a percentage of revenue due to
the addition of IPAs, which do not require clinical staffing.
Medical claims of consolidated IPAs increased to $10.1 million from $.5
million for 1994. The increase in medical claims is due primarily to HPI's
affiliation with additional IPAs in January and August 1995. The increase is
also attributable to growth after HPI's affiliation with these additional IPAs
as physicians were added and covered lives increased for existing physicians.
General corporate expenses increased in gross dollars as HPI has continued
to expand its management team, corporate office and install and operate its
information systems. HPI expects general corporate expenses to increase in the
future in gross dollars. However, the expense should decline as a percentage of
revenue.
LIQUIDITY AND CAPITAL RESOURCES
HPI requires capital primarily to acquire the assets of group practices,
develop managed care networks around its affiliated group practices, develop
affiliations with new IPAs and expand the managed care contracting network of
its affiliated IPAs. The aggregate purchase price of HPI's previous transactions
have ranged from $75,000 to $5.25 million. To fund this development and growth,
HPI has sold HPI Preferred Stock to Oxford and WellPoint pursuant to the 1994
Securities' Purchase Agreement. As of February, 1997, Oxford and WellPoint had
purchased an aggregate of $50 million of HPI Preferred Stock.
Cash was $7.9 million as of June 30, 1997, compared to $2.9 million as of
December 31, 1996. At June 30, 1997, HPI had a working capital deficit of $.7
million, compared to a deficit of $1.8 million as of December 31, 1996. Cash
used in operating activities was $.6 million, ($1.1) million, ($4.9) million,
and ($4.5) million for the six months ended June 30, 1997 and the years ended
December 31, 1996, 1995 and 1994, respectively. The operating deficits are
attributable to general corporate expenses required to generate growth for HPI
into additional markets and to fund operating resources required to increase the
operational effectiveness of the managed care networks. HPI has no planned
material capital expenditures or capital commitments.
As a result of HPI's capital requirements to fund its projected
acquisition, growth and development plans and normal capital expenditures for
existing group practices, HPI expects that its existing cash resources and
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<PAGE> 100
anticipated cash flow from operations will not be sufficient to meet capital
requirements for the next 12 months. If HPI is unable to consummate the Merger
and is unable to significantly increase its cash flow from operations, HPI will
be required to explore other financing alternatives. These alternatives will
include a potential initial public offering of HPI Common Stock, the issuance of
long-term or short-term indebtedness or the issuance of its securities in a
private transaction. No assurances can be made that such financings will be
available to HPI on satisfactory terms and conditions.
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<PAGE> 101
BUSINESS OF HPI
HPI is a PPM which invests in and manages multi-specialty physician medical
groups and IPAs. While HPI does not engage in the practice of medicine, certain
HPI Subsidiaries, affiliated medical groups or IPAs contract with HMOs and other
Payors on a capitated or global fee basis in selected metropolitan markets to
provide services to assigned enrollees. HPI's strategy is to affiliate with
physicians who are seeking a partner to assist the medical group or network in
transitioning from a fee-for-service oriented health care system to a managed
care system. Each HPI Subsidiary acquires the property, medical and office
equipment of a group practice and simultaneously enters into an exclusive
administrative services agreement with a newly formed professional corporation.
The administrative services agreement requires the applicable HPI Subsidiary to
provide the newly formed professional corporation with management systems and
services, non-physician health care personnel and equipment. The HPI Subsidiary
may also contract with Payors and enter into a provider services agreement with
the newly formed professional corporation. The newly formed professional
corporation contracts with physicians, other professional medical corporations,
and/or contracts with Payors. Certain HPI Subsidiaries provide similar services
to IPAs, except such subsidiaries do not provide non-physician health care
personnel and equipment to the IPAs; however, they do provide certain medical
management services to the IPAs. The HPI Subsidiaries do not purchase the
property, medical and office equipment of the practice, but may purchase certain
contractual relationships with Payors and/or other providers.
In each market, HPI seeks to affiliate with a locally prominent medical
group or IPA and assist the medical group or IPA in building a managed care
infrastructure and developing a high quality, geographically strong network of
physicians. The network is designed to increase the number of available primary
care physicians, which provides an opportunity for HPI to increase the number of
patients served under a capitated or global fee contract. HPI believes this
approach enables physicians to provide high quality, cost-effective health care,
is highly desirable to both Payors and patients and is more likely to assist
physicians in successfully adapting to a managed care environment. HPI has
targeted major metropolitan markets with lower HMO penetration. HPI should
benefit as managed health care grows in these geographic markets by an increase
in new Payor and physician relationships.
The key elements of HPI's strategy are as follows:
Focus on High Quality Physician Group Practices. HPI develops managed
care networks in local communities by affiliating with high quality and
locally prominent physician groups. These physicians are often community
leaders, are sought after by both Payors and patients, and are likely to
better lead and adapt to a managed care system that requires significantly
more efficient delivery of health care resources. In such affiliations, HPI
purchases substantially all of the practices' operating assets and enters
into long-term administrative services agreements, which align the
incentives of HPI and the physicians to provide high quality efficient
care. HPI's affiliation with these physician group practices and IPAs
serves as the hub for the development of managed care networks.
Develop Primary Care-Oriented Networks. HPI develops primary
care-oriented multispecialty physician networks which deliver high quality,
low cost health care to patients and HMOs. Primary care physicians, as the
"gatekeepers" of the managed care system, control patient access to
specialist, hospital and other services. By controlling patient access,
primary care physicians can exert significant control over the quality and
price of specialist and hospital services, which control often exceeds that
of Payors. Furthermore, this control is enhanced through the addition of
primary care physicians, which has the capability of increasing the number
of covered members in the managed care network.
Manage the Delivery of Quality Medical Care. HPI seeks to enhance the
ability of its affiliated physicians to provide efficient, high quality
care to their patients. HPI empowers its affiliated physicians to develop
and lead the implementation of quality and utilization management programs.
By placing physicians in the decision making and oversight roles, HPI
believes it can generate greater physician enthusiasm and patient
satisfaction in the managed care environment and achieve superior quality
and cost of care results.
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Develop Sophisticated Information Systems. Sophisticated information
technology is critical for HPI and its affiliated physicians to manage the
financial and clinical risk of its capitation arrangements. HPI's
information system is a comprehensive system which administers patient
eligibility and benefits, claims payment, physician referrals, case
management and data management. The system enables HPI to administer
physician-designed quality and utilization management programs, pay for
specialist services at rates below HMO fees and analyze financial and
clinical data.
Negotiate Capitated Arrangements with Payors. HPI has negotiated
multiple shared and full risk contracts with Payors for certain HPI
Subsidiaries or for its affiliated group practices or IPAs. The contracting
party is determined based on the provisions of the respective
administrative services agreement with the group practice or IPA and will
vary by contract. These arrangements provide incentives to HPI's affiliated
physicians to deliver high quality, cost effective services to their
patients. HPI believes that the marketplace for such services is
increasing.
Target Local Communities in Major Metropolitan Areas. HPI has targeted
local communities in major metropolitan areas for its development areas.
Large markets offer significant growth opportunities that can leverage
existing management and physician infrastructure. A concentrated community
presence increases both the attractiveness of HPI's managed care networks
and its ability to negotiate favorable rates and contract terms with Payors
and other providers. In addition, many metropolitan markets have a
substantial oversupply of specialist physicians and hospital beds, which
provides HPI the opportunity to obtain significant contractual discounts on
specialist and hospital services.
ADMINISTRATIVE SERVICES AGREEMENTS
Each HPI Subsidiary enters into an administrative services agreement which
provides for the HPI Subsidiary to assume the administrative responsibilities of
the group practice or the IPA. These responsibilities include the provision of
management systems and services, non-physician health care and management
personnel, facilities, medical and office equipment. The agreements typically
provide for (i) initial terms of five years with either two, six or nine renewal
periods of five years each or (ii) ten year terms with a minimum of six renewal
periods of five years each or (iii) perpetual or forty year terms. Renewals
under these arrangements are at the sole discretion of the HPI Subsidiary.
However, two HPI Subsidiaries have entered into administrative services
agreements with initial terms of five years with renewal terms not at the sole
discretion of HPI. One agreement provides for an automatic renewal for an
additional five year term unless either party provides notice twelve months
prior to renewal notifying the other party of termination of the administrative
services agreement. The second agreement provides for an automatic renewal for
successive two year terms unless either party provides notice within 180 days
prior to renewal notifying the other party of termination of the administrative
services agreement.
Pursuant to the administrative services agreement, the professional
corporation has assigned to the HPI Subsidiary the revenue of the professional
corporation and has granted a security interest in the professional
corporation's or IPA's accounts receivable. The assignment of revenue does not
include any revenue which cannot be assigned to the HPI Subsidiary by operation
of law. Pursuant to the administrative services agreement, the HPI Subsidiary
receives a management fee in consideration for its services, which varies by
agreement. The management fee is calculated either (i) as a contracted sharing
of revenue and profits or (ii) the HPI Subsidiary's costs plus a percentage of
revenue or a fixed dollar amount or (iii) revenue minus expenses. The ranges of
management fees payable are (i) five to fourteen percent of revenue as defined
in the administrative services agreements, (ii) cost plus $.4 million to cost
plus $1 million or cost plus eight percent of revenue as defined in the
administrative services agreements or (iii) revenue minus expenses. The
management fee is intended to yield the net profits interests in the affiliated
medical group or IPA.
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SECURITY OWNERSHIP OF CERTAIN HPI BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of HPI's securities as of June 30, 1997 by: (i) each of HPI's
directors (other than David B. Snow Jr., Thomas C. Geiser and Max Brown, who do
not own any securities of HPI) and executive officers, (ii) all directors and
named executive officers of HPI as a group and (iii) each person known to HPI to
be a beneficial owner of 5% or more of any class of HPI's voting securities.
<TABLE>
<CAPTION>
NUMBER OF SHARES
OF HPI COMMON STOCK
NAME AND ADDRESS OF CLASS OF SECURITIES BENEFICIALLY PERCENT OF HPI
HPI SECURITIES HOLDERS CURRENTLY OWNED OWNED(1) COMMON STOCK
- ----------------------------------------------- ------------------- ------------------- --------------
<S> <C> <C> <C>
Directors and Executive Officers:
Charles G. Berg(2) Common 834,000 8.38%
800 Connecticut Ave.
Norwalk, CT 06854
Charles D. Phillips(3) Common 12,500 *
800 Connecticut Ave.
Norwalk, CT 06854
Paul Conlin(4) Common 25,000 *
800 Connecticut Ave.
Norwalk, CT 06854
Stephen F. Wiggins(5) Common 475,000 4.91%
800 Connecticut Ave.
Norwalk, CT 06854
All Directors and Named Executive Officers Common 1,346,500 13.47%
as a Group (4 persons)(6)
5% Stockholders:
Oxford Health Plans, Inc.(7) Series B Preferred 4,700,043 48.59%
800 Connecticut Ave. Stock
Norwalk, CT 06854
WellPoint Development Company, Inc.(8) Series A Preferred 3,299,982 34.11%
21555 Oxnard Street Stock
Woodland Hills, CA 91367
</TABLE>
- ---------------
(1) Includes shares of HPI Common Stock subject to options which may be
exercised within 60 days of June 30, 1997. 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 this table.
(2) The number of shares of HPI Common Stock for Mr. Berg includes vested HPI
Options to purchase 44,850 shares of HPI Common Stock and unvested HPI
Options to purchase 239,150 shares of HPI Common Stock which will vest at
the Effective Time pursuant to the termination of the HPI Employment
Agreement.
(3) The number of shares of HPI Common Stock for Mr. Phillips represents vested
HPI Options to purchase 12,500 shares of HPI Common Stock.
(4) The number of shares of HPI Common Stock for Mr. Conlin represents vested
HPI Options to purchase 25,000 shares of HPI Common Stock.
(5) Mr. Wiggins serves as Chairman of Oxford. Mr. Wiggins disclaims beneficial
ownership of the shares of HPI Preferred Stock owned by Oxford.
(6) Includes HPI Options to purchase 321,500 shares of HPI Common Stock.
(7) HPI Preferred Stock and HPI Common Stock vote together as a class, thus
Messrs. Phillips, Conlin and Wiggins do not hold in excess of 5% of HPI
Voting Securities.
(8) WellPoint owns all 25,000 shares of the HPI Series A Convertible Preferred
Stock, which is convertible into 3,299,982 shares of HPI Common Stock.
Pursuant to a Shareholder Agreement, dated July 1, 1997, WellPoint agreed to
convert its shares of HPI Series A Convertible Preferred Stock into shares
of HPI Common Stock prior to the Closing of the Merger. Therefore, for
purposes of this table, such shares are being treated as if converted.
* Less than one percent.
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EXECUTIVE OFFICERS OF HPI
Charles G. Berg, 40, has served as the President and Chief Executive
Officer of HPI since September 1993 and is a founder of HPI. From 1987 to 1992,
Mr. Berg was a Senior Vice President and Managing Director of WSGP Partners,
L.P., a Los Angeles, California-based investment firm. Mr. Berg specialized in
corporate investments and served as a director of various portfolio companies.
From 1982 to 1987, Mr. Berg was an attorney with Gibson, Dunn & Crutcher LLP in
Los Angeles, California and London, England specializing in corporate
acquisitions and financings.
Charles D. Phillips, 42, has served as Chief Operating Officer of HPI since
May 1996 and has been Chief Operating Officer of Cincinnati Health Partners,
Inc., an HPI Subsidiary, since September 1995. Prior to joining HPI, Mr.
Phillips was employed by Community Mutual Insurance Company of Columbus, Ohio
from 1991 to 1995 as Vice President/General Manager for the national account
strategic business unit and as Vice President/Chief Financial Officer for
Community Mutual's life insurance affiliates. From 1989 to 1990, he served as
Executive Vice President/Chief Financial and Operating Officer for Credit Life
Companies, Inc. where he directed the finance, treasury, claims, information
systems and legal functions at this financial services company. From 1981 to
1989, Mr. Phillips was employed by Ernst & Young LLP. As a Senior Manager, Mr.
Phillips was responsible for various client audit matters and strategic and
financial planning engagements. His specialties included insurance, health care
and SEC reporting. Mr. Phillips is a Certified Public Accountant.
Paul Conlin, 39, has served as Executive Vice President, New York Region of
HPI since May 1996 and has served as Chief Operating Officer of Brooklyn Health
Partners, Inc., an HPI Subsidiary, since March 1995. Mr. Conlin has eleven years
of managed care experience with the Prudential Health Care Plans. From 1992 to
1995, he served as Vice President of Managed Care Operations where he was
responsible for the northeastern regional managed medical, managed dental and
customer service operations. From 1988 to 1992, he was the Executive Director of
Prudential's St. Louis, Missouri managed care operations where he oversaw an
80,000 member plan. From 1987 to 1988, Mr. Conlin was the Regional Director in
Houston, Texas where he oversaw an eight city network expansion for a 250,000
member point-of-service account (Southwestern Bell) and established new networks
in Little Rock, Arkansas and Corpus Christi and El Paso, Texas. From 1985 to
1986, he was responsible for establishing Prudential's managed care operations
in the Dallas/Ft Worth, Texas area. From 1984 to 1985, he served as a Manager in
PruCare's Group Model operations in Memphis, Tennessee responsible for health
center development and claim operations.
HPI EXECUTIVE OFFICER AND DIRECTOR COMPENSATION
EXECUTIVE OFFICER COMPENSATION
HPI believes that it employs only three people who will be employed by HPI
or FPA as executive officers after the Merger. The following sets table sets
forth information for the fiscal year ended December 31, 1996 for such persons:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION ---------------
NAME AND PRINCIPAL -------------------------------------------------- SECURITIES
POSITION WITH OTHER ANNUAL UNDERLYING
HPI YEAR SALARY BONUS COMPENSATION(1) OPTIONS/SARS
- ------------------------------ ---- -------- -------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Charles G. Berg............... 1996 $250,000 -- -- 125,000(2)
Chief Executive Officer
Charles D. Phillips........... 1996 160,000 $103,750 $52,687 50,000(2)
Chief Operating Officer
Paul Conlin................... 1996 156,000 66,300 -- 50,000(3)
Executive Vice President,
New York Region
</TABLE>
- ---------------
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(1) Includes benefits paid by HPI, such as auto allowance, long-term disability
and life insurance premiums and relocation expenses, which amounts exceeded
the lesser of $50,000 or 10% of annual salary and bonus for each of the
named executive officers.
(2) HPI options become exercisable in four equal annual installments commencing
on the first anniversary of the date of grant.
(3) One-fourth of Mr. Conlin's options became exercisable on the date of grant,
and three-fourths will become exercisable in three equal annual installments
commencing on the first anniversary of the date of grant.
The following table presents information with respect to grants of stock
options pursuant to the HPI 1994 Stock Option Plan, during the year ended
December 31, 1996, to the named executive officers reflected in the Summary
Compensation Table:
OPTION/SAR GRANTS IN THE LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL
INDIVIDUAL GRANTS REALIZABLE VALUE
-------------------------------------------------------------- AT ASSUMED ANNUAL
PERCENT OF RATES OF STOCK
NUMBER OF TOTAL OPTIONS PRICE APPRECIATION
SECURITIES GRANTED TO FOR
UNDERLYING EMPLOYEES OPTION TERM(1)
OPTION/SARS IN FISCAL EXERCISE PRICE ---------------------
NAME GRANTED YEAR PER SHARE EXPIRATION DATE 5% 10%
- --------------------- ----------- ------------- -------------- --------------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Charles G. Berg...... 125,000(2) 25.20 $ 3.25 1/29/06 $255,488 $647,458
Charles D.
Phillips........... 50,000(2) 10.08 3.25 1/29/06 102,195 258,983
Paul Conlin.......... 50,000(3) 10.08 3.25 1/29/06 102,195 258,983
</TABLE>
- ---------------
(1) The 5% and 10% assumed annual rates of appreciation were set by the
Commission and are not intended to forecast future appreciation, if any, of
the stock underlying such options.
(2) Messrs. Berg and Phillips' options become exercisable in four equal annual
installments commencing on the first anniversary of the date of grant.
(3) One-fourth of Mr. Conlin's options became exercisable on the date of grant,
and three-fourths will become exercisable in three equal annual installments
commencing on the first anniversary of the date of grant.
No HPI options were exercised by any of the named executive officers during
the fiscal year ended December 31, 1996.
The following table presents information concerning the HPI option values
as of December 31, 1996 for unexercised HPI options held by each of the named
executive officers:
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR
AND YEAR END OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF SECURITIES IN-THE-MONEY OPTIONS/SARS
NUMBER UNDERLYING UNEXERCISED
OF SHARES OPTIONS/SARS AT YEAR END AT FISCAL YEAR END(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Charles G. Berg.............. -- -- 44,850 114,150 $89,036 $ 180,430
Charles D. Phillips(2)....... -- -- 12,500 37,500 12,500 37,500
Paul Conlin.................. -- -- 25,000 25,000 25,000 25,000
</TABLE>
- ---------------
(1) Represents the number of unexercised shares multiplied by the difference
between (i) the per share fair market value of HPI Common Stock at December
31, 1996 and (ii) the exercise price per share.
(2) In addition to the options listed in the table, Mr. Phillips has been issued
options to purchase 75,000 shares in an HPI Subsidiary which employed Mr.
Phillips prior to HPI. To date, Mr. Phillips'
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<PAGE> 106
options to purchase 15,000 of such shares, representing an estimated $13,500
in value, have vested; Mr. Phillips' options to purchase 60,000 of such
shares, representing an estimated $59,250 in value, are unvested. Upon
consummation of the Merger, all vested and unvested options in such HPI
Subsidiary will be cancelled and substitute HPI Options to purchase 14,221
shares of HPI Common Stock will be granted. See "THE MERGER
AGREEMENT -- Roll-up Transactions."
DIRECTOR COMPENSATION
Directors of HPI do not receive any compensation for servicing as a
director of HPI, other than reimbursement for travel costs and other
out-of-pocket expenses incurred in attending each director's meeting and
committee meeting.
LEGAL MATTERS
The validity of the FPA Common Stock offered hereby and certain federal
income tax consequences of the Merger will be passed upon for FPA by Pillsbury
Madison & Sutro LLP, San Diego, California. Certain federal income tax
consequences of the Merger and certain legal matters in connection with the
Merger will be passed upon for HPI by Gibson, Dunn & Crutcher LLP, Los Angeles,
California.
ADDITIONAL INFORMATION
The HPI Board is not aware of any additional business to be acted upon at
the HPI Special Meeting other than as described herein. If, however, other
matters are properly brought before the Special Meeting, or any adjournment or
postponement 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.
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EXPERTS
The consolidated financial statements of FPA included in this Proxy
Statement/Prospectus in FPA's Annual Report on Form 10-K, as amended by Form
10-K/A, for the year ended December 31, 1996 have been audited by Deloitte &
Touche LLP, independent auditors, as stated in their report which is included
herein, and have been included herein in reliance upon the report of such firm
given upon their authority as experts in accounting and auditing.
The consolidated balance sheet as of December 31, 1995 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,
included herein, have been audited by Coopers & Lybrand LLP, independent
accountants, given on the authority of that firm as experts in accounting and
auditing.
The Consolidated Financial Statements of FPA included in this Proxy
Statement/Prospectus in FPA's Current Report on Form 8-K dated July 31, 1997
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their report which is included herein, and have been included herein 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. as of
December 31, 1996 and the year then ended included in this Proxy
Statement/Prospectus in FPA's Current Report on Form 8-K dated March 17, 1997,
as amended by Form 8-K/A, have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report which is included herein, and
have been included herein 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. as of
December 31, 1995 and for each of the two years in the period ended December 31,
1995, included in the consolidated financial statements of FPA for such periods,
which statements appear in the Current Reports on Form 8-K filed on July 31,
1997 and May 30, 1997, and included herein, have been audited by Ernst & Young
LLP, independent auditors, as stated in their reports therein and included
herein, and have been included herein in reliance upon the reports of such firm
given upon their authority as experts in accounting and auditing.
The consolidated financial statements of HPI and subsidiaries as of
December 31, 1994, 1995 and 1996, and for each of the years in the three-year
period ended December 31, 1996, have been included herein and in the
registration statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.
The combined financial statements of Foundation Health Medical Services (a
wholly-owned subsidiary of Foundation Health Corporation) and affiliates as of
June 30, 1995 and 1996 and for each of the three years in the period ended June
30, 1996, included in this Proxy Statement/Prospectus have been audited by
Deloitte & Touche LLP (except for the December 31, 1993 financial statements of
Thomas-Davis Medical Centers, P.C.) as stated in their report which is included
herein (such report expresses an unqualified opinion and includes an explanatory
paragraph referring to significant related party transactions), and have been
included herein in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing. The financial statements of
Thomas-Davis Medical Centers, P.C. for the year ended December 31, 1993 have
been audited by Stevenson, Jones, Imig, Holmaas & Kleinhans, P.C., as stated in
their report appearing elsewhere herein.
102
<PAGE> 108
HEALTH PARTNERS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Consolidated Financial Statements -- Years Ended December 31, 1996, 1995 and 1994
Independent Auditors' Report....................................................... F-2
Consolidated Statements of Financial Position...................................... F-3
Consolidated Statements of Operations.............................................. F-4
Consolidated Statements of Cash Flows.............................................. F-5
Consolidated Statements of Changes in Stockholders' Equity......................... F-6
Notes to Consolidated Financial Statements......................................... F-7
Consolidated Financial Statements (Unaudited) -- Quarters Ended June 30, 1997 and
1996
Consolidated Statements of Financial Position (Unaudited).......................... F-20
Consolidated Statements of Operations (Unaudited).................................. F-21
Consolidated Statements of Cash Flows (Unaudited).................................. F-22
Notes to Consolidated Financial Statements (Unaudited)............................. F-23
</TABLE>
F-1
<PAGE> 109
INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors of
Health Partners, Inc.:
We have audited the accompanying consolidated statements of financial
position of Health Partners, Inc. and Subsidiaries as of December 31, 1994, 1995
and 1996 and the related consolidated statements of operations, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Health
Partners, Inc. and Subsidiaries as of December 31, 1994, 1995 and 1996 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996 in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
White Plains, New York
February 28, 1997
F-2
<PAGE> 110
HEALTH PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1994 1995 1996
------- -------- --------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents.................................. $ 4,734 $ 4,473 $ 7,823
Accounts receivable, net of allowance for bad debts........ -- 104 284
Amounts due from affiliated medical corporations and
IPAs.................................................... 1,917 2,631 5,682
Prepaid expenses and other current assets.................. 351 1,510 1,385
------- -------- --------
Total current assets............................... 7,002 8,718 15,174
Net property, equipment and leasehold improvements........... 3,646 7,354 8,662
Net intangible assets........................................ 8,667 14,017 23,337
Other long-term assets....................................... 432 564 496
------- -------- --------
Total assets....................................... $19,747 $ 30,653 $ 47,669
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses...................... $ 2,340 $ 4,167 $ 6,721
Accrued medical costs...................................... -- -- 6,254
Other current liabilities.................................. 443 1,810 2,131
Notes payable, current..................................... -- 2,887 1,877
Current portion of long-term debt.......................... 19 24 27
------- -------- --------
Total current liabilities.......................... 2,802 8,888 17,010
Other long-term liabilities.................................. 255 175 228
Long-term debt............................................... 719 696 670
Notes payable, long-term..................................... 1,750 2,437 3,653
------- -------- --------
Total liabilities.................................. 5,526 12,196 21,561
------- -------- --------
Minority Interests........................................... 1,886 1,293 915
------- -------- --------
Stockholders' Equity:
Preferred stock:
Series A convertible preferred stock.................... 9,000 15,000 22,500
Series B convertible preferred stock.................... 9,000 15,000 25,000
Common stock ($.001 par value, 15,000 shares authorized,
1,550, 1,550 and 1,624 shares issued and outstanding in
1994, 1995
and 1996)............................................... 2 2 2
Accumulated deficit........................................ (5,667) (12,838) (22,309)
------- -------- --------
Total stockholders' equity......................... 12,335 17,164 25,193
------- -------- --------
Total liabilities and stockholders' equity....... $19,747 $ 30,653 $ 47,669
======= ======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-3
<PAGE> 111
HEALTH PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- --------
<S> <C> <C> <C>
Net Revenue:
Net revenue of consolidated IPAs........................... $ 2,497 $16,340 $ 45,741
------- ------- --------
Amounts associated with unconsolidated entities:
Net revenue of unconsolidated affiliated medical
corporations.......................................... 17,675 36,910 53,677
Net revenue of unconsolidated IPAs...................... -- 34,027 40,456
Cost of affiliated physician services................... (4,579) (12,327) (16,419)
Medical claims of unconsolidated affiliated medical
corporations.......................................... (4,628) (9,829) (10,389)
Medical claims of unconsolidated IPAs................... -- (33,145) (38,499)
------- ------- --------
Management services revenue................................ 8,468 15,636 28,826
Other revenue.............................................. 36 165 255
------- ------- --------
Net revenue........................................ 11,001 32,141 74,822
------- ------- --------
Operating Expenses:
Clinic salaries, wages and benefits........................ 5,743 11,457 13,995
Medical claims of consolidated IPAs........................ 471 10,507 45,379
Network operating expenses................................. 897 2,889 4,676
Other clinic expenses...................................... 4,745 9,797 13,371
General corporate expenses................................. 2,152 3,904 4,974
Depreciation and amortization.............................. 1,865 1,372 2,462
Net interest expense (income).............................. (156) (106) 117
------- ------- --------
Total operating expenses........................... 15,717 39,820 84,974
------- ------- --------
Loss before minority interests and provision for income
taxes................................................... (4,716) (7,679) (10,152)
Minority interests' share in net loss...................... 367 683 866
Provision for income taxes................................. (40) (175) (185)
------- ------- --------
Net loss................................................... $(4,389) $(7,171) $ (9,471)
======= ======= ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-4
<PAGE> 112
HEALTH PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss................................................... $(4,389) $(7,171) $ (9,471)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization........................... 1,865 1,372 2,462
Minority interests' share in net loss................... (367) (683) (866)
Changes in assets and liabilities:
Decrease (increase) in accounts receivable.............. 1,854 (104) (180)
Increase in amounts due from unconsolidated affiliated
medical corporations and IPAs......................... (1,499) (622) (1,293)
(Increase) decrease in prepaid expenses and other
current assets........................................ (20) (1,085) 268
(Increase) decrease in other long-term assets........... (19) (80) 103
(Decrease) increase in accounts payable and accrued
expenses.............................................. (1,495) 787 1,238
Decrease (increase) in accrued medical costs............ (307) -- 6,233
(Decrease) increase in other long-term liabilities...... (37) 1,211 374
------- ------- --------
Net cash used by operating activities.............. (4,414) (6,375) (1,132)
======= ======= ========
Cash flows from investing activities:
Payments for acquisitions, net of cash acquired............ (6,764) (3,321) (7,700)
Additions to property, equipment and improvements.......... (1,149) (3,972) (2,347)
------- ------- --------
Net cash used by investing activities.............. (7,913) (7,293) (10,047)
------- ------- --------
Cash flows from financing activities:
Proceeds from issuance of preferred stock.................. 13,000 12,000 17,500
Proceeds from long-term debt............................... 738 -- --
Proceeds from notes payable................................ -- 1,450 800
Payments on notes payable and long-term debt............... (95) (45) (3,771)
Other...................................................... (125) 2 --
------- ------- --------
Net cash provided by financing activities.......... 13,518 13,407 14,529
------- ------- --------
Net change in cash and cash equivalents............ 1,191 (261) 3,350
Cash and cash equivalents at beginning of period... 3,543 4,734 4,473
------- ------- --------
Cash and cash equivalents at end of period......... $ 4,734 $ 4,473 $ 7,823
======= ======= ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-5
<PAGE> 113
HEALTH PARTNERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
OLD-SERIES A NEW-SERIES A SERIES B
CUMULATIVE CONVERTIBLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK COMMON STOCK
----------------- ----------------- ---------------- -------------------- ACCUMULATED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
------- ------- ------- ------- ------ ------- ----------- ------ ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1993.................. 5,000 $ 5,112 0 $ 0 0 $ 0 4,875,000 $ 5 $ (1,307) $ 3,810
Net loss................ -- -- -- -- -- -- -- -- (4,389) (4,389)
Series A preferred stock
dividend
(8% per annum)........ -- 131 -- -- -- -- -- -- (131) 0
Payment of preferred
stock dividend........ -- (52) -- -- -- -- -- -- -- (52)
Elimination of preferred
stock dividend........ -- (191) -- -- -- -- -- -- 191 0
Purchase of common
stock................. -- -- -- -- -- -- (4,200,000) (4) -- (4)
Stock dividend.......... -- -- -- -- -- -- 675,000 1 (1) 0
Issuance of common
stock................. -- -- -- -- -- -- 200,000 0 -- 0
Exchange of preferred
stock................. (5,000) (5,000) -- -- 5,000 5,000 -- -- -- 0
Issuance of preferred
stock (Series A and
B).................... -- -- 9,000 9,000 4,000 4,000 -- -- -- 13,000
Costs related to
issuance of preferred
stock................. -- -- -- -- -- -- -- -- (30) (30)
----- ------ ------ ------- ------ ------- --------- --- -------- -------
BALANCE, DECEMBER 31,
1994.................. 0 0 9,000 9,000 9,000 9,000 1,550,000 2 (5,667) 12,335
Net loss................ -- -- -- -- -- -- -- -- (7,171) (7,171)
Issuance of preferred
stock (Series A and
B).................... -- -- 6,000 6,000 6,000 6,000 -- -- -- 12,000
----- ------ ------ ------- ------ ------- --------- --- -------- -------
BALANCE, DECEMBER 31,
1995.................. 0 0 15,000 15,000 15,000 15,000 1,550,000 2 (12,838) 17,164
Net loss................ -- -- -- -- -- -- -- -- (9,471) (9,471)
Issuance of common stock
pursuant to stock
options............... -- -- -- -- -- -- 73,500 0 -- 0
Issuance of preferred
stock (Series A and
B).................... -- -- 7,500 7,500 10,000 10,000 -- -- -- 17,500
----- ------ ------ ------- ------ ------- --------- --- -------- -------
BALANCE, DECEMBER 31,
1996.................. 0 $ 0 22,500 $22,500 25,000 $25,000 1,623,500 $ 2 $ (22,309) $25,193
===== ====== ====== ======= ====== ======= ========= === ======== =======
</TABLE>
See accompanying notes to the consolidated financial statements.
F-6
<PAGE> 114
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994, 1995 AND 1996
(1) ORGANIZATION AND OPERATION
Health Partners, Inc. ("HPI" or the "Company") was incorporated and
commenced operations on September 15, 1993. HPI, through its majority owned
subsidiaries, provides management systems and services, non-physician health
care personnel and equipment to affiliated medical corporations, independent
practice associations ("IPAs") and managed care contracting networks. HPI
operates primarily in the managed health care business and supports health care
networks of multi-specialty physicians, through which managed health care is
provided under contracts with prepaid health plans. Affiliated medical
corporations, IPAs and managed care contracting networks employ physicians,
contract with physicians and professional medical corporations, and/or contract
with health maintenance organizations ("HMOs"). Pursuant to the administrative
services agreements between the Company's subsidiaries and the affiliated
medical corporations and IPAs, the resulting management services revenue is
equivalent to a net profits interest in the preponderance of medical services
provided by the affiliated medical corporations and IPAs. The accompanying
consolidated financial statements include the accounts of the Company and its
majority owned subsidiaries in which the Company has more than a 50% ownership
interest and exercises direct unilateral and perpetual control. The majority
owned subsidiaries of the Company include management services organizations and
IPAs. For those affiliated medical corporations and IPAs where the Company does
not exercise control but has a net profits interest, the Company displays the
revenue and expenses of such entities in the accompanying consolidated
statements of operations. Amounts retained by the managed affiliated medical
corporations and IPAs are deducted from net revenue of unconsolidated affiliated
medical corporations and from net revenue of unconsolidated IPAs in the
accompanying consolidated statements of operations. Amounts retained by managed
affiliated medical corporations and IPAs include cost of affiliated physician
services and medical claims of unconsolidated affiliated medical corporations
and IPAs. Management of the Company believes that this data provides readers of
the financial statements with additional useful information about its
operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its majority owned subsidiaries in which the Company has more
than a 50% ownership interest and exercises direct unilateral and perpetual
control. Significant intercompany accounts and transactions have been eliminated
in consolidation.
Minority Interests
Minority interests represent the minority stockholders' proportionate share
of the equity of subsidiaries. Brooklyn Health Partners, Inc. ("BHPI"), Gotham
Practice Management, Inc. ("GPMI"), Network Management Strategies Corporation
("NMS"), San Antonio Health Partners, Inc. ("SAHPI") and Comprehensive Primary
Care MSO, Inc. ("CPC") have incurred net losses which exceed the minority
interests' share of equity. To the extent the net losses exceed the equity of
the minority interests, the Company recognizes all losses in the consolidated
statements of operations. As these subsidiaries generate net income, the Company
will recognize all net income until such losses have been fully offset. At
December 31, 1994, 1995 and 1996, cumulative net losses of minority interests
recognized by the Company were approximately $491,000, $1,033,000, and
$1,551,000, respectively.
Net Revenue and Cost Recognition
Net revenue in the consolidated statement of operations consists of the
total net revenue of the Company's consolidated IPAs and management services
revenue after deducting amounts retained by the managed affiliated medical
corporations and IPAs. Net revenue of consolidated IPAs consists of capitation
F-7
<PAGE> 115
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
revenue (including shared-risk revenue) and fee-for-service revenue.
Fee-for-service revenue is recorded by the affiliated medical corporations at
established rates reduced by provisions for contractual allowances and doubtful
accounts. Management services revenue is equal to the difference between the
amount of net revenue (including fee-for-service, capitation and shared-risk
revenue) and amounts retained by the managed IPAs and affiliated medical
corporations for risk pool payments, compensation and other expenses. Management
services revenue is based on several different types of arrangements including
contracted sharing of revenue and profits, cost plus either a percentage of
revenue or a fixed dollar amount or revenue minus expenses. The Company
recognizes capitation revenue from HMOs contracting with independent practice
associations for the delivery of health care services. Amounts for consolidated
IPAs that are due to affiliated medical corporations, independent practice
associations and other health care providers for the provision of health care
services in connection with HMO contracts are accrued as incurred. The HMO
contracts contain shared-risk provisions whereby additional incentive revenue
can be earned or penalties can be incurred based upon the utilization of
inpatient services by assigned HMO enrollees. The Company records estimated
shared-risk amounts receivable from (or payable to) HMOs for consolidated IPAs
based upon inpatient utilization and associated costs incurred by assigned HMO
enrollees compared to budgeted costs. Differences between actual contract
settlements and amounts estimated as receivable (or payable) relating to HMO
shared-risk arrangements are recorded in the year of final settlement.
Management believes that accrued medical costs, which represent the amounts
payable for services incurred by patients of the consolidated IPAs but not yet
paid at December 31, 1994, 1995 and 1996, is adequate to cover claims that will
ultimately be paid.
Amounts due from Unconsolidated Affiliated Medical Corporations and IPAs
Amounts due from unconsolidated affiliated medical corporations and IPAs
represent amounts due for management services rendered and funds provided to
unconsolidated affiliated medical corporations and IPAs for various operating
purposes. Amounts are secured by the accounts receivable of the unconsolidated
affiliated medical corporations and IPAs.
Contractual Adjustments
Contractual adjustments arise due to the terms of certain reimbursement
arrangements and managed care contracts. These adjustments represent the
difference between charges at established rates and estimated reimbursable
amounts and are recognized in the period the services are rendered. Any
differences between the estimated reimbursable amounts and actual payments under
reimbursement arrangements are reported in the year the payments are received.
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements are stated at cost.
Depreciation is computed using the straightline method over the estimated useful
lives of the assets. The principal estimated useful lives are 5 years for
medical, computer and office equipment and 30 years for buildings. Leasehold
improvements are amortized over the estimated useful lives of the improvements
or the terms of the leases, whichever is shorter. The principal estimated useful
life is 10 years.
Upon retirement or sale, the cost and related accumulated depreciation are
removed from the accounts and any resultant gains or losses are included in the
consolidated statements of operations.
Intangible Assets
Intangible assets resulting from business acquisitions principally consist
of the excess of the acquisition cost over the fair value of the net assets
acquired ("goodwill"). Goodwill is amortized on a straight-line basis over 20 to
30 years based upon its estimated useful life.
F-8
<PAGE> 116
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
Other intangible assets are amortized on a straight-line basis over their
estimated useful lives.
During 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" ("SFAS No. 121").
SFAS No. 121 establishes accounting standards for the impairment of long-lived
assets, certain identifiable intangibles, and goodwill related to those assets
to be held and used and for long-lived assets and certain identifiable
intangibles to be disposed of. If events and circumstances occur which indicate
impairment, SFAS No. 121 requires that impairment losses be recognized based on
the difference between the fair value and carrying value of the assets.
Long-lived assets to be disposed of should be reported at the lower of carrying
amount or fair value less cost to sell. SFAS No. 121 is effective for financial
statements issued for fiscal years beginning after December 15, 1995. The
Company has complied with the provisions of SFAS No. 121. The adoption of SFAS
No. 121 did not have a material effect on the accompanying consolidated
financial statements.
Income Taxes
The Company follows Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No.
109"). SFAS No. 109 requires accounting for income taxes on an asset and
liability method. Under the asset and liability method of SFAS No. 109, deferred
tax assets and liabilities are recognized for the consequences attributable to
differences between the financial statement carrying amount of existing assets
and liabilities and respective tax bases. Under this method, deferred tax
liabilities and assets are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. Certain entities file tax returns on a stand
alone basis.
Accounting for Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued SFAS Statement
No. 123, "Accounting for StockBased Compensation" ("SFAS No. 123") which is
effective for financial statements for fiscal years beginning after December 15,
1995. As permitted under SFAS No. 123, the Company has elected not to adopt the
fair value based method of accounting for its stock-based compensation plans,
but has complied with the disclosure requirements of SFAS No. 123 (note 10) and
will continue to account for such compensation under the provisions of
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees".
Cash and Cash Equivalents
HPI considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents. A substantial portion of HPI's cash
and cash equivalents is deposited in three banks. HPI monitors each bank's
financial status and does not believe the deposits are subject to a significant
degree of risk.
Disclosures about the Fair Value of Financial Instruments
The Company values its financial instruments as required by SFAS Statement
No. 107, "Disclosures about Fair Values of Financial Instruments." The carrying
amounts of cash and cash equivalents, accounts receivable, accounts payable,
short-term debt and long-term variable-rate debt approximate fair value.
F-9
<PAGE> 117
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
Management's Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform with the 1996
presentation.
(3) ACQUISITIONS
During 1994, 1995 and 1996 the Company acquired the medical organizations
described below and accounted for the transactions in accordance with the
purchase method of accounting. The results of operations of the acquired
companies are included in the Company's consolidated statements of operations
for the periods in which they were owned by the Company. The acquisitions are
generally financed through various combinations of cash payments, notes payable
and the assumption of certain liabilities. Simultaneous with its acquisitions,
the Company's majority owned subsidiaries enter into an administrative services
agreement ("ASA") with affiliated medical corporations and/or IPAs. After an
initial term, the ASAs relative to the medical organizations have automatic
long-term renewal options, except for SAHPI which has a forty year ASA and
Gateway Physician Services, L.P. ("GPS") which has an indefinite term, and can
only be terminated if the subsidiaries breach the ASA or at the option of the
subsidiary.
In August 1994, the Company acquired a majority interest in VMA, Inc. for
an aggregate purchase price of approximately $5,250,000. The stock of VMA, Inc.
was transferred by the Company to Gateway Physician Services, L.P. for an equal
ownership interest in GPS. The minority shareholders also exchanged their
ownership interests in VMA, Inc. for an equivalent ownership interest in GPS.
Simultaneous with the transaction, GPS entered into non-compete agreements with
certain physicians.
In October 1994, GPMI acquired the property, medical equipment and office
equipment of Gotham Practice Management Services, Inc. for approximately
$700,000.
In January 1995, Network Management Strategies Corporation ("NMS") was
organized to provide management services to independent practice associations.
In August 1995, NMS acquired the stock of Health One Associates, Inc. and
certain of the assets of Palm Lake Administrators, Inc. for an aggregate
purchase price of $2,000,000.
In July 1995, Cincinnati Health Partners, Inc. ("CHPI") acquired the
property, medical and office equipment of Timmerman & Saelinger, P.S.C. and
Family Physicians of Northern Kentucky, P.S.C. and entered into non-compete
agreements for an aggregate purchase price of approximately $3,700,000.
In June 1996, Paramount Medical Management, Inc. ("PMM") acquired the
property, medical and office equipment of Vento Medical Services, P.C. and
entered into non-compete agreements for an aggregate purchase price of
approximately $1,900,000.
In June 1996, San Antonio Health Partners, Inc. was organized to provide
management services to independent practice associations.
In July 1996, Hudson Valley Health Partners, Inc. ("HVHPI") acquired the
property, medical and office equipment of Clarkstown Pediatrics Associates, P.C.
and entered into non-compete agreements for an aggregate purchase price of
$2,475,000.
F-10
<PAGE> 118
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
In October 1996, CHPI acquired the property, medical and office equipment
of Primary Care Associates of Northern Kentucky, P.S.C. and entered into
non-compete agreements for an aggregate purchase price of $3,275,000.
In November 1996, CPC acquired the property, medical and office equipment
of Gerald Family Practice, P.C. and entered into non-compete agreements for an
aggregate purchase price of $2,050,000.
The following financial information sets forth the unaudited pro forma
consolidated results of operations for the years ended December 31, 1995 and
1996 as if the acquisitions had occurred effective January 1, 1995:
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Net revenue of consolidated and unconsolidated
affiliated medical corporations and IPAs...... $122,316,000 $152,803,000
Net loss........................................ $ (5,975,000) $ (8,902,000)
</TABLE>
The unaudited pro forma information is not necessarily indicative either of
results of operations that would have occurred had the purchases been made on
January 1, 1995 or future results of operations of the consolidated companies.
Intangible assets resulting from business combinations at December 31,
1994, 1995 and 1996 consist of goodwill of $9,493,000, $13,493,000 and
$18,615,000, respectively, and non-compete agreements of $1,090,000, $2,859,000
and $7,713,000, respectively. Accumulated amortization of intangible assets at
December 31, 1994, 1995 and 1996 was approximately $1,916,000, $2,335,000 and
$2,991,000, respectively.
(4) PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements at December 31, 1994, 1995
and 1996 consist of the following:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ----------- -----------
<S> <C> <C> <C>
Building.............................................. $ 842,000 $ 842,000 $ 842,000
Medical, computer and office equipment................ 1,862,000 4,994,000 6,928,000
Leasehold improvements................................ 1,078,000 2,631,000 3,745,000
Construction in progress.............................. 176,000 73,000 --
---------- ----------- -----------
3,958,000 8,540,000 11,515,000
Less accumulated depreciation and amortization........ (312,000) (1,186,000) (2,853,000)
---------- ----------- -----------
$3,646,000 $ 7,354,000 $ 8,662,000
========== =========== ===========
</TABLE>
Depreciation and leasehold improvement amortization expense for the years
ended December 31, 1994, 1995 and 1996 was $292,000, $1,006,000 and $1,785,000.
F-11
<PAGE> 119
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
(5) LEASES
The Company has operating leases covering facilities and equipment for
which rental expense for the years ended December 31, 1994, 1995 and 1996 was
$1,668,000, $2,750,000 and $4,474,000, respectively. Minimum rental commitments
under noncancelable capital and operating leases are as follows:
<TABLE>
<S> <C>
1997............................................ $ 4,190,000
1998............................................ $ 3,378,000
1999............................................ $ 2,669,000
2000............................................ $ 2,234,000
2001............................................ $ 1,765,000
Thereafter...................................... $ 5,339,000
</TABLE>
(6) CREDIT FACILITIES
In October 1994, GPS executed a credit agreement with a bank that provided
a line of credit (the "line") of $800,000 and an equipment loan with maximum
permitted borrowing of $600,000 ("equipment loan"). The agreement required GPS
to meet both financial and non-financial covenants and contained covenants
restricting the payment of dividends, incurrence of debt and sale of assets. As
of December 31, 1994, GPS had no borrowings under this agreement.
In September 1995, GPS converted outstanding borrowings under its equipment
loan into a term note. The principal balance of approximately $315,000 bears
interest at 8.9% and is payable over five years.
In October 1995, GPS amended its credit agreement with a bank to provide a
$1,500,000 line of credit and increase the equipment loan to $500,000. GPS's
requirement to meet both financial and non-financial covenants remained
unchanged.
In May 1996, GPS amended its credit agreement with a bank regarding its
existing line of credit and equipment loan. The line, which provided for
borrowing based upon 80% of eligible accounts receivable, as defined, was
terminated in August 1996. The principal balance was repaid in two installments
in July and August 1996. The equipment loan, which was based on 90% of the
purchased equipment's value and bore interest at the bank's prime rate plus a
spread based on GPS's financial ratios, was terminated in May 1996. Effective
with this amendment, GPS maintained its existing deed of trust note, term note
and the covenants contained in GPS's prior agreement with the bank.
As of December 31, 1996, GPS was in default on both financial and
non-financial covenants. GPS is in discussions with the bank regarding curing
the default.
Borrowings under the line are collateralized by the accounts receivable,
and borrowings under the equipment loan are collateralized by the underlying
equipment. Also, the bank maintains an additional security interest in all
current and future assets of GPS and is superior to all current and future
indebtedness of GPS.
F-12
<PAGE> 120
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
The following schedule summarizes the activity with respect to the credit
agreements and term note:
<TABLE>
<CAPTION>
DECEMBER 31, 1994 DECEMBER 31, 1995 DECEMBER 31, 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Line of Credit:
Borrowings.................................. $ 0 $ 1,450,000 $ 0
Interest rate............................... N/A 10.5% 10.5%
Term Note:
Borrowings.................................. $ 0 $ 300,000 $ 246,000
Interest rate............................... N/A 8.9% 8.9%
</TABLE>
In December 1996, HVHPI entered into a $250,000 line of credit agreement
with a bank. The line of credit bears interest at the bank's prime rate plus
1/2 percentage point, is collateralized by HVHPI's accounts receivable and
expires on December 10, 1997. At December 31, 1996, there were no borrowings
under this agreement.
See Note 7, Long-Term Debt and Notes Payable, for information regarding the
deed of trust note.
(7) LONG-TERM DEBT AND NOTES PAYABLE
In December 1994, GPS executed a $738,000 deed of trust note ("the note")
collateralized by GPS's building. Payment of the note is based on a 15 year
payment schedule with a five year balloon payment and bears a fixed rate of
interest at 10.35%. GPS is subject to the same financial, non-financial and
restrictive covenants as in its credit facilities (See Note 6 -- Credit
Facilities). The balance of the note was $738,000, $720,000 and $697,000 as of
December 31, 1994, 1995 and 1996, respectively.
In conjunction with the acquisition of VMA, Inc., the Company agreed to a
deferred purchase price of $1,750,000 payable over 3 years beginning in 1996. In
1996 the deferred purchase price was renegotiated to $1,450,000.
Obligations under capital leases at December 31, 1996 totaled $315,000 of
which $87,000 was current.
F-13
<PAGE> 121
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
The following is a summary of notes payable and long-term debt at December
31, 1996:
<TABLE>
<CAPTION>
ORIGINAL INTEREST
DESCRIPTION PRINCIPAL RATE BALANCE EXPIRATION
- ----------------------------------------------- ---------- -------- ---------- --------------
<S> <C> <C> <C> <C>
Deferred Purchase Price (GPS).................. $1,750,000 (5) $ 942,000 August 1998(1)
Term Note (GPS)................................ $ 315,000 8.90% 246,000 September 2000(2)
Notes Payable (CHPI)........................... $1,303,000 8.25% 788,000 June 2000(2)
Notes Payable (CHPI)........................... $ 764,000 (5) 382,000 August 1997(1)
Notes Payable (CHPI)........................... $ 579,000 7.00% 579,000 November 2000(2)
Term Note (CHPI) (7)........................... $ 800,000 7.25% 781,000 November 2003(2)
Note Payable (PMM)............................. $ 588,000 8.00% 524,000 June 2000(3)
Note Payable (PMM)............................. $ 85,000 8.00% 85,000 October 2000(3)
Note Payable (CPC)............................. $ 400,000 7.00% 400,000 November 2000(3)
Notes Payable (HVHPI).......................... $ 536,000 8.00% 496,000 July 1999(3)
Note Payable (HVHPI)........................... $ 150,000 (5) 148,000 December 2001(2)
Term Note (HVHPI) (7).......................... $ 100,000 (4) 100,000 July 1999(2)
Other Notes Payable............................ $ 65,500 (6) 59,000 various
----------
Total Notes Payable............................ 5,530,000
Long-Term Debt (GPS)........................... 697,000
----------
Total Notes Payable and LongTerm Debt.......... $6,227,000
==========
</TABLE>
- ---------------
(1) Annual payments each August
(2) Payable monthly
(3) Payable quarterly
(4) Interest at the bank's prime rate plus 1/2 percentage point
(5) Note is non-interest bearing
(6) Interest at 8% and the prime rate
(7) Secured by accounts receivable and equipment
Aggregate maturities of long-term debt and notes payable are as follows:
<TABLE>
<S> <C>
1997............................................. $1,904,000
1998............................................. $1,568,000
1999............................................. $1,082,000
2000............................................. $1,345,000
2001............................................. $ 138,000
Thereafter....................................... $ 190,000
</TABLE>
F-14
<PAGE> 122
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
(8) INCOME TAXES
The provision for income taxes for the years ended December 31, 1994, 1995
and 1996 consisted of the following:
<TABLE>
<CAPTION>
1994 1995 1996
------- -------- --------
<S> <C> <C> <C>
Current provision:
Federal................................... $ -- $ -- $ --
State..................................... 40,000 175,000 185,000
------- -------- -------
Total Current..................... 40,000 175,000 185,000
------- -------- -------
Deferred provision:
Federal................................... -- -- --
State..................................... -- -- --
------- -------- -------
Total Deferred.................... -- -- --
------- -------- -------
Provision for income taxes.................. $40,000 $175,000 $185,000
======= ======== =======
</TABLE>
The Company has established a valuation allowance for the net deferred tax
assets that arose during 1994, 1995 and 1996. Therefore, no tax benefit has been
reflected in the consolidated statements of operations.
The components of deferred tax assets and liabilities as of December 31,
1994, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
----------- ------------ ------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carry forwards................. $ 2,406,000 $ 5,155,000 $ 7,665,000
Management fee payable............................ 4,259,000 10,085,000 11,865,000
Accounts payable.................................. 1,597,000 9,465,000 3,446,000
Other............................................. 49,000 285,000 4,810,000
---------- ----------- -----------
Total deferred tax assets............... 8,311,000 24,990,000 27,786,000
---------- ----------- -----------
Deferred tax liabilities:
Accounts receivable............................... 2,200,000 9,873,000 3,789,000
Management fee receivable......................... -- 1,913,000 1,627,000
Property, equipment and leasehold improvements.... 127,000 270,000 250,000
Intangible Assets................................. -- -- 3,038,000
Prepaid expenses.................................. 20,000 72,000 33,000
Other............................................. 4,000 194,000 1,506,000
---------- ----------- -----------
Total deferred tax liabilities.................... 2,351,000 12,322,000 10,243,000
Less valuation allowance.......................... (5,960,000) (12,668,000) (17,543,000)
---------- ----------- -----------
Net deferred tax asset liability.................. $ -- $ -- $ --
========== =========== ===========
</TABLE>
Subsequently recognized tax benefits relating to the valuation allowance
for deferred tax assets as of December 31, 1996 will be applied to reduce future
tax provisions, except for certain tax benefits resulting from acquisitions
which may be allocated to goodwill depending on the timing and the nature of
their use.
At December 31, 1996, the Company had net operating loss carryforwards of
approximately $17,450,000 which will begin to expire in 2008.
F-15
<PAGE> 123
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
(9) STOCKHOLDERS' EQUITY
In May 1994, the Company underwent a capital restructuring whereby the
Articles of Incorporation were amended to redefine the Company's Series A
preferred stock and establish a Series B preferred stock. The capital
restructuring eliminated the redemption feature of the Old-Series A preferred
stock and added a conversion feature, at the holder's option or under certain
circumstances as defined below, to the Company's common stock based upon a
predetermined conversion price.
The preferred stock is subject to a mandatory conversion if the Company
consummates a public offering of its common stock in excess of stated levels.
Also, the preferred stock has a liquidation preference equal to the original
issuance price, accrued dividends and declared but unpaid dividends. The Series
B preferred stock maintains the same provisions as the New-Series A preferred
stock except for the conversion price.
In May 1994, Oxford Health Plans, Inc. ("Oxford"), a minority shareholder,
purchased all outstanding Old-Series A preferred stock for stated value. Oxford
then exchanged the Old-Series A preferred stock for Series B preferred stock and
payment of cumulative unpaid dividends, which approximated $52,000, on Oxford's
Old-Series A preferred stock.
In conjunction with the restructuring, the Company purchased 4,200,000
shares of its common stock for $4,200 and declared and paid a stock dividend,
which amounted to 675,000 shares. Subsequent to the dividend, the Company issued
an additional 200,000 shares of common stock for $200.
The following is a summary of the shares of the Series A preferred stock
and the Series B preferred stock that the Company has sold to Foxfield Ventures,
Inc. and Oxford, respectively:
<TABLE>
<CAPTION>
NUMBER OF SHARES
--------------------- AGGREGATE
DATE SOLD SERIES A SERIES B PURCHASE PRICE
------------------------------------ -------- -------- --------------
<S> <C> <C> <C>
May 1994............................ 5,000 5,000 $ 10,000,000
August 1994......................... 4,000 4,000 8,000,000
May 1995............................ 6,000 6,000 12,000,000
May 1996............................ 2,500 2,500 5,000,000
July 1996........................... 5,000 5,000 10,000,000
November 1996....................... -- 2,500 2,500,000
------ ------ -----------
Total..................... 22,500 25,000 $ 47,500,000
====== ====== ===========
</TABLE>
In February 1997, the Company sold 2,500 shares of the Series A preferred
stock to Foxfield for $2,500,000.
Stockholders' equity consists of the following at December 31, 1994, 1995
and 1996:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ----------- -----------
<S> <C> <C> <C>
Series A convertible preferred stock, $1,000 stated
value, 25,000 shares authorized, 9,000, 15,000 and
22,500 shares issued and outstanding in 1994, 1995
and 1996........................................... $9,000,000 $15,000,000 $22,500,000
Series B convertible preferred stock, $1,000 stated
value, 25,000 shares authorized, 9,000, 15,000 and
25,000 shares issued and outstanding in 1994, 1995
and 1996........................................... $9,000,000 $15,000,000 $25,000,000
Common Stock, $.001 par value, 15,000,000 shares
authorized in 1994, 1995 and 1996, 1,550,000 shares
issued and outstanding in 1994 and 1995, 1,624,000
shares issued and outstanding in 1996.............. $ 1,550 $ 1,550 $ 1,624
</TABLE>
F-16
<PAGE> 124
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
Both the Series A and Series B preferred stock bear a cumulative dividend
of $80 per annum per share. As of December 31, 1994, 1995 and 1996, the Company
had cumulative unpaid dividends on the Series A and Series B preferred stock of
approximately $760,000, $2,829,000 and $6,006,000, respectively. If a
stockholder exercises the preferred stock's conversion feature, the cumulative
dividend is not required to be paid in accordance with the Company's Articles of
Incorporation.
In connection with the capital restructuring, HPI entered into a securities
purchase agreement with certain corporate and management investors. This
agreement provides for additional sales of HPI's Series A and Series B
convertible preferred stock and superseded the existing securities purchase
agreement.
(10) STOCK OPTION PLAN
In 1994, the Company adopted a fixed stock option plan ("1994 Option Plan")
for key employees and consultants to acquire 450,000 shares of common stock of
the Company. In 1995, the Company allocated 1,000,000 additional shares of
common stock to the 1994 Option Plan. Options vest over four to five years,
become exercisable as specified in the individual stock option agreements and
expire ten years after the date of grant. The following schedule summarizes the
activity within the stock option plan:
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
Options outstanding, January 1..................... 0 381,000 491,000
Options granted.................................... 381,000 110,000 496,000
Options exercised.................................. 0 0 (73,500)
Options forfeited.................................. 0 0 (99,000)
Options expired.................................... 0 0 0
-------- -------- --------
Options outstanding, December 31................... 381,000 491,000 814,500
======== ======== ========
Options exercisable, December 31................... 23,700 100,900 146,100
Compensation expense recorded...................... $ 0 $ 0 $ 0
</TABLE>
Weighted average option exercise price information for the years ended
December 31, 1994, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
----- ----- -----
<S> <C> <C> <C>
(1) Outstanding, January 1................ N/A $.001 $.314
(2) Granted during the year............... $.001 $1.40 $3.39
(3) Grant date fair value................. $ 001 $1.40 $3.39
(4) Outstanding, December 31.............. $.001 $.314 $2.21
(5) Exercisable, December 31.............. $.001 $.001 $ .44
(6) Options forfeited during the year..... N/A N/A $.165
(7) Options exercised during the year..... N/A N/A $.001
</TABLE>
At December 31, 1996, the exercise price of options outstanding ranged from
$.001 to $5.32 per share and the weighted-average remaining contractual life of
the options outstanding was approximately 8.5 years.
The fair value of each stock option grant is estimated on the date of grant
using the Black Scholes option pricing model with the following weighted average
assumptions used for grants in 1996: risk-free interest rate of 7.0%; expected
dividend yield of 0%; expected life of 5 years; and expected volatility of 0%.
The following financial information sets forth the unaudited proforma
consolidated results of operations for the years ended December 31, 1994, 1995
and 1996 as if the Company had determined compensation cost based on fair value
in accordance with SFAS 123:
<TABLE>
<CAPTION>
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Proforma net loss....................... $(4,389,000) $(7,176,000) $(9,550,000)
</TABLE>
F-17
<PAGE> 125
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
(11) 401(k) PLAN
Effective September 1, 1994, the Company adopted the Health Partners, Inc.
401(k) Savings Plan ("Plan"). The Plan is a Code Section 401(k) plan that
requires one-half year of service to become a participant in the Plan. Service
for a predecessor employer will be considered for participation requirements in
the Plan for all employees employed by the Company through its acquisition
activities. Eligible employees may contribute up to 17% of their compensation.
The Company matches employee contributions at 50% up to the first 4% of
compensation. Employees vest in matching contributions according to a graduated
5-year schedule. Company contributions to the plan were approximately $24,000,
$182,000 and $301,000 for the years ended December 31, 1994, 1995 and 1996,
respectively.
(12) CONCENTRATION OF CREDIT RISK
As of December 31, 1994, 1995 and 1996, various affiliated medical groups
had net receivables from Oxford of approximately $1,687,000, $3,542,000 and
$2,106,000, respectively, as a result of their capitated contracts (see Note 2 -
Revenue and Cost Recognition). Also, Oxford accounted for 62%, 69% and 70% of
HPI's net revenue of consolidated and unconsolidated affiliated medical
corporations and IPAs for the years ended December 31, 1994, 1995 and 1996,
respectively.
(13) RELATED PARTY TRANSACTIONS
The laws of various states prevent corporations, such as HPI and its
subsidiaries, from providing medical care to patients. Various agreements for
the provision of medical services have been made with affiliated medical groups
primarily owned by the presidents of HPI's subsidiaries. The agreements for the
provision of medical services, including services required under certain HMO
contracts, are held by the affiliated medical groups. HPI is dependent upon the
performance of medical services by the affiliated medical groups, insofar as
medical care delivery is concerned.
The presidents and other physicians of certain HPI subsidiaries have
entered into lease arrangements whereby medical space and/or medical equipment
is leased to certain HPI subsidiaries at fair market value and terms ranging
from one to fifteen years. The following schedule summarizes the rental expense
under these arrangements:
<TABLE>
<CAPTION>
HPI SUBSIDIARY 1994 1995 1996
------------------------------------------ ------- -------- --------
<S> <C> <C> <C>
GPS (a)................................... $45,000 $142,000 $238,000
CHPI (b).................................. -- $333,000 $821,000
PMM (c)................................... -- -- $133,000
HVHPI (d)................................. -- -- $ 83,000
------- -------- --------
</TABLE>
- ---------------
(a) Lease payments began on August 1, 1994.
(b) Lease payments began on July 11, 1995.
(c) Lease payments began on June 10, 1996.
(d) Lease payments began on July 10, 1996
The Company leases office space and utilizes certain services from Oxford.
All such arrangements are at fair market value.
F-18
<PAGE> 126
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996
(14) COMMITMENTS AND CONTINGENCIES
Employment Agreements
The Company has entered into Employment Agreements with certain of its
management employees, which include, among other terms, noncompete provisions
and provision for salary and benefit continuation.
Insurance
The Company, its subsidiaries and affiliated medical organizations are
insured with respect to medical malpractice and other professional liability
risks on either an occurrence or claims-made basis. Claims-made policies cover
claims reported to the insurance carrier prior to the end of the policy period.
The Company and its affiliated medical organizations intend to renew the
existing or similar claims-made policies annually and expect to be able to
reasonably obtain such coverage. Management is not aware of any claims against
it or the affiliated medical organizations that might have a material impact on
the Company's financial position.
(15) SUPPLEMENTAL CASH FLOW INFORMATION
Cash disbursements for the years ending December 31, 1994, 1995 and 1996
included interest of $120,000, $225,000 and $399,000, respectively, and income
taxes of $40,000, $151,000 and $66,000, respectively. For the years ending
December 31, 1994, 1995 and 1996, non-cash investing activities included the
deferred purchase prices relating to the acquisitions of VMA, Inc., CHPI, PMM,
HVHPI and CPC and the purchase of computer and office equipment through capital
leases totaling $201,000 in 1994, $38,000 in 1995 and $120,000 in 1996.
F-19
<PAGE> 127
HEALTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
JUNE 30, 1996 AND 1997
(AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
JUNE 30,
-----------------------
1996 1997
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................................... $ 2,902 $ 7,880
Accounts receivable, net of allowance for bad debts................ 216 1,518
Amounts due from unconsolidated affiliated medical corporations and
IPAs............................................................ 3,781 7,707
Prepaid expenses and other current assets.......................... 1,410 1,497
------- -------
Total current assets....................................... 8,309 18,602
Net property, equipment and leasehold improvements................... 8,170 8,384
Net intangible assets................................................ 15,444 23,380
Other long-term assets............................................... 557 640
------- -------
Total assets............................................... $ 32,480 $ 51,006
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.............................. $ 4,060 $ 7,829
Accrued medical costs.............................................. 2,988 7,022
Other current liabilities.......................................... 1,710 2,389
Notes payable, current............................................. 2,754 2,123
Current portion of long-term debt.................................. 25 28
------- -------
Total current liabilities.................................. 11,537 19,391
Other long-term liabilities.......................................... 214 194
Long-term debt....................................................... 683 657
Notes payable, long-term............................................. 2,873 3,187
------- -------
Total liabilities.......................................... 15,307 23,429
------- -------
Minority Interests................................................... 941 746
------- -------
Stockholders' Equity:
Preferred stock:
Series A convertible preferred stock............................ 17,500 25,000
Series B convertible preferred stock............................ 17,500 25,000
Common stock ($.001 par value, 15,000 shares authorized, 1,550
and
1,674 issued and outstanding in 1996 and 1997)................ 2 2
Accumulated deficit................................................ (18,770) (23,171)
------- -------
Total stockholders' equity................................. 16,232 26,831
------- -------
Total liabilities and stockholders' equity................. $ 32,480 $ 51,006
======= =======
</TABLE>
See accompanying note to the unaudited financial statements.
F-20
<PAGE> 128
HEALTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
1996 1997
-------- --------
<S> <C> <C>
Net Revenue:
Net revenue of consolidated IPAs..................................... $ 20,125 $ 60,803
-------- --------
Amounts associated with unconsolidated entities:
Net revenue of unconsolidated affiliated medical corporations..... 25,200 21,906
Net revenue of unconsolidated IPAs................................ 20,310 21,680
Cost of affiliated physicians services............................ (7,876) (10,747)
Medical claims of unconsolidated affiliated medical
corporations..................................................... (5,709) --
Medical claims of unconsolidated IPAs............................. (19,401) (20,490)
-------- --------
Management services revenue.......................................... 12,524 12,349
Other revenue........................................................ 101 247
-------- --------
Net revenue.................................................. 32,750 73,399
-------- --------
Operating Expenses:
Clinic salaries, wages and benefits.................................. 6,229 9,362
Medical claims of consolidated IPAs.................................. 21,133 50,256
Network operating expenses........................................... 2,010 2,503
Other clinic expenses................................................ 6,092 7,598
General corporate expenses........................................... 2,314 2,896
Depreciation and amortization........................................ 1,132 1,713
Net interest expense................................................. 68 88
-------- --------
Total operating expenses..................................... 38,978 74,416
-------- --------
Loss before minority interests and provision for income taxes........ (6,228) (1,017)
Minority interests' share in net loss................................ 352 169
Provision for income taxes........................................... (56) (14)
-------- --------
Net loss............................................................. $ (5,932) $ (862)
======== ========
</TABLE>
See accompanying note to unaudited financial statements.
F-21
<PAGE> 129
HEALTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------
1996 1997
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss............................................................... $(5,932) $ (862)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization....................................... 1,132 1,713
Minority interests' share in net loss............................... (352) (169)
Changes in assets and liabilities:
Increase in accounts receivable..................................... (112) (1,234)
Increase in amounts due from unconsolidated affiliated medical
corporations and IPAs,............................................. (842) (1,889)
Decrease (increase) in prepaid expenses and other current assets.... 173 (112)
Decrease (increase) in other long-term assets....................... 8 (135)
(Increase) decrease in accounts payable and accrued expenses........ (329) 1,101
Increase in accrued medical costs................................... 2,989 768
(Decrease) increase in other long-term liabilities.................. (61) 224
------ -------
Net cash used by operating activities............................... (3,326) (595)
------ -------
Cash flows from investing activities:
Payments for acquisitions, net of cash acquired........................ (1,464) (490)
Additions to property, equipment and improvements...................... (1,484) (926)
------ -------
Net cash used by investing activities............................... (2,948) (1,416)
------ -------
Cash flows from financing activities:
Proceeds from issuance of preferred stock.............................. 5,000 2,500
Payments on notes payable and long-term debt........................... (297) (432)
------ -------
Net cash provided by financing activities........................... 4,703 2,068
------ -------
Net change in cash and cash equivalents............................. (1,571) 57
Cash and cash equivalents at beginning of period.................... 4,473 7,823
------ -------
Cash and cash equivalents at end of period.......................... $ 2,902 $ 7,880
====== =======
</TABLE>
See accompanying note to unaudited financial statements.
F-22
<PAGE> 130
HEALTH PARTNERS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(1) SUBSEQUENT EVENTS
The Company has entered into an Agreement and Plan of Merger dated as of
July 1, 1997 with FPA Medical Management, Inc. ("FPA") whereby the Company will
become a wholly owned subsidiary of FPA and all outstanding securities of the
Company will be exchanged for FPA common stock. The total merger consideration
to be received will be subject to adjustment depending upon the average closing
stock price of FPA as reported on the Nasdaq for the ten consecutive trading
days ending on the date that is two trading days prior to the closing of the
transaction. All outstanding options at the time of the merger will be cancelled
in exchange for a number of shares of fully paid FPA common stock. The FPA
common stock will have a market value equal to the fair value of such option by
applying a variation of the Black-Scholes option pricing model by an investment
banking firm.
In connection with the aforementioned transaction, WellPoint and Oxford
have agreed to convert the Series A Convertible Preferred Stock and Series B
Convertible Preferred Stock, respectively, into 3,299,982 and 4,700,043 shares
of Company common stock, respectively and the cancellation of cumulative unpaid
dividends which was provided in the 1994 Securities Purchase Agreement.
As the result of entering into the foregoing agreement, the Company has
exercised its right to exchange the minority stockholders' shares of the equity
of the Company's subsidiaries for the Company's common stock. The Company has
reached agreement with the stockholders of all of the Company's subsidiaries
and, in connection with these transactions, will issue 871,697 shares of HPI
common stock with an aggregate value of approximately $8,739,000. Also, the
Company will cancel all existing stock options to purchase shares in the
Company's subsidiaries in exchange for the issuance of options to purchase
170,287 shares of HPI Common Stock. The acquisition of minority interests shall
be treated under the puchase method of accounting with the difference between
the fair value of the HPI Common Stock issued and the fair values of assets and
liabilities recorded as goodwill.
F-23
<PAGE> 131
APPENDIX A
================================================================================
AGREEMENT AND PLAN OF MERGER
DATED AS OF JULY 1, 1997
BY AND AMONG
FPA MEDICAL MANAGEMENT, INC.,
FPA ACQUISITION CORP.
AND
HEALTH PARTNERS, INC.
================================================================================
<PAGE> 132
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
ARTICLE I THE MERGER................................................................... A-1
Section 1.1 The Merger............................................................. A-1
Section 1.2 Effective Time of the Merger........................................... A-1
ARTICLE II THE SURVIVING CORPORATION AND PARENT........................................ A-1
Section 2.1 Certificate of Incorporation........................................... A-1
Section 2.2 Bylaws................................................................. A-1
Section 2.3 Directors and Executive Officers of the Surviving Corporation.......... A-2
Section 2.4 Effects of Merger...................................................... A-2
ARTICLE III CONVERSION OF SHARES....................................................... A-2
Section 3.1 Conversion of Shares in the Merger..................................... A-2
Section 3.2 Equitable Adjustment................................................... A-3
Section 3.3 Exchange of Certificates............................................... A-3
Section 3.4 No Fractional Securities............................................... A-4
Section 3.5 Options to Purchase Company Stock...................................... A-5
Section 3.6 Closing................................................................ A-5
Section 3.7 Closing of the Company's Transfer Books................................ A-5
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PARENT
AND ACQUISITION......................................................................... A-6
Section 4.1 Organization and Qualification......................................... A-6
Section 4.2 Capitalization......................................................... A-6
Section 4.3 Authority; Non-Contravention; Approvals................................ A-7
Section 4.4 Reports and Financial Statements....................................... A-8
Section 4.5 Absence of Undisclosed Liabilities..................................... A-8
Section 4.6 Absence of Certain Changes or Events................................... A-8
Section 4.7 Litigation............................................................. A-9
Section 4.8 Registration Statement and Proxy Statement............................. A-9
Section 4.9 No Violation of Law.................................................... A-9
Section 4.10 Compliance............................................................. A-10
Section 4.11 Taxes.................................................................. A-10
Section 4.12 No Parent Stockholders' Approval Required.............................. A-10
Section 4.13 Pooling and Tax-Free Reorganization Matters............................ A-10
Section 4.14 Brokers................................................................ A-11
ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY................................ A-11
Section 5.1 Organization and Qualification......................................... A-11
Section 5.2 Capitalization......................................................... A-11
Section 5.3 Subsidiaries........................................................... A-12
Section 5.4 Authority; Non-Contravention; Approvals................................ A-12
Section 5.5 Financial Statements................................................... A-13
Section 5.6 Absence of Undisclosed Liabilities..................................... A-13
Section 5.7 Absence of Certain Changes or Events................................... A-14
Section 5.8 Litigation............................................................. A-14
Section 5.9 Registration Statement and Proxy Statement............................. A-14
Section 5.10 No Violation of Law.................................................... A-14
Section 5.11 Compliance............................................................. A-15
Section 5.12 Taxes.................................................................. A-15
Section 5.13 Employee Benefit Plans; ERISA.......................................... A-15
</TABLE>
i
<PAGE> 133
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
Section 5.14 Labor Controversies.................................................... A-16
Section 5.15 Environmental Matters.................................................. A-16
Section 5.16 Title to Assets........................................................ A-16
Section 5.17 Company Stockholders' Approval......................................... A-17
Section 5.18 Pooling and Tax-Free Reorganization Matters............................ A-17
Section 5.19 Insurance.............................................................. A-17
Section 5.20 Opinion of Company's Financial Advisor................................. A-17
Section 5.21 Brokers................................................................ A-17
Section 5.22 Contracts and Commitments.............................................. A-17
Section 5.23 Intellectual Property.................................................. A-18
ARTICLE VI CONDUCT OF BUSINESS PENDING THE MERGER...................................... A-18
Section 6.1 Conduct of Business by the Company Pending the Merger.................. A-18
Section 6.2 Conduct of Business by Parent and Acquisition Pending the Merger....... A-20
Section 6.3 Control of the Company's Operations.................................... A-21
Section 6.4 Control of Parent's Operations......................................... A-21
Section 6.5 Conduct of Business of Acquisition..................................... A-21
ARTICLE VII ADDITIONAL AGREEMENTS...................................................... A-21
Section 7.1 Access to Information.................................................. A-21
Section 7.2 Registration Statement and Proxy Statement............................. A-22
Section 7.3 Company Stockholders' Approval......................................... A-22
Section 7.4 Affiliates of the Company and Parent................................... A-22
Section 7.5 Exchange Listing....................................................... A-23
Section 7.6 Expenses and Fees...................................................... A-23
Section 7.7 Agreement to Cooperate................................................. A-23
Section 7.8 Public Statements...................................................... A-23
Section 7.9 Employee Matters....................................................... A-23
Section 7.10 Notification of Certain Matters........................................ A-24
Section 7.11 Corrections to the Proxy Statement/Prospectus and Registration
Statement.............................................................. A-24
Section 7.12 Insurance; Indemnity................................................... A-24
Section 7.13 No Solicitations....................................................... A-25
Section 7.14 Roll-up Transactions................................................... A-25
Section 7.15 Bank Consent........................................................... A-26
ARTICLE VIII CONDITIONS................................................................. A-26
Section 8.1 Conditions to Each Party's Obligation to Effect the Merger............. A-26
Section 8.2 Conditions to Obligation of the Company to Effect the Merger........... A-27
Section 8.3 Conditions to Obligations of Parent and Acquisition to Effect the
Merger................................................................. A-27
ARTICLE IX TERMINATION, AMENDMENT AND WAIVER............................................ A-28
Section 9.1 Termination............................................................ A-28
Section 9.2 Effect of Termination.................................................. A-29
Section 9.3 Amendment.............................................................. A-29
Section 9.4 Waiver................................................................. A-30
ARTICLE X GENERAL PROVISIONS............................................................ A-30
Section 10.1 Non-Survival of Representations and Warranties......................... A-30
Section 10.2 Notices................................................................ A-30
Section 10.3 Interpretation......................................................... A-31
Section 10.4 Miscellaneous.......................................................... A-31
Section 10.5 Counterparts........................................................... A-31
</TABLE>
ii
<PAGE> 134
AGREEMENT AND PLAN OF MERGER
This Agreement and Plan of Merger is made this 1st day of July, 1997
("Agreement"), by and among FPA Medical Management, Inc., a Delaware corporation
("Parent"), FPA Acquisition Corp., a Delaware corporation and a wholly-owned
subsidiary of Parent ("Acquisition"), and Health Partners, Inc., a Delaware
corporation (the "Company").
WITNESSETH:
WHEREAS, the boards of directors of Parent, Acquisition and the Company
believe it to be advisable and in the best interests of their respective
stockholders that Acquisition merge with and into the Company on the terms set
forth in this Agreement (the "Merger");
WHEREAS, the Merger is intended for Federal income tax purposes to qualify
as a reorganization under the provisions of Section 368 of the Internal Revenue
Code of 1986, as amended (the "Code");
WHEREAS, the Merger also is intended to qualify for treatment as a pooling
of interests under Accounting Principles Board Opinion No. 16 ("APB No. 16").
NOW, THEREFORE, in consideration of the premises and the representations,
warranties, covenants and agreements contained herein, the parties hereto,
intending to be legally bound, hereby agree as follows:
ARTICLE I
THE MERGER
SECTION 1.1 The Merger.
Upon the terms and subject to the conditions of this Agreement, at the
Effective Time (as defined in Section 1.2 hereof), in accordance with the
Delaware General Corporation Law ("DGCL"), Acquisition shall be merged with and
into the Company and the separate existence of Acquisition shall thereupon
cease. The Company shall be the surviving corporation in the Merger and is
hereinafter sometimes referred to as the "Surviving Corporation."
SECTION 1.2 Effective Time of the Merger.
The Merger shall become effective at the date and time (the "Effective
Time") when a duly prepared and executed Certificate of Merger is filed with the
Secretary of State of the State of Delaware (the "Merger Filing") in accordance
with the DGCL. The Merger Filing shall be made simultaneously with or as soon as
practicable after the closing of the transactions contemplated by this Agreement
in accordance with Section 3.6 hereof.
ARTICLE II
THE SURVIVING CORPORATION AND PARENT
SECTION 2.1 Certificate of Incorporation.
The Certificate of Incorporation of Acquisition as in effect immediately
prior to the Effective Time shall be the Certificate of Incorporation of the
Surviving Corporation after the Effective Time, and thereafter may be amended in
accordance with its terms and as provided by law and this Agreement.
SECTION 2.2 Bylaws.
The bylaws of Acquisition as in effect immediately prior to the Effective
Time shall be the bylaws of the Surviving Corporation after the Effective Time,
and thereafter may be amended in accordance with their terms and as provided by
law and the Certificate of Incorporation of the Surviving Corporation.
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<PAGE> 135
SECTION 2.3 Directors and Executive Officers of the Surviving Corporation.
The directors of the Surviving Corporation shall be the directors of
Acquisition serving immediately prior to the Effective Time and the executive
officers of the Surviving Corporation shall be the executive officers of the
Company in office immediately prior to the Effective Time, and such directors
and executive officers shall serve in accordance with the bylaws of the
Surviving Corporation until their respective successors are duly elected or
appointed and qualified.
SECTION 2.4 Effects of Merger.
The Merger shall have the effects set forth in Section 259 of the DGCL.
ARTICLE III
CONVERSION OF SHARES
SECTION 3.1 Conversion of Shares in the Merger.
(a) Company Common Stock. At the Effective Time, by virtue of the Merger
and without any action on the part of the holder thereof, each issued and
outstanding share of Company Common Stock, par value $.001 per share (the
"Company Common Stock"), other than shares to be canceled in accordance with
Section 3.1(c) hereof and other than Dissenting Shares (as defined in Section
3.1(d) hereof), shall be converted into the right to receive the number of
shares of fully paid and nonassessable common stock, par value $.002 per share,
of Parent ("Parent Common Stock") determined by dividing the "Numerator" by the
"Denominator" (the quotient herein referred to as the "Exchange Ratio"). The
Denominator shall be the maximum number of shares of Company Common Stock issued
and outstanding at the Effective Time plus shares of Company Common Stock
issuable pursuant to Section 7.14 hereof. The Numerator shall be the remainder
which results when (y) the Stock Option Shares is subtracted from (z) the
quotient which results when $115,000,000 is divided by the Effective Valuation
Amount. The Effective Valuation Amount shall be:
(i) the average of the closing prices of Parent Common Stock as
reported on the Nasdaq National Market ("NNM") for the ten (10) consecutive
trading days ending on the date that is two (2) trading days prior to the
Closing Date (as defined in Section 3.6) (the "Parent Value") if such
average is greater than or equal to $18.00 but less than or equal to
$22.00; or
(ii) $18.00, if the Parent Value is less than $18.00; or
(iii) $22.00, if the Parent Value is greater than $22.00.
The Stock Option Shares shall equal the number of shares of Parent Common Stock
issuable pursuant to Section 3.5 hereof in respect of Company Stock Options (as
defined in Section 3.5 hereof) outstanding on the Closing Date whether or not
the same are vested immediately after giving effect to the Merger.
The Company shall provide to Parent, no later than the date on which the
Parent Value is determinable pursuant to this Section 3.1, a certificate (the
"Denominator Certificate") reasonably acceptable to Parent setting forth the
Denominator and the method used in the calculation thereof. If, prior to the
Effective Time, the announcement of a transaction by the Parent requires the
amendment or re-filing of the Registration Statement (as defined in Section
4.8), and, as a result of the re-filing or amendment of the Registration
Statement, the Closing occurs more than 90 days after the date of this
Agreement, notwithstanding clause (ii) of the definition of Effective Valuation
Amount, the Effective Valuation Amount shall equal the Parent Value if the
Parent Value is less than $18.00. Except as set forth in the immediately
preceding sentence, in no event will the number of shares of Parent Common Stock
issued upon the Merger (including shares issued under Section 3.5 hereof) exceed
6,388,889 shares.
(b) Company Preferred Stock. The Company shall use its reasonable best
efforts to cause, immediately prior to the Effective Time, each issued and
outstanding share of the Company's Series A Convertible Preferred Stock, par
value $.001 per share, and Series B Convertible Preferred Stock, par value $.001
per
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<PAGE> 136
share (collectively, the "Company Preferred Stock") to be converted into shares
of Company Common Stock, in accordance with the provisions of the relevant
Certificate of Designations for such Company Preferred Stock. At the Effective
Time, by virtue of the Merger and without any action on the part of the holder
thereof, such shares of Common Stock, other than shares to be canceled in
accordance with Section 3.1(c) hereof and other than Dissenting Shares, shall be
converted into the right to receive a number of shares of fully paid and
nonassessable shares of Parent Common Stock based on the Exchange Ratio.
(c) Cancellation of Company Stock. All shares of Company Common Stock and
Company Preferred Stock (collectively, "Company Stock") which, immediately prior
to the Effective Time, are held by the Company in its treasury shall be canceled
and extinguished and shall cease to exist and no consideration shall be
delivered with respect thereto.
(d) Dissenting Shares. (i) If applicable, notwithstanding any provision of
this Agreement to the contrary, each outstanding share of Company Stock, the
holder of which (x) has not voted in favor of the Merger, (y) has perfected such
holder's right to an appraisal of such holder's shares in accordance with the
applicable provisions of the DGCL and (z) 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
3.1(a) or 3.1(b), as applicable, 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
Parent Common Stock pursuant to Section 3.1(a) or 3.1(b), as applicable.
(ii) The Company shall give Parent 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 shall allow Parent the right to direct any
proceedings and the resolution thereof relating to such process.
(e) Acquisition Shares. Each share of capital stock of Acquisition issued
and outstanding immediately prior to the Effective Time shall be converted into
and exchanged for one validly issued, fully paid and nonassessable share of
common stock of the Surviving Corporation.
SECTION 3.2 Equitable Adjustment.
The calculations set forth in Section 3.1 hereof shall be subject to
equitable adjustment in the event of, or the setting of a record date prior to
the Effective Time with respect to, any stock split, stock dividend, reverse
stock split, recapitalization, reclassification or combination of Company Stock
or Parent Common Stock or dividend or distribution with respect to Parent Common
Stock or Company Stock or other change in the number of shares of Company Stock
outstanding prior to the Closing (as defined in Section 3.6 hereof) other than
issuances of shares pursuant to the exercise of outstanding stock options and
issuance of shares pursuant to the transactions contemplated by Section 7.14
hereof.
SECTION 3.3 Exchange of Certificates.
(a) From and after the Effective Time, each holder of an outstanding
certificate which immediately prior to the Effective Time represented shares of
Company Stock shall be entitled to receive in exchange therefor, upon surrender
thereof to a bank or trust company designated before the Effective Time by
Parent and reasonably acceptable to the Company (the "Exchange Agent"), a
certificate or certificates representing the number of whole shares of Parent
Common Stock to which such holder is entitled pursuant to Section 3.1 hereof.
Notwithstanding any other provision of this Agreement, (i) until holders or
transferees of certificates theretofore representing shares of Company Stock
have surrendered them for exchange as provided herein, no dividends shall be
paid with respect to any shares represented by such certificates and no payment
for fractional shares shall be made and (ii) without regard to when such
certificates representing shares of Company Stock are surrendered for exchange
as provided herein, no interest shall be paid on any dividends or
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<PAGE> 137
any payment for fractional shares. Upon surrender of a certificate which
immediately prior to the Effective Time represented shares of Company Stock,
there shall be paid to the holder of such certificate the amount of any
dividends which theretofore became payable, but which were not paid by reason of
the foregoing, with respect to the number of whole shares of Parent Common Stock
represented by the certificate or certificates issued upon such surrender.
(b) If any certificate for shares of Parent Common Stock is to be issued in
a name other than that in which the certificate for shares of Company Stock
surrendered in exchange therefor is registered, it shall be a condition of such
exchange that the person requesting such exchange shall pay any applicable
transfer or other taxes required by reason of such issuance.
(c) Promptly after the Effective Time, Parent shall make available to the
Exchange Agent the certificates representing shares of Parent Common Stock
required to effect the exchanges referred to in paragraph (a) above and cash for
payment of any fractional shares referred to in Section 3.4 hereof.
(d) Promptly after the Effective Time, the Exchange Agent shall mail to
each holder of record of a certificate or certificates that immediately prior to
the Effective Time represented outstanding shares of Company Stock (the "Company
Certificates") (i) a letter of transmittal (which shall specify that delivery
shall be effected, and risk of loss and title to the Company Certificates shall
pass, only upon actual delivery of the Company Certificates to the Exchange
Agent) and (ii) instructions for use in effecting the surrender of the Company
Certificates in exchange for certificates representing shares of Parent Common
Stock. Upon surrender of Company Certificates for cancellation to the Exchange
Agent, together with a duly executed letter of transmittal and such other
documents as the Exchange Agent shall reasonably require, the holder of such
Company Certificates shall be entitled to receive in exchange therefor a
certificate representing that number of whole shares of Parent Common Stock into
which the shares of Company Stock theretofore represented by the Company
Certificates so surrendered shall have been converted pursuant to the provisions
of Section 3.1 hereof, and the Company Certificates so surrendered shall be
canceled.
(e) Promptly following the date which is nine (9) months after the
Effective Time, the Exchange Agent shall deliver to Parent all cash,
certificates (including any Parent Common Stock) and other documents in its
possession relating to the transactions described in this Agreement, and the
Exchange Agent's duties shall terminate. Thereafter, each holder of a Company
Certificate may surrender such Company Certificate to the Surviving Corporation
and (subject to applicable abandoned property, escheat and similar laws) receive
in exchange therefor the Parent Common Stock, without any interest thereon. If
any certificate or certificates that immediately prior to the Effective Time
represented outstanding shares of Company Stock entitled to payment pursuant to
Section 3.1 hereof shall not have been surrendered for such payment prior to
such date on which any payment in respect thereof would otherwise escheat to or
become property of any governmental agency or other governmental entity, such
shares of Company Stock shall, to the extent permitted by applicable law, be
deemed to be canceled and no money or other payment will be due to the holder
thereof.
(f) In the event any Company Certificate shall have been lost, stolen or
destroyed, upon the making of an affidavit of that fact by the person claiming
such Company Certificate to be lost, stolen or destroyed, Parent shall issue in
exchange for such lost, stolen or destroyed Company Certificate the Parent
Common Stock deliverable in respect thereof determined in accordance with
Section 3.1 hereof. When authorizing such payment in exchange therefor, the
board of directors of Parent may, in its discretion and as a condition precedent
to the issuance thereof, require the owner of such lost, stolen or destroyed
Company Certificate to give the Surviving Corporation such indemnity as it may
reasonably direct as protection against any claim that may be made against the
Surviving Corporation with respect to the Company Certificate alleged to have
been lost, stolen or destroyed.
SECTION 3.4 No Fractional Securities.
Notwithstanding any other provision of this Agreement, no certificates or
scrip for fractional shares of Parent Common Stock shall be issued in the Merger
and no Parent Common Stock dividend, stock split or interest shall relate to any
fractional security, and such fractional interests shall not entitle the owner
thereof to vote or to any other rights of a security holder. In lieu of any such
fractional shares, each holder of Company
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<PAGE> 138
Stock who would otherwise have been entitled to receive a fraction of a share of
Parent Common Stock (in the aggregate) upon surrender of Company Certificates
for exchange pursuant to Section 3.3 hereof shall be entitled to receive from
the Exchange Agent a cash payment equal to such fraction multiplied by the
Parent Value.
SECTION 3.5 Options to Purchase Company Stock.
(a) Each option to purchase shares of Company Common Stock (a "Company
Stock Option") which is outstanding immediately prior to the Effective Time
pursuant to any stock option plan of the Company in effect on the date hereof
(the "Company Stock Plans") shall be canceled at the Effective Time and the
holder of such Company Stock Option shall be entitled to receive a number of
shares of Parent Common Stock, decreased to the nearest whole share, equal to
the quotient which results when the "Fair Market Value" of such Company Stock
Option at the Effective Time is divided by the Parent Value. The Fair Market
Value of all Company Stock Options shall be the fair value thereof determined by
an investment banking firm selected by the Company that is acceptable to the
Parent based upon the Effective Valuation Amount and the Exchange Ratio and
otherwise using valuation techniques reasonably acceptable to Parent and the
Company and consistent with the requirements of APB No. 16.
(b) Parent shall not issue fractional shares or pay cash to the holders of
Company Stock Options receiving shares of Parent Common Stock in lieu of issuing
fractional shares of Parent Common Stock. Instead, all fractional shares of
Parent Common Stock issuable under this Section 3.5 shall be decreased to the
nearest whole share.
(c) The Company shall use its reasonable best efforts to cause the holders
of Company Stock Options to execute prior to the Closing Date a form of
acknowledgement reasonably acceptable to Parent regarding their acceptance of
the treatment of Company Stock Options set forth in this Section 3.5 (each a
"Stock Option Acknowledgement").
SECTION 3.6 Closing.
The closing (the "Closing") of the transactions contemplated by this
Agreement shall take place at the offices of Pillsbury Madison & Sutro LLP, 101
West Broadway, Suite 1800, San Diego, California, or at any other location
mutually agreeable to Parent and the Company on the second business day
immediately following the date on which the last of the conditions set forth in
Article VIII is fulfilled or waived, or at such other time as Parent and the
Company shall agree (the date on which the Closing occurs is referred to in this
Agreement as the "Closing Date").
SECTION 3.7 Closing of the Company's Transfer Books.
At and after the Effective Time, holders of Company Certificates shall
cease to have any rights as stockholders of the Company, except for (a) the
right to an appraisal for Dissenting Shares pursuant to Section 3.1(d) hereof
(but solely as provided by the DGCL), (b) the right to receive shares of Parent
Common Stock pursuant to Section 3.3 hereof and (c) the right to receive cash
for payment of fractional shares pursuant to Section 3.4 hereof. At the
Effective Time, the stock transfer books of the Company shall be closed and no
transfer of shares of Company Stock which were outstanding immediately prior to
the Effective Time shall thereafter be made. If, after the Effective Time,
subject to the terms and conditions of this Agreement, Company Certificates
formerly representing Company Stock are presented to the Surviving Corporation,
they shall be canceled and exchanged for Parent Common Stock in accordance with
this Article III.
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<PAGE> 139
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF PARENT AND ACQUISITION
Parent and Acquisition each represent and warrant to the Company as
follows:
SECTION 4.1 Organization and Qualification.
Each of Parent and Acquisition is a corporation duly organized, validly
existing and in good standing under the laws of the State of Delaware and has
the requisite power and authority to own, lease and operate its assets and
properties and to carry on its business as it is now being conducted. Each of
Parent and Acquisition is qualified to do business and is in good standing in
each jurisdiction in which the properties owned, leased or operated by it or the
nature of the business conducted by it makes such qualification necessary,
except where the failure to be so qualified and in good standing would not have
a Parent Material Adverse Effect. As used in this Agreement, a "Parent Material
Adverse Effect" shall mean any event, circumstance, development or occurrence,
individually or when taken together with all other such events, circumstances,
developments or occurrences, causing, resulting in or having, or reasonably
likely to cause, result in or have, a material adverse effect on the business,
operations, properties, assets, condition (financial or other) or results of
operations of Parent and its subsidiaries (as defined in Section 4.2 hereof),
taken as a whole. True, accurate and complete copies of each of Parent's and
Acquisition's Certificates of Incorporation and bylaws, in each case as in
effect on the date hereof, including all amendments thereto, have heretofore
been delivered to the Company.
SECTION 4.2 Capitalization.
(a) The authorized capital stock of Parent consists of (i) 98,000,000
shares of Parent Common Stock, par value $.002, of which 33,234,157 shares were
outstanding as of the date of this Agreement, and (ii) 2,000,000 shares of
preferred stock, par value $.002 per share ("Parent Preferred Stock"), of which
no shares were outstanding as of the date of this Agreement. All of the issued
and outstanding shares of Parent Common Stock and Parent Preferred Stock are
validly issued and are fully paid, nonassessable and free of preemptive rights.
(b) The authorized capital stock of Acquisition consists of 100 shares of
Acquisition Common Stock, par value $.01, of which 10 shares are issued and
outstanding, which shares are owned beneficially and of record by Parent.
(c) Except as set forth on Schedule 4.2(c) attached hereto, as of the date
of this Agreement, there are no outstanding subscriptions, options, calls,
contracts, commitments, understandings, restrictions, arrangements, rights or
warrants, including any right of conversion or exchange under any outstanding
security, instrument or other agreement and also including any rights plan or
other anti-takeover agreement, obligating Parent or any subsidiary of Parent to
issue, deliver or sell, or cause to be issued, delivered or sold, additional
shares of the capital stock of Parent or obligating Parent or any subsidiary of
Parent to grant, extend or enter into any such agreement or commitment. There
are no voting trusts, proxies or other agreements or understandings to which
Parent or any subsidiary of Parent is a party or by which Parent or any
subsidiary of Parent is bound with respect to the voting of any shares of
capital stock of Parent. The shares of Parent Common Stock issued to
stockholders of the Company in the Merger will be at the Effective Time duly
authorized, validly issued, fully paid, nonassessable, and free of preemptive
rights. As used in this Agreement, "subsidiary" means, with respect to any party
hereto (a "Subject 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 Subject Party or (ii) which is a professional
corporation as to which such Subject Party or a subsidiary thereof has executed
a succession or similar stockholder agreement.
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SECTION 4.3 Authority; Non-Contravention; Approvals.
(a) Parent and Acquisition each have full corporate power and authority to
enter into this Agreement and, subject to the Parent Required Statutory
Approvals (as defined in Section 4.3(c) hereof), to consummate the transactions
contemplated hereby. This Agreement has been approved by the boards of directors
of Parent and Acquisition and by Parent as the sole stockholder of Acquisition,
and no other corporate proceedings on the part of Parent or Acquisition are
necessary to authorize the execution and delivery of this Agreement or the
consummation by Parent and Acquisition of the transactions contemplated hereby.
This Agreement has been duly executed and delivered by each of Parent and
Acquisition, and, assuming the due authorization, execution and delivery hereof
by the Company, constitutes a valid and legally binding agreement of each of
Parent and Acquisition enforceable against each of them in accordance with its
terms, except that such enforcement may be subject to (i) bankruptcy, fraudulent
conveyance, insolvency, reorganization, moratorium or other similar laws
affecting or relating to enforcement of creditors' rights generally and (ii)
general equitable principles, and except that the availability of equitable
remedies, including specific performance and injunctive relief, is subject to
the discretion of the court before which any proceedings may be brought.
(b) Except as set forth on Schedule 4.3(b) attached hereto, the execution
and delivery of this Agreement by each of Parent and Acquisition do not violate,
conflict with or result in a breach of any provision of, or constitute a default
(or an event which, with notice or lapse of time or both, would constitute a
default) under, or result in the termination of, or accelerate the performance
required by, or result in a right of termination or acceleration under, or
result in the creation of any lien, security interest, charge or encumbrance
upon any of the properties or assets of Parent or any of its subsidiaries under
any of the terms, conditions or provisions of (i) the respective charters or
bylaws of Parent or any of its subsidiaries, (ii) any statute, law, ordinance,
rule, regulation, judgment, decree, order, injunction, writ, permit or license
of any court or governmental authority applicable to Parent or any of its
subsidiaries or any of their respective properties or assets or (iii) any note,
bond, mortgage, indenture, deed of trust, license, franchise, permit,
concession, contract, lease or other instrument, obligation or agreement of any
kind to which Parent or any of its subsidiaries is now a party or by which
Parent or any of its subsidiaries or any of their respective properties or
assets may be bound or affected. The consummation by Parent and Acquisition of
the transactions contemplated hereby will not result in any violation, conflict,
breach, termination, acceleration or creation of liens under any of the terms,
conditions or provisions described in clauses (i) through (iii) of the preceding
sentence, subject to (x) in the case of the terms, conditions or provisions
described in clause (ii) above, obtaining (prior to the Effective Time) the
Parent Required Statutory Approvals (as defined in Section 4.3(c) hereof) and
(y) in the case of the terms, conditions or provisions described in clause (iii)
above, obtaining (prior to the Effective Time) consents required from commercial
lenders, lessors or other third parties named in Schedule 4.3(b) attached
hereto. Set forth on Schedule 4.3(b) attached hereto is a list of hospital
contracts with respect to which the consent of any party other than Parent is
required in order that consummation by Parent of the transactions contemplated
hereby will not result in a breach or termination of the respective contracts.
Excluded from the foregoing sentences of this paragraph (b), insofar as they
apply to the terms, conditions or provisions described in clauses (ii) and (iii)
of the first sentence of this paragraph (b), are such violations, conflicts,
breaches, defaults, terminations, accelerations or creations of liens, security
interests, charges or encumbrances that would not have a Parent Material Adverse
Effect.
(c) Except for (i) the filings by Parent and the Company required by the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
Act"), (ii) the filing of the Proxy Statement/Prospectus (as defined in Section
4.8 hereof) with the Securities and Exchange Commission (the "Commission")
pursuant to the Securities Act of 1933, as amended (the "Securities Act"), and
the declaration of the effectiveness thereof by the Commission and filings with
various state blue sky authorities, (iii) the making of the Merger Filing with
the Secretary of State of the State of Delaware in connection with the Merger
and (iv) any other required filings with or approvals from applicable Federal
and state governmental authorities (the filings and approvals referred to in
clauses (i) through (iv) are collectively referred to as the "Parent Required
Statutory Approvals"), no declaration, filing or registration with, or notice
to, or authorization, consent or approval of, any governmental or regulatory
body or authority is necessary for the execution and
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delivery of this Agreement by Parent or Acquisition or the consummation by
Parent or Acquisition of the transactions contemplated hereby, other than such
declarations, filings, registrations, notices, authorizations, consents or
approvals which, if not made or obtained, as the case may be, would not have a
Parent Material Adverse Effect.
SECTION 4.4 Reports and Financial Statements.
Since October 20, 1994, Parent has filed with the Commission all material
forms, statements, reports and documents (including all exhibits, amendments and
supplements thereto) required to be filed by it under each of the Securities
Act, the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and
the respective rules and regulations thereunder, all of which, as amended if
applicable, complied in all material respects at the time of filing with all
applicable requirements of the appropriate act and the rules and regulations
thereunder. Parent has previously delivered or made available to the Company a
copy of its (a) Annual Report on Form 10-K, as amended, for the fiscal years
ended December 31, 1994, 1995 and 1996, and its report on Form 10-Q for the
quarter ended March 31, 1997, each as filed with the Commission, (b) proxy and
information statements relating to (i) all meetings of its stockholders (whether
annual or special) and (ii) actions by written consent in lieu of a
stockholders' meeting from October 20, 1994, until the date hereof, and (c) all
other reports, including quarterly and current reports, or registration
statements filed by Parent with the Commission (the documents referred to in
clauses (a), (b) and (c) are collectively referred to as the "Parent SEC
Reports"). As of their respective dates, the Parent SEC Reports complied in all
material respects with the requirements of the Exchange Act and/or the
Securities Act and the rules and regulations of the Commission thereunder
applicable to such Parent SEC Reports. As of their respective dates, the Parent
SEC Reports did not contain any untrue statement of a material fact or omit to
state a material fact required to be stated therein or necessary 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 of Parent included in such reports,
including the notes and schedules thereto (collectively, the "Parent Financial
Statements"), have been prepared in accordance with generally accepted
accounting principles applied on a consistent basis (except as may be indicated
therein or in the notes thereto) and fairly present the financial position of
Parent and its subsidiaries as of the dates thereof and the results of their
operations and changes in financial position for the periods then ended,
subject, in the case of the unaudited interim financial statements, to normal
year-end and audit adjustments and any other adjustments described therein.
SECTION 4.5 Absence of Undisclosed Liabilities.
Except as disclosed in the Parent SEC Reports or with respect to
acquisitions or potential transactions or commitments heretofore disclosed to
the Company in writing or as set forth on Schedule 4.5 attached hereto, neither
Parent nor any of its subsidiaries had at December 31, 1996, or has incurred
since that date, any liabilities or obligations (whether absolute, accrued,
contingent or otherwise) of any nature, except: (a) liabilities, obligations or
contingencies (i) which are accrued or reserved against in the Parent Financial
Statements or reflected in the notes thereto or (ii) which were incurred after
December 31, 1996 and were incurred in the ordinary course of business and
consistent with past practices; and (b) liabilities and obligations which are of
a nature not required to be reflected in the consolidated financial statements
of Parent and its subsidiaries prepared in accordance with generally accepted
accounting principles consistently applied and which were incurred in the normal
course of business (provided that no liabilities, obligations or contingencies
excepted by subparagraphs (a)(ii) or (b) hereof will have, individually or in
the aggregate, a Parent Material Adverse Effect).
SECTION 4.6 Absence of Certain Changes or Events.
Except as disclosed in the Parent SEC Reports or with respect to
acquisitions or potential transactions or commitments heretofore disclosed to
the Company in writing or as set forth on Schedule 4.6 attached hereto, since
December 31, 1996, there has not been any change or event (other than changes
generally affecting the
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industry in which Parent and its subsidiaries operate or arising from general
business or economic conditions or as a result of this Agreement) that would
have a Parent Material Adverse Effect.
SECTION 4.7 Litigation.
Except as disclosed in the Parent SEC Reports, there are no claims, suits,
actions or proceedings pending or, to the knowledge of Parent, threatened
against, relating to or affecting Parent or any of its subsidiaries, before any
court, governmental department, commission, agency, instrumentality or
authority, or any arbitrator that seek to restrain or enjoin the consummation of
the Merger or which would have a Parent Material Adverse Effect. Except as set
forth in the Parent SEC Reports, neither Parent nor any of its subsidiaries is
subject to any judgment, decree, injunction, rule or order of any court,
governmental department, commission, agency, instrumentality or authority or any
arbitrator which prohibits or restricts the consummation of the transactions
contemplated hereby or would have any Parent Material Adverse Effect.
SECTION 4.8 Registration Statement and Proxy Statement.
None of the information to be supplied by Parent or its subsidiaries for
inclusion in (a) the Registration Statement on Form S-4 to be filed under the
Securities Act with the Commission by Parent in connection with the Merger for
the purpose of registering the shares of Parent Common Stock to be issued in the
Merger (the "Registration Statement") or (b) the proxy statement to be
distributed in connection with the Company's meeting of its stockholders to vote
upon this Agreement and the transactions contemplated hereby (the "Proxy
Statement" and, together with the prospectus included in the Registration
Statement, the "Proxy Statement/Prospectus") will, in the case of the Proxy
Statement or any amendments thereof or supplements thereto, at the time of the
mailing of the Proxy Statement and any amendments or supplements thereto, and at
the time of the meeting of stockholders of the Company to be held in connection
with the transactions contemplated by this Agreement, 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 are made, not misleading, or, in the case of
the Registration Statement, as amended or supplemented, at the time it becomes
effective and at the time of such meeting of the stockholders of the Company,
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 not misleading. The Proxy Statement/Prospectus, as of its Effective
Time, will comply as to form in all material respects with all applicable laws,
including the provisions of the Securities Act and the Exchange Act and the
rules and regulations promulgated thereunder, except that no representation is
made by Parent or Acquisition with respect to information supplied by the
Company for inclusion therein.
SECTION 4.9 No Violation of Law.
Except as disclosed in the Parent SEC Reports, neither Parent nor any of
its subsidiaries is in violation of, or has been given notice or been charged
with any violation of, any law, statute, order, rule, regulation, ordinance or
judgment (including, without limitation, any applicable environmental law) of
any governmental or regulatory body or authority, except for violations which
would not have a Parent Material Adverse Effect. Except as disclosed in the
Parent SEC Reports, as of the date of this Agreement, to the knowledge of
Parent, no investigation or review by any governmental or regulatory body or
authority is pending or threatened, nor has any governmental or regulatory body
or authority indicated an intention to conduct the same, other than, in each
case, those the outcome of which would not have a Parent Material Adverse
Effect. Parent and its subsidiaries have all permits, licenses, franchises,
variances, exemptions, orders and other governmental authorizations, consents
and approvals necessary to conduct their businesses as presently conducted
(collectively, the "Parent Permits"), except for permits, licenses, franchises,
variances, exemptions, orders, authorizations, consents and approvals the
absence of which would not have a Parent Material Adverse Effect. Parent and its
subsidiaries are not in violation of the terms of any Parent Permit, except for
delays in filing reports or violations which would not have a Parent Material
Adverse Effect.
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SECTION 4.10 Compliance.
Except as disclosed in the Parent SEC Reports or on Schedule 4.10 attached
hereto, Parent and each of its subsidiaries are not in breach or violation of or
in default in the performance or observance of any term or provision of, and no
event has occurred which, with lapse of time or action by a third party, would
result in a default under (a) the respective charters, bylaws or other similar
organizational instruments of Parent or any of its subsidiaries or (b) any
contract, commitment, agreement, indenture, mortgage, loan agreement, note,
lease, bond, license, approval or other instrument to which Parent or any of its
subsidiaries is a party or by which any of them is bound or to which any of
their property is subject, which breaches, violations and defaults, in the case
of clause (b) of this Section 4.10, would have a Parent Material Adverse Effect.
SECTION 4.11 Taxes.
(a) Parent and its subsidiaries have (i) duly filed (or timely requested
and received an extension to file) with the appropriate governmental authorities
all Tax Returns (as defined in Section 4.11(c) hereof) required to be filed by
them for all periods ending on or prior to the Effective Time, other than those
Tax Returns the failure of which to file would not have a Parent Material
Adverse Effect, and such Tax Returns are true, correct and complete in all
material respects and (ii) duly paid in full or made adequate provision for the
payment of all Taxes (as defined in Section 4.11(b) hereof) for all periods
ending at or prior to the Effective Time. The liabilities and reserves for Taxes
reflected in the Parent balance sheet included in the latest Parent SEC Report
are adequate to cover all Taxes for all periods ending at or prior to the date
of such balance sheet and 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 Internal
Revenue Service (the "IRS") or any other governmental taxing authority with
respect to Taxes of Parent or any of its subsidiaries which, if decided
adversely would have a Parent Material Adverse Effect. 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
subsidiary of Parent other than agreements the consequences of which are
adequately reserved for in the Parent Financial Statements. Neither Parent nor
any of its 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.
(b) For purposes of this Agreement, the term "Taxes" shall mean all taxes,
including, without limitation, income, gross receipts, excise, property, sales,
withholding, social security, occupation, use, service, service use, license,
payroll, franchise, transfer and recording taxes, fees and charges, windfall
profits, severance, customs, import, export, employment or similar taxes,
charges, fees, levies or other assessments imposed by the United States, or any
state, local or foreign government or subdivision or agency thereof, whether
computed on a separate, consolidated, unitary, combined or any other basis, and
such term shall include any interest, fines, penalties or additional amounts and
any interest in respect of any additions, fines or penalties attributable or
imposed or with respect to any such taxes, charges, fees, levies or other
assessments.
(c) For purposes of this Agreement, the term "Tax Return" shall mean any
return, report or other document or information required to be supplied to a
taxing authority in connection with Taxes.
SECTION 4.12 No Parent Stockholders' Approval Required.
No vote of stockholders of Parent is required by Parent's Certificate of
Incorporation, bylaws, any applicable law or any national securities exchange or
The NNM for the approval of this Agreement or the consummation of the
transactions contemplated hereby (including the issuance, registration and
inclusion on the NNM of Parent Common Stock)
SECTION 4.13 Pooling and Tax-Free Reorganization Matters.
To the knowledge of Parent and based upon consultation with its independent
accountants, neither Parent nor Acquisition nor any of their affiliates has
taken or agreed to take any action that would interfere with the ability of
Parent to (a) account for the business combination to be effected by the Merger
as a pooling of
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interests under APB No. 16 for accounting and financial statement purposes or
(b) treat the Merger as a tax-free reorganization pursuant to Sections
368(a)(1)(A) and 368(a)(2)(E) of the Code.
SECTION 4.14 Brokers.
Parent and Acquisition represent and warrant that no broker, finder or
investment banker is entitled to any brokerage, finder's or other fee or
commission in connection with the Merger or the transactions contemplated by
this Agreement based upon arrangements made by or on behalf of Parent or
Acquisition.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to Parent and Acquisition as follows:
SECTION 5.1 Organization and Qualification.
The Company is a corporation duly organized, validly existing and in good
standing under the laws of the State of Delaware and has the requisite corporate
power and authority to own, lease and operate its assets and properties and to
carry on its business as it is now being conducted. The Company is qualified to
do business and is in good standing in each jurisdiction in which the properties
owned, leased or operated by it or the nature of the business conducted by it
makes such qualification necessary, except where the failure to be so qualified
and in good standing would not have a Company Material Adverse Effect. As used
in this Agreement, a "Company Material Adverse Effect" shall mean any event,
circumstance, development or occurrence, individually or when taken together
with all other such events, circumstances, developments or occurrences, causing,
resulting in or having, or reasonably likely to cause, result in or 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 (as defined in Section 4.2 hereof), taken as a whole. True,
accurate and complete copies of the Company's Certificate of Incorporation and
bylaws, in each case as in effect on the date hereof, including all amendments
thereto, have heretofore been delivered to Parent.
SECTION 5.2 Capitalization.
(a) The authorized capital stock of the Company consists of 15,000,000
shares of Company Common Stock, par value $.001 per share, and 50,000 shares of
Company Preferred Stock, par value $.001 per share, of which 25,000 shares have
been designated Series A Convertible Preferred Stock and 25,000 shares have been
designated Series B Convertible Preferred Stock. As of the date of this
Agreement, 1,673,500 shares of Company Common Stock and 50,000 shares of Company
Preferred Stock were issued and outstanding (25,000 and 25,000 shares of which
are designated Series A Convertible Preferred Stock and Series B Convertible
Preferred Stock respectively). All of such issued and outstanding shares are
validly issued and are fully paid, nonassessable and free of preemptive rights.
(b) Except as set forth on Schedule 5.2(b) attached hereto, as of the date
hereof there are no outstanding subscriptions, options, calls, contracts,
commitments, understandings, restrictions, arrangements, rights or warrants,
including any right of conversion or exchange under any outstanding security,
instrument or other agreement and also including any rights plan or other
anti-takeover agreement, obligating the Company or any subsidiary of the Company
to issue, deliver or sell, or cause to be issued, delivered or sold, additional
shares of the capital stock of the Company or obligating the Company or any
subsidiary of the Company to grant, extend or enter into any such agreement or
commitment. Except as set forth on Schedule 5.2(b) attached hereto, there are no
voting trusts, proxies or other agreements or understandings to which the
Company or any subsidiary of the Company is a party or by which the Company or
any subsidiary of the Company is bound with respect to the voting of any shares
of capital stock of the Company.
(c) Each Stock Option Acknowledgement executed and delivered by the holder
of a Company Stock Option as contemplated by Section 3.5(a) above shall, from
and after the Effective Time, be binding upon the holder of the Company Stock
Option to which such Stock Option Acknowledgement relates on the terms and
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subject to the conditions provided in Section 3.5(a) and such Stock Option
Acknowledgement. Except as set forth on Schedule 5.2(c) attached hereto, none of
the benefits available under the Company Stock Options are subject to
acceleration as a result of the Merger or otherwise, and the Company shall take
no action to permit or foster any such acceleration.
SECTION 5.3 Subsidiaries.
Schedule 5.3 sets forth the name, state of incorporation and stockholders
of each subsidiary of the Company. Each subsidiary of the Company is duly
organized, validly existing and in good standing under the laws of its
jurisdiction of incorporation or formation and has the requisite power and
authority to own, lease and operate its assets and properties and to carry on
its business as it is now being conducted. Each subsidiary of the Company is
qualified to do business, and is in good standing, in each jurisdiction in which
the properties owned, leased or operated by it or the nature of the business
conducted by it makes such qualification necessary, except where the failure to
be so qualified and in good standing would not have a Company Material Adverse
Effect. All of the outstanding shares of capital stock of each corporate
subsidiary of the Company are duly authorized, validly issued, fully paid,
nonassessable and free of preemptive rights and are owned directly or indirectly
by the Company, free and clear of any liens, claims, encumbrances, security
interests, equities, charges and options of any nature whatsoever except as set
forth on Schedule 5.3 attached hereto. There are no subscriptions, options,
warrants, rights, calls, contracts, voting trusts, proxies or other commitments,
understandings, restrictions or arrangements relating to the issuance, sale,
voting, transfer, ownership or other rights with respect to any shares of
capital stock of any corporate subsidiary of the Company, including any right of
conversion or exchange under any outstanding security, instrument or agreement
except as disclosed on Schedule 5.3 attached hereto.
SECTION 5.4 Authority; Non-Contravention; Approvals.
(a) The Company has full corporate power and authority to enter into this
Agreement and, subject to the Company Stockholders' Approval of the Merger (as
defined in Section 7.3(a)) and the Company Required Statutory Approvals (as
defined in Section 5.4(c)), to consummate the transactions contemplated hereby.
This Agreement has been approved by the board of directors of the Company, and
no other corporate proceedings on the part of the Company are necessary to
authorize the execution and delivery of this Agreement or, except for the
Company Stockholders' Approval, the consummation by the Company of the
transactions contemplated hereby. This Agreement has been duly executed and
delivered by the Company, and, assuming the due authorization, execution and
delivery hereof by Parent and Acquisition, constitutes a valid and legally
binding agreement of the Company, enforceable against the Company in accordance
with its terms, except that such enforcement may be subject to (i) bankruptcy,
fraudulent conveyance, insolvency, reorganization, moratorium or other similar
laws affecting or relating to enforcement of creditors' rights generally and
(ii) general equitable principles, and except that the availability of equitable
remedies, including specific performance and injunctive relief, is subject to
the discretion of the court before which any proceedings may be brought.
(b) Except as set forth on Schedule 5.4(b) attached hereto, the execution
and delivery of this Agreement by the Company do not violate, conflict with or
result in a breach of any provision of, or constitute a default (or an event
which, with notice or lapse of time or both, would constitute a default) under,
or result in the termination of, or accelerate the performance required by, or
result in a right of termination or acceleration under, or result in the
creation of any lien, security interest, charge or encumbrance upon any of the
properties or assets of the Company or any of its subsidiaries under any of the
terms, conditions or provisions of (i) the respective charters or bylaws of the
Company or any of its subsidiaries, (ii) any statute, law, ordinance, rule,
regulation, judgment, decree, order, injunction, writ, permit or license of any
court or governmental authority applicable to the Company or any of its
subsidiaries or any of their respective properties or assets, or (iii) any note,
bond, mortgage, indenture, deed of trust, license, franchise, permit,
concession, contract, lease or other instrument, obligation or agreement of any
kind to which the Company or any of its subsidiaries is now a party or by which
the Company or any of its subsidiaries or any of their respective properties or
assets may be bound or affected. The consummation by the Company of the
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transactions contemplated hereby will not result in any violation, conflict,
breach, termination, acceleration or creation of liens under any of the terms,
conditions or provisions described in clauses (i) through (iii) of the preceding
sentence, subject to (x) in the case of the terms, conditions or provisions
described in clause (ii) above, obtaining (prior to the Effective Time) the
Company Required Statutory Approvals and the Company Stockholders' Approval and
(y) in the case of the terms, conditions or provisions described in clause (iii)
above, obtaining (prior to the Effective Time) consents required from commercial
lenders, lessors or other third parties. Set forth on Schedule 5.4(b) attached
hereto is a list of hospital contracts with respect to which the consent of any
party other than the Company is required in order that consummation by the
Company of the transactions contemplated hereby will not result in a breach or
termination of the respective contracts. Excluded from the foregoing sentences
of this paragraph (b), insofar as they apply to the terms, conditions or
provisions described in clauses (ii) and (iii) of the first sentence of this
paragraph (b), are such violations, conflicts, breaches, defaults, terminations,
accelerations or creations of liens, security interests, charges or encumbrances
that would not have a Company Material Adverse Effect.
(c) Except for (i) the filings by Parent and the Company required by the
HSR Act, (ii) the filing of the Proxy Statement/Prospectus with the Commission
pursuant to the Securities Act and the declaration of the effectiveness thereof
by the Commission and filings with various state blue sky authorities, (iii) the
making of the Merger Filing with the Secretary of State of the State of Delaware
in connection with the Merger and (iv) any other required filings with or
approvals from applicable Federal and state governmental authorities (the
filings and approvals referred to in clauses (i) through (iv) are collectively
referred to as the "Company Required Statutory Approvals"), no declaration,
filing or registration with, or notice to, or authorization, consent or approval
of, any governmental or regulatory body or authority is necessary for the
execution and delivery of this Agreement by the Company or the consummation by
the Company of the transactions contemplated hereby, other than such
declarations, filings, registrations, notices, authorizations, consents or
approvals which, if not made or obtained, as the case may be, would not have a
Company Material Adverse Effect.
SECTION 5.5 Financial Statements.
The Company has previously delivered or made available to Parent a copy of
the following financial statements (the "Company Financial Statements"), all of
which have been prepared on a consolidated basis (except as otherwise indicated)
in accordance with generally accepted accounting principles consistently applied
throughout the periods indicated (except as may be indicated in the notes
thereto):
(a) Audited Consolidated Statements of Financial Position, Operations,
Cash Flows and Changes in Stockholders' Equity of the Company and its
consolidated subsidiaries at or for the twelve (12) months ended December
31, 1994, 1995, 1996 and related Notes to the Consolidated Financial
Statements as of and for the years ended December 31, 1994, 1995, 1996; and
(b) Unaudited Consolidated Statements of Financial Position and
Operations at or for the three (3) months ended March 31, 1997.
The Company Financial Statements fairly present the financial position of the
Company and its subsidiaries as of the dates thereof and the results of their
operations and changes in financial position for the periods then ended,
although the unaudited Company Financial Statements do not contain the footnotes
required by generally accepted accounting principles and are subject to normal
year-end and audit adjustments and any other adjustments described therein.
SECTION 5.6 Absence of Undisclosed Liabilities.
Except with respect to acquisitions or potential transactions or
commitments disclosed on Schedule 5.6 attached hereto, neither the Company nor
any of its subsidiaries had at December 31, 1996, or has incurred since that
date, any liabilities or obligations (whether absolute, accrued, contingent or
otherwise) of any nature, except: (a) liabilities, obligations or contingencies
(i) which are accrued or reserved against in the Company Financial Statements or
reflected in the notes thereto or (ii) which were incurred after December 31,
1996 and were incurred in the ordinary course of business and consistent with
past practices; and (b)
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liabilities and obligations which are of a nature not required to be reflected
in the consolidated financial statements of the Company and its subsidiaries
prepared in accordance with generally accepted accounting principles
consistently applied and which were incurred in the normal course of business
(provided that no liabilities, obligations or contingencies excepted by
subparagraphs (a)(ii) or (b) hereof will have, individually or in the aggregate,
a Company Material Adverse Effect).
SECTION 5.7 Absence of Certain Changes or Events.
Except as set forth on Schedule 5.7 attached hereto, since December 31,
1996, there has not been any change or event (other than changes generally
affecting the industry in which the Company and its subsidiaries operate or
arising from general business or economic conditions or as a result of this
Agreement) that would have a Company Material Adverse Effect.
SECTION 5.8 Litigation.
Except as set forth on Schedule 5.8 attached hereto, there are no claims,
suits, actions or proceedings pending or, to the knowledge of the Company,
threatened against, relating to or affecting the Company or any of its
subsidiaries, before any court, governmental department, commission, agency,
instrumentality or authority, or any arbitrator that seek to restrain the
consummation of the Merger or which would have a Company Material Adverse
Effect. Except as referred to in Schedule 5.8 attached hereto, neither the
Company nor any of its subsidiaries is subject to any judgment, decree,
injunction, rule or order of any court, governmental department, commission,
agency, instrumentality or authority or any arbitrator which prohibits or
restricts the consummation of the transactions contemplated hereby or would have
any Company Material Adverse Effect.
SECTION 5.9 Registration Statement and Proxy Statement.
None of the information to be supplied by the Company or its subsidiaries
for inclusion in (a) the Registration Statement or (b) the Proxy Statement will,
in the case of the Proxy Statement or any amendments thereof or supplements
thereto, at the time of the mailing of the Proxy Statement and any amendments or
supplements thereto, and at the time of the meeting of stockholders of the
Company to be held in connection with the transactions contemplated by this
Agreement, 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, or, in the case of the Registration Statement, as amended or
supplemented, at the time it becomes effective and at the time of such meeting
of the stockholders of the Company, 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 not misleading. The Proxy
Statement/Prospectus, as of its Effective Time, will comply as to form in all
material respects with all applicable laws, including the provisions of the
Securities Act and the Exchange Act and the rules and regulations promulgated
thereunder, except that no representation is made by the Company with respect to
information supplied by Parent or Acquisition for inclusion therein.
SECTION 5.10 No Violation of Law.
Except as set forth on Schedule 5.10 attached hereto, neither the Company
nor any of its subsidiaries is in violation of or has been given notice or been
charged with any violation of, any law, statute, order, rule, regulation,
ordinance or judgment (including, without limitation, any applicable
environmental law, ordinance or regulation) of any governmental or regulatory
body or authority, except for violations which would not have a Company Material
Adverse Effect. As of the date of this Agreement, to the knowledge of the
Company, no investigation or review by any governmental or regulatory body or
authority is pending or threatened, nor has any governmental or regulatory body
or authority indicated an intention to conduct the same, other than, in each
case, those the outcome of which would not have Company Material Adverse Effect.
The Company and its subsidiaries have all permits, licenses, franchises,
variances, exemptions, orders and other governmental authorizations, consents
and approvals necessary to conduct their businesses as presently conducted
(collectively, the "Company Permits"), except for permits, licenses, franchises,
variances, exemptions, orders,
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authorizations, consents and approvals the absence of which would not have a
Company Material Adverse Effect. The Company and its subsidiaries are not in
violation of the terms of any Company Permit, except for delays in filing
reports or violations which would not have a Company Material Adverse Effect.
SECTION 5.11 Compliance.
Except as set forth on Schedule 5.11 attached hereto, the Company and each
of its subsidiaries are not in breach or violation of or in default in the
performance or observance of any term or provision of, and no event has occurred
which, with lapse of time or action by a third party, would result in a default
under, (a) the respective charters, bylaws or similar organizational instruments
of the Company or any of its subsidiaries or (b) any contract, commitment,
agreement, indenture, mortgage, loan agreement, note, lease, bond, license,
approval or other instrument to which the Company or any of its subsidiaries is
a party or by which any of them is bound or to which any of their property is
subject, which breaches, violations and defaults, in the case of clause (b) of
this Section 5.11, would have a Company Material Adverse Effect.
SECTION 5.12 Taxes.
The Company and its subsidiaries have (i) duly filed (or timely requested
and received an extension to file) with the appropriate governmental authorities
all Tax Returns required to be filed by them for all periods ending on or prior
to the Effective Time, other than those Tax Returns the failure of which to file
would not have a Company Material Adverse Effect, and such Tax Returns are true,
correct and complete in all material respects, and (ii) duly paid in full or
made adequate provision for the payment of all Taxes for all periods ending at
or prior to the Effective Time. The liabilities and reserves for Taxes reflected
in the most recent audited Company balance sheet are adequate to cover all Taxes
for all periods ending at or prior to the Effective Time and 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 IRS or any other governmental taxing authority
with respect to Taxes of the Company or any of its subsidiaries which, if
decided adversely would have a Company Material Adverse Effect. 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 Code.
SECTION 5.13 Employee Benefit Plans; ERISA.
(a) All material employee benefit plans, programs, arrangements or
practices covering current or former employees of the Company, including
employee benefit plans within the meaning set forth in Section 3(3) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), are
listed in Schedule 5.13(a) attached hereto (such plans, programs, arrangements
or practices of Company together with those of its subsidiaries being referred
to as the "Company Plans"). True and complete copies of each Company Plan has
been made available to the Company. To the extent applicable, each Company Plan
complies in all material respects with the requirements of its terms, ERISA and
the Code. Each Company Plan intended to be qualified under Section 401(a) of the
Code has received a favorable determination letter from the IRS. No Company Plan
is covered by Title IV of ERISA or Section 412 of the Code. Neither the Company
nor any of its subsidiaries has incurred any liability or penalty under Section
4975 of the Code or Section 502(i) of ERISA with respect to any Company Plan. To
the knowledge of the Company, there are no pending, threatened or anticipated
claims against or otherwise involving the Company Plans, except routine claims
for benefits. All material contributions required to be made as of the date of
this Merger Agreement to the Company Plans have been made or properly accounted
for. Neither the Company nor any entity under "common control" with the Company
within the meaning of Section 4001 of ERISA has contributed to or been required
to contribute to, any "multiemployer plan" (as defined in Section 3(37) of
ERISA). No Company Plan provides for post-retirement medical benefits, other
than as required by applicable law.
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SECTION 5.14 Labor Controversies.
Except as set forth on Schedule 5.14 attached hereto, (a) there are no
significant controversies pending or, to the knowledge of the Company,
threatened between the Company or its subsidiaries and any representatives of
any of their employees, (b) to the knowledge of the Company, there are no
material organizational efforts presently being made involving any of the
presently unorganized employees of the Company or its subsidiaries, (c) the
Company and its subsidiaries have, to the knowledge of the Company, complied in
all material respects with all laws relating to the employment of labor,
including, without limitation, any provisions thereof relating to wages, hours,
collective bargaining, and the payment of social security and similar taxes, and
(d) no person has, to the knowledge of the Company, asserted that the Company or
any of its subsidiaries is liable in any amount for any arrears of wages or any
taxes or penalties for failure to comply with any of the foregoing, except for
such controversies, organizational efforts, noncompliance and liabilities which
would not have a Company Material Adverse Effect.
SECTION 5.15 Environmental Matters.
Except as set forth on Schedule 5.15 attached hereto, (i) the Company and
its subsidiaries have conducted their respective businesses in compliance with
all applicable Environmental Laws, including, without limitation, having all
permits, licenses and other approvals and authorizations necessary for the
operation of their respective businesses as presently conducted, (ii) none of
the properties owned by the Company or any of its subsidiaries contain any
Hazardous Substance as a result of any activity of the Company or any of its
subsidiaries in amounts exceeding the levels permitted by applicable
Environmental Laws, (iii) neither the Company nor any of its subsidiaries has
received any notices, demand letters or requests for information from any
Federal, state, local or foreign governmental entity or third party indicating
that the Company or any of its subsidiaries may be in violation of, or liable
under, any Environmental Law in connection with the ownership or operation of
their businesses, (iv) there are no civil, criminal or administrative actions,
suits, demands, claims, hearings, investigations or proceedings pending or, to
the knowledge of the Company and its subsidiaries, threatened against the
Company or any of its subsidiaries relating to any violation, or alleged
violation, of any Environmental Law, (v) no reports have been filed, or are
required to be filed, by the Company or any of its subsidiaries concerning the
release of any Hazardous Substance or the threatened or actual violation of any
Environmental Law, (vi) no Hazardous Substance has been disposed of, released or
transported in violation of any applicable Environmental Law from any properties
owned by the Company or any of its subsidiaries as a result of any activity of
the Company or any of its subsidiaries during the time such properties were
owned, leased or operated by the Company or any of its subsidiaries, (vii) there
have been no environmental investigations, studies, audits, tests, reviews or
other analyses regarding compliance or noncompliance with any applicable
Environmental Law conducted by or which are in the possession of the Company or
its subsidiaries relating to the activities of the Company or its subsidiaries
which have not been delivered to Parent prior to the date hereof, (viii) there
are, to the knowledge of Company and its subsidiaries, no underground storage
tanks on, in or under any properties owned by the Company or any of its
subsidiaries and no underground storage tanks have been closed or removed from
any of such properties during the time such properties were owned, leased or
operated by the Company or any of its subsidiaries, (ix) there is, to the
knowledge of Company and its subsidiaries, no asbestos or asbestos containing
material present in any of the properties owned by the Company and its
subsidiaries, and no asbestos has been removed from any of such properties
during the time such properties were owned, leased or operated by the Company or
any of its subsidiaries, and (x) neither the Company, its subsidiaries nor any
of their respective properties are subject to any material liabilities or
expenditures (fixed or contingent) relating to any suit, settlement, court
order, administrative order, regulatory requirement, judgment or claim asserted
or arising under any Environmental Law, except for violations of the foregoing
clauses (i) through (x) that would not reasonably be expected to have a Company
Material Adverse Effect.
SECTION 5.16 Title to Assets.
Except as set forth on Schedule 5.16 attached hereto, the Company and each
of its subsidiaries has good and marketable title in fee simple to all its real
property and good title to all its leasehold interests and other
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properties, as reflected in the most recent balance sheet included in the
Company Financial Statements, except for properties and assets that have been
disposed of in the ordinary course of business since the date of such balance
sheet, 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 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 Schedule 5.16 attached hereto, and except for
such matters which would not have a Company Material Adverse Effect. 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 would
not have a Company Material Adverse Effect.
SECTION 5.17 Company Stockholders' Approval.
The affirmative vote of stockholders of the Company required for approval
and adoption of this Agreement and the Merger is a majority of the outstanding
shares of Company Common Stock and sixty percent (60%) of the holders of each
class of Company Preferred Stock.
SECTION 5.18 Pooling and Tax-Free Reorganization Matters.
To the knowledge of the Company and based upon consultation with its
independent accountants, neither the Company nor any of its affiliates has taken
or agreed to take any action that would interfere with the ability of Parent to
(a) account for the business combination to be effected by the Merger as a
pooling of interests or (b) treat the Merger as a tax-free reorganization
pursuant to Sections 368(a)(1)(A) and 368(a)(2)(E) of the Code.
SECTION 5.19 Insurance.
Except as set forth on Schedule 5.19 attached hereto, the Company maintains
insurance with financially responsible insurance companies in amounts customary
in its industry to insure it against risks and losses associated with the
operation of its business and its properties. Copies of such policy or policies
have been made available to Parent.
SECTION 5.20 Opinion of Company's Financial Advisor.
The Board of Directors of the Company has received the opinion of Smith
Barney Inc. ("Smith Barney"), financial advisor to the Company, to the effect
that, as of the date of this Agreement, the Exchange Ratio is fair, from a
financial point of view, to the holders of Company Common Stock (the "Smith
Barney Opinion").
SECTION 5.21 Brokers.
The Company represents and warrants that no broker, finder or investment
banker is entitled to any brokerage, finder's or other fee or commission in
connection with the Merger or the transactions contemplated by this Agreement
based upon arrangements made by or on behalf of the Company (except for fees,
expenses and amounts of indemnity payable to Smith Barney).
SECTION 5.22 Contracts and Commitments.
(a) There is no default or event that with notice or lapse of time, or
both, would constitute a material default by the Company or any of its
subsidiaries under any of the material contracts (a "Material Contract") to
which it is a party. Neither the Company nor any of its subsidiaries has
received written notice of an outstanding, uncured default under any Material
Contract by any other party thereto. Except as set forth in Schedule 5.22
attached hereto, neither the Company nor any of its subsidiaries has any
knowledge (i) that any
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hospital, hospital system, independent practice association ("IPA"), physician
group, physician, pharmacy, laboratory, home health care agency, nursing
facility, mental health provider, therapist or other allied health care
professional or institution (each a "Provider" and collectively "Providers")
representing individually or in the aggregate in excess of ten percent (10%) of
the enrollees of the Company or of the total number of Providers are organized
or attempting to organize any entity (whether or not incorporated) for the
purpose of bargaining or otherwise dealing with the Company on a collective
basis (except with respect to individual Providers who have formed professional
corporations or partnerships with respect to IPAs and medical groups which
already contract with the Company or its subsidiaries); (ii) that IPAs, medical
groups or individual physicians which contract with the Company or its
subsidiaries and which serve individually or in the aggregate more than ten
percent (10%) of the enrollees of the Company or its subsidiaries have provided
written notice of an intent (whether or not legally binding) to terminate or not
to renew their respective contracts with the Company or its subsidiaries; (iii)
of any circumstances likely to result in disenrollment of enrollees, the loss of
which individually and in the aggregate would have a Company Material Adverse
Effect, other than those occurring as a result of general economic or financial
conditions or other conditions or developments that are not unique to the
Company and its subsidiaries but also affect other persons who participate or
are engaged in the lines of business in which the Company and its subsidiaries
participate or are engaged; or (iv) of any Provider providing services to the
Company and its subsidiaries that does not maintain professional liability
insurance.
(b) Each of the Material Contracts is enforceable against the Company or
any of its subsidiaries, as the case may be, in accordance with its terms,
except as such enforceability may be limited by general principles of equity or
by bankruptcy, insolvency or other similar laws relating to rights of creditors.
Neither the Company nor any of its subsidiaries has received written notice that
any party to any of the Material Contracts intends to cancel or terminate any of
the Material Contracts or to exercise or not exercise any options under any of
the Material Contracts.
SECTION 5.23 Intellectual Property.
Except as set forth on Schedule 5.23 attached hereto, the Company does not
have any patents, trademarks, service marks, trade names, corporate names
(including all registrations and applications therefor) and copyright
registrations and applications that are material to the business or condition of
the Company or any of its subsidiaries.
ARTICLE VI
CONDUCT OF BUSINESS PENDING THE MERGER
SECTION 6.1 Conduct of Business by the Company Pending the Merger.
Except as otherwise contemplated by this Agreement, after the date hereof
and prior to the Closing Date or earlier termination of this Agreement, unless
Parent shall otherwise agree in writing, the Company shall, and shall cause its
subsidiaries, to:
(a) conduct their respective businesses in the ordinary and usual
course of business and consistent with past practice;
(b) not (i) amend or propose to amend their respective charters or
bylaws, (ii) 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, (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 or (v) directly or indirectly
redeem, repurchase or otherwise acquire any shares of its capital stock or
any option with respect thereto;
(c) not issue, sell, pledge or dispose of, or agree to issue, sell,
pledge or dispose of, any additional shares of, or any options, warrants or
rights of any kind to acquire any shares of, their capital stock of any
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class or any debt or equity securities convertible into or exchangeable for
such capital stock, except that the Company (i) may grant options to the
extent required to be granted automatically under the Company's Plans or
pursuant to written employment agreements disclosed on a Schedule hereto,
(ii) may issue shares upon conversion of convertible securities and
exercise of options outstanding on the date hereof, or options granted
pursuant to subsection (c)(i) of this Section 6.1 and (iii) may issue
shares necessary to effect the transactions contemplated by Section 7.14;
(d) not (i) 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 (net of any amounts of any such indebtedness
discharged during such period), or (ii) 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, (iii) redeem, purchase, acquire or offer to purchase
or acquire any shares of its capital stock or any options, warrants or
rights to acquire any of its capital stock or any security convertible into
or exchangeable for its capital stock, (iv) knowingly take any action which
would jeopardize the treatment of the Merger as a pooling of interests
under APB No. 16, (v) knowingly take or fail to take any action which
action or failure would cause the Company or its stockholders (except to
the extent that any stockholders receive cash in lieu of fractional shares)
to recognize gain or loss for Federal income tax purposes as a result of
the consummation of the Merger, (vi) make any acquisition of any assets or
businesses in an aggregate amount in excess of $250,000, (vii) sell,
pledge, dispose of or encumber any assets or businesses other than sales in
the ordinary course of business or (viii) enter into any contract,
agreement, commitment or arrangement with respect to any of the foregoing;
(e) not, 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 body or
authority;
(f) use all reasonable efforts to preserve intact their respective
business organizations and goodwill, keep available the services of their
respective present officers and key employees, and preserve the goodwill
and business relationships with customers and others having business
relationships with them and not engage in any action, directly or
indirectly, with the intent to adversely impact the transactions
contemplated by this Agreement;
(g) confer on a regular and frequent basis with one or more
representatives of Parent to report operational matters of materiality and
the general status of ongoing operations;
(h) not enter into or amend any employment, severance, special pay
arrangement with respect to termination of employment or other similar
arrangements or agreements with any directors, officers or key employees,
except in the ordinary course and consistent with past practice;
(i) not adopt, enter into or amend any bonus, profit sharing,
compensation, stock option, pension, retirement, deferred compensation,
health care, employment or other employee benefit plan, agreement, trust,
fund or arrangement for the benefit or welfare of any employee or retiree,
except as required to comply with changes in applicable law; and
(j) maintain with financially responsible insurance companies
insurance on its tangible assets and its businesses in such amounts and
against such risks and losses as are consistent with past practice.
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SECTION 6.2 Conduct of Business by Parent and Acquisition Pending the Merger.
Except as otherwise contemplated by this Agreement, after the date hereof
and prior to the Closing Date or earlier termination of this Agreement, unless
the Company shall otherwise agree in writing, Parent and Acquisition shall, and
shall cause their subsidiaries, to:
(a) not (i) amend or propose to amend their respective charters or
bylaws, (ii) 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, (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 (except in connection with the
potential acquisitions described on Schedule 6.2 attached hereto or
subsequently disclosed to Company in writing) or (v) directly or indirectly
redeem, repurchase or otherwise acquire any shares of its capital stock or
any option with respect thereto;
(b) not issue, sell, pledge or dispose of, or agree to issue, sell,
pledge or dispose of, any shares of Parent Common Stock, or any options,
warrants or rights of any kind to acquire any shares of their capital stock
of any class or any debt or equity securities convertible into or
exchangeable for such capital stock, except that Parent may issue shares
(i) upon conversion of convertible securities and exercise of options
outstanding on the date hereof or granted following the date hereof
consistent with Parent's prior practices and (ii) in connection with the
potential acquisitions described on Schedule 6.2 attached hereto or
subsequently disclosed to Company in writing;
(c) not (i) 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 $300,000,000 (net of any amounts of any such indebtedness
discharged during such period), (ii) 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 $300,000,000, (iii) redeem, purchase, acquire or offer to
purchase or acquire any shares of its capital stock or any options,
warrants or rights to acquire any of its capital stock or any security
convertible into or exchangeable for its capital stock, (iv) knowingly take
any action which would jeopardize the treatment of the Merger as a pooling
of interests under APB No. 16, (v) knowingly take or fail to take any
action which action or failure to take action would cause the Company or
its stockholders (except to the extent that any stockholders receive cash
in lieu of fractional shares) to recognize gain or loss for Federal income
tax purposes as a result of the consummation of the Merger, (vi) make any
acquisition of any assets or businesses other than expenditures for fixed
or capital assets in the ordinary course of business and as described on
Schedule 6.2 attached hereto or subsequently disclosed to Company in
writing, (vii) sell, pledge, dispose of or encumber any assets or
businesses other than sales in the ordinary course of business or (viii)
enter into any contract, agreement, commitment or arrangement with respect
to any of the foregoing;
(d) use all reasonable efforts to preserve intact their respective
business organizations and goodwill, keep available the services of their
respective present officers and key employees, and preserve the goodwill
and business relationships with customers and others having business
relationships with them and not engage in any action, directly or
indirectly, with the intent to adversely impact the transactions
contemplated by this Agreement; and
(e) be reasonably available to confer on a regular and frequent basis
with one or more representatives of the Company to report operational
matters of materiality and the general status of ongoing operations.
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SECTION 6.3 Control of the Company's Operations.
Nothing contained in this Agreement shall give to Parent, directly or
indirectly, rights to control or direct the Company's operations prior to the
Effective Time. Prior to the Effective Time, the Company shall exercise,
consistent with the terms and conditions of this Agreement, complete control and
supervision of its operations.
SECTION 6.4 Control of Parent's Operations.
Nothing contained in this Agreement shall give to the Company, directly or
indirectly, rights to control or direct Parent's or Acquisition's operations
prior to the Effective Time. Prior to the Effective Time, Parent and Acquisition
shall exercise, consistent with the terms and conditions of this Agreement,
complete control and supervision of their respective operations.
SECTION 6.5 Conduct of Business of Acquisition.
During the period from the date of this Agreement to the Effective Time,
Acquisition shall not engage in any activities of any nature except as provided
in or contemplated by this Agreement. Parent shall take all actions necessary to
cause Acquisition to perform its obligations under this Agreement and to
consummate the Merger on the terms and conditions set forth herein.
ARTICLE VII
ADDITIONAL AGREEMENTS
SECTION 7.1 Access to Information.
(a) The Company and its subsidiaries shall afford to Parent and Acquisition
and their respective accountants, counsel, financial advisors and other
representatives (the "Parent Representatives") and Parent and its subsidiaries
shall afford to the Company and its accountants, counsel, financial advisors and
other representatives (the "Company Representatives") reasonable access during
normal business hours throughout the period prior to the earlier of the
termination of this Agreement or the Effective Time to all of their respective
properties, books, contracts, commitments and records (including, but not
limited to, Tax Returns) and, during such period, shall furnish promptly to one
another (i) a copy of each report, schedule and other document filed or received
by any of them pursuant to the requirements of Federal or state securities laws
or filed by any of them with the Commission in connection with the transactions
contemplated by this Agreement or which may have a material effect on their
respective businesses, properties or personnel and (ii) such other information
concerning their respective businesses, properties and personnel as Parent,
Acquisition or the Company, as the case may be, shall reasonably request;
provided that no investigation pursuant to this Section 7.1 shall amend or
modify any representations or warranties made herein or the conditions to the
obligations of the respective parties to consummate the Merger. Parent and its
subsidiaries shall hold and shall use their reasonable best efforts to cause the
Parent Representatives to hold, and the Company and its subsidiaries shall hold
and shall use their reasonable best efforts to cause the Company Representatives
to hold, in strict confidence all such information in accordance with the terms
of the confidentiality agreement dated as of November 6, 1996 (the
"Confidentiality Agreement"), between Parent and the Company.
(b) In the event that this Agreement is terminated in accordance with its
terms, each party shall promptly return to the other all non-public written
material provided pursuant to this Section 7.1 or the Confidentiality Agreement
and shall not retain any copies, extracts or other reproductions in whole or in
part of such written material. In such event, all documents, memoranda, notes
and other writings prepared by Parent or the Company based on the information in
such material shall be destroyed (and Parent and the Company shall use their
respective reasonable best efforts to cause their advisors and representatives
to similarly destroy their documents, memoranda and notes), and such destruction
(and reasonable best efforts) shall be certified in writing by an authorized
officer supervising such destruction.
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(c) The Company shall promptly advise Parent and Parent shall promptly
advise the Company in writing of any change or the occurrence of any event after
the date of this Agreement having, or which could reasonably be expected to
have, any Company Material Adverse Effect or Parent Material Adverse Effect, as
the case may be.
SECTION 7.2 Registration Statement and Proxy Statement.
Parent shall file with the Commission as soon as is reasonably practicable
after the date hereof the Proxy Statement/Prospectus and shall use all
reasonable efforts to have the Registration Statement declared effective by the
Commission as promptly as practicable. Parent shall also take any action
required to be taken under applicable state blue sky, securities laws or rules
or regulations of any national securities exchange or the NNM in connection with
the issuance of Parent Common Stock pursuant hereto. Parent and the Company
shall promptly furnish to each other all information, and take such other
actions, as may reasonably be requested in connection with any action by any of
them in connection with the preceding two sentences.
SECTION 7.3 Company Stockholders' Approval.
The Company, Parent and Stockholders of the Company holding, in the
aggregate, a number of shares of Company Common Stock and Company Preferred
Stock sufficient to approve and adopt this Agreement are parties to a
Stockholder Agreement dated the date of this Agreement whereby such stockholders
have agreed to vote for approval and adoption of the Agreement and the
transactions contemplated hereby, among other matters (the "Stockholder
Agreement"). The Stockholder Agreement is in form attached hereto as Exhibit
7.3. The Company shall, as promptly as practicable, submit this Agreement and
the transactions contemplated hereby for the approval of its stockholders at a
meeting of stockholders and shall use its best efforts to seek to obtain
stockholder approval and adoption (the "Company Stockholders' Approval") of this
Agreement and the transactions contemplated hereby. Such meeting of stockholders
shall be held as soon as practicable following the date upon which the
Registration Statement becomes effective. Subject to the fiduciary duties of the
board of directors of the Company under applicable law, the Company shall,
through its board of directors, recommend to its stockholders approval of the
transactions contemplated by this Agreement. Subject to the foregoing, the
Company (i) acknowledges that a breach of its covenant contained in this Section
7.3(a) to convene a meeting of its stockholders and call for a vote thereat with
respect to the approval of this Agreement and the Merger will result in
irreparable harm to Parent which will not be compensable in money damages and
(ii) agrees that such covenant shall be specifically enforceable and that
specific performance and injunctive relief shall be a remedy properly available
to Parent for a breach of such covenant.
SECTION 7.4 Affiliates of the Company and Parent.
On or prior to July 15, 1997, the Company and Parent shall each deliver to
the other a letter pursuant to Staff Accounting Bulletins 65 & 76 and Accounting
Series Releases 130 & 135 (the "APB No. 16 Affiliate Letter") identifying all
persons who may be deemed affiliates of the Company or Parent, respectively, for
the purposes of the foregoing, including, without limitation, all directors and
executive officers of the Company or of the Parent as of the date of the APB No.
16 Affiliate Letter. On or prior to the date that is five (5) days prior to the
Closing Date, (i) the Company shall deliver to Parent another letter (the "Rule
145 Letter") identifying all persons who may be affiliates of the Company, as
defined under Rule 145 under the Securities Act ("Rule 145"), as of the date of
the Rule 145 Letter, and (ii) the Company shall advise the persons identified in
the Rule 145 Letter of the resale restrictions imposed by applicable securities
laws. Each of the Company and Parent shall use its reasonable best efforts to
obtain as soon as practicable from each person listed on the respective APB No.
16 Affiliate Letter and from any person who may be deemed to have become an
affiliate of the Company or Parent for the purposes of the foregoing after such
party's delivery of the APB No. 16 Affiliate Letter and in any event not later
than July 31, 1997, an agreement not to sell shares of Company Common Stock or
Parent Common Stock in excess of an amount which would, in the aggregate,
contravene the provisions of the foregoing until combined results of operations
of the Company and Parent
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covering at least thirty (30) days of combined operations are made public.
Parent will keep current its filings under the Exchange Act for purposes of
reliance by Company affiliates upon the resale provisions of Rule 145.
SECTION 7.5 Exchange Listing.
Parent shall use its reasonable best efforts to effect, at or before the
Effective Time, authorization for inclusion on the NNM, upon official notice of
issuance, of the shares of Parent Common Stock to be issued pursuant to the
Merger.
SECTION 7.6 Expenses and Fees.
All costs and expenses incurred in connection with this Agreement and the
transactions contemplated hereby shall be paid by the party incurring such
expenses.
SECTION 7.7 Agreement to Cooperate.
(a) Subject to the terms and conditions herein provided, each of the
parties hereto shall use its reasonable best efforts to take, or cause to be
taken, all actions and to do, or cause to be done, all things necessary, proper
or advisable under applicable laws and regulations to consummate and make
effective the transactions contemplated by this Agreement, including using its
reasonable best efforts to obtain all necessary or appropriate waivers, consents
and approvals and Commission "no-action" letters to effect all necessary
registrations, filings and submissions and to lift any injunction or other legal
bar to the Merger (and, in such case, to proceed with the Merger as
expeditiously as possible).
(b) Without limitation of the foregoing, each of Parent and the Company
undertakes and agrees to (i) take all actions necessary to cause the Merger to
(a) qualify as a tax-free merger under Section 368 of the Code and (b) be
treated as a pooling of interests under APB No. 16 for accounting and financial
statement purposes, and (ii) file as soon as practicable after the date hereof a
Notification and Report Form under the HSR Act with the Federal Trade Commission
(the "FTC") and the Antitrust Division of the Department of Justice (the
"Antitrust Division"). Each of Parent and the Company shall (i) use its
reasonable efforts to comply as expeditiously as possible with all lawful
requests of the FTC or the Antitrust Division for additional information and
documents and (ii) not extend any waiting period under the HSR Act or enter into
any agreement with the FTC or the Antitrust Division not to consummate the
transactions contemplated by this Agreement, except with the prior written
consent of such parties.
SECTION 7.8 Public Statements.
The parties shall consult with each other prior to issuing any press
release or any written public statement with respect to this Agreement or the
transactions contemplated hereby and shall not issue any such press release or
written public statement prior to such consultation unless required by law, by
regulation of the NNM or upon written advice of counsel.
SECTION 7.9 Employee Matters.
(a) From and after the Effective Time, Parent and the Surviving
Corporation, and their respective affiliates will honor in accordance with their
terms all existing employment, severance, consulting and salary continuation
agreements between the Company and any current or former officer, director,
employee or consultant to the Company.
(b) Parent agrees that, for one year after the Effective Time, Parent
shall, or shall cause the Surviving Corporation to, provide employee benefit
plans and programs for the benefit of employees and former employees of the
Company ("Company Employees"), which, in the aggregate, are no less favorable
than the Company employee benefit plans and programs in effect immediately prior
to the Effective Time. Parent further agrees that, for the two year period
beginning on the date one year following the Effective Time, Parent shall
provide, or shall cause the Surviving Corporation to provide, Company Employees
with employee benefit plans and programs that are no less favorable in the
aggregate to those provided from time to time to
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employees of Parent of comparable status and seniority. Except with respect to
plans and programs set forth on Schedule 7.9 attached hereto, with respect to
such benefits, past service, compensation and expense credits of such Company
Employees shall be recognized, whenever reasonably possible consistent with the
terms of such plans and programs, for all purposes under such plans (including,
but not limited to, participation, eligibility, vesting and calculation of
benefits), and each employee or fringe benefit plan or program available to
Company Employees as contemplated hereby shall be applied to such Company
Employees.
SECTION 7.10 Notification of Certain Matters.
Each of the Company, Parent and Acquisition agrees to give prompt notice to
each other of, and to use their respective reasonable best efforts to prevent or
promptly remedy, (a) the occurrence or failure to occur or the impending or
threatened occurrence or failure to occur, of any event which occurrence or
failure to occur would be likely to cause any of its representations or
warranties in this Agreement to be untrue or inaccurate in any material respect
at any time from the date hereof to the Effective Time and (b) any material
failure on its part to comply with or satisfy any covenant, condition or
agreement to be complied with or satisfied by it hereunder; provided, however,
that the delivery of any notice pursuant to this Section 7.10 shall not limit or
otherwise affect the remedies available hereunder to the party receiving such
notice.
SECTION 7.11 Corrections to the Proxy Statement/Prospectus and Registration
Statement.
Prior to the date of the Company Stockholders' Approval of the Merger, each
of the Company, Parent and Acquisition shall correct promptly any information
provided by it to be used in the Proxy Statement/Prospectus and Registration
Statement that shall have become false or misleading in any material respect and
shall take all reasonable steps necessary to file with the Commission and have
declared effective or cleared by the Commission any amendment or supplement to
the Proxy Statement/Prospectus or the Registration Statement so as to correct
the same and to cause the Proxy Statement/Prospectus as so corrected to be
disseminated to the stockholders of the Company and Parent, in each case to the
extent required by applicable law.
SECTION 7.12 Insurance; Indemnity.
For a period of six (6) years following the Effective Time, Parent shall
indemnify, defend and hold harmless to the fullest extent permitted under
applicable law each person who is now or has been an officer, director,
employee, trustee or agent of the Company (or any subsidiary or division
thereof), including, without limitation, each person controlling any of the
foregoing persons (individually, an "Indemnified Party" and collectively, the
"Indemnified Parties"), against all losses, claims, damages, liabilities, costs
or expenses (including reasonable attorneys' fees), judgments, fines, penalties
and amounts paid in settlement in connection with any claim, action, suit,
proceeding or investigation arising out of or pertaining to acts or omissions,
or alleged acts or omissions, by them in their capacities as such, whether
commenced, asserted or claimed before or after the Effective Time. In the event
of any such claim, action, suit, proceeding or investigation (an "Action"), (i)
Parent shall pay the reasonable fees and expenses of counsel selected by the
Indemnified Party, which counsel shall be reasonably acceptable to Parent, in
advance of the final disposition of any such Action to the full extent and under
all circumstances permitted by Delaware law as in effect on the date hereof,
upon receipt of any undertaking required by applicable law, and (ii) Parent will
direct the defense of any such matter; provided, however, 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, 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. Immediately following the Effective Time, Parent shall purchase and
maintain or cause the Surviving Corporation to purchase and maintain, for a
period of six (6) years following the Effective Time, policies of directors' and
officers' liability insurance covering each person who was a director or officer
of the Company at any time prior to the Effective Time with respect to claims
arising from facts or events that occurred on or prior to the Effective Time and
providing at least the same coverage and amounts and containing terms that are
no less advantageous to the insured parties as those in effect immediately prior
to the Effective Time for officers and directors of Parent. The provisions of
this
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Section 7.12 are intended to be for the benefit of, and shall be enforceable by,
each Indemnified Party and each party entitled to insurance coverage under the
previous sentence hereof, 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 Company or any of its subsidiaries, under the DGCL or otherwise.
SECTION 7.13 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 portion of the assets of the Company and its
subsidiaries taken as a whole, (ii) any of the outstanding shares of Company
Common Stock or (iii) any 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; and (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. There shall be excepted from this Section 7.13 the transactions
effected pursuant to Section 7.14 hereof.
SECTION 7.14 Roll-up Transactions.
(a) Roll-up Notices. Following the execution of this Agreement, the Company
shall deliver notices to each of the holders ("Minority Holders"), excluding the
Company and its affiliates, of stock ("Minority Shares") and/or stock options
("Minority Options") in any of the Company's subsidiaries (as defined in Section
4.2(c) above), which notices shall serve to inform the Minority Holders of the
Company's intention to undertake the transactions contemplated by the
shareholder agreements ("Minority Shareholder Agreements") and stock option
plans ("Minority Option Plans") relating to such subsidiaries to eliminate the
Minority Holders' interests in each such subsidiary ("Roll-up Transactions").
The Company will use its best efforts to consummate all of the Roll-up
Transactions as of the Effective Time.
(b) Minority Shares. If the Roll-up Transactions relating to the Minority
Shares of a particular subsidiary are consummated as of the Effective Time, such
Minority Shares shall be exchanged for Company Common Stock at the Effective
Time as provided in the related Minority Shareholder Agreement and shall be
treated in the Merger as other issued and outstanding Company Common Stock is
treated pursuant to Section 3.1 of this Agreement. If the Roll-up Transactions
relating to the Minority Shares of a particular subsidiary will not be
consummated as of the Effective Time, the Company shall use its best efforts to
induce each holder of Minority Shares in such subsidiary to enter into an escrow
agreement with Parent and the Company ("Escrow Agreement") providing that such
holder shall have no actions, causes of action or claims against the Company or
Parent with respect to such holder's Minority Shares other than for a number of
shares of Parent Common Stock not to exceed those held in the escrow
specifically to complete the Roll-up Transactions for such subsidiary.
(c) Minority Options. If the Roll-up Transactions relating to the Minority
Options issued by a particular subsidiary are consummated as of the Effective
Time, such Minority Options shall be exchanged for Company Stock Options at the
Effective Time as provided in the related Minority Option Plan and shall be
treated in the Merger as other issued and outstanding Company Stock Options are
treated pursuant to Section 3.5 of this Agreement. If the Roll-up Transactions
relating to the Minority Options of a particular subsidiary will not be
consummated as of the Effective Time, the Company shall use its best efforts to
induce each holder of such Minority Options to enter into an Escrow Agreement
providing that such holder shall have
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no actions, causes of action or claims against the Company or Parent with
respect to such holder's Minority Options other than for a number of shares of
Parent Common Stock and/or Parent Stock Options held in the escrow specifically
to complete the Roll-up Transactions for such subsidiary.
(d) Escrow Provisions. Any shares of Parent Common Stock or Parent Stock
Options held in any escrow pursuant to this Section 7.14 shall constitute shares
or options which would otherwise be issuable to stockholders or optionees of the
Company in the Merger. The terms of each Escrow Agreement and any related escrow
arrangements shall be reasonably agreed upon by Parent and the Company.
(e) Adjustments Following Completion of Roll-up Transactions. If, following
the completion of a Roll-up Transaction for any subsidiary after the Effective
Time, there are shares of Parent Common Stock remaining in any escrow account
established with respect to the Minority Shares of or Minority Options issued by
such subsidiary, a number of such shares remaining in all such escrow account
shall be distributed to the former Company stockholders and option holders who
received shares of Parent Common Stock pursuant to Section 3.1 and Section 3.5,
respectively.
SECTION 7.15 Bank Consent.
Parent shall use its reasonable best efforts to obtain the consent of its
senior lender with respect to the transactions contemplated by this Agreement on
or before August 15, 1997.
ARTICLE VIII
CONDITIONS
SECTION 8.1 Conditions to Each Party's Obligation to Effect the Merger.
The respective obligations of each party to effect the Merger shall be
subject to the fulfillment at or prior to the Closing Date of the following
conditions:
(a) Stockholder Approval. This Agreement and the transactions
contemplated hereby shall have been approved and adopted by the requisite
vote of the stockholders of the Company under the Company's Certificate of
Incorporation and applicable law.
(b) Inclusion of Parent Common Stock. The shares of Parent Common
Stock issuable in the Merger shall have been authorized for listing on the
NNM upon official notice of issuance.
(c) HSR Act. The waiting period applicable to the consummation of the
Merger under the HSR Act shall have expired or been terminated.
(d) Registration Statement. The Registration Statement shall have
become effective in accordance with the provisions of the Securities Act
and state blue sky laws, if applicable, and no stop order suspending such
effectiveness shall have been issued and remain in effect and no proceeding
for that purpose shall have been instituted by the Commission or any state
regulatory authorities.
(e) No Injunction. No preliminary or permanent injunction or other
order or decree by any Federal or state court which prevents the
consummation of the Merger shall have been issued and remain in effect
(each party agreeing to use its reasonable efforts to have any such
injunction, order or decree lifted).
(f) Pooling. Parent and the Company shall have received letters from
Deloitte & Touche LLP and KPMG Peat Marwick LLP, respectively, dated not
more than two business days prior to the Effective Time, to the effect that
the Merger qualifies for "pooling of interests" accounting treatment if
consummated in accordance with this Agreement and if the operations of
Parent and the Surviving Corporation are conducted in a manner that do not
violate "pooling of interests" accounting treatment.
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SECTION 8.2 Conditions to Obligation of the Company to Effect the Merger.
Unless waived by the Company, the obligation of the Company to effect the
Merger shall be subject to the fulfillment at or prior to the Closing Date of
the following additional conditions:
(a) Compliance with Covenants; Accuracy of Representations and
Warranties. Parent and Acquisition shall have performed in all material
respects their agreements, covenants and obligations contained in this
Agreement required to be performed or complied with by Parent and
Acquisition on or prior to the Closing Date and the representations and
warranties of Parent and Acquisition contained in this Agreement shall be
true and correct in all material respects (except for such representations
and warranties that are qualified by a reference to materiality, which
representations and warranties as so qualified shall be true in all
respects) on and as of the date made and on and as of the Closing Date as
if made at and as of such date, and the Company shall have received a
certificate of the Chairman of the Board and Chief Executive Officer, the
President or a Vice President of Parent and of the President and Chief
Executive Officer or a Vice President of Acquisition to that effect.
(b) Tax Opinion. The Company shall have received from Gibson, Dunn &
Crutcher LLP, counsel to the Company, on the date of the Proxy Statement
and on the Closing Date opinions, in each case dated as of such respective
dates and stating that the Merger will be treated for Federal income tax
purposes as a reorganization within the meaning of Section 368(a) of the
Code and that Parent, Acquisition and the Company will each be a party to
that reorganization within the meaning of Section 368(b) of the Code. In
rendering such opinions, counsel for the Company shall be entitled to rely
upon representations of officers and affiliates of Parent, Acquisition and
the Company reasonably satisfactory in form and substance to such counsel
and to Parent and Acquisition.
(c) Fairness Opinion. The Smith Barney Opinion shall not have been
withdrawn.
(d) Consents; Approvals. Parent shall have obtained all of the
consents set forth on Schedule 4.3(b) attached hereto. With respect to the
Parent Required Statutory Approvals, all approvals shall have been obtained
and all filings which are required to be made prior to the Effective Time
shall have been submitted.
(e) Employee Matters. Parent shall have entered into employment
agreements and have taken such other employee related matters as are listed
on a Memorandum of even date herewith initialed among the parties.
(f) Registration Rights Agreement. Parent shall have executed and
delivered the Registration Rights Agreement in the form attached hereto as
Exhibit 8.2(f).
(g) Opinions of Counsel. The Company shall have received the opinions
of Pillsbury Madison & Sutro LLP, and James A. Lebovitz, Esq., counsel to
Parent, dated the Closing Date, in form reasonably satisfactory to the
Company.
(h) Bank Consent. Parent shall have received the consent of its senior
lender with respect to the transactions contemplated by this Agreement not
later than the date set forth in Section 7.15.
SECTION 8.3 Conditions to Obligations of Parent and Acquisition to Effect the
Merger.
Unless waived by Parent and Acquisition, the obligations of Parent and
Acquisition to effect the Merger shall be subject to the fulfillment at or prior
to the Effective Time of the additional following conditions:
(a) Compliance with Covenants; Accuracy of Representations and
Warranties. The Company shall have performed in all material respects its
agreements, covenants and obligations contained in this Agreement required
to be performed or complied with by the Company on or prior to the Closing
Date and the representations and warranties of the Company contained in
this Agreement shall be true and correct in all material respects (except
for such representations and warranties that are qualified by their terms
by a referral to materiality, which representations and warranties as so
qualified shall be true in all respects) on and as of the date made and on
and as of the Closing Date as if made at and as of such date,
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and Parent shall have received a Certificate of the President and Chief
Executive Officer or of a Vice President of the Company to that effect.
(b) Tax Opinion. Parent shall have received from Pillsbury Madison &
Sutro LLP, counsel to Parent, on the date of the Proxy Statement and on the
Closing Date opinions, in each case dated as of such respective dates and
stating that the Merger will be treated for Federal income tax purposes as
a reorganization within the meaning of Section 368(a) of the Code and that
Parent, Acquisition and the Company will each be a party to that
reorganization within the meaning of Section 368(b) of the Code. In
rendering such opinions, counsel for Parent shall be entitled to rely upon
representations of officers and affiliates of Parent, Acquisition and the
Company reasonably satisfactory in form and substance to such counsel and
to the Company.
(c) Consents; Approvals. The Company shall have obtained all of the
consents set forth on Schedule 5.4(b) attached hereto. With respect to the
Company Required Statutory Approvals, all approvals shall have been
obtained and all filings which are required to be made prior to the
Effective Time shall have been submitted.
(d) Resignations. Parent shall have received from the Company the
resignations of all individuals serving as directors of the Company
immediately prior to the Effective Time.
(e) Master Strategic Agreement for Private Practice Partnerships. The
Company and Oxford Health Plans, Inc., a Delaware corporation ("Oxford"),
shall have executed a master strategic agreement substantially in the form
of Exhibit 8.3(e) hereof.
(f) Wellpoint Memorandum of Understanding. The Company and Wellpoint
Health Networks, Inc., a Delaware corporation ("Wellpoint"), shall have
executed a Memorandum of Understanding substantially in the form of Exhibit
8.3(f) hereof.
(g) Opinion of Counsel. Parent shall receive the opinion of Gibson,
Dunn & Crutcher LLP, counsel to the Company, dated the Closing Date, in
form reasonably satisfactory to Parent.
(h) No Preferred Stock Outstanding. The Company and the holders of
Company Preferred Stock shall have taken all necessary actions to ensure
that all of the outstanding shares of Preferred Stock will be canceled or
converted into shares of Company Common Stock no later than immediately
prior to the Effective Time.
(i) Stock Option Acknowledgements. Stock Option Acknowledgements shall
have been executed and delivered by the holders of Company Stock Options
representing no less than eighty percent (80%) of the shares of Company
Stock available under all Company Stock Options (whether such Company Stock
Options are vested or unvested) as of immediately prior to the Effective
Time.
(j) Roll Up. Each Roll-up Transaction shall either be complete as of
the Effective Time or the parties with respect thereto shall have entered
into Escrow Agreements as contemplated by Section 7.14.
(k) Denominator Certificate. Parent shall have received the
Denominator Certificate in form reasonably acceptable to Parent.
ARTICLE IX
TERMINATION, AMENDMENT AND WAIVER
SECTION 9.1 Termination.
This Agreement may be terminated at any time prior to the Closing Date,
whether before or after approval by the stockholders of the Company, as follows:
(a) The Company shall have the right to terminate this Agreement:
(i) if the Merger is not completed by the date 120 days from the
date of this Agreement otherwise than on account of delay or default on
the part of the Company, provided that Parent may
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extend such date for an additional 30 days if all Parent Required
Statutory Approvals and all Company Required Statutory Approvals have
not then been obtained or if the transactions contemplated by Section
7.14 shall not have been concluded;
(ii) if the Merger is enjoined by a final, unappealable court order
not entered at the request or with the support of the Company or any of
its 5% stockholders or any of their affiliates or associates;
(iii) if Parent (A) fails to perform in any material respect any of
its material covenants in this Agreement and (B) does not cure such
default in all material respects within thirty (30) days after written
notice of such default is given to Parent by the Company;
(iv) if any condition set forth in Section 8.1 or Section 8.2
hereof is not satisfied, other than as a result of the conduct of the
Company;
(v) if the Parent Value is less than $15.65; or
(vi) if the Parent shall not have received the consent of its
senior lender specified in Section 8.2(h) by not later than August 15,
1997.
(b) Parent shall have the right to terminate this Agreement.
(i) if the Merger is not completed by the date 120 days from the
date of this Agreement otherwise than account of delay or default on the
part of Parent, provided that Company may extend such date for an
additional 30 days if all Parent Required Statutory Approvals and
Company Required Statutory Approvals have not then been obtained or if
the transactions contemplated by Section 7.14 shall not have been
concluded;
(ii) if the Merger is enjoined by a final, unappealable court order
not entered at the request or with the support of Parent or any of its
5% stockholders or any of their affiliates or associates;
(iii) if the Company (A) fails to perform in any material respect
any of its material covenants in this Agreement and (B) does not cure
such default in all material respects within thirty (30) days after
written notice of such default is given to the Company by Parent; or
(iv) if any condition set forth in Section 8.1 or Section 8.3
hereof is not satisfied, other than as a result of the conduct of
Parent.
(c) As used in this Agreement, (i) "affiliate" has the meaning
assigned to it in the Federal securities laws and (ii) "group" has the
meaning set forth in Section 13(d) of the Exchange Act and the rules and
regulations thereunder.
SECTION 9.2 Effect of Termination.
In the event of termination of this Agreement by either Parent or the
Company, as provided in Section 9.1 hereof, this Agreement shall forthwith
become void and there shall be no further obligation on the part of the Company,
Parent, Acquisition or their respective officers or directors with respect to
obligations existing thereunder prior to the termination (except as set forth in
this Section 9.2 and in Sections 7.1, 7.6 and 7.8 hereof and except for the
rights of any non-breaching party in respect of a willful breach or a knowing
violation by another party of a covenant, representation or warranty hereunder,
all of which shall survive the termination).
SECTION 9.3 Amendment.
This Agreement may not be amended except by action taken by the parties'
respective boards of directors or duly authorized committees thereof and then
only by an instrument in writing signed on behalf of each of the parties hereto
and in compliance with applicable law.
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SECTION 9.4 Waiver.
At any time prior to the Effective Time, the parties hereto may (a) extend
the time for the performance of any of the obligations or other acts of the
other parties hereto, (b) waive any inaccuracies in the representations and
warranties contained herein or in any document delivered pursuant thereto and
(c) waive compliance with any provisions of this Agreement or conditions
contained herein except that, after the vote of the Company's stockholders with
respect to this Agreement, the Exchange Ratio shall not be changed from that
provided herein. Any agreement on the part of a party hereto to any such
extension or waiver shall be valid if set forth in an instrument in writing
signed on behalf of such party.
ARTICLE X
GENERAL PROVISIONS
SECTION 10.1 Non-Survival of Representations and Warranties.
All representations and warranties in this Agreement shall not survive the
Merger, and after effectiveness of the Merger neither the Company, Parent, the
Surviving Corporation or their respective officers or directors shall have any
further obligation with respect thereto.
SECTION 10.2 Notices.
All notices and other communications hereunder shall be in writing and
shall be deemed given if delivered personally, mailed by nationally recognized
overnight mail service or sent via facsimile to the parties at the following
addresses (or at such other address for a party as shall be specified by like
notice):
(a) If to Parent or Acquisition to:
FPA Medical Management, Inc.
3636 Nobel Drive, 2nd Floor
San Diego, CA 92122
Attention: Chief Financial Officer
with copies to:
James A. Lebovitz, Esq.
Senior Vice President,
General Counsel & Secretary
FPA Medical Management, Inc.
3636 Nobel Drive, 2nd Floor
San Diego, CA 92122
and
Pillsbury Madison & Sutro LLP
101 W. Broadway, Suite 1800
San Diego, CA 92101
Attention: David R. Snyder, Esq.
(b) If to the Company, to:
Health Partners, Inc.
800 Connecticut Avenue
Norwalk, CT 06854
Attention: Charles G. Berg,
Chief Executive Officer
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with a copy to:
Bruce D. Meyer, Esq.
Gibson, Dunn & Crutcher LLP
333 South Grand Avenue
Los Angeles, CA 90071
SECTION 10.3 Interpretation.
The headings contained in this Agreement are for reference purposes only
and shall not affect in any way the meaning or interpretation of this Agreement.
In this Agreement, unless a contrary intention appears, (i) the words "herein",
"hereof" and "hereunder" and other words of similar import refer to this
Agreement as a whole and not to any particular Article, Section or other
subdivision and (ii) reference to any Article or Section means such Article or
Section hereof. No provision of this Agreement shall be interpreted or construed
against any party hereto solely because such party or its legal representative
drafted such provision.
SECTION 10.4 Miscellaneous.
This Agreement (including the documents and instruments referred to herein)
(a) constitutes the entire agreement and supersedes all other prior agreements
and understandings, both written and oral, among the parties, or any of them,
with respect to the subject matter hereof, (b) except with respect to the
provisions of Sections 3.5 and 7.12, is not intended to confer upon any other
person any rights or remedies hereunder and shall be binding upon and inure to
the benefit solely of each party hereto, and their respective successors and
assigns, and (c) shall not be assigned by operation of law or otherwise, except
that Acquisition may assign this Agreement to any other wholly-owned subsidiary
of Parent. THIS AGREEMENT SHALL BE GOVERNED IN ALL RESPECTS, INCLUDING VALIDITY,
INTERPRETATION AND EFFECT, BY THE LAWS OF THE STATE OF DELAWARE APPLICABLE TO
CONTRACTS EXECUTED AND TO BE PERFORMED WHOLLY WITHIN SUCH STATE.
SECTION 10.5 Counterparts.
This Agreement may be executed in two or more counterparts, each of which
shall be deemed to be an original, but all of which shall constitute one and the
same agreement. Each party agrees (i) to accept the facsimile signature of the
other party's representatives hereto and (ii) to be bound by its own
representative's facsimile signature hereon.
IN WITNESS WHEREOF, Parent, Acquisition and the Company have caused this
Agreement to be signed by their respective officers as of the date first written
above.
Parent
FPA MEDICAL MANAGEMENT, INC.
By: /s/ SETH M. FLAM
------------------------------------
Print Name: Seth M. Flam
Title: President & Chief Executive
Officer
A-31
<PAGE> 165
Acquisition
FPA ACQUISITION CORP.
By: /s/ SETH M. FLAM
------------------------------------
Print Name: Seth M. Flam
Title: President & Chief Executive
Officer
Company
HEALTH PARTNERS, INC.
By: /s/ CHARLES G. BERG
------------------------------------
Print Name: Charles G. Berg
Title: Chief Executive Officer
A-32
<PAGE> 166
APPENDIX B
[LETTERHEAD OF SMITH BARNEY INC.]
July 1, 1997
The Board of Directors
Health Partners, Inc.
800 Connecticut Avenue
Norwalk, Connecticut 06854
Members of the Board:
You have requested our opinion as to the fairness, from a financial point of
view, to the holders of the common stock of Health Partners, Inc. ("Health
Partners") of the consideration to be received by such holders pursuant to the
terms and subject to the conditions set forth in the Agreement and Plan of
Merger, dated as of July 1, 1997 (the "Merger Agreement"), by and among FPA
Medical Management, Inc. ("FPA"), FPA Acquisition Corp., a wholly owned
subsidiary of FPA ("Acquisition Sub"), and Health Partners. As more fully
described in the Merger Agreement, (i) Acquisition Sub will be merged with and
into Health Partners (the "Merger") and (ii) the outstanding shares of the
common stock, par value $0.001 per share, of Health Partners (the "Health
Partners Common Stock") will be converted into the right to receive that number
of shares of the common stock, par value $0.002 per share, of FPA (the "FPA
Common Stock") having an aggregate value of $115 million (the "Merger
Consideration"), subject to adjustment as more fully specified in the Merger
Agreement if the average closing prices of FPA Common Stock for the 10
consecutive trading days ending on the date that is two trading days prior to
the closing of the Merger is less than $18.00 or greater than $22.00.
In arriving at our opinion, we reviewed the Merger Agreement and held
discussions with certain senior officers, directors and other representatives
and advisors of Health Partners and certain senior officers and other
representatives of FPA concerning the businesses, operations and prospects of
Health Partners and FPA. We examined certain business and financial information
relating to Health Partners and certain publicly available business and
financial information relating to FPA as well as certain financial forecasts and
other information and data for Health Partners and FPA which were provided to or
otherwise discussed with us by the respective managements of Health Partners 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 FPA Common Stock; the historical and projected earnings and other operating
data of Health Partners and FPA; and the capitalization and financial condition
of Health Partners and FPA. We considered, to the extent publicly available, the
financial terms of certain other 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 Health Partners and FPA. We also evaluated the potential pro forma financial
impact of the Merger on FPA. In connection with our engagement, we were
requested to approach on a limited basis, and held discussions with, certain
third parties to solicit indications of interest in a possible acquisition of
Health Partners. 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 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 Health Partners and FPA that such forecasts and
other information and data were reasonably prepared on bases reflecting the best
currently available estimates and judgments of the managements of Health
Partners and
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The Board of Directors
Health Partners, Inc.
July 1, 1997
Page 2
FPA as to the future financial performance of Health Partners 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
and as a tax-free reorganization for federal income tax purposes. We also have
assumed, with your consent, and have taken into account to the extent relevant
to our analysis, that prior to the consummation of the Merger all outstanding
shares of the Series A Convertible Preferred Stock, par value $0.001 per share,
of Health Partners and Series B Convertible Preferred Stock, par value $0.001
per share, of Health Partners and all outstanding minority interests in
subsidiaries of Health Partners will be converted into shares of Health Partners
Common Stock. We are not expressing any opinion as to what the value of the FPA
Common Stock actually will be when issued to Health Partners 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 Health Partners or FPA nor have we made any physical inspection of the
properties or assets of Health Partners or FPA. 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 Health
Partners 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 in connection with the delivery of this
opinion. In the ordinary course of our business, we and our affiliates may
actively trade or hold the securities of 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 investment banking
services to FPA unrelated to the proposed Merger, for which services we have
received compensation. In addition, we and our affiliates (including Travelers
Group Inc. and its affiliates) may maintain relationships with Health Partners
and FPA.
Our advisory services and the opinion expressed herein are provided for the
information of the Board of Directors of Health Partners 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.
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 Merger Consideration is fair, from a
financial point of view, to the holders of Health Partners Common Stock.
Very truly yours,
SMITH BARNEY INC.
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<PAGE> 168
APPENDIX C
DELAWARE GENERAL CORPORATIONS
LAW SECTION 262
SEC. 262. APPRAISAL RIGHTS
(a) Any stockholder of a corporation of this State who holds shares of
stock on the date of the making of a demand pursuant to subsection (d) of this
section with respect to such shares, who continuously holds such shares through
the effective date of the merger or consolidation, who has otherwise complied
with subsection (d) of this section and who has neither voted in favor of the
merger or consolidation nor consented thereto in writing pursuant to sec. 228 of
this title shall be entitled to an appraisal by the Court of Chancery of the
fair value of his shares of stock under the circumstances described in
subsections (b) and (c) of this section. As used in this section, the word
"stockholder" means a holder of record of stock in a stock corporation and also
a member of record of a nonstock corporation; the words "stock" and "share" mean
and include what is ordinarily meant by those words and also membership or
membership interest of a member of a nonstock corporation; and the words
"depository receipt" mean a receipt or other instrument issued by a depository
representing an interest in one or more shares, or fractions thereof, solely of
stock of a corporation, which stock is deposited with the depository.
(b) Appraisal rights shall be available for the shares of any class or
series of stock of a constituent corporation in a merger or consolidation to be
effected pursuant to sec. 251 (other than a merger effected pursuant to
subsection (g) of sec. 251), sec. 252, sec. 254, sec. 257, sec. 258, sec. 263 or
sec. 264 of this title:
(1) Provided, however, that no appraisal rights under this section
shall be available for the shares of any class or series of stock, which
stock, or depository receipts in respect thereof, at the record date fixed
to determine the stockholders entitled to receive notice of and to vote at
the meeting of stockholders to act upon the agreement of merger or
consolidation, were either (i) listed on a national securities exchange or
designated as a national market system security on an interdealer quotation
system by the National Association of Securities Dealers, Inc. or (ii) held
of record by more than 2,000 holders; and further provided that no
appraisal rights shall be available for any shares of stock of the
constituent corporation surviving a merger if the merger did not require
for its approval the vote of the stockholders of the surviving corporation
as provided in subsection (f) of sec. 251 of this title.
(2) Notwithstanding paragraph (1) of this subsection, appraisal rights
under this section shall be available for the shares of any class or series
of stock of a constituent corporation if the holders thereof are required
by the terms of an agreement of merger or consolidation pursuant to
sec.sec. 251, 252, 254, 257, 258, 263 and 264 of this title to accept for
such stock anything except:
a. Shares of stock of the corporation surviving or resulting from
such merger or consolidation, or depository receipts in respect thereof;
b. Shares of stock of any other corporation, or depository receipts
in respect thereof, which shares of stock or depository receipts at the
effective date of the merger or consolidation will be either listed on a
national securities exchange or designated as a national market system
security on an interdealer quotation system by the National Association
of Securities Dealers, Inc. or held of record by more than 2,000
holders;
c. Cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs a. and b. of this
paragraph; or
d. Any combination of the shares of stock, depository receipts and
cash in lieu of fractional shares or fractional depository receipts
described in the foregoing subparagraphs a., b. and c. of this
paragraph.
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(3) In the event all of the stock of a subsidiary Delaware corporation
party to a merger effected under sec. 253 of this title is not owned by the
parent corporation immediately prior to the merger, appraisal rights shall
be available for the shares of the subsidiary Delaware corporation.
(c) Any corporation may provide in its certificate of incorporation that
appraisal rights under this section shall be available for the shares of any
class or series of its stock as a result of an amendment to its certificate of
incorporation, any merger or consolidation in which the corporation is a
constituent corporation or the sale of all or substantially all of the assets of
the corporation. If the certificate of incorporation contains such a provision,
the procedures of this section, including those set forth in subsections (d) and
(e) of this section, shall apply as nearly as is practicable.
(d) Appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which appraisal rights
are provided under this section is to be submitted for approval at a
meeting of stockholders, the corporation, not less than 20 days prior to
the meeting, shall notify each of its stockholders who was such on the
record date for such meeting with respect to shares for which appraisal
rights are available pursuant to subsection (b) or (c) hereof that
appraisal rights are available for any or all of the shares of the
constituent corporations, and shall include in such notice a copy of this
section. Each stockholder electing to demand the appraisal of his shares
shall deliver to the corporation, before the taking of the vote on the
merger or consolidation, a written demand for appraisal of his shares. Such
demand will be sufficient if it reasonably informs the corporation of the
identity of the stockholder and that the stockholder intends thereby to
demand the appraisal of his shares. A proxy or vote against the merger or
consolidation shall not constitute such a demand. A stockholder electing to
take such action must do so by a separate written demand as herein
provided. Within 10 days after the effective date of such merger or
consolidation, the surviving or resulting corporation shall notify each
stockholder of each constituent corporation who has complied with this
subsection and has not voted in favor of or consented to the merger or
consolidation of the date that the merger or consolidation has become
effective; or
(2) If the merger or consolidation was approved pursuant to sec. 228
or sec. 253 of this title, each constituent corporation, either before the
effective date of the merger or consolidation or within ten days
thereafter, shall notify each of the holders of any class or series of
stock of such constituent corporation who are entitled to appraisal rights
of the approval of the merger or consolidation and that appraisal rights
are available for any or all shares of such class or series of stock of
such constituent corporation, and shall include in such notice a copy of
this section; provided that, if the notice is given on or after the
effective date of the merger or consolidation, such notice shall be given
by the surviving or resulting corporation to all such holders of any class
or series of stock of a constituent corporation that are entitled to
appraisal rights. Such notice may, and, if given on or after the effective
date of the merger or consolidation, shall, also notify such stockholders
of the effective date of the merger or consolidation. Any stockholder
entitled to appraisal rights may, within twenty days after the date of
mailing of such notice, demand in writing from the surviving or resulting
corporation the appraisal of such holder's shares. Such demand will be
sufficient if it reasonably informs the corporation of the identity of the
stockholder and that the stockholder intends thereby to demand the
appraisal of such holder's shares. If such notice did not notify
stockholders of the effective date of the merger or consolidation, either
(i) each such constituent corporation shall send a second notice before the
effective date of the merger or consolidation notifying each of the holders
of any class or series of stock of such constituent corporation that are
entitled to appraisal rights of the effective date of the merger or
consolidation or (ii) the surviving or resulting corporation shall send
such a second notice to all such holders on or within 10 days after such
effective date; provided, however, that if such second notice is sent more
than 20 days following the sending of the first notice, such second notice
need only be sent to each stockholder who is entitled to appraisal rights
and who has demanded appraisal of such holder's shares in accordance with
this subsection. An affidavit of the secretary or assistant secretary or of
the transfer agent of the corporation that is required to give either
notice that such notice has been given shall, in the absence of fraud, be
prima facie evidence of the facts stated therein. For purposes of
determining the stockholders entitled to receive either notice, each
constituent corporation may fix, in advance, a record date that shall be
not more than 10 days prior to the
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date the notice is given; provided that, if the notice is given on or after
the effective date of the merger or consolidation, the record date shall be
such effective date. If no record date is fixed and the notice is given
prior to the effective date, the record date shall be the close of business
on the day next preceding the day on which the notice is given.
(e) Within 120 days after the effective date of the merger or
consolidation, the surviving or resulting corporation or any stockholder who has
complied with subsections (a) and (d) hereof and who is otherwise entitled to
appraisal rights, may file a petition in the Court of Chancery demanding a
determination of the value of the stock of all such stockholders.
Notwithstanding the foregoing, at any time within 60 days after the effective
date of the merger or consolidation, any stockholder shall have the right to
withdraw his demand for appraisal and to accept the terms offered upon the
merger or consolidation within 120 days after the effective date of the merger
or consolidation, any stockholder who has complied with the requirements of
subsections (a) and (d) hereof, upon written request, shall be entitled to
receive from the corporation surviving the merger or resulting from the
consolidation a statement setting forth the aggregate number of shares not voted
in favor of the merger or consolidation and with respect to which demands for
appraisal have been received and the aggregate number of holders of such shares.
Such written statement shall be mailed to the stockholder within 10 days after
his written request for such a statement is received by the surviving or
resulting corporation or within 10 days after expiration of the period for
delivery of demands for appraisal under subsection (d) hereof, whichever is
later.
(f) Upon the filing of any such petition by a stockholder, service of a
copy thereof shall be made upon the surviving or resulting corporation, which
shall within 20 days after such service file in the office of the Register in
Chancery in which the petition was filed a duly verified list containing the
names and addresses of all stockholders who have demanded payment for their
shares and with whom agreements as to the value of their shares have not been
reached by the surviving or resulting corporation. If the petition shall be
filed by the surviving or resulting corporation, the petition shall be
accompanied by such a duly verified list. The Register in Chancery, if so
ordered by the Court, shall give notice of the time and place fixed for the
hearing of such petition by registered or certified mail to the surviving or
resulting corporation and to the stockholders shown on the list at the addresses
therein stated. Such notice shall also be given by 1 or more publications at
least 1 week before the day of the hearing, in a newspaper of general
circulation published in the City of Wilmington, Delaware or such publication as
the Court deems advisable. The forms of the notices by mail and by publication
shall be approved by the Court, and the costs thereof shall be borne by the
surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall determine the
stockholders who have complied with this section and who have become entitled to
appraisal rights. The Court may require the stockholders who have demanded an
appraisal for their shares and who hold stock represented by certificates to
submit their certificates of stock to the Register in Chancery for notation
thereon of the pendency of the appraisal proceedings; and if any stockholder
fails to comply with such direction, the Court may dismiss the proceedings as to
such stockholder.
(h) After determining the stockholders entitled to an appraisal, the Court
shall appraise the shares, determining their fair value exclusive of any element
of value arising from the accomplishment or expectation of the merger or
consolidation, together with a fair rate of interest, if any, to be paid upon
the amount determined to be the fair value. In determining such fair value, the
Court shall take into account all relevant factors. In determining the fair rate
of interest, the Court may consider all relevant factors, including the rate of
interest which the surviving or resulting corporation would have had to pay to
borrow money during the pendency of the proceeding. Upon application by the
surviving or resulting corporation or by any stockholder entitled to participate
in the appraisal proceeding, the Court may, in its discretion, permit discovery
or other pretrial proceedings and may proceed to trial upon the appraisal prior
to the final determination of the stockholder entitled to an appraisal. Any
stockholder whose name appears on the list filed by the surviving or resulting
corporation pursuant to subsection (f) of this section and who has submitted his
certificates of stock to the Register in Chancery, if such is required, may
participate fully in all proceedings until it is finally determined that he is
not entitled to appraisal rights under this section.
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(i) The Court shall direct the payment of the fair value of the shares,
together with interest, if any, by the surviving or resulting corporation to the
stockholders entitled thereto. Interest may be simple or compound, as the Court
may direct. Payment shall be so made to each such stockholder, in the case of
holders of uncertificated stock forthwith, and the case of holders of shares
represented by certificates upon the surrender to the corporation of the
certificates representing such stock. The Court's decree may be enforced as
other decrees in the Court of Chancery may be enforced, whether such surviving
or resulting corporation be a corporation of this State or of any state.
(j) The costs of the proceeding may be determined by the Court and taxed
upon the parties as the Court deems equitable in the circumstances. Upon
application of a stockholder, the Court may order all or a portion of the
expenses incurred by any stockholder in connection with the appraisal
proceeding, including, without limitation, reasonable attorney's fees and the
fees and expenses of experts, to be charged pro rata against the value of all
the shares entitled to an appraisal.
(k) From and after the effective date of the merger or consolidation, no
stockholder who has demanded his appraisal rights as provided in subsection (d)
of this section shall be entitled to vote such stock for any purpose or to
receive payment of dividends or other distributions on the stock (except
dividends or other distributions payable to stockholders of record at a date
which is prior to the effective date of the merger or consolidation); provided,
however, that if no petition for an appraisal shall be filed within the time
provided in subsection (e) of this section, or if such stockholder shall deliver
to the surviving or resulting corporation a written withdrawal of his demand for
an appraisal and an acceptance of the merger or consolidation, either within 60
days after the effective date of the merger or consolidation as provided in
subsection (e) of this section or thereafter with the written approval of the
corporation, then the right of such stockholder to an appraisal shall cease.
Notwithstanding the foregoing, no appraisal proceeding in the Court of Chancery
shall be dismissed as to any stockholder without the approval of the Court, and
such approval may be conditioned upon such terms as the Court deems just.
(l) The shares of the surviving or resulting corporation to which the
shares of such objecting stockholders would have been converted had they
assented to the merger or consolidation shall have the status of authorized and
unissued shares of the surviving or resulting corporation.
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APPENDIX D
FPA'S ANNUAL REPORT ON FORM 10-K/A
FOR THE YEAR ENDED DECEMBER 31, 1996
D-1
<PAGE> 173
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-24276
FPA MEDICAL MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<CAPTION>
<S> <C>
DELAWARE 3636 NOBEL DRIVE,
(STATE OR OTHER JURISDICTION OF SUITE 200,
INCORPORATION OR ORGANIZATION) SAN DIEGO, CA
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
33-0604264 92122
(I.R.S. EMPLOYER (ZIP CODE)
IDENTIFICATION NO.)
</TABLE>
Registrant's telephone number, including area code: (619) 453-1000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.002 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of
the registrant at March 21, 1997 was $604,077,078.
The number of shares outstanding of the registrant's Common Stock as of
March 21, 1997 was 30,708,632.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE FOLLOWING DOCUMENTS ARE INCORPORATED BY
REFERENCE IN THIS FORM 10-K/A.
None
<PAGE> 174
PART I
ITEM 1. BUSINESS
GENERAL
FPA Medical Management, Inc. ("FPA" or the "Company") is a national
physician practice management company ("PPM") which acquires, organizes and
manages primary care physician practice networks and provides contract
management services to hospital emergency departments. FPA provides primary and
specialty care services to prepaid managed care enrollees and fee-for-service
patients through a network of independent practice association ("IPA")
physicians and owned primary care physician groups. On March 17, 1997, the
Company completed its previously announced merger with AHI Healthcare Systems,
Inc. ("AHI") pursuant to which approximately 5.8 million shares of FPA Common
Stock were issued to AHI stockholders and AHI became a wholly-owned subsidiary
of the Company. Following the merger with AHI, FPA is affiliated with
approximately 6,100 primary care physicians and 13,500 specialty care
physicians, and provides services to approximately 830,000 enrollees of 35
health maintenance organizations ("HMOs") or other prepaid health insurance
plans (collectively, "Payors") in ten states. Through its merger with Sterling
Healthcare Group, Inc. ("Sterling") in October 1996, FPA is affiliated with
approximately 1,000 emergency department physicians and manages the emergency
departments of 104 hospitals in 20 states.
FPA's relationships with its subsidiaries, affiliated professional
corporations (the "Professional Corporations"), other providers of medical
services and Payors (collectively, the "FPA Network") offer physicians the
opportunity to participate more effectively in managed care programs by
organizing physician groups within geographic areas to contract with Payors. FPA
improves physician practice operations by assuming administrative functions
necessary in a managed care environment. These functions include claims
adjudication, utilization management of medical services, Payor contract
negotiations, credentialing, financial reporting and the operation of management
information systems. Under these arrangements, FPA, on behalf of the
Professional Corporations, is responsible for the payment of the cost of medical
services, including professional, ancillary and medical management services, and
is entitled to amounts received from Payors in excess of such costs. FPA
believes that its IPA management model is appealing to independent physicians
because it allows the physicians to retain control of their own practices while
gaining access to more patients through participation in a managed care program.
Agreements with Payors and providers are entered into with, and approved
by, one of the Professional Corporations or subsidiaries of the Company,
depending on applicable state law. Pursuant to administrative services
agreements with the Professional Corporations, payments received from Payors are
assigned to FPA.
The FPA Network manages all covered primary and specialty medical care for
each enrollee in exchange for fixed monthly capitation payments pursuant to
Payor contracts. Specialty care physician services, inpatient hospitalization
and certain other services managed by primary care physicians are subject to
preauthorization guidelines and are provided through contracts negotiated by FPA
for the Professional Corporations or subsidiaries of the Company based on
discounted fee-for-service, per diem or capitation rates. Contracts with Payors
and primary care physicians generally include shared risk arrangements and other
incentives designed to encourage the provision of high-quality, cost effective
health care. Because FPA is obligated to provide medical services, the costs of
some of which are variable, its profitability may vary based on the ability of
FPA and its affiliated providers to control such health care costs.
Additionally, state laws in California, operations in which represented
approximately 22% of FPA's operating revenues for the year ended December 31,
1996, require entities such as FPA to be licensed as health care service plans.
The application of a wholly-owned subsidiary of FPA for a restricted license was
approved by the California Department of Corporations in December 1996. The loss
or revocation of such license would have a material adverse effect on FPA. In
addition, there can be no assurance that regulatory authorities in the other
states in which FPA or its affiliates operate will not impose similar
requirements.
As part of its management and support services to hospital emergency
departments, Sterling recruits physicians and contracts for their services to
provide staffing of emergency departments. Sterling also assists its hospital
clients in such areas as physician scheduling, operations support, quality
assurance and departmental accreditation as well as billing and record keeping.
In addition, Sterling has expanded its hospital-based services to include the
management of anesthesiology departments, correctional institutional health
facilities and rural health care clinics.
The future growth of FPA is largely dependent on a continued increase in
the number of new enrollees in the FPA Network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
2
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serving enrollees of Payors in the FPA Network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations or
subsidiaries of FPA have contracts and whose members are patients of physicians
in the FPA Network or (iii) agreements with Payors, physicians and hospitals in
other geographic markets. The process of identifying and consummating suitable
acquisitions of, or affiliations with, physician groups can be lengthy and
complex. The marketplace for such acquisitions and affiliations is subject to
increasing competitive pressures. There can be no assurance that FPA will be
successful in identifying, acquiring or affiliating with additional physician
groups or hospitals or that the Professional Corporations or subsidiaries of FPA
will be able to contract with new Payors. In addition, there can be no assurance
that the Company's acquisitions will be successfully integrated on a timely
basis or that the anticipated benefits of these acquisitions will be realized;
failure to effectively accomplish the integration of acquired entities may have
a material adverse effect on FPA's results of operations and financial
condition. FPA's ability to expand is also dependent upon its ability to comply
with legal and regulatory requirements in the jurisdictions in which it operates
or will operate and to obtain necessary regulatory approvals, certificates and
licenses.
The health care industry is subject to extensive federal and state
legislation and regulation. Changes in the regulations or reinterpretations of
existing regulations could significantly affect the business of FPA.
THE MANAGED HEALTH CARE INDUSTRY
Medical services traditionally have been provided on a fee-for-service
basis with insurance companies assuming responsibility for paying all or a
portion of such fees. The increase in medical costs under traditional indemnity
health care plans has been caused by a number of factors, including, but not
limited to, the lack of incentives on the part of health care providers to
deliver cost-effective medical care and the absence of controls over the
utilization of costly specialty care physicians and hospitals.
As a result of escalating health care costs, employers, insurers and
governmental entities have all been seeking cost-effective approaches to the
delivery of and payment for quality health care services. HMOs and other managed
health care organizations have emerged as integral components in this effort.
HMOs enroll members by entering into contracts with employer groups or directly
with individuals to provide a broad range of health care services for a
capitation payment, with minimal or no deductibles or co-payments required of
the members. HMOs, in turn, contract either directly with physicians, or through
organizations like FPA, hospitals and other health care providers to administer
medical care to HMO members. These contracts provide for payment to the provider
on either a discounted fee-for-service or per diem basis, or through capitation
payments based on the number of members covered, regardless of the amount of
necessary medical care required within the covered benefits.
In response to the growth in HMO penetration, several provider group models
have evolved pursuant to which Payors generally shift certain administrative and
economic burdens to physicians. Administrative burdens include justifying
medical procedures, seeking authorization for tests and surgical procedures and
responding to additional oversight from Payors. These burdens have been
exacerbated by the proliferation of HMOs, which require physicians to comply
with multiple formats for claims processing, credentialing and other
administrative reporting requirements. As a result, physicians' operating
expenses and the number of hours devoted to non-medical activities have
increased. In addition to adding these administrative pressures, by capitating
payments to physicians, HMOs, in effect, have also begun to shift to physicians
a significant portion of the economic risk of providing health care. These
arrangements exert more pressure on the physician to reduce costs and
unnecessary medical treatments while continuing to deliver quality medical care.
To relieve these administrative and economic burdens, physicians have begun
to outsource to third parties, such as PPMs, both the management of economic
risk and the non-medical management tasks associated with the practice of
medicine. PPMs provide management and other administrative services to
physicians and, in certain circumstances, manage a portion of the economic risk
involved in providing health care. PPMs also help physician groups by
negotiating capitation rates and incentive payment arrangements with Payors.
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In addition to physician practices, hospitals have been affected by the
changing health care industry. Cost considerations are important to hospital
operations, particularly with respect to emergency room departments. FPA
believes that hospital emergency departments play a central role in determining
levels of admissions and profitability as well as in establishing a hospital's
reputation in the community. However, the ability of hospitals to provide high
quality health care services, including emergency care services, has been
adversely affected by recent trends in the U.S. health care industry. Continuing
cost-containment pressures are causing hospitals to seek new ways to provide
high quality services in a cost effective manner. In addition, hospitals face
numerous problems in managing their emergency departments, including
difficulties in recruiting, evaluating, scheduling and retaining emergency
physicians. Hospital emergency departments also continue to experience
increasing patient volumes, a shortage of board certified emergency physicians
and extensive use for routine primary care, particularly at night and on
weekends.
THE FPA NETWORK
The FPA Network currently has contracts to provide services to
approximately 830,000 enrollees of 35 Payors, which enrollees are serviced by
approximately 6,100 primary care physicians and 13,500 specialty care
physicians. Listed below is a breakdown as of March 21, 1997 of enrollees,
Payors, primary care physicians and specialty care physicians by region.
<TABLE>
<CAPTION>
STATES ENROLLEES NUMBER OF PAYORS PRIMARY CARE SPECIALTY CARE PHYSICIANS
- ------ --------- ---------------- PHYSICIANS -------------------------
----------
<S> <C> <C> <C> <C>
Arizona 194,415 3 572 1,036
California 312,288 20 1,741 5,235
Delaware 7,978 1 75 74
Florida 114,433 2 492 2,095
Michigan 34,687 1 406 1,028
New Jersey 27,618 3 926 447
North Carolina 12,205 2 52 24
South Carolina 10,384 1 207 20
Texas 118,846 9 1,067 2,495
Pennsylvania - - 351 -
Georgia 353 1 182 863
Kentucky - - 70 197
</TABLE>
MANAGED CARE BUSINESS
FPA provides management services to physicians, hospitals and Payors in the
FPA Network. FPA's services include: (i) comprehensive management information
systems ("MIS") that collect and assimilate data necessary for monitoring and
managing health care costs; (ii) claims administration and billing services;
(iii) utilization management of medical services and related financial reporting
and analysis; (iv) care coordination and case management assistance for
enrollees requiring medically complex or long-term health care; (v) monitoring
of the quality and cost of hospital and ancillary care; and (vi) credentialing
and recruiting of physicians.
Management Information Systems. FPA maintains an on-line database that
provides inpatient and outpatient utilization statistics and patient encounter
reporting and tracking. FPA believes that the availability of timely information
on utilization patterns improves primary care physician productivity and
effectiveness. This data also plays an integral role in the specialty care
physician and hospital utilization control process as by enabling the medical
directors and utilization control nurses to monitor encounter data, case
management decisions and patient outcomes. In addition, Serling has developed
MIS specific to hospital and clinical management services. The MIS collects data
regarding patient flow utilization, physician efficiency and other data used by
Sterling and hospital clients. In particular, Sterling uses the data to develop
staffing patterns. Further, the MIS assist FPA in performing various
administrative functions, including insurance verification, payment of accounts
payable, financial reporting and claims payment. The MIS also include the
customer service documentation system which assists FPA in resolving concerns
enrollees may have and in evaluating patient and physician satisfaction.
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Claims Administration and Billing Services. FPA possesses complete medical
bill review and claims processing capabilities. These capabilities include
determining enrollee eligibility, identifying appropriate benefits, issuing
payments to providers, processing hospital and outpatient facility charges for
the payment of claims and providing and analyzing encounter data. As a service
to certain Professional Corporations, FPA performs fee-for-service billing and
collections. Billing staff register fee-for-service patients, send monthly
statements and pursue collection.
Utilization Management. Physicians within the FPA Network have established
a utilization management program to help ensure the delivery of high quality,
cost-effective health care. Utilization management encourages physicians in the
FPA Network to provide cost-effective, quality care by emphasizing preventive
medicine and by eliminating unnecessary tests, procedures, surgeries,
hospitalizations and referrals to specialty care physicians. Referrals to
specialty care physicians and all hospital admissions, with the exception of
emergencies, generally require prior approval by the utilization management
committees of the various Professional Corporations or subsidiaries. Each
utilization management committee has established guidelines for routine
referrals which can be authorized by the committee's staff. Following admission,
a patient's status is monitored daily by a member of the utilization management
committee, in conjunction with the admitting physician or in-house intensivist,
to assure timely and appropriate hospital discharge. A member of the utilization
management committee coordinates with hospital nurses for discharge planning and
use of sub-acute alternatives to hospitalization. FPA has developed separate
utilization management committees on a regional basis due to expansion into new
geographic markets.
Case Management. Case management is a service administered by the various
utilization management committees and is a clinical and administrative process
by which health care services are identified, coordinated, implemented and
evaluated on an ongoing basis for enrollees experiencing selected health
problems. Such selected health problems include chronic disability, complex
medical cases or problems requiring long-term care. Case management involves the
coordination of a variety of services, including home nursing, home infusion and
the provision of durable medical equipment. This approach provides a continuum
of quality care throughout the extended treatment period.
Quality Assurance. The FPA Network maintains, as a service to both its
physicians and Payors, a comprehensive quality assurance program designed to
improve patient care. The quality assurance program incorporates peer review,
patient satisfaction surveys, medical records audit, continuing medical staff
development and regular continuing medical education seminars as required by
accrediting organizations, state law and licensing requirements. Medical staff
development includes the provision of training and support programs to encourage
the team-oriented delivery of high quality, cost-effective medical care.
Physician Credentialing and Recruitment. As a service to Payors and the
Professional Corporations, FPA verifies that the credentials of physicians in
the FPA Network meet the minimum requirements specified in Payor contracts. In
addition, FPA assists the Professional Corporations in the recruitment of highly
competent physicians who share in the philosophy of prepaid managed health care.
The recruitment process includes a lengthy series of interviews and reference
checks incorporating a number of credentialing and competency assurance
protocols. All of the FPA Network's physicians are licensed to practice medicine
in the state where they provide medical services and are generally either board
certified or board eligible.
EMERGENCY DEPARTMENT BUSINESS
General. With the acquisition of Sterling, FPA provides physician practice
management services to 104 hospital emergency departments, one hospital
anesthesiology department and four correctional institutional health
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facilities in 20 states. FPA contracts with approximately 1,000 affiliated
physicians. These contracts typically provide all necessary physician coverage
for hospital emergency departments on a 24-hour, 365-day basis. The Company
identifies and recruits physicians as candidates for admission to a client's
medical staff and coordinates the on-going scheduling of staff physicians, who
provide clinical coverage in the area of emergency medicine and, in one
hospital, anesthesiology. The Company also provides an on-site medical director
for the hospital's emergency department, who works directly with the hospital
medical staff and administration in such areas as quality assurance, risk
management and departmental accreditation.
Physician Recruiting. Recruiting physicians is an essential service
provided by Sterling to its hospital clients. Sterling's physician recruitment
methods include the use if its in-house search firm and certain third party
search firms, direct contact with residency programs, mail solicitations,
medical journal advertising, telemarketing and use of personal contacts.
Sterling has developed a proprietary computer database, which is periodically
updated, to identify physicians who might be available as independent
contractors for Sterling.
Affiliating with Sterling offers physicians the opportunity to minimize
their administrative burden and concentrate on the practice of medicine. The
Company believes that many physicians enjoy the relative freedom from the
business aspects of medicine, including the development of a patient base, the
financing of a practice and the complexity associated with billing and
collection procedures, that results from affiliation with Sterling. As a
provider of contract management services across a broad geographic spectrum,
Sterling can offer a physician substantial flexibility in terms of geographic
location, type of facility and opportunities for relocation. The physician also
tends to gain greater individual control over the number and scheduling of hours
worked. Physicians under contract with Sterling also have the option of
conveniently obtaining professional liability insurance with somewhat more
favorable terms than might otherwise be available.
AGREEMENTS WITH PAYORS, PROVIDERS AND EMERGENCY DEPARTMENTS; ADMINISTRATIVE
SERVICE AGREEMENTS
Contracts with Payors. FPA arranges for contracts between Payors and the
Professional Corporations or subsidiaries. These contracts generally provide for
terms of one to thirty years, with automatic renewal periods, terminable upon
prior notice (generally between 30 and 180 days) by either party. These
contracts obligate the Professional Corporations or subsidiaries to deliver
covered medical benefits and to coordinate all inpatient and outpatient care for
enrollees. Under most of these arrangements, the Professional Corporation or
subsidiary receives a capitation payment for each Payor enrollee who selects a
primary care physician who is employed by or affiliated with such Professional
Corporation or subsidiary. These capitation payments, in turn, are assigned to
FPA pursuant to FPA's administrative services agreement with the Professional
Corporation. The Professional Corporations (and indirectly, FPA) retain a level
of risk for the provision of appropriate medical care. In addition, these
contracts typically provide for bonuses derived from shared risk arrangements
and provide other financial incentives designed to encourage efficient
utilization of hospital and other medical services provided to enrollees. To
encourage efficient utilization of hospital and related services, the Payor
contracts typically establish a yearly shared risk pool from which all payments
for hospitalization and other specified services are deducted. At the end of the
period, the Professional Corporation or subsidiary is entitled to a portion of
any excess amounts over actual expenditures deducted from the pool. Certain of
the Payor contracts which are material to FPA obligate the Professional
Corporation to bear a portion of any deficit in this fund. To date, however,
neither FPA nor any Professional Corporation has been called upon to pay any
deficit. Under most circumstances, when such deficits do occur, they are carried
forward and offset against future surpluses. Additionally, some Payor contracts
contain similar arrangements with respect to other specialty care services. FPA
purchases stoploss insurance protection which provides thresholds or "attachment
points," generally $100,000 for inpatient services (up to an aggregate of $5
million) and $25,000 for outpatient services (up to an aggregate of $1 million)
per year, at which substantially all financial exposure for an enrollee beyond
such thresholds is contractually shifted to the insurer. The failure of FPA to
negotiate favorable attachments points in the future could have a material
adverse effect on FPA's financial condition, results of operations and/or
liquidity. There can be no assurance that FPA will be able to negotiate
favorable attachment points in the future.
In 1996, revenue from two Payors, Physician Corporation of America and
Foundation Health Corporation, each exceeded 10% of FPA's operating revenue, and
collectively accounted for approximately 25% of FPA's operating revenue. The
loss of either of these Payors could have a material adverse effect on FPA.
Contracts with Providers. The FPA Network, through the Professional
Corporations, subsidiaries and Payors, contracts with a variety of providers,
including primary and specialty care physicians, hospitals and other ancillary
providers. These agreements generally have terms up to three years, are
automatically renewable and are terminable by either party on the
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following December 31 upon at least 90 days' prior notice. A primary care
physician's affiliation and compensation arrangement with a Professional
Corporation or subsidiary may take one of several forms. The physician may be
(i) an individual or a member of a group practice or an IPA which (a) contracts
with FPA and a Professional Corporation for FPA's services and receives
capitation payments based on the number of enrollees and is entitled to
additional compensation based upon efficiency in utilizing the services of
specialty care providers, subject to other factors including but not limited to
compliance with contractual quality standards or (b) enters into an arrangement
with FPA and one of its Professional Corporations; or (ii) an individual or
group practice of physicians which sells to FPA and a Professional Corporation
the assets of its practice and receives as compensation for employment a base
salary and productivity bonus, or receives a percentage of net collections of
the practice determined in accordance with applicable law. The physician or
group which sells its practice still practices medicine in the same location.
While such physician or group is employed and paid by a Professional Corporation
or subsidiary, FPA provides most employees and administrative services to such
physician or group. In general, a primary care physician is entitled to earn
additional compensation if the medical practice, determined in accordance with
applicable law, meets certain performance standards.
In November 1994, the Board of Directors approved a physician stock option
program effective January 1, 1995. Under this program, physicians are eligible
to receive options to purchase FPA's Common Stock if they reach objective
quality standards set by FPA.
The compensation structures for primary care physicians are set to be
competitive within the geographic area in which each physician is employed. FPA
currently surveys physician compensation patterns and programs in HMO and other
group practice settings to ensure that FPA Network physicians' compensation and
benefits are competitive.
Specialty care providers contract with a Professional Corporation or
subsidiary to provide medical services to enrollees and are compensated on a
discounted fee-for-service or capitated basis. Hospital and affiliated medical
facilities contract with a Professional Corporation or subsidiary and Payors to
provide both inpatient and outpatient services to enrollees on a
fee-for-service, per diem or capitated basis, which are discounted from
customary charges.
Emergency Departments-Client Contracts. Sterling provides physician
practice management services to hospitals under fee-for-service contracts and
flat-rate contracts. A substantial portion of Sterling's hospital-based net
revenues are derived from payments made on a fee-for-service basis. Hospitals
entering into fee-for-service contracts agree, in exchange for Sterling's
services, to authorize Sterling and its contracted health care professionals to
bill and collect the professional component of the charges for medical services
rendered by Sterling's contracted health care professionals. Under the
fee-for-service arrangements with hospital clients, Sterling receives direct
disbursements of the amounts collected and, depending on the magnitude of
services provided to the hospital and payor mix, may also receive a subsidy from
the hospital client for Sterling's physician practice management services.
Pursuant to such arrangement, Sterling accepts responsibility for billing and
collection and assumes the risks of changes in patient volume, payor mix and
third-party reimbursement rates, delays attendant to reimbursement through
government programs and other third-party payors and uncollectibility of
accounts. All of these factors are taken into consideration by Sterling in
arriving at contractual arrangements with health care institutions and
professionals. Clients entering into flat-rate contracts pay fees to Sterling
based on the hours of physician coverage provided.
Sterling provides physician practice management services to hospitals under
contracts that generally have terms of one or two years, renewable automatically
under the same terms and conditions unless either party gives the other written
notice of its intent not to renew at least 90 days prior to the end of the then
current term. Many of these agreements provide for termination by the hospital
without cause on relatively short notice.
Emergency Departments-Physician Contracts. Sterling contracts with
physicians as independent contractors to provide services to hospital clients.
Professional fees from Sterling to the physicians are typically calculated on a
flat rate based on the number of hours of coverage provided. Some physicians may
receive, in addition to a flat hourly fee, other compensation based upon
departmental performance and their individual contribution to such performance.
Consistent with Sterling's treatment of the physicians as independent
contractors, under his or her contract, each physician is responsible for his or
her own self-employment tax, social security and workers' compensation insurance
payments, if any. Under Sterling's contracts with hospitals, a physician who
provides services at hospitals is required to obtain professional liability
insurance with coverage limits as specified in such contracts. Agreements
between Sterling and its independent contractor physicians typically can be
terminated by Sterling at any time under certain circumstances
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(including, in the case of the independent contractors retained to staff
hospital emergency rooms, termination of Sterling's contract with the hospital)
or by either party without cause, typically upon 90 to 120 days' prior notice.
Administrative Services Agreements. FPA has entered into administrative
services agreements with the Professional Corporations which delegate to FPA
certain administrative, management and support functions which are required by
physicians in the practice of medicine (the "Administrative Services
Agreements"). Pursuant to the Administrative Services Agreements, FPA generally
provides facilities, fixtures and equipment for the provision of all medical
services. The Administrative Services Agreements generally have either (i)
initial terms of 10 years and are renewable for an additional 10 year period at
FPA's election and thereafter renew automatically for a third 10-year term
unless either party elects to terminate or (ii) a term of 40 years.
Pursuant to the Administrative Services Agreements, the Professional
Corporations have assigned to FPA, as agent for the Professional Corporations
and as security for the payment to FPA of its management fee, substantially all
revenue received by the Professional Corporations, retain the rights to its
fee-for-service revenue and provide for its own operating costs. "Revenue" is
generally defined as all capitated sums which the Professional Corporations
receive or become entitled to receive for the performance of medical services by
physicians employed by or under contract with the Professional Corporations, all
fee-for-service revenue and substantially all shared risk pool revenue received.
Amounts that may not be assigned to FPA under applicable law (including
traditional fee-for-service Medicare payments) are not included in the revenue
assigned to FPA. As compensation for services rendered to the Professional
Corporations by FPA under the Administrative Services Agreements, FPA receives a
management fee, which consists of assigned revenues minus the costs associated
with the provision of medical care and general and administrative expenses. FPA
remits a portion of the capitation payments on behalf of the Professional
Corporations to the primary care physicians in the FPA Network based on the
number of enrollees each physician covers, regardless of the amount of medical
care provided. Pursuant to the Administrative Services Agreements, the
Professional Corporations appoint FPA as collection and disbursement agent to
collect receivables and disburse funds required to discharge obligations arising
form the Payor agreements.
AGREEMENTS WITH BILLING FIRMS
Sterling's fee-for-service hospital-based billing and collection services
are provided by two nonaffiliated billing firms. Sterling enters into a separate
written agreement with each billing firm for each hospital client to which
services are provided. Each billing firm reviews patient charts, prepares
invoices for the services provided and submits insurance claims, if any. Under
Sterling's arrangements with independent contractor physicians, collections are
paid directly to accounts from which Sterling has the right to withdraw its
management fees. Sterling receives monthly reports on billings invoiced and cash
collected. As of December 1996, the monthly rates paid by Sterling to the
billing firms and collection services were approximately $900,000, collectively.
Sterling's primary care billing and collection functions are serviced
internally.
COMPETITION
The health care industry is highly competitive and is subject to continuing
changes in how services are provided and how providers are selected and paid.
Generally, FPA and the Professional Corporations compete with any entity that
contracts with Payors for the provision of prepaid health care services. The FPA
Network also competes with other companies, including PPMs, which provide
management services to health care providers. FPA also competes with local
physician groups and hospitals for the provision of physician practice
management services to hospital emergency departments. FPA also competes with
other companies for acquisitions of PPMs, IPAs and physician practices. Certain
competitors are significantly larger and better capitalized than FPA, provide a
wider variety of services, have greater experience in providing physician
practice management services and have longer-established relationships with
buyers of such services than does the Company.
GOVERNMENTAL REGULATION
The health care industry is highly regulated, and there can be no assurance
that the regulatory environment in which FPA operates will not change
significantly in the future. Generally, regulation of health care companies is
increasing.
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Reimbursement. Various proposals affecting federal and state regulation of
the health care industry, including limitations on Medicare and Medicaid
payments, have been introduced in the past, including provisions that would
reduce funds available for the Medicare program. Any limitation on Medicare,
Medicaid or other government sponsored payments may adversely affect FPA. For
example, Sterling derived approximately 30% of its 1996 hospital-based operating
revenue from payments made by government-sponsored health care programs,
principally Medicare and Medicaid. Furthermore, funds received under these
programs are subject to audit and retroactive review. In addition, many of
Sterling's services are reimbursed pursuant to Resource Based Relative Value
Scale ("RBRVS"). FPA believes that the impact of RBRVS on Sterling's operations
and financial condition has not been significant. However, if future changes are
adopted relating to the RBRVS fee structure, the aggregate fee payments from
Medicare for certain emergency department procedures could be affected. If the
result is a reduction in such fees, especially if followed by reductions in
reimbursement by commercial third party payors, the RBRVS system could adversely
affect Sterling's operating results or financial condition. There can be no
assurance that the payments under any governmental and private third party payor
program will remain at levels comparable to present levels or will be sufficient
to cover the costs allocable to patients eligible for reimbursement pursuant to
such programs. Furthermore, changes in reimbursement regulations, policies,
practices, interpretations or statutes could adversely affect the operations of
the Company.
Corporate Practice of Medicine. Federal law and the laws of the states
where FPA and the Professional Corporations currently operate generally specify
who may practice medicine and limit the scope of relationships between medical
practitioners and other parties. Under certain states' laws, FPA is prohibited
from practicing medicine or exercising control over the provisions of medical
services. In order to comply with such laws, the FPA Network is organized so
that all physician services are offered by the physicians who are employed by or
affiliated with the Professional Corporations. In order to comply with such
laws in those states, FPA does not employ practicing physicians as
practitioners, exert control over their decisions regarding medical care or
represent to the public that it offers medical services. FPA has entered into
administrative services agreements with the Professional Corporations which
delegate to FPA the performance of certain administrative, management and
support functions. FPA believes that the services it provides to the FPA Network
do not constitute the practice of medicine under applicable laws.
Licensing Requirements. Every state imposes licensing requirements on
individual physicians and on facilities and services operated by physicians. In
addition, federal and state laws regulate HMOs and other managed care
organizations with which the physician groups may have contracts. Many states
require regulatory approval, including certificates of need, before establishing
or expanding certain types of health care facilities, offering certain services
or making expenditures in excess of statutory thresholds for health care
equipment, facilities or programs. Some states also require licensing of
third-party administrators, entities performing utilization management functions
and collection agencies. Certain of FPA's subsidiaries have obtained third-party
administrator and utilization management licenses. In connection with its
existing operations and its expansion into new markets, FPA believes it is in
compliance with all such laws and regulations and current interpretations
thereof, but there can be no assurance that such laws, regulations or
interpretations will not restrict expansion or affect operations in the future
or that additional laws and regulations will not be enacted. The ability of FPA
to operate profitably will depend in part upon FPA and its affiliated physician
groups obtaining and maintaining all necessary licenses, certificates of need
and other approvals and operating in compliance with applicable health care
regulations.
Fraud and Abuse; Self-referral. Federal law prohibits the offer, payment,
solicitation or receipt of any form of remuneration in return for, or in order
to induce: (i) the referral of a person for services; (ii) the furnishing or
arranging for the furnishing of items or services; or (iii) the purchase, lease
or order of arranging or recommending purchasing; leasing or ordering of any
item or service, in each case, reimbursable under Medicare or Medicaid. Pursuant
to this anti-kickback law, the federal government has announced a policy of
increased scrutiny of joint ventures and other transactions among health care
providers in an effort to reduce potential fraud and abuse relating to Medicare
patients. The applicability of these provisions to many kinds of business
transactions in the health care industry has not yet been subject to judicial
and regulatory interpretation. In addition, federal legislation currently
restricts the ability of physicians to refer patients to entities in which they
have an ownership interest or compensation arrangement for clinical laboratory
services. Effective January 1, 1995, the federal anti-referral legislation
extended to entities that provide certain other "designated health services."
Many states, including those in which FPA presently does business, have similar
anti-kickback and anti-referral laws.
A violation of the federal anti-kickback statute generally requires several
elements: (i) the offer, payment, solicitation or receipt of remuneration; (ii)
the intent to induce referrals; and (iii) the ability of the parties to make or
influence
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referrals of patients for services reimbursable under Medicare or Medicaid
programs or to provide items or services reimbursable under such programs.
Noncompliance with, or violation of, the federal anti-kickback legislation can
result in exclusion for Medicare and Medicaid programs and civil and criminal
penalties. With respect to the self-referral prohibition, the entity and the
referring physician are prohibited from receiving Medicare or Medicaid
reimbursement for services rendered. Similar penalties are provided for
violation of state and anti-kickback and anti-referral laws. The federal
government has promulgated "safe harbor" regulations that identify certain
business and payment practices which are deemed not to violate the federal
anti-kickback statute. Although FPA's business does not fall within certain of
the current or proposed safe harbors, FPA believes that its operations
materially comply with such statutes and regulations.
FPA believes that its business operations do not involve the offer,
payment, solicitation or receipt of remuneration to induce referrals of patients
because compensation arrangements with primary care physicians who make
referrals are designed to discourage referrals to the extent they are
unnecessary. These physicians are paid either on a capitation or fee-for-service
basis and do not receive any financial benefit from making referrals. FPA also
believes that its business arrangements do not involve the referral of patients
to entities with whom referring physicians have an ownership interest or
compensation arrangement within the meaning of federal and state anti-referral
laws, because most referrals are made directly to other providers rather than to
entities in which referring physicians have an ownership or compensation
arrangement. FPA further believes its compensation arrangements with physicians
fall within various exceptions to state and federal anti-referral laws,
including exceptions for ownership or compensation arrangements with certain
managed care organizations and for physician incentive plans that limit
referrals. In addition, FPA believes that the methods used to acquire existing
physician practices and to recruit new physicians do not violate anti-kickback
and anti-referral laws and regulations. Should any of FPA's business
arrangements be deemed to constitute arrangements designed to induce the
referral of Medicare or Medicaid patients or to involve referrals to entities
with whom the referring physician has an ownership interest or compensation
arrangement, then such arrangements could be viewed as possibly violating
anti-kickback or anti-referral laws and regulations. A determination of
liability under any such law could have a material adverse effect on FPA's
results of operations.
Insurance Regulation. Federal and state laws regulate insurance companies,
HMOs and other managed care organizations. Generally, these laws apply to
entities that accept financial risk. Certain of the risk arrangements entered
into by FPA could be characterized by some states as the business of insurance.
FPA, however, believes that the acceptance of capitation payments by a health
care provider does not constitute the conduct of the business of insurance. Many
states also regulate the establishment and operation of networks of health care
providers. Generally, these laws do not apply to the hiring and contracting of
physicians by other health care providers. There can be no assurance that
regulators in the states in which FPA operates would not apply these laws to
require licensure of FPA's operations as an insurer or provider network. FPA
believes that it is in compliance with these laws in the states in which it does
business, but there can be no assurance that future interpretations of these
laws by the regulatory authorities in these states or the states in which FPA
may expand will not require licensure or a restructuring of some or all of FPA's
operations. In the event that FPA is required to become licensed under these
laws, the licensure process can be lengthy and time consuming and, unless the
regulatory authority permits FPA to continue to operate while the licensure
process is progressing, FPA could experience a material adverse change in its
business while the licensure process is pending. In addition, many of the
licensing requirements mandate strict financial and other requirements which FPA
may not immediately be able to meet. Further, once licensed, FPA would be
subject to continuing oversight by and reporting to the respective regulatory
agency.
State laws in California, operations in which represented approximately 22%
of FPA's operating revenues for the year ended December 31, 1996, require
entities such as FPA to be licensed as health care service plans. The
application of a wholly-owned subsidiary of FPA for a restricted license was
approved by the California Department of Corporations in December 1996. The loss
or revocation of such license would have a material adverse effect on FPA. In
addition, there can be no assurance that regulatory authorities in the other
states in which FPA or its affiliates operate will not impose similar
requirements.
Possible Negative Effects of Prospective Health Care Reform. Various plans
have been proposed and are being considered on federal, state and local levels
to reduce costs in health care spending. Although FPA believes its management
model responds to the concerns addressed by such plans, it is not possible to
assess the likelihood any of these proposals will be enacted or to assess the
impact any of these proposals may have on reimbursement to health care
providers. Any plan to control health care costs, however, could result in lower
rates of reimbursement. Lower rates of
10
<PAGE> 183
reimbursement may reduce the amount assigned to FPA by the Professional
Corporations and accordingly, would have a material effect of FPA's business and
results of operations.
Other. In recent years, legislation has been proposed in Congress to
implement an "any willing provider" law on a national level. These laws, which
are in effect in some states, require managed care organizations, such as HMOs,
to contract with any physician who is appropriately licensed and who meets any
applicable membership criteria. Such laws could limit the flexibility of managed
care organizations to achieve efficiency by controlling the size of their
primary care provider networks and the number of specialty care providers to
whom enrollees are referred. At present, no state in which FPA Network
physicians practice has such a law although "any willing provider" laws have
been proposed in states in which FPA operates. FPA cannot predict what effect
such laws would have on its operations.
CORPORATE LIABILITY AND INSURANCE
In recent years, physicians, hospitals and other participants in the managed
health care industry have become subject to an increasing number of lawsuits
alleging medical malpractice and related claims based on the withholding of
approval for or reimbursement of necessary medical services. Many of these
lawsuits involve large claims and substantial defense costs.
The Company requires all physicians in the FPA Network to carry certain
minimum amounts of malpractice insurance coverage. The Professional Corporations
and certain subsidiaries maintain their own malpractice insurance. The Company
also maintains an errors and omissions insurance policy which covers utilization
review activities. Sterling currently maintains professional liability insurance
underwritten by an insurance company unaffiliated with Sterling for itself, its
hospital clients and its contracted physicians, in amounts it deems to be
appropriate, based upon historical claims and the nature and risks of its
business. The professional liability insurance coverage is on a claims-made
basis (the coverage includes claims reported during the period that the insured
was covered by the policy) and includes certain self-insurance retention. Such
insurance provides coverage, subject to policy limits, in the event that
Sterling is held liable as a co-defendant in a lawsuit against an independent
contractor physician or hospital client. In addition to any potential tort
liability of Sterling, Sterling's contracts with hospitals generally contain
provisions under which Sterling agrees to indemnify the hospital for losses
resulting from the negligence of the hospital or hospital personnel. Any claim
or claims in excess of insurance policy limits could have a material adverse
effect on FPA.
EMPLOYEES
At March 21, 1997, the Company had approximately 4,000 full time employees.
Management believes that its employee relations are good. None of the FPA
Network's employees are subject to a collective bargaining agreement, however,
certain physicians in Thomas-Davis Medical Centers, P.C., a professional
corporation affiliated with FPA, and employees in Tucson, Arizona voted in late
1996 and early 1997, respectively, to form a collective bargaining unit. Appeals
with respect to the vote are currently pending before the National Relations
Board.
11
<PAGE> 184
ITEM 2. PROPERTIES
FPA leases administrative office space in each of its regions, as follows:
<TABLE>
<CAPTION>
REGION SQUARE FEET TERMINATION DATE
------ ----------- ----------------
<S> <C> <C>
San Diego, CA................................................ 20,150 September 2001
Coral Gables, FL............................................. 38,000 April 2000
San Diego, CA................................................ 25,000 May 1999
Sacramento, CA............................................... 5,000 June 2001
Los Angeles, CA.............................................. 16,000 December 2000
Newtown Square, PA........................................... 13,000 October 2000
Phoenix, AZ.................................................. 10,000 January 2001
San Antonio, TX.............................................. 36,000 October 2005
-------
Total................................................... 163,150
=======
</TABLE>
FPA also leases certain other administrative offices and various medical
office spaces for the health centers that FPA, its subsidiaries and the
Professional Corporations operate. As FPA, its subsidiaries and the Professional
Corporations acquire additional physician practices, management expects that
FPA, its subsidiaries and the Professional Corporations will enter into
additional medical office space leases.
ITEM 3. LEGAL PROCEEDINGS
FPA is party to certain legal actions arising in the ordinary course of
business. In the opinion of FPA's management, liability, if any, under these
claims is adequately covered by insurance or will not have a material effect on
FPA's financial position or results of operations.
AHI is a defendant in a purported class action securities lawsuit entitled
In re AHI Healthcare Systems, Inc. Securities Litigation filed in the United
States District Court for the Central District of California, Western Division.
The suit was initially filed against AHI, certain of its officers and directors,
and its underwriters on December 20, 1995. The suit asserts that AHI
artificially inflated the price of its stock by, among other things, misleading
securities analysts and by failing to disclose in its initial public offering
prospectus alleged difficulties with the acquisition of Lakewood Health Plan,
Inc. and with two of AHI's payor contracts with FHP, Inc. The plaintiffs seek
unspecified damages on behalf of the stockholders who purchased AHI's common
stock between September 28, 1995 and December 19, 1995. On January 17, 1997 the
district court (a) granted AHI's motion for partial summary judgment and
dismissed the class plaintiffs' claims concerning the alleged misrepresentations
regarding AHI's intended use of initial public offering proceeds and AHI's
relationship with FHP, Inc. but (b) denied summary judgment on the claims
relating to the proposed acquisition of Lakewood Health Plan, Inc. As a result,
only those claims relating to Lakewood Health Plan and AHI's alleged liability
for the public statements of securities analysts following AHI remain in the
suit. Since the court's ruling on AHI's motion for partial summary judgment, the
plaintiffs have asked the court for leave to amend their complaint to add an
additional claim alleging problems with AHI's medical group operations in
Downey, California. Additionally, on November 12, 1996, FPA, AHI and AHI's
directors were named as defendants in a class action lawsuit filed in Delaware
Chancery Court by Joshua Chopp, a stockholder of AHI. The suit asserts, among
other things, that the "intrinsic value" of AHI's stock is higher than that
which AHI's stockholders will receive in the merger, and that the directors of
AHI breached their fiduciary duties by approving the merger without undertaking
steps to accurately ascertain AHI's market value. The stockholder further
alleges that FPA knowingly aided and abetted a breach of fiduciary duty by the
individual defendants. The stockholder is seeking equitable relief. FPA intends
to vigorously defend both of these lawsuits and does not expect that the outcome
of these lawsuits will have a material adverse effect on its financial condition
or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At a special meeting of FPA stockholders held on October 31, 1996, two
matters were voted upon by the FPA stockholders. The FPA stockholders adopted an
agreement and plan of merger pursuant to which Sterling Healthcare Group, Inc.
became a wholly-owned subsidiary of FPA. The vote to adopt such agreement and
plan of merger was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 7,480,410
AGAINST 20,167
WITHHELD 32,784
ABSTENTIONS 26,753
BROKER NON-VOTES --
</TABLE>
The second matter voted upon was the approval of amendments to the FPA Omnibus
Stock Option Plan to increase the total number of shares of FPA Common Stock
issuable upon exercise of options granted under such plan by 2,500,000 to
5,000,000 and limit the number of shares of FPA Common Stock for which options
may be granted under such plan to any person during calendar year to 750,000.
The vote to approve such amendments was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 5,377,171
AGAINST 2,153,321
WITHHELD --
ABSTENTIONS 29,622
BROKER NON-VOTES --
</TABLE>
12
<PAGE> 185
At a special meeting of FPA stockholders held on March 17, 1997, two
matters were voted upon by the FPA stockholders. The FPA stockholders adopted an
agreement and plan of merger pursuant to which AHI Healthcare Systems, Inc.
became a wholly-owned subsidiary of FPA. The vote to adopt such agreement and
plan of merger was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 15,530,374
AGAINST 38,512
WITHHELD -
ABSTENTIONS 19,024
BROKER NON-VOTES -
</TABLE>
The second matter voted upon was the approval of amendments to the Omnibus Stock
Option Plan to increase the total number of shares of FPA Common Stock issuable
upon exercise of options granted under such plan by 1,500,000 to 6,500,000. The
vote to approve such amendment was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 13,361,987
AGAINST 2,171,741
WITHHELD -
ABSTENTIONS 54,182
BROKER NON-VOTES -
</TABLE>
Executive Officers of the Registrant
Set forth below is information about the executive officers of FPA. The
offices referred to below are offices of FPA unless otherwise indicated.
All executive officers are elected to serve at the pleasure of the Board of
Directors.
Dr. Sol Lizerbram (49), Chairman of the Board since 1986 and President from
1986 until October 31, 1996.
Dr. Seth Flam (38), Chief Executive Officer since 1986 and President since
November 1, 1996.
Dr. Stephen Dresnick (47), Vice Chairman of the Board since 1996 and
President, Sterling Healthcare Group, Inc. since 1987.
Dr. Howard Hassman (40), Executive Vice President -- Corporate Development
since September 1994; Chief Financial Officer from 1986 to September 1994.
Dr. Kevin Ellis (40), Chief Medical Officer since April 1995. Chief
Operating Officer from 1988 until April 1995.
Steven M. Lash (43), Executive Vice President and Chief Financial Officer
since September 1994. Executive Vice President for Institutional Care at Sharp
Health care, a health care system providing medical services throughout San
Diego, California, from April 1993 to September 1994; Senior Vice President of
Business Affairs and Chief Financial Officer of San Diego Hospital Association,
doing business as Sharp Healthcare, from 1981 to April 1993.
James A. Lebovitz (39), Senior Vice President, General Counsel and
Secretary since March 1996. Partner, Ballard Spahr Andrews & Ingersoll, a law
firm, from 1991 until March 1996.
Cheryl A. Moore (31), Vice President-Finance since July 1996; Controller
since January 1994; Vice President and Chief Accounting Officer since August
1994. Audit manager, Deloitte & Touche, from 1993 to January 1994; auditor,
Deloitte & Touche, from 1988 to 1993.
13
<PAGE> 186
PART II
ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
FPA's Common Stock is traded on The Nasdaq Stock Market under the symbol
FPAM. The table below shows the high and low bid prices for FPA's Common Stock
for each quarter during 1995 and 1996.
<TABLE>
<CAPTION>
1995 HIGH LOW
---- ---- ---
<S> <C> <C>
1st Quarter............................. $11.250 $6.000
2nd Quarter............................. 12.500 7.875
3rd Quarter............................. 12.125 8.875
4th Quarter............................. 9.750 5.875
<CAPTION>
1996 HIGH LOW
---- ---- ---
<S> <C> <C>
1st Quarter............................. $13.250 $8.625
2nd Quarter............................. 20.125 12.125
3rd Quarter............................. 27.125 12.500
4th Quarter............................. 29.500 16.375
</TABLE>
At March 21, 1997, there were approximately 251 holders of record of
Common Stock. FPA declared no cash dividends during 1995 or 1996 and has no
plans to declare cash dividends in the foreseeable future.
14
<PAGE> 187
ITEM 6. SELECTED FINANCIAL DATA.
The following statement of operations data and balance sheet data have been
derived from the audited consolidated financial statements of the Company.
Selected financial data below should be read in conjunction with the
consolidated financial statements and notes thereto, included elsewhere in this
document.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
CONSOLIDATED STATEMENTS OF OPERATIONS: 1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Operating revenue $ 8,275 $ 13,988 $ 57,691 $ 168,352 $ 440,319
Medical services expense 6,423 10,348 41,352 113,743 313,707
----------- ----------- ------------ ------------ -----------
1,852 3,640 16,339 54,609 126,612
General and administrative expenses 1,893 3,471 13,607 44,893 99,230
Merger, restructuring and other
unusual charges 1,590 37,971
----------- ----------- ------------ ------------ -----------
Income (loss) from operations (41) 169 2,732 8,126 (10,589)
Other income (expense), net 10 9 -- (1,569) (5,127)
----------- ----------- ------------ ------------ -----------
Income (loss) before income taxes (31) 178 2,732 6,557 (15,716)
Income tax (expense) benefit -- -- (942) (2,723) --
----------- ----------- ------------ ------------ -----------
Net income (loss) $ (31) $ 178 $ 1,790 $ 3,834 $ (15,716)
=========== =========== ============ ============ ===========
PRO FORMA PER SHARE DATA:
Net income per share $ 0.27 $ 0.26 $ 0.28 $ (0.72)
Weighted average shares outstanding 3,163,000 6,579,828 13,693,192 21,702,786
CONSOLIDATED BALANCE SHEET DATA:
Cash and marketable securities $ 423 $ 610 $ 12,217 $ 11,401 $ 45,595
Working capital surplus (deficit) (634) (600) 22,164 25,974 (12,078)
Total assets 1,027 1,633 45,052 152,407 539,197
Long-term liabilities -- 21 9,650 23,839 193,318
Stockholders' equity (deficit) (546) (358) 24,326 93,227 143,518
</TABLE>
15
<PAGE> 188
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
FPA Medical Management, Inc., its subsidiaries and the Professional
Corporations derive substantially all of their operating revenue from (i) the
payments made by Payors to the Professional Corporations for managed care
medical services and (ii) fee-for-service revenues for medical centers in the
managed care business and (iii) fee-for-service revenues from emergency
department medical services.
MANAGED CARE BUSINESS
The Company has two types of Payor contracts: contracts for both inpatient
and outpatient services ("global capitation" contracts) and those limited to
outpatient services or professional medical services ("outpatient capitation"
contracts). Under global capitation contracts, the Company receives a fixed
monthly amount per enrollee for which the Company is financially responsible to
provide the enrollees with all necessary inpatient and outpatient care. Under
outpatient capitation contracts, the Company receives a fixed monthly amount per
enrollee for which the Company is financially responsible to provide the
enrollees with all necessary outpatient care. Additionally, under these
outpatient capitation contracts, the Company is a party to shared risk
arrangements with Payors which generally reward the Company for the efficient
utilization of hospital inpatient services. Under these shared risk
arrangements, the Company shares any surplus or, in some cases, deficit, of
amounts pre-established by the Payor in relation to inpatient expense. Revenue
under global capitation contracts represented 0%, 20.9% and 36.3% for 1994, 1995
and 1996, respectively, of managed care business operating revenue. Revenue
under outpatient capitation contracts represented 98.5%, 72.4% and 51.7% for
1994, 1995 and 1996, respectively, of managed care business operating revenue.
The Company also generates fee-for-service revenue for the performance of
medical services through the Professional Corporations and its subsidiaries.
These revenues are presented net of contractual deductions and represented 1.5%,
6.7% and 12.0% for 1994, 1995 and 1996, respectively, of managed care business
operating revenue.
Through the Professional Corporations and its subsidiaries, the Company
contracts with various healthcare providers to provide primary care and
specialty medical services to covered enrollees. Primary care physicians are
compensated
16
<PAGE> 189
on either a salary or capitation basis. Specialty care physician services
are paid for on either a discounted fee-for-service or capitation basis. Managed
care business medical services expense paid for on a capitation basis (for
certain primary care and specialty care services) or fixed salary basis (for
primary care only) totaled 42.5%, 31.9% and 25.8% for 1994, 1995 and 1996
respectively, of managed care business operating revenues, with the remainder of
medical services expense (for primary care, specialty care, ancillary services,
inpatient and outpatient services, lab charges, etc.) paid for on a discounted
fee-for-service or per diem basis.
EMERGENCY DEPARTMENT BUSINESS
Through the emergency department business, the Company provides contract
management and support services primarily to emergency departments. As of
December 31, 1996 the Company provided physician practice management services on
a contract basis to 104 emergency departments, one anesthesia department, three
correctional health care facilities and one rural health urgent care clinic
located in 20 states. The Company contracts with approximately 1,000 affiliated
physicians who provide certain medical services to approximately 1.4 million
patients annually.
The Company's contractual arrangements with hospitals are primarily
fee-for-service contracts whereby hospitals generally agree, in exchange for the
Company's services, to authorize the Company and its contracted health care
professionals to bill and collect the professional component of the charges for
medical services rendered by the Company's contracted health care professionals.
Fee-for-service contracts may, depending on the hospital's patient volume and
payor mix, involve the payment of a subsidy to the Company by the hospital. In
1994, 1995 and 1996, respectively, 94.0%, 84.4% and 84.6% of the Company's
emergency department operating revenue was earned on a fee-for-service basis,
and the Company emphasized fee-for-service contracts in its marketing
activities.
Medical services expense for the emergency department business consists
primarily of payments made to independent contractor and employee physicians
("Physician Costs") and, to a lesser extent the costs of medical supplies and
malpractice insurance and
17
<PAGE> 190
laboratory fees. In 1994, 1995 and 1996, Physician Costs accounted for 95.1%,
91.8% and 92.1%, respectively, of emergency department medical services expense.
OPERATIONAL DEVELOPMENT
The future growth of FPA is largely dependent on a continued increase in
the number of new enrollees in the FPA network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
serving enrollees of Payors in the FPA network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations have
contracts and whose members are patients of physicians in the FPA network or
(iii) agreements with Payors, physicians and hospitals in other geographic
markets. The process of identifying and consummating suitable acquisitions of,
or affiliations with, physician groups can be lengthy and complex. The
marketplace for such acquisitions and affiliations is subject to increasing
competitive pressures. There can be no assurance that FPA will be successful in
identifying, acquiring or affiliating with additional physician groups or
hospitals or that the Professional Corporations will be able to contract with
new Payors. In addition, there can be no assurance that the Company's
acquisitions will be successfully integrated on a timely basis or that the
anticipated benefits of these acquisitions will be realized; failure to
effectively accomplish the integration of acquired companies could have a
material adverse effect on FPA's results of operations and financial condition.
FPA's ability to expand is also dependent upon its ability to comply with legal
and regulatory requirements in the jurisdictions in which it operates or will
operate and to obtain necessary regulatory approvals, certificates and licenses.
In March 1997, the Company completed its merger with AHI Healthcare
Systems, Inc. In January 1996, the Company acquired three independent practice
associations in the Los Angeles, Ventura and Sacramento regions of California,
which now service approximately 76,000 enrollees and include 570 primary care
physicians. In June 1996, FPA acquired Physicians First, Inc., operating 40
medical clinics in Florida, through which 110 primary care physicians provided
services to approximately 80,000 enrollees. In July 1996, the Company acquired
two independent practice associations, one in Arizona and Florida, providing
services to approximately 14,000 and 4,000 enrollees, respectively. In October
1996, FPA and Sterling completed a merger. Effective in December 1996, the
Company and certain Professional Corporations acquired two medical groups, one
each in California and Arizona, providing services to approximately 63,000 and
157,000 enrollees, respectively.
Listed below is a breakdown of enrollees, Payors, primary care physicians,
specialty care physicians, and emergency department business contracts
(including anesthesiology, urgent care and correctional facility business
contracts) by region at December 31, 1996.
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF NUMBER OF NUMBER OF EMERGENCY
PAYOR PRIMARY CARE SPECIALTY CARE DEPARTMENT
ENROLLEES CONTRACTS PHYSICIANS PHYSICIANS CONTRACTS
--------- --------- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C>
California 207,967 21 681 3,191 --
Arizona 186,102 4 459 771 --
New Jersey 29,029 4 926 447 --
Delaware 7,782 1 74 74 --
South Carolina 12,473 3 176 51 2
North Carolina 11,074 1 52 -- 11
Texas 46,199 6 64 427 16
Florida 95,520 3 228 777 9
Michigan 27,334 2 406 1,028 10
Louisiana -- -- -- -- 10
Mississippi -- -- -- -- 8
Tennessee -- -- -- -- 7
Alabama -- -- -- -- 6
Others -- -- -- -- 30
------- --- ----- ----- ---
Total 623,480 45 3,066 6,766 109
======= === ===== ===== ===
</TABLE>
RESULTS OF OPERATIONS
18
<PAGE> 191
The following table sets forth for 1994, 1995 and 1996 selected financial
data and selected financial data expressed as a percentage of operating revenue.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995
---- ----
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Operating revenue $ 18,435,877 $39,255,573 $57,691,450 $ 52,691,955 $115,659,527 $168,351,482
Medical services
expense 13,628,430 27,723,675 41,352,105 37,757,244 75,985,634 113,742,878
General and
administrative
expenses 4,423,842 9,183,231 13,607,073 13,310,386 33,172,287 46,482,673
------------ ----------- ----------- ------------ ------------ ------------
Income (loss)
from operations 383,605 2,348,667 2,732,272 1,624,325 6,501,606 8,125,931
Other (income)
expense (79,892) 80,301 409 (189,725) 1,758,371 1,568,646
------------ ----------- ----------- ------------ ------------ ------------
Income (loss)
before tax 463,497 2,268,366 2,731,863 1,814,050 4,743,235 6,557,285
Income tax expense 75,184 866,841 942,025 811,588 1,911,732 2,723,320
------------ ----------- ----------- ------------ ------------ ------------
Net income (loss) $ 388,313 $ 1,401,525 $ 1,789,838 $ 1,002,462 $ 2,831,503 $ 3,833,965
============ =========== =========== ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996
----
MANAGED EMERGENCY
CARE DEPARTMENT
BUSINESS BUSINESS TOTAL
-------- -------- -----
<S> <C> <C> <C>
Operating revenue $ 303,557,843 $ 136,760,770 $ 440,318,613
Medical services
expense 219,456,632 94,249,976 313,706,608
General and
administrative
expenses (1) 88,536,451 48,664,736 137,201,187
------------- ------------- -------------
Income (loss)
from operations (4,435,240) (6,153,942) (10,589,182)
Other (income)
expense 4,273,613 853,631 5,127,244
------------- ------------- -------------
Income (loss)
before tax (8,708,853) (7,007,573) (15,716,426)
Income tax expense -- -- --
------------- ------------- -------------
Net income (loss) $ (8,708,853) $ (7,007,573) $ (15,716,426)
============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1995
---- ----
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Operating revenue 100% 100% 100.0% 100.0% 100.0% 100.0%
Medical services
expense 73.9% 70.6% 71.7% 71.7% 65.7% 67.6%
General and
administrative
expenses 24.0% 23.4% 23.6% 25.3% 28.7% 27.5%
----- ---- ----- ----- ----- -----
Income (loss) from
operations 2.1% 6.0% 4.7% 3.0% 5.6% 4.8%
Other (Income)
expense (0.4)% 0.2% 0.0% (0.4)% 1.5% 0.9%
----- ---- ----- ----- ----- -----
Income (loss)
before tax 2.5% 5.8% 4.7% 3.4% 4.1% 3.9%
Income tax expense 0.4% 2.2% 1.6% 1.5% 1.7% 1.6%
----- ---- ----- ----- ----- -----
Net income (loss) 2.1% 3.6% 3.1% 1.9% 2.4% 2.3%
===== ==== ===== ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996
----
MANAGED EMERGENCY
CARE DEPARTMENT
BUSINESS BUSINESS TOTAL
-------- -------- -----
<S> <C> <C> <C>
Operating revenue 100.0% 100.0% 100.0%
Medical services
expense 72.3% 68.9% 71.3%
General and
administrative
expenses (1) 29.2% 35.5% 31.2%
----- ----- -----
Income (loss)
from operations (1.5)% (4.5)% (2.4)%
Other (Income)
expense 1.4% 0.6% 1.2%
----- ----- -----
Income (loss)
before tax (2.9)% (5.1)% (3.6)%
Income tax expense 0.0% 0.0% 0.0%
----- ----- -----
Net income (Loss) (2.9)% (5.1)% (3.6)%
===== ===== =====
</TABLE>
(1) Includes nonrecurring charges of $38.0 million in 1996. Excluding
these nonrecurring charges, general and administrative expense was
22.6% of operating revenue and income from operations was 6.2% of
operating revenue in 1996.
MANAGED CARE BUSINESS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
Operating Revenue -- The Company's managed care business operating revenue
increased to $303.6 million in 1996 from $52.7 million in 1995 and $18.4 million
in 1994. The revenue increase resulted primarily from the increase in average
enrollment to 327,000 in 1996, from 63,000 in 1995 and 30,000 in 1994. As
compared to 1995, the 1996 increase resulted from the addition of (i)
approximately 161,000 enrollees in California primarily as a result of
acquisitions, (ii) approximately 174,000 enrollees in Arizona primarily as a
result of a December 1996 acquisition, (iii) enrollment of 42,000, 14,000, and
15,000 enrollees, respectively, in the Mid Atlantic region, Texas and Florida as
a result of internal growth, (iv) approximately 27,000 enrollees in Michigan and
(v) approximately 80,000 enrollees in Florida, as a result of a June 1996
acquisition. In 1996, the Company generated net fee-for-
19
<PAGE> 192
service revenue of $35.9 million compared to 1995 net fee-for-service revenue of
$2.8 million and no fee-for-service revenue in 1994. The growth in
fee-for-service revenue is attributable to the increasing number of medical
facilities managed by FPA.
Medical Services Expense -- Medical services expense for 1996 was $219.5
million or 72.3% of managed care business operating revenue as compared to $37.8
million or 71.7% of such operating revenue in 1995 and $13.6 million or 73.9% of
such operating revenue in 1994. The increase in medical services expense as a
percent of such operating revenue from 1995 to 1996 resulted primarily from
significantly increased membership in the Mid-Atlantic and Florida regions under
global capitation contracts which initially experience a higher medical loss
ratio than outpatient only capitation contracts. The decrease in medical
services expense as a percentage of such operating revenue from 1994 to 1995
resulted from a higher revenue base per member per month as a result of
increased shared risk earnings and increased capitation of specialists which
limited costs for the specialty services provided.
General and Administrative Expense -- General and administrative expense
including nonrecurring charges for 1996 was $88.5 million or 29.2% of managed
care business operating revenue as compared to $13.3 million or 25.3% of such
operating revenue in 1995 and $4.4 million or 24.0% of such operating revenue in
1994. Excluding the effect of nonrecurring charges recognized in 1996, general
and administrative expense would have decreased to 22.6% of such operating
revenue as the Company achieved economies of scale in its operations. In 1995,
the Company hired additional staffing and other personnel in new regions prior
to the addition of a significant number of enrollees. The Company has also made
significant investments in information systems, and has deployed this technology
to the majority of its regions.
Merger, Restructuring and Other Unusual Charges -- During 1996, the managed
care business of the Company incurred approximately $20.3 million in
nonrecurring charges. Approximately $6.6 million resulted from write-offs of
goodwill and other assets related to unprofitable operations in Arizona and
California. Approximately $11.7 million related to costs of legal fees,
accounting fees, investment bankers' fees and other costs associated with the
Sterling merger. As the Sterling merger was accounted for as pooling of
interests, generally accepted accounting principles require that transaction
costs be expensed as incurred. Approximately $2.0 million arose from the costs
of severance payments,
20
<PAGE> 193
lease terminations and other costs associated with consolidating medical centers
and adjusting staffing in Florida, Arizona and as a result of the Sterling
merger.
Income (Loss) from Operations -- In 1996, the managed care business of the
Company generated a loss from operations of $4.4 million including the
nonrecurring charges. Excluding such nonrecurring charges, 1996 income from
operations was $15.9 million as compared to income from operations of $1.6
million in 1995, and $.4 million in 1994.
EMERGENCY DEPARTMENT BUSINESS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
The 1994 consolidated financial statements include the activities of the
emergency department business from June 1, 1994 (date of inception) to December
31, 1994.
Operating Revenue -- Emergency department business operating revenue
consists of gross patient revenue, net of contractual deductions and estimated
uncollectible accounts, plus other revenue, which consists principally of
hospital subsidy payments, flat-rate hospital contract revenue and non-patient
generated revenues. Operating revenue increased to $136.8 million in 1996 from
$115.7 million in 1995 and $39.3 million in 1994. On a percentage basis, the
emergency department business' operating revenue grew 195% in 1995 and 18.2% in
1996. The increases were primarily attributable to the increases in the number
of the Company's emergency department contracts from 61 in 1994 and 89 in 1995
to 104 in 1996.
Medical Services Expense -- Medical services expense increased to $94.2
million for 1996 from $76.0 million in 1995 and $27.7 million in 1994 due
primarily to the increase in the number of healthcare professionals under
contract, resulting from the increase in the number of the Company's emergency
department contracts, as well as negotiated increases in fees paid to certain
healthcare professionals. Medical services expense as a percentage of operating
revenue was 68.9% in 1996, 65.7% in 1995 and 70.6% in 1994.
General and Administrative Expense -- General and administrative expense
including nonrecurring charges was $48.7 million in 1996, $33.2 million in 1995
and $9.2 million in 1994. Excluding the effect of nonrecurring charges in 1996,
general and administrative expense would have been $31.0 million. During 1995,
the emergency department business increased the number of its regional offices
as well as the number of administrative employees to accommodate the increase in
emergency department contracts. In
21
<PAGE> 194
1996, the Company, through cost cutting measures, including the closing of one
of its regional offices as well as the down-sizing of another, reduced this
expense. As a percentage of revenue, general and administrative expense was
35.5% in 1996 including non-recurring charges or 22.6% excluding non-recurring
charges, 28.7% in 1995 and 23.4% in 1994.
Merger, Restructuring and Other Unusual Charges -- During 1996, the Company
incurred approximately $17.7 million in non-recurring adjustments and
restructuring charges. Approximately $12.3 million resulted from write-offs of
goodwill and other assets related to terminated emergency department contracts.
Approximately $5.1 million related to costs of legal fees, accounting fees,
investment bankers' fees and other costs associated with the Sterling merger. As
the Sterling merger was accounted for as pooling of interests, generally
accepted accounting principles require that transaction costs be expensed as
incurred. Approximately $.3 million related to restructuring charges arose from
the costs of severance payments, lease terminations and other costs associated
with the Sterling merger.
Net Income (loss) from Operations -- In 1996, the emergency department
business of the Company generated a loss from operations of $6.2 million,
including nonrecurring charges. Excluding such charges, income from operations
would have been $11.5 million as compared to $6.5 million in 1995 and $2.3
million in 1994.
QUARTERLY RESULTS
The following table presents financial information for the eight quarters
ended December 31, 1996. In the opinion of management, this information has been
prepared on the same basis as the audited consolidated financial statements
appearing elsewhere in this document and all necessary adjustments, consisting
only of normal recurring adjustments, have been included in the amounts
presented below to present fairly the quarterly results when read in conjunction
with the audited consolidated financial statements of the Company and notes
thereto. The Company's quarterly results have in the past been subject to
fluctuation and as a result, the operating results for any quarter are not
necessarily indicative of results for any future period. All numbers in the
following table are in thousands.
22
<PAGE> 195
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995 1996 1996 1996 1996
--------- -------- ------------- ------------ --------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenue $ 29,533 $37,489 $44,569 $56,760 $73,162 $92,075 $124,034 $ 151,048
-------- ------- ------- ------- ------- ------- -------- ---------
Medical services
expense 19,804 25,255 30,035 38,648 51,550 66,120 92,126 103,911
-------- ------- ------- ------- ------- ------- -------- ---------
9,729 12,234 14,534 18,112 21,612 25,955 31,908 47,137
General and
administrative
expenses 8,467 9,883 11,559 14,984 17,108 20,286 24,592 37,244
Merger, restructuring
and other unusual
charges -- -- -- 1,590 -- -- 1,746 36,225
-------- ------- ------- ------- ------- ------- -------- ---------
Income (loss) from
operations 1,262 2,351 2,975 1,538 4,504 5,669 5,570 (26,332)
Other expense 208 410 644 307 507 838 993 2,789
-------- ------- ------- ------- ------- ------- -------- ---------
Income (loss) before
taxes 1,054 1,941 2,331 1,231 3,997 4,831 4,577 (29,121)
Income tax (benefit)
expense 434 765 970 554 1,657 2,007 1,948 (5,612)
-------- ------- ------- ------- ------- ------- -------- ---------
Net income (loss) $ 620 $ 1,176 $ 1,361 $ 677 $ 2,340 $ 2,824 $ 2,629 $ (23,509)
======== ======= ======= ======= ======= ======= ======== =========
</TABLE>
Operating and medical services expense during the first and third quarters
have been and continue to be affected by movements of members in Payor plans
from one plan to another during periods of open enrollment for Payors.
Retroactive capitation rate increases generally take effect during the second
quarter, while medical services expense increases tend to occur ratably
throughout the year. Quarterly results may be affected by final settlements of
shared risk distributions which generally occur in the second and third quarter
accrued in the previous year. From time to time, final settlements may differ
from such estimated amounts. As the Company adds new Payors into the FPA
network, the timing of these adjustments may vary and, consequently, quarterly
results may be affected in the future, especially due to the start-up of
operations in new regions where there is no operating history. Similarly, if
medical services expense varies from amounts previously accrued for claims
incurred but not reported ("IBNR"), quarterly operating results may fluctuate. A
portion of the Company's expansion strategy includes the acquisition of
individual and group physician practices by the FPA network, and any such
acquisition may materially affect quarterly operating results, causing quarterly
fluctuations.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to develop physician networks,
acquire physician practices and establish an infrastructure in new regions.
Capitation arrangements positively impact cash flow because FPA generally
receives capitation revenue prior to paying costs associated with services
provided under those agreements. However, shared risk arrangements negatively
impact cash flow because settlements in connection with
23
<PAGE> 196
these arrangements are typically not collected until significantly after the end
of the period in which they were accrued. Fee-for-service revenues also
negatively impact cash flow because payment for services rendered generally lags
by 90 to 120 days.
At December 31, 1996, the Company had cash, cash equivalents and marketable
securities of $45.6 million and a working capital deficit (current liabilities
in excess of current assets) of $12.1 million compared to cash, cash equivalents
and marketable securities of $11.4 million and working capital of $26.0 million
at December 31, 1995. The increase in cash, cash equivalents and marketable
securities of $34.2 million resulted primarily from (i) $55.0 million borrowed
under arrangements with financial institutions, (ii) net proceeds of $73.0
million from the Company's issuance of convertible subordinated notes, and (iii)
$10.6 million received from the exercise of stock options and warrants,
partially offset by (a) approximately $10.5 million of cash payments in
connection with acquisitions, (b) approximately $9.1 million for the acquisition
of property and equipment, (c) approximately $13.3 million used to purchase
intangible assets, (d) approximately $3.0 million invested in Great Lakes
Health Plan, Inc., (e) approximately $50.8 million in payments on notes payable
related to acquisitions, and (f) approximately $10.0 in net payments under a
bank line of credit. At December 31, 1996 approximately 30% of the Company's
current liabilities consist of amounts accrued as payable to specialty care
physicians, ancillary providers, hospital and other providers of medical
services. These accrued liabilities include claims received by the Company which
have not yet been paid as well as an estimate of costs for covered medical
benefits incurred by enrollees but not yet reported by providers. These amounts
are not due and payable until after the provider has presented a claim and are
typically paid within 45 business days of receipt of such claims. The increase
in claims payable, including incurred but not reported claims, from
approximately $10.3 million at December 1995 to $65.6 million at December 31,
1996 resulted primarily from significantly increased membership and the fact
that much of the new membership is under global capitation contracts (which
includes hospital services), which resulted in more claims payable per enrollee.
During 1996, the Company entered into a $55.0 million credit, security,
guarantee and pledge agreement (the "Credit Agreement") with four financial
institutions. Permitted Borrowings, as defined in the Credit Agreement,
generally include acquisitions and capital expenditures. Borrowings under this
agreement bear interest
24
<PAGE> 197
at either LIBOR plus 2-1/2%, 2-3/4% or 3%, or prime rate plus 1%, 1-1/4% or
1-1/2%, as defined in the agreement. At December 31, 1996, the Company had
borrowed the maximum of $55.0 million under the Credit Agreement.
In December 1996, the Company issued $75.0 million of convertible
subordinated debentures, which resulted in net proceeds to the Company of
approximately $73.0 million. The notes bear interest at 6-1/2%, payable
semiannually, and are convertible into shares of the Company's stock at $25.95
per share. The debentures are redeemable by the Company after December 20, 1999.
Upon the occurrence of a Repurchase Event, as defined in the debentures, each
holder has the right to require repayment of the debentures at 100% of the
principal amount plus accrued interest.
The increase in long-term debt from $26.1 million at December 31, 1995 to
$254.8 million at December 31, 1996 resulted primarily from approximately $55.0
million in borrowings under arrangements with financial institutions and the
issuance of notes payable and assumption of long-term debt in connection with
acquisitions of physician practice assets of approximately $273.6 million net of
repayments of acquisition debt of approximately $60.7 million. At December 31,
1996, long-term debt exceeded stockholders' equity.
The Company believes that its cash on hand and anticipated cash flows from
its operations will be sufficient to meet the Company's operating capital needs
through 1997. The Company intends to obtain additional financing to support
planned expansion through an expansion of a line of credit facility to
approximately $100.0 million or through other potential financing alternatives
including private and public offerings of debt and equity-related securities.
There can be no assurance that the Company will be able to obtain such increased
credit facility or that it will be able to issue debt or equity-related
securities on terms satisfactory to it. To the extent that additional financing
is not available, the Company may delay certain potential acquisitions or
certain geographic expansion or may seek alternate sources of financing.
The strategy to expand the FPA network involves the acquisition of
individual and group physician practice assets and related businesses. Such
acquisitions may be consummated using cash, stock, notes or any combination
thereof. Management does not believe that inflation will have a material effect
on the operations of the Company.
25
<PAGE> 198
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 3,172,225 $ 5,594,877
Marketable securities 8,228,788 40,000,000
Accounts receivable -- net of allowance for uncollectible accounts of
$47,006,677 and $59,796,488 at December 31, 1995 and December 31, 1996,
respectively 40,229,995 95,306,672
Accounts receivable - other 4,636,973 25,095,247
Notes receivable from affiliate 300,086 --
Income tax receivable 1,227,949 --
Prepaid expenses 656,003 5,397,174
Capitation deposit -- 15,409,771
Deferred income tax asset 2,861,898 3,478,751
------------- -------------
Total current assets 61,313,917 190,282,492
Property and equipment - net 9,591,799 40,139,332
Restricted cash and deposits 3,285,000 488,535
Goodwill -- net of accumulated amortization of $1,724,606 and $5,046,296 at
December 31, 1995 and December 31, 1996, respectively 69,498,404 284,288,009
Intangible assets -- net of accumulated amortization of $249,682 and
$3,123,381 at December 31, 1995 and December 31, 1996, respectively 5,988,579 6,667,269
Investment in GLHP 1,994,900 4,994,900
Deferred income tax asset -- 3,189,665
Other assets 733,937 9,146,431
------------- -------------
Total $ 152,406,536 $ 539,196,633
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 14,851,559 $ 46,215,398
Claims payable, including incurred but not reported claims 10,247,476 65,618,268
Accrued payroll and related liabilities 1,363,304 3,814,695
Income tax payable 436,775 2,294,159
Other liabilities -- 13,104,704
Borrowings on line of credit 788,325 --
Current portion of accrued liability for professional liability claims 610,000 1,297,790
Long-term debt, current portion 7,042,635 70,015,734
------------- -------------
Total current liabilities 35,340,074 202,360,748
Long-term debt, net of current portion 9,012,552 184,774,984
Bank line of credit 10,000,000 --
Accrued liability for professional liability claims, net of current portion 2,440,000 4,217,000
Deferred income tax liability 1,989,770 --
Other long-term liabilities 397,175 4,325,862
------------- -------------
Total Liabilities 59,179,571 395,678,594
Stockholders' equity:
Preferred stock, $.001 par value per share, 2,000,000 shares authorized,
no shares outstanding -- --
Common stock, $.002 par value, 98,000,000 shares authorized, 18,566,326 and
24,771,149 shares issued and outstanding at December 31, 1995 and
December 31, 1996, respectively 37,133 49,542
Additional paid-in capital 87,652,123 153,396,348
Stock payable 567,000 534,600
Accumulated earnings (deficit) 5,253,975 (10,462,451)
Less: Deferred compensation - stock options (283,266) --
------------- -------------
Total stockholders' equity 93,226,965 143,518,039
------------- -------------
Total $ 152,406,536 $ 539,196,633
============= =============
</TABLE>
See notes to consolidated financial statements.
26
<PAGE> 199
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1994 1995 1996
------------ ------------- -------------
<S> <C> <C> <C>
Managed care revenue $ 18,193,286 $ 49,880,875 $ 267,641,917
Fee-for-service revenue, net of
contractual deductions 39,498,164 118,470,607 172,676,696
------------ ------------- -------------
Operating revenue 57,691,450 168,351,482 440,318,613
Expenses:
Medical services expense - Professional
Corporations 4,173,204 7,234,374 27,190,347
Medical services expense - others 37,178,901 106,508,504 286,516,261
------------ ------------- -------------
16,339,345 54,608,604 126,612,005
General and administrative expense 13,607,073 44,892,765 99,230,319
Merger, restructuring and other unusual
charges (Note 9) -- 1,589,908 37,970,868
------------ ------------- -------------
Income (loss) from operations 2,732,272 8,125,931 (10,589,182)
Other income (expense):
Interest and other income 186,955 609,297 852,288
Interest expense (187,364) (2,177,943) (5,979,532)
------------ ------------- -------------
Total other expense (409) (1,568,646) (5,127,244)
------------ ------------- -------------
Income (loss) before income taxes 2,731,863 6,557,285 (15,716,426)
Income tax expense 942,025 2,723,320 --
------------ ------------- -------------
Net income (loss) $ 1,789,838 $ 3,833,965 $ (15,716,426)
============ ============= =============
Net income (loss) per share $ .28 $ (.72)
============= =============
Pro forma (Note 1):
Adjustment to income tax expense $ (110,235)
------------
Net income $ 1,679,603
------------
Net income per share $ .26
============
Weighted average shares
outstanding 6,579,828 13,693,192 21,702,786
============ ============= =============
</TABLE>
See notes to consolidated financial statements.
27
<PAGE> 200
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
(STOCK
SUBSCRIPTIONS
ADDITIONAL RECEIVABLE)/ ACCUMULATED DEFERRED
COMMON PAID-IN- STOCK EARNINGS/ COMPENSATION
STOCK CAPITAL PAYABLE (DEFICIT) STOCK OPTIONS TOTAL
----- ------- ------- --------- ------------- -----
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1994 $ 2,188 $ 9,812 $ -- $ (369,828) $ -- $ (357,828)
Pooling of interests combination
with Sterling Healthcare Group,
Inc. effective October 31, 1996 16,195 8,552,074 -- -- (369,000) 8,199,269
Common stock issued through
private placement for cash, net
of costs 1,294 4,571,625 -- -- -- 4,572,919
Preferred stock issued and
redeemed (3,750,000) -- -- -- (3,750,000)
Common stock issued through
initial public offering for cash,
net of costs 2,795 11,574,068 -- -- -- 11,576,863
Common stock issued in connection
with acquisition 313 1,953,250 -- -- -- 1,953,563
Net income for the year -- -- -- 1,789,838 1,789,838
Other 36 333,329 (14,227) -- 22,658 341,796
One-for-one stock dividend,
effective March 1, 1995 6,626 (6,626) -- -- -- --
----------- ------------- --------- ------------ ------------ -------------
Balances, December 31, 1994 29,447 23,237,532 (14,227) 1,420,010 (346,342) 24,326,420
Common stock issued through
public offering for cash, net of
costs 8,501 50,392,907 -- -- -- 50,401,408
Common stock issued in
connection with acquisitions 450 13,889,419 -- -- -- 13,889,869
Common stock payable issued in
connection with acquisitions -- -- 567,000 -- -- 567,000
Net income for the year -- -- -- 3,833,965 -- 3,833,965
Other (1,265) 132,265 14,227 -- 63,076 208,303
----------- ------------- --------- ------------ ------------ -------------
Balances, December 31, 1995 37,133 87,652,123 567,000 5,253,975 (283,266) 93,226,965
Stock options and warrants
exercised 515 10,305,788 -- -- -- 10,306,303
Common stock issued in connection
with acquisitions 3,407 52,200,372 41,500 -- -- 52,245,279
Common stock issued in connection
with conversion of debt 1,086 3,498,914 -- -- -- 3,500,000
Net loss for the year -- -- -- (15,716,426) -- (15,716,426)
Other 7,401 (260,849) (73,900) -- 283,266 (44,082)
----------- ------------- --------- ------------ ------------ -------------
Balances, December 31, 1996 $ 49,542 $ 153,396,348 $ 534,600 $(10,462,451) $ -- $ 143,518,039
=========== ============= ========= ============ ============ =============
</TABLE>
See notes to consolidated financial statements.
28
<PAGE> 201
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1994 1995 1996
------------ ------------ -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,789,838 $ 3,833,965 $ (15,716,426)
Adjustments to reconcile net income (loss)
to net cash used by
operating activities:
Depreciation and amortization 570,733 3,419,060 10,736,151
Imputed interest on notes payable -- 132,489 98,023
Loss on disposal of business -- 772,875 --
Deferred compensation stock options 22,658 38,076 --
Impairment of goodwill -- 434,602 18,900,000
Changes in assets and liabilities, net
of effects of acquisitions:
Accounts receivable (4,448,976) (17,983,548) (68,452,200)
Income tax receivable/payable (163,560) (1,064,389) 3,397,211
Capitation deposit -- -- (15,409,771)
Deferred income taxes (205,580) 591,545 (5,302,617)
Accounts payable and accrued expenses 850,558 469,485 13,818,166
Claims payable, including incurred but
not reported claims (315,194) 5,348,274 43,807,285
Accrued liability for professional
liability claims (124,216) (738,500) 2,464,790
Accrued payroll and related liabilities (7,157) 336,625 2,451,391
Prepaid expenses and other assets (129,057) (507,908) 548,093
------------ ------------ -------------
Total adjustments (3,949,791) (8,751,314) 7,056,522
------------ ------------ -------------
Net cash used by operating activities (2,159,953) (4,917,349) (8,659,904)
Cash flows from investing activities:
Purchase of property and equipment (971,053) (4,808,619) (9,126,829)
Payments for intangible assets (270,621) (1,703,570) (13,341,849)
Net payments (to) from affiliate 44,372 (214,546) (350,867)
Investment in GLHP -- (1,994,900) (3,000,000)
Net sale (purchase) of marketable securities (10,079,811) 1,851,023 (31,771,212)
Acquisitions, net of cash acquired (3,713,133) (38,529,816) (10,491,630)
Payments escrowed for acquisitions -- (3,285,000) 2,796,465
Proceeds from sale of business -- 1,600,000 --
Other -- (46,212) --
------------ ------------ -------------
Net cash used by investing activities (14,990,246) (47,131,640) (65,285,922)
------------ ------------ -------------
Cash flows from financing activities:
Proceeds from merger, net 5,699,870 -- (169,334)
Net proceeds from issuance of common
stock 11,441,604 50,401,408 --
Net proceeds from private placement of
stock 4,812,919 -- --
Redemption of preferred stock (3,750,000) -- --
Issuance of convertible subordinate notes
payable 1,000,000 -- 73,125,000
</TABLE>
29
<PAGE> 202
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S> <C> <C> <C>
Proceeds from exercise of stock options and
warrants 43,365 156,000 10,575,526
Issuance of notes payable -- -- 53,628,334
Net borrowings under bank line of credit 207,242 7,814,781 --
Receipt of payment for stock subscriptions 35,773 14,227 --
Payments on long-term debt (922,779) (5,302,072) (60,791,048)
------------ ------------ -------------
Net cash provided by financing
activities 18,567,994 53,084,344 76,368,478
------------ ------------ -------------
Net increase in cash and cash equivalents 1,417,795 1,035,355 2,422,652
Cash and cash equivalents, beginning
of year 719,075 2,136,870 3,172,225
------------ ------------ -------------
Cash and cash equivalents, end of year $ 2,136,870 $ 3,172,225 $ 5,594,877
============ ============ =============
Supplemental cash flow information:
Cash paid for interest $ 117,400 $ 1,957,194 4,026,106
Cash paid for income taxes $ 1,840,296 $ 4,781,045 870,382
Equipment acquired under capital leases $ 155,361 $ 438,643 2,009,655
Common stock issued in connection with
acquisitions $ 4,741,976 $ 13,889,870 $ 52,245,279
Effects of acquisitions:
Fair value of assets acquired $ 7,371,926 $ 78,845,644 $ 273,610,635
Liabilities assumed $ 3,658,793 $ 40,315,828 $ 263,119,005
Net cash paid for acquisitions $ 3,713,133 $ 38,529,816 $ 10,491,630
============ ============ =============
</TABLE>
See notes to consolidated financial statements.
30
<PAGE> 203
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General -- FPA Medical Management, Inc. ("FPA" or the "Company"), a
Delaware corporation incorporated in 1994, is a national physician practice
management company, which, through its network of primary care physicians,
affiliated professional corporations ("Professional Corporations") and
subsidiaries, contracts with health maintenance organizations ("HMOs") and other
prepaid health insurance plans (collectively, "Payors") to provide and manage
physician and related healthcare services to enrollees who select FPA network
primary care physicians. FPA also provides contract management services to
hospital emergency and anesthesia departments in twenty states.
On October 31, 1996, FPA and Sterling Healthcare Group, Inc. ("Sterling")
consummated a business combination (the "Merger"). As a result of the Merger,
each outstanding share of Sterling common stock $.0001 par value per share was
converted to .951 shares of FPA Common Stock, $.002 par value per share (FPA
"Common Stock"). Sterling's stockholders were issued 8,097,781 shares of FPA
Common Stock representing approximately 37% of the total issued and outstanding
shares of FPA Common Stock after the Merger. The shares of FPA Common Stock
issued to the Sterling stockholders have been registered on a Registration
Statement on Form S-4 filed under the Securities Act of 1933, as amended. The
Merger has been treated as a tax-free reorganization and accounted for as a
pooling of interests and, accordingly, the accompanying consolidated financial
statements have been prepared on a basis that includes the accounts of Sterling
since June 1, 1994, Sterling's date of inception. Information concerning Common
Stock and per share data has been restated on an equivalent share basis.
Presented below is the effect of the pooling of interests on previously reported
results of operations for the years ended December 31:
<TABLE>
<CAPTION>
1994 1995
---- ----
<S> <C> <C>
Operating revenue:
FPA $ 18,435,877 $ 52,691,955
Sterling 39,255,573 115,659,527
------------ ------------
$ 57,691,450 $168,351,482
============ ============
Net income:
FPA $ 388,313 $ 1,002,462
Sterling 1,401,525 2,831,503
------------ ------------
$ 1,789,838 $ 3,833,965
============ ============
</TABLE>
31
<PAGE> 204
Managed Care Business -- FPA, its subsidiaries and the Professional
Corporations currently manage the provision of prepaid managed healthcare
services for networks of primary care physicians in numerous states. The "FPA
Network" consists of FPA, its subsidiaries, the Professional Corporations and
various independent practitioners.
The Professional Corporations and certain subsidiaries contract with Payors
to provide for the delivery of healthcare services on a capitation basis (i.e.,
a fixed payment per enrollee per month). Through administrative services
agreements, the Professional Corporations assign payments from Payors to the
Company in return for management services, specialty medical care claims
administration and payment, and other services.
FPA has direct or indirect unilateral and perpetual control over the assets
and operations of the Professional Corporations for all periods presented, other
than by means of owning the majority of the voting stock of the Professional
Corporations. FPA and its subsidiaries are unable to own a majority interest in
the Professional Corporations formed in states which prohibit the corporate
practice of medicine. The Professional Corporations have as shareholders and
directors certain physicians who are employees of FPA or one of its
subsidiaries. Each shareholder/director has entered into a succession agreement
which requires such shareholder/director to sell to a designee of FPA such
shareholder/director's shares of stock for a nominal amount if such
shareholder/director is terminated from employment with FPA. This ensures
unilateral and perpetual control over the Professional Corporations by FPA. Due
to a parent-subsidiary relationship under generally accepted accounting
principles, FPA has consolidated the financial statements of the Professional
Corporations. FPA believes that consolidation of the financial statements of
these Professional Corporations is necessary to present fairly the financial
position and results of operations of the Company. All significant inter-entity
transactions have been eliminated in consolidation. The consolidated financial
statements include the operations of the Company, all of the Company's
subsidiaries and Professional Corporations since they were acquired, were
incorporated, or entered into an administrative services agreement with FPA or
one of its subsidiaries.
Managed care capitation payments from Payors are paid monthly and are
recognized as revenue during the period in which enrollees are entitled to
receive services. Contracts with Payors generally provide for terms of one to
thirty years, with automatic renewal periods, terminable on prior notice
(generally between 30 and 180 days).
32
<PAGE> 205
The Company has two types of managed care Payor contracts: contracts for
both inpatient and outpatient services ("global capitation" contracts) and those
limited to outpatient services ("outpatient capitation" contracts). Under global
capitation contracts, which accounted for approximately 20.9% and 36.3% of
managed care business operating revenue in 1995, and 1996, respectively, the
Company receives a fixed monthly amount per enrollee for which the Company is
financially responsible to provide the enrollees with all necessary inpatient
and outpatient care. In 1994, the Company had no global capitation contracts.
Under outpatient capitation contracts, the Company receives a fixed monthly
amount per enrollee for which the Company is financially responsible to provide
the enrollees with all necessary outpatient care. Additionally, under these
outpatient capitation contracts, the Company is a party to shared risk
arrangements with Payors which generally reward the Company for the efficient
utilization of inpatient services. Under these shared risk arrangements, the
Company shares any surplus or, in some cases, deficit of inpatient cost in
relation to amounts pre-established by the Payor. Estimates of shared risk funds
to be received or paid by the Company are recorded based on estimates of
hospital utilization costs. Differences between actual settlements and amounts
estimated as receivable (or payable) relating to the shared risk arrangements
are recorded at the time of settlement, generally in the second or third quarter
of the following year. The Company does not believe that the final settlements
of these shared risk arrangements will differ materially from the estimated
amounts recorded in the financial statements. Revenue under outpatient
capitation contracts represented 98.5%, 72.4% and 51.7% of managed care business
operating revenue in 1994, 1995 and 1996, respectively.
The Company also generates fee-for-service revenue for the performance of
medical services through the Professional Corporations. These revenues are
presented net of contractual deductions and represented 1.5%, 6.7% and 12.0% for
1994, 1995 and 1996, respectively, of managed care business operating revenue.
Emergency Department Business -- The Company provides physician contract
management for hospital emergency and anesthesia departments in twenty states at
December 31, 1996. Contractual arrangements with hospitals are primarily
fee-for-service whereby hospitals agree to authorize the Company and its
contracted healthcare professionals to bill and collect for the professional
component of the charges for medical services rendered by the Company's
contracted healthcare professionals.
Through the emergency department business, the Company generates
fee-for-service revenues. These revenues are presented net of contractual
deductions, and represented 94.0%, 84.4% and 84.6% of the emergency department
business operating revenues in 1994, 1995 and 1996, respectively. The Company
has arrangements with certain hospitals for monthly subsidy amounts
33
<PAGE> 206
which either compensate for patient revenues not achieving specified levels or
to fund front-end staffing and insurance costs. The Company also has a physician
recruiting and medical management consulting division.
Revenue Recognition and Accounts Receivable -- Fee-for-service revenue is
reported on the accrual basis, net of estimated third-party contractual
deductions. Further adjustments are recorded to reflect amounts estimated to be
uncollectible based upon individual contract experience. The allowance
considered necessary to cover contractual deductions and uncollectible accounts
is based on an analysis of current and past due accounts, collection experience
in relation to amounts billed and other relevant information. Accounts
receivable represents amounts due from third-party payors including Medicare and
Medicaid, patients and others for services rendered.
For emergency department receivables, the concentration of credit risk
relating to accounts and subsidy receivables is limited by the number and
geographic dispersion of hospital emergency departments managed by the Company,
as well as by the large number of patients and payors, including various
governmental agencies in the states in which the Company operates.
In 1994, 1995 and 1996, revenues from governmental agencies made up
approximately 33%, 19% and 34%, respectively, of operating revenue for both
divisions of the Company.
Medical Services Expense -- Through the Professional Corporations and its
subsidiaries, the Company contracts with various healthcare providers to provide
medical services to covered enrollees. Primary care physicians are compensated
by the Company under compensation arrangements with the Professional
Corporations on either a salary or capitation basis and the cost is recorded as
"Medical services expense -- Professional Corporations" in the accompanying
consolidated statements of operations. The costs of referrals to specialty care
physicians are paid on either a discounted fee-for-service or capitation basis.
Under global capitation contracts, the Company contracts for inpatient services
which are paid on a fee-for-service or per diem basis. Medical services expense
paid through capitation (for certain primary care and specialty care services),
fixed salary (for primary care only) or for contracted hours of emergency
department coverage at fixed hourly rates totaled 14%, 51% and 38% of operating
revenues in 1994, 1995 and 1996, respectively, with the remainder of medical
services expense (for primary care, specialty care, ancillary services,
inpatient and outpatient services, lab charges, etc.) paid for on a discounted
fee-for-service or per diem basis. The costs of healthcare services paid for on
a fee-for-service or per diem basis are recorded by the Company in the period
for which services are provided based
34
<PAGE> 207
in part on estimates, including an accrual for medical services provided but not
yet billed to the Company ("incurred but not reported") and are included in
claims payable in the accompanying consolidated balance sheets.
The Company has negotiated "attachment points" for stoploss insurance
independent of Payor contracts which represent the contractual limits, generally
$25,000 per year per enrollee for outpatient services and $100,000 per year per
enrollee for inpatient services. In 1997, the Company increased its outpatient
services attachment point to $50,000 in most cases.
Cash and Cash Equivalents -- Cash and cash equivalents are defined as
highly liquid financial instruments with original maturities of three months or
less. A substantial portion of the Company's cash is deposited in three
financial institutions. The Company monitors financial conditions of each
financial institution and does not believe that the deposits are subject to a
significant degree of risk.
Marketable Securities -- Marketable securities consist of corporate debt
securities and certificates of deposit. Such securities have been classified by
management of FPA as available for sale in accordance with the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". The estimated fair value of the
Company's marketable securities is based on quoted market prices, which
approximate cost, and therefore no unrealized gains or losses have been recorded
in the accompanying consolidated financial statements. Marketable securities at
December 31, 1995 consist of corporate debt securities and at December 31, 1996
consist of Eurodollar certificates of deposit.
Capitation Deposits -- Capitation deposits represent funds on deposit from
a major Payor in Florida. In accordance with the Payor contract, 60% of the
capitation revenue earned each month is set aside for payment of claims. The
Company is entitled to all of the interest earned on this account. The contract
requires a minimum balance in this account.
Property and Equipment -- Property and equipment are recorded at cost, less
accumulated depreciation and amortization. Depreciation and amortization are
computed on a straight-line basis over the estimated useful lives of the assets,
generally three to seven years. Leasehold improvements are amortized over the
lesser of the estimated useful life or the remaining life of the related lease.
Restricted Cash and Deposits -- The Company records as restricted cash
funds escrowed for payment of claims, for future acquisitions, and other funds
contractually required to be segregated from the Company's operating cash.
Goodwill -- The Company has classified as goodwill the excess of the
purchase price over the fair value of the net assets of entities acquired.
Goodwill is being amortized on a straight-line basis over the estimated periods
of future benefit of 15 to 30 years. At each balance sheet date following the
acquisition of a business, the Company reviews
35
<PAGE> 208
the carrying value of the goodwill to determine if facts and circumstances
suggest that it may be impaired or that the amortization period may need to be
changed. The Company considers external factors relating to each acquired
business, including hospital and physician contract changes, local market
developments, changes in third party payments, national health care trends, and
other publicly available information. If these external factors indicate that
the goodwill will not be recoverable, as determined based upon undiscounted cash
flows before interest charges of the business acquired over the remaining
amortization period, the carrying value of the goodwill will be reduced. In
December 1995, the Company sold and closed a total of eight primary care
clinics. In connection with the sale and closing, the Company recorded a charge
for impairment of goodwill in the amount of $434,000. In 1996, the Company
recorded charges for impairment of goodwill of $4.1 million as a result of a
1995 acquisition in Arizona and $14.8 million related to terminated emergency
department contracts. The Company does not believe there currently are any
indicators that would require an additional adjustment to the carrying value of
the goodwill or its remaining useful life at December 31, 1996.
Intangible Assets -- Intangible assets consist of capitalized costs of
geographic expansion related to the Company's operations in new regions and
non-compete agreements associated with acquisitions. Intangible assets are being
amortized on a straight-line basis over the expected period of future benefit,
ranging from 5 to 15 years.
Income Taxes -- The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting For Income
Taxes," which requires the use of the liability method for deferred income taxes
(see Note 8).
Professional Liability Coverage - The Company maintains professional
liability coverage for the Company and its employee and independent contractor
physicians on a claims made basis. The Company records an estimate of its
liabilities for medical malpractice claims incurred but not reported. Such
liabilities are not discounted.
36
<PAGE> 209
Pro Forma Information -- The pro forma net income and net income per share
information in the 1994 consolidated statement of operations reflect the effect
on historical results as if FPA had been a C Corporation rather than an S
Corporation for income tax purposes, and no tax benefit arose as a result of the
change in tax status.
Net Income (Loss) per Common Share -- Net income (loss) per Common Share is
computed based on the weighted average number of shares and share equivalents
(options and warrants) outstanding, giving retroactive effect to all stock
splits, including a one-for-one common stock dividend effective March 1, 1995.
Accounting Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
New Accounting Standards -- In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.
123, "Accounting for Stock-Based Compensation," which was effective for the
Company beginning January 1, 1996. SFAS No. 123 requires expanded disclosures of
stock-based compensation arrangements with employees and encourages (but does
not require) compensation cost to be measured based on the fair value of the
equity instrument awarded. Corporations are permitted, however, to continue to
apply Accounting Principles Board ("APB") Opinion No. 25, which recognizes
compensation cost based on the intrinsic value of the equity instrument awarded.
The Company has continued to apply APB Opinion No. 25 to its stock-based
compensation awards to employees and has disclosed the required pro forma effect
on net income (loss) per share (See Note 7).
Reclassifications -- Certain reclassifications have been made to prior
years' financial statements to conform to current year classifications.
37
<PAGE> 210
2. RELATED PARTY TRANSACTIONS
In Texas, the Company leases its main facility, certain leasehold
improvements, and certain medical and office equipment from an officer of a
Texas subsidiary pursuant to a noncancelable operating lease agreement expiring
November 8, 2005. The agreement provides for monthly payments of $58,654,
subject to certain increases based on the consumer price index. The lease also
contains certain provisions that may, at the option of the officer, require FPA
to acquire the facility at its fair market value.
Effective October 1, 1996, a Professional Corporation and FPA acquired
substantially all of the assets and assumed certain liabilities of Family
Practice Associates of San Diego, an Osteopathic Corporation ("FPASD"), owned by
certain officers of the Company. The purchase price was supported by an
independent valuation and approved by a committee of the Independent Directors
of the Company. During 1995, FPA entered into a loan agreement with FPASD under
which FPASD was permitted to borrow a maximum of $650,000 for working capital
purposes. This loan replaces a previous loan with a maximum balance of $155,000.
At December 31, 1995 and 1996, the balance was $300,086 and $0, respectively.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Land and buildings $ 164,825 $ 523,758
Computer hardware and software 1,730,733 12,526,830
Furniture, fixtures and equipment, including medical equipment 7,519,444 25,677,238
Leasehold improvements 1,479,653 6,764,846
Vehicles -- 311,972
------------ ------------
Total 10,894,655 45,804,644
Less accumulated depreciation and amortization (2,576,385) (6,358,498)
------------ ------------
Subtotal 8,318,270 39,446,146
Capitalized software development costs 1,273,529 693,186
------------ ------------
Property and equipment -- net $ 9,591,799 $ 40,139,332
============ ============
</TABLE>
38
<PAGE> 211
4. DEBT
Convertible Subordinated Notes Payable -- On October 5, 1994, FPA sold
$1.0 million of convertible subordinated notes to representatives of the
underwriters of FPA's initial public offering. The notes bore interest at 6%,
payable semiannually, with principal due October 1999. During 1996, the notes
were converted into 200,000 shares of FPA Common Stock.
In December 1996, the Company issued $75.0 million of convertible
subordinated debentures due December 2001, which resulted in net proceeds to the
Company of approximately $73.0 million. The notes bear interest at 6-1/2%, with
interest payable semiannually, and are convertible into FPA Common Stock at
$25.95 per share. The debentures are redeemable by the Company after December
20, 1999. Upon the occurrence of a Repurchase Event, as defined in the
debenture, each holder has the right to require repayment of the debentures at
100% of the principal amount plus accrued interest. In January 1997, upon
exercise of the overallotment option granted to the Initial Purchasers, the
Company issued additional convertible subordinated debentures with the same
terms for net proceeds of $5.4 million.
Convertible Promissory Note -- In connection with the acquisition of a
Texas subsidiary on November 1, 1995, FPA issued a 36-month, $2.5 million 9%
convertible promissory note with payments of interest only due for the first 24
months and principal and interest monthly thereafter. During 1996, the note was
converted into 243,191 shares of FPA Common Stock.
Notes Payable -- In connection with certain acquisitions, the Company
has issued various other notes payable. Following is a summary of all long-term
debt.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1995 1996
----------- ----------
<S> <C> <C>
Notes payable, interest ranging from 7% to 10.25% and principal due
through December 2000 $ 5,270,421 $3,484,627
Note payable, interest at 9% and principal due November 1997 2,500,000 --
Convertible note payable, interest at 9% and principal due November 1998 2,500,000 --
Convertible debentures payable, interest at 6.5% and principal due
December 2001 -- 75,000,000
Notes payable to former shareholders of Sterling Healthcare, Inc., interest
at rates ranging from 5% to 5.54%, payable in 60 monthly installments
through January 1998 1,372,895 759,420
Notes payable, interest at prime, payable in two equal installments in --
December 1996 and 1997 1,200,000 600,000
6% convertible subordinated notes, interest payable each April
and October through 1999, principal due October 1999 1,000,000 --
</TABLE>
39
<PAGE> 212
<TABLE>
<S> <C> <C>
Notes payable to financial institutions, interest at 5.5%, due in full
in October 1997 714,858 55,000,000
Note payable, interest at LIBOR, 59 payments of principal and interest
due commencing February 1999, through December 2003 -- 97,759,244
Notes payable interest at 6.02% and principal due January 2006 -- 20,174,914
Other 1,497,013 2,012,513
----------- ------------
Total 16,055,187 254,790,718
Less current portion 7,042,635 70,015,734
----------- ------------
Long term debt, net of current portion $ 9,012,552 $184,774,984
=========== ============
</TABLE>
At December 31, 1996 future payments on long-term debt are as follows:
<TABLE>
<CAPTION>
NOTES PAYABLE CAPITAL
AND OTHER LEASES
--------- ------
<S> <C> <C>
1997 $ 68,885,510 $ 1,130,244
1998 1,859,868 585,239
1999 8,024,125 226,843
2000 8,722,934 67,358
2001 83,755,099 --
Thereafter 81,855,064 --
------------ ------------
$253,102,600 2,009,664
============
Less amount representing interest on capital leases (321,546)
------------
Present value of net minimum capital lease payments 1,688,118
Notes payable and other 253,102,600
------------
Total $254,790,718
============
</TABLE>
The fair market value of the Company's debt approximates its carrying value.
Credit Agreement -- On January 29, 1996, the Company entered into a credit,
security, guarantee and pledge agreement ("Credit Agreement") with certain
financial institutions. Permitted Borrowings, as defined in the Credit
Agreement, generally include those for acquisitions and capital expenditures.
The Company and the financial institutions amended the Credit Agreement during
1996. Fees of $1,250,000 were paid in connection with the Credit Agreement
during 1996. Borrowings bear interest at rates ranging from either LIBOR plus
2 1/2%, 2 3/4% or 3%, or prime rate plus 1%, 1 1/4%, or 1 1/2% as defined by the
Credit Agreement. The balance outstanding is due on October 31, 1997. Periodic
payments of accrued interest are due during the term of the Credit Agreement.
Additionally, the financial institutions were granted a security interest in
substantially all of the assets of the Company (excluding those of FPA Medical
Management of Michigan, Inc. d/b/a QualNet, Inc., and the stock of certain
subsidiaries of FPA) and Professional Corporations. The debt is also guaranteed
by the Professional Corporations. In connection with the Credit Agreement, the
Company must maintain certain debt and equity ratios and profitability
thresholds. The Company issued to the financial institutions a warrant to
purchase
40
<PAGE> 213
50,000 shares of Common Stock at $9.125 per share exercisable prior to February
2, 2001, subject to certain anti-dilution provisions. At December 31, 1996, the
Company had borrowed the maximum of $55.0 million under the Credit Agreement.
5. MAJOR CUSTOMERS
In 1994, two Payors accounted for 11% and 34%, respectively, of the
Company's operating revenue. In 1995, two Payors accounted for 10% and 19%
respectively, of the Company's operating revenue. In 1996, two Payors accounted
for 11% and 14%, respectively, of the Company's operating revenue.
6. COMMITMENTS AND CONTINGENCIES
Legal -- The Company is party to certain legal actions arising in the
ordinary course of business. In the opinion of the Company's management,
liability, if any, under these claims is adequately covered by insurance and
will not have a material effect on the Company's financial position or results
of operations. The Company maintains professional liability insurance.
Operating Leases -- The Company is a party to certain facilities and
equipment leases which terminate at various dates through November 8, 2005.
Future minimum lease payments required under all operating leases are as
follows:
<TABLE>
<S> <C>
1997 $21,911,887
1998 19,606,444
1999 17,329,150
2000 15,214,255
2001 2,352,625
Thereafter 1,878,572
-----------
Total $78,292,933
===========
</TABLE>
For 1994, 1995 and 1996, total expense under these non-cancelable operating
leases was $844,094, $2,966,964, and $6,909,028, respectively.
7. STOCKHOLDERS' EQUITY
41
<PAGE> 214
Stock Splits and Dividends -- The accompanying consolidated financial
statements and notes retroactively reflect all stock splits, and a one-for-one
Common Stock dividend distributed April 3, 1995 to stockholders of record on
March 1, 1995. All share, per share and stock option data have been restated to
reflect the stock splits and dividend.
Preferred Stock -- During 1994, FPA issued a stock dividend consisting of
one share of Series A Redeemable Preferred Stock (the "Preferred Stock") for
each 437,600 shares of FPA's Common Stock. Accordingly, five shares of Preferred
Stock were issued through the stock dividend, one to each of the Company's five
founding directors. The Preferred Stock was subsequently redeemed by FPA at the
redemption price of $750,000 per share of Preferred Stock (aggregate $3,750,000)
in connection with the 1994 private placement of Common Stock.
Omnibus Stock Option Plan -- During 1994, FPA adopted the Omnibus Stock
Option Plan under which an aggregate of 1,000,000 shares of Common Stock of FPA
may be issued through incentive stock options or nonqualified stock options. On
July 13, 1995, October 31, 1996 and March 17, 1997, the stockholders of the
Company authorized an increase in the total number of shares which may be
granted under the plan to 1,500,000, 5,000,000 and 6,500,000, respectively. The
option price per share may not be less than 100% of the fair market value of the
Common Stock on the date of grant, as defined in the stock option plan document.
Options granted under the plan generally vest over three to five years.
1994 Physician Stock Option Plan -- During 1994, FPA adopted the 1994
Physician Stock Option Plan under which an aggregate of 1,000,000 shares of
Common Stock of FPA may be issued through nonqualified stock options. The
option price per share may not be less than 100% of the fair market value of the
Common Stock on the date of grant, as defined in the stock option plan document.
Options granted under the plan generally vest over two to five years.
1995 Non-Employee Directors Non-Qualified Stock Option Plan -- On July 13,
1995, the stockholders of the Company approved the 1995 Non-Employee Directors
Non-Qualified Stock Option Plan under which options to purchase up to 200,000
shares of Common Stock may be granted to non-employee directors. Options granted
under the plan generally vest over one year.
Stock option transactions and prices are summarized as follows:
42
<PAGE> 215
<TABLE>
<CAPTION>
1995
OMNIBUS 1994 NON-EMPLOYEE DIRECTORS
STOCK PHYSICIAN STOCK NON-QUALIFIED
OPTION PLAN OPTION PLAN STOCK OPTION PLAN
----------- ----------- -----------------
<S> <C> <C> <C>
Shares under option:
Outstanding at January 1, 1994 -- -- --
Granted 858,254 -- --
Exercised -- -- --
Canceled (3,000) -- --
---------- -------- ---------
Outstanding at December 31, 1994 855,254 -- --
Granted 709,072 477,460 17,500
Exercised -- -- --
Canceled (13,692) (25) --
---------- -------- ---------
Outstanding at December 31, 1995 1,550,634 477,435 17,500
Granted in connection with Sterling merger 1,313,583
Otherwise granted 3,077,801 184,292 12,500
Exercised (181,421) (14,200) (5,000)
Canceled (35,477) (10,100) --
---------- -------- ---------
Outstanding at December 31, 1996 5,725,120 637,427 25,000
========== ======== =========
Average option price per share:
At December 31, 1994 $ 5.11 N/A N/A
At December 31, 1995 $ 6.27 $ 7.02 $ 8.40
At December 31, 1996 $ 13.75 $ 9.33 $ 13.51
Options exercisable:
At December 31, 1994 100,000 -- --
At December 31, 1995 215,332 31,500 --
At December 31, 1996 1,705,560 146,689 12,500
</TABLE>
Common Stock -- All stock options are granted at fair market value of the
Common Stock at the grant date. The weighted average fair value of the stock
options granted during 1996 was $8.63. The fair value of each stock option grant
is estimated on the date of grant using the Black Scholes option pricing model
with the following weighted average assumptions used for grants in 1996:
risk-free interest rate of 5.7%; expected divided yield of 0%; expected life of
3 years; and expected volatility of 48%. Stock options generally expire ten
years from the grant date. Stock options generally vest over a three year
period, with one-third of the shares becoming exercisable on each of the first
three anniversaries of the grant date. The outstanding stock options at December
31, 1996 have weighted average remaining contractual life of 8.42 years. The
number of stock option shares exercisable at December 31, 1996 was 1,864,749.
These stock options have a weighted average exercise price of $10.94 per share.
The Company accounts for its options in accordance with Accounting
Principles Board Opinion No. 25, under which no compensation cost has been
recognized for stock option awards. Had compensation cost been determined
43
<PAGE> 216
consistent with SFAS No. 123, the Company's pro forma net income and earnings
per share for 1995 would have been $1,867,126 and $.14, respectively, and the
Company's pro forma net loss and net loss per share for 1996 would have been
$21,875,211 and $1.01, respectively. Because the SFAS No. 123 method of
accounting has not been applied to options granted prior to January 1, 1995, the
resulting pro forma compensation cost may not be representative of that to be
expected in future years.
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
RANGE OF EXERCISE OUTSTANDING REMAINING WEIGHTED AVERAGE NUMBER EXERCISABLE WEIGHTED AVERAGE
PRICES AT DECEMBER 31, 1996 CONTRACTUAL LIFE EXERCISE PRICE AT DECEMBER 31, 1996 EXERCISE PRICE
------ -------------------- ---------------- ---------------- -------------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 5.0000-$ 8.6250 1,759,463 8.03 $ 6.3571 789,214 $ 6.1599
$ 8.8750-$13.7500 1,664,773 8.17 11.5848 663,630 12.0322
$13.8125-$18.8438 1,022,647 8.28 16.2501 180,487 14.5660
$19.0625-$28.3750 1,940,664 9.04 19.5457 231,418 21.2547
--------- ---- --------- --------- ---------
$ 5.0000-$28.3750 6,387,547 8.42 $ 13.3104 1,864,749 $ 10.9366
========= ==== ========= ========= =========
</TABLE>
8. INCOME TAXES
Upon the inception of FPA in October 1992, FPA elected S Corporation status
under the Internal Revenue Code which provides that taxable income or loss is
attributable to the stockholders. Effective January 1, 1994, FPA revoked its
election to be treated as an S Corporation and became subject to income taxes.
In accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," the Company recognized a deferred tax benefit on
the date it became a taxable enterprise.
The components of income tax expense as of December 31 are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Federal Expense:
Current $ 974,870 $ 2,190,978 $ 5,230,179
Deferred (181,312) 204,808 (5,230,179)
State Expense:
Current 171,936 348,882 1,566,982
Deferred (23,469) (21,348) (1,566,982)
----------- ----------- -----------
Total $ 942,025 $ 2,723,320 $ --
=========== =========== ===========
</TABLE>
The Company's income tax expense differs from the amount that would have
resulted from applying the Federal statutory rate to pretax income because of
the effect of the following items:
44
<PAGE> 217
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Tax expense (benefit) at U.S. statutory rate 34.0% 34.0% (35.0%)
Revocation of FPA S Corporation status (4.9%) -- --
State taxes, net of Federal income tax benefit 3.2% 3.7% (1.8%)
Nondeductible goodwill amortization -- 1.7% 11.0%
Nondeductible acquisition costs -- -- 21.5%
Other 2.2% 2.1% 4.3%
---- ---- -----
34.5% 41.5% --
==== ==== =====
</TABLE>
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for reporting and the
amounts used for income tax purposes. The tax effects of items comprising the
Company's net deferred tax assets and liabilities at December 31 are as follows:
<TABLE>
<CAPTION>
1995 1996
---- ----
<S> <C> <C>
Deferred tax assets:
Goodwill -- $ 4,087,001
Allowance for uncollectible accounts $ 2,307,580 2,700,811
Accrued liability for professional liability claims 321,256 595,000
Net operating losses 296,511 67,058
Other 50,392 720,821
----------- ------------
Total deferred tax assets $ 2,975,739 $ 8,170,691
----------- ------------
Deferred tax liabilities:
Geographic expansion costs $ (179,893) $ (392,305)
Start-up costs (231,498) --
State income tax -- (290,987)
Deferred compensation (57,565) (19,069)
Depreciation and amortization (1,008,458) (799,914)
----------- ------------
Total deferred tax liabilities $(1,477,414) $ (1,502,275)
----------- ------------
Net deferred tax assets $ 1,498,325 $ 6,668,416
=========== ============
</TABLE>
No valuation allowance was deemed necessary as a result of management's
evaluation of the likelihood that all of the deferred tax assets will be
realized.
9. MERGER, RESTRUCTURING AND OTHER UNUSUAL CHARGES
In 1995, the Company recorded nonrecurring expenses of $1.6 million. This
amount includes a $434,000 charge for impairment of goodwill, a $773,000 charge
for the loss on disposition of businesses and $375,000 relating to the
bankruptcy of one of its hospital clients. In 1995, the Company sold
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<PAGE> 218
six and closed two primary care clinics (seven in Florida and one in Texas). The
goodwill impairment and loss on sale are directly related to the sale and
closure of the primary care clinics. These clinics accounted for approximately
$2.1 million in revenue and generated an operating loss (including the unusual
items) of $3.7 million during 1995.
In 1996, the Company recorded nonrecurring expenses of $38.0 million
($28.8 million after tax or $1.32 per share). This amount is comprised of (i)
costs related to the Merger in the amount of $16.8 million comprised of
investment bankers' fees, attorneys' fees, accountants' fees, legal fees, and
severance and compensation required to be paid as part of the Merger, (ii)
write-offs of goodwill and other assets in the amount of $18.9 million related
to terminated emergency room contracts and an unprofitable acquisition in
Arizona, and (iii) restructuring charges in the amount of $2.3
million primarily related to severance for terminated employees.
10. SEGMENT INFORMATION
Sterling is a physician practice management company engaged in the business
of providing contract management and support services primarily to hospital
based emergency departments ("Emergency Department"). FPA manages the provision
of prepaid managed healthcare services for networks of primary care physicians
("Managed Care"). The activities related to the Managed Care segment and the
Emergency Department segment are as follows:
<TABLE>
<CAPTION>
EMERGENCY MANAGED
DEPARTMENT CARE CONSOLIDATED
---------- ---- ------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
DECEMBER 31, 1996
Operating revenues $ 136,761 $ 303,558 $ 440,319
Operating loss (6,154) (4,435) (10,589)
Assets employed at year-end 77,900 499,370 577,270
Depreciation and amortization 3,204 7,532 10,736
Capital expenditures 650 8,477 9,127
DECEMBER 31,1995
Operating revenues $ 115,660 $ 52,691 $ 168,351
Operating income 6,502 1,624 8,126
Assets employed at year-end 78,608 73,799 152,407
Depreciation and amortization 2,260 1,159 3,419
Capital expenditures 1,634 3,175 4,809
DECEMBER 31,1994
Operating revenues $ 39,256 $ 18,435 $ 57,691
Operating income 2,349 383 2,732
</TABLE>
46
<PAGE> 219
<TABLE>
<S> <C> <C> <C>
Assets employed at year-end 26,742 18,310 45,052
Depreciation and amortization 438 133 571
Capital expenditures 499 472 971
</TABLE>
11. ACQUISITIONS
Following is a summary of material acquisitions consummated during 1996 by
the Company, one of its subsidiaries, or one of the Professional Corporations.
Such acquisitions were accounted for using the purchase method of accounting.
Goodwill totaling approximately $242 million was recorded, which is being
amortized over periods ranging from 25 to 30 years. In connection with these
acquisitions, the Company issued (i) FPA Common Stock valued at $51.6 million,
(ii) notes payable of $163.8 million, and (iii) cash of $19.4 million.
VIP, IPA, A Professional Corporation January 1996
Foundation Health IPA January 1996
Century Family Medical Group, IPA January 1996
Century Family Medical Group, Inc. January 1996
Chabot Medical Group IPA January 1996
Physicians First, Inc. June 1996
Family First Pharmacy, Inc. June 1996
FPA Family Pharmacy, Inc. June 1996
Physicians Medical Group of Florida, Inc. June 1996
FHC IPA, Inc. July 1996
Intergroup IPA, P.C. July 1996
Foundation Health Medical Services(1) December 1996
Foundation Health Medical Group, Inc.(1) December 1996
FHMG/TDMC Medical Group, A Professional Corporation(1) December 1996
Thomas Davis Medical Centers, P.C.(1) December 1996
(1) The Company is in the process of determining the appropriate values to be
assigned to the assets acquired and liabilities assumed in connection with
these acquisitions. Accordingly, the Company's estimate of these values are
subject to revision upon completion of an independent valuation which may
result in an adjustment to goodwill.
The following unaudited pro forma financial information presents the
consolidated results of operations as if all significant acquisitions had
occurred as of the beginning of the periods presented, after including the
impact of certain adjustments, such as amortization of intangibles and goodwill,
executive compensation per employment agreements, and the related income tax
effects.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996
------------- -------------
<S> <C> <C>
Revenues $ 366,483,000 $ 599,662,000
Net loss (43,914,000) (77,348,857)
Net loss per share (2.40) (3.00)
</TABLE>
47
<PAGE> 220
The Company believes that this unaudited pro forma information is not
indicative of future results of operations, nor of historical operations, if the
acquisitions had occurred as of the beginning of the periods presented.
12. MICHIGAN SUBSIDIARY
On April 10, 1995, the Company signed an exclusive agreement to provide
management services through a majority-owned subsidiary, with Great Lakes Health
Plan, Inc. ("GLHP") headquartered in Southfield, Michigan. In connection with
this transaction, the Company invested $2 million in GLHP and the subsidiary.
The subsidiary began limited start-up operations on April 10, 1995. Included in
intangible assets are $266,034 in start-up costs related to activity in
Michigan. These costs are being amortized over five years. On March 7, 1996, FPA
made an additional capital contribution of $3 million to GLHP in connection with
the acquisition by GLHP of a clinic health plan and a number of clinics in
Michigan. The acquired plan currently services approximately 27,000 Medicaid
enrollees.
13. LICENSURE
The application of Family and Senior Care, Inc., a wholly-owned subsidiary
of FPA, for a restricted healthcare service plan license was approved by the
California Department of Corporations on December 5, 1996. Following that date,
all of the Company's managed care activity in the State of California occurred
in this subsidiary.
14. SUBSEQUENT EVENTS
The following significant events have occurred subsequent to the balance
sheet date:
On March 17, 1997, FPA completed the merger (the "AHI Merger") of FPA
Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of FPA,
with and into AHI Healthcare Systems, Inc., a Delaware corporation ("AHI").
Pursuant to the AHI Merger, AHI became a wholly-owned subsidiary of FPA and each
outstanding share of AHI Common Stock was exchanged for .391 shares of FPA
Common Stock. The shares of FPA Common Stock issued to the AHI stockholders were
registered on a Registration Statement on Form S-4 filed
48
<PAGE> 221
under the Securities Act of 1933, as amended. The AHI Merger will be treated as
a tax-free reorganization and accounted for as a pooling of interests.
The following pro forma unaudited consolidated information presents the
operations of FPA and AHI, as though the AHI Merger had occurred as of the
beginning of the periods presented. The 1996 information includes the twelve
months ended September 30, 1996 for AHI as information for the twelve months
ended December 31, 1996 is not yet available.
Management believes that when actual twelve month financial statements
for the year ended December 31, 1996 are available, they will result in a net
loss higher than that presented in the following table as a result of higher
medical costs experienced recently by AHI.
49
<PAGE> 222
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996
------------- -------------
<S> <C> <C>
Revenues $ 282,635,482 $ 559,386,613
Net income (loss) 470,965 (32,061,426)
Net income (loss) per share .04 (1.19)
</TABLE>
50
<PAGE> 223
INDEPENDENT AUDITORS' REPORT
To the Stockholders of FPA Medical Management, Inc.:
We have audited the consolidated balance sheets of FPA Medical Management, Inc.
and subsidiaries as of December 31, 1995 and 1996 and the related consolidated
statements of operations, changes in stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial statements give
retroactive effect to the merger with Sterling Healthcare Group, Inc., which
has been accounted for as a pooling of interests as described in Note 1 to the
consolidated financial statements. We did not audit the consolidated balance
sheet of Sterling Healthcare Group, Inc. as of December 31, 1995, or the
related consolidated statements of operations, changes in stockholders' equity
and cash flows of Sterling Healthcare Group, Inc. for the period June 1, 1994
(date of inception) to December 31, 1994 and the year ended December 31, 1995,
which statements reflect total assets of $78,608,252 as of December 31, 1995,
and total revenues of $39,255,573 and $115,659,527 for the seven-month period
ended December 31, 1994 and the year ended December 31, 1995, respectively.
Such financial statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for Sterling Healthcare Group, Inc. for 1994 and 1995, is based solely on the
report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, such
consolidated financial statements present fairly, in all material respects, the
financial position of FPA Medical Management, Inc. and subsidiaries as of
December 31, 1995 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
San Diego, California
March 21, 1997
51
<PAGE> 224
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
Sterling Healthcare Group, Inc.
Coral Gables, Florida
We have audited the consolidated balance sheets of Sterling Healthcare Group,
Inc. as of December 31, 1995, and the related consolidated statements of
operations, changes in stockholders' equity, and cash flows for year ended
December 31, 1995 and the seven month period ended December 31, 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Sterling Healthcare
Group, Inc. as of December 31, 1995, and the results of their operations and
their cash flows for the year ended December 31, 1995 and the seven month
period ended December 31, 1994, in conformity with generally accepted
accounting principles.
/s/ COOPERS & LYBRAND LLP
Miami, Florida
March 15, 1996
52
<PAGE> 225
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NOT APPLICABLE
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors. The information with respect to the directors required
under this item is set forth below.
The Registrant's Board of Directors is classified into three classes.
Directors are elected by the stockholders of the Registrant at each annual
meeting of stockholders and serve until the third annual meeting of
stockholders following their election and until their successors are elected and
qualified or until their earlier removal or resignation. The offices referred
to in the table are offices of the Registrant, unless otherwise indicated.
<TABLE>
<CAPTION>
YEAR FIRST BECAME
NAME AND AGE A DIRECTOR PRINCIPAL OCCUPATION DURING THE PAST FIVE YEARS
- ------------ ----------------- ------------------------------------------------
<S> <C> <C>
Members of the Board of Directors--terms expiring in 1999;
Dr. Seth Flam, 38 1986 Chief Executive Officer since 1986 and President
since November 1, 1996.
Dr. Howard Hassman, 40 1986 Executive Vice President - Corporate Development
since September 1994; Chief Financial Officer from
1986 to September 1994.
Sheldon Derezin, 49 1996 Managing Partner, Derezin Breier & Company, a
public accounting firm, since 1982.
Dr. Stephen J. Dresnick, 47 1996 Vice Chairman of the Board since 1996 and
President and Chief Executive Officer, Sterling
Healthcare Group, Inc. since 1987. Director,
Embassy Acquisition Corp. and Trustee, Florida
International University.
Members of the Board of Directors--terms expiring in 1998;
Dr. Kevin Ellis, 40 1988 Chief Medical Officer since April 1995; Chief
Operating Officer from 1988 until April 1995.
Dr. Herbert A. Wertheim, 57 1996 Founder, Chairman and Chief Executive Officer,
Brain Power Incorporated, a manufacturer of optical
instruments and chemicals, since 1971. Director,
Bacou USA, Inc. and Trustee, Florida International
University.
Members of the Board of Directors--terms expiring in 1997;
Dr. Sol Lizerbram, 49 1986 Chairman of the Board since 1986 and President
from 1986 until October 31, 1996. Director,
MedNet, MPC Corporation, a publicly held
managed pharmacy service company.
Dr. Michael Feinstein, 48 1986 Primary Care Physician, Family Practice Associates
of San Diego, Inc., an osteopathic medical
corporation since 1986; Director of
Medical Education from 1986 until January 1996.
</TABLE>
Pursuant to the terms of the Agreement and Plan of Merger dated May 19,
1996 by and among the Registrant, Sterling Acquisition Corporation and Sterling
Healthcare Group, Inc., Dr. Dresnick and Dr. Wertheim were appointed to the
Board of Directors until the date of the 1999 and 1998 annual meeting of
stockholders, respectively.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the
directors, certain officers of the Registrant and beneficial owners of more than
ten percent of the Registrant's Common Stock to file reports of securities
ownership and changes in such ownership with the Securities and Exchange
Commission. Based solely upon a review of the copies of such forms furnished
to the Registrant and the representations made by such persons to the
Registrant, the Registrant believes that during the last fiscal year its
directors, officers and ten percent beneficial owners complied with all
reporting requirements under Section 16(a) of the Securities Exchange Act of
1934.
(b) Executive Officers of the Registrant. The information with respect to
the executive officers required under this item is set forth in Part I of this
Report.
53
<PAGE> 226
ITEM 11. EXECUTIVE COMPENSATION
The information required under this item is set forth below.
EXECUTIVE COMPENSATION
Cash Compensation
The following table sets forth certain information regarding
compensation from the Registrant which was awarded to, earned by, or paid to
the Registrant's Chief Executive Officer and the four other most highly
compensated executive officers in 1996.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM
-------------------------------------- COMPENSATION AWARDS
OTHER ANNUAL ------------------- ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION SHARES UNDERLYING COMPENSATION
POSITION YEAR ($)(1) ($) ($)(2) OPTIONS/SARs(#) ($)(3)
- ------------------ ---- -------- ---------- ------------ ------------------- ------------
<S> <C>
Seth Flam................................... 1994 $172,500 $ 4,953 50,000 $750,000
President, Chief Executive Officer and 1995 201,000 18,226 60,000 3,606
Director(4) 1996 296,048 $ 800,000 14,727 671,000 1,204
Sol Lizerbram............................... 1994 150,000 7,010 50,000 757,030
Chairman of the Board of Directors(5) 1995 189,750 16,214 60,000 16,397
1996 296,048 800,000 22,091 671,000 19,404
Stephen J. Dresnick......................... 1994 262,000 205,635(6) 300,000
Vice Chairman of the Board of Directors 1995 325,000 303,349(7) 252,000
and President, Sterling Healthcare 1996 330,208 1,592,859 722,502(8) 481,250
Group, Inc.
Steven M. Lash(9)........................... 1994 68,974 3,676 269,274 773
Executive Vice President and Chief 1995 205,000 50,000 11,645 20,000 7,246
Financial Officer 1996 257,583 800,000 8,431 437,250 113,125
Howard Hassman.............................. 1994 150,000 7,368 50,000 754,941
Executive Vice President -- Corporate 1995 174,750 16,815 60,000 6,566
Development and Director 1996 232,465 800,000 22,150 303,000 7,026
</TABLE>
- ------------------
(1) Includes compensation accrued for the benefit of Drs. Flam, Lizerbram,
Dresnick and Hassman of $68,546, $68,546, $42,706 and $32,965,
respectively, and $47,583 for the benefit of Mr. Lash as of December 31,
1996, that was paid in March 1997.
(2) Includes payment by the Registrant of auto expenses.
(3) Includes a stock dividend received by Drs. Flam, Lizerbram and Hassman,
which stock was subsequently redeemed for $750,000. Includes stock received
by Mr. Lash in 1996 valued at $106,500 and taxable income resulting from
the exercise of non-qualified stock options received by Dr. Dresnick in
1996 in the amount of $481,250. Also includes life and disability insurance
premiums paid on behalf of each such officer.
(4) Dr. Flam was elected President effective November 1, 1996.
(5) Dr. Lizerbram served as President until November 1, 1996.
54
<PAGE> 227
(6) $80,635 of such amount was accrued for Dr. Dresnick's benefit as of
December 31, 1994 and paid to Dr. Dresnick in February 1995.
(7) $68,807 of such amount was accrued for Dr. Dresnick's benefit as of
December 31, 1995 and paid to Dr. Dresnick in April 1996.
(8) Includes 572,502 options granted by the Registrant after completion of
the merger with Sterling Healthcare Group, Inc. to replace options
previously granted to Dr. Dresnick by Sterling Healthcare Group, Inc.
(9) Mr. Lash commenced employment with the Registrant on September 1, 1994.
Stock Option Grants in 1996
The following table sets forth information concerning stock options
granted to the named executive officers in 1996.
OPTION GRANTS DURING 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------------------------------------
Potential Realizable
Shares % of Total Value at Assumed Annual
Underlying Options/ Rates of Stock Price
Options/ SARs Exercise Appreciation for
SARs Granted to or Base Option Term(3)
Granted Employees Price Expiration -------------------------
Name (#)(1) During Year ($/Sh)(2) Date 5%($) 10%($)
---- ---------- ----------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Seth Flam. . . . . . . 100,000(A) 2.26 $10.8125 3/12/2006 $ 679,992 $ 1,723,234
51,000(B) 1.15 13.7500 7/10/2006 440,859 1,117,137
120,000(C) 2.72 17.0000 7/26/2006 1,282,945 3,251,234
400,000(D) 9.05 19.0625 11/29/2006 4,795,322 12,152,286
Sol Lizerbraun . . . . 100,000(A) 2.26 10.8125 3/12/2006 679,992 1,723,234
51,000(B) 1.15 13.7500 7/10/2006 440,860 1,117,137
120,000(C) 2.72 17.0000 7/26/2006 1,282,945 3,251,235
400,000(D) 9.05 19.0625 11/29/2006 4,785,322 12,152,286
Stephen J. Dresnick. . 95,100(E) 2.15 21.2300 9/08/2001 308,522 898,266
95,100(F) 2.15 14.4600 5/06/2007 1,692,236 3,626,956
1,902(G) 0.04 13.1400 6/01/2000 18,764 26,708
95,100(G) 2.15 11.4400 4/03/2000 1,082,683 1,457,566
285,300(G) 6.46 12.6200 10/31/2006 5,374,489 10,690,662
150,000(D) 3.39 19.0625 11/29/2006 1,796,246 4,557,107
Steven M. Lash . . . . 80,000(A) 1.81 10.8125 3/12/2006 543,994 1,376,587
47,250(B) 1.07 13.7500 7/10/2006 408,444 1,034,995
60,000(C) 1.36 17.0000 7/26/2006 641,473 1,625,617
250,000(D) 5.66 19.0625 11/29/2006 2,997,076 7,595,179
Howard Hassman . . . . 60,000(A) 1.36 10.8125 3/12/2006 407,996 1,033,940
45,000(B) 1.02 13.7500 7/10/2006 388,993 985,709
48,000(C) 1.09 17.0000 7/26/2006 513,178 1,300,494
150,000(D) 3.39 19.0625 11/20/2006 1,798,246 4,557,107
</TABLE>
- ---------------
(1) A. One-fourth of these options vest on each of March 12, 1998, 1999, 2000
and 2001.
B. One-third of these options vest on each of August 1, 1997, 1998 and 1999.
C. One-third of these options vest on each of July 26, 1999, 2000 and 2001.
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<PAGE> 228
D. One-tenth of these options vest on each of the first through
tenth anniversaries of the date of grant, November 29, 1996,
upon achievement of earnings per share targets.
E. These options have vested.
F. Two-thirds of these options have vested, and one-third will
vest upon the earlier of May 6, 2005 or the date the Registrant
obtains net earnings per share of $.73 for the trailing four
quarters.
G. These options have vested.
(2) The option exercise price may be paid in shares of the Registrant's
Common Stock, in cash, or in any other form of valid consideration or a
combination of any of the foregoing, as determined by the Compensation
Committee of the Registrant's Board in its discretion.
(3) The potential realizable value portion of the foregoing table
illustrates value that might be realized should the granted options be
exercised immediately prior to their expiration date and assumes that
the respective rates of appreciation on the Registrant's Common Stock
compound annually until such exercise. These figures make no allowance
for any reduction of potential value which may be caused because of the
termination of the options following termination of employment,
nontransferability or vesting over periods of up to five years.
Aggregated Stock Option Exercises in 1996 and Stock Option Values at December
31, 1996
The following tables set forth information concerning the number of
stock options granted during 1996 and the value of unexercised options to
purchase the Registrant's Common Stock held by the named executive officers at
December 31, 1996. None of the named executive officers exercised any stock
options during 1996.
OPTION EXERCISES DURING 1996 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS
YEAR END($) AT YEAR END($)(1)
----------------------------- -----------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Seth Flam............ 37,000 744,000 $ 597,063 $4,614,000
Sol Lizerbram........ 37,000 744,000 597,063 4,616,000
Stephen J. Dresnick.. 524,592 197,910 4,171,533 982,376
Steven M. Lash....... 131,456 595,068 2,261,332 5,130,052
Howard Hassman....... 37,000 376,000 597,063 2,907,625
</TABLE>
- ------------
(1) The closing price for the Common Stock as reported on the Nasdaq National
Market on December 31, 1996 was $22.375. Value is calculated on the basis
of the difference, if any, between the option exercise price and $22.375,
multiplied by the number of shares of the Registrant's Common Stock
issuable upon exercise of the option.
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<PAGE> 229
Employment Agreements
The Registrant entered into employment agreements with Drs. Flam,
Lizerbram and Hassman, and Mr. Lash, as President and Chief Executive Officer;
Chairman; Executive Vice President -- Corporate Development; and Executive Vice
President and Chief Financial Officer, respectively, each effective as of
October 1, 1996 and terminating on December 31, 2002, subject to two automatic
one-year extensions unless notice by either party is given. Pursuant to these
agreements as amended, Drs. Flam, Lizerbram and Hassman and Mr. Lash receive
annual base salaries, commencing October 1, 1996, of $425,000, $425,000,
$250,000 and $325,000, respectively. Such salaries will be subject to annual
increases after 1997 as determined subjectively by the Compensation Committee of
the Registrant's Board based on individual performance and the Registrant's
results of operations. In addition, each of the executives will be entitled to a
bonus calculated as a percentage of base salary based on pre-established
performance targets for each year.
The employment agreements generally provide that if the employee is
terminated other than for cause, the employee is entitled to full salary and
benefits through December 31, 2002. In the event of a change in control of he
Registrant, each of the executives will be entitled to payments equal to
approximately three times the previous year's base salary and bonus. The
employment agreements also provide each of the above officers with a car
allowance, professional fees, term life insurance, vacation, medical insurance,
disability insurance and liability insurance. In addition, each of the
employment agreements contains a covenant not to compete during employment and
for five years thereafter.
Dr. Dresnick has entered into an employment agreement terminating on
October 31, 1999 pursuant to which he receives an annual base salary of
$325,000, which salary is subject to annual increases at the discretion of the
Board of Directors of Sterling Healthcare Group, Inc. ("Sterling"), and an
annual bonus based on the net income, before taxes of Sterling. Dr. Dresnick is
not entitled to any compensation in the event of a change in control or
non-renewal of his employment agreement upon termination. The employment
agreement provides Dr. Dresnick with a car allowance, vacation and medical
insurance and contains a covenant not to compete during employment and for two
years thereafter.
Compensation of Directors
Non-employee directors currently receive $1,000 per Board of Directors
or committee meeting attended. The Company also reimburses directors for
expenses incurred in connection with attendance at meetings of the Board of
Directors and committees.
In addition, under the Company's 1995 Non-Employee Directors'
Non-Qualified Stock Option Plan (the "Directors' Plan"), non-employee directors
receive an annual grant of options to purchase 5,000 shares of Common Stock at
a price equal to the fair market
57
<PAGE> 230
value of the Common Stock on the date the option is granted. Each option
generally expires upon the earlier of twelve months after the optionee ceases
to be a director of the Company or ten years after the date of grant. The
purpose of the Directors' Plan is to attract and retain independent directors
and to strengthen the mutuality of interests between such directors and the
Company's stockholders.
Compensation Committee Report
The Compensation Committee of the Board of Directors (the "Committee")
made all recommendations regarding salaries and incentive compensation for the
senior executive officers during 1996.
The Committee is composed entirely of outside, nonmanagement directors.
No member of the Committee is a former or current officer of the Company. The
Committee employed in 1996 and the Committee will employ in 1997 the following
policies for determining compensation for the Company's executive officers.
The goals of the Company's compensation program continue to be to
attract and retain executive officers, motivate such officers to achieve the
Company's business objectives and to contribute to the long-term success of the
Company, foster teamwork and reward officers for the achievement of such goals.
The Company utilizes salary and performance-based bonuses and stock options to
meet these goals.
Specifically, the Company seeks to: (i) provide rewards which are
closely linked to Company, team and individual performance; (ii) align the
interests of the Company's employees with those of its stockholders; and (iii)
ensure that compensation and benefits are at levels which enable the Company to
attract and retain high-quality employees.
The Company applies these objectives and policies to most employees
through a combination of base salaries, performance-based cash incentive
opportunities and stock option grants based upon pre-established revenue and
profit targets, significant corporate achievements and other subjective job
performance criteria.
The Company has considered and will continue to consider the potential
impact of Section 162(m) of the Internal Revenue Code adopted under the Revenue
Reconciliation Act of 1993. Section 162(m) disallows a tax deduction for any
publicly-held corporation for individual compensation exceeding $1 million in
any taxable year for the named executive officers, unless compensation is
performance-based. Since the targeted non-performance based cash compensation
of each of the named executive officers is below the $1 million threshold and
any options granted under the Company's stock option plan will meet the
requirement of being performance-based, the Company believes that this section
will not reduce the tax deduction available to the Company. The Company's
policy is to qualify to the maximum extent possible its executives'
compensation for deductibility under applicable tax laws.
58
<PAGE> 231
Base Salary and Bonus
Executive officer base salary and individual performance-based bonus
awards are determined by reference to Company-wide and individual performance
for the previous fiscal year, based on a wide range of quantitative and
qualitative measures which permit comparisons with competitors' performance and
internal earnings and market share targets set before the start of each year.
In addition to Company-wide measures of performance, the Company considers
those performance factors particular to each executive officer, the performance
of the group or groups for which such officer had management responsibility and
individual managerial accomplishments.
The Company relies heavily, but not exclusively, on these quantitative
and qualitative measures in setting compensation for all officers and, in
particular, the executive officers. The Company also exercises subjective
judgment and discretion in light of these measures and in view of the Company's
compensation objectives and policies described above to determine base
salaries, overall bonus funds and individual bonus awards.
Stock Options and Stock Grants
In addition to base salary and bonus, the Company may utilize stock
options and stock grants to motivate and retain executive officers. The Company
believes that this form of compensation closely aligns the officers' interests
with those of stockholders and provides a major incentive to officers in
building stockholder value. Options are granted annually and are subject to
vesting provisions to encourage officers to remain employed with the Company.
During the past fiscal year, each executive officer received stock options in
amounts based upon a determination of that officer's relative position,
responsibilities, performance during the previous fiscal year and anticipated
performance in the upcoming year. The Company also reviews the total holdings
of the executive officers and the prior level of grants to the officers and
other members of senior management, including the number of shares which
continue to be subject to vesting under outstanding options, in setting the
level of options to be granted to the executive officers.
Compensation of the Chief Executive Officer
The Company's approach in establishing Dr. Flam's annual compensation
was governed by the Company's overall compensation strategy as discussed above.
This report was provided by the following members of the Board of
Directors for 1996:
Sheldon Derezin
Dr. Herbert Wertheim
59
<PAGE> 232
Stock Performance Graph
The following performance graph compares the performance of the
Company's Common Stock to the Nasdaq Stock Market U.S. Index and the Nasdaq
Stock Market Health Services Index (the "Indices") from October 20, 1994, the
date of the Company's initial public offering of Common Stock, until December
31, 1996. The graph is based on publicly available information. The graph
assumes an investment of $100 in the Company's Common Stock and in each of the
Indices on October 20, 1994, the date of the Company's initial public offering
of Common Stock, and assumes reinvestment of dividends.
Price Points
FPA MEDICAL MANAGEMENT
PRICE POINTS
<TABLE>
<CAPTION>
10/20/94 12/30/94 3/31/95 6/30/95 9/29/95 12/29/95 3/29/96 6/28/96 9/30/96 12/31/96
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
FPAM 100 125 225 200 185 187.5 250 311.25 527.5 447.5
Nasdaq (US) 100 98.27 107.13 122.54 137.3 138.97 145.46 157.34 162.93 170.92
Nasdaq Health Service Stocks 100 97.74 107.1 92.18 107.03 124.15 129.44 141.1 140.57 124.28
</TABLE>
60
<PAGE> 233
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of shares of Common Stock as of April 1, 1997 by (i) each
person known by the Company to be the beneficial owner of more than 5% of the
outstanding shares of Common Stock, (ii) each of the Company's directors who
owns shares of Common Stock, (iii) each executive officer named in the table
under the caption "Executive Compensation" and (iv) all directors and officers
as a group.
<TABLE>
<CAPTION>
Percentage
Name and Address of Beneficial Owner (1) Shares of Common Stock Beneficially
- ---------------------------------------- ---------------------- ------------
<S> <C> <C>
Sol Lizerbram(2)...................................... 380,113 1.2%
Seth Flam............................................. 396,175 1.3%
Howard Hassman(3)..................................... 396,600 1.3%
Kevin Ellis........................................... 410,600 1.3%
Michael Feinstein..................................... 408,100 1.3%
Stephen Dresnick(4)................................... 1,869,254 5.7%
Sheldon Derezin....................................... 25,500 *
Steven Lash........................................... 170,692 *
Herbert Wertheim...................................... 203,894 *
Foundation Health Corporation(5)...................... 4,076,087 11.7%
All officers and directors as a group (11 persons).... 4,303,978 12.3%
</TABLE>
- ---------------
* Less than 1%.
(1) Unless otherwise indicated, the address of each of the persons named above
is in care of the Registrant at 3636 Nobel Drive, Suite 200, San Diego,
California 92122. A person is deemed to be the beneficial owner of
securities that can be acquired by such person within 60 days from April 1,
1997 upon the exercise of options or warrants. Each beneficial owner's
number of shares is determined by assuming that options or warrants that
are held by such person (but not those held by any other person) and that
are exercisable within 60 days from April 1, 1997 have been exercised. The
total outstanding shares used to calculate each beneficial owner's
percentage includes such options and warrants. Unless otherwise noted, the
Registrant believes that all persons named in the table have sole voting
and investment power with respect to all shares of Common Stock
beneficially owned to them.
(2) Shares attributable to Dr. Lizerbram are held by the Lizerbram Family
Trust, of which Dr. Lizerbram is Trustee and together with his wife, the
sole beneficiaries.
(3) Shares attributable to Dr. Hassman are held by Hassman, L.P., a limited
partnership of which Clinical Partners Medical Group, P.C. is the General
Partner, of which Dr. Hassman is the sole shareholder.
(4) Shares attributable to Dr. Dresnick are held by several corporations and
limited partnerships in which Dr. Dresnick or a corporation owned by him is
the sole stockholder and limited and general partners.
(5) Foundation Health Corporation ("FHC") and the Registrant entered into a
voting agreement as of November 29, 1996 pursuant to which FHC has agreed
to vote its shares of FPA Common Stock in accordance with the
recommendation of the Board of Directors of FPA as to all matters with
respect to which the Board makes a recommendation except with respect to
(a) any sale, lease, assignment, transfer or other conveyance of all or
substantially all of the assets or capital stock of FPA, or any
consolidation or merger involving FPA, or any reclassification or other
change of any stock, or any recapitalization of FPA and (b) any amendment
of the Certificate of Incorporation or By-laws of FPA if such amendment
would change any of the rights, preferences or privileges of the FPA Common
Stock.
61
<PAGE> 234
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Effective October 1, 1996, one of the Registrant's affiliated
professional corporations and the Registrant acquired substantially all of the
assets and assumed certain liabilities of Family Practice Associates of San
Diego, an Osteopathic Corporation ("FPASD"), for aggregate consideration of
approximately $4,200,000. FPASD is owned by Drs. Flam, Lizerbram, Hassman,
Feinstein and Kevin Ellis, the Registrant's Executive Vice President and Chief
Medical Officer.
62
<PAGE> 235
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
(1) Financial Statements:
Report of Independent Public Accountants
Consolidated Balance Sheets, December 31, 1995 and 1996
Consolidated Statements of Operations for the Years Ended
December 31, 1994, 1995 and 1996
Consolidated Statements of Stockholders' Equity (Deficit) for the
Years Ended December 31, 1994, 1995 and 1996
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1994, 1995 and 1996
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
All schedules have been omitted because they are inapplicable, not
required, or the information is included elsewhere in the consolidated
Financial Statements or Notes thereto.
(3) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF DOCUMENTS
- ----------- ------------------------
<S> <C>
3.1 Certificate of Incorporation.*
3.2 Bylaws.
3.3 Certificate of Amendment of Certificate of Incorporation filed
October 20, 1994 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1994 at Exhibit No.
3.3) .
3.4 Certificate of Amendment of Certificate of Incorporation filed
August 6, 1996.
4.1 Specimen of Common Stock Certificate.*
4.2 Form of Warrant.*
10.1 IPA Medicare Partial Risk Services Agreement between PacifiCare of
California and Family Practice Associates of San Diego, Inc.
("FPASD") dated January 1, 1993, including an amendment thereto
effective the date thereof and an amendment thereto date effective
January 1, 1994.* **
10.2 [Reserved]
10.3 Medical Services Organization Agreement dated January 21, 1995
between FPANJ and Medigroup, Inc. (HMO Blue).* **
10.4 PacifiCare IPA Commercial Services Agreement with FPASD dated May 1,
1995.* **
10.5 Amendment to IPA Medicare Partial Risk Services Agreement between
PacifiCare of California and FPASD dated April 1995.* **
10.6 [Reserved]
10.7 Form of Primary Care Physician Agreement/California.* **
10.8 Form of Specialty Care Physician Agreement/California.* **
10.9 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
10.10 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
</TABLE>
63
<PAGE> 236
<TABLE>
<CAPTION>
<S> <C>
10.11 Form of Succession Agreement.*
10.12 Employment Agreement between FPA and Dr. Sol Lizerbram effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.13) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.12).* +
10.13 Employment Agreement between FPA and Dr. Seth Flam effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.14) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.13).* +
10.14 Employment Agreement between FPA and Dr. Howard Hassman effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.15) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.14).* +
10.15 Employment Agreement between FPA and Dr. Kevin Ellis effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.16) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.15).* +
10.16 Amended and Restated Employment Agreement between FPA and Steven M.
Lash effective September 1, 1994 (incorporated by reference to FPA's
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit No. 10.26). +
10.17 Amended and Restated Employment Contract dated as of January 1, 1995
between Sterling Healthcare Group, Inc. and Stephen J. Dresnick,
M.D. (incorporated by reference to Sterling Healthcare Group, Inc.'s
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit 10.31). +
10.18 Employment Agreement between FPA and James A. Lebovitz effective
March 1, 1996 (incorporated by reference to FPA's Annual Report on
Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.18). +
10.19 FPA Omnibus Stock Option Plan (incorporated by reference to
Registration Statement No. 33-79714 at Exhibit No. 10.19). +
10.20 Indenture dated as of December 18, 1996 by and between FPA and First
Union National Trust Bank relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.1).
10.21 Registration Rights Agreement dated December 13, 1996 by and among
FPA and the Initial Purchasers relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.2).
10.22 Form of Rule 144A Restricted Global Debenture relating to FPA's 6
1/2% Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.4).
10.23 Form of Regulation S Global Debenture relating to FPA's 6 1/2%
Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.5).
10.24 401(K) Salary Savings Plan effective January 1, 1994. +
10.25 1995 Directors Stock Option Plan.* +
10.26 1994 Physicians Stock Option Plan.*
10.27 Credit, Security, Guarantee and Pledge Agreement dated as of January
29, 1996 among FPA and its subsidiaries and certain guarantors and
the lenders named therein and Banque Paribas, as amended March 15,
1996 (incorporated by reference to FPA's Annual Report on Form 10-K
for the year ended December 31, 1995 at Exhibit No. 10.27).
</TABLE>
64
<PAGE> 237
<TABLE>
<CAPTION>
<S> <C>
10.28 [Reserved]
10.29 Form of Indemnification Agreement.*
21 Subsidiaries of the Registrant.
23 Consent of Deloitte & Touche LLP.
23.1 Consent of Coopers & Lybrand LLP.
</TABLE>
* Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form S-1, Reg. No. 33-97456, at the
exhibit number set forth opposite such exhibit's description above.
** Registrant has requested confidential treatment from the Securities
and Exchange Commission for portions of this exhibit, which
confidential portions have been filed separately.
+ Constitutes a management contract or compensatory plan to be filed
as an Exhibit to this Report pursuant to Item 14(c) of Form 10-K.
(b) Reports on Form 8-K. The Registrant filed the following current Reports
on Form 8-K during the quarter ended December 31, 1996 and through March 21,
1997:
DATE OF REPORT ITEMS REPORTED
- -------------- --------------
October 31, 1996.................................................2 and 7
November 8, 1996.................................................5 and 7
November 26, 1996................................................5 and 7
December 10, 1996................................................2 and 7
December 13, 1996................................................5 and 7
December 18, 1996................................................7 and 9
March 17, 1997...................................................2 and 7
65
<PAGE> 238
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
FPA MEDICAL MANAGEMENT, INC.
(Registrant)
By: /s/ SETH FLAM
------------------------
Seth Flam
President
April 28, 1997
66
<PAGE> 239
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF DOCUMENTS
----------- ------------------------
<TABLE>
<CAPTION>
<S> <C>
3.1 Certificate of Incorporation.*
3.2 Bylaws.
3.3 Certificate of Amendment of Certificate of Incorporation filed
October 20, 1994 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1994 at Exhibit No.
3.3) .
3.4 Certificate of Amendment of Certificate of Incorporation filed
August 6, 1996.
4.1 Specimen of Common Stock Certificate.*
4.2 Form of Warrant.*
10.1 IPA Medicare Partial Risk Services Agreement between PacifiCare of
California and Family Practice Associates of San Diego, Inc.
("FPASD") dated January 1, 1993, including an amendment thereto
effective the date thereof and an amendment thereto date effective
January 1, 1994.* **
10.2 [Reserved]
10.3 Medical Services Organization Agreement dated January 21, 1995
between FPANJ and Medigroup, Inc. (HMO Blue).* **
10.4 PacifiCare IPA Commercial Services Agreement with FPASD dated May 1,
1995.* **
10.5 Amendment to IPA Medicare Partial Risk Services Agreement between
PacifiCare of California and FPASD dated April 1995.* **
10.6 [Reserved]
10.7 Form of Primary Care Physician Agreement/California.* **
10.8 Form of Specialty Care Physician Agreement/California.* **
10.9 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
10.10 Form of Administrative Services Agreement between FPA and a
Professional Corporation.*
10.11 Form of Succession Agreement.*
10.12 Employment Agreement between FPA and Dr. Sol Lizerbram effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.13) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.12).* +
10.13 Employment Agreement between FPA and Dr. Seth Flam effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.14) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.13).* +
10.14 Employment Agreement between FPA and Dr. Howard Hassman effective as
of January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.15) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.14).* +
10.15 Employment Agreement between FPA and Dr. Kevin Ellis effective as of
January 1, 1994, including an amendment thereto effective as of
January 1, 1994 (incorporated by reference to Registration Statement
No. 33-79714 at Exhibit No. 10.16) and amendment thereto effective
as of July 1, 1995 (incorporated by reference to FPA's Annual Report
on Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.15).* +
</TABLE>
<PAGE> 240
<TABLE>
<CAPTION>
<S> <C>
10.16 Amended and Restated Employment Agreement between FPA and Steven M.
Lash effective September 1, 1994 (incorporated by reference to FPA's
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit No. 10.26). +
10.17 Amended and Restated Employment Contract dated as of January 1, 1995
between Sterling Healthcare Group, Inc. and Stephen J. Dresnick,
M.D. (incorporated by reference to Sterling Healthcare Group, Inc.'s
Annual Report on Form 10-K for the year ended December 31, 1994 at
Exhibit 10.31). +
10.18 Employment Agreement between FPA and James A. Lebovitz effective
March 1, 1996 (incorporated by reference to FPA's Annual Report on
Form 10-K for the year ended December 31, 1995 at Exhibit No.
10.18). +
10.19 FPA Omnibus Stock Option Plan (incorporated by reference to
Registration Statement No. 33-79714 at Exhibit No. 10.19). +
10.20 Indenture dated as of December 18, 1996 by and between FPA and First
Union National Trust Bank relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.1).
10.21 Registration Rights Agreement dated December 13, 1996 by and among
FPA and the Initial Purchasers relating to FPA's 6 1/2% Convertible
Subordinated Debentures Due 2001 (incorporated by reference to
Registration Statement No. 333-20007 at Exhibit 4.2).
10.22 Form of Rule 144A Restricted Global Debenture relating to FPA's 6
1/2% Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.4).
10.23 Form of Regulation S Global Debenture relating to FPA's 6 1/2%
Convertible Subordinated Debentures Due 2001 (incorporated by
reference to Registration Statement No. 333-20007 at Exhibit 4.5).
10.24 401(K) Salary Savings Plan effective January 1, 1994. +
10.25 1995 Directors Stock Option Plan.* +
10.26 1994 Physicians Stock Option Plan.*
10.27 Credit, Security, Guarantee and Pledge Agreement dated as of January
29, 1996 among FPA and its subsidiaries and certain guarantors and
the lenders named therein and Banque Paribas, as amended March 15,
1996 (incorporated by reference to FPA's Annual Report on Form 10-K
for the year ended December 31, 1995 at Exhibit No. 10.27).
10.28 [Reserved]
10.29 Form of Indemnification Agreement.*
21 Subsidiaries of the Registrant.
23 Consent of Deloitte & Touche LLP.
23.1 Consent of Coopers & Lybrand LLP.
</TABLE>
* Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form S-1, Reg. No. 33-97456, at the
exhibit number set forth opposite such exhibit's description above.
** Registrant has requested confidential treatment from the Securities
and Exchange Commission for portions of this exhibit, which
confidential portions have been filed separately.
+ Constitutes a management contract or compensatory plan to be filed
as an Exhibit to this Report pursuant to Item 14(c) of Form 10-K.
<PAGE> 241
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements on Form
S-3 (Nos. 333-3760 and 333-2007) and Form S-8 (Nos. 33-00074, 33-00076,
333-16741 and 333-15755) of FPA Medical Management, Inc. of our report dated
March 21, 1997, appearing in this Annual Report on Form 10-K/A of FPA Medical
Management, Inc. for the year ended December 31, 1996.
/s/ Deloitte & Touche LLP
San Diego, California
April 25, 1997
<PAGE> 242
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statements of
FPA Medical Management, Inc. on Form S-3 (File Nos. 333-3760 and 333-2007) and
on Form S-8 (File Nos. 333-00076, 333-16741 and 333-15755) of our report dated
March 15, 1996, on our audits of the consolidated financial statements of
Sterling Healthcare Group, Inc. as of December 31, 1995, and for the year ended
December 31, 1995 and for the period from June 1, 1994 to December 31, 1994,
which report is included in this Annual Report on Form 10-K/A.
/s/ COOPERS & LYBRAND LLP
Miami, Florida
April 22, 1997
<PAGE> 243
[ARTICLE] 5
<TABLE>
<S> <C>
[PERIOD-TYPE] YEAR
[FISCAL-YEAR-END] DEC-31-1996
[PERIOD-START] JAN-01-1996
[PERIOD-END] DEC-31-1996
[CASH] 5,594,877
[SECURITIES] 40,000,000
[RECEIVABLES] 216,272,051
[ALLOWANCES] 59,796,488
[INVENTORY] 0
[CURRENT-ASSETS] 228,356,136
[PP&E] 46,497,830
[DEPRECIATION] 6,358,498
[TOTAL-ASSETS] 577,270,277
[CURRENT-LIABILITIES] 240,434,392
[BONDS] 0
[COMMON] 49,542
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[OTHER-SE] 143,468,497
[TOTAL-LIABILITY-AND-EQUITY] 577,270,277
[SALES] 0
[TOTAL-REVENUES] 440,318,613
[CGS] 0
[TOTAL-COSTS] 313,706,608
[OTHER-EXPENSES] 137,201,187
[LOSS-PROVISION] 0
[INTEREST-EXPENSE] (5,127,244)
[INCOME-PRETAX] (15,716,426)
[INCOME-TAX] 0
[INCOME-CONTINUING] (15,716,426)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (15,716,426)
[EPS-PRIMARY] 0
[EPS-DILUTED] 0
</TABLE>
<PAGE> 244
APPENDIX E
FPA'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1997
E-1
<PAGE> 245
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
--------- ----------
COMMISSION FILE NUMBER 0-24276
FPA MEDICAL MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0604264
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
---------------
3636 NOBEL DRIVE
SUITE 200
SAN DIEGO, CA 92122
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(619) 453-1000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NONE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
---------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS:
[X] YES [ ] NO
AS OF MAY 12, 1997 THERE WERE OUTSTANDING 30,867,750 SHARES OF THE
REGISTRANT'S COMMON STOCK, PAR VALUE $.002 PER SHARE.
================================================================================
<PAGE> 246
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets............................................... 1
Consolidated Statements of Operations (Unaudited)......................... 2
Consolidated Statements of Cash Flows (Unaudited)......................... 3
Notes to Consolidated Financial Statements................................ 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................... 5
PART II -- OTHER INFORMATION
Item 4. Submission of matters to a Vote of Security Holders....................... 12
Item 6. Exhibits and Reports on Form 8-K.......................................... 12
Signatures................................................................................ 13
</TABLE>
<PAGE> 247
ITEM 1. Financial Statements
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS [1]
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
- ------
Current Assets:
Cash and cash equivalents $ 15,471,770 $ 20,135,507
Marketable securities 40,000,000 15,060,856
Accounts receivable - net of allowance for uncollectible accounts 106,298,672 133,567,261
Accounts receivable - other 25,095,247 25,215,528
Notes receivable from affiliate 512,822 --
Prepaid expenses and other assets 6,498,174 6,740,990
Capitation deposit 15,409,771 20,947,369
Deferred income tax asset 3,478,751 12,043,116
------------- -------------
Total current assets 212,765,207 233,710,627
Property and equipment - net of accumulated depreciation 46,495,863 41,714,485
Restricted cash and deposits 488,535 500,000
Goodwill - net of accumulated amortization 295,594,009 301,358,247
Intangible assets - net of accumulated amortization 6,667,269 5,456,098
Investment in GLHP 4,994,900 4,994,900
Deferred income tax asset 3,189,665 2,736,327
Other assets 9,468,006 8,452,417
------------- -------------
Total $ 579,663,454 $ 598,923,101
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 62,003,039 $ 78,191,686
Claims payable, including incurred but not reported claims 97,688,268 127,286,239
Accrued payroll and related liabilities 3,880,272 12,099,013
Income tax payable 2,294,159 --
Other current liabilities 13,218,704 13,099,616
Current portion of accrued liability for professional liability claims 1,297,790 1,147,878
Long-term debt, current portion 70,474,667 74,731,037
------------- -------------
Total current liabilities 250,856,899 306,555,469
Long-term debt, net of current portion 185,889,219 171,775,894
Accrued liability for professional liability claims, net of current portion 4,217,000 3,597,000
Other long-term liabilities 4,325,862 350,793
------------- -------------
Total liabilities 445,288,980 482,279,156
Stockholders' equity:
Preferred stock, $.001 par value per share, 2,000,000 shares authorized,
no shares outstanding -- --
Common stock, $.002 par value, 98,000,000 shares authorized, 30,596,218 and
30,856,155 shares issued and outstanding at December 31, 1996
and March 31, 1997, respectively 61,192 61,712
Additional paid-in capital 201,282,914 202,611,195
Stock payable 534,600 --
Due from stockholder (401,000) --
Accumulated deficit (67,103,232) (86,028,962)
------------- -------------
Total stockholders' equity 134,374,474 116,643,945
------------- -------------
Total $ 579,663,454 $ 598,923,101
============= =============
</TABLE>
See notes to consolidated financial statements.
[1] These financial statements include the balances of AHI Healthcare Systems,
Inc. for all periods presented.
1
<PAGE> 248
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) [1]
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------
MARCH 31, 1996 MARCH 31, 1997
------------- -------------
<S> <C> <C>
Managed care revenue $ 66,455,352 $ 157,314,519
Fee-for-service revenue, net of contractual deductions 37,497,463 65,525,095
------------- -------------
Operating revenue 103,952,815 222,839,614
Expenses:
Medical services expense 74,725,588 158,105,080
------------- -------------
29,227,227 64,734,534
General and administrative expense 26,477,739 51,705,602
Merger, restructuring and other unusual charges -- 36,833,586
------------- -------------
Income (loss) from operations 2,749,488 (23,804,654)
Other income (expense):
Interest and other income 510,858 934,664
Interest expense (684,331) (4,166,767)
------------- -------------
Total other income (expense) (173,473) (3,232,103)
------------- -------------
Income (loss) before income taxes 2,576,015 (27,036,757)
Income tax (expense) benefit (1,159,683) 8,111,027
------------- -------------
Net income (loss) $ 1,416,332 $ (18,925,730)
============= =============
Net income (loss) per share $ .05 $ (0.59)
============= =============
Weighted average shares outstanding 25,814,913 32,288,183
============= =============
</TABLE>
See notes to consolidated financial statements.
[1] These financial statements include the balances of AHI Healthcare Systems,
Inc. for all periods presented.
2
<PAGE> 249
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) [1]
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------
MARCH 31, 1996 MARCH 31, 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,416,332 $(18,925,730)
Adjustments to reconcile net income (loss) to net cash
used by operating activities:
Depreciation and amortization 2,375,785 5,865,269
Imputed interest on notes payable 22,475 --
Changes in assets and liabilities:
Accounts receivable (12,351,446) (27,388,870)
Income tax receivable/payable 1,009,570 --
Capitation deposit -- (5,537,598)
Deferred income taxes (25,110) (10,405,186)
Accounts payable and accrued expenses (1,209,942) 16,188,647
Claims payable, including incurred but not reported claims 8,590,460 23,737,238
Accrued liability for professional liability claims -- (769,912)
Accrued payroll and related liabilities 71,188 8,218,741
Prepaid expenses and other (1,585,631) (1,974,057)
------------ ------------
Total adjustments (3,102,651) 7,934,272
------------ ------------
Net cash used by operating activities (1,686,319) (10,991,458)
Cash flows from investing activities:
Purchase of property and equipment (2,207,334) (3,263,073)
Payments for intangible assets (1,007,580) --
Net payments (to) from affiliate (306,535) --
Net sale of marketable securities 5,149,845 24,939,144
Acquisitions, net of cash required (11,270,677) --
------------ ------------
Net cash provided (used) by investing activities (9,642,281) 21,676,071
Cash flows from financing activities:
Proceeds from merger, net 1,945 --
Issuance of notes payable 8,400,000 8,176,152
Payments on long-term debt (3,560,516) (15,392,229)
Net payments under bank line of credit (788,325) --
Proceeds from exercise of stock options and warrants 738,794 1,195,201
Increase in bank overdrafts 214,395 --
------------ ------------
Net cash provided (used) by financing activities 5,006,293 (6,020,876)
------------ ------------
Net increase (decrease) in cash (6,322,307) 4,663,737
Cash, beginning of period 34,780,225 15,471,770
------------ ------------
Cash, end of period $ 28,457,918 $ 20,135,507
============ ============
Supplemental cash flow information
Cash paid for interest $ 413,695 $ 2,431,388
Cash paid for income taxes 44,740 --
Equipment acquired under capital leases 247,901 --
Common stock issued in connection with acquisitions 420,000 --
Effects of acquisitions:
Fair value of assets acquired 24,310,738 8,778,943
Liabilities assumed 13,040,061 8,778,943
------------ ------------
Net cash paid for acquisitions $ 11,270,677 $ --
============ ============
</TABLE>
See notes to consolidated financial statements.
[1] These financial statements include the balances of AHI Healthcare Systems,
Inc. for all periods presented.
3
<PAGE> 250
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
In the opinion of management, the accompanying consolidated financial
statements include all adjustments (which consist only of normal recurring
adjustments) necessary for a fair presentation of the financial position of FPA
Medical Management, Inc. ("FPA") and subsidiaries and certain affiliated
professional corporations (collectively, the "Company"), and the results of its
operations and its cash flows for the interim periods presented. Although FPA
believes that the disclosures in these consolidated financial statements are
adequate to make the information presented not misleading, certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. Results of operations for the interim periods are not necessarily
indicative of results to be expected for any other interim period or for the
full year.
The consolidated financial statements for the three months ended March 31,
1996 and March 31, 1997 are unaudited and should be read in conjunction with the
consolidated financial statements and notes thereto included in FPA's Annual
Report on Form 10-K, as amended, for the year ended December 31, 1996.
Consolidation of Subsidiaries - The Company's financial statements include
the activity of all of its wholly-owned subsidiaries and certain affiliated
professional corporations ("Professional Corporations") over which the Company
has direct or indirect unilateral and perpetual control. 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. All intercompany transactions have been eliminated in
consolidation. These financial statements include the balances of AHI Healthcare
Systems, Inc. ("AHI") for all periods presented (see Note 2).
Net Income per Common Share - Net income per common share is computed based
on the weighted average number of shares and share equivalents (options and
warrants) outstanding, giving retroactive effect to all stock splits and
poolings of interests.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". This
statement specifies the computation, presentation, and disclosure requirements
for earnings per share for entities with publicly held common stock. SFAS No.
128 is not in effect for the Company in the first quarter of 1997, but will be
in effect for financial statements issued for periods ending after December 15,
1997, including interim periods. The Company does not expect the adoption of
SFAS No. 128 to have a material effect on its Net Income (Loss) Per Share.
2. SUBSEQUENT EVENTS
The following significant events have occurred subsequent to December 31,
1996:
On March 17, 1997, FPA completed the merger (the "Merger") of FPA
Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of FPA,
with and into AHI. Pursuant to the Merger, AHI became a wholly-owned subsidiary
of FPA and each outstanding share of AHI Common Stock was exchanged for .391
shares of FPA Common Stock. The shares of FPA Common Stock issued to the AHI
stockholders were registered on a Registration Statement on Form S-4 filed under
the Securities Act of 1933, as amended. The Merger was treated as a tax-free
reorganization and accounted for as a pooling of interests.
4
<PAGE> 251
ITEM 2. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations.
GENERAL
FPA Medical Management, Inc., its subsidiaries and the Professional
Corporations derive substantially all of their operating revenue from (i) the
payments made by health maintenance organizations or other prepaid health
insurance plans (collectively, "Payors") to the Professional Corporations for
managed care medical services, (ii) fee-for-service revenues for medical centers
in the managed care business, and (iii) fee-for-service revenues from emergency
department medical services.
MANAGED CARE BUSINESS
The Company has two types of Payor contracts: contracts for both
inpatient and outpatient services ("global capitation" contracts) and those
limited to outpatient services or professional medical services ("outpatient
capitation" contracts). Under global capitation contracts, the Company receives
a fixed monthly amount per enrollee for which the Company is financially
responsible to provide the enrollees with all necessary inpatient and outpatient
care. Under outpatient capitation contracts, the Company receives a fixed
monthly amount per enrollee for which the Company is financially responsible to
provide the enrollees with all necessary outpatient care. Additionally, under
these outpatient capitation contracts, the Company is a party to shared risk
arrangements with Payors which generally reward the Company for the efficient
utilization of hospital inpatient services. Under these shared risk
arrangements, the Company shares any surplus or, in some cases, deficit, of
amounts pre-established by the Payor in relation to inpatient expense. Revenue
under global capitation contracts represented 9.6% and 22.3% for the three
months ended March 31, 1996 and March 31, 1997, respectively, of managed care
business operating revenue. Revenue under outpatient capitation contracts
represented 84.5% and 61.9% for the three months ended March 31, 1996 and March
31, 1997, respectively, of managed care business operating revenue.
The Company also generates fee-for-service revenue for the performance of
medical services through the Professional Corporations and its subsidiaries.
These revenues are presented net of contractual deductions and represented 5.9%
and 15.8% for the three months ended March 31, 1996 and March 31, 1997,
respectively, of managed care business operating revenue.
Through the Professional Corporations and its subsidiaries, the Company
contracts with various healthcare providers to provide primary care and
specialty medical services to covered enrollees. Primary care physicians are
compensated on either a salary or capitation basis. Specialty care physician
services are paid for on either a discounted fee-for-service or capitation
basis. Managed care business medical services expense paid for on a capitation
basis (for certain primary care and specialty care services) or fixed salary
basis totaled 48.1% and 35.8% for the three months ended March 31, 1996 and
March 31, 1997, respectively, of managed care business operating revenues, with
the remainder of medical services expense (for primary care, specialty care,
ancillary services, inpatient and outpatient services, lab charges, etc.) paid
for on a discounted fee-for-service or per diem basis.
EMERGENCY DEPARTMENT BUSINESS
Through the emergency department business, the Company provides contract
management and support services primarily to emergency departments. As of March
31, 1997 the Company provided physician practice management services on a
contract basis to 109 emergency departments, one anesthesia department, three
correctional health care facilities and two rural health urgent care clinics
located in 22 states. The Company contracts with approximately 1300 affiliated
physicians who provide certain medical services to approximately 1.4 million
patients annually.
The Company's contractual arrangements with hospitals are primarily
fee-for-service contracts whereby hospitals generally agree, in exchange for the
Company's services, to authorize the Company and its contracted healthcare
professionals to bill and collect the professional component of the charges for
medical services rendered by the Company's contracted healthcare professionals.
Fee-for-service contracts may, depending on the hospital's patient volume and
payor mix, involve the payment of a subsidy to the Company by the hospital.
During each of the three months ended March 31, 1996 and March 31, 1997, 83.2%
of the Company's emergency department operating revenue was earned on a
fee-for-service basis, and the Company emphasized fee-for-service contracts in
its marketing activities.
5
<PAGE> 252
Medical services expense for the emergency department business consists
primarily of payments made to independent contractor and employee physicians
("Physician Costs") and, to a lesser extent the costs of medical supplies and
malpractice insurance and laboratory fees. During the three months ended March
31, 1996 and March 31, 1997, Physician Costs accounted for 93.0% and 94.3%,
respectively, of emergency department business medical services expense.
OPERATIONAL DEVELOPMENT
The future growth of FPA is largely dependent on a continued increase in the
number of new enrollees in the FPA network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
serving enrollees of Payors in the FPA network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations have
contracts and whose members are patients of physicians in the FPA network or
(iii) agreements with Payors, physicians and hospitals in other geographic
markets. The process of identifying and consummating suitable acquisitions of,
or affiliations with, physician groups can be lengthy and complex. The
marketplace for such acquisitions and affiliations is subject to increasing
competitive pressures. There can be no assurance that FPA will be successful in
identifying, acquiring or affiliating with additional physician groups or
hospitals or that the Professional Corporations will be able to contract with
new Payors. In addition, there can be no assurance that the Company's
acquisitions will be successfully integrated on a timely basis or that the
anticipated benefits of these acquisitions will be realized. Failure to
effectively accomplish the integration of acquired companies could have a
material adverse effect on FPA's results of operations and financial condition.
FPA's ability to expand is also dependent upon its ability to comply with legal
and regulatory requirements in the jurisdictions in which it operates or will
operate and to obtain necessary regulatory approvals, certificates and licenses.
In March 1997, the Company completed its merger with AHI Healthcare Systems,
Inc., which serviced approximately 210,000 enrollees. In January 1996, the
Company acquired three independent practice associations in the Los Angeles,
Ventura and Sacramento regions of California, which now service approximately
76,000 enrollees and include 570 primary care physicians. In June 1996, FPA
acquired Physicians First, Inc., operating 40 medical clinics in Florida,
through which 110 primary care physicians provided services to approximately
80,000 enrollees. In July 1996, the Company acquired two independent practice
associations, one in Arizona and Florida, providing services to approximately
14,000 and 4,000 enrollees, respectively. In October 1996, FPA and Sterling
Healthcare Group, Inc. completed a merger. Effective in December 1996, the
Company and certain Professional Corporations acquired two medical groups, one
each in California and Arizona, providing services to approximately 63,000 and
157,000 enrollees, respectively.
Listed below is a breakdown of enrollees, Payors, primary care physicians,
specialty care physicians, and emergency department business contracts
(including anesthesiology, urgent care and correctional facility business
contracts) by region at March 31, 1997.
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
NUMBER OF NUMBER OF SPECIALTY EMERGENCY
PAYOR PRIMARY CARE CARE DEPARTMENT
ENROLLEES CONTRACTS PHYSICIANS PHYSICIANS CONTRACTS
--------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
California 314,777 53 1,640 5,213 --
Arizona 198,409 5 495 1,101 --
New Jersey 34,257 4 934 447 --
Delaware 9,082 1 76 75 --
South Carolina 8,094 3 186 60 2
North Carolina 14,844 1 152 24 9
Texas 134,044 14 1,254 2,496 15
Florida 110,024 3 539 2,521 8
</TABLE>
6
<PAGE> 253
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Michigan 33,969 2 476 1,028 7
Louisiana 7,023 2 228 156 17
Mississippi -- -- 102 -- 9
Tennessee -- -- 124 -- 7
Alabama -- -- 123 -- 6
Kentucky -- -- 47 -- 3
Pennsylvania -- -- 351 -- --
Georgia 253 1 237 863 4
Others -- -- 245 -- 22
------- -- ----- ------ ---
Total 864,776 89 7,209 13,984 109
======= == ===== ====== ===
</TABLE>
RESULTS OF OPERATIONS
The following table sets forth for the quarters ended March 31, 1996 and
March 31, 1997 selected financial data expressed as a percentage of operating
revenue.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------------------------------------------
1996 1997
---------- ----------
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- ---------- ----- -------- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Operating
revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Medical services
expense 73.7% 68.1% 71.9% 70.4% 73.6% 71.0%
General and
administrative
expenses 25.9% 24.4% 25.5% 24.0% 19.2% 23.2%
Merger,
restructuring
and other
unusual charges -- -- -- 19.7% -- 16.5%
----- ----- ----- ----- ----- -----
Income (loss)
from operations 0.4% 7.5% 2.6% (14.1%) 7.2% (10.7%)
Other income
(expense) 0.1% (0.7%) (0.1%) (1.7%) (0.1%) (1.4%)
----- ----- ----- ----- ----- -----
Income (loss)
before income taxes 0.5% 6.8% 2.5% (15.8%) 7.1% (12.1%)
Income tax
benefit (expense) (0.4%) (2.7%) (1.1%) 4.3% -- 3.6%
----- ----- ----- ----- ----- -----
Net income (loss) 0.1% 4.1% 1.4% (11.5%) 7.1% (8.5%)
===== ===== ===== ===== ===== =====
</TABLE>
MANAGED CARE BUSINESS
THREE MONTHS ENDED MARCH 31, 1996 AND MARCH 31, 1997
Operating Revenue -- The Company's managed care business operating revenue
increased to $186.8 million for the three months ended March 31,1997 from $70.6
million for the three months ended March 31, 1996. The revenue increase resulted
primarily from the increase in average enrollment for the quarter to 853,000 for
the three months ended March 31, 1997 from 380,000 for the comparable period in
1996. The 1997 increase resulted from the addition of (i) approximately 56,000
enrollees in California primarily as a result of acquisitions, (ii)
approximately 157,000 enrollees in Arizona as a result of a December
1996 acquisition, and approximately 30,000 enrollees as a result of internal
growth (iii) enrollment of 36,000 and 51,000 enrollees, respectively, in the
Mid-Atlantic region and Texas as a result of internal growth, (iv) approximately
84,000 enrollees in Florida as a result of acquisitions and 28,000 enrollees as
a result of internal growth and (v) approximately 31,000 enrollees in other
regions. For the three months ended March 31, 1997, the Company generated net
fee-for-service revenue of $29.5 million
7
<PAGE> 254
compared to net fee-for-service revenue for the three months ended March 31,
1996 of $4.1 million. The growth in fee-for-service revenue is attributable to
the increasing number of medical facilities managed by FPA.
Medical Services Expense - Medical services expense for the three months
ended March 31, 1997 was $131.6 million or 70.4% of managed care business
operating revenue as compared to $52.0 million or 73.7% of such operating
revenue for the three months ended March 31, 1996. The decrease in medical
services expense as a percent of such operating revenue for the three months
ended March 31, 1997 compared to the comparable period in 1996 resulted
primarily from the lower medical loss ratio in the expanding Florida market and
in medical groups in Sacramento and Tucson acquired since the first quarter of
1996.
General and Administrative Expense -- General and administrative expense
for the three months ended March 31, 1997 was $44.8 million or 24.0% of managed
care business operating revenue as compared to $18.3 million or 25.9% of such
operating revenue for the comparable period in 1996, as the Company achieved
economies of scale in its operations.
Merger, Restructuring and Other Unusual Charges - During the first quarter
of 1997, the managed care business of the Company incurred approximately $36.8
million in merger, restructuring and other unusual charges. Approximately $5.3
million related to costs of legal fees, accounting fees, investment bankers'
fees and other costs associated with the Merger. As the Merger was accounted for
as a pooling of interests, generally accepted accounting principles require that
transaction costs be expensed in the period in which the Merger is consummated.
Approximately $24.4 million arose from the costs of severance payments,
facilities and equipment lease terminations and other costs associated with
consolidating facilities and reducing staffing as a result of the Merger.
Approximately $5.6 million of the charges resulted from conformance of
accounting policies and other related costs associated with the Merger.
Approximately $1.5 million related to miscellaneous unusual charges.
Income (Loss) from Operations - For the three months ended March 31, 1997,
the managed care business of the Company generated a loss from operations of
$26.4 million including merger, restructuring and other unusual charges.
Excluding such merger, restructuring and other unusual charges, for the three
months ended March 31, 1997 income from operations was $10.5 million as compared
to income from operations of $0.3 million for the three months ended March 31,
1996.
EMERGENCY DEPARTMENT BUSINESS
THREE MONTHS ENDED MARCH 31, 1996 and 1997
Operating Revenue -- Emergency department business operating revenue
consists of gross patient revenue, net of contractual deductions and estimated
uncollectible accounts, plus other revenue, which consists principally of
hospital subsidy payments, flat-rate hospital contract revenue and non-patient
generated revenues. Operating revenue increased to $36.0 million for the three
months ended March 31, 1997 from $33.3 million for the three months ended March
31, 1996. On a percentage basis, the emergency department business' operating
revenue grew 8.0% in 1997. The increase was primarily attributable to the
increases in the number of the Company's emergency department contracts from 91
at March 31, 1996 to 109 at March 31, 1997.
Medical Services Expense -- Medical services expense increased to $26.5
million for the three months ended March 31, 1997 from $22.7 million for the
three months ended March 31, 1996 due primarily to the increase in the number of
healthcare professionals under contract, resulting from the increase in the
number of the Company's emergency department contracts, as well as negotiated
increases in fees paid to certain healthcare professionals. Medical services
expense as a percentage of operating revenue was 73.6% for the three months
ended March 31, 1997 compared to 68.1% for the three months ended March 31,
1996. The increase in medical costs as a percentage of operating revenue results
from the fact that in 1996, the operations of certain primary care centers were
reported
8
<PAGE> 255
under the emergency department business, while in 1997, they are included in the
managed care business, due to a change in the reporting structure of these
medical groups. These medical groups experienced a lower medical loss ratio than
the core emergency department business. The medical loss ratio as a percentage
of operating revenue for the emergency department business has remained stable.
General and Administrative Expense -- General and administrative expense was
$6.9 million for the three months ended March 31, 1997 as compared to $8.1
million or 24.4% of operating revenue for the corresponding period of the prior
year. The decrease in general and administrative expenses as a percentage of
operating revenue is primarily attributable to internal growth without added
administrative infrastructure and reductions in expense as a result of the
Sterling/FPA merger.
Net Income from Operations - For the three months ended March 31, 1997, the
emergency department business of the Company generated income from operations of
$2.6 million as compared to $2.5 million for the three months ended March
31, 1996.
QUARTERLY RESULTS
The following table presents financial information for the eight quarters ended
March 31, 1997. In the opinion of management, this information has been prepared
on the same basis as the audited consolidated financial statements and all
necessary adjustments, consisting only of normal recurring adjustments (unless
otherwise noted), have been included in the amounts presented below to present
fairly the quarterly results when read in conjunction with the audited
consolidated financial statements of the Company and notes thereto. The
Company's quarterly results have in the past been subject to fluctuation and as
a result, the operating results for any quarter are not necessarily indicative
of results for any future period. All numbers in the following table are in
thousands and retroactively include all AHI activity.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------------------------------------
June 30, September 30, December 31, March 31, June 30, September 30, December 31, March 31,
1995 1995 1995 1996 1996 1996 1996 1997
-------- ------------- ------------ --------- --------- ------------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenue $ 66,984 $ 74,435 $ 86,737 $ 103,953 $ 120,496 $ 154,025 $ 179,692 $ 222,840
Medical services
expense 49,344 53,002 61,487 74,726 91,981 120,477 143,494 158,105
General and
administrative
expenses 17,011 19,033 23,711 26,478 30,141 34,125 48,905 51,706
Merger,
restructuring
and other
unusual charges -- -- 1,590 -- -- 1,707 50,864 36,834
-------- -------- -------- --------- --------- --------- --------- ---------
Income (loss)
from operations 629 2,400 (51) 2,749 (1,626) (2,284) (63,571) (23,805)
Other income
(expense) (523) (839) 67 (173) (571) (762) (2,666) (3,232)
-------- -------- -------- --------- --------- --------- --------- ---------
Income (loss)
before taxes 106 1,561 16 2,576 (2,197) (3,046) (66,237) (27,037)
Income tax
(expense) benefit 281 (970) (554) (1,160) (2,006) (1,949) 4,035 8,111
-------- -------- -------- --------- --------- --------- --------- ---------
Net income (loss) $ 387 $ 591 $ ( 538) $ 1,416 $ (4,203) $ (4,995) $ (62,202) $ (18,926)
======== ======== ======== ========= ========= ========= ========= =========
</TABLE>
Operating revenue and medical services expense during the first and third
quarters have been and continue to be affected by movements of members in Payor
plans from one plan to another during periods of open enrollment for Payors.
Retroactive capitation rate increases generally take effect during the second
quarter, while medical services expense increases tend to occur ratably
throughout the year. Quarterly results may be affected by final settlements of
shared risk distributions which generally occur in the second and third quarter
of the year after which they are estimated. From time to time, final settlements
may differ from such estimated amounts. As the Company adds new Payors into the
FPA network, the timing of these adjustments may vary and, consequently,
quarterly results may be affected in the future, especially due to the start-up
of operations in new regions where there is no operating history. Similarly, if
medical services expense varies from amounts previously accrued for claims
incurred but not reported ("IBNR"),
9
<PAGE> 256
quarterly operating results may fluctuate. A portion of the Company's expansion
strategy includes the acquisition of individual and group physician practices by
the FPA network, and any such acquisition may materially affect quarterly
operating results, causing quarterly fluctuations.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to develop physician networks,
acquire physician practices and establish an infrastructure in new regions.
Capitation arrangements positively impact cash flow because FPA generally
receives capitation revenue prior to paying costs associated with services
provided under those agreements. However, shared risk arrangements negatively
impact cash flow because settlements in connection with these arrangements are
typically not collected until significantly after the end of the period in which
they were accrued. Fee-for-service revenues also negatively impact cash flow
because payment for services rendered generally lags by 90 to 120 days.
At March 31, 1997, the Company had cash, cash equivalents and marketable
securities of $35.2 million and a working capital deficit (current liabilities
in excess of current assets) of $72.9 million compared to cash, cash equivalents
and marketable securities of $55.5 million and working capital deficit of $38.1
million at December 31, 1996. Of the $72.9 million working capital deficit,
approximately $27.8 million results from the addition of AHI's balance sheet
(which had a working capital deficit of $26.5 million at December 31, 1996),
approximately $35.0 million relates to accrued merger, restructuring and other
unusual charges and approximately $9.0 million relates to increased IBNR claims.
Non-operating sources of cash include proceeds of approximately $5.5 million
from the exercise by the underwriters of the overallotment of convertible
subordinated debentures, issuance of a note payable of approximately $2.6
million, and proceeds from the issuance of stock options and warrants of
approximately $1.2 million. Non-operating uses of cash include the purchase of
property and equipment for approximately $3.3 million and the payment of
approximately $15.4 million in long-term debt.
At March 31, 1997 approximately 41% of the Company's current liabilities
consist of amounts accrued as payable to specialty care physicians, ancillary
providers, hospital and other providers of medical services. These accrued
liabilities include claims received by the Company which have not yet been paid
as well as an estimate of costs for covered medical benefits incurred by
enrollees but not yet reported by providers. These amounts are not due and
payable until after the provider has presented a claim and are typically paid
within 45 business days of receipt of such claims. The increase in claims
payable, including incurred but not reported claims, from approximately $97.7
million at December 31, 1996 to $127.3 million at March 31, 1997 resulted
primarily from increased membership and a shift in Payor mix of enrollees in
which enrollees incurred varying levels of IBNR claims.
During 1996, the Company entered into a $55.0 million credit, security,
guarantee and pledge agreement (the "Credit Agreement") with four financial
institutions. Permitted Borrowings, as defined in the Credit Agreement,
generally include acquisitions and capital expenditures. Borrowings under this
agreement bear interest at either LIBOR plus 2-1/2%, 2-3/4% or 3%, or prime rate
plus 1%, 1-1/4% or 1-1/2%, as defined in the agreement. At December 31, 1996 and
March 31, 1997, the Company had borrowed the maximum of $55.0 million under the
Credit Agreement.
In December 1996, the Company issued $75.0 million of convertible
subordinated debentures, which resulted in net proceeds to the Company of
approximately $73.0 million. The debentures bear interest at 6-1/2%, payable
semiannually, and are convertible into shares of the Company's stock at $25.95
per share. The debentures are redeemable by the Company after December 20, 1999.
Upon the occurrence of a Repurchase Event, as defined in the debentures, each
holder has the right to require repayment of the debentures at 100% of the
principal amount plus accrued interest. In January, 1997, the underwriters
exercised their overallotment and purchased an additional $5.5 million of the
debentures with identical terms.
10
<PAGE> 257
The Company believes that its cash on hand and anticipated cash flows from
its operations will be sufficient to meet the Company's operating capital needs
through 1997. The Company intends to obtain additional financing to support
planned expansion through an expansion of a line of credit facility to
approximately $100.0 million or through other potential financing alternatives
including private and public offerings of debt and equity-related securities.
There can be no assurance that the Company will be able to obtain such increased
credit facility or that it will be able to issue debt or equity-related
securities on terms satisfactory to it. To the extent that additional financing
is not available, the Company may delay certain potential acquisitions or
certain geographic expansion or may seek alternate sources of financing.
The strategy to expand the FPA network involves the acquisition of
individual and group physician practice assets and related businesses. Such
acquisitions may be consummated using cash, stock, notes or any combination
thereof. Management does not believe that inflation will have a material effect
on the operations of the Company.
FORWARD-LOOKING STATEMENTS
Certain Statements contained in this Quarterly Report are forward-looking.
Although FPA Medical Management, Inc. believes that its expectations are based
on reasonable assumptions within the bounds of its knowledge of its business
and operations, there can be no assurance that actual results will not differ
materially from its expectations. Factors that could cause actual results to
differ from expectations include the difficulty in controlling healthcare
costs, integrating new operations from acquired companies and the possible
negative effects of prospective healthcare reform. For other important factors
that may cause actual results to differ materially from expectations and
underlying assumptions, see reports by FPA Medical Management, Inc. filed with
the Securities and Exchange Commission.
11
<PAGE> 258
ITEM 4. Submission of matters to a Vote of Security Holders
At a special meeting of FPA stockholders held on March 17, 1997, two
matters were voted upon by the FPA stockholders. The FPA stockholders adopted
an agreement and plan of merger pursuant to which AHI Healthcare Systems, Inc.
became a wholly-owned subsidiary of FPA. The vote to adopt such agreement and
plan of merger was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 15,530,374
AGAINST 38,512
WITHHELD -
ABSTENTIONS 19,024
BROKER NON-VOTES -
</TABLE>
The second matter voted upon was the approval of amendments to the Omnibus
Stock Option Plan to increase the total number of shares of FPA Common Stock
issuable upon exercise of options granted under such plan by 1,500,000 to
6,500,000. The vote to approve such amendment was as follows:
<TABLE>
<CAPTION>
<S> <C>
FOR 13,361,987
AGAINST 2,171,741
WITHHELD -
ABSTENTIONS 54,182
BROKER NON-VOTES -
</TABLE>
ITEM 6. Exhibits And Reports On Form 8-K
(b) Reports on Form 8-K: The Company filed the following Reports on
Form 8-K since December 31, 1996:
Date of Report Items Reported
-------------- --------------
March 17, 1997 2, 7
12
<PAGE> 259
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FPA MEDICAL MANAGEMENT, INC.
(Registrant)
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ SETH FLAM Chief Executive Officer May 15, 1997
- ---------------------- (Principal Executive officer)
Seth Flams
/s/ STEVEN M. LASH Chief Financial Officer May 15, 1997
- ---------------------- (Principal Financial officer)
Steven M. Lash
13
<PAGE> 260
[ARTICLE] 5
<TABLE>
<S> <C>
[PERIOD-TYPE] 3-MOS
[FISCAL-YEAR-END] DEC-31-1997
[PERIOD-START] JAN-01-1997
[PERIOD-END] MAR-31-1997
[CASH] 20,135,507
[SECURITIES] 15,060,856
[RECEIVABLES] 158,782,789
[ALLOWANCES] 0
[INVENTORY] 0
[CURRENT-ASSETS] 233,710,627
[PP&E] 41,714,485
[DEPRECIATION] 0
[TOTAL-ASSETS] 598,923,101
[CURRENT-LIABILITIES] 306,555,469
[BONDS] 0
[COMMON] 61,712
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[OTHER-SE] 116,582,233
[TOTAL-LIABILITY-AND-EQUITY] 598,923,101
[SALES] 0
[TOTAL-REVENUES] 222,839,614
[CGS] 0
[TOTAL-COSTS] 158,105,080
[OTHER-EXPENSES] 88,539,188
[LOSS-PROVISION] 0
[INTEREST-EXPENSE] (3,232,103)
[INCOME-PRETAX] (27,036,757)
[INCOME-TAX] (8,111,027)
[INCOME-CONTINUING] (18,925,730)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (18,925,730)
[EPS-PRIMARY] (.59)
[EPS-DILUTED] (.59)
</TABLE>
<PAGE> 261
APPENDIX F
FPA'S CURRENT REPORT ON FORM 8-K/A DATED MARCH 17, 1997
F-1
<PAGE> 262
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): March 17, 1997
FPA MEDICAL MANAGEMENT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 0-24276 33-0604264
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
3636 Nobel Drive
Suite 200
San Diego, California 92122
(Address of principal executive offices) (Zip Code)
(619) 453-1000
(Registrant's telephone number, including area code)
Not Applicable
(Former name or former address, if changed since last report)
<PAGE> 263
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) Financial Statements of AHI Healthcare Systems, Inc.
(b) Pro Forma Financial Information.
<PAGE> 264
ITEM 7(a). AHI Healthcare Systems, Inc.
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations, Stockholders' Equity and Cash Flows for
the years ended December 31, 1996, 1995 and 1994
<PAGE> 265
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this current report on Form 8-K/A to be signed on
its behalf by the undersigned hereunto duly authorized.
FPA MEDICAL MANAGEMENT, INC.
By: /s/ JAMES A. LEBOVITZ
---------------------------------
Date: May 30, 1997 Title: Senior Vice President,
General Counsel and Secretary
<PAGE> 266
REPORT OF INDEPENDENT AUDITORS
AHI Healthcare Systems, Inc.
We have audited the accompanying consolidated balance sheet of AHI Healthcare
Systems, Inc., as of December 31, 1996, and the related consolidated statements
of operations, stockholders' equity and cash flows for the year then ended.
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 audit. The financial statements of the Company for the years ended
December 31, 1995 and 1994 were audited by other auditors whose report, dated
February 22, 1996, expressed an unqualified opinion on those statements.
We conducted our audit 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 audit provide a reasonable basis for our opinion.
In our opinion, such 1996 financial statements present fairly, in all material
respects, the consolidated financial position of AHI Healthcare Systems, Inc.
at December 31, 1996, and the consolidated results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles.
As discussed in Note 9 to the consolidated financial statements, AHI Healthcare
Systems, Inc. completed a merger with FPA Medical Management, Inc. on March 17,
1997.
DELOITTE & TOUCHE LLP
San Diego, California
May 2, 1997
<PAGE> 267
REPORT OF INDEPENDENT AUDITORS
Stockholder and Board of Directors
AHI Healthcare Systems, Inc.
We have audited the accompanying consolidated balance sheet of AHI Healthcare
Systems, Inc., as of December 31, 1995, and the related consolidated statements
of operations, stockholders' equity and cash flows for each of the two 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.
In our opinion, the consolidated 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 the consolidated results of
its operations and its cash flows for each of the two years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
February 22, 1996
<PAGE> 268
AHI Healthcare Systems, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31
1996 1995
--------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 9,868,000 $ 31,608,000
Accounts receivable, net of allowances of $3,704,000 in
1996 and $1,293,000 in 1995 10,613,000 12,639,000
Due from related parties and minority stockholders 141,000 177,000
Prepaid expenses 1,101,000 880,000
Recoverable income taxes (Note 3) - 1,050,000
Deferred income taxes (Note 3) - 858,000
--------------------------------
Total current assets 21,723,000 47,212,000
Equipment and leasehold improvements:
Equipment 9,590,000 5,738,000
Leasehold improvements 1,396,000 1,168,000
--------------------------------
10,986,000 6,906,000
Less: accumulated depreciation and amortization (4,736,000) (3,412,000)
--------------------------------
6,250,000 3,494,000
Deposits and other assets 309,000 422,000
Goodwill and other intangible assets, net (Notes 2 and 9) 11,306,000 25,128,000
--------------------------------
Total assets $ 39,588,000 $ 76,256,000
================================
</TABLE>
<PAGE> 269
AHI Healthcare Systems, Inc.
Consolidated Balance Sheets (continued)
<TABLE>
<CAPTION>
DECEMBER 31
1996 1995
--------------------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accrued medical claims $ 32,070,000 $ 15,442,000
Accounts payable 15,757,000 11,526,000
Notes payable and capital lease obligations, current portion
(Note 5) 437,000 3,364,000
Unsecured notes payable to stockholders, current portion
(Note 4) - 333,000
------------------------------------
Total current liabilities 48,264,000 30,665,000
Notes payable and capital lease obligations (Note 5) 1,094,000 1,203,000
Contingencies (Note 8)
Stockholders' equity:
8% cumulative convertible voting preferred stock, $0.01
par value, 25,000,000 shares authorized, none issued
-- --
Common stock, $0.01 par value, 75,000,000 shares authorized, 14,523,000
shares issued and outstanding at December 31, 1996 and 1995, respectively
(Note 2 and 6)
145,000 145,000
Additional paid-in capital 47,753,000 47,753,000
Accumulated deficit (57,267,000) (2,999,000)
Unamortized deferred compensation expense - (61,000)
Due from stockholder (401,000) (450,000)
-------------------------------------
(9,770,000) 44,388,000
-------------------------------------
Total liabilities and stockholders' equity $ 39,588,000 $ 76,256,000
=====================================
</TABLE>
See notes to consolidated financial statements.
<PAGE> 270
AHI Healthcare Systems, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1996 1995 1994
-------------------------------------------------------------
<S> <C> <C> <C>
Total operating revenue $ 118,786,000 $ 114,284,000 $ 60,746,000
Cost of medical services 117,911,000 88,997,000 43,464,000
-------------------------------------------------------------
Gross margin 875,000 25,287,000 17,282,000
-------------------------------------------------------------
Operating expenses:
Medical network operating expenses 9,721,000 6,717,000 2,883,000
General and administrative 23,738,000 11,586,000 7,377,000
Goodwill writedown 14,601,000 - -
Depreciation and amortization 2,728,000 2,167,000 760,000
Network development 4,229,000 9,127,000 4,223,000
-------------------------------------------------------------
55,017,000 29,597,000 15,243,000
-------------------------------------------------------------
Operating income (loss) (54,142,000) (4,310,000) 2,039,000
Interest income 1,139,000 520,000 115,000
Interest expense (185,000) (530,000) (210,000)
-------------------------------------------------------------
Net interest income (expense) 954,000 (10,000) (95,000)
-------------------------------------------------------------
Income (loss) before income taxes and minority
interest (53,188,000) (4,320,000) 1,944,000
Minority interest - - 332,000
-------------------------------------------------------------
Income (loss) before income taxes (53,188,000) (4,320,000) 2,276,000
Income taxes expense (benefit) 1,080,000 (1,219,000) 725,000
-------------------------------------------------------------
Net income (loss) $ (54,268,000) $ (3,101,000) $ 1,551,000
=============================================================
Historical net income (loss) per share $ (3.74) $ (0.26) $ 0.13
=============================================================
Pro forma information:
Historical net income (loss) $ (54,268,000) $ (3,101,000) $ 1,551,000
Charge in lieu of income taxes for Subchapter S
Corporations (Note 3) - (262,000) -
-------------------------------------------------------------
Pro forma net income (loss) $ (54,268,000) $ (3,363,000) $ 1,551,000
=============================================================
Pro forma net income (loss) per share $ (3.74) $ (0.29) $ 0.13
=============================================================
Weighted average shares outstanding 14,523,000 11,800,000 11,998,000
See accompanying notes.
</TABLE>
<PAGE> 271
AHI Healthcare Systems, Inc.
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Additional Retained
Common Stock Preferred Paid-In Earnings
Shares Amount Stock Capital (Deficit)
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993 13,276,000 $133,000 - $ 752,000 $ 614,000
Issuance of common stock in
acquisition 192,000 2,000 1,980,000
Repurchase and cancellation of
common stock (2,577,000) (26,000) 26,000 (1,483,000)
Issuance of common stock for
stockholder notes 2,577,000 26,000 2,974,000
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)
Other equity transactions (16,000)
Amortization
Net income 1,551,000
Dividends paid (522,000)
----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1994 10,891,000 109,000 - 2,742,000 160,000
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
Issuance of common stock in
initial public offering 3,600,000 36,000 44,503,000
Amortization
Net Loss (3,101,000)
----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 14,523,000 145,000 - 47,753,000 (2,999,000)
Amortization
Payments received on notes
receivable from stockholder
Net loss (54,268,000)
----------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 14,523,000 $ 145,000 $ - $ 47,753,000 $(57,267,000)
============================================================================
Unamortized
Deferred
Compensation Due from
Expense Stockholder Total
-----------------------------------------------
<C> <C> <C>
$ (140,000) $ - $ 1,359,000
1,982,000
(1,483,000)
(3,000,000) -
-
3,000,000 -
(16,000)
39,000 39,000
1,551,000
(522,000)
-----------------------------------------------
(101,000) - - 2,910,000
-
(450,000) -
44,539,000
40,000 40,000
(3,101,000)
-----------------------------------------------
(61,000) (450,000) 44,388,000
61,000 61,000
49,000 49,000
(54,268,000)
-----------------------------------------------
$ - $ (401,000) $ (9,770,000)
===============================================
</TABLE>
See accompanying notes.
<PAGE> 272
AHI Healthcare Systems, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1996 1995 1994
-------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $(54,268,000) $(3,101,000) $ 1,551,000
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Goodwill writedown 14,601,000
Depreciation and amortization 2,728,000 2,167,000 760,000
Amortization of deferred compensation expense 61,000 40,000 23,000
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 2,026,000 (4,253,000) (2,380,000)
Due from related parties 36,000 118,000 37,000
Prepaid expenses (221,000) (596,000) (44,000)
Recoverable and deferred income taxes 1,908,000 (1,406,000) (399,000)
Deposits and other assets 113,000 (139,000) (121,000)
Accrued medical claims 16,250,000 (2,448,000) (233,000)
Accounts payable 3,256,000 3,785,000 1,027,000
Income taxes payable - (810,000) 744,000
-------------------------------------------------
Net cash provided by (used in) operating activities (13,510,000) (6,643,000) 1,833,000
INVESTING ACTIVITIES
Purchase of equipment and leasehold improvements (4,080,000) (2,140,000) (1,597,000)
Acquisition of subsidiaries, net of cash acquired (503,000) (2,481,000) (1,238,000)
-------------------------------------------------
Net cash used in investing activities (4,583,000) (4,621,000) (2,835,000)
FINANCING ACTIVITIES
Proceeds from issuance of notes payable and
Bank Facility borrowings 5,550,000 12,065,000 222,000
Principal payments on notes payable and Bank Facility
borrowings (9,246,000) (14,387,000) (237,000)
Proceeds from payments of notes receivable from stockholder 49,000 - -
Dividends paid - - (522,000)
Issuance of common stock - 44,539,000 20,000
Purchase of treasury shares - - (1,253,000)
-------------------------------------------------
Net cash provided by (used in) financing activities (3,647,000) 42,217,000 (1,770,000)
-------------------------------------------------
Increase (decrease) in cash and cash equivalents (21,740,000) 30,953,000 (2,772,000)
Cash and cash equivalents at beginning of year 31,608,000 655,000 3,427,000
-------------------------------------------------
Cash and cash equivalents at end of year $ 9,868,000 $31,608,000 $ 655,000
=================================================
</TABLE>
<PAGE> 273
AHI Healthcare Systems, Inc.
Consolidated Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31
1996 1995 1994
----------------------------------------------
<S> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Stockholder note receivable issued in connection
with common stock issuance $ - $ 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 $ 2,173,000 $ 19,305,000 $ 9,895,000
Less:
Issuance of promissory notes 327,000 1,703,000 3,193,000
Other liabilities assumed 1,343,000 14,166,000 3,197,000
Common stock issued - - 1,962,000
----------------------------------------------
Cash paid for acquisitions (503,000) (3,436,000) (1,543,000)
Cash of acquired businesses - 955,000 305,000
----------------------------------------------
Net cash paid $ (503,000) $ (2,481,000) $(1,238,000)
==============================================
</TABLE>
See accompanying notes.
<PAGE> 274
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") 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"), 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, three in Northern
California, 24 in Texas, six in Florida and eight in Georgia. AHI is developing
additional Physician Networks in several other states. AHI, its subsidiaries and
the Physician Networks are collectively referred to herein as the "Company."
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. In some
of the 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 AHI 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 or significant stockholders of AHI. Effective January
31, 1997, all such minority interest have been acquired by the applicable
Physician Network for aggregate consideration consisting of AHI common stock
valued at approximately $200,000.
Effective January 1, 1994, two of the Physician Networks, and January 1, 1995,
the remaining Physician Networks, entered into a Management Agreement (the
"Agreements") with AHI. The Agreements codify AHI's previously existing
unilateral and perpetual control over the business enterprise of the Physician
Networks. Such Agreements reflect the intent and operating practices of the
Company 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
Physician Networks. The Company may unilaterally terminate the Agreements
without cause. Under the Agreements, in return for the assignment of revenue of
the
<PAGE> 275
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS AND BASIS OF PRESENTATION (CONTINUED)
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 the total of (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 shared risk 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, 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 interest in any residual
profits of the Physician Network. 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 AHI from owning an
organization which engages in the practice of medicine. Therefore,
notwithstanding the aforementioned services provided by AHI, 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, AHI has the right to sell, purchase
and encumber all assets of the Physician Networks.
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 by 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
<PAGE> 276
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS AND BASIS OF PRESENTATION (CONTINUED)
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 Network, 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 AHI and the Physician Network,
and due to AHI'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 the Company. All significant
inter-entity transactions have been eliminated in consolidation.
The Company also consolidates all majority-owned subsidiaries. All significant
intercompany transactions have been eliminated in consolidation.
<PAGE> 277
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS AND BASIS OF PRESENTATION (CONTINUED)
The Company managed health care services for prepaid covered lives under
contract with various health plans as follows:
<TABLE>
<CAPTION>
Enrollees at
December 31
1996 1995 1994
-----------------------------------
<S> <C> <C> <C>
Commercial 162,119 147,982 104,839
Senior 20,865 24,048 10,857
Medicaid 23,505 7,528 2,632
-----------------------------------
206,489 179,558 118,328
===================================
</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.
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.
<PAGE> 278
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 method over the shorter of the lease period
or the estimated useful lives of the leasehold improvements.
GOODWILL
Goodwill totaling $28,667,000 arose as the result of several acquisitions in
1996, 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. 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 events or circumstances are present which may indicate
impairment, 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 acquisition 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 upon a review of the carrying value of goodwill
and the Company's significant operating loss in 1996 resulting primarily from
recent adjustments to increase risk share receivable and medical costs reserves
and high administrative service costs as a percentage of revenue compared to the
industry, the Company recorded a $14,601,000 charge to write off goodwill
balances associated with these acquisitions, except for goodwill associated with
The Healthcare Partnership ("THP") acquisition in Houston, Texas. Although, THP
had a deficiency in its assets at the February 1995 acquisition date, the
Company has made modifications to the payor and physician contracts, and
increased administrative efficiencies to address the operating deficiencies at
THP. As a result of these changes, the Company estimates that it will be able to
recover the goodwill acquired in the THP transaction.
<PAGE> 279
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL (CONTINUED)
Goodwill has been recorded at cost and is being amortized on the straight-line
method over 20 years. Accumulated amortization was $1,199,000 and $1,365,000 at
December 31, 1996 and 1995, 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 assets. The adoption of
SFAS No. 121 at January 1, 1996 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 No. 123") "Accounting for
Stock-Based Compensation," which became effective for the current fiscal year.
SFAS No. 123 requires expanded disclosures of stock-based compensation
arrangements with employees and encourages (but does not require) compensation
expense 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 expense based on the
intrinsic value of the equity instrument awarded. The Company has continued to
apply APB Opinion No. 25 to its stock-based compensation awards to employees and
has disclosed the required pro forma effect on net income (loss) per share (see
Note 6).
DEFERRED COMPENSATION EXPENSE
Upon the consummation of employment agreements with certain physician employees,
the Company sold such employees shares of AHI common stock 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.
<PAGE> 280
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MEDICAL REVENUES AND COST RECOGNITION
Operating revenue of the Company consists primarily of fees for medical services
provided by the Physician Networks under capitated contracts with various
managed care payors including health maintenance organizations (HMOs). For the
years ended December 31, 1996, 1995 and 1994, FHP Inc. represented approximately
17%, 22% and 35%, respectively, of the Company's total operating revenue, and
CareAmerica Southern California, Inc. represented approximately 6%, 11% and 22%,
respectively, of the Company's total operating revenue. Upon completion of the
THP acquisition in February 1995, the Company'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 each of the fiscal years 1996 and 1995, after giving effect to
the merger between FHP, Inc. and PacifiCare Health Systems, Inc., approximately
50% of the Company's total operating revenue would have been attributable to
payor agreements with the merged FHP/PacifiCare entity. Capitation revenue under
HMO contracts is prepaid monthly to the Physician Networks (and assigned to AHI)
based on the number of enrollees electing any one of the Physician Networks as
their health care provider. HMO contracts also include provisions to share in
the risk for hospitalization whereby the Company 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 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, 1996 and
1995 are $4,177,000 and $6,624,000, 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 Company participates in reinsurance protection programs which limit the
amount of risk it ultimately bears by providing reimbursement payments once
medical services provided to an individual enrollee exceed an agreed-upon
amount. Estimates of reinsurance recoveries are
<PAGE> 281
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MEDICAL REVENUES AND COST RECOGNITION (CONTINUED)
included in accounts receivable in the accompanying consolidated 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.
MEDICAL MALPRACTICE LIABILITY INSURANCE
The Company maintains 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 December
1996, the Company renewed its 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 insurance coverage, the Company maintains 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.
<PAGE> 282
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company (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 and subsidiaries elected to operate as a C-Corporation,
while the Physician Networks continued to elect S-Corporation status through
December 31, 1994. Effective January 1, 1995, all except two of the Physician
Networks, and effective January 1, 1996, all but one of the Physician Networks,
elected C-Corporation status. As a result of the S-Corporation status, the
Company through December 31, 1993, was not subject to federal income taxes;
however, the Physician Networks 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 109 was
not significant, and the impact on the combined results of operations for the
three years ended December 31, 1996 also was not significant. Income taxes have
been provided using the liability method in accordance with SFAS No.109.
NET INCOME (LOSS) PER SHARE
Net income (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 years ended December
31, 1996 and 1995 and were dilutive for the year ended December 31, 1994.
In February 1997, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earning per Share." This
Statement specifies the computation, presentation, and disclosure requirements
for earnings per share for entities with publicly held common stock. SFAS No.
128 is not in effect for the Company for 1996, but will be in effect for
financial statements issued for period ending after December 15, 1997,
including interim periods. The Company does not expect the adoption of SFAS No.
128 to have a material effect on its net income per share.
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 1995 and 1994 amounts have been made to correspond
with the 1996 presentation.
<PAGE> 283
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
2. ACQUISITIONS
During the years ended December 31, 1996 and 1995, AHI made acquisitions as set
forth below, each of which has been accounted for as a purchase. The
consolidated financial statements include the operating results of each business
from the date of acquisition.
PRIVATE PHYSICIANS GROUP AT STANFORD ("PPGS")
Effective February 28, 1996, AHI, through a physician stockholder of a Physician
Network, acquired PPGS for consideration totaling $327,000. This acquisition
resulted in goodwill totaling $2,229,000.
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 the Company for $29,000 per stockholder per year
for 10 years, payable in quarterly installments of approximately $7,000 per
stockholder beginning June 1, 1995. The intangible asset associated with the
covenant not-to-compete was written off in connection with the Goodwill
write-off (Note 1). In addition, the Company entered into provider agreements
with each minority stockholder for a period of 10 years, which contain certain
minimum payment guarantees. The purchase price in excess of assets acquired was
$4,133,000.
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 payable. The acquisition
price in excess of assets acquired was $12,505,000.
INTEGRATED MEDICAL MANAGEMENT SYSTEMS, INC. AND INTEGRATED MEDICAL MARKETING
SYSTEMS, INC. (COLLECTIVELY, "IMMS")
On December 12, 1994, the Company issued approximately 192,000 shares 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
<PAGE> 284
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
2. ACQUISITIONS (CONTINUED)
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.
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 the Company as if the acquisitions of the above mentioned businesses had
taken place as of January 1, 1995. 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>
1996 1995
-------------------------------------
<S> <C> <C>
Total operating revenues $119,051,000 $119,011,000
Net loss (54,350,000) (3,627,000)
Net loss per share $ (3.74) $ (0.31)
</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.
<PAGE> 285
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
3. INCOME TAXES (CONTINUED)
The components of the provision for income taxes (benefit) are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1996 1995 1994
---------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 43,000 $ - $ 922,000
State 62,000 20,000 220,000
---------------------------------------------
105,000 1,142,000
20,000
Deferred:
Federal 608,000 (960,000) (358,000)
State 367,000 (279,000) (59,000)
---------------------------------------------
975,000 (1,239,000) (417,000)
Total:
Federal 651,000 (960,000) 564,000
State 429,000 (259,000) 161,000
=============================================
$ 1,080,000 $(1,219,000) $725,000
=============================================
</TABLE>
Temporary differences and carryforwards that result in deferred income tax
assets as of December 31 are as follows:
<TABLE>
<CAPTION>
1996 1995
-----------------------------
<S> <C> <C>
Deferred income tax assets:
Depreciation and amortization $ 76,000 $ 22,000
Net operating loss carryforward 13,961,000 895,000
Accrued expenses 1,267,000 434,000
-----------------------------
15,304,000 1,351,000
Valuation allowance (15,304,000) (493,000)
=============================
Net deferred income taxes $ -0- $ 858,000
=============================
</TABLE>
<PAGE> 286
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
3. INCOME TAXES (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>
1996 1995 1994
-------------------------------------------------
<S> <C> <C> <C>
Tax provision (credit) at statutory rate $(18,084,000) $ (1,469,000) $ 774,000
State taxes, net of federal benefit (283,000) (259,000) 123,000
Effect of S-Corporation elections and
revocations - - (121,000)
Goodwill amortization 5,226,000 498,000 53,000
Loss (with)/without carryforward
benefit 14,189,000 - (57,000)
Other 32,000 11,000 (47,000)
-------------------------------------------------
$ 1,080,000 $ (1,219,000) $ 725,000
=================================================
</TABLE>
Effective January 1, 1995, all but two of the Physician Networks, and effective
January 1, 1996, all but one of the Physician Networks, 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%.
The Company has net operating loss carryforwards of approximately $48,400,000
which may be utilized in future years before expiring between 2007 and 2011. Of
this amount, approximately $1,200,000 arose from pre-acquisition losses of an
acquired Physician Network, the use of which is limited to future taxable income
of this Physician Network.
Taxes paid totaled approximately $100,000, $1,253,000 and $363,000 in 1996, 1995
and 1994, respectively.
<PAGE> 287
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (Continued)
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. Dr. Berezovsky was paid approximately $1,600,000 in accordance with
the terms of his agreement as a result of the merger between the Company and
FPA Medical Management, Inc.
In May 1995, AHI entered into an employment agreement with a Director of
AHI 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 $-0-, $23,000 and $1,000 in 1996, 1995 and 1994,
respectively. Additionally, the Company leases certain property from a trust of
a former owner of IMMS. Annual rental payments totaled approximately $94,000,
$75,000 and $-0- in 1996, 1995 and 1994, respectively. The lease expires in
April 2001, unless renewed by the Company for up to an additional ten years.
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 a Physician Network 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 in 1995 and $41,000 in 1994.
The Company has capitated and fee-for-service provider contracts with physician
professional corporations owned by physician stockholders of the Company.
Medical costs incurred totaled approximately $989,000, $760,000 and $391,000 for
1996, 1995, and 1994, respectively.
<PAGE> 288
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
4. RELATED PARTY TRANSACTIONS (CONTINUED)
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 1996, 1995 and 1994, respectively. This
agreement was terminated in March 1997.
<PAGE> 289
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
5. NOTES PAYABLE
Notes payable consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31
1996 1995
-------------------------
<S> <C> <C>
Note payable for the acquisition of Camino Real Medical Group, interest at the
applicable Federal short-term rate (6.58% at August 31, 1996 and 6.08% at
December 31, 1995), 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
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. 1,240,000 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
Other notes payable 291,000 98,000
--------------------------
1,531,000 4,567,000
Less current portion 437,000 3,364,000
--------------------------
$1,094,000 $1,203,000
==========================
</TABLE>
<PAGE> 290
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
5. NOTES PAYABLE (CONTINUED)
The Company has a revolving line of credit with two banks (the "Bank Facility")
totaling $15,000,000 at December 31, 1996. 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 Physician Networks. The line is collateralized by AHI and the
guarantor's accounts receivable and unencumbered equipment. The line of credit
was 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 amended the Bank Facility effective March 31, 1996, namely the
cash flow coverage and debt coverage ratio covenants. Effective June 30, 1996,
the Bank Facility was again amended, deleting all financial covenants, namely
the cash flow coverage and debt coverage ratio covenants. At December 31, 1996,
the Company had no indebtedness under the line of credit agreement.
Interest paid on all obligations totaled $185,000, $427,000, and $59,000, in
1996, 1995, and 1994, 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.
<PAGE> 291
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK TRANSACTIONS (CONTINUED)
In May 1995, a Director of the Company 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, the Company 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 the Company 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 Physician Networks.
On May 5, 1994, the Company entered into a stock repurchase and mutual release
agreement (the Agreement) with a former officer of AHI. Under the terms of the
Agreement, the Company agreed to purchase the former officer's entire equity
interest representing approximately 19% of all the Company's 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 1994, respectively. This former officer also received an additional $300,000
upon the completion of the Company's initial public offering in 1995 in
connection with the Agreement.
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.
<PAGE> 292
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
Under the LT Plans, awards of options of AHI common 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.
<PAGE> 293
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
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, 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
Granted 194,000 2,000
Exercised - -
Canceled (221,389)
----------------------------------
Outstanding at December 31, 1996 2,694,399 17,000
==================================
</TABLE>
Stock options are granted at fair market value of the common stock at the date
of grant. Stock options generally expire ten years from the date of grant. Stock
options generally vest over a four to five year period, with equal amounts
vesting on each anniversary from the date of grant.
<PAGE> 294
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
The weighted average fair value of the stock options granted during 1996 was
$6.20. The fair value of each stock option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following weighted
average assumptions used for grants in 1996: risk-free interest rate of 5.7%;
expected dividend yield of 0%; expected life of 1.7 years; and expected
volatility of 48%. The expected life of the 1996 stock option grants was
computed using an expiration date less than the remaining contractual life of
the option because AHI became a subsidiary of FPA Medical Management, Inc. on
March 17, 1997 (see Note 9).
The outstanding stock options at December 31, 1996 have a weighted average
remaining contractual life of 0.21 years. Stock options totaling 1,498,826
shares were exercisable at December 31, 1996 and have a weighted average
exercise price of $10.73 per share.
The Company accounts for its stock options in accordance with Accounting
Principles Board Opinion No. 25, under which no compensation cost has been
recognized for stock option awards because the stock options were granted at
fair market value at the date of grant. Had compensation cost been determined
consistent with SFAS No. 123, the Company's pro forma net loss and net loss per
share would have been $(54,591,000) and $(3.76), respectively for 1996 and the
Company's pro forma net loss and net loss per share would have been $(3,217,000)
and $(.27), respectively for 1995. Because the SFAS No. 123 method of accounting
has not been applied to options granted prior to January 1, 1995, the resulting
pro forma compensation cost may not be representative of that to be expected in
future years.
Following is a summary of outstanding stock options at December 31, 1996:
<TABLE>
<CAPTION>
Weighted
Average Weighted Weighted
Stock Options Remaining Average Stock Options Average
Range of Outstanding at Contractual Exercise Exercisable at Exercise
Exercise Prices December 31, 1996 Life Price December 31, 1996 Price
----------------- -------------------- -------------- ------------ --------------------- ------------
<S> <C> <C> <C> <C> <C>
$ 6.00 - $ 7.02 1,209,279 0.21 $ 6.9285 709,256 $ 7.0200
$14.00 - $14.33 1,502,120 0.21 14.0526 789,570 14.0558
---------- ---------- -------- ---------- ---------
$ 6.00 - $14.33 2,711,399 $ 0.21 10.8752 $ 1,498,826 10.7264
========== ========== ======== =========== =========
</TABLE>
<PAGE> 295
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
Pursuant to AHI's merger with FPA on March 17, 1997 (see Note 9), AHI stock
option grants totaling 1,207,279 shares at prices less than $8.99 per share
became fully exercisable and were converted directly into 108,208 shares of FPA
common stock. AHI stock options granted at a price greater than $8.99 totaling
15,000 shares granted pursuant to the 1995 Non-Employee Director Stock Option
Plan were converted into FPA stock options. The remaining 1,489,120 stock
options outstanding, which were granted at prices greater than $8.99, were
canceled.
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. Pursuant to AHI's merger with FPA on March 17,
1997 (see Note 9), the warrant was converted into an FPA warrant.
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,
1996, are as follows:
<TABLE>
<S> <C>
1997 $3,668,000
1998 3,119,000
1999 1,938,000
2000 1,374,000
2001 893,000
Thereafter 2,100,000
-----------
$13,092,000
===========
</TABLE>
Total rent expense was $3,731,000 in 1996, $2,377,000 in 1995, and $910,000 in
1994.
<PAGE> 296
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
8. CONTINGENCIES
The Company is involved in litigation arising in the normal course of business.
Management, in consultation with legal counsel, has determined that any such
contingencies would not materially affect the Company's financial position or
operating results.
The Company 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 the Company, certain of its
officers and directors, and its Underwriters on December 20, 1995. The suit
asserts that the Company, among other things, artificially inflated the price of
its stock by misleading securities analysts and by failing to disclose in its
initial public offering prospectus alleged difficulties with the acquisition of
the Lakewood Health Plan. The plaintiffs seek unspecified damages on behalf of
the stockholders who purchased AHI common stock between September 28, 1995 and
December 19, 1995. The Company intends to vigorously defend this lawsuit. The
Company does not expect that the outcome of the lawsuit will have a material
adverse effect on the financial condition or results of operations of the
Company.
9. SUBSEQUENT EVENTS
On March 17, 1997, AHI completed a merger with FPA Medical Management, Inc.
("FPA"). AHI was merged with and into FPA Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of FPA. Pursuant to the merger
agreement, AHI became a wholly-owned subsidiary of FPA and each outstanding
share of AHI common stock was exchanged for 0.391 shares of FPA common stock.
The shares of FPA common stock issued to the AHI stockholders were registered
through a registration statement filed under the Securities Act of 1933, as
amended. AHI's merger with FPA has been treated as a tax-free reorganization and
accounted for as a pooling of interests.
The Department of Corporations ("DOC"), the regulatory body for all managed care
plans in the state of California, and the Company have recently discussed
whether, under the DOC's current regulatory interpretation, the Company's
operations in California, as currently conducted, meet the definition of a
health service plan. As a result of such discussions, the Company voluntarily
determined to commence the process of preparing, through a wholly-owned
subsidiary, an application for restricted licensure as a Knox-Keene health care
service plan for its California operations. The restricted license, if granted,
allows for the receipt of capitation payments for hospital and medical
professional services, but does not allow the marketing of a health care
<PAGE> 297
AHI Healthcare Systems, Inc.
Notes to Consolidated Financial Statements (continued)
9. SUBSEQUENT EVENTS (CONTINUED)
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 reduction of revenue) and/or incur additional
administrative costs in the future to meet applicable regulatory requirements.
Although the Company expects the licensure process to have no material impact on
its operations, there can be no assurances the DOC will not impose requirements
adverse to the Company's business. In 1997, the Company requested the licensure
process be put on hold with the DOC because of its merger with FPA. On
February 24, 1997, FPA submitted a Notice of Material Modification to request
incorporation of the California activity of AHI under FPA's restricted DOC
license. On May 27, 1997, the DOC consented to the withdrawal of AHI's licensure
application.
<PAGE> 298
ITEM 7(b). Pro Forma Financial Information
FPA MEDICAL MANAGEMENT, INC. AND AHI HEALTHCARE SYSTEMS, INC.
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
DECEMBER 31, 1996
<TABLE>
<CAPTION>
FPA Medical AHI Healthcare Pro Forma Pro Forma
Management, Inc. Systems, Inc. Adjustments Consolidated
---------------- -------------- ----------- ------------
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 5,594,877 9,868,000 15,462,877
Marketable securities 40,000,000 40,000,000
Accounts receivable - net 95,306,672 10,613,000 105,919,672
Accounts receivable - other 25,095,247 25,095,247
Due from related parties and minority stockholders 141,000 141,000
Prepaid expenses 5,397,174 1,101,000 6,498,174
Capitation deposit 15,409,771 15,409,771
Deferred income tax asset 3,478,751 3,478,751
------------ ----------- ----------- ------------
Total current assets 190,282,492 21,723,000 212,005,492
Property and equipment - net 40,139,332 6,250,000 46,389,332
Restricted cash and deposits 488,535 488,535
Goodwill - net 284,288,009 11,306,000 295,594,009
Intangible assets - net 6,667,269 6,667,269
Investment in GLHP 4,994,900 4,994,900
Deferred income tax asset 3,189,665 3,189,665
Other assets 9,146,431 309,000 9,455,431
------------ ----------- ----------- ------------
Total $539,196,633 39,588,000 -- 578,784,633
============ =========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 46,215,398 15,757,000 35,300,000 A 97,272,398
Claims payable, including incurred but not reported claims 65,618,268 32,070,000 97,688,268
Accrued payroll and related liabilities 3,814,695 3,814,695
Income tax payable 2,294,159 2,294,159
Other liabilities 13,104,704 13,104,704
Current portion of accrued liability for professional
liability claims 1,297,790 1,297,790
Long-term debt, current portion 70,015,734 437,000 70,452,734
------------ ----------- ----------- ------------
Total current liabilities 202,360,748 48,264,000 35,300,000 285,924,748
Long-term debt, net of current portion 184,774,984 1,094,000 185,868,984
Accrued liability for professional liability claims,
net of current portion 4,217,000 4,217,000
Other long-term liabilities 4,325,862 4,325,862
------------ ----------- ----------- ------------
Total liabilities 395,678,594 49,358,000 35,300,000 480,336,594
Stockholders' equity:
Preferred stock
Common stock 49,542 145,000 (133,643) B 60,899
Additional paid-in capital 153,396,348 47,753,000 133,643 B 201,282,991
Stock payable 534,600 534,600
Due from stockholder (401,000) (401,000) (401,000)
Accumulated deficit (10,462,451) (57,267,000) (35,300,000) A (103,029,451)
------------ ----------- ----------- ------------
Total stockholders' equity 143,518,039 (9,770,000) (35,300,000) 98,448,039
------------ ----------- ----------- ------------
Total $539,196,633 39,588,000 -- 578,784,633
============ =========== =========== ============
</TABLE>
See notes to the pro forma condensed consolidated financial statements.
<PAGE> 299
FPA MEDICAL MANAGEMENT, INC. AND AHI HEALTHCARE SYSTEMS, INC.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
Year Ended December 31, 1996
<TABLE>
<CAPTION>
FPA Medical AHI
Management, Healthcare Pro Forma
Inc. Systems, Inc. Consolidated
------------ ------------- ------------
<S> <C> <C> <C>
Managed care revenue $267,641,917 $115,775,000 $383,416,917
Fee-for-service revenue, net of
contractual deductions 172,676,696 3,011,000 175,687,696
------------ ------------- ------------
Operating revenue 440,318,613 118,786,000 559,104,613
Expenses:
Medical services expense 313,706,608 117,911,000 431,617,608
------------ ------------- ------------
126,612,005 875,000 127,487,005
General and administrative expense 99,230,319 40,416,000 139,646,319
Merger, restructuring and other unusual
charges 37,970,868 14,601,000 52,571,868
------------ ------------- ------------
Loss from operations (10,589,182) (54,142,000) (64,731,182)
Other income (expense):
Interest and other income 852,288 1,139,000 1,991,288
Interest expense (5,979,532) (185,000) (6,164,532)
------------ ------------- ------------
Total other income (expense) (5,127,244) 954,000 (4,173,244)
------------ ------------- ------------
Loss before income taxes (15,716,426) (53,188,000) (68,904,426)
Income tax expense -- 1,080,000 1,080,000
------------ ------------- ------------
Net loss $(15,716,426) $(54,268,000) $(69,984,426)
============ ============ ============
Net loss per share [C] $ (.72) $ (9.56) $ (2.56)
============ ============ ============
Weighted average shares outstanding [C] 21,702,786 5,678,509 27,381,295
============ ============ ============
</TABLE>
See notes to the pro forma condensed consolidated financial statements.
23
<PAGE> 300
FPA MEDICAL MANAGEMENT, INC. AND AHI HEALTHCARE SYSTEMS, INC.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
Year Ended December 31, 1995
<TABLE>
<CAPTION>
FPA Medical AHI Healthcare Pro Forma
Management, Inc. Systems, Inc. Consolidated
---------------- -------------- ------------
<S> <C> <C> <C>
Managed care revenue $ 49,880,875 $110,243,000 $160,123,875
Fee-for-service revenue, net
of contractual deductions 118,470,607 4,041,000 122,511,607
------------ ------------ ------------
Operating revenue 168,351,482 114,284,000 282,635,482
Expenses:
Medical services expense 113,742,878 88,997,000 202,739,878
------------ ------------ ------------
54,608,604 25,287,000 79,895,604
General and administrative expense 44,892,765 29,597,000 74,489,765
Merger, restructuring and other
unusual charges 1,589,908 -- 1,589,908
------------ ------------ ------------
Income (loss) from operations 8,125,931 (4,310,000) 3,815,931
Other income (expense):
Interest and other income 609,297 520,000 1,129,297
Interest expense (2,177,943) (530,000) (2,707,943)
------------ ------------ ------------
Total other expense (1,568,646) (10,000) (1,578,646)
------------ ------------ ------------
Income (loss) before income taxes 6,557,285 (4,320,000) 2,237,285
Income tax expense (benefit) 2,723,320 (1,219,000) 1,504,320
------------ ------------ ------------
Net income (loss) $ 3,833,965 $ (3,101,000) $ 732,965
============ ============ ============
Net income (loss) per share [C] $ .28 $ (.67) $ .04
============ ============ ============
Weighted average shares
outstanding [C] 13,693,192 4,613,800 18,306,992
============ ============ ============
</TABLE>
See notes to the pro forma condensed consolidated financial statements.
23
<PAGE> 301
FPA MEDICAL MANAGEMENT, INC. AND AHI HEALTHCARE SYSTEMS, INC.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
Year Ended December 31, 1994
<TABLE>
<CAPTION>
FPA Medical AHI Healthcare Pro Forma
Management, Inc. Systems, Inc. Consolidated
---------------- -------------- ------------
<S> <C> <C> <C>
Managed care revenue $ 18,193,286 $ 58,721,000 $ 76,914,286
Fee-for-service revenue, net
of contractual deductions 39,498,164 2,025,000 41,523,164
------------ ------------ ------------
Operating revenue 57,691,450 60,746,000 118,437,450
Expenses:
Medical services expense 41,352,105 43,464,000 84,816,105
------------ ------------ ------------
16,339,345 17,282,000 33,621,345
General and administrative expense 13,607,073 14,911,000 28,518,073
------------ ------------ ------------
Income from operations 2,732,272 2,371,000 5,103,272
Other income (expense):
Interest and other income 186,955 115,000 301,955
Interest expense (187,364) (210,000) (397,364)
------------ ------------ ------------
Total other expense (409) (95,000) (95,409)
------------ ------------ ------------
Income before income taxes 2,731,863 2,276,000 5,007,863
Income tax expense 942,025 725,000 1,667,025
------------ ------------ ------------
Net income $ 1,789,838 $ 1,551,000 $ 3,340,838
============ ============ ============
Pro forma: (Note 2)
Adjustment to income tax expense $ (110,235) $ -- $ (110,235)
Net income $ 1,679,603 $ 1,551,000 $ 3,230,603
Net income per share $ .26 $ .33 $ .30
============ ============ ============
Weighted average shares
outstanding [C] 6,579,828 4,691,218 11,271,046
============ ============ ============
</TABLE>
See notes to the pro forma condensed consolidated financial statements.
24
<PAGE> 302
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES AND
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Unaudited)
(1) On March 17, 1997, FPA Medical Management, Inc. ("FPA") consummated the
merger (the "Merger") of a wholly owned subsidiary of FPA ("Merger Sub"), with
and into AHI Healthcare Systems, Inc., a Delaware corporation ("AHI"), pursuant
to an Agreement and Plan of Merger entered into as of November 8, 1996 as
amended by Amendment No. 1 to Agreement and Plan of Merger, dated as of February
5, 1997 (the "Merger Agreement"). Pursuant to the Merger Agreement, AHI became a
wholly owned subsidiary of the Registrant and each outstanding share of AHI
common stock was converted into approximately .391 shares of FPA's common stock.
The shares of FPA's common stock issued to the AHI shareholders were registered
on a Registration Statement on Form S-4 filed under the Securities Act of 1933,
as amended, which was declared effective on February 13, 1997.
The Merger has been accounted for as a pooling of interests and the Pro
Forma Condensed Consolidated Financial Statements are a restatement of the
historical financial statements of FPA and AHI as if the Merger had been
consummated for all periods presented.
The following adjustments are necessary to reflect the pro forma
effects of the Merger.
<PAGE> 303
[A] Nonrecurring costs estimated to be $35,300,000 will be recorded in
connection with the Merger. These costs consist primarily of professional
fees, certain employee termination costs and charges associated with
conformance of accounting policies. Because such costs are nonrecurring,
they have not been recorded in the accompanying unaudited pro forma
condensed consolidated statements of operations. However, such costs were
charged to income in the period the Merger was consummated.
[B] Reflects the exchange of each share of AHI common stock for .391 shares (the
exchange ratio) of FPA common stock pursuant to the Merger. Based on AHI's
14,533,041 shares outstanding at December 31, 1996, the pro forma number of
additional shares of FPA common stock outstanding is 5,678,507 shares.
[C] The net income (loss) per share and the weighted average shares outstanding
was calculated based on the historical weighted average shares outstanding
(as restated for prior acquisitions and mergers) of FPA and AHI giving
effect to the shares of FPA common stock issued in connection with the
Merger at an exchange ratio of .391.
(2) The pro forma net income and net income per share information in the
1994 consolidated statement of operations for FPA reflect the effect on
historical results as if FPA had been a C Corporation rather than a S
Corporation for income tax purposes, and no tax benefit arose as a result of
the change in tax status.
<PAGE> 304
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements on Form
S-3 (Nos. 33-3760 and 333-2007) and Form S-8 (Nos. 33-00076, 333-16741 and
333-15755) of FPA Medical Management, Inc. of our report dated May 2, 1997, on
the consolidated financial statements of AHI Healthcare System, Inc. for the
year ended December 31, 1996, appearing in this Current Report on Form 8-K/A of
FPA Medical Management, Inc.
DELOITTE & TOUCHE LLP
San Diego, California
May 29, 1997
<PAGE> 305
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-3 Nos. 33-3760 and 333-2007 and Form S-8 Nos. 33-00076, 333-16741 and
333-15755) of FPA Medical Management, Inc. and in the related Prospectuses of
our report dated February 22, 1996, with respect to the 1995 and 1994
consolidated financial statements of AHI Healthcare Systems, Inc. included in
this Current Report (Form 8-K/A) of FPA Medical Management, Inc.
/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Los Angeles, California
May 28, 1997
<PAGE> 306
APPENDIX G
FPA's CURRENT REPORT ON FORM 8-K/A DATED JULY 31, 1997
G-1
<PAGE> 307
APPPENDIX H
FPA'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1997
H-1
<PAGE> 308
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ____________
COMMISSION FILE NUMBER 0-24276
FPA MEDICAL MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0604264
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
----------------
3636 NOBEL DRIVE
SUITE 200
SAN DIEGO, CA 92122
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(619) 453-1000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NONE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
----------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS:
[X] YES [ ] NO
AS OF AUGUST 12, 1997 THERE WERE OUTSTANDING 33,206,485 SHARES OF THE
REGISTRANT'S COMMON STOCK, PAR VALUE $.002 PER SHARE.
================================================================================
<PAGE> 309
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets................... 3
Consolidated Statements of Operations
(Unaudited)................................. 4
Consolidated Statements of Cash Flows
(Unaudited)................................. 5
Notes to Consolidated Financial Statements.... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................. 8
PART II -- OTHER INFORMATION
Item 4. Submission of matters to a Vote of Security
Holders..................................... 16
Item 6. Exhibits and Reports on Form 8-K.............. 16
Signatures.............................................. 17
</TABLE>
2
<PAGE> 310
ITEM 1. Financial Statements
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS [1]
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 16,307,770 $ 12,648,662
Marketable securities 40,000,000 24,619,747
Accounts receivable - net of allowance for uncollectible accounts 106,978,672 155,018,465
Accounts receivable - other 25,095,247 31,367,778
Notes receivable from affiliate 1,327,822 395,000
Prepaid expenses and other assets 7,024,174 4,942,817
Prepaid income taxes -- 3,667,457
Capitation Deposits 15,409,771 --
Deferred income tax asset 3,478,751 6,158,892
------------- -------------
Total current assets 215,622,207 238,818,818
Property and equipment - net of accumulated depreciation 47,486,863 39,123,772
Restricted cash and deposits 488,535 500,000
Goodwill - net of accumulated amortization 295,594,009 303,730,344
Intangible assets - net of accumulated amortization 6,667,269 2,676,470
Investment in GLHP 4,994,900 4,994,900
Deferred income tax asset 3,189,665 3,689,058
Other assets 10,104,006 19,708,636
------------- -------------
Total $ 584,147,454 $ 613,241,998
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 63,716,039 $ 43,010,855
Claims payable, including incurred but not reported claims 100,769,268 124,044,354
Accrued payroll and related liabilities 4,124,272 19,987,173
Income tax payable 2,294,159 --
Other current liabilities 13,218,704 920,000
Current portion of accrued liability for professional liability claims 1,297,790 585,668
Long-term debt, current portion 70,610,667 12,416,613
------------- -------------
Total current liabilities 256,030,899 200,964,663
Long-term debt, net of current portion 186,131,219 271,099,787
Accrued liability for professional liability claims, net of current
portion 4,217,000 3,195,912
Other long-term liabilities 4,801,862 16,758,033
------------- -------------
Total liabilities 451,180,980 492,018,395
Stockholders' equity:
Preferred stock, $.001 par value per share, 2,000,000 shares
authorized, no shares outstanding
Common stock, $.002 par value, 98,000,000 shares authorized,
32,656,637 and 32,966,497 shares issued and outstanding at
December 31, 1996 and June 30, 1997, respectively 65,313 65,933
Additional paid-in capital 207,126,793 209,292,915
Stock payable 534,600 534,600
Due from stockholder (427,000) (427,000)
Accumulated deficit (74,333,232) (88,242,845)
------------- -------------
Total stockholders' equity 132,966,474 121,223,603
------------- -------------
Total $ 584,147,454 $ 613,241,998
============= =============
</TABLE>
See notes to consolidated financial statements.
[1] These financial statements include the balances of AHI Healthcare Systems,
Inc. and HealthCap, Inc. for all periods presented. See Note 2.
3
<PAGE> 311
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) [1]
<TABLE>
<CAPTION>
SIX MONTHS ENDED THREE MONTHS ENDED
------------------------------ ------------------------------
JUNE 30, 1996 JUNE 30, 1997 JUNE 30, 1996 JUNE 30, 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Managed care revenue $ 160,830,580 $ 337,816,319 $ 88,354,228 $ 173,738,800
Fee-for-service revenue, net of
contractual deductions 76,370,748 137,752,525 38,835,285 70,818,430
------------- ------------- ------------- -------------
Operating revenue 237,201,328 475,568,844 127,189,513 244,557,230
Medical services expense 177,674,950 340,833,454 97,613,362 174,725,374
------------- ------------- ------------- -------------
59,526,378 134,735,390 29,576,151 69,831,856
General and administrative expense 59,293,090 109,904,940 31,676,351 54,575,338
Merger, restructuring and other
unusual charges -- 38,004,841 -- 1,171,255
------------- ------------- ------------- -------------
Income (loss) from operations 233,288 (13,174,391) (2,100,200) 14,085,263
Other income (expense):
Interest and other income 1,007,651 4,778,925 461,793 3,826,261
Interest expense (1,675,068) (8,865,929) (990,737) (4,694,162)
------------- ------------- ------------- -------------
Total other expense (667,417) (4,087,004) (528,944) (867,901)
Income (loss) before income taxes (434,129) (17,261,395) (2,629,144) 13,217,362
Income tax (expense) benefit (3,175,048) 3,351,782 (2,015,365) (4,758,245)
------------- ------------- ------------- -------------
Net income (loss) $ (3,609,177) $ (13,909,613) $ (4,644,509) $ 8,459,117
============= ============= ============= =============
Net income (loss) per share $ (0.13) $ (0.40) $ (0.16) $ 0.25
============= ============= ============= =============
Weighted average shares outstanding 27,660,452 34,510,257 28,317,866 34,259,107
============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
[1] These financial statements include the balances of AHI Healthcare Systems,
Inc. and HealthCap, Inc. for all periods presented. See Note 2.
4
<PAGE> 312
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) [1]
<TABLE>
<CAPTION>
SIX MONTHS ENDED
------------------------------
JUNE 30, JUNE 30,
1996 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (3,609,177) $ (13,909,613)
Adjustments to reconcile net loss to net cash used
by operating activities:
Depreciation and amortization 5,097,791 13,009,995
Imputed interest on notes payable 40,341 --
Changes in assets and liabilities:
Accounts receivable (34,296,946) (54,246,074)
Income tax receivable/payable 3,052,810 (5,961,616)
Capitation deposit -- 15,409,771
Deferred income taxes (149,100) (3,179,534)
Accounts payable and accrued expenses 587,542 (20,705,184)
Claims payable, including incurred but not reported claims 24,879,507 23,275,086
Accrued liability for professional liability claims -- (1,733,210)
Other liabilities (148,461) (342,533)
Accrued payroll and related liabilities 2,725,107 15,862,901
Prepaid expenses and other 823,653 (7,521,473)
------------- -------------
Total adjustments 2,612,244 (26,131,871)
------------- -------------
Net cash used by operating activities (996,933) (40,041,484)
Cash flows from investing activities:
Purchase of property and equipment (5,846,239) (3,053,951)
Payments for intangible assets (1,709,493) (4,237,539)
Net payments (to) from affiliate (676,968) 932,822
Net sale of marketable securities 6,512,258 15,380,253
Investment in GLHP (3,000,000) --
Acquisitions, net of cash acquired (7,911,954) (817,667)
Payments escrowed for acquisition 85,000 (11,465)
Other (108,900) --
------------- -------------
Net cash provided (used) by investing activities (12,656,296) 8,192,453
Cash flows from financing activities:
Proceeds from merger, net 28,890 --
Proceeds from issuance of preferred stock 150,000 --
Proceeds from issuance of long-term debt 17,233,760 8,176,152
Payments on long-term debt (14,586,539) (169,336,743)
Net borrowings/(payments) under bank line of credit (788,325) 187,820,105
Proceeds from exercise of stock options and warrants 6,736,373 1,530,409
------------- -------------
Net cash provided by financing activities 8,774,159 28,189,923
------------- -------------
Net decrease in cash (4,879,070) (3,659,108)
Cash and cash equivalents, beginning of period 37,165,225 16,307,770
------------- -------------
Cash and cash equivalents, end of period $ 32,286,155 $ 12,648,662
============= =============
Supplemental cash flow information
Cash paid for interest $ 990,052 $ 9,406,161
Cash paid for income taxes 2,789,602 5,789,368
Equipment acquired under capital leases 495,900 --
Common stock issued in connection with acquisitions 9,361,657 --
Effects of acquisitions:
Fair value of assets acquired 48,227,016 9,711,610
Liabilities assumed 40,315,062 8,893,943
------------- -------------
Net cash paid for acquisitions $ 7,911,954 $ 817,667
============= =============
</TABLE>
See notes to consolidated financial statements.
[1] These financial statements include the balances of AHI Healthcare Systems,
Inc. and HealthCap, Inc. for all periods presented. See Note 2.
5
<PAGE> 313
FPA MEDICAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
In the opinion of management, the accompanying consolidated financial
statements include all adjustments (which consist only of normal recurring
adjustments) necessary for a fair presentation of the financial position of FPA
Medical Management, Inc. ("FPA") and subsidiaries and certain affiliated
professional corporations (collectively, the "Company"), and the results of its
operations and its cash flows for the interim periods presented. Although FPA
believes that the disclosures in these consolidated financial statements are
adequate to make the information presented not misleading, certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. Results of operations for the interim periods are not necessarily
indicative of results to be expected for any other interim period or for the
full year.
The consolidated financial statements for the three and six months ended
June 30, 1996 and June 30, 1997 are unaudited and should be read in conjunction
with the consolidated financial statements and notes thereto included in FPA's
Annual Report on Form 10-K, as amended, for the year ended December 31, 1996 and
the supplemental consolidated financial statements filed on Form 8-K dated July
31, 1997.
Consolidation Policy - The Company's financial statements include the
activity of all of its wholly-owned subsidiaries and certain affiliated
professional corporations ("Professional Corporations") over which the Company
has direct or indirect unilateral and perpetual control. 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. All intercompany transactions have been eliminated in
consolidation. These financial statements include the balances of AHI Healthcare
Systems, Inc. ("AHI") and HealthCap, Inc. ("HealthCap") for all periods
presented (see Note 2).
Net Income (Loss) per Share - Net income (loss) per share is computed based
on the weighted average number of shares and share equivalents (options and
warrants) outstanding, giving retroactive effect to all stock splits and pooling
of interests transactions.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". This
statement specifies the computation, presentation, and disclosure requirements
for earnings per share for entities with publicly held common stock. SFAS No.
128 is not in effect for the Company in the quarter ended June 30, 1997, but
will be in effect for financial statements issued for periods ending after
December 15, 1997, including interim periods. The Company does not expect the
adoption of SFAS No. 128 to have a material effect on its Net income (loss) per
share.
2. SUBSEQUENT EVENTS
The following significant events have occurred subsequent to December 31,
1996:
On March 17, 1997, FPA completed the merger (the "AHI Merger") of FPA
Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of FPA,
with and into AHI. Pursuant to the AHI Merger, AHI became a wholly-owned
subsidiary of FPA and each outstanding share of AHI Common Stock was exchanged
for .391 shares of FPA Common Stock. The shares of FPA Common Stock issued to
the AHI stockholders were registered on a Registration Statement on Form S-4
filed under the Securities Act of 1933, as amended. The AHI Merger was treated
as a tax free reorganization and accounted for as a pooling of interests.
On June 30, 1997, FPA completed the merger (the "HealthCap Merger") of FPA
Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of FPA,
with and into HealthCap. Pursuant to the HealthCap Merger, HealthCap became a
wholly-owned subsidiary of FPA and each outstanding share of HealthCap Common
Stock was exchanged for .0829 shares of FPA Common Stock. The shares of FPA
Common Stock issued to HealthCap stockholders were registered on a Registration
Statement on Form S-3 filed under the Securities Act of 1933. The HealthCap
Merger was treated as a tax free reorganization and accounted for as a pooling
of interests.
On July 1, 1997, FPA entered into an Agreement and Plan of Merger with
Health Partners, Inc. ("Health Partners"), providing for the acquisition of
Health Partners by FPA in a tax free reorganization anticipated to be accounted
for as a pooling of interests. The
6
<PAGE> 314
completion of the proposed merger is subject to approval by the stockholders of
Health Partners, receipt of all necessary regulatory approvals and other
customary conditions.
The Company entered into a Credit Agreement with Lehman Commercial Paper
Inc. and the several lenders from time to time parties thereto (the "Lenders")
dated as of June 30, 1997 (the "Credit Agreement") consisting of a $175 million
three-year revolving line of credit and a $100 million four and one-quarter year
term loan. The obligations of the Company under the Credit Agreement are secured
by all the assets of the Company and all the capital stock of its subsidiaries.
The Credit Agreement contains customary terms, events of default and covenants
(including financial covenants) which, among other things, limit payment of cash
dividends, the consummation of certain acquisitions and the incurrence of
additional debt. Borrowings under this agreement bear interest at either
Citibank, N.A.'s prime rate (the "Base Rate"), plus the applicable margin or
LIBOR plus the applicable margin, as defined in the agreement. As of June 30,
1997, the Company had drawn $187.8 million under the Credit Agreement.
7
<PAGE> 315
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
GENERAL
The Company derives substantially all of its operating revenue from (i) the
payments made by health maintenance organizations and other prepaid health
insurance plans (collectively, "Payors") to the Professional Corporations for
managed care medical services, (ii) fee-for-service revenues for medical centers
in the managed care business, and (iii) fee-for-service revenues from emergency
department medical services.
MANAGED CARE BUSINESS
The Company has two types of Payor contracts: contracts for both inpatient
and outpatient services ("global capitation" contracts) and those limited to
outpatient services or professional medical services ("outpatient capitation"
contracts). Under global capitation contracts, the Company receives a fixed
monthly amount per enrollee for which the Company is financially responsible to
provide the enrollees with all necessary inpatient and outpatient care. Under
outpatient capitation contracts, the Company receives a fixed monthly amount per
enrollee for which the Company is financially responsible to provide the
enrollees with all necessary outpatient care. Additionally, under these
outpatient capitation contracts, the Company is a party to shared risk
arrangements with Payors which generally reward the Company for the efficient
utilization of hospital inpatient services. Under these shared risk
arrangements, the Company shares any surplus or, in some cases, deficit, of
amounts pre-established by the Payor in relation to inpatient expense. Revenue
under global capitation contracts represented 28.2% and 21.7% for the three
months ended June 30, 1996 and 1997, respectively, and 23.1% and 21.5% for the
six months ended June 30, 1996 and 1997, respectively, of managed care business
operating revenue. Revenue under outpatient capitation contracts represented
65.7% and 61.7% for the three months ended June 30, 1996 and 1997, respectively,
and 71.1% and 62.3% for the six months ended June 30, 1996 and 1997,
respectively, of managed care business operating revenue.
The Company also generates fee-for-service revenue for the performance of
medical services through the Professional Corporations and its subsidiaries.
These revenues are presented net of contractual deductions and represented 6.1%
and 16.6% for the three months ended June 30, 1996 and 1997, respectively, and
5.8% and 16.2% for the six months ended June 30, 1996 and 1997, respectively, of
managed care business operating revenue.
Through the Professional Corporations and its subsidiaries, the Company
contracts with various healthcare providers to provide primary care and
specialty medical services to covered enrollees. Primary care physicians are
compensated on either a salary or capitation basis. Specialty care physician
services are paid for on either a discounted fee-for-service or capitation
basis. Managed care business medical services expense paid for on a capitation
basis (for certain primary care and specialty care services) or fixed salary
basis totaled 47.5% and 14.4% for the three months ended June 30, 1996 and 1997,
respectively, and 46.4% and 24.3% for the six months ended June 30, 1996 and
1997, respectively, of managed care business operating revenue, with the
remainder of medical services expense (for primary care, specialty care,
ancillary services, inpatient and outpatient services, lab charges, etc.) paid
for on a discounted fee-for-service or per diem basis.
EMERGENCY DEPARTMENT BUSINESS
Through the emergency department business, the Company provides contract
management and support services primarily to emergency departments. As of June
30, 1997 the Company provided physician practice management services on a
contract basis to
8
<PAGE> 316
108 emergency departments, one anesthesia department, three correctional
healthcare facilities and two rural health urgent care clinics located in 22
states. The Company contracts with approximately 1,300 affiliated physicians who
provide certain medical services to approximately 1.4 million patients annually.
The Company's contractual arrangements with hospitals are primarily
fee-for-service contracts whereby hospitals generally agree, in exchange for the
Company's services, to authorize the Company and its contracted healthcare
professionals to bill and collect the professional component of the charges for
medical services rendered by the Company's contracted healthcare professionals.
Fee-for-service contracts may, depending on the hospital's patient volume and
payor mix, involve the payment of a subsidy to the Company by the hospital.
During the three months ended June 30, 1996 and 1997 and the six months ended
June 30, 1996 and 1997, 84.1% and 82.4%, and 83.6% and 82.8%, respectively, of
the Company's emergency department business operating revenue was earned on a
fee-for-service basis, and the Company emphasized fee-for-service contracts in
its marketing activities.
Medical services expense for the emergency department business consists
primarily of payments made to independent contractor and employee physicians
("Physician Costs") and, to a lesser extent the costs of medical supplies and
malpractice insurance and laboratory fees. During the three months ended June
30, 1996 and 1997 and the six months ended June 30, 1996 and 1997, Physician
Costs accounted for 93.4% and 93.6%, and 93.2% and 97.2%, respectively, of
emergency department business medical services expense.
OPERATIONAL DEVELOPMENT
The future growth of FPA is largely dependent on a continued increase in
the number of new enrollees in the FPA network. This growth may come from (i)
affiliations with, or acquisitions of, individual or group physician practices
serving enrollees of Payors in the FPA network or of new Payors, (ii) increased
membership in plans of Payors with which the Professional Corporations have
contracts and whose members are patients of physicians in the FPA network or
(iii) agreements with Payors, physicians and hospitals in other geographic
markets. The process of identifying and consummating suitable acquisitions of,
or affiliations with, physician groups can be lengthy and complex. The
marketplace for such acquisitions and affiliations is subject to increasing
competitive pressures. There can be no assurance that FPA will be successful in
identifying, acquiring or affiliating with additional physician groups or
hospitals or that the Company will be able to contract with new Payors. In
addition, there can be no assurance that the Company's acquisitions will be
successfully integrated on a timely basis or that the anticipated benefits of
these acquisitions will be realized. Failure to effectively accomplish the
integration of acquired companies could have a material adverse effect on FPA's
results of operations and financial condition. FPA's ability to expand is also
dependent upon its ability to comply with legal and regulatory requirements in
the jurisdictions in which it operates or will operate and to obtain necessary
regulatory approvals, certificates and licenses.
In June 1997, the Company completed its merger with HealthCap, which
serviced approximately 85,000 enrollees. In March 1997, the Company completed
its merger with AHI, which serviced approximately 210,000 enrollees. Effective
in December 1996, the Company and certain Professional Corporations acquired two
medical groups, one each in California and Arizona, providing services to
approximately 63,000 and 157,000 enrollees, respectively. In October 1996, the
Company and Sterling Healthcare Group, Inc. (the "Sterling Merger") completed a
merger. In July 1996, the Company acquired two independent practice
associations, one in Arizona and Florida, providing services to approximately
14,000 and 4,000 enrollees, respectively. In June 1996, the Company acquired
Physicians First, Inc., operating 40 medical clinics in Florida, through which
110 primary care physicians provided services to approximately 80,000 enrollees.
In January 1996, the Company acquired three independent practice associations in
the Los Angeles, Ventura and Sacramento regions of California, which now service
approximately 76,000 enrollees and include 570 primary care physicians.
9
<PAGE> 317
Listed below is a summary of enrollees, Payor contracts, primary care
physicians, specialty care physicians, and emergency department business
contracts (including anesthesiology, urgent care and correctional facility
contracts) by region at June 30, 1997.
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
NUMBER OF NUMBER OF SPECIALTY EMERGENCY
PAYOR PRIMARY CARE CARE DEPARTMENT
ENROLLEES CONTRACTS PHYSICIANS PHYSICIANS CONTRACTS
-------------- -------------- -------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
California 317,897 53 1,692 5,492 --
Arizona 212,078 5 434 1,055 --
New Jersey 31,281 4 896 447 --
Delaware 9,248 1 73 75 --
South Carolina 7,813 3 203 120 2
North Carolina 14,033 1 169 43 9
Texas 133,999 22 894 2,345 12
Florida 136,217 4 264 3,249 9
Michigan 39,537 2 493 1,028 6
Louisiana 6,572 4 182 183 17
Mississippi -- -- 116 -- 10
Tennessee -- -- 91 -- 8
Alabama -- -- 129 -- 6
Kentucky -- -- 42 -- 3
Pennsylvania -- -- 353 -- --
Georgia 21,841 1 237 698 4
Nevada 18,641 1 110 151 --
Missouri 15,911 3 65 280 --
Others -- -- 326 243 23
-------- ------- --------- -------- -------
Total 965,068 104 6,769 15,409 109
======== ======= ========= ======== =======
</TABLE>
RESULTS OF OPERATIONS
The following tables set forth for the three and six months ended June 30,
1996 and 1997 selected financial data (in thousands) and selected financial data
expressed as a percentage of operating revenue.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
- -------------------------------------------------------------------------------------------------------------
1996 1997
----------------------------------------- -----------------------------------------
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- ---------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Operating
revenue $ 94,142 $ 33,048 $127,190 $208,287 $ 36,270 $244,557
Medical services
expense 75,140 22,474 97,614 147,752 26,974 174,726
General and
administrative
expense 23,617 8,059 31,676 48,030 6,545 54,575
Merger,
restructuring
and other
unusual charges -- -- -- 1,171 -- 1,171
-------- ---------- -------- -------- ---------- --------
Income (loss)
from operations (4,615) 2,515 (2,100) 11,334 2,751 14,085
Other expense, net (303) (226) (529) (843) (25) (868)
-------- ---------- -------- -------- ---------- --------
Income (loss)
before income
taxes (4,918) 2,289 (2,629) 10,491 2,726 13,217
Income tax
benefit (expense) (1,123) (892) (2,015) (4,758) -- (4,758)
-------- ---------- -------- -------- ---------- --------
Net income (loss) $ (6,041) $ 1,397 $ (4,644) $ 5,733 $ 2,726 $ 8,459
======== ========== ======== ======== ========== ========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
- -------------------------------------------------------------------------------------------------------------
1996 1997
---------------------------------------- -----------------------------------------
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- ----------- ----- -------- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Operating
revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Medical services
expense 79.8% 68.0% 76.7% 70.9% 74.4% 71.4%
General and
administrative
expense 25.1% 24.4% 24.9% 23.1% 18.0% 22.3%
Merger,
restructuring
and other
unusual charges -- -- -- 0.6% -- 0.5%
----- ----- ----- ----- ----- -----
Income (loss)
from operations (4.9%) 7.6% (1.6%) 5.4% 7.6% 5.8%
Other expense, net (0.3%) (0.7%) (0.4%) (0.4%) (0.1%) (0.4%)
----- ----- ----- ----- ----- -----
Income (loss)
before income
taxes (5.2%) 6.9% (2.0%) 5.0% 7.5% 5.4%
Income tax
benefit (expense) (1.2%) (2.7%) (1.6%) (2.3%) -- (1.9%)
----- ----- ----- ----- ----- -----
Net income (loss) (6.4%) 4.2% (3.6%) 2.7% 7.5% 3.5%
===== ===== ===== ===== ===== =====
</TABLE>
10
<PAGE> 318
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
- -------------------------------------------------------------------------------------------------------------
1996 1997
----------------------------------------- -----------------------------------------
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
-------- ---------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Operating
revenue $170,805 $ 66,396 $237,201 $403,292 $ 72,277 $475,569
Medical services
expense 132,498 45,177 177,675 287,352 53,482 340,834
General and
administrative
expense 43,085 16,208 59,293 96,433 13,472 109,905
Merger,
restructuring
and other
unusual charges -- -- -- 38,005 -- 38,005
-------- ---------- -------- -------- ---------- --------
Income (loss)
from operations (4,778) 5,011 233 (18,498) 5,323 (13,175)
Other expense, net (211) (456) (667) (4,039) (48) (4,087)
-------- ---------- -------- -------- ---------- --------
Income (loss)
before income
taxes (4,989) 4,555 (434) (22,537) 5,275 (17,262)
Income tax
benefit (expense) (1,397) (1,778) (3,175) 3,352 -- 3,352
-------- ---------- -------- -------- ---------- --------
Net income (loss) $ (6,386) $ 2,777 $ (3,609) $(19,185) $ 5,275 $(13,910)
======== ========== ======== ======== ========== ========
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
- ------------------------------------------------------------------------------------------------------------
1996 1997
-------------------------------------------- -------------------------------------------
MANAGED EMERGENCY MANAGED EMERGENCY
CARE DEPARTMENT CARE DEPARTMENT
BUSINESS BUSINESS TOTAL BUSINESS BUSINESS TOTAL
------------- ------------- ------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Operating
revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Medical services
expense 77.6% 68.0% 74.9% 71.3% 74.0% 71.7%
General and
administrative
expense 25.2% 24.4% 25.0% 23.9% 18.6% 23.1%
Merger,
restructuring
and other
unusual charges -- -- -- 9.4% -- 8.0%
----- ---- ---- ---- ----- -----
Income (loss)
from operations (2.8%) 7.6% 0.1% (4.6%) 7.4% (2.8%)
Other expense, net (0.1%) (0.7%) (0.3%) (1.0%) (0.1%) (0.8%)
----- ---- ---- ---- ---- ----
Income (loss)
before income
taxes (2.9%) 6.9% (0.2%) (5.6%) 7.3% (3.6%)
Income tax
benefit (expense) (0.8%) (2.7%) (1.3%) 0.8% -- 0.7%
----- ---- ---- ---- --- ----
Net income (loss) (3.7%) 4.2% (1.5%) (4.8%) 7.3% (2.9%)
===== ==== ==== ==== ==== ======
</TABLE>
MANAGED CARE BUSINESS
THREE MONTHS ENDED JUNE 30, 1996 AND JUNE 30, 1997
Operating Revenue -- The Company's managed care business operating revenue
increased to $208.3 million for the three months ended June 30, 1997 from $94.1
million for the three months ended June 30, 1996. The revenue increase resulted
primarily from the increase in average enrollment for the quarter to 965,000 for
the three months ended June 30, 1997. Enrollment increases resulted primarily
from the addition of (i) approximately 56,000 enrollees in California as a
result of acquisitions, (ii) approximately 157,000 enrollees in Arizona as a
result of a December 1996 acquisition, and approximately 30,000 enrollees as a
result of internal growth (iii) enrollment of 36,000 and 51,000 enrollees,
respectively, in the Mid-Atlantic region and Texas as a result of internal
growth, (iv) approximately 84,000 enrollees in Florida as a result of
acquisitions and 28,000 enrollees as a result of internal growth and (v)
approximately 31,000 enrollees in other regions. For the three months ended June
30, 1997, the Company generated fee-for-service revenue, net of contractual
deductions, of $34.5 million compared to fee-for-service revenue, net of
contractual deductions, for the three months ended June 30, 1996 of $5.8
million. The growth in fee-for-service revenue is attributable primarily to
acquisitions of medical groups by the Company.
Medical Services Expense - Medical services expense for the three months
ended June 30, 1997 was $147.8 million or 70.9% of managed care business
operating revenue as compared to $75.1 million or 79.8% of such operating
revenue for the three months ended June 30, 1996. The decrease in medical
services expense as a percent of such operating revenue for the three months
ended June 30, 1997 compared to the comparable period in 1996 resulted primarily
from the lower medical loss ratio in the expanding Florida market and in medical
groups in Sacramento and Tucson acquired since the first quarter of 1996.
General and Administrative Expense -- General and administrative expense
for the three months ended June 30, 1997 was $48.0 million or 23.1% of managed
care business operating revenue as compared to $23.6 million or 25.1% of such
operating revenue for the comparable period in 1996, as the Company continues to
achieve economies of scale in its operations.
Merger, Restructuring and Other Unusual Charges - During the second quarter
of 1997, the managed care business of the Company incurred approximately $1.2
million in merger, restructuring and other unusual charges. Such charges consist
primarily of legal fees, accounting fees, investment bankers' fees and other
costs associated with the Company's mergers. As most of the Company's mergers
are accounted for as pooling of interests transactions, generally accepted
accounting principles require that transaction costs be expensed in the period
in which the merger is consummated.
11
<PAGE> 319
Income (Loss) from Operations - For the three months ended June 30, 1997,
the managed care business of the Company generated income from operations of
$11.3 million including merger, restructuring and other unusual charges.
Excluding such merger, restructuring and other unusual charges, for the three
months ended June 30, 1997 income from operations was $12.5 million as compared
to a loss from operations of $4.6 million for the three months ended June 30,
1996.
SIX MONTHS ENDED JUNE 30, 1996 AND JUNE 30, 1997
Operating Revenue -- The Company's managed care business operating revenue
increased to $403.3 million for the six months ended June 30, 1997 from $170.8
million for the six months ended June 30, 1996. The revenue increase resulted
primarily from the increase in average enrollment for the period to 956,000 for
the six months ended June 30, 1997. The enrollment increases resulted from the
addition of (i) approximately 56,000 enrollees in California primarily as a
result of acquisitions, (ii) approximately 157,000 enrollees in Arizona as a
result of a December 1996 acquisition, and approximately 30,000 enrollees as a
result of internal growth (iii) enrollment of 36,000 and 51,000 enrollees,
respectively, in the Mid-Atlantic region and Texas as a result of internal
growth, (iv) approximately 84,000 enrollees in Florida as a result of
acquisitions and 28,000 enrollees as a result of internal growth and (v)
approximately 31,000 enrollees in other regions. For the six months ended June
30, 1997, the Company generated fee-for-service revenue, net of contractual
deductions, of $65.4 million compared to fee-for-service revenue, net of
contractual deductions, for the six months ended June 30, 1996 of $9.9 million.
The growth in fee-for-service revenue is primarily attributable to acquisitions
of medical groups by the Company.
Medical Services Expense - Medical services expense for the six months
ended June 30, 1997 was $287.3 million or 71.3% of managed care business
operating revenue as compared to $132.5 million or 77.6% of such operating
revenue for the six months ended June 30, 1996. The decrease in medical services
expense as a percent of such operating revenue for the period ended June 30,
1997 compared to the comparable period in 1996 resulted primarily from the lower
medical loss ratio in the expanding Florida market and in medical groups in
Sacramento and Tucson acquired since the first quarter of 1996.
General and Administrative Expense -- General and administrative expense
for the six months ended June 30, 1997 was $96.4 million or 23.9% of managed
care business operating revenue as compared to $43.1 million or 25.2% of such
operating revenue for the comparable period in 1996, as the Company continues to
achieve economies of scale in its operations.
Merger, Restructuring and Other Unusual Charges - During the first six
months of 1997, the managed care business of the Company incurred approximately
$38.0 million in merger, restructuring and other unusual charges. Approximately
$36.8 million related to costs of legal fees, accounting fees, investment
bankers' fees and other costs associated with the merger with AHI. As the AHI
Merger was accounted for as a pooling of interests, generally accepted
accounting principles require that transaction costs be expensed in the period
in which the merger is consummated. Approximately $24.4 million arose from the
costs of severance payments, facilities and equipment lease terminations and
other costs associated with consolidating facilities and reducing staffing as a
result of the AHI Merger. Approximately $5.6 million of the charges resulted
from other related costs associated with the AHI Merger. Approximately $1.5
million related to miscellaneous unusual charges.
Income (Loss) from Operations - For the six months ended June 30, 1997, the
managed care business of the Company generated a loss from operations of $18.5
million including merger, restructuring and other unusual charges. Excluding
such merger, restructuring and other unusual charges, for the six months ended
June 30, 1997 income from operations was $19.5 million as compared to a loss
from operations of $4.8 million for the six months ended June 30, 1996.
EMERGENCY DEPARTMENT BUSINESS
THREE MONTHS ENDED JUNE 30, 1996 AND JUNE 30, 1997
Operating Revenue -- Emergency department business operating revenue
consists of gross patient revenue, net of contractual deductions, plus other
revenue, which consists principally of hospital subsidy payments, flat-rate
hospital contract revenue and non-patient generated revenues. Operating revenue
increased to $36.3 million for the three months ended June 30, 1997 from $33.0
million for the three months ended June 30, 1996.
Medical Services Expense -- Medical services expense increased to $27.0
million for the three months ended June 30, 1997 from $22.5 million for the
three months ended June 30, 1996 due primarily to the increase in the number of
healthcare professionals under contract, resulting from the increase in the
number of the Company's emergency department contracts, as well as negotiated
increases in fees paid to certain healthcare professionals. Medical services
expense as a percentage of emergency department business operating revenue was
74.4% for the three months
12
<PAGE> 320
ended June 30, 1997 compared to 68.0% of such operating revenue for the three
months ended June 30, 1996. The increase in medical costs as a percentage of
such operating revenue results from the fact that in 1996, the operations of
certain primary care centers were reported under the emergency department
business, while in 1997, they are included in the managed care business, due to
a change in the reporting structure of these medical groups. These medical
groups experienced a lower medical loss ratio than the core emergency department
business. The medical loss ratio as a percentage of operating revenue for the
emergency department business has remained stable.
General and Administrative Expense -- General and administrative expense
was $6.5 million or 18.0% of emergency department business operating revenue for
the three months ended June 30, 1997 as compared to $8.0 million or 24.4% of
such operating revenue for the corresponding period of the prior year. The
decrease in general and administrative expense as a percentage of such
operating revenue is primarily attributable to internal growth without added
administrative infrastructure and reductions in expense as a result of the
Sterling Merger.
Income from Operations - For the three months ended June 30, 1997, the
emergency department business of the Company generated income from operations of
$2.7 million as compared to $2.5 million for the three months ended June 30,
1996.
SIX MONTHS ENDED JUNE 30, 1996 AND JUNE 30, 1997
Operating Revenue -- Emergency department business operating revenue
consists of gross patient revenue, net of contractual deductions, plus other
revenue, which consists principally of hospital subsidy payments, flat-rate
hospital contract revenue and non-patient generated revenues. Operating revenue
increased to $72.3 million for the six months ended June 30, 1997 from $66.4
million for the six months ended June 30, 1996.
Medical Services Expense -- Medical services expense increased to $53.5
million for the six months ended June 30, 1997 from $45.2 million for the six
months ended June 30, 1996 due primarily to the increase in the number of
healthcare professionals under contract, resulting from the increase in the
number of the Company's emergency department contracts, as well as negotiated
increases in fees paid to certain healthcare professionals. Medical services
expense as a percentage of operating revenue was 74.0% for the six months ended
June 30, 1997 compared to 68.0% of such operating revenue for the six months
ended June 30, 1996.
General and Administrative Expense -- General and administrative expense
was $13.5 million or 18.6% of emergency department business operating revenue
for the six months ended June 30, 1997 as compared to $16.2 million or 24.4% of
operating revenue for the corresponding period of the prior year. The decrease
in general and administrative expense as a percentage of emergency department
business operating revenue is primarily attributable to internal growth without
added administrative infrastructure and reductions in expense as a result of the
Sterling Merger.
Income from Operations - For the six months ended June 30, 1997, the
emergency department business of the Company generated income from operations of
$5.3 million as compared to $5.0 million for the six months ended June 30, 1996.
13
<PAGE> 321
QUARTERLY RESULTS
The following table presents financial information for the eight quarters
ended June 30, 1997. In the opinion of management, this information has been
prepared on the same basis as the audited consolidated financial statements and
all necessary adjustments, consisting only of normal recurring adjustments
(unless otherwise noted), have been included in the amounts presented below to
present fairly the quarterly results when read in conjunction with the audited
consolidated financial statements of the Company and notes thereto. The
Company's quarterly results have in the past been subject to fluctuation and as
a result, the operating results for any quarter are not necessarily indicative
of results for any future period. All amounts in the following table are in
thousands and retroactively include all AHI and HealthCap activity.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1995 1995 1996 1996 1996 1996 1997 1997
------------- ------------ --------- --------- ------------- ------------ --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating revenue $ 76,945 $ 89,996 $ 110,012 $ 127,189 $ 161,190 $ 187,940 $ 231,012 $ 244,557
Medical services
expense 55,161 64,216 80,062 97,613 126,378 150,499 166,108 174,725
General and
administrative
expense 19,889 24,889 27,617 31,676 36,008 52,547 55,330 54,576
Merger,
restructuring
and other
unusual charges -- 1,590 -- -- 1,707 50,865 36,834 1,171
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss)
from operations 1,895 (699) 2,333 (2,100) (2,903) (65,971) (27,260) 14,085
Other income
(expense) (827) 111 (138) (529) (742) (2,657) (3,219) (868)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss)
before taxes 1,068 (588) 2,195 (2,629) (3,645) (68,628) (30,479) 13,217
Income tax
(expense) benefit (975) (554) (1,160) (2,015) (1,951) 4,035 8,110 (4,758)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) $ 93 $ (1,142) $ 1,035 $ (4,644) $ (5,596) $ (64,593) $ (22,369) $ 8,459
========= ========= ========= ========= ========= ========= ========= =========
</TABLE>
Operating revenue and medical services expense during the first and third
quarters have been and continue to be affected by movements of members in Payor
plans from one plan to another during periods of open enrollment for Payors.
Retroactive capitation rate increases generally take effect during the second
quarter, while medical services expense increases tend to occur ratably
throughout the year. Quarterly results may be affected by final settlements of
shared risk distributions which generally occur in the second and third quarters
of the year after which they are estimated. From time to time, final settlements
may differ from such estimated amounts. As the Company adds new Payors into the
FPA network, the timing of these adjustments may vary and, consequently,
quarterly results may be affected in the future, especially due to the start-up
of operations in new regions where there is no operating history. Similarly, if
medical services expense varies from amounts previously accrued for claims
incurred but not reported ("IBNR"), quarterly operating results may fluctuate.
The Company's expansion strategy includes the acquisition of individual and
group physician practices by the FPA network, and any such acquisition may
materially affect quarterly operating results, causing quarterly fluctuations.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to develop physician networks,
acquire physician practices and establish an infrastructure in new regions.
Capitation arrangements positively impact cash flow because FPA generally
receives capitation revenue prior to paying costs associated with services
provided under those agreements. However, shared risk arrangements negatively
impact cash flow because settlements in connection with these arrangements are
typically not collected until significantly after the end of the period in which
they were accrued. Fee-for-service revenues also negatively impact cash flow
because payment for services rendered is generally not collected until 90 to 120
days after the service is provided.
At June 30, 1997, the Company had cash, cash equivalents and marketable
securities of $37.2 million and a working capital surplus (current assets in
excess of current liabilities) of $37.8 million compared to cash, cash
equivalents and marketable securities of $71.7 million and working capital
deficit of $40.4 million at December 31, 1996.
During the six months ended June 30, 1997, non-operating sources of cash
include advances on a new line of credit and term loan of approximately $187.8
million, proceeds of approximately $5.5 million from the exercise by the
underwriters of the overallotment of convertible subordinated debentures,
14
<PAGE> 322
issuance of a note payable of approximately $2.6 million, and proceeds from the
issuance of stock options and warrants of approximately $1.5 million.
Non-operating uses of cash include the purchase of property and equipment for
approximately $3.0 million and the payment of approximately $169.3 million in
long-term debt.
At June 30, 1997 approximately 62% of the Company's current liabilities
consist of amounts accrued as payable to specialty care physicians, ancillary
providers, hospital and other providers of medical services. These accrued
liabilities include claims received by the Company which have not yet been paid
as well as an estimate of costs for covered medical benefits incurred by
enrollees but not yet reported by providers. These amounts are not due and
payable until after the provider has presented a claim and are typically paid
within 45 business days of receipt of such claims. The increase in claims
payable, including incurred but not reported claims, from approximately $100.8
million at December 31, 1996 to $124.0 million at June 30, 1997 resulted
primarily from increased membership and a shift in Payor mix of enrollees in
which enrollees incurred varying levels of IBNR claims.
On June 30, 1997, the Company entered into a commercial paper credit
agreement for a $175 million three-year revolving line of credit ("Line of
Credit") and a $100 million four and one-quarter year term loan ("Term Loan"). A
maximum of $155 million and $30 million of the proceeds of the Line of Credit
can be used to refinance debt and to secure the Company's capitation deposits,
respectively. The remaining proceeds of the Line of Credit can be used for
working capital. The proceeds of the Term Loan may be used to refinance debt.
The borrowings bear interest based on the prime rate plus 50-75 basis points or
the Interbank Eurodollar rate plus 150-175 basis points, as defined in the
agreement. In connection with the credit agreement, the Company agreed to
maintain certain debt and equity ratios and profitability thresholds. The
facility is secured by the assets of the Company.
During 1996, the Company entered into a $55.0 million credit, security,
guarantee and pledge agreement (the "Credit Agreement") with four financial
institutions. Permitted Borrowings, as defined in the Credit Agreement,
generally include acquisitions and capital expenditures. Borrowings under this
agreement bear interest at either LIBOR plus 2-1/2%, 2-3/4% or 3%, or prime rate
plus 1%, 1-1/4% or 1-1/2%, as defined in the agreement. At December 31, 1996,
the Company had borrowed the maximum of $55.0 million under the Credit
Agreement. At June 30, 1997, this credit facility was paid in full.
In December 1996, the Company issued $75.0 million of convertible
subordinated debentures, which resulted in net proceeds to the Company of
approximately $73.0 million. The debentures bear interest at 6-1/2%, payable
semiannually, and are convertible into shares of the Company's stock at $25.95
per share. The debentures are redeemable by the Company after December 20, 1999.
Upon the occurrence of a Repurchase Event, as defined in the debentures, each
holder has the right to require repayment of the debentures at 100% of the
principal amount plus accrued interest. In January, 1997, the underwriters
exercised their overallotment and purchased an additional $5.5 million of the
debentures with identical terms.
The Company believes that its cash on hand and anticipated cash flows from
its operations will be sufficient to meet the Company's operating capital needs
through 1997. The Company may obtain additional financing to support planned
expansion through an expansion of its credit facilities or through other
potential financing alternatives including private and public offerings of debt
and equity-related securities. There can be no assurance that the Company will
be able to obtain such increased credit facility or that it will be able to
issue debt or equity-related securities on terms satisfactory to it. To the
extent that additional financing is not available, the Company may delay certain
potential acquisitions or certain geographic expansion or may seek alternate
sources of financing.
The strategy to expand the FPA network involves the acquisition of
individual and group physician practice assets and related businesses. Such
acquisitions may be consummated using cash, stock, notes or any combination
thereof. Management does not believe that inflation will have a material effect
on the operations of the Company.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report are forward-looking.
Although the Company believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. Factors that could cause actual results to differ from
expectations include the difficulty in controlling healthcare costs, integrating
new operations from acquired companies and the possible negative effects of
prospective healthcare reform. For other important factors that may cause actual
results to differ materially from expectations and underlying assumptions, see
reports by FPA Medical Management, Inc. filed with the Securities and Exchange
Commission.
15
<PAGE> 323
ITEM 4. Submission of matters to a Vote of Security Holders
At the meeting of stockholders on July 24, 1997, the following matters were
submitted to a vote of the Registrant's stockholders:
1. Election of Director: The following director was elected until the
annual meeting of stockholders in 2000 and until his respective successor is
duly elected and qualified.
NAME OF DIRECTOR VOTES FOR WITHHELD
- ---------------- --------- --------
Dr. Sol Lizerbram 23,396,756 513,494
Mr. Sheldon Derezin, Dr. Stephen J. Dresnick, Dr. Kevin Ellis, Dr. Seth Flam,
Dr. Howard Hassman and Dr. Herbert Wertheim continue as directors of the
Registrant.
2. Amendment of the Registrant's 1995 Non-Employee Directors' Non-Qualified
Stock Option Plan (the "Directors Plan") (i) to increase (from 5,000 to 15,000)
the number of shares of the Registrants' Common Stock ("Common Stock") that may
be purchased pursuant to the automatic grant of an option to each non-employee
director following each annual meeting of stockholders of the Registrant; (ii)
to increase (from 2,500 to 7,500) the number of shares of Common Stock that may
be purchased pursuant to an option automatically granted to any non-employee
director who is elected after the date of an annual meeting of stockholders of
the Registrant to fill a vacancy on the Board of Directors; (iii) to grant to
each non-employee director annually the option to purchase an additional 2,500
(3,500 if a committee chairperson) shares of Common Stock for each committee of
the Board of Directors on which such non-employee director serves; and (iv) to
require approval by the Registrant's stockholders of any amendments or
modifications thereto only as required by applicable laws and regulations.
VOTES FOR VOTES AGAINST ABSTENTIONS
- -------- ------------- -----------
20,367,832 6,208,283 26,681
3. Amendment of the Registrant's Omnibus Stock Option Plan (the "Omnibus
Plan") (i) to increase from 6,500,000 to 8,500,000 the number of shares of the
Common Stock for which options may be granted under the Omnibus Plan; and (ii)
to require approval by the Registrant's stockholders of any amendments or
modifications thereto only as required by applicable laws and regulations.
VOTES FOR VOTES AGAINST ABSTENTIONS
- -------- ------------- -----------
12,882,254 8,403,744 39,702
4. Ratification of the selection of Deloitte & Touche, LLP as the
Registrant's independent auditors for the year ending December 31, 1997.
VOTES FOR VOTES AGAINST ABSTENTIONS
- -------- ------------- -----------
26,869,919 27,678 12,653
ITEM 6. Exhibits And Reports On Form 8-K
(b) Reports on Form 8-K: The Company filed the following Reports on Form 8-K
since March 31, 1997:
<TABLE>
<CAPTION>
DATE OF REPORT ITEMS REPORTED
-------------- --------------
<S> <C>
March 17, 1997 5
March 17, 1997 7
July 31, 1997 7
</TABLE>
16
<PAGE> 324
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FPA MEDICAL MANAGEMENT, INC.
(Registrant)
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ SETH FLAM Chief Executive Officer August 14, 1997
- ------------------------------------ (Principal Executive officer)
Seth Flam
/s/ STEVEN M. LASH Chief Financial Officer August 14, 1997
- ------------------------------------ (Principal Financial officer)
Steven M. Lash
</TABLE>
17
<PAGE> 325
APPENDIX I
THE AUDITED COMBINED BALANCE SHEETS OF FOUNDATION HEALTH MEDICAL SERVICES
(A WHOLLY OWNED SUBSIDIARY OF FOUNDATION HEALTH CORPORATION) AND AFFILIATES 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.
I-1
<PAGE> 326
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
I-2
<PAGE> 327
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.
I-3
<PAGE> 328
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.
I-4
<PAGE> 329
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.
I-5
<PAGE> 330
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>
I-6
<PAGE> 331
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.
I-7
<PAGE> 332
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
I-8
<PAGE> 333
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.
I-9
<PAGE> 334
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
I-10
<PAGE> 335
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>
I-11
<PAGE> 336
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.
I-12
<PAGE> 337
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>
I-13
<PAGE> 338
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
I-14
<PAGE> 339
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.
I-15
<PAGE> 340
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.
I-16
<PAGE> 341
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.
I-17
<PAGE> 342
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.
I-18
<PAGE> 343
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.
I-19
<PAGE> 344
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.
I-20
<PAGE> 345
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.
I-21
<PAGE> 346
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the General Corporation Law of the State of Delaware
provides that a corporation may indemnify its officers, directors, employees and
agents (or persons who have served, at the corporation's request, as officers,
directors, employees or agents of another corporation) against the expenses,
including attorneys' fees, actually and reasonably incurred by them in
connection with the defense of any action by reason of being or having been
directors, officers, employees or agents, if such person shall have acted in
good faith and in a manner he reasonably believed to be in or not opposed to the
best interests of the corporation, and with respect to any criminal action or
proceedings, had no reason to believe his conduct was unlawful, except that if
such action shall be in the right of the corporation, no such indemnification
shall be provided as to any claim, issue or matter as to which such person shall
have been adjudged to have been liable to the corporation unless and only to the
extent that the Court of Chancery of the State of Delaware, or any other court
in which the suit was brought, shall determine upon application that, in view of
all the circumstances of the case, such person is fairly and reasonably entitled
to indemnity for such expenses which the Court of Chancery or such other court
shall deem proper.
FPA's Certificate of Incorporation, as amended, has the following
indemnification provisions:
"SEVENTH"
A. Each person who was or is a party or is threatened to be made a party to
or is involved in any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative
(hereinafter a "proceeding"), by reason of the fact that he or she, or a
person of whom he or she is the legal representative, is or was a
director or officer of the Corporation or is or was serving at the
request of the Corporation as a director, officer, employee or agent of
another corporation or of a partnership, joint venture, trust or other
enterprise, including service with respect to employee benefit plans,
whether the basis of such proceeding is alleged action in an official
capacity as a director, officer, employee or agent or in any other
capacity while serving as a director, officer, employee or agent, shall
be indemnified and held harmless by the Corporation to the fullest
extent authorized by the Delaware General Corporation Law, as the same
exists or may hereafter be amended (but, in the case of any such
amendment, only to the extent that such amendment permits the
Corporation to provide broader indemnification rights than said law
permitted the Corporation to provide prior to such amendment), against
all expense, liability and loss (including attorneys' fees, judgements,
fines, ERISA excise taxes or penalties and amounts paid or to be paid in
settlement) actually and reasonably incurred or suffered by such person
in connection therewith, and such indemnification shall continue as to a
person who has ceased to be a director, officer, employee or agent and
shall inure to the benefit of his or her heirs, executors and
administrators; provided, however, that, except as provided in Paragraph
B hereof, the Corporation shall indemnify any such person seeking
indemnification in connection with a proceeding (or part thereof)
initiated by such person only if such proceeding (or part thereof) was
authorized by the Board of Directors of the Corporation. The right to
indemnification conferred in this Article SEVENTH shall be a contract
right and shall include the right to be paid by the Corporation the
expenses incurred in defending any such proceeding in advance of its
final disposition; provided, however, that, if the Delaware General
Corporation Law requires, the payment of such expenses incurred by a
director or officer in his or her capacity as a director or officer (and
not in any other capacity in which service was or is rendered by such
person while a director or officer, including, without limitation,
service to an employee benefit plan) in advance of the final disposition
of a proceeding, shall be made only upon delivery to the Corporation of
an undertaking, by or on behalf of such director or officer, to repay
all amounts so advanced if it shall ultimately be determined that such
director or officer is not entitled to be indemnified under this Article
SEVENTH or otherwise. The Corporation may, by action of its Board
II-1
<PAGE> 347
of Directors, provide indemnification to employees and agents of the
Corporation with the same scope and effect as the foregoing
indemnification of directors and officers.
B. If a claim under Paragraph A of this Article SEVENTH is not paid in full
by the Corporation within thirty days after a written claim has been
received by the Corporation, the claimant may at any time thereafter
bring suit against the Corporation to recover the unpaid amount of the
claim and, if successful in whole or in part, the claimant shall be
entitled to be paid also the expense of prosecuting such claim. It shall
be a defense to any such action (other than a action brought to enforce
a claim for expenses incurred in defending any proceeding in advance of
its final disposition where the required undertaking, if any is
required, has been tendered to the Corporation) that the claimant has
not met the standards of conduct which make it permissible under the
Delaware General Corporation Law for the Corporation to indemnify the
claimant for the amount claimed, but the burden of providing such
defense shall be on the Corporation. Neither the failure of the
Corporation (including its Board of Directors, independent legal
counsel, or its stockholders) to have made a determination prior to the
commencement of such action that indemnification of the claimant is
proper in the circumstances because he or she has met the applicable
standard of conduct set forth in the Delaware General Corporation Law,
nor an actual determination by the Corporation (including its Board of
Directors, independent legal counsel, or its stockholders) that the
claimant has not met such applicable standard of conduct, shall be a
defense to the action or create a presumption that the claimant has not
met the applicable standard of conduct.
C. The right to indemnification and the payment of expenses incurred in
defending a proceeding in advance of its final disposition conferred in
this Article SEVENTH shall not be exclusive of any other right which any
person may have or hereafter acquire under any statute, provision of the
Certificate of Incorporation, by-law, agreement, vote of stockholders or
disinterested directors or otherwise.
D. The Corporation may maintain insurance, at its expense, to protect
itself and any person who is or was a director, officer, employee or
agent of the Corporation or is or was serving at the request of the
Corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise
against any such expense, liability or loss, whether or not the
Corporation would have the power to indemnify such person against such
expense, liability or loss under the Delaware General Corporation Law.
FPA's By-laws similarly provide that FPA shall indemnify its officers and
directors to the fullest extent permitted by the Delaware Law.
In addition, FPA has entered into individual indemnification agreements
(the "Indemnification Agreements") with each of the directors. The general
effect on directors' liabilities is set forth in the provisions of the
Indemnification Agreements summarized below:
Proceedings Other Than Proceedings by or in the Right of FPA. A director
shall be entitled to the rights of indemnification if, by reason of his position
with FPA, he is, or is threatened to be made, a party to any threatened,
pending, or completed proceeding, other than a proceeding by or in the right of
FPA. In such case, such director shall be indemnified against all expenses,
judgments, penalties, fines and amounts paid in settlement actually and
reasonably incurred by him or on his behalf in connection with such proceeding
or any claim, issue or matter therein, if he acted in good faith and in a manner
he reasonably believed to be in or not opposed to the best interests of FPA and,
with respect to any criminal proceeding, had no reasonable cause to believe his
conduct was unlawful.
Proceedings by or in the Right of Company. Generally, a director shall be
entitled to the rights of indemnification if, by reason of his position with
FPA, he is, or is threatened to be made, a party to any threatened, pending or
completed proceeding brought by or in the right of FPA to procure a judgment in
its favor. In such case, the director shall be indemnified against all expenses
actually and reasonably incurred by him or on his behalf in connection with such
proceeding if he acted in good faith and in a manner he reasonably believed to
be in or not opposed to the best interests of FPA; provided, however, that if
applicable law so provides, no indemnification against such expenses shall be
made in respect of any claim, issue or
II-2
<PAGE> 348
matter in such proceeding as to which the director shall have been adjudged to
be liable to FPA unless and to the extent that the Court of Chancery of the
State of Delaware, or the court in which such proceeding shall have been brought
or is pending, shall determine that such indemnification may be made.
Indemnification for Expenses of a Party Who is Wholly or Partly
Successful. Notwithstanding any other provision of the Indemnification
Agreements, to the extent that the director is, by reason of his position with
FPA, a party to and is successful, on the merits or otherwise, in any
proceeding, he shall be indemnified against all expenses actually and reasonably
incurred by him or on his behalf in connection therewith. If the director is not
wholly successful in such proceeding but is successful, on the merits or
otherwise, as to one or more but less than all claims, issues or matters in such
proceeding, FPA shall indemnify the director against all expenses actually and
reasonably incurred by him or on his behalf in connection with each successfully
resolved claim, issue or matter.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibit
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ---------------------------------------------------------------------------------
<S> <C> <C>
2 -- Agreement and Plan of Merger by and among the Registrant, FPA Acquisition Corp.
and Health Partners, Inc. (included as Appendix A)
3.1 -- Certificate of Incorporation.*
3.2 -- Bylaws.*
3.3 -- Certificate of Amendment of Certificate of Incorporation filed October 20, 1994
(incorporated by reference to FPA's Annual Report on Form 10-K for the year ended
December 31, 1994 at Exhibit No. 3.3.
4.1 -- Specimen of Common Stock Certificate.*
4.2 -- Form of Warrant.*
4.3 -- Indenture dated as of December 18, 1996, by and between the Registrant and the
Trustee for the 6 1/2% Convertible Subordinated Debentures (incorporated by
reference to the Registrant's Current Report on Form 8-K dated December 18,
1996.)
4.4 -- Registration Rights Agreement dated December 13, 1996 by and among the Registrant
and the Initial Purchasers of the 6 1/2% Convertible Subordinated Debentures
(incorporated by reference to the Registrant's Current Report on Form 8-K dated
December 18, 1996.)
4.5 -- Form of Rule 144A Restricted Global Debenture (incorporated by reference to the
Registrant's Current Report on Form 8-K dated December 18, 1996.)
4.6 -- Form of Regulation S Global Debenture (incorporated by reference to the
Registrant's Current Report on Form H-K dated December 18, 1996.)
4.7 -- Registration Rights Agreement dated June 30, 1997 by and among the Registrant,
and certain stockholders of HealthCap, Inc. (incorporated by reference to
Registration Statement No. 333-21251 at Exhibit No. 4.7)
4.8 -- Form of Registration Rights Agreement by and among the Registrant and certain
holders of Health Partners, Inc. Common Stock and Preferred Stock.
4.9 -- Registration Rights Agreement dated September 2, 1997 by and among the Registrant
and the shareholders of Emergency Medical Care Incorporated.
5 -- Opinion of Pillsbury Madison & Sutro LLP.
</TABLE>
II-3
<PAGE> 349
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ---------------------------------------------------------------------------------
<S> <C> <C>
8.1 -- Opinion of Pillsbury Madison & Sutro LLP with respect to tax matters.
8.2 -- Opinion of Gibson, Dunn & Crutcher LLP with respect to tax matters.
10.1 -- IPA Medicare Partial Risk Services Agreement between Pacificare of California and
Family Practice Associates of San Diego, Inc. ("FPASD") dated January 1, 1993,
including an amendment thereto date effective January 1, 1994.* **
10.2 -- [Reserved]
10.3 -- Medical Services Organization Agreement dated January 21, 1995 between FPANJ and
Medigroup, Inc. (HMO Blue).* **
10.4 -- Pacificare IPA Commercial Services Agreement with FPASD dated May 1, 1995.* **
10.5 -- Amendment to IPA Medicare Partial Risk Services Agreement between Pacificare of
California and FPASD dated April 1995.* **
10.6 -- [Reserved]
10.7 -- Form of Primary Care Physician Agreement/California.* **
10.8 -- Form of Specialty Care Physician Agreement/California.* **
10.9 -- Form of Administrative Services Agreement between FPA and a Professional
Corporation.*
10.10 -- Form of Administrative Services Agreement between FPA and a Professional
Corporation.*
10.11 -- Form of Succession Agreement.*
10.12 -- Employment Agreement between FPA and Dr. Sol Lizerbram effective as of October 1,
1996.
10.13 -- Employment Agreement between FPA and Dr. Seth Flam effective as of October 1,
1996.
10.14 -- Employment Agreement between FPA and Dr. Howard Hassman effective as of October
1, 1996.
10.15 -- Employment Agreement between FPA and Dr. Kevin Ellis effective as of October 1,
1996.
10.16 -- Employment Agreement between FPA and Steven M. Lash effective as of October 1,
1996.
10.17 -- Employment Agreement between FPA and Robert J. Burg effective December 1, 1994
(incorporated by reference to FPA's Annual Report on Form 10-K for the year ended
December 31, 1994 at Exhibit No. 10.27).
10.18 -- Employment Agreement between FPA and James A. Lebovitz effective as of February
1, 1997.
10.19 -- FPA Amended Omnibus Stock Option Plan (incorporated by reference to Registration
Statement No. 333-34027 at Exhibit 99).
10.20 -- Amended and Restated Employment Contract between Sterling HealthCare Group, Inc.
("Sterling") and Stephen J. Dresnick, M.D. ("Dresnick"), dated July 15, 1994,
Amendment No. 1 to Amended and Restated Employment Contract between Sterling and
Dresnick entered into as of October 31, 1996 and Amendment No. 2 to Amended and
Restated Employment Contract between Sterling and Dresnick entered into as of
July 1997.
10.21 -- [Reserved]
10.22 -- [Reserved]
10.23 -- [Reserved]
10.24 -- 401(k) Salary Savings Plan effective January 1, 1994 (incorporated by reference
to Registration Statement No. 33-79714 at Exhibit 10.20).
10.25 -- 1995 Directors Stock Option Plan.*
10.26 -- 1994 Physicians Stock Option Plan.*
</TABLE>
II-4
<PAGE> 350
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ---------------------------------------------------------------------------------
<S> <C> <C>
10.27 -- Credit, Security, Guarantee and Pledge Agreement dated as of January 29, 1996
among FPA and its subsidiaries and certain guarantors and the lenders named
therein and Banque Paribas, as amended March 15, 1996 (incorporated by reference
to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
1995).
10.28 -- Agreement and Plan of Merger among FPA, FPA Acquisition Corporation and AHI
Healthcare Systems, Inc. made November 8, 1996, as amended by Amendment No. 1 to
Agreement and Plan of Merger, dated as of February 5, 1997 (incorporated by
reference to Registration Statement No. 333-21721 at Exhibit No. 2).
10.29 -- Form of Indemnification Agreement*
10.30 -- Stock and Note Purchase Agreement by and among, inter alia, the Registrant and
Foundation Health Corporation dated as of June 28, 1996 (incorporated by
reference to Registrant's Current Report on Form 8-K dated June 21, 1996).
10.31 -- Agreement and Plan of Merger dated June 5, 1997 by and among the Registrant, FPA
Acquisition Corp. and HealthCap, Inc. (incorporated by reference to Registration
Statement No. 333- 31351 at Exhibit No. 10.31).
10.32 -- Credit Agreement dated as of June 30, 1997 by and among the Registrant, Lehman
Commercial Paper, Inc. and the lenders parties thereto (incorporated by reference
to Registration Statement No. 333-31351 at Exhibit No. 10.32).
10.33 -- HealthCap Management Group, Inc. 1994 Stock Option Plan (incorporated by
reference to Registration Statement No. 333- 31341 at Exhibit No. 99.1).
10.34 -- HealthCap Management Group, Inc. Quality Consultant Stock Option Plan
(incorporated by reference to Registration Statement No. 333-31341 at Exhibit No.
99.2).
13 -- Annual Report on Form 10-K (incorporated by reference to Registrant's Annual
Report on Form 10-K, as amended by Form 10-K/A for the fiscal year ended December
31, 1996).
21 -- Subsidiaries of FPA.
23.1 -- Consent of Deloitte & Touche LLP.
23.2 -- Consent of Coopers & Lybrand LLP.
23.3 -- Consent of KPMG Peat Marwick LLP.
23.4 -- Consent of Ernst & Young LLP.
23.5 -- Consent of Deloitte & Touche LLP.
23.6 -- Consent of Stevenson, Jones, Imig, Holmaas & Kleinhans, P.C.
23.7 -- Consent of Pillsbury Madison & Sutro LLP (included in Exhibits 5 and 8.1).
23.8 -- Consent of Gibson, Dunn & Crutcher LLP (included in Exhibit 8.2)
24 -- Power of Attorney (included in Part II of Registration Statement).
99.1 -- Form of HPI Proxy.
99.2 -- Consent of Smith Barney Inc.
</TABLE>
- ---------------
* Incorporated by reference to the exhibit to the Registrant's Registration
Statement on Form S-1, Reg. No. 33-97456, at the exhibit number set forth
opposite such exhibit's description above.
** Registrant has requested confidential treatment from the Securities and
Exchange Commission for portions of this exhibit, which confidential portions
have been filed separately.
II-5
<PAGE> 351
ITEM 22. UNDERTAKINGS
The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
The undersigned Registrant hereby undertakes as follows: that prior to any
public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this registration statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c), the
issuer undertakes that such reoffering prospectus will contain the information
called for by the applicable registration form with respect to reofferings by
persons who may be deemed underwriters, in addition to the information called
for by the other Items of the applicable form.
The Registrant hereby undertakes that every prospectus (i) that is filed
pursuant to the paragraph immediately preceding, or (ii) that purports to meet
the requirements of section 10(a)(3) of the Securities Act of 1933, as amended
(the "Securities Act"), and is used in connection with an offering of securities
subject to Rule 415, will be filed as a part of an amendment to the registration
statement and will not be used until such amendment is effective, and that, for
purposes of determining any liability under the Securities Act, each such
post-effective amendment shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
application of such issue.
The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through the
date of responding to the request.
The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set for the registration
statement. Notwithstanding the
II-6
<PAGE> 352
foregoing, any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b)(sec. 230.424(b) of this
chapter) if, in the aggregate, the changes in volume and price represent no
more than 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement;
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
II-7
<PAGE> 353
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 2 to the Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of San Diego, State of California, on September 28, 1997.
FPA MEDICAL MANAGEMENT INC.
By: /s/ SETH FLAM
------------------------------------
Seth Flam
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 2 to the Registration Statement has been signed by the
following persons in the capacities indicated on September 28, 1997.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- ----------------------------------------------- --------------------------------------------
<C> <S>
/s/ SOL LIZERBRAM Director and Chairman of the Board of
- ----------------------------------------------- Directors
Sol Lizerbram
/s/ SETH FLAM President, Chief Executive Officer and
- ----------------------------------------------- Director (Principal Executive Officer)
Seth Flam
* /s/ STEPHEN J. DRESNICK Director and Vice-Chairman of the Board of
- ----------------------------------------------- Directors
Stephen J. Dresnick
/s/ STEVEN M. LASH Executive Vice President and Chief Financial
- ----------------------------------------------- Officer and Treasurer (Principal Financial
Steven M. Lash and Accounting Officer)
* /s/ HOWARD HASSMAN Director
- -----------------------------------------------
Howard Hassman
* /s/ KEVIN ELLIS Director
- -----------------------------------------------
Kevin Ellis
* /s/ SHELDON DEREZIN Director
- -----------------------------------------------
Sheldon Derezin
* /s/ HERBERT A. WERTHEIM Director
- -----------------------------------------------
Herbert A. Wertheim
* /s/ JAMES A. LEBOVITZ
- -----------------------------------------------
James A. Lebovitz,
Attorney-in-Fact
</TABLE>
II-8
<PAGE> 354
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIAL
EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
- ------- --------------------------------------------------------------------------- ----------
<S> <C> <C>
2 Agreement and Plan of Merger by and among the Registrant, FPA Acquisition
Corp. and Health Partners, Inc. (included as Appendix A)...................
3.1 Certificate of Incorporation*..............................................
3.2 Bylaws*....................................................................
3.3 Certificate of Amendment of Certificate of Incorporation filed October 20,
1994 (incorporated by reference to FPA's Annual Report on Form 10-K for the
year ended December 31, 1994 at Exhibit No. 3.3)...........................
4.1 Specimen of Common Stock Certificate*......................................
4.2 Form of Warrant*...........................................................
4.3 Indenture dated as of December 18, 1996, by and between the Registrant and
the Trustee for the 6 1/2% Convertible Subordinated Debentures
(incorporated by reference to the Registrant's Current Report on Form 8-K
dated December 18, 1996)...................................................
4.4 Registration Rights Agreement dated December 13, 1996 by and among the
Registrant and the Initial Purchasers of the 6 1/2% Convertible
Subordinated Debentures (incorporated by reference to the Registrant's
Current Report on Form 8-K dated December 18, 1996)........................
4.5 Form of Rule 144A Restricted Global Debenture (incorporated by reference to
the Registrant's Current Report on Form 8-K dated December 18, 1996).......
4.6 Form of Regulation S Global Debenture (incorporated by reference to the
Registrant's Current Report on Form 8-K dated December 18, 1996)...........
4.7 Registration Rights Agreement dated June 30, 1997 by and among the
Registrant and certain stockholders of HealthCap, Inc. (incorporated by
reference to Registration Statement No. 333-31351 at Exhibit No. 4.7)......
4.8 Form of Registration Rights Agreement by and among the Registrant and
certain holders of Health Partners, Inc. Common Stock and Preferred
Stock......................................................................
4.9 Registration Rights Agreement dated September 2, 1997 by and among the
Registrant and the shareholders of Emergency Medical Care Incorporated.....
5 Opinion of Pillsbury Madison & Sutro LLP...................................
8.1 Opinion of Pillsbury Madison & Sutro LLP with respect to tax matters.......
8.2 Opinion of Gibson, Dunn & Crutcher LLP with respect to tax matters.........
10.1 IPA Medicare Partial Risk Services Agreement between Pacificare of
California and Family Practice Associates of San Diego, Inc. ("FPASD")
dated January 1, 1993, including an amendment thereto effective the date
thereof and an amendment thereto date effective January 1, 1994* **........
10.2 [Reserved].................................................................
10.3 Medical Services Organization Agreement dated January 21, 1995 between
FPANJ and Medigroup, Inc. (HMO Blue)* **...................................
10.4 Pacificare IPA Commercial Services Agreement with FPASD dated May 1, 1995*
**.........................................................................
10.5 Amendment to IPA Medicare Partial Risk Services Agreement between
Pacificare of California and FPASD dated April 1995* **....................
10.6 [Reserved].................................................................
10.7 Form of Primary Care Physician Agreement/California* **....................
</TABLE>
<PAGE> 355
<TABLE>
<CAPTION>
SEQUENTIAL
EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
- ------- --------------------------------------------------------------------------- ----------
<S> <C> <C>
10.8 Form of Specialty Care Physician Agreement/California* **..................
10.9 Form of Administrative Services Agreement between FPA and a Professional
Corporation.*..............................................................
10.10 Form of Administrative Services Agreement between FPA and a Professional
Corporation.*..............................................................
10.11 Form of Succession Agreement.*.............................................
10.12 Employment Agreement between FPA and Dr. Sol Lizerbram effective as of
October 1, 1996............................................................
10.13 Employment Agreement between FPA and Dr. Seth Flam effective as of October
1, 1996....................................................................
10.14 Employment Agreement between FPA and Dr. Howard Hassman effective as of
October 1, 1996............................................................
10.15 Employment Agreement between FPA and Dr. Kevin Ellis effective as of
October 1, 1996............................................................
10.16 Employment Agreement between FPA and Steven M. Lash effective as of October
1, 1996....................................................................
10.17 Employment Agreement between FPA and Robert J. Burg effective December 1,
1994 (incorporated by reference to FPA's Annual Report on Form 10-K for the
year ended December 31, 1994 at Exhibit No. 10.27).........................
10.18 Employment Agreement between FPA and James A. Lebovitz effective as of
February 1, 1997...........................................................
10.19 FPA Amended Omnibus Stock Option Plan (incorporated by reference to
Registration Statement No. 333-34027 at Exhibit 99)........................
10.20 Amended and Restated Employment Contract between Sterling HealthCare Group,
Inc. ("Sterling") and Stephen J. Dresnick, M.D. ("Dresnick"), dated July
15, 1994, Amendment No. 1 to Amended and Restated Employment Contract
between Sterling and Dresnick entered into as of October 31, 1996 and
Amendment No. 2 to Amended and Restated Employment Contract between
Sterling and Dresnick entered into as of July 1997.........................
10.21 [Reserved].................................................................
10.22 [Reserved].................................................................
10.23 [Reserved].................................................................
10.24 401(k) Salary Savings Plan effective January 1, 1994 (incorporated by
reference to Registration Statement No. 33-79714 at Exhibit 10.20).........
10.25 1995 Directors Stock Option Plan.*.........................................
10.26 1994 Physicians Stock Option Plan.*........................................
10.27 Credit, Security, Guarantee and Pledge Agreement dated as of January 29,
1996 among FPA and its subsidiaries and certain guarantors and the lenders
named therein and Banque Paribas, as amended March 15, 1996 (incorporated
by reference to Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995)...................................................
10.28 Agreement and Plan of Merger among FPA, FPA Acquisition Corporation and AHI
Healthcare Systems, Inc. made November 8, 1996, as amended by Amendment No.
1 to Agreement and Plan of Merger, dated as of February 5, 1997
(incorporated by reference to Registration Statement No. 333-21721 at
Exhibit No. 2).............................................................
</TABLE>
<PAGE> 356
<TABLE>
<CAPTION>
SEQUENTIAL
EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
- ------- --------------------------------------------------------------------------- ----------
<S> <C> <C>
10.29 Form of Indemnification Agreement.*........................................
10.30 Stock and Note Purchase Agreement among, inter alia, the Registrant and
Foundation Health Corporation dated as of June 28, 1996 (incorporated by
reference to Registrant's Current Report on Form 8-K dated June 21,
1996)......................................................................
10.31 Agreement and Plan of Merger dated June 5, 1997 by and among the
Registrant, FPA Acquisition Corp. and HealthCap, Inc. (incorporated by
reference to Registration Statement No. 333-31351 at Exhibit No. 10.31)....
10.32 Credit Agreement dated June 30, 1997 by and among the Registrant, Lehman
Commercial Paper, Inc. and the lenders parties thereto (incorporated by
reference to Registration Statement No. 333-31351 at Exhibit No. 10.32)....
10.33 HealthCap Management Group, Inc. 1994 Stock Option Plan (incorporated by
reference to Registration Statement No. 333-31341 at Exhibit No. 99.1).....
10.34 HealthCap Management Group, Inc. Quality Consultant Stock Option Plan
(incorporated by reference to Registration Statement No. 333-31341 at
Exhibit No. 99.2)..........................................................
13 Annual Report on Form 10-K (incorporated by reference to Registrant's
Annual Report on Form 10-K, as amended by Form 10-K/A for the fiscal year
ended December 31, 1996)...................................................
21 Subsidiaries of FPA........................................................
23.1 Consent of Deloitte & Touche LLP...........................................
23.2 Consent of Coopers & Lybrand LLP...........................................
23.3 Consent of KPMG Peat Marwick LLP...........................................
23.4 Consent of Ernst & Young LLP...............................................
23.5 Consent of Deloitte & Touche LLP...........................................
23.6 Consent of Stevenson, Jones, Imig, Holmaas & Kleinhans, P.C................
23.7 Consent of Pillsbury Madison & Sutro LLP (included in Exhibits 5 and
8.1).......................................................................
23.8 Consent of Gibson, Dunn & Crutcher LLP (included in Exhibit 8.2)...........
24 Power of Attorney (included in Part II of Registration Statement)..........
99.1 Form of HPI Proxy..........................................................
99.2 Consent of Smith Barney Inc................................................
</TABLE>
- ---------------
* Incorporated by reference to the exhibit to the Registrant's Registration
Statement on Form S-1, Reg. No. 33-97456, at the exhibit number set forth
opposite such exhibit's description above.
** Registrant has requested confidential treatment from the Securities and
Exchange Commission for portions of this exhibit, which confidential portions
have been filed separately.
<PAGE> 1
EXHIBIT 8.1
September 29, 1997
FPA Medical Management, Inc.
3636 Nobel Drive, 2nd Floor
San Diego, CA 92122
Ladies and Gentlemen:
With reference to the Registration Statement on Form S-4 (the
"Registration Statement") filed by FPA Medical Management, Inc., a Delaware
corporation ("FPA"), with the Securities and Exchange Commission in connection
with the Registration under the Securities Act of 1933, as amended, of shares of
its common stock, par value $0.002 per share ("FPA Common Stock"), to be issued
in connection with the transactions contemplated by the Agreement and Plan of
Merger (the "Merger Agreement") dated as of July 1, 1997 by and among Health
Partners, Inc., a Delaware corporation ("HPI"), FPA and FPA Acquisition Corp., a
Delaware corporation and a wholly owned subsidiary of FPA, which Merger
Agreement is described therein and filed as Appendix A to the Registration
Statement, we hereby confirm our opinion that the discussion set forth under the
captions "Summary - The Merger - Material Federal Income Tax Consequences" and
"The Merger - Certain Federal Income Tax Consequences" in the Registration
Statement describes the material federal income tax considerations relevant to
the HPI shareholders receiving FPA Common Stock pursuant to the Merger
Agreement.
We hereby consent to the filing of this opinion as Exhibit 8.1 to the
Registration Statement and to the use of our name in the Registration Statement
and in the Prospectus included therein.
Very truly yours,
/s/ Pillsbury Madison & Sutro LLP
<PAGE> 1
EXHIBIT 8.2
September 29, 1997
Health Partners, Inc.
800 Connecticut Avenue
Norwalk, Connecticut 06854
Ladies and Gentlemen:
With reference to the Registration Statement on Form S-4 (the
"Registration Statement") filed by FPA Medical Management, Inc., a Delaware
corporation ("FPA"), with the Securities and Exchange Commission in connection
with the Registration under the Securities Act of 1933, as amended, of shares of
its common stock, par value $0.002 per share ("FPA Common Stock"), to be issued
in connection with the transactions contemplated by the Agreement and Plan of
Merger (the "Merger Agreement") dated as of July 1, 1997 by and among Health
Partners, Inc., a Delaware corporation ("HPI"), FPA and FPA Acquisition Corp., a
Delaware corporation and a wholly owned subsidiary of FPA, which Merger
Agreement is described therein and filed as Appendix A to the Registration
Statement, we hereby confirm our opinion that the discussion set forth under the
captions "Summary - The Merger - Material Federal Income Tax Consequences" and
"The Merger - Certain Federal Income Tax Consequences" in the Registration
Statement describes the material federal income tax considerations relevant to
the HPI shareholders receiving FPA Common Stock pursuant to the Merger
Agreement.
We hereby consent to the filing of this opinion as Exhibit 8.1 to the
Registration Statement and to the use of our name in the Registration Statement
and in the Prospectus included therein. In giving this consent, we do not admit
that we are within the category of persons whose consent is required under
Section 7 of the Securities Act on the General Rules and Regulations of the
Commission.
Very truly yours,
/s/ Gibson, Dunn & Crutcher LLP
<PAGE> 1
EXHIBIT 10.20
AMENDED AND RESTATED EMPLOYMENT CONTRACT
BETWEEN
STERLING HEALTHCARE GROUP, INC.
AND
STEPHEN J. DRESNICK, M.D.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
RECITALS ...................................................................................................... 1
ARTICLE I
RECITALS ................................................................................................. 1
ARTICLE II
TERM ..................................................................................................... 1
ARTICLE III
DUTIES ................................................................................................... 1
ARTICLE IV
COMPENSATION ............................................................................................. 2
ARTICLE V
EXPENSES AND INSURANCE ................................................................................... 4
ARTICLE VI
VACATION ................................................................................................. 4
ARTICLE VII
DEATH OR DISABILITY DURING EMPLOYMENT .................................................................... 4
ARTICLE VIII
TERMINATION OF EMPLOYMENT ................................................................................ 4
ARTICLE IX
RESIGNATION .............................................................................................. 5
ARTICLE X
CHANGE IN CONTROL ........................................................................................ 6
ARTICLE XI
NON-COMPETITION .......................................................................................... 7
ARTICLE XII
NOTICES .................................................................................................. 7
ARTICLE XIII
CONSTRUCTION OF CONTRACT................................................................................. 8
ARTICLE XIV
MISCELLANEOUS ............................................................................................ 9
</TABLE>
- i -
<PAGE> 3
AMENDED AND RESTATED EMPLOYMENT CONTRACT
THIS CONTRACT SUPERSEDES THAT CERTAIN EMPLOYMENT CONTRACT DATED JULY
15, 1994. THIS CONTRACT is made and entered as of the 1st day of January, 1995
("Contract"), between STERLING HEALTHCARE GROUP, INC., a Florida corporation
("EMPLOYER"), and STEPHEN J. DRESNICK, M.D. ("EMPLOYEE").
R E C I T A L S :
A. EMPLOYEE is the President, Chief Executive Officer and Chairman of
the Board of Directors of EMPLOYER.
B. EMPLOYEE and EMPLOYER desire to enter into this Contract to
memorialize the employment relationship between EMPLOYER and EMPLOYEE.
NOW, THEREFORE, in consideration of the mutual promises contained
herein and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereto mutually agree
as follows:
ARTICLE I
RECITALS
The above stated Recitals are true and correct and are incorporated by
reference into this Contract.
ARTICLE II
TERM
The initial term (the "Initial Term") of this Contract shall be three
(3) years commencing as of July 15, 1994 and ending three (3) years thereafter
unless terminated earlier as provided herein. The Initial Term shall be extended
for successive one (1) year periods, unless either party gives the other thirty
(30) days' prior written notice of its intent not to renew prior to the
expiration of the then current term.
ARTICLE III
DUTIES
A. In General. Upon the terms and subject to the conditions of this
Contract, EMPLOYER hereby employs EMPLOYEE for the term of this Contract as its
President, Chief Executive Officer and Chairman of the Board of Directors.
During the Initial Term of this Contract, EMPLOYEE shall serve as the President
and Chief Executive Officer of EMPLOYER. EMPLOYEE shall have the powers and
duties as set forth in the Bylaws of EMPLOYER for its
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President and Chief Executive Officer (subject to the direction of the Board of
Directors, which direction shall be pursuant to reasonable policies adopted from
time to time and communicated by written notice to EMPLOYEE). EMPLOYEE's duties
shall include the management of EMPLOYER's business interests ("Businesses") and
such other duties as are consistent with his position (the "Duties"). During the
term of this Contract and except for illness, disability, reasonable vacation
periods and reasonable leaves of absence, EMPLOYEE shall devote such portions of
his business time, attention, skill and efforts as is necessary for the faithful
performance of the Duties.
EMPLOYEE hereby accepts such employment and, consistent with fiduciary
standards which exist between an employer and an employee, EMPLOYEE shall
perform the Duties in an efficient, trustworthy and businesslike manner.
EMPLOYEE hereby consents to serve as a member of the Board of Directors of
EMPLOYER without any additional salary or compensation (other than reimbursement
for out-of-pocket expenses).
B. Delegation. Notwithstanding anything to the contrary contained in
this Article III, EMPLOYEE shall have the right and authority to delegate
responsibility to one or more personnel if he deems such delegation appropriate,
and is hereby authorized to hire on behalf of EMPLOYER additional agents,
employees and other representatives which are in his opinion necessary to handle
the affairs of EMPLOYER and to terminate the employment of any and all agents,
employees and other representatives of the Company, including, but not limited
to, officers of the Company.
C. Other Activities. EMPLOYEE shall use his best efforts for the
benefit of EMPLOYER by whatsoever activities he deems appropriate to maintain
and improve EMPLOYER's standing in the community generally and among other
members of the industries in which EMPLOYER is from time to time engaged,
including such entertaining for business purposes as he considers appropriate.
ARTICLE IV
COMPENSATION
A. Base Salary, Bonus and Employee Benefit Plans. For all services
rendered by EMPLOYEE in any capacity during his employment under this Contract
(including any renewals hereof), EMPLOYER shall pay EMPLOYEE as compensation the
sum of the amounts set forth in the following subparagraphs 1. through 3.:
1. Base Salary. Commencing on January 1, 1995, EMPLOYEE shall
be paid the sum of Three Hundred Twenty-Five Thousand ($325,000) Dollars on an
annualized basis, payable semi-monthly. On each anniversary thereafter during
the term of this Contract and any extensions thereof, and for each subsequent
year of the term of this Contract, EMPLOYEE shall be entitled to an annual
increase in his base salary subject to the discretion of the Board of Directors
of EMPLOYER.
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2. Bonus. On or before one hundred twenty (120) days subsequent
to EMPLOYER's fiscal year end, EMPLOYER shall pay to EMPLOYEE ten percent (10%)
of the marginal increase, if any, of EMPLOYER's net income, before taxes, over
One Million Nine Hundred Seventy-Six Thousand ($1,976,000) Dollars, which
represents EMPLOYER's net income before taxes for EMPLOYER's fiscal year ended
December 31, 1993.
3. Employee Benefit Plans. EMPLOYEE shall be entitled to
participate in any and all plans, arrangements or distributions by EMPLOYER
pertaining to or in connection with any pension, bonus, profit sharing, stock
options and/or similar benefits and/or health benefits for its regular employees
and/or for its employees and/or for its executives, as determined by the Board
of Directors or committees, pursuant to the governing instruments which
establish and/or determine eligibility and other rights of the participants and
beneficiaries under such plans or other benefit programs.
B. Payments Upon Termination.
1. Termination by EMPLOYER for Cause; Voluntary Unilateral
Decision by EMPLOYEE Without Cause. If EMPLOYEE is terminated by (i) EMPLOYER
for Cause (as hereinafter defined); or (ii) voluntary unilateral decision by
EMPLOYEE without Cause (as hereinafter defined), then EMPLOYEE shall be entitled
to (1) base salary pursuant to Paragraph A.1. of Article IV earned through the
date of termination; (2) accrued vacation under Article VI hereof; and (3) all
applicable reimbursements from EMPLOYER due under Article V hereof.
2. Termination for Reasons Other than Termination by EMPLOYER
for Cause; or Voluntary Unilateral Decision by EMPLOYEE. If there is a
termination of this Contract for any reason by either party, other than as a
result of (i) termination by EMPLOYER for Cause (as hereinafter defined); (ii)
termination by voluntary unilateral decision by EMPLOYEE without Cause (as
hereinafter defined), EMPLOYEE shall be entitled to (1) receive, in one lump sum
payment, that amount which is equivalent to EMPLOYEE's total compensation (base
salary plus bonus) paid by EMPLOYER to EMPLOYEE for the two fiscal years prior
to EMPLOYEE's termination; and (2) all applicable reimbursements from EMPLOYER
due under Article V.
3. Non-Renewal of Contract. If there is a termination of this
Contract as a result of notification by EMPLOYER of its intent not to renew this
Contract (other than for Cause), EMPLOYEE shall be entitled to (1) receive, in
one lump sum payment, that amount which is equivalent to EMPLOYEE's total
compensation (base salary plus bonus) paid by EMPLOYER to EMPLOYEE for the two
fiscal years prior to EMPLOYEE's termination; and (2) all applicable
reimbursements from EMPLOYER due under Article V.
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ARTICLE V
EXPENSES AND INSURANCE
A. Business Expenses. EMPLOYEE is authorized to incur reasonable
expenses to execute and/or promote the Businesses of EMPLOYER, including, but
not limited to, expenses related to maintenance of professional licenses and
expenses for entertainment, travel, and similar items. EMPLOYER will reimburse
EMPLOYEE for all reasonable travel or other expenses incurred while on business.
B. Automobile. During the term of this Contract, EMPLOYER shall furnish
EMPLOYEE with an automobile, of make and model acceptable to EMPLOYER, and pay
all expenses related to such automobile, which such automobile shall be used by
EMPLOYEE in the performance of his duties as are or may be customary for
executives in the community who perform similar duties.
C. Insurance. EMPLOYER will provide for EMPLOYEE medical insurance
reasonably satisfactory to EMPLOYEE, his spouse and family dependents.
ARTICLE VI
VACATION
EMPLOYEE will be entitled to six (6) weeks paid vacation annually or
such other time as authorized by the Board of Directors.
ARTICLE VII
DEATH OR DISABILITY DURING EMPLOYMENT
If EMPLOYEE dies or becomes permanently and totally disabled during the
term of the Contract, EMPLOYER shall pay to EMPLOYEE or EMPLOYEE's estate, as
the case may be, the base salary which would otherwise be payable to EMPLOYEE,
for a period of three (3) months after the date on which EMPLOYEE's death or
disability occurred. EMPLOYER shall have no further financial obligations to
EMPLOYEE or his estate, except as otherwise provided in Articles IV and V
hereof.
ARTICLE VIII
TERMINATION OF EMPLOYMENT
A. Termination by EMPLOYEE. EMPLOYEE may terminate his employment with
EMPLOYER at any time upon notice to EMPLOYER for "Cause." For this purpose, the
term "Cause" means: (1) an adjudication by a court of competent jurisdiction
that EMPLOYER has materially breached any provision of this Contract; provided,
however, that in the event EMPLOYEE believes that this Contract has been
breached, he shall provide EMPLOYER with written notice of such breach and
provide the EMPLOYER with a thirty (30) day period in which
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to cure or remedy such breach; or (2) at any time that a determination is made
that EMPLOYEE shall not be renominated as a member of the Board of Directors or
if he is asked to resign from the Board of Directors.
B. Termination by EMPLOYER. EMPLOYEE's employment may be terminated by
EMPLOYER at any time upon notice to EMPLOYEE for "Cause." For this purpose, the
term "Cause" means:
1. EMPLOYEE's material breach of any provision of this
Contract; provided, however, that in the event EMPLOYER believes that this
Contract has been breached, it shall provide EMPLOYEE with written notice of
such breach and provide EMPLOYEE with a thirty (30) day period in which to cure
or remedy such breach;
2. An adjudication by a court of competent jurisdiction that
EMPLOYEE committed an injurious act of fraud or dishonesty against EMPLOYER, its
subsidiaries or affiliates; and
3. The use by EMPLOYEE of an illegal substance, including, but
not limited to, marijuana, cocaine, heroin, and all other illegal substances,
and/or the dependence by EMPLOYEE upon the use of alcohol, which, in any case,
in the opinion of both EMPLOYEE's family physician and a physician chosen by
EMPLOYER, materially impairs EMPLOYEE's ability to perform his Duties hereunder,
which dependence is not cured or rehabilitated, as determined by EMPLOYEE's
physician, within three (3) months of receipt of written notice from EMPLOYER to
EMPLOYEE.
C. Death or Disability. This Contract shall terminate upon the death or
the disability of EMPLOYEE. Termination for death or disability shall not be
termination for Cause. EMPLOYEE or his heirs or estate (as the case may be)
shall be entitled to the compensation provided for termination by death or
disability in this Contract.
D. Termination of Obligations. Upon the resignation of EMPLOYEE or
termination of EMPLOYEE's employment in accordance with the provisions of this
Article IX, all obligations of EMPLOYEE and EMPLOYER hereunder shall be
terminated except as otherwise provided herein.
ARTICLE IX
RESIGNATION
Any termination of employment under this Contract, whether or not
voluntary, will automatically constitute a resignation of EMPLOYEE as an officer
and director of all subsidiaries of EMPLOYER.
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ARTICLE X
CHANGE IN CONTROL
This Contract shall continue in full force and effect notwithstanding
any change in control, merger, consolidation or reorganization of any kind
involving EMPLOYER or the sale of all or substantially all of its assets. This
Contract shall be binding upon EMPLOYER and EMPLOYEE and their respective heirs,
executors, administrators, successors and assigns.
Notwithstanding anything to the contrary contained herein, if at any
time during the term of this Contract and any renewal thereof, there shall be a
change in control of EMPLOYER, such change in control to be measured by a change
in the ownership, to one or more parties under common control, of at least more
than fifty percent (50%) of the outstanding voting shares of EMPLOYER and if
such change in control results in a diminution in EMPLOYEE's compensation,
responsibilities or position such that EMPLOYEE cannot in good faith continue to
fulfill the responsibilities for which he is employed, as determined by EMPLOYEE
in his sole discretion, and if such change in control did not occur due to
EMPLOYEE's intentional bulk sale of voting shares of EMPLOYER owned by him
directly to such control persons or group, then EMPLOYEE shall have the option
of terminating this Contract upon thirty (30) days' notice and, in such event
EMPLOYER shall pay to EMPLOYEE at the time of such termination (1) a lump sum in
an amount equal to EMPLOYEE's total compensation (base salary plus bonus) paid
by EMPLOYER to EMPLOYEE for the two fiscal years prior to the change in control;
and (2) all applicable reimbursements from EMPLOYER due under Article V. Said
lump sum payment shall be in lieu of any and all compensation due to EMPLOYEE
for the years that would otherwise be remaining for the term of this Contract.
Upon receipt of said lump sum payment, this Contract and all rights and duties
of the parties shall be terminated, except as follows: In consideration for such
lump sum payment and for the right to terminate the Contract under the
conditions set forth above, EMPLOYEE agrees to consult with EMPLOYER and its
officers if requested to do so for a period of at least two (2) years from the
date of such termination. However, EMPLOYEE shall be required to devote only
such part of his time to such services as EMPLOYEE believes reasonable in
EMPLOYEE's sole discretion, and the time and date such services are offered
shall be determined by EMPLOYEE so long as that time and date is within a
reasonable period of time after the request. It is expressly agreed that
EMPLOYER's rights to avail itself of the advice and consulting services of
EMPLOYEE shall at all times be exercised in a reasonable manner, that adequate
notice shall be given to EMPLOYEE in such event, and that noncompliance with any
such request by EMPLOYEE for good cause, including, but not limited to, ill
health, prior commitments, conflicts of interest or absence from Dade County,
Florida, shall not constitute a breach or violation of this Contract. EMPLOYEE
agrees that, except for reimbursement of all reasonable expenses incurred by him
with respect to such consulting and advisory services, payable as such
consulting and advisory services are rendered, he shall not be entitled to any
further compensation. It is understood that in furnishing any advisory and
consulting services provided herein, EMPLOYEE shall not be an EMPLOYEE of
EMPLOYER but shall act in the capacity of an independent contractor.
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ARTICLE XI
NON-COMPETITION
A. Non-Competition. While in the employment of EMPLOYER and for the
period of two (2) years thereafter, unless otherwise agreed to in writing by
EMPLOYER, EMPLOYEE will not, directly or indirectly, own, manage, operate, join,
control, be employed by or participate in the ownership, management, operation
or control of, or be connected in any manner with any business engaged in
providing physician contract management services in the same geographic areas in
which EMPLOYER is then conducting such business. It is agreed that each of the
cities, counties and other political subdivisions constituting the geographic
areas in which EMPLOYER shall be conducting such business shall be considered a
separate geographic area and a separate covenant from EMPLOYEE to EMPLOYER and
the invalidity of any of such covenants shall not affect this Contract or any
other covenant made hereunder.
B. Remedies. In the event of an actual or threatened breach by the
EMPLOYEE of Paragraph A. of this Article XI, EMPLOYER shall be entitled to an
injunction restraining EMPLOYEE from its prohibited conduct. If the court should
hold that the duration and/or scope (geographic or otherwise) of the covenants
contained herein are unreasonable, then, to the extent permitted by law, the
court may prescribe a duration and/or scope (geographic or otherwise), that is
reasonable and the parties agree to accept such determination, subject to their
rights of appeal. Nothing contained herein shall be construed as prohibiting
EMPLOYER or any third party from pursuing any of the remedies available to it
for such breach or threatened breach, including recovery of damages from
EMPLOYEE. In any action or proceeding to enforce the provisions of this Article
XI, the prevailing party shall be reimbursed by the other party for all costs
incurred in such action or proceeding, including, without limitation, all court
costs and filing fees and all attorneys' fees, incurred either at the trial
level or at the appellate level. If EMPLOYEE shall be in violation of any of the
restrictive covenants contained in this Contract, then the time limitation
otherwise applicable to such restrictive covenant shall be extended for a period
of time equal to the period of time during which such breach or breaches occur.
If EMPLOYER seeks injunctive relief from such breach in any court, then the
covenant shall be extended for a period of time equal to the pendency of such
proceedings, including all appeals. The existence of any claim or cause of
action by EMPLOYEE against EMPLOYER, whether predicated upon this Contract or
otherwise, shall not constitute a defense to the enforcement by EMPLOYER of the
foregoing restrictive covenant, but shall be litigated separately.
ARTICLE XII
NOTICES
Any notice, request, demand, offer, payment or communication required
or permitted to be given by any provision of this Contract shall be deemed to
have been delivered and given for all purposes if written and if (a) delivered
personally or by courier or delivery service, at the time of such delivery; or
(b) directed by registered or certified United States mail, postage and charges
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prepaid, addressed to the intended recipient, at the address specified below, at
such time that the intended recipient or its agent signs or executes the
receipt:
If to EMPLOYER:
Sterling Healthcare Group, Inc.
2333 Ponce de Leon Boulevard, Suite 511
Miami, Florida 33134
If to EMPLOYEE:
Stephen J. Dresnick, M.D.
2333 Ponce de Leon Boulevard, Suite 511
Miami, Florida 33134
Any party may change the address to which notices are to be mailed by giving
written notice as provided herein to the other party. Commencing immediately
after the receipt of such notice, such newly designated address shall be such
person's address for purposes of all notices or other communications required or
permitted to be given pursuant to this Contract.
ARTICLE XIII
CONSTRUCTION OF CONTRACT
A. Florida Law. This Contract shall be considered for all purposes a
Florida document and shall be construed pursuant to the laws of the State of
Florida, and all of its provisions shall be administered according to and its
validity shall be determined under the laws of the State of Florida without
regard to any conflict or choice of law issues.
B. Gender and Number. Whenever appropriate, references in this Contract
in any gender shall be construed to include all other genders, references in the
singular shall be construed to include the plural, and references in the plural
shall be construed to include the singular, unless the context clearly indicates
to the contrary.
C. Certain Words. The words "hereof," "herein," "hereunder," and other
similar compounds of the word "here" shall mean and refer to the entire Contract
and not to any particular article, provision or paragraph unless so required by
the context.
D. Captions. Paragraph titles or captions contained in this Contract
are inserted only as a matter of convenience and/or reference, and they shall in
no way be construed as limiting,
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extending, defining or describing either the scope or intent of this Contract or
of any provision hereof.
E. Counterparts. This Contract may be executed in one or more
counterparts, and any such counterpart shall, for all purposes, be deemed an
original, but all such counterparts together shall constitute but one and the
same instrument.
F. Severability. The invalidity or unenforceability of any provision
hereunder (or any portion of such a provision) shall not affect the validity or
enforceability of the remaining provisions (or remaining portions of such
provisions) of this Contract.
ARTICLE XIV
MISCELLANEOUS
A. Entire Contract. This Contract (and all other documents executed
simultaneously herewith or pursuant hereto) constitutes the entire agreement
among the parties pertaining to the subject matter hereof, and supersedes and
revokes any and all prior or existing agreements, written or oral, relating to
the subject matter hereof, and this Contract shall be solely determinative of
the subject matter hereof.
B. Restrictive Covenant. In the event the non-competition clause or any
other restrictive covenant of this Contract shall be deemed unenforceable,
invalid or overbroad in whole or in part for any reason, then any court of
competent jurisdiction is hereby authorized, requested and instructed to reform
such provision(s) to provide for the maximum competitive restraints upon
EMPLOYEE's activities (in time and geographic area), which may then be legal and
valid.
C. Waiver. Either EMPLOYER or EMPLOYEE may, at any time or times, waive
(in whole or in part) any rights or privileges to which he or it may be entitled
hereunder. However, no waiver by any party of any condition or of the breach of
any term, covenant, representation or warranty contained in this Contract, in
any one or more instances, shall be deemed to be or construed as a further
continuing waiver of any other condition or of any breach of any other terms,
covenants, representations or warranties contained in this Contract, and no
waiver shall be effective unless it is in writing and signed by the waiving
party.
D. Attorneys' Fees. In the event that either party shall be required to
retain the services of an attorney to enforce any of his or its rights
hereunder, the prevailing party in any arbitration or court action shall be
entitled to receive from the other party all costs and expenses including (but
not limited to) court costs and attorneys' fees (whether in the arbitration or
in a court of original jurisdiction or one or more courts of appellate
jurisdiction) incurred by him or it in connection therewith. The parties hereby
expressly confer on the arbitrator the right to award costs and attorneys' fees
in the arbitration.
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E. Venue. Any arbitration or other litigation arising hereunder shall
be instituted only in Dade County, Florida, the place where this Contract was
executed, and all parties hereto agree that venue shall be proper in said county
for all such legal or equitable proceedings.
F. Assignment. The rights and obligations of the parties under this
Contract shall inure to the benefit of and shall be binding upon their
successors, assigns, and/or other legal representatives. This Contract shall not
be assignable by EMPLOYER. The services of EMPLOYEE are personal and his
obligations may not be delegated by him except as otherwise provided herein.
G. Amendment. This Contract may not be amended, modified, superseded,
cancelled, or terminated, and any of the matters, covenants, representations,
warranties or conditions hereof may not be waived, except by a written
instrument executed by EMPLOYER and EMPLOYEE or, in the case of a waiver, by the
party to be charged with such waiver.
H. No Third Party Beneficiary. Nothing expressed or implied in this
Agreement is intended or shall be construed to confer upon or give any person,
other than EMPLOYER and EMPLOYEE and their respective successors and permitted
assigns, any rights or remedies under or by reason of this Agreement.
IN WITNESS WHEREOF, EMPLOYER and EMPLOYEE have caused this Contract to
be executed on the day and year first above written.
"EMPLOYER"
STERLING HEALTHCARE GROUP, INC.
By:___________________________
Authorized Representative
"EMPLOYEE"
------------------------------
Stephen J. Dresnick, M.D.
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<PAGE> 13
AMENDMENT NO. 1 TO
AMENDED AND RESTATED EMPLOYMENT CONTRACT
This Amendment is made and entered into as of October 31, 1996 between
Sterling Healthcare Group, Inc., a Florida corporation ("Employer"), and Stephen
J. Dresnick, M.D. ("Employee").
WHEREAS, Employer and Employee entered into an Amended and Restated
Employment Contract as of January 1, 1995 (the "Contract"), pursuant to which
Employer employs Employee on the terms and subject to the conditions set forth
therein; and
WHEREAS, on October 31, 1996, FPA Medical Management, Inc. ("FPA")
completed the merger of Employer into a wholly-owned subsidiary of FPA pursuant
to which Employer became a wholly-owned subsidiary of FPA; and
WHEREAS, Employer and Employee have agreed to amend the Contract as
hereinafter set forth;
NOW, THEREFORE, in consideration of the mutual promises contained
herein and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereto mutually agree
as follows:
1. All terms with initial capital letters not otherwise defined herein
shall have the meanings ascribed to those terms in the Contract.
2. Employer shall pay to Employee one million dollars ($1,000,000) in
cash (the "Payment") on or prior to November 30, 1996.
3. From and after October 31, 1996, the Contract is hereby amended and
modified as follows:
(a) The first sentence of ARTICLE II of the Contract is
hereby amended to read in full as follows:
The initial term (the "Initial Term") of this
Contract shall commence as of July 15, 1994 and end on October
31, 1999 unless terminated earlier as provided herein.
(b) Paragraph B.3. of Article IV of the Contract is hereby
deleted in its entirety.
(c) Article X of the Contract is hereby deleted in its
entirety.
<PAGE> 14
4. Except as otherwise modified or amended herein, all terms and
conditions of the Contract shall remain in full force and effect.
IN WITNES WHEREOF, EMPLOYER and EMPLOYEE have caused this Amendment to
be executed as of the day and year first above written.
STERLING HEALTHCARE GROUP, INC.
By:_________________________________
Authorized Representative
------------------------------------
Stephen J. Dresnick, M.D.
<PAGE> 15
AMENDMENT NO. 2
TO
AMENDED AND RESTATED EMPLOYMENT CONTRACT
This Amendment is made and entered into as of July , 1997 between
Sterling Healthcare Group, Inc., a Florida corporation ("Employer"), and Stephen
J. Dresnick, M.D. ("Employee").
WHEREAS, Employer and Employee entered into an Amended and Restated
Employment Contract as of January 1, 1995, as amended by Amendment No. 1 entered
into as of October 31, 1996 (the "Contract"), pursuant to which Employer employs
Employee on the terms and subject to the conditions set forth therein; and
WHEREAS, Employer and Employee have agreed to amend the Contract as
hereinafter set forth;
NOW, THEREFORE, in consideration of the mutual promises contained
herein and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereto mutually agree
as follows:
1. All terms with initial capital letters not otherwise defined herein
shall have the meanings ascribed to those terms in the Contract.
2. Employer shall pay to Employee one million dollars ($1,000,000) in
cash, Five Hundred Thousand dollars ($500,000) of which shall be paid on or
prior to July 30, 1997 and Five Hundred Thousand dollars ($500,000) of which
shall be paid on or prior to January 31, 1998.
3. From and after January 1, 1997, the Contract is hereby amended and
modified as follows:
(a) Paragraph A.2 of ARTICLE IV of the Contract is hereby
deleted in its entirety and amended to read in full as follows:
2. Bonus. On or before one hundred twenty (120) days
subsequent to EMPLOYER's fiscal year and , EMPLOYER shall pay
to EMPLOYEE a bonus up to on hundred and fifty percent (150%)
of EMPLOYEE's base salary for such year upon achievement of
annual performance objectives agreed upon by EMPLOYEE and
EMPLOYER, one-half of such bonus to be based on EMPLOYER's
performance and the other half to be based on the performance
of FPA Medical Management, Inc. (which performance bonus shall
be based on the same criteria and
<PAGE> 16
calculated in the same manner as the performance bonus for
the Chief Executive Officer of FPA Medical Management, Inc.)
4. Notwithstanding any provisions in the FPA Medical Management, Inc.
Omnibus Stock Options Plan, as amended (the "Plan"), or otherwise, any options
granted under the Plan not otherwise exercisable at the date of termination of
EMPLOYEE'S employment under the contract (other than termination for Cause or by
voluntary unilateral decision by EMPLOYEE without Cause) shall become
immediately exercisable.
5. Except as otherwise modified or amended herein, all terms and
conditions of the Contract shall remain in full force and effect.
IN WITNES WHEREOF, EMPLOYER and EMPLOYEE have caused this Amendment to
be executed as of the day and year first above written.
STERLING HEALTHCARE GROUP, INC.
By:_________________________________
Authorized Representative
------------------------------------
Stephen J. Dresnick, M.D.
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amendment No. 2 to Registration Statement No.
333-32687 of our report dated March 21, 1997, appearing in the Annual Report on
Form 10-K/A of FPA Medical Management, Inc. for the year ended December 31,
1996, our report dated May 2, 1997, appearing in the Current Report on Form
8-K/A of FPA Medical Management, Inc. filed on May 30, 1997 and our report dated
May 2, 1997, appearing in the Current Report on Form 8-K of FPA Medical
Management, Inc filed on July 31, 1997.
We also consent to the reference to us under the heading "Experts" in the
Prospectus, which is part of the Registration Statement.
/s/ DELOITTE & TOUCHE LLP
San Diego, California
September 26, 1997
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in the registration statement of FPA Medical
Management, Inc. in this Amendment No. 2 to Registration Statement (File No.
333-32687) of our report dated March 15, 1996, on our audits of the consolidated
financial statements of Sterling Healthcare Group, Inc. as of December 31, 1995,
and for the year ended December 31, 1995 and for the period from June 1, 1994 to
December 31, 1994, which is included in the Annual Report on Form 10-K/A and the
Current Report on Form 8-K dated July 31, 1997. We also consent to the
reference to our Firm under the caption "Experts."
/s/ COOPERS & LYBRAND L.L.P.
- ----------------------------
Coopers & Lybrand L.L.P.
Miami, Florida
September 26, 1997
<PAGE> 1
EXHIBIT 23.3
To the Board of Directors
Health Partners, Inc.:
We consent to the use of our report included herein and to the reference to
our firm under the heading "Experts" in the prospectus.
(signed) KPMG PEAT MARWICK LLP
White Plains, New York
September 26, 1997
<PAGE> 1
EXHIBIT 23.4
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" in Amendment
No. 2 to the Registration Statement (form S-4 No. 333-32687) of FPA Medical
Management, Inc. and in the related Prospectus and to the use of our report
dated February 22, 1996, with respect to the 1995 and 1994 consolidated
financial statements of AHI Healthcare Systems, Inc. included in the Current
Reports on Form 8-K of FPA Medical Management, Inc. filed on July 31, 1997 and
May 30, 1997, with the Securities and Exchange Commission.
ERNST & YOUNG LLP
Los Angeles, California
September 26, 1997
<PAGE> 1
EXHIBIT 23.5
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amendment No. 2 to Registration Statement No.
333-32687 of FPA Medical Management, Inc. of our report dated September 30,
1996, on the combined financial statements of Foundation Health Medical Services
(a wholly-owned subsidiary of Foundation Health Corporation) and Affiliates as
of June 30, 1995 and 1996 and for each of the three years in the period ended
June 30, 1996 (such report expresses an unqualified opinion and includes an
explanatory paragraph referring to significant related party transactions),
appearing in the Proxy Statement/Prospectus, which is part of this Registration
Statement.
We also consent to the reference to us under the heading "Experts" in the Proxy
Statement/Prospectus, which is a part of this Registration Statement.
Deloitte & Touche LLP
Sacramento, California
September 26, 1997
<PAGE> 1
EXHIBIT 23.6
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Amendment No. 2 of this
Registration Statement of FPA Medical Management, Inc. on Form S-4 of the report
of Stevenson, Jones, Imig, Holmaas & Kleinhans, P.C. dated April 27, 1994 on the
financial statements of Thomas-Davis Medical Centers, P.C. as of December 31,
1993 and for the year then ended, appearing in Registration Statement No.
333-32687 of FPA Medical Management, Inc. on Form S-4 under the Securities Act
of 1933.
We also consent to the reference to us under the heading "Experts" in
the Proxy Statement/Prospectus, which is part of this Registration Statement.
STEVENSON, JONES & HOLMAAS, P.C.
Tucson, Arizona
September 26, 1997
<PAGE> 1
EXHIBIT 99.1
HEALTH PARTNERS, INC.
THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS FOR THE SPECIAL
MEETING OF STOCKHOLDERS TO BE HELD ON _____________, 1997
The undersigned hereby appoints _____________ and ______________, each
with the power to appoint his substitute, as Proxies to represent and vote, as
designated below, all shares of common stock, par value $.001 per share (the
"Common Stock"), of Health Partners, Inc. (the "Company") held of record by the
undersigned at the Special Meeting of Stockholders of the Company to be held on
__________, 1997 at 10:00 a.m. at the Company's corporate headquarters, 800
Connecticut Avenue, Norwalk, Connecticut (the "Special Meeting"), and at any
adjournments or postponements thereof.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR EACH OF THE FOLLOWING
PROPOSALS:
1. Approval and adoption of the Agreement and Plan of Merger dated as
of July 1, 1997 by and among FPA Medical Management, Inc., FPA Acquisition
Corp., and the Company (the "Merger Agreement").
[ ] FOR [ ] AGAINST [ ] ABSTAIN
2. Approval of certain payments and benefits (collectively, the
"Payments") to be paid to or received by Charles G. Berg, president and chief
executive officer of the Company.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. In their discretion, the Proxies are each authorized to vote upon
such other matters as may properly come before the Special Meeting and any
adjournments or postponement thereof.
THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED AS DIRECTED HEREIN BY
THE UNDERSIGNED. ABSTENTIONS AND NON-VOTES WILL HAVE THE EFFECT OF A VOTE
AGAINST APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND AGAINST APPROVAL OF
THE PAYMENTS.
-----------------------------------------------------------------------------
(CONTINUED AND TO BE SIGNED AND DATED ON THE OTHER SIDE)
Do you plan to attend the meeting? [ ] YES [ ] NO
Please sign exactly as your name appears on the
stock certificate(s). When shares are held by
joint tenants, both should sign. When signing as
attorney, executor, administrator, trustee or
guardian, please give your full title as such. If
a corporation, please sign in full corporate name
by the president or other authorized officer. If a
partnership, please sign the partnership's name by
an authorized person.
DATED: _______________________, 1997
________________________________________________
Signature
________________________________________________
Signature if jointly held
PLEASE MARK, SIGN, DATE AND RETURN THE PROXY CARD PROMPTLY USING THE
ENCLOSED ENVELOPE.
<PAGE> 1
EXHIBIT 99.2
[LETTERHEAD OF SMITH BARNEY INC.]
The Board of Directors
Health Partners Inc.
800 Connecticut Avenue
Norwalk, Connecticut 06854
Members of the Board:
We hereby consent to the inclusion of our opinion letter to the Board
of Directors of Health Partners Inc. ("HPI") as Appendix B to the Proxy
Statement/Prospectus of HPI and FPA Medical Management, Inc. ("FPA") relating
to the proposed merger transaction involving HPI and FPA and references thereto
in such Proxy Statement/Prospectus under the captions "SUMMARY - The
Merger-Opinion of HPI's Financial Advisor" and "THE MERGER - Opinion of HPI's
Financial Advisor." In giving such consent, we do not admit that we come within
the category of persons whose consent is required under, and we do not admit
that we are "experts" for purposes of, the Securities Act of 1933, as amended,
and the rules and regulations promulgated thereunder.
By: /s/ SMITH BARNEY INC.
-------------------------------
SMITH BARNEY INC.
September 29, 1997