SCHEDULE 14A
(RULE 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange
Act of 1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission only (as permitted by Rule
14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12
MEDCATH INCORPORATED
(Name of Registrant as Specified In Its Charter)
Not Applicable
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(Name of Person(s) Filing Proxy Statement, if other than the
Registrant)
PAYMENT OF FILING FEE (Check the appropriate box):
[ ] No fee required.
[X] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies: Common
Stock, $.01 par value
(2) Aggregate number of securities to which transaction applies: 11,813,404
shares
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
The filing fee was computed using the $19 per share in cash to be
received by the shareholders in the merger proposal to which this Proxy
Statement relates
(4) Proposed maximum aggregate value of transaction: $224,454,676
(5) Total fee paid: $44,891
[X] $44,891 of fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form, Schedule or Registration Statement No.:
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(3) Filing Party:
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(4) Date Filed:
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MEDCATH INCORPORATED
7621 Little Avenue, Suite 106
Charlotte, North Carolina 28226
July , 1998
To Our Shareholders:
You are cordially invited to attend a Special Meeting of Shareholders (the
"Special Meeting") of MedCath Incorporated (the "Company" or "MedCath") to be
held on July 30, 1998, at 10:00 a.m., local time, at Raintree Country Club,
located at 8600 Raintree Lane, Charlotte, North Carolina. The purpose of the
Special Meeting is to consider and vote upon a merger (the "Merger") that, if
approved and subsequently consummated, will result in the public shareholders
of MedCath receiving $19 in cash per share for their stock and MedCath becoming
a privately-owned company.
If approved by MedCath's shareholders, the Merger would be accomplished
pursuant to an Agreement and Plan of Merger (the "Merger Agreement") as
follows. MCTH Acquisition, Inc. (the "Acquiror"), a newly-formed North Carolina
corporation which is an indirect, wholly-owned subsidiary of MedCath Holdings,
Inc., a newly-formed Delaware corporation (the "Parent"), would merge with and
into MedCath, which would be the surviving corporation in the Merger. If the
Merger is consummated, each outstanding share of common stock, $.01 par value,
of MedCath (the "Common Stock"), other than shares held by shareholders who are
entitled to and who have perfected their dissenters' rights and shares held by
the Acquiror, will be canceled and converted automatically into the right to
receive $19 in cash, payable to the holder thereof, without interest.
The Parent was organized at the direction of two private investment
partnerships that have jointly agreed, together with certain affiliated
entities and individuals, to acquire (indirectly through the Parent in the
Merger) the stock of the public shareholders of MedCath. The first partnership
is KKR 1996 Fund, L.P. (the "KKR Partnership"), an affiliate of Kohlberg Kravis
Roberts & Co., L.P. ("KKR"). The second partnership is Welsh, Carson, Anderson
& Stowe VII, L.P. ("WCAS VII"). One other private investment partnership and 12
individuals affiliated with WCAS VII will also participate in the transaction
(together with WCAS VII, the "WCAS Investors").
Three other members of MedCath's management and I (the "Management Group")
have each agreed to contribute to the Parent in kind at least 50% of the value
of our equity interests in MedCath, which includes both shares of Common Stock
and the difference between $19 per share and the exercise prices of our stock
options. Certain of the WCAS Investors have also agreed to contribute a portion
of their shares of Common Stock to the Parent. In addition, the approximately
80 physicians (the "Physicians") who own shares of Common Stock issued to them
in connection with the Company's acquisition of contracts to manage their
practices will be individually offered the opportunity to contribute to the
Parent up to 50% of their shares of Common Stock (or, in the case of two of the
Physicians, 100% of their shares). All of the approximately 30 employees (the
"Employees") of MedCath (not including members of the Management Group) who
hold options to purchase shares of Common Stock will individually be offered
the opportunity to exchange their existing options for options to purchase
shares of common stock of the Parent.
If the Merger is consummated, the Management Group, the WCAS Investors,
the Physicians and the Employees will not receive any cash in the Merger for
the value of their equity interests in MedCath contributed to the Parent.
Instead, they will receive shares, and (in the case of the Management Group and
the Employees) options to purchase shares, of common stock of the Parent and
will continue to have indirect ownership interests in MedCath following the
Merger. They will, however, receive cash in the Merger (on the same terms as
the other shareholders) for their shares of Common Stock that they do not
contribute to the Parent. The Management Group and the Employees will also
receive cash for the difference between $19 per share and the exercise prices
of any stock options they do not agree to exchange for substantially equivalent
options to purchase shares of common stock of the Parent.
A special committee of the Board of Directors of MedCath (the "Special
Committee"), consisting of two independent directors (who are neither members
of the Management Group nor affiliated with WCAS VII or the KKR Partnership)
was formed nearly a year ago to investigate, consider and evaluate strategic
alternatives to maximize shareholder value. The Special Committee has
unanimously recommended to MedCath's Board of Directors that the Merger and
related agreements be approved. In connection with its evaluation of strategic
alternatives, the Special Committee engaged Goldman, Sachs & Co. ("Goldman
Sachs") to act as its financial advisor. Goldman Sachs has rendered its opinion
that, as of July 6, 1998, based upon and subject to the assumptions,
limitations and qualifications set forth in such opinion, the cash merger
consideration of $19 per share to be received in the Merger is fair from a
financial point of view to the shareholders of the Company (other than the
Management Group, the KKR Partnership, the WCAS Investors and the Acquiror).
The written opinion of
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Goldman Sachs, dated July 6, 1998, is attached as Appendix B to the enclosed
Proxy Statement and should be read carefully and in its entirety by the
shareholders.
The Special Committee and the Board of Directors believe that the terms of
the Merger are fair to, and in the best interests of, the Company's
shareholders and unanimously recommend that the shareholders approve the
Merger. Four of the six members of MedCath's Board of Directors are either
members of the Management Group or WCAS Investors and, consequently, have
conflicts of interest in connection with this recommendation. None of those
directors participated in the vote on the Merger. As a result, the two
independent directors (who also constituted the Special Committee) were the
only members of the Board of Directors who voted on the Merger.
Approval of the Merger at the Special Meeting will require the affirmative
vote of holders of a majority of the outstanding shares of Common Stock
entitled to vote at the Special Meeting. Shareholders (including the Management
Group, the other executive officers of MedCath, the WCAS Investors, Welsh,
Carson, Anderson & Stowe V, L.P., an affiliate of WCAS VII, and the members of
the Special Committee) who, as of the record date, beneficially owned
approximately 23% of the outstanding shares of Common Stock, have either agreed
to or expressed their intention to vote their shares for approval of the
Merger.
The accompanying Proxy Statement provides you with a summary of the
proposed Merger and additional information about the parties involved and their
interests. Please give all this information your careful attention. Whether or
not you plan to attend, it is important that your shares are represented at the
Special Meeting. A failure to vote will count as a vote against the Merger.
Accordingly, you are requested to promptly complete, sign and date the enclosed
proxy and return it in the envelope provided.
STEPHEN R. PUCKETT
Chairman, President and Chief Executive
Officer
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MEDCATH INCORPORATED
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NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
To be held July 30, 1998
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To Our Shareholders:
Notice is hereby given that a Special Meeting of Shareholders (the
"Special Meeting") of MedCath Incorporated, a North Carolina corporation (the
"Company" or "MedCath"), will be held on July 30, 1998 at 10:00 a.m., local
time, at Raintree Country Club, located at 8600 Raintree Lane, Charlotte, North
Carolina, for the following purposes:
(1) To consider and vote on a proposal to approve an Agreement and Plan of
Merger pursuant to which MCTH Acquisition, Inc., a newly-formed company
(the "Acquiror"), will be merged (the "Merger") with and into MedCath
and each shareholder of the Company (other than shareholders who are
entitled to and have perfected their dissenters' rights and the
Acquiror) will become entitled to receive $19 in cash for each
outstanding share of common stock, $.01 par value, of the Company (the
"Common Stock") owned immediately prior to the effective time of the
Merger. A copy of the Agreement and Plan of Merger dated as of March 12,
1998 is attached as Appendix A to and is described in the accompanying
Proxy Statement.
(2) To consider and act upon such other matters as may properly come before
the Special Meeting or any adjournment or adjournments thereof.
The Board of Directors has determined that only holders of Common Stock of
record at the close of business on June 22, 1998, will be entitled to notice
of, and to vote at, the Special Meeting or any adjournment or adjournments
thereof.
By Order of the Board of Directors,
RICHARD J. POST
Chief Financial Officer, Secretary and
Treasurer
YOUR VOTE IS IMPORTANT
Whether or not you are able to attend the meeting, please date, sign and
return the accompanying proxy card promptly in the enclosed envelope which
requires no postage if mailed in the United States. Please do not send in any
certificates for your shares at this time.
Any shareholder shall have the right to dissent from the consummation of
the transactions contemplated by the Agreement and Plan of Merger and to
receive payment of the "fair value" of his or her shares upon compliance with
the procedures set forth in Chapter 55, Article 13 of the General Statutes of
North Carolina. See "RIGHTS OF DISSENTING SHAREHOLDERS" in the Proxy Statement
that accompanies this notice and the full text of Chapter 55, Article 13 of the
General Statutes of North Carolina, which is attached as Appendix C and is
described in the accompanying Proxy Statement.
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MEDCATH INCORPORATED
7621 Little Avenue, Suite 106
Charlotte, North Carolina 28226
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PROXY STATEMENT
---------------
Introduction
This Proxy Statement is being furnished to the shareholders of MedCath
Incorporated, a North Carolina corporation (the "Company" or "MedCath"), in
connection with the solicitation by its Board of Directors (the "Board") of
proxies to be used at a Special Meeting of Shareholders (the "Special Meeting")
to be held on July 30, 1998 at 10:00 a.m., local time, at Raintree Country
Club, located at 8600 Raintree Lane, Charlotte, North Carolina, and at any
adjournment or adjournments thereof. This Proxy Statement, the Notice of
Special Meeting of Shareholders and the enclosed proxy card are first being
mailed to shareholders of MedCath on or about July , 1998.
The Special Meeting has been called to consider and vote on a proposal to
approve an Agreement and Plan of Merger (the "Merger Agreement"), which is
attached to this Proxy Statement as Appendix A. Pursuant to the Merger
Agreement, MCTH Acquisition, Inc. (the "Acquiror"), a newly-formed North
Carolina corporation, will be merged with and into MedCath (the "Merger"). In
the Merger, each outstanding share of common stock, $.01 par value, of MedCath
(the "Common Stock") (other than shares held by shareholders who are entitled
to and who have perfected their Dissenters' Rights (as defined below) and
shares held by the Acquiror) will be canceled and converted automatically into
the right to receive $19 in cash, payable to the holder thereof, without
interest.
The Acquiror is an indirect, wholly-owned subsidiary of MedCath Holdings,
Inc. (the "Parent"), a newly-formed Delaware corporation organized at the
direction of two private investment partnerships, KKR 1996 Fund, L.P. (the "KKR
Partnership"), which is an affiliate of Kohlberg Kravis Roberts & Co., L.P.
("KKR"), and Welsh, Carson, Anderson & Stowe VII, L.P. ("WCAS VII"). One other
private investment partnership and 12 individuals affiliated with WCAS VII
(together with WCAS VII, the "WCAS Investors") will also participate in the
transaction. Welsh, Carson, Anderson & Stowe V, L.P. ("WCAS V"), a private
investment partnership related to WCAS VII that currently holds approximately
7.5% of the outstanding Common Stock, will not participate in the transaction
and will instead receive $19 per share in cash for its shares on the same basis
as other MedCath shareholders. Four members of MedCath's management, Stephen R.
Puckett, Chairman, President and Chief Executive Officer; David Crane,
Executive Vice President and Chief Operating Officer; Charles W. (Todd)
Johnson, Senior Vice President-Development and Managed Care; and Richard J.
Post, Chief Financial Officer, Secretary and Treasurer (together, the
"Management Group") are participating in the transaction, will remain the
executive officers of the Company immediately following the Merger and will
become the executive officers of the Parent. Mr. Puckett and Mr. Crane will
become directors of the Parent. The Management Group, the KKR Partnership and
the WCAS Investors are sometimes referred to together as the "Investor Group."
Immediately prior to the Effective Time (as defined below), certain
parties will contribute to the Parent shares of Common Stock or options to
purchase Common Stock in exchange for shares of common stock or stock options
of the Parent as follows:
o The Management Group. Each member of the Management Group has agreed to
contribute to the Parent in kind at least 50% of the value of his equity
interest in MedCath, including both shares of Common Stock and the
difference between $19 per share and the exercise prices of his MedCath
stock options times the number of shares issuable upon exercise of such
options (the "Aggregate Unrealized Gain"). In exchange for shares of
Common Stock contributed, each member of the Management Group will
receive shares of common stock of the Parent. In exchange for MedCath
stock options, each member of the Management Group will receive similar
options, which will be fully vested and immediately exercisable, with
the same Aggregate Unrealized Gain to purchase shares of common stock of
the Parent.
o The WCAS Investors. Certain of the WCAS Investors, including two
non-management members of MedCath's Board of Directors, Patrick J. Welsh
and Andrew M. Paul (the "WCAS Directors"), have also agreed to
contribute to the Parent a portion of their shares of Common Stock in
exchange for shares of the Parent.
o The Physicians. The approximately 80 physicians who own shares of Common
Stock issued to them in connection with the Company's acquisition of
contracts to manage their practices (the "Physicians") will be
individually offered
<PAGE>
the opportunity to contribute to the Parent up to 50% of their shares of
Common Stock (or, in the case of two of the Physicians, 100% of their
shares) in exchange for shares of common stock of the Parent.
o The Employees. All of the approximately 30 employees of MedCath (not
including members of the Management Group) who hold options to purchase
shares of Common Stock (the "Employees") will individually be offered
the opportunity to exchange their existing options for options to
purchase shares of common stock of the Parent. The new options will be
fully vested at the time of grant and will have the same Aggregate
Unrealized Gain as the canceled options to purchase Common Stock.
The Board of Directors of the Parent will reserve shares of the Parent's
common stock representing 15% of the fully diluted equity of the Parent for the
grant after consummation of the Merger of stock options at an exercise price of
$19 per share (the "New Options"). It is anticipated that the Management Group
will receive a substantial portion of the New Options, which will vest as
described under "SPECIAL FACTORS -- Conflicts of Interest."
If the Merger is consummated, the Management Group, the WCAS Investors and
the Physicians will not receive any cash in the Merger for the shares of Common
Stock contributed to the Parent. Similarly, the Management Group and the
Employees will not receive any cash in the Merger for the Aggregate Unrealized
Gain on the options to purchase shares of Common Stock that they exchange for
options to purchase shares of common stock of the Parent. Instead, they will
all receive equity interests in the Parent and will continue to have indirect
ownership interests in MedCath following the Merger. The Management Group, the
WCAS Investors and the Physicians will, however, receive cash in the Merger on
the same terms as other MedCath shareholders for the shares of Common Stock
that they do not contribute to the Parent. The Management Group and the
Employees will also receive cash for the Aggregate Unrealized Gain on any stock
options that they do not exchange for similar options to purchase shares of
common stock of the Parent.
The aggregate consideration payable in the Merger, excluding fees and
expenses, is approximately $242 million. The amount to be paid in cash will be
reduced by the aggregate value of the equity interests in MedCath that the
Management Group, the WCAS Investors, the Physicians and the Employees
contribute to the Parent.
Approval of the Merger at the Special Meeting will require the affirmative
vote of the holders of a majority of the outstanding shares of Common Stock
entitled to vote at the Special Meeting. Shareholders (including the Management
Group, the other executive officers of MedCath, the WCAS Investors, WCAS V and
the members of the Special Committee) who, as of the record date, beneficially
owned approximately 23% of the outstanding shares of Common Stock have either
agreed to or expressed their intention to vote their shares for approval of the
Merger.
The consummation of the Merger is subject to a number of conditions.
Accordingly, even if shareholders approve the Merger, there can be no assurance
that the Merger will be consummated. This Proxy Statement, the Notice of
Special Meeting and the enclosed proxy card are first being mailed to
shareholders of the Company on or about July , 1998.
The Merger has not been approved or disapproved by the Securities and
Exchange Commission nor has the Commission passed upon the fairness or merits
of the Merger nor upon the accuracy or adequacy of the information contained in
this document. Any representation to the contrary is unlawful.
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TABLE OF CONTENTS
<TABLE>
<S> <C>
AVAILABLE INFORMATION .............................................. iii
SUMMARY ............................................................ 1
Date, Time and Place of the Special Meeting ..................... 1
Purpose of the Special Meeting .................................. 1
Record Date and Quorum .......................................... 1
Vote Required ................................................... 1
Parties to the Merger ........................................... 1
The Merger ...................................................... 3
Effective Time of the Merger and Payment for Shares ............. 3
The Special Committee's and Board's Recommendation .............. 3
Opinion of Financial Advisor .................................... 3
Purpose and Reasons of the Affiliates for the Merger ............ 4
Position of the Affiliates as to Fairness of the Merger ......... 4
Conflicts of Interest ........................................... 5
Certain Effects of the Merger ................................... 6
Conditions to the Merger, Termination and Expenses .............. 6
Federal Income Tax Consequences ................................. 8
Rights of Dissenting Shareholders ............................... 8
Accounting Treatment ............................................ 8
Financing of the Merger ......................................... 8
Market Prices of Common Stock and Dividends ..................... 8
SPECIAL FACTORS .................................................... 9
Background of the Merger ........................................ 9
The Special Committee's and the Board's Recommendation .......... 16
Opinion of Financial Advisor .................................... 20
Purpose and Reasons of the Affiliates for the Merger ............ 24
Position of the Affiliates as to Fairness of the Merger ......... 25
Conflicts of Interest ........................................... 25
Certain Effects of the Merger ................................... 29
Conduct of MedCath's Business After the Merger .................. 29
Certain Forward Looking Information ............................. 29
THE SPECIAL MEETING ................................................ 30
Proxy Solicitation .............................................. 30
Record Date and Quorum Requirement .............................. 30
Voting Procedures ............................................... 30
Voting and Revocation of Proxies ................................ 30
Effective Time .................................................. 30
THE MERGER ......................................................... 31
Conversion of Securities ........................................ 31
Cash-out of MedCath Stock Options ............................... 31
Transfer of Shares .............................................. 31
Conditions ...................................................... 31
Representations and Warranties .................................. 32
Covenants ....................................................... 33
Nonsolicitation Covenant ........................................ 34
Indemnification and Insurance ................................... 34
Expenses ........................................................ 34
Termination, Amendment and Waiver ............................... 35
Termination Fee ................................................. 35
Financing ....................................................... 36
Expenses of the Transaction ..................................... 37
Regulatory Approvals ............................................ 37
</TABLE>
i
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<TABLE>
<S> <C>
Accounting Treatment .......................................... 37
RIGHTS OF DISSENTING SHAREHOLDERS ................................ 37
FEDERAL INCOME TAX CONSEQUENCES .................................. 39
BUSINESS OF THE COMPANY .......................................... 40
Overview ...................................................... 40
Business Segments ............................................. 40
Hospital Division ............................................. 40
Practice Management Division .................................. 41
Diagnostics Division .......................................... 42
Competition ................................................... 43
Employees ..................................................... 43
Properties .................................................... 43
Legal Proceedings ............................................. 44
SELECTED CONSOLIDATED FINANCIAL DATA ............................. 45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION ......................................... 47
Hospital Division ............................................. 47
Practice Management and Diagnostics Divisions ................. 47
Results of Operations ......................................... 48
Liquidity and Capital Resources ............................... 51
General Trends and Business Outlook ........................... 53
Newly Issued Accounting Standards ............................. 54
Other ......................................................... 55
CERTAIN FORWARD LOOKING INFORMATION .............................. 55
The June Projection ........................................... 55
The December Projection ....................................... 56
The March Projection .......................................... 57
MANAGEMENT ....................................................... 58
Directors and Executive Officers of MedCath ..................... 58
Executive Compensation .......................................... 60
PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF MANAGEMENT ......... 63
CERTAIN INFORMATION CONCERNING THE PARENT, HOLDINGS, THE ACQUIROR
AND OTHER AFFILIATES ............................................ 64
SHAREHOLDER PROPOSALS ............................................ 65
INDEPENDENT AUDITORS ............................................. 65
OTHER MATTERS .................................................... 65
INDEX TO FINANCIAL STATEMENTS .................................... F-1
</TABLE>
APPENDICES
<TABLE>
<S> <C>
APPENDIX A -- The Agreement and Plan of Merger ........................................ A-1
APPENDIX B -- Opinion of Goldman, Sachs & Co. ......................................... B-1
APPENDIX C -- Text of Chapter 55, Article 13 of the General Statutes of North Carolina C-1
</TABLE>
ii
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AVAILABLE INFORMATION
The Company 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"). The reports, proxy
statements, and other information filed with the Commission can be inspected
and copied at the public reference facilities maintained by the Commission at
450 Fifth Street, N.W., Judiciary Plaza, Washington D.C. 20549 and at the
following Regional Offices of the Commission: 500 West Madison Street, Suite
1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New York,
New York 10048. Copies of such material can be obtained at prescribed rates
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.
Judiciary Plaza, Washington, D.C. 20549. The Commission maintains a World Wide
Web site on the Internet at http://www.sec.gov that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission, including the Company. The same information
is also available on the Internet at http://www.FreeEDGAR.com.
The Company, the Parent, MedCath Intermediate Holdings, Inc., a
newly-formed Delaware corporation which is a wholly-owned subsidiary of the
Parent ("Holdings") that owns all of the issued and outstanding shares of the
Acquiror, the Acquiror, the Management Group, WCAS VII and the WCAS Directors
(the "Affiliates") have filed a Schedule 13E-3 with the Commission with respect
to the transactions contemplated by the Merger Agreement. As permitted by the
rules and regulations of the Commission, this Proxy Statement omits certain
information contained in the Schedule 13E-3. The Schedule 13E-3, including any
amendments and exhibits filed or incorporated by reference as a part thereof,
is available for inspection or copying as set forth above. Statements contained
in this Proxy Statement or in any document incorporated herein by reference as
to the contents of any contract or other document referred to herein or therein
are not necessarily complete and in each instance reference is made to such
contract or other document filed as an exhibit to the Schedule 13E-3 or such
other document, and each such statement shall be deemed qualified in its
entirety by such reference.
No person has been authorized to give any information or make any
representation in connection with the solicitation of proxies made hereby other
than those contained or incorporated by reference in this Proxy Statement, and,
if given or made, such information or representation must not be relied upon as
having been authorized by the Company, the Parent or the Acquiror. This Proxy
Statement does not constitute a solicitation of a proxy in any jurisdiction
where, or to or from any person to whom, it is unlawful to make such proxy
solicitation in such jurisdiction. The delivery of this Proxy Statement shall
not, under any circumstances, create any implication that there has been no
change in the affairs of the Company since the date hereof or that the
information contained or incorporated by reference herein is correct as of any
time subsequent to its date.
iii
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SUMMARY
The following is a summary of certain information contained elsewhere in
this Proxy Statement. Reference is made to, and this Summary is qualified in
its entirety by, the more detailed information contained elsewhere or
incorporated by reference in this Proxy Statement. Shareholders are urged to
read this Proxy Statement and its appendices in their entirety before voting.
Date, Time and Place of the Special Meeting
A Special Meeting of Shareholders (the "Special Meeting") of MedCath
Incorporated (the "Company" or "MedCath") will be held on July 30, 1998, at
10:00 a.m., local time, at Raintree Country Club, located at 8600 Raintree
Lane, Charlotte, North Carolina.
Purpose of the Special Meeting
At the Special Meeting, the shareholders of the Company will consider and
vote on a proposal to approve an Agreement and Plan of Merger (the "Merger
Agreement"), which is attached to this Proxy Statement as Appendix A, pursuant
to which MCTH Acquisition, Inc. (the "Acquiror"), a newly-formed North Carolina
corporation which is an indirect, wholly-owned subsidiary of MedCath Holdings,
Inc., a newly-formed Delaware corporation (the "Parent"), would merge with and
into MedCath (the "Merger"), which would be the surviving corporation in the
Merger, and each outstanding share of common stock, $.01 par value, of MedCath
(the "Common Stock"), other than shares held by shareholders who are entitled
to and who have perfected their Dissenters' Rights (as defined below) and
shares held by the Acquiror will be converted automatically into the right to
receive $19 in cash payable to the holders thereof, without interest (the "Cash
Merger Consideration"). See "THE MERGER."
Record Date and Quorum
The Board of Directors of the Company (the "Board") has fixed the close of
business on June 22, 1998 as the record date (the "Record Date") for the
determination of shareholders entitled to notice of, and to vote at, the
Special Meeting and any adjournment or adjournments thereof. Each holder of
record of Common Stock at the close of business on the Record Date is entitled
to one vote for each share then held on each matter submitted to a vote of
shareholders. At the close of business on the Record Date, there were
11,813,404 shares of Common Stock outstanding. The holders of a majority of the
outstanding shares of Common Stock entitled to vote at the Special Meeting must
be present in person or represented by proxy to constitute a quorum for the
transaction of business. See "THE SPECIAL MEETING."
Vote Required
The affirmative vote of the holders of a majority of the outstanding
shares of Common Stock entitled to vote at the Special Meeting is required to
approve the Merger Agreement. Thus, a failure to vote or a vote to abstain will
have the same legal effect as a vote cast against approval. In addition,
brokers who hold shares of Common Stock as nominees will not have discretionary
authority to vote such shares in the absence of instructions from the
beneficial owners. A broker non-vote will have the same effect as a vote
against the Merger. See "THE SPECIAL MEETING -- Voting Procedures."
Shareholders (including the Management Group, the other executive officers
of MedCath, the WCAS Investors, WCAS V, and the members of the Special
Committee) who as of the record date owned 2,772,835, or approximately 23%, of
the outstanding shares of Common Stock have either agreed or expressed their
intention to vote their shares for approval of the Merger. Holders of 9,040,569
shares of Common Stock, or approximately 77%, of the outstanding shares of
Common Stock, remain uncommitted with respect to how they will vote on the
Merger. Accordingly, the affirmative vote by holders of Common Stock
representing approximately 3,133,868 of such uncommitted shares, or
approximately 27% of the outstanding shares, will be required to approve the
Merger.
Parties to the Merger
The Company
The Company is a provider of cardiology and cardiovascular services
through the development, operation and management of specialized cardiac
facilities and the management of physician practices. The Company operates four
specialty heart hospitals: The McAllen Heart Hospital in McAllen, Texas (which
opened in January 1996), the Arkansas Heart Hospital in Little Rock, Arkansas
(which opened in March 1997), the Tucson Heart Hospital in Tucson, Arizona
(which opened in
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October 1997) and the Arizona Heart Hospital in Phoenix, Arizona (which opened
in June 1998). (These hospitals are sometimes referred to in this Proxy
Statement as "McAllen," "Little Rock," "Tucson" and "Phoenix" respectively).
The Company has four additional heart hospitals under development. (The
Company's existing and planned heart hospitals are referred to in this Proxy
Statement as "Heart Hospitals.") The Company also manages six medical practices
comprising approximately 115 physicians, manages eight fixed-site cardiac
diagnostic and therapeutic centers, and owns and operates 23 mobile cardiac
catheterization laboratories serving networks of hospitals. The principal
executive offices of the Company are located at 7621 Little Avenue, Suite 106,
Charlotte, North Carolina 28226. The Company's telephone number is (704)
541-3228. See "BUSINESS OF THE COMPANY."
The Acquiror
The Acquiror is a newly-formed North Carolina corporation organized at the
direction of the Parent for the sole purpose of effecting the Merger and has
not conducted any prior business. The principal executive offices of the
Acquiror are located at 2800 Sand Hill Road, Suite 200, Menlo Park, California
94025. The Acquiror's telephone number is (650) 233-6560.
The Parent
The Parent is a newly-formed Delaware corporation organized at the
direction of the KKR Partnership and WCAS VII, each of which is a private
investment partnership. See "CERTAIN INFORMATION CONCERNING THE PARENT,
HOLDINGS, THE ACQUIROR AND OTHER AFFILIATES." Prior to the consummation of the
Merger, certain members of the Investor Group will contribute to the Parent
shares of Common Stock or options to purchase Common Stock in exchange for
shares of common stock or stock options of the Parent as follows:
o The KKR Partnership. The KKR Partnership will contribute up to
approximately $106 million in cash, provided that such contribution is
subject to reduction by an amount equal to one-half of the Aggregate
Unrealized Gain on the stock options contributed to the Parent by the
Employees.
o The WCAS Investors. The WCAS Investors will contribute an aggregate of
262,474 shares of Common Stock (valued at $19 per share with an aggregate
value of approximately $5 million), plus approximately $101 million of
cash, such that the total amount of the WCAS Investors' contribution to
the Parent is equal to approximately $106 million; provided that the cash
portion of such contribution is subject to reduction by an amount equal
to (i) the aggregate value (at $19 per share) of the shares of Common
Stock contributed to the Parent by the Physicians and (ii) one-half of
the Aggregate Unrealized Gain on the stock options contributed to the
Parent by the Employees. The WCAS Investors include WCAS VII, WCAS
Healthcare Partners, L.P., a private investment limited partnership, and
13 individuals who are affiliates of WCAS VII or have a business
relationship with WCAS VII.
o The Management Group. Each member of the Management Group has agreed to
contribute to the Parent in kind at least 50% of the value of his equity
interest in MedCath, including both shares of Common Stock and the
difference between $19 per share and the exercise prices of his MedCath
stock options times the number of shares issuable upon exercise of such
options (the "Aggregate Unrealized Gain"). In exchange for shares of
Common Stock contributed, each member of the Management Group will
receive shares of common stock of the Parent. In exchange for MedCath
stock options, each member of the Management Group will receive similar
options, which will be fully vested and immediately exercisable, with the
same Aggregate Unrealized Gain to purchase shares of common stock of the
Parent. The members of the Management Group are the following executive
officers of MedCath: Stephen R. Puckett, Chairman of the Board, President
and Chief Executive Officer; David Crane, Executive Vice President and
Chief Operating Officer; Charles W. (Todd) Johnson, Senior Vice President
-- Development and Managed Care; and Richard J. Post, Chief Financial
Officer, Secretary and Treasurer. Following consummation of the Merger,
the current executive officers of MedCath will retain their positions
with MedCath and become the executive officers of the Parent.
o The Physicians. The approximately 80 physicians who own shares of Common
Stock issued to them in connection with the Company's acquisition of
contracts to manage their practices (the "Physicians") will be
individually offered the opportunity to contribute to the Parent up to
50% of their shares of Common Stock (or, in the case of two of the
Physicians, 100% of their shares) in exchange for shares of common stock
of the Parent.
o The Employees. All of the approximately 30 employees of MedCath (not
including members of the Management Group) who hold options to purchase
shares of Common Stock (the "Employees") will individually be offered the
opportunity to exchange their existing options for options to purchase
shares of common stock of the Parent. The
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new options will be fully vested at the time of grant and will have the
same Aggregate Unrealized Gain as the canceled options to purchase Common
Stock.
The executive offices of the Parent are located at 2800 Sand Hill Road, Suite
200, Menlo Park, California 94025. The Parent's telephone number is (650)
233-6560.
The Merger
The Merger Agreement provides that subject to satisfaction of certain
conditions, the Acquiror will be merged with and into MedCath, and that
following the Merger, the separate existence of the Acquiror will cease and
MedCath will continue as the surviving corporation and an indirect,
wholly-owned subsidiary of the Parent. At the effective time of the Merger,
which shall be the date and time of filing of Articles of Merger with the
Secretary of State of the State of North Carolina (the "Effective Time"), and
subject to the terms and conditions set forth in the Merger Agreement, each
share of issued and outstanding Common Stock (other than shares as to which
Dissenters' Rights (as defined below) are properly perfected and not withdrawn
and shares held by the Acquiror) will, by virtue of the Merger, be canceled and
converted into the right to receive $19 in cash, without interest (the "Cash
Merger Consideration"). As a result of the Merger, MedCath's Common Stock will
no longer be publicly traded and will be 100% owned (indirectly) by the Parent.
See "THE MERGER."
Effective Time of the Merger and Payment for Shares
The Effective Time is currently expected to occur as soon as practicable
after the Special Meeting, subject to approval of the Merger Agreement at the
Special Meeting and satisfaction or waiver of the terms and conditions of the
Merger Agreement. See " -- Conditions to the Merger, Termination and Expenses"
and "THE MERGER -- Conditions." Detailed instructions with regard to the
surrender of share certificates, together with a letter of transmittal, will be
forwarded to shareholders by the Company's transfer agent, LaSalle National
Bank (the "Disbursing Agent"), promptly following the Effective Time.
Shareholders should not submit their certificates to the Disbursing Agent until
they have received such materials. The Disbursing Agent will send payment of
the Cash Merger Consideration to shareholders as promptly as practicable
following receipt by the Disbursing Agent of their certificates and other
required documents. No interest will be paid or accrued on the cash payable
upon the surrender of certificates. See "THE MERGER -- Conversion of
Securities." Shareholders should not send any share certificates at this time.
The Special Committee's and Board's Recommendation
In July 1997, because of the possibility of a sale of the Company in a
transaction in which management and the WCAS Directors might have a continuing
financial interest, the Board appointed a committee of disinterested directors
to review and evaluate the Company's strategic options, including a possible
sale of the Company (the "Special Committee"). Based on the factors set forth
in this Proxy Statement (see "SPECIAL FACTORS -- The Special Committee's and
the Board's Recommendation"), the Special Committee unanimously recommended to
the Board that the Merger Agreement be approved and that it be recommended to
the shareholders of the Company. Following the unanimous recommendation of the
Special Committee, the Board approved the Merger Agreement and recommended that
the shareholders of the Company approve the Merger Agreement. In connection
with the foregoing, the Special Committee and the Board determined that the
Merger is substantively and procedurally fair to the shareholders of the
Company other than the Investor Group and the Acquiror (the "Public
Shareholders"). The Special Committee and the Board each reconfirmed, as of the
date of this Proxy Statement, that the Merger is substantively and procedurally
fair to the Public Shareholders of the Company. At the meetings of the Board at
which the Merger Agreement was considered, all directors other than the members
of the Special Committee either abstained from voting or absented themselves
from the meeting due to their conflicts of interests. See "SPECIAL FACTORS --
Conflicts of Interest." In connection with their recommendations, the Special
Committee and the Board each adopted the analyses and findings of the Special
Committee's financial advisor, Goldman, Sachs & Co. See "SPECIAL FACTORS --
Opinion of Financial Advisor." The Special Committee and the Board recommend
that the shareholders vote "For" the approval of the Merger Agreement.
Opinion of Financial Advisor
Goldman, Sachs & Co. ("Goldman Sachs") provided its oral opinion, later
confirmed in writing, to the Special Committee on March 12, 1998 that, as of
the date of such opinion, the Cash Merger Consideration was fair from a
financial point of view to the Public Shareholders of the Company. Goldman
Sachs subsequently confirmed its earlier opinion by delivery of its written
opinion dated July 6, 1998.
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The full text of the written opinion of Goldman Sachs dated July 6, 1998,
which sets forth assumptions made, matters considered and limitations on the
review undertaken in connection with the opinion, is attached hereto as
Appendix B and is incorporated herein by reference. The opinion of Goldman
Sachs referred to herein does not constitute a recommendation as to how any
holder of such shares should vote with respect to the Merger. Holders of shares
of Common Stock are urged to, and should, read such opinion in its entirety.
See "SPECIAL FACTORS -- Opinion of Financial Advisor."
The Company has agreed to pay Goldman Sachs, contingent upon consummation
of the Merger, a transaction fee of 1% of the aggregate consideration (the
total value of the Common Stock valued at $19 per share plus the outstanding
debt of MedCath assumed by the Acquiror), subject to a minimum of $3.25
million. The Company has agreed to reimburse Goldman Sachs for its reasonable
out-of-pocket expenses, including attorneys' fees, and to indemnify Goldman
Sachs against certain liabilities, including certain liabilities under the
federal securities laws.
Purpose and Reasons of the Affiliates for the Merger
The purpose of the Parent, Holdings, the Acquiror, the members of the
Management Group, WCAS VII and the WCAS Directors (the "Affiliates") for
engaging in the transactions contemplated by the Merger Agreement is to acquire
(indirectly through the Parent), together with any participating Physicians and
Employees, up to 100% of the ownership of the Company. The Affiliates believe
that as a private company MedCath will have greater operating flexibility to
focus on enhancing value by emphasizing growth and operating cash flow without
the constraint of the public market's emphasis on quarterly earnings and the
potentially disruptive effect associated with losses in connection with the
construction and start-up of new Heart Hospitals.
The members of the Management Group beneficially own, in the aggregate,
approximately 15.2% of the outstanding Common Stock. The two WCAS Directors may
be deemed to beneficially own, in the aggregate, approximately 8.2% and 7.7%,
respectively, of the outstanding Common Stock, including 7.5% that is held of
record by WCAS V. See "PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF
MANAGEMENT."
Prior to consummation of the Merger, members of the Management Group have
agreed to contribute a portion of their equity interests in MedCath to the
Parent, representing an investment of approximately $17 million in the Parent
(based on the $19 per share to be received by shareholders in the Merger), in
exchange for 668,016 shares of common stock of the Parent and options to
purchase 329,422 shares of common stock of the Parent. The WCAS Investors have
agreed to contribute an aggregate of 262,474 shares of Common Stock to the
Parent (of which 88,385 will be contributed by the WCAS Directors) in exchange
for an equivalent number of shares of common stock of the Parent.
As a result of the Merger, the KKR Partnership will acquire, indirectly
through the Parent for an investment of up to approximately $106 million, up to
approximately 46% of the equity interest in the Company; the WCAS Investors
will acquire, indirectly through the Parent for an investment of up to
approximately $106 million, up to approximately 46% of the equity interest in
the Company, and the Management Group will acquire, indirectly through the
Parent for an investment in kind of approximately $17 million of their equity
interest in MedCath, approximately 8% of the equity interest in the Company.
See "SPECIAL FACTORS -- Background of the Merger." Members of the Management
Group and the WCAS Investors will also receive the Cash Merger Consideration
for the remainder of their investment in the Company on the same terms as other
shareholders.
Position of the Affiliates as to Fairness of the Merger
Each of the Affiliates has considered the analyses and findings of the
Special Committee and the Board (described in detail in "SPECIAL FACTORS -- The
Special Committee's and the Board's Recommendation") with respect to the
fairness of the Merger to the unaffiliated shareholders of the Company. As of
the date of this Proxy Statement, each of the Affiliates adopts the analyses
and findings of the Special Committee and the Board with respect to the
fairness of the Merger and believes that the Merger is both procedurally and
substantively fair to the Company's unaffiliated shareholders; provided that no
opinion is expressed as to the fairness to any shareholder making an investment
in the Parent. None of the Affiliates makes any recommendation as to how the
Company's shareholders should vote on the Merger Agreement. See "SPECIAL
FACTORS -- Position of the Affiliates as to Fairness of the Merger." The WCAS
Directors have financial interests in the Merger and the members of the
Management Group have financial and employment interests in the Merger. See
"SPECIAL FACTORS -- Conflicts of Interest."
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Conflicts of Interest
In considering the recommendation of the Board with respect to the Merger,
shareholders should be aware that certain officers and directors of MedCath and
affiliates of these officers and directors have interests in connection with
the Merger which may present them with actual or potential conflicts of
interest, which are described in more detail under "SPECIAL FACTORS --
Conflicts of Interest."
The Management Group. After consummation of the Merger, members of the
Management Group will own shares of common stock of the Parent, and fully
vested options to purchase such shares, representing approximately 8% of such
shares expected to be then issued and outstanding (assuming exercise of such
options). The Parent, the KKR Partnership and WCAS VII have also agreed with
the Management Group that the Parent will reserve for issuance, pursuant to
future grants of additional options, shares of common stock of the Parent
representing 15% of the fully diluted equity of the Parent. It is contemplated
that members of the Management Group will receive a substantial portion of such
option grants. In addition, the Management Group will become executive officers
of the Parent and will designate two persons, Stephen R. Puckett and David
Crane, to serve on the Board of the Parent immediately following the Merger. As
a condition to the Merger Agreement, the members of the Management Group have
entered into a voting agreement with the Acquiror and the Parent pursuant to
which they have agreed to vote their shares of Common Stock in favor of the
Merger.
Shares of Common Stock held by the Management Group that are not
contributed to the Parent will be converted into the right to receive the same
Cash Merger Consideration as shares of Common Stock held by other shareholders
of MedCath. Options to purchase shares of Common Stock held by the members of
the Management Group that are not exchanged for similar options to purchase
shares of common stock of the Parent will be converted into the right to
receive a cash payment equal to the Aggregate Unrealized Gain on such stock
options. See "THE MERGER -- Cash-out of MedCath Stock Options."
The members of the Management Group will, upon consummation of the Merger,
enter into new employment agreements with the Parent replacing their existing
employment agreements with MedCath. The new employment agreements will provide
for the payment to them of base salaries, possible annual cash bonuses,
potential severance benefits and a separate payment in respect of the
termination of their previously existing employment agreements. The base
salaries for each of Stephen R. Puckett, David Crane, Charles W. (Todd) Johnson
and Richard J. Post pursuant to each of their employment agreements will
initially remain at their current levels of $325,680, $263,172, $189,996 and
$157,992, respectively. The potential annual cash bonuses for each of the
members of the Management Group pursuant to each of their employment agreements
will equal a percentage of each of their base salaries, be calculated using a
bonus formula comparable to the bonus formula in effect immediately prior to
the Merger, and will depend upon the Company meeting or exceeding certain
performance targets to be established yearly by the Board.
The consummation of the Merger will constitute a "change of control"
triggering severance payment obligations under their existing employment
agreements. In connection with entering into their new employment agreements,
each member of the Management Group has agreed to waive any rights and forego
any severance payments that he may have under his current employment agreement
or that he might otherwise be entitled to upon a "change of control" of the
Company in consideration of the payments to be received pursuant to the new
employment agreements described immediately below. If they had not agreed to
forego such payments, then Stephen R. Puckett, David Crane, Charles W. (Todd)
Johnson and Richard J. Post would have been entitled to receive $778,342,
$613,326, $530,155 and $441,982 respectively, under their current employment
agreements upon the occurrence of a "Change of Control." See "SPECIAL FACTORS
- -- Conflicts of Interest."
Each member of the Management Group will be entitled under his new
employment agreement to a separate payment in respect of the termination of his
previously existing employment agreement and a separate payment in respect of a
covenant not to compete. The amounts of such payments to be received by each
member of the Management Group immediately after consummation of the Merger are
set forth in the table below.
<TABLE>
<CAPTION>
Management Group Member Termination Payment Non-Compete Payment
- ----------------------------- --------------------- --------------------
<S> <C> <C>
Stephen R. Puckett $378,342 $400,000
David Crane 298,326 315,000
Charles W. (Todd) Johnson 265,155 265,000
Richard J. Post 221,982 220,000
</TABLE>
After consummation of the Merger, the Parent and the members of the
Management Group will enter into a stockholders' agreement that will restrict
the Management Group's ability to transfer the shares of common stock of the
Parent to be owned by them and create certain other rights and obligations in
respect of such shares.
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The WCAS Directors. After consummation of the Merger, the WCAS Directors
may be deemed to beneficially own approximately 44% of the shares of common
stock of the Parent expected to be then issued and outstanding (including
approximately 43% that will be held of record by WCAS VII, which the WCAS
Directors and certain of the other individual WCAS Investors may be deemed to
indirectly beneficially own). In addition, the WCAS Investors will designate
three persons to serve on the Board of Directors of the Parent following the
Merger.
Upon consummation of the Merger, MedCath will pay a financial advisory fee
to WCA Management Corporation, the investment adviser to WCAS VII and related
funds ("WCA Management"), of not more than $2.25 million for services rendered
in connection with the financing of the Merger and related transactions. In
addition, MedCath will pay WCA Management a monitoring fee annually in an
amount to be determined after consummation of the Merger for ongoing financial
advisory services.
The Special Committee. The members of the Special Committee will receive a
payment for their shares of Common Stock and the Aggregate Unrealized Gain on
such options in the aggregate amount of $1,212,750 upon consummation of the
Merger. As compensation for serving on the Special Committee, which met more
than 20 times from July 1997 through the date of this Proxy Statement, the
members of the Special Committee each received fees in the amount of
approximately $20,000, which were paid pursuant to the Board's policy for
compensation of directors for attendance at committee meetings. Members of the
Special Committee will be entitled to certain indemnification rights granted
under the Merger Agreement to the current and former directors and officers of
the Company. See "SPECIAL FACTORS -- Conflicts of Interest."
Indemnification Rights. The Merger Agreement provides that the current and
former directors and officers of the Company (including the members of the
Special Committee) will be indemnified by the Company, to the full extent
permitted by applicable law, against all liabilities (including reasonable
attorneys' fees) relating to actions or omissions arising out of such directors
or officers being a director, officer, employee or agent of the Company at or
prior to the Effective Time (including the transactions contemplated by the
Merger Agreement). In addition, the directors and executive officers of the
Company will be provided with continuing directors' and officers' liability
insurance coverage following the Merger, subject to certain limitations. See
"SPECIAL FACTORS -- Conflicts of Interest."
Certain Effects of the Merger
As a result of the Merger, the entire equity interest in the Company will
be owned (indirectly) through the Parent) by the Investor Group and by the
Physicians and the Employees who elect to invest in the Parent. The public
shareholders will no longer have any interest in, and will not be shareholders
of, MedCath, and therefore will not participate in MedCath's future earnings
and potential growth. Instead, the public shareholders will have the right to
receive $19 in cash, without interest, for each share held (other than shares
in respect of which Dissenters' Rights (as defined below) have been perfected).
An equity investment in the Company (indirectly through an equity investment in
the Parent) following the Merger involves substantial risk resulting from the
limited liquidity of any such investment and the leverage resulting from the
future borrowings that will be required to fund the substantial capital
expenditures necessary to execute the Company's business strategy. Nonetheless,
if the Company successfully executes its business strategy, the value of such
an equity investment would be considerably greater than the original cost
thereof. See "SPECIAL FACTORS -- Conflicts of Interest" and "CERTAIN FORWARD
LOOKING INFORMATION."
In addition, the Common Stock will no longer be traded on the Nasdaq
National Market and price quotations with respect to sales of shares in the
public market will no longer be available. The registration of the Common Stock
under the Exchange Act will terminate, and this termination will eliminate the
Company's obligation to file periodic financial and other information with the
Commission and will make most other provisions of the Exchange Act
inapplicable. See "SPECIAL FACTORS -- Certain Effects of the Merger."
Conditions to the Merger, Termination and Expenses
Each party's obligation to effect the Merger is subject to satisfaction of
a number of conditions, each of which may be waived by a specified party or
parties (to the extent permitted by law), including with respect to one or both
parties: (i) the Merger Agreement shall have been approved by holders of a
majority of the outstanding shares of Common Stock, (ii) all required consents
and approvals shall have been obtained, (iii) the Acquiror shall have obtained
financing on terms satisfactory to it, (iv) the representations and warranties
of the parties shall be true and correct in all material respects as of the
Effective Time except as contemplated by the Merger Agreement, and (v) neither
MedCath nor any of its subsidiaries shall
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be under investigation for any violation of the "Stark" laws, anti-kickback
laws or the laws relating to Medicare, Medicaid, CHAMPUS, or any rules or
regulations related thereto. Any or all of the conditions that have not been
satisfied may be waived (other than the condition that the Merger Agreement
shall have been approved by holders of a majority of the outstanding shares of
Common Stock). After approval of the Merger Agreement by the shareholders of
MedCath, however, no condition may be waived which reduces the amount or
changes the form of the Cash Merger Consideration to be received by the
shareholders or that would adversely affect the shareholders of MedCath unless
a waiver of such condition is approved by the shareholders. If, after the
Special Meeting is held and the shareholders approve the Merger Agreement, the
members of the Company's Board of Directors, in the exercise of their fiduciary
duties and in accordance with any applicable statute or regulation, determine
that any material amendment or waiver of a material provision in the Merger
Agreement (including any of the conditions to closing) requires the approval of
the Company's shareholders, the Board of Directors will schedule another
Special Meeting and resolicit proxies from the Company's shareholders. See "THE
MERGER -- Conditions." Even if the shareholders approve the Merger Agreement,
there can be no assurance that the Merger will be consummated.
At any time prior to the Effective Time, the Merger Agreement may be
terminated by the mutual consent of the Board and the Board of Directors of the
Acquiror. In addition, any of the parties may terminate the Merger Agreement
prior to the Effective Time if (i) the conditions precedent to effecting the
Merger have not occurred on or before August 31, 1998 (which failure to become
effective shall not be the result primarily of the breach of any
representation, warranty or covenant by the party desiring to terminate), (ii)
the requisite approval by the shareholders of MedCath has not been obtained, or
(iii) a court or other governmental entity permanently enjoins, restrains or
prohibits the Merger and such action is final and non-appealable. See "THE
MERGER -- Termination, Amendment and Waiver."
The Merger Agreement may be terminated by the Acquiror prior to the
Effective Time by written notice to MedCath if (i) MedCath breaches any
representation, warranty or covenant and fails to cure such breach within
thirty days after written notice, (ii) the Board withdraws or modifies its
approval or recommendation of the Merger Agreement or the Merger, (iii) MedCath
enters into a definitive agreement with any party regarding an Acquisition
Proposal (as defined below), or (iv) a third party commences a tender or
exchange offer for 25% or more of the Common Stock and the Board has
recommended that MedCath's shareholders tender their shares in connection with
such offer.
An "Acquisition Proposal" is defined under the Merger Agreement to include
any offer or proposal by any corporation, partnership, person or other entity
or group concerning any tender or exchange offer, proposal for a merger, share
exchange, recapitalization, consolidation or other business combination
involving MedCath or any of its subsidiaries or divisions, or any proposal or
offer to acquire in any manner, directly or indirectly, a significant equity
interest in, or a substantial portion of the assets, of MedCath or any of its
subsidiaries, other than pursuant to the transactions contemplated by the
Merger Agreement.
MedCath may terminate the Merger Agreement if (i) the Board or Special
Committee determines, based upon advice of counsel, that the continued
recommendation of the Merger or the Merger Agreement would violate fiduciary
duties of the Board under applicable law, (ii) the Board or Special Committee
determines that MedCath has entered into a definitive agreement with any party
regarding an Acquisition Proposal, provided the Board first determines, based
upon advice of counsel, that failing to take such action would violate the
Board's fiduciary duties under applicable law, or (iii) a third party commences
a tender or exchange offer for 25% or more of the Common Stock and the Board
has recommended that the shareholders of MedCath tender their shares in
connection with such offer, provided that the Board or Special Committee first
determines, based upon advice of counsel, that failing to take such action
would violate the Board's fiduciary duties under applicable law. See "THE
MERGER -- Termination, Amendment and Waiver."
MedCath has agreed to pay a termination fee (the "Termination Fee") in the
amount of $6,774,640 to the Acquiror in the event the Merger Agreement is
terminated by MedCath due to certain events, including (i) the Board or the
Special Committee withdrawing or modifying its approval or recommendation of
the Merger Agreement or the Merger in connection with the exercise of its
fiduciary duties, (ii) MedCath entering into a definitive agreement with any
party with respect to an Acquisition Proposal following a determination that
the Company's failure to do so would violate the Board's fiduciary duties or
(iii) the commencement by a third party of a tender offer for 25% or more of
the Common Stock which the Board has recommended to MedCath's shareholders. See
"THE MERGER -- Termination Fee."
Each of the parties has agreed to pay its own costs and expenses in
connection with the Merger. In the event, however, that the Merger Agreement is
terminated due to the failure of MedCath's shareholders to approve the
transaction, MedCath has agreed to reimburse the Acquiror for its reasonable
out-of-pocket fees and expenses. See "THE MERGER -- Expenses" and " --
Termination Fee."
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Federal Income Tax Consequences
The receipt of the Cash Merger Consideration by holders of Common Stock
pursuant to the Merger will be a taxable transaction for federal income tax
purposes. All holders of Common Stock are urged to consult their tax advisors
to determine the effect of the Merger on such holders under federal, state,
local and foreign tax laws. See "FEDERAL INCOME TAX CONSEQUENCES."
Rights of Dissenting Shareholders
Any shareholder of MedCath who does not vote in favor of the proposal to
approve the Merger Agreement and who complies strictly with the applicable
provisions of Article 13 of Chapter 55 of the North Carolina General Statutes
("Article 13") has the right to dissent and be paid cash for the "fair value"
for such holder's shares of Common Stock ("Dissenters' Rights"). The applicable
provisions of Article 13 are attached to this Proxy Statement as Appendix C. To
perfect Dissenters' Rights with respect to the Merger, a MedCath shareholder
must follow the procedures set forth therein precisely. Those procedures are
summarized in this Proxy Statement under "RIGHTS OF DISSENTING SHAREHOLDERS."
Shares of Common Stock held by persons properly exercising Dissenters'
Rights (the "Dissenting Shares") will not be converted into the Cash Merger
Consideration in the Merger and after the Effective Time will represent only
the right to receive such consideration as is determined to be due such
dissenting shareholder pursuant to Article 13. If after the Effective Time any
dissenting shareholder fails to perfect or loses such right to payment or
appraisal under Article 13, each share of Common Stock of such shareholder
shall be treated as a share that had been converted as of the Effective Time
into the right to receive the Cash Merger Consideration.
Accounting Treatment
The Merger will be treated as a purchase business combination for
accounting purposes.
Financing of the Merger
It is estimated that approximately $260 million will be required to
consummate the Merger and pay related fees and expenses. This sum will be
provided by (i) equity contributions to the Parent of up to approximately $106
million from currently available funds by each of the KKR Partnership and the
WCAS Investors (reduced, in the case of the WCAS Investors, by the aggregate
value (at $19 per share) of the shares of Common Stock contributed to the
Parent by the WCAS Investors and by the Physicians, and, in the case of each of
the WCAS Investors and the KKR Partnership, by an amount equal to one-half of
the Aggregate Unrealized Gain on the stock options contributed to the Parent by
the Employees), (ii) a contribution in kind of approximately $17 million in
value of their equity interests in MedCath by the Management Group and (iii) a
draw of approximately $31 million under the MedCath revolving credit facility.
See "THE MERGER -- Financing."
Market Prices of Common Stock and Dividends
The Common Stock is traded on the Nasdaq National Market (symbol: MCTH).
The following table sets forth the high and low sales prices for each quarterly
period for the two most recent fiscal years and for the current fiscal year to
date.
<TABLE>
<CAPTION>
Fiscal Years Ended or Ending September 30,
------------------------------------------------------------------------------
1996 1997 1998
---------------------- ----------------------- ---------------------------
High Low High Low High Low
---------- --------- ---------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter ............... $25 3/4 $ 17 $17 1/2 $12 1/8 $ 18 1/8 $ 13
Second Quarter .............. 30 18 1/2 16 14 18 3/8 12 3/4
Third Quarter ............... 42 5/8 10 3/4 16 12 3/8 18 9/16 17 3/4
Fourth Quarter .............. 19 1/4 7 3/4 20 1/4 14 5/8 18 3/8* 18 1/4*
</TABLE>
- ---------
* Through July 7, 1998
On March 12, 1998, the last trading day prior to announcement of the
execution of the Merger Agreement, the closing price per share of Common Stock
as reported by Nasdaq was $16.50. On July 7, 1998, the last trading day prior
to printing of this Proxy Statement, the closing price per share of Common
Stock as reported by Nasdaq was $18 3/8.
At June 22, 1998, there were 217 holders of record of Common Stock and
approximately 3,900 persons or entities holding in nominee name.
The Company has never paid any cash dividends on its Common Stock. Under
the Merger Agreement, the Company has agreed not to pay any dividends on the
Common Stock prior to the Effective Time.
In April 1996, MedCath made an underwritten public offering of 2,300,000
shares of Common Stock. The offering price per share was $28.75, and the net
proceeds received by MedCath were approximately $62.5 million.
8
<PAGE>
SPECIAL FACTORS
Background of the Merger
Management's Preliminary Discussions Regarding a Sale of the Company.
During the Spring of 1997, the Management Group discussed the effect on the
market price of the Common Stock (which during the Spring frequently had traded
below the Company's initial public offering price of $14 per share) of start-up
losses experienced by new Heart Hospitals, the large capital expenditure budget
associated with the development of Heart Hospitals and fluctuations in the
Company's profitability. Management concluded that, under the Company's
existing operating strategy, shareholders likely would not begin to realize the
value management believed is inherent in the Company's business strategy until
a significant number of Heart Hospitals had achieved profitability. Once this
had occurred, management believed the cash flow and earnings generated by its
existing Heart Hospitals would be sufficient to absorb the development costs
and start-up expenses associated with opening new hospitals, which management
believed had historically depressed the market price of the Common Stock.
Management believed such a critical mass of profitable hospitals would not
exist for a minimum of two years. See " -- The Special Committee's and the
Board's Recommendation" for a discussion of these factors.
Management considered that a sale of the Company to a strategic or
financial buyer having the financial resources to absorb the short-term losses
that are inherent in the Company's operating strategy might constitute a viable
option to accelerate the recognition by shareholders of the Company's long-term
value. In May 1997, management met informally with an investment banking firm
on behalf of the Company to discuss in general terms a possible sale of the
Company. Based on the Company's historical performance through the first half
of fiscal year 1997 and the Company's projected operations for the balance of
the fiscal year and through fiscal year 2002, management believed that a sale
of the Company at an appropriate price might be achievable.
Later in May 1997, Stephen R. Puckett discussed with John B. McKinnon, a
director of the Company since 1996, management's views about a possible sale of
the Company. Mr. McKinnon recommended that Mr. Puckett, on behalf of the
Company, contact Goldman Sachs (which is not the investment banking firm with
which management met informally in May 1997 as described above) to obtain its
views regarding possible buyers for the Company. In order to gauge the interest
of strategic buyers in acquiring a business meeting the Company's general
description, Mr. Puckett, on behalf of the Company, requested Goldman Sachs to
evaluate on a preliminary basis a number of health care providers as potential
acquirors of the Company. Based on the results of these evaluations, which were
made in June and July 1997, management concluded that a sale of the Company to
a strategic buyer at an appropriate price might be a possibility.
Concurrently with management's discussions with Mr. McKinnon and Goldman
Sachs described above, management explored other avenues relating to a possible
sale of the Company. Believing that institutional investors that previously had
invested in MedCath might be potential buyers of the Company, Mr. Puckett and
Mr. Post in May 1997 approached the WCAS Directors, Patrick J. Welsh and Andrew
M. Paul, and the principal investment group of Goldman Sachs regarding whether
they might be interested in participating with management in a potential
purchase of the Company. (Certain investment partnerships affiliated with
Goldman Sachs had been early venture capital investors in the Company.)
Consideration of this alternative ended in July 1997, however, when the parties
decided they were not interested in such a transaction.
Appointment of Special Committee. In July 1997, Mr. Puckett reported to
Mr. McKinnon his recent conversations with the WCAS Directors and Goldman
Sachs. Because of the possibility of a sale of the Company in a transaction in
which management and the WCAS Directors might have a continuing financial
interest, Mr. McKinnon and Mr. Puckett agreed that the Board should appoint a
committee of disinterested directors to review and evaluate the Company's
strategic options, including a possible sale of the Company (the "Special
Committee"). Mr. McKinnon and Mr. Puckett further agreed that it would be
appropriate to recommend to the Board that it appoint to the Special Committee
the only directors not affiliated with WCAS V or management, Mr. McKinnon and
Dr. W. Jack Duncan, a director of the Company since 1994. Mr. McKinnon, the
former President and a director of Integon Corporation (positions he
relinquished in October 1997), served as President of Sara Lee Corporation from
1986 to 1988 and Dean of the Babcock Graduate School of Management at Wake
Forest University from 1989 to 1995. He currently serves as a director of
Premark International, Inc., Morrison's Health Care, Inc., Ruby Tuesday, Inc.
and two privately-held companies. Mr. McKinnon received an A.B. from Duke
University and an M.B.A. from Harvard Business School. (Mr. McKinnon had been a
director of and investor in HealthTech Corporation, an operator of mobile cath
labs acquired by the Company in 1995 ("HealthTech"). HealthTech had been
founded in 1991 by Charles W. (Todd) Johnson, who became employed by the
Company following its acquisition of HealthTech and is a member of the
Management Group. Mr. Johnson and Mr. McKinnon also have been co-investors in
other ventures unrelated to HealthTech and the Company.) Dr. Duncan, a personal
friend of Mr. Puckett since 1970, has served as Acting Dean of the School of
Business at the University of Alabama at Birmingham ("UAB") since June 1997.
9
<PAGE>
Since 1987, he has been a Professor and University Scholar in Management in the
Graduate School of Management and Professor of Health Care Organization and
Policy and a Senior Scholar in the Lister Hill Center for Health Policy in the
School of Public Health of UAB. Dr. Duncan received a B.S. in Economics from
Howard College and an M.B.A. and a Ph.D. from Louisiana State University.
Neither Mr. McKinnon nor Dr. Duncan has any material business, financial or
other relationship with KKR or any of the WCAS Investors.
In anticipation of Mr. McKinnon's and Dr. Duncan's formal appointment as
members of the Special Committee, Mr. McKinnon engaged Womble Carlyle Sandridge
& Rice, PLLC of Charlotte, North Carolina ("Womble Carlyle") to advise the
Special Committee regarding its duties in connection with a possible sale of
the Company. On July 28, 1997, Mr. McKinnon, Dr. Duncan and Womble Carlyle met
with Mr. Puckett, Mr. Crane and Mr. Post and with representatives of Goldman
Sachs at the Company's headquarters in Charlotte, North Carolina. At the
meeting, Mr. Puckett reviewed with Mr. McKinnon and Dr. Duncan management's
views concerning a possible sale of the Company, and Goldman Sachs summarized
its views on possible market interest, all as described above. In addition,
Goldman Sachs confirmed that, although it had considered participating as
principal in a sale of the Company, it was no longer interested in pursuing
such opportunity.
Mr. Puckett first informed the Board as a whole of management's views
concerning a possible sale of the Company at a regular meeting of the Board
held on July 29, 1997. Mr. Puckett summarized for the Board the discussions
that had occurred regarding a possible sale of the Company beginning in the
Spring of 1997 (as discussed above under "Management's Preliminary Discussions
Regarding a Sale of the Company"). At the meeting, the Board formally appointed
Mr. McKinnon and Dr. Duncan as the members of the Special Committee and
authorized the Special Committee to review and evaluate strategic options that
might be available to the Company and independently to solicit proposals to
acquire the Company. The Board granted the Special Committee exclusive
authority on behalf of the Board to review, evaluate and negotiate any
transaction proposed by a group which included one or more members of
management or the Board or an affiliate of any member of management or the
Board and any competing offer to acquire the Company not involving a conflict
of interest. The Board retained authority to review, evaluate and negotiate
proposals only in the absence of any proposal which would create a conflict of
interest.
Solicitation and Receipt of Preliminary Proposals. Pursuant to a letter
dated August 8, 1997, the Special Committee formally engaged Goldman Sachs to
act as its financial advisor in connection with the proposed sale of the
Company. The Special Committee engaged Goldman Sachs based primarily on Goldman
Sachs' nationally recognized reputation as an investment banking firm that has
substantial experience in acquisitions involving public companies, including
companies in the health care industry. The Special Committee also considered
Mr. McKinnon's experience with Goldman Sachs, which had provided investment
banking services to two companies (Sara Lee Corporation and Integon
Corporation) that Mr. McKinnon had served as President as described above. The
Special Committee also considered Goldman Sachs' specific knowledge of the
Company based on its informal discussions with Mr. Puckett who, on behalf of
the Company and upon Mr. McKinnon's recommendation, had requested Goldman Sachs
to evaluate a number of health care providers as possible acquirors of the
Company as described above. The Special Committee considered management's prior
contacts with Goldman Sachs to have focused primarily on the feasibility of a
sale of the Company to an unaffiliated strategic buyer and, therefore, not to
have created a conflict of interest with respect to the Special Committee's
engagement of Goldman Sachs. The Special Committee further considered the
possible interest of Goldman Sachs' principal investment group in participating
in an acquisition of the Company and retained Goldman Sachs only after
obtaining Goldman Sachs' confirmation that its principal investment group would
not participate in such an acquisition. Neither Mr. McKinnon nor Dr. Duncan has
any material professional, financial or other relationship with Goldman Sachs.
Based on discussions with management and the Special Committee and its own
knowledge of the Company's industry, Goldman Sachs assembled an initial list of
13 potential buyers of the Company that the Special Committee and Goldman Sachs
believed were most likely to have an interest. The initial list included seven
strategic buyers and six financial buyers. At the request of management, and
with the concurrence of the Special Committee, Goldman Sachs omitted from the
list one strategic buyer that is a major competitor of the Company in markets
served by two of its existing three Heart Hospitals and in certain markets to
be served by Heart Hospitals under development. Such competitor was eliminated
because, in the view of management and the Special Committee, it would be able
to use information concerning a possible sale of the Company to the Company's
competitive disadvantage. The initial list also did not include WCAS VII, which
was aware of the possible sale of the Company because of the service on the
Board of the WCAS Directors and which the Special Committee believed would
decide whether to participate in the process independently of the marketing
efforts undertaken by the Special Committee and Goldman Sachs. Five additional
financial buyers (including WCAS VII) were later added to the initial list of
13.
10
<PAGE>
Beginning in August 1997, Goldman Sachs circulated a confidential offering
memorandum (the "Offering Memorandum") concerning the Company to potential
buyers that had agreed to enter into confidentiality agreements, including nine
of the potential buyers on the initial list and the five that were later added
to such list as referred to above. Of the 14 potential buyers that received the
Offering Memorandum, 10 initiated a due diligence investigation and
participated in management presentations. The Offering Memorandum contained a
projection, prepared by management in June 1997, of the Company's operations
for the balance of the fiscal year ending September 30, 1997 and for each year
in the five year period ending September 30, 2002 (the "June Projection"). The
June Projection and the principal assumptions on which it is based are
summarized in this Proxy Statement under "CERTAIN FORWARD LOOKING INFORMATION."
On October 30, 1997, each of the parties that had participated in
management presentations was invited to submit by November 7, 1997 a written,
preliminary non-binding proposal to acquire the Company. Three proposals
representing four financial buyers, including KKR, were submitted. No strategic
buyer submitted a proposal. All of the proposals contemplated an acquisition of
the Company for cash at prices ranging between $18 and $24 per share, with
management retaining a significant equity interest in the surviving company
through the rollover of a portion of their equity interest in the Company. The
KKR proposal was priced at $20 to $22 per share. All of the proposals were
subject to customary conditions, including the completion of due diligence.
The Special Committee met with Goldman Sachs on November 9, 1997, to
review and discuss the three preliminary proposals. On November 10, 1997, the
Special Committee and Goldman Sachs met with Mr. Puckett and Mr. Post to review
the proposals with them and determine whether management anticipated
significant issues in reaching an agreement with any of the four potential
buyers. Mr. Puckett expressed his initial impression that management could work
with any of the potential buyers, although management would need to be
comfortable with the capitalization of the surviving company. At a meeting of
the Board on November 11, 1997, the Special Committee reported to the Board the
status of the bidding process for the Company.
On November 13, 1997, the Company issued a press release announcing
results of operations for the fiscal year ended September 30, 1997 (the
"November Press Release"). The November Press Release disclosed that the
openings of the Tucson Heart Hospital in October and the Arizona Heart Hospital
(expected in the second quarter of fiscal year 1998) were expected to have a
dampening effect on earnings in the first and second quarters of fiscal year
1998, but that the ramp-up of the two new hospitals was expected to accelerate
earnings momentum in the second half of the fiscal year, allowing the then
current earnings projection of approximately $0.72 per share for the fiscal
year ending September 30, 1998 to be met.
Subsequent to the Board meeting on November 11, 1997, the Special
Committee decided not to pursue the lowest of the three proposals, at $18 to
$20 per share, because it was regarded as too low and the buyer required a
significantly longer timeline prior to entering into a transaction than either
of the other bidders. In due diligence sessions during November and December
with the bidder that had submitted the highest proposal, at $22 to $24 per
share, such bidder concluded that it would not be able to finance a bid and
subsequently withdrew its proposal. Such bidder advised the Company that its
bid required the participation of an additional equity partner, which it had
been unable to obtain, and that, given the Company's existing debt levels, such
bidder believed additional debt financing was impracticable.
In mid-December 1997, Paul B. Queally, a general partner of the sole
general partner of WCAS VII, met with representatives of both KKR and the
Company to conduct due diligence and discuss the terms of a possible joint bid
by KKR and WCAS VII. While Andrew M. Paul, a WCAS Director, had had preliminary
conversations with KKR representatives immediately prior to the submission of
KKR's November 7 proposal regarding a joint bid, WCAS VII indicated that it was
not, at that time, interested in making a joint bid and did not join KKR's
November proposal.
Developments Relating to Tucson. During the first two weeks of December
1997, management provided to Goldman Sachs, which in turn provided to KKR,
operating data relating to the ramp-up of Tucson, which had opened in October.
While the June Projection assumed that the Company's Heart Hospitals would
incur start-up losses for a period of approximately six to nine months
following their opening, Tucson's progress was unexpectedly slow, as evidenced
by December data in particular. In December, the average daily census for
Tucson (which has a capacity of 66 beds, approximately 21 of which were then
staffed) was eight. In addition, the number and overall mix of procedures were
far short of expectations as reflected in the June Projection. Based primarily
on this information, KKR advised Goldman Sachs on or about December 18, 1997
that it no longer believed it would be able to submit a bid in the $20-$22
range set forth in its first proposal submitted November 7, 1997. Goldman Sachs
discussed the matter with the Special Committee on December 19, 1997. Goldman
Sachs reported to the Special Committee that it had discussed KKR's concerns
with Mr. Puckett and Mr. Post,
11
<PAGE>
who stated that management was in the process of evaluating the situation but
believed that the problems that were contributing to the slow ramp-up of Tucson
were potentially long-term in nature and that Tucson's performance would
materially and adversely impact the Company's ability to achieve the June
Projection.
The Special Committee thereafter requested a meeting with management on
December 22, 1997 to discuss recent developments at Tucson. During this
meeting, management outlined the estimated impact of Tucson on the June
Projection and outlined certain preliminary action steps designed to address
Tucson's slow ramp-up. While management expressed to the Special Committee its
confidence in the Company's Heart Hospital concept and business strategy,
management also expressed concern regarding whether Tucson's operating problems
could be successfully resolved.
On December 22, 1997, KKR submitted a revised, non-binding proposal to
acquire the Company for a cash purchase price of $18 per share (the "Revised
Proposal"). WCAS VII joined in the Revised Proposal, subject to reaching an
agreement with KKR regarding corporate governance and other stockholder rights
issues for the surviving company. The proposal indicated that before a
definitive agreement could be reached, KKR and WCAS VII would need to conduct
additional due diligence.
Following receipt of the Revised Proposal on December 22, 1997, the
Special Committee and Goldman Sachs met with management. The Special Committee
expressed its view that, while there may have been a change in the current
operating environment, the Special Committee was unwilling, based on
information currently available to it, to reduce its price expectations. The
Special Committee requested management to analyze the Tucson situation,
consider the implications for the Company's business strategy, prepare a
revised projection and make a formal presentation to the Special Committee as
soon as practicable.
Representatives of Goldman Sachs had further due diligence conversations
with individual members of management following the Special Committee's meeting
with management on December 22, 1997. During these conversations, Goldman Sachs
explored in more detail the basis for management's concerns regarding Tucson
and the effect of Tucson on the June Projection.
On December 31, 1997, at a meeting held at the Company's headquarters in
Charlotte, North Carolina, the Management Group presented the Special Committee
with a revised projection of the Company's operations for the balance of fiscal
year 1998 and through fiscal year 2003 (the "December Projection"). The
December Projection, which was also provided to KKR and WCAS VII, and the
principal assumptions on which it is based are summarized in this Proxy
Statement under "CERTAIN FORWARD LOOKING INFORMATION." The performance of the
Company as reflected in the December Projection, when compared to the June
Projection, demonstrated the estimated impact of Tucson on the Company's future
operations. The Special Committee engaged the Management Group in an extensive
discussion of the revised assumptions underlying the December Projection,
including management's assumptions regarding the reduced roll-out rate for new
hospitals, the assumed annual growth rate for new and existing Heart Hospitals
and the ramp-up period for new Heart Hospitals. During the presentation, the
Management Group confirmed its preliminary view, communicated to Goldman Sachs
prior to its meeting with the Special Committee on December 19, 1997, that the
performance of Tucson would materially and adversely affect the Company's
ability to achieve the June Projection, as evidenced by the December
Projection. During the December 31, 1997 meeting, the Management Group also
expressed its view that the market's concern regarding the Company's Heart
Hospital concept is reflected in the performance of the Common Stock and,
accordingly, the market price of the Common Stock is a barometer of the
Company's desirability as a business partner for physicians with whom the
Company may desire to develop future Heart Hospitals. This view is based on
discussions between the Company and market analysts, institutional shareholders
and physicians (including physicians who have contracted with the Company and
physicians who have elected not to contract with the Company). The Management
Group expressed concern that Tucson's performance could have a continuing
impact on the market price of the Common Stock and thus could materially and
adversely affect the Company's development plans.
Immediately after the December 31, 1997 meeting, Mr. McKinnon met
individually with certain members of management to ascertain their views of the
Company's business prospects, including in particular the business prospects
for Tucson. Their views were consistent with the views expressed by the
Management Group at the December 31, 1997 meeting with the Special Committee.
Based on information provided by management at the December 31, 1997
meeting, the Special Committee believes that the operating problems experienced
at the Tucson Heart Hospital in December 1997 were significant and likely
long-term in nature. Tucson's average daily census for December 1997 was eight,
which was far short of the Company's projection. In addition, the number and
type of cardiovascular procedures being performed at Tucson in December 1997
fell far short of expectations. As a result, Tucson's revenues were
significantly below the June Projection and resulted in a pre-tax loss
12
<PAGE>
at Tucson for the quarter ended December 31, 1997 of twice the pre-tax loss for
the quarter assumed for the purpose of the June Projection. Based on its
discussions with management, the Special Committee believes that the principal
factors contributing to Tucson's poor performance in December 1997 include the
large number of competing cardiology service providers in the Tucson market,
the significant penetration of the Tucson market by managed care providers and
HMOs, the low-cost health care environment in the Tucson market and the
geographic dispersion of the physicians who are on the medical staff of the
Tucson Heart Hospital and their lack of proximity to the hospital. The Special
Committee believes these factors explain the significant shortfall in Tucson's
performance in December 1997 and, because they are structural to the Tucson
market, indicate that Tucson's operating problems likely are long-term in
nature.
On January 2, 1998, representatives of Goldman Sachs met with management
to review the December Projection. On January 5, 1998, the Special Committee
and its legal counsel met in New York City with Goldman Sachs. During the
meeting, the Special Committee and Goldman Sachs reviewed progress to date and
again discussed in detail the December Projection, including the reasonableness
of management's assumptions underlying the projection. The Special Committee
focused particularly on the following assumptions underlying the December
Projection that reflected a slower growth rate for the Heart Hospitals than had
been provided for in the June Projection:
o The December Projection assumed a ramp-up period for the Heart Hospitals
of four quarters, compared to the two quarter ramp-up period provided for
in the June Projection. This change was consistent with the Company's
experience with the three Heart Hospitals currently in operation. The
actual ramp-up periods for McAllen and Little Rock were 11 months and
eight months, respectively, and the projected ramp-up period for Tucson,
which had been lengthened due to its significant start up problems, was
15 months, resulting in an average ramp-up period for the three Heart
Hospitals of 11.3 months or approximately four quarters.
o The December Projection assumed the rate of increase in revenue for the
10 quarters immediately following a post ramp-up base year would be 10%
annually, compared to 20% annually provided for in the June Projection.
This change was consistent with the Company's experience with McAllen,
which is the only Heart Hospital which had been in operation for more
than nine months. The Special Committee also believed the reduction in
the assumed rate of increase in revenue was justified by the unforeseen
start-up difficulties the Company had experienced with two out of its
three Heart Hospitals. Management believed such difficulties would
discourage physicians in other markets from participating in the
development of new Heart Hospitals and thus would adversely affect the
Company's growth prospects in such markets. Management also believed that
the fact that the Company had experienced unforeseen difficulties with
two out of its three existing Heart Hospitals (McAllen and Tucson)
indicated a likelihood that the Company's future Heart Hospitals might
also experience unforeseen difficulties.
o The December Projection assumed the Company would open two new Heart
Hospitals per year beginning in the year 2000, compared to three new
Heart Hospitals provided for in the June Projection. The Special
Committee believed this reduction in the roll-out rate for new Heart
Hospitals was justified by a combination of factors, including
construction delays the Company had experienced with certain of its Heart
Hospitals then under construction, the likelihood that issues involving
the Tucson Heart Hospital would continue to absorb a significant amount
of management's time and the likelihood that similar issues and
corresponding demands on management's time might arise with respect to
future Heart Hospitals.
Based on the Special Committee's and Goldman Sachs' meetings with
management on December 31, 1997 and January 2, 1998, and the Special
Committee's review of the December Projection and discussion of the December
Projection with Goldman Sachs (including the reasons for changes in the
assumptions on which the June Projection had been based, as discussed above),
the Special Committee concluded that management's rationale for modifying the
assumptions underlying the June Projection was reasonable. The Special
Committee further concluded that the operating uncertainties represented by
Tucson and the Company's Heart Hospital concept justified selling the Company
at a price below the range that earlier had appeared appropriate and that
negotiations with KKR and WCAS VII should continue.
Negotiations with KKR and WCAS VII. On January 14, 1998, KKR submitted a
formal offer to acquire all of the outstanding shares of Common Stock for $18
per share in cash on the terms and conditions set forth in a mark-up of the
Company's form of merger agreement that accompanied the offer. The offer
contemplated that the Management Group would roll over no less than 50% of the
value of their equity interest in the Company, and it was made subject to KKR's
ability to structure a mutually acceptable arrangement with management. The
offer was further conditioned on, among other things, KKR's receipt of
financing on terms acceptable to KKR, resolution of legal due diligence issues
and negotiation and execution of a definitive merger agreement. WCAS VII did
not join in the offer, but WCAS VII did discuss the offer's terms with KKR, as
well as initial KKR proposals for corporate governance and stockholder rights
in the acquiring company.
13
<PAGE>
The Special Committee and Goldman Sachs met on January 15, 1998, following
the Special Committee's receipt of the KKR offer. Also attending the meeting
were Mr. Puckett and Mr. Post, representing the Management Group, Womble
Carlyle and representatives of the Company's law firm, Moore & Van Allen, PLLC
of Charlotte, North Carolina ("Moore & Van Allen"). During the meeting, the
Special Committee reviewed and discussed with management, Goldman Sachs, Womble
Carlyle and Moore & Van Allen the revised offer by KKR, recent performance of
the Tucson Heart Hospital, results of operations of the Company for the quarter
ended December 31, 1997 (which were more favorable than had been reflected in
the December Projection due to certain recent developments of a nonrecurring
nature that were unrelated to Tucson), issues arising in connection with the
mark-up of the Company's form of merger agreement which accompanied KKR's offer
and the status of the Management Group's progress in reaching an agreement with
KKR relating to management's participation in the proposed transaction. The
Special Committee concluded that while further improvements in the terms of the
KKR offer should be sought, it was prepared to enter into substantive
negotiations with KKR.
From January 16 to January 18, 1998, Womble Carlyle and Goldman Sachs on
behalf of the Special Committee, together with the Management Group, Moore &
Van Allen, and KKR and WCAS VII and their legal counsel, met in New York City
to negotiate a definitive merger agreement. The Management Group's personal
counsel, Wilmer Cutler & Pickering of Washington, D.C., also was present to
advise the Management Group in negotiating the terms of its participation in
the transaction with KKR and WCAS VII. Aside from the purchase price, the
principal points of negotiation among the parties under the Merger Agreement
included (i) the "fiduciary out" provisions of the agreement, permitting the
Board to consider alternative proposals or offers to acquire the Company
submitted after the date of the Merger Agreement, (ii) the circumstances under
which the Company would be required to pay a termination fee to KKR and WCAS
VII and to reimburse KKR and WCAS VII for their out-of-pocket expenses, as well
as the amount of such termination fee, (iii) KKR and WCAS VII's ability to
terminate the Merger Agreement based on matters relating to the Tucson Heart
Hospital and the results of KKR's and WCAS VII's due diligence investigations,
and (iv) the scope of certain representations and warranties of the Company.
While the parties made substantial progress in resolving the issues under the
Merger Agreement, they were unable to reach a definitive agreement. The parties
agreed that KKR and WCAS VII should complete their remaining due diligence
prior to the parties' resuming negotiations.
Prior to the opening of the market on January 29, 1998, the Company issued
a press release announcing results of operations for the first quarter of
fiscal year 1998 (the "January Press Release"). The January Press Release
disclosed, among other things, that the ramp-up of the Tucson Heart Hospital
had been slower than expected and that, primarily as a result of Tucson's
performance (as well as a delay in the opening of the Arizona Heart Hospital),
the Company no longer expected to achieve its earnings projection of $0.72 per
share for fiscal year 1998, which had been disclosed in the November Press
Release. The closing price of the Common Stock on the day prior to the
announcement was $13.88 per share. The low sale and closing prices of the
Common Stock on January 29 were $12.88 and $13.13 per share, respectively.
In early March 1998, Goldman Sachs was contacted by a party which stated
it might be interested in pursuing an acquisition of the Company. Such party
was advised that if it was interested in pursuing such a possibility it should
promptly submit an indicative bid. Such party did not submit any bid or
thereafter contact the Company or its representatives regarding the possibility
of an acquisition of the Company.
From the end of January through February 1998, KKR and WCAS VII continued
their due diligence investigation of the Company. In late February 1998, KKR
advised Goldman Sachs that KKR and WCAS VII were prepared to resume
negotiations to acquire the Company at a purchase price of $18 per share.
On March 4, 1998, management provided the Special Committee and Goldman
Sachs with an updated projection (the "March Projection") which management had
prepared at the request of the Special Committee. The March Projection, which
was also provided to KKR and WCAS VII, and the principal assumptions on which
it is based are summarized in this Proxy Statement under "CERTAIN FORWARD
LOOKING INFORMATION." The Special Committee and Goldman Sachs met with
representatives of the Management Group on March 10, 1998 to review the March
Projection. During the meeting, management reported that each of the Heart
Hospitals had performed well above the levels reflected in the December
Projection. Management further reported, however, that Tucson had failed to
sustain this performance in February and through the first week of March. In
addition, the March Projection was negatively impacted by an estimated
four-month delay in the opening of the Arizona Heart Hospital in Phoenix due to
damage resulting from a burst water pipe that occurred immediately prior to the
scheduled occupancy of the Heart Hospital in January 1998. Thus, although the
March Projection reflected the improved January performance of the Heart
Hospitals, the overall business of the Company was not materially different
from that reflected in the December Projection.
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On March 10 and 11, 1998, Mr. McKinnon on behalf of the Special Committee
communicated with Mr. Welsh and Mr. Queally on behalf of WCAS VII regarding the
proposed purchase price for the Company and the structure of the transaction.
Mr. McKinnon expressed to Mr. Welsh and Mr. Queally the Special Committee's
view that it would not negotiate with WCAS VII and KKR on an exclusive basis
based on a valuation of $18 per share. Mr. McKinnon also stated that the
Special Committee would need to be satisfied that the "fiduciary out"
provisions of the Merger Agreement would not be unduly restrictive. In a series
of conversations between Mr. McKinnon and Mr. Queally, Mr. Queally offered to
increase the purchase price from $18 to $18.50 per share (which Mr. McKinnon
rejected) and, finally, to $19 per share, in consideration of an increase in
the termination fee payable to KKR and WCAS VII under certain circumstances
from $4 million to approximately $6.8 million. Mr. McKinnon agreed to recommend
the $19 per share purchase price and the increase in the termination fee. Mr.
McKinnon and Mr. Queally expressed confidence that counsel to the parties could
work out satisfactorily the "fiduciary out" provisions of the Merger Agreement.
During this period, legal counsel for the respective parties negotiated certain
provisions of the Merger Agreement to reflect the foregoing understandings and
KKR and WCAS VII reached an agreement in principle regarding corporate
governance and stockholder rights in the surviving company.
On March 12, 1998, the Special Committee met to consider the Merger
Agreement, including Mr. McKinnon's recommendation relating to the $19 per
share purchase price and the increased termination fee. At this meeting, the
Special Committee received Goldman Sachs' oral opinion, which it later
confirmed in writing, that as of March 12, 1998 the Cash Merger Consideration
was fair from a financial point of view to the Public Shareholders of the
Company. The Special Committee concluded that the Merger (including the Cash
Merger Consideration to be paid to the Public Shareholders) was substantively
and procedurally fair and recommended the Merger Agreement to the full Board.
Following the Special Committee's vote to recommend the Merger Agreement to the
Board, the Board met to approve the Merger Agreement and recommend it to the
shareholders of the Company. Because of the financial interest in the merger of
four of the members of the Board (Mr. Puckett, Mr. Crane, Mr. Welsh and Mr.
Paul), a majority of the Board could not independently review and determine the
fairness of the Merger to the Public Shareholders. Mr. Welsh and Mr. Paul did
not attend the Board meeting because of their conflicts of interest, and Mr.
Puckett and Mr. Crane abstained from voting with respect to the Merger because
of their conflicts of interest. Therefore, the remaining directors (who also
constituted the Special Committee) were the only directors who voted on the
Merger. The parties executed the definitive Merger Agreement after the close of
business on March 12, 1998.
On April 7, 1998, the Company signed a non-binding letter of intent with
Carondelet Health Systems, Inc., a not-for-profit healthcare provider
("Carondelet"), which contemplated Carondelet's becoming an investor in the
Tucson Heart Hospital. See "BUSINESS OF THE COMPANY -- Hospital Division --
Recent Developments in the Hospital Division -- Tucson Heart Hospital." On
April 9, 1998, the Special Committee and its financial and legal advisors met
with management of the Company to receive an update concerning the Company's
discussions with Carondelet. Management informed the Special Committee that the
consolidation of the heart programs of Tucson Heart Hospital and Carondelet,
which owns two not-for-profit hospitals in the Tucson area, would improve the
Heart Hospital's revenues. However, management stated that an agreement with
Carondelet was contingent on the parties' resolving several critical issues,
including the extent and timing of the closure of Carondelet's existing heart
programs, the extent to which Carondelet would maintain certain diagnostic and
emergency services and certain economic terms of the joint venture.
Accordingly, management emphasized that whether the parties would be able to
reach a definitive agreement and the timing of an agreement, if any, were
extremely uncertain. The Special Committee encouraged management to pursue and
successfully conclude discussions with Carondelet regarding the proposed joint
venture as soon as possible.
On June 12, 1998, the Special Committee and its financial and legal
advisors met with management to receive a further update concerning the
Company's discussions with Carondelet. Management reported that discussions
with Carondelet were still ongoing but that progress had been slow. Management
reported that representatives of the Company and Carondelet had met on a weekly
or bi-weekly basis since the parties had entered into their non-binding letter
of intent and that Carondelet currently is in the process of performing due
diligence with respect to the Company's Heart Hospitals. However, management
reported that the parties had not resolved the critical issues referred to
above relating to the extent and timing of the consolidation of the parties'
heart programs or the economic terms of the joint venture. Management stated
its belief that if an agreement with Carondelet could be consummated, the
benefits to the Tucson Heart Hospital would at a minimum enable the Heart
Hospital to operate on a break-even basis. Management further stated that it
remained extremely difficult to predict whether the parties would be able to
reach an agreement or, if an agreement were reached, the timing of such an
agreement. Following the June 12, 1998 meeting, Dr. Duncan, on behalf of the
Special Committee, contacted Carondelet to discuss the status of its
negotiations with the Company and confirmed the status of negotiations.
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At the June 12, 1998 meeting, management also updated the Special
Committee and Goldman Sachs regarding the Company's results of operations for
the months of April and May 1998. Based on such update, the Special Committee
concluded that the Company's business and business prospects had not changed
materially from that reflected in the March Projection.
Following the June 12, 1998 meeting, management provided the Special
Committee and Goldman Sachs certain financial data, prepared by management at
the request and for the use of Carondelet, relating to the combined operations
of the Tucson Heart Hospital and Carondelet. On June 23, 1998 the Special
Committee and Goldman Sachs met with management to discuss such financial data.
This data incorporated certain of Carondelet's historical operating results
into the Company's fiscal year 1999 financial model for the Tucson Heart
Hospital, assuming complete consolidation of the parties' heart programs and
reflecting alternative revenue assumptions. Management informed the Special
Committee and Goldman Sachs that it believes Carondelet requested this data as
a preliminary step in building its own financial model for a joint venture with
the Tucson Heart Hospital and that this data does not represent the Company's
projection of the future operations of the joint venture, should the parties
enter into and consummate an agreement.
On July 6, 1998, the Special Committee met to determine whether to
reconfirm its finding that the Merger is substantively and procedurally fair to
the Public Shareholders. Immediately prior to this meeting, Mr. McKinnon on
behalf of the Special Committee received from Mr. Puckett on behalf of
management a further update concerning developments in the Company's business
since the Special Committee's meeting with management on June 12, 1998. Based
on such update, the Special Committee concluded that the Company's business and
business prospects (including the prospects of a joint venture between the
Tucson Heart Hospital and Carondelet, as discussed above) had not changed
materially since June 12, 1998. At the July 6, 1998 meeting, the Special
Committee received an oral opinion of Goldman Sachs (which it confirmed in
writing) that, as of July 6, 1998, the Cash Merger Consideration was fair from
a financial point of view to the Public Shareholders, and the Special Committee
reconfirmed its March 12, 1998 determination that the Merger was substantively
and procedurally fair to the Public Shareholders. Goldman Sachs' opinion dated
July 6, 1998 is attached to this Proxy Statement as Appendix B.
The Special Committee's and the Board's Recommendation
The Special Committee met on over 20 occasions between July 28, 1997 and
the date of this Proxy Statement, in person or by telephone conference, to
consider developments relating to a possible sale of the Company, including
meetings on 13 occasions to consider successive proposals by KKR and WCAS VII.
The Special Committee was assisted in its deliberations by its financial
advisor, Goldman Sachs, and its legal counsel, Womble Carlyle. At a meeting
held on March 12, 1998, the Special Committee determined that the Merger,
including the Cash Merger Consideration to be paid to the Public Shareholders,
was substantively and procedurally fair and recommended that the full Board
approve the Merger Agreement. At a meeting held on July 6, 1998, the Special
Committee reconfirmed its determination that the Merger was substantively and
procedurally fair to the Public Shareholders. The Special Committee is unaware
of any development since its July 6, 1998 meeting that would affect its July 6,
1998 reconfirmation, and, accordingly, the Special Committee reconfirms, as of
the date of this Proxy Statement, its determination that the Merger is
substantively and procedurally fair to the Public Shareholders. Based on the
foregoing, the Board also reconfirms, as of the date of this Proxy Statement,
its determination that the Merger is substantively and procedurally fair to the
Public Shareholders.
The material factors the Special Committee evaluated in determining that
the Merger is substantively and procedurally fair to the Public Shareholders
are described below. Except as noted below, the Special Committee considered
the following factors to be positive factors supporting its determination that
the Merger is substantively and procedurally fair to the Public Shareholders.
In arriving at its decision, the Special Committee gave the most weight to:
(i) The Special Committee's view that the market price of the Common
Stock has not reflected, and for an indefinite period of time would not
reflect, the value that may be inherent in the Company's business strategy
due to the risk (which the Special Committee believed to be significant)
that the Company may not successfully execute its business strategy
relating to Heart Hospitals. The following factors contributed to the
Special Committee's assessment of the risk of execution of the Company's
business strategy:
o The Company has experienced unanticipated start-up problems at two of
the Company's first three Heart Hospitals (McAllen and Tucson). Such
start-up problems are a basis for uncertainty relating to the Company's
Heart Hospital concept, including uncertainty relating to the extent to
which the Heart Hospital concept is transportable nationwide without
significant alteration of the model to address local factors.
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o The Common Stock is susceptible to significant declines based on
negative developments relating to the performance of the Company's Heart
Hospitals. Because the market price of the Common Stock is viewed as a
barometer of the Company's desirability as a business partner, a
precipitous decline in the market price could lead to the Company's
inability to attract physician participation in the development of, and
to obtain financing to fund, new Heart Hospitals and thus significantly
impede the Company's opening of Heart Hospitals in the future.
o The Company's operating strategy requires it to incur significant debt
to fund new Heart Hospitals. The Company's ability to generate cash flow
sufficient to service its debt is highly dependent on the operations of
the Company's existing Heart Hospitals. The failure of the Company's
Heart Hospitals to generate positive cash flow in accordance with the
Company's projections, such as the Company has experienced with Tucson,
may have a material and adverse effect on the Company's ability to
develop new Heart Hospitals. In this connection, the March Projection
showed that the Company might encounter cash flow deficits in certain
years included in the March Projection. Such deficits assume no increase
in the Company's revolving credit facility, which management believes
could be increased based on the projected increase in the Company's
accounts receivable through such period. Nevertheless, the Special
Committee believes, and management acknowledges, that the continued
underperformance of Tucson could make it difficult for the Company to
obtain capital to finance future Heart Hospitals.
o The Company operates in a highly regulated environment in which changes
in regulations or in their interpretations could force the Company to
modify the way it does business.
(ii) The impact on the value of the Company resulting from the start-up
problems at the Tucson Heart Hospital, which the Special Committee believes
justifies selling the Company at a price below the range that earlier had
appeared appropriate. Primarily as a result of Tucson's operating problems,
the Company projects that its earnings per share for fiscal year 1998 will
be $0.43 per share, compared to $0.78 per share assumed for the purpose of
the June Projection. As reflected in the March Projection, such problems
are expected to continue to materially and adversely affect the Company's
earnings per share, which according to the June Projection would have
increased from $0.78 per share in fiscal year 1998 to $2.85 in fiscal year
2002 but, according to the March Projection, are now expected to increase
from only $0.43 in fiscal year 1998 to only $1.65 in fiscal year 2002. The
Special Committee's original understanding of the Company's value was based
on the June Projection, which was prepared months before Tucson opened and
its start-up problems surfaced. As described above under " -- Developments
Relating to Tucson," the Special Committee believes the factors that have
given rise to the operating problems experienced at Tucson to date, most of
which are structural to the Tucson market, indicate such problems likely
will be long-term in nature. In this connection, the Special Committee also
considered the non-binding letter of intent entered into on April 7, 1998
between the Company and Carondelet. See " -- Background of the Merger --
Negotiations with KKR and WCAS VII" and "BUSINESS OF THE COMPANY --
Hospital Division -- Recent Developments in the Hospital Division -- Tucson
Heart Hospital." The Special Committee considered that the Tucson Heart
Hospital would benefit from consummation of a joint venture that would
result in the consolidation of Carondelet's and the Tucson Heart Hospital's
heart programs. The Special Committee also considered, however, that the
parties had not resolved certain critical issues relating to the structure
of the joint venture, and that is not possible to predict whether or when
the Company and Carondelet might successfully reach a definitive agreement
and consummate the joint venture. The possibility that the Company might
consummate a joint venture with Carondelet was a negative factor in the
Special Committee's determination that the Merger is fair to the Public
Shareholders. However, the continuing uncertainty of the prospects for and
timing of such a transaction led the Special Committee to reconfirm such
fairness determination.
(iii) The belief of the Special Committee that the Merger represents a
more desirable alternative than continuing to operate the Company as a
public company. In this connection, the Special Committee gave strong
consideration to rejecting the KKR and WCAS VII proposal in favor of
maintaining the Company's independence and enabling the Public Shareholders
to share in the Company's future earnings and growth potential. However,
the Special Committee believes that continuing to operate the Company as an
independent entity would subject the Company and its shareholders to the
risk of execution of the Company's business strategy as described above.
After evaluating such risk (including the factors described under item (i)
above), the Special Committee concluded that, while the Company's business
strategy could ultimately prove successful, the risk that the Company's
Heart Hospitals will continue to experience significant operating problems
adversely impacting the performance of the Common Stock justifies a sale of
the Company pursuant to the terms of the Merger Agreement. The Special
Committee did not consider alternatives to the
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Merger, other than continuing to operate the Company as an independent
entity and the preliminary proposals that are described above under " --
Solicitation and Receipt of Preliminary Proposals."
(iv) Information with respect to the financial condition, results of
operations and business of the Company. The Special Committee focused in
particular on the March Projection, which reflected substantially lower
earnings for future periods than had been anticipated prior to fiscal year
1998. The March Projection projected earnings per share for the Company for
fiscal years 1998 through 2002 of $0.43, $0.75, $1.10, $1.35 and $1.65,
respectively, compared to earnings per share reflected in the June
Projection of $0.78, $1.19, $1.67, $2.26 and $2.85, respectively.
(v) The scope of efforts to sell the Company, including the number and
identity of potential buyers from which indications of interest were
solicited. In this connection, the Special Committee considered that
Goldman Sachs received only three indications of interest and that several
firms that declined to submit an indication of interest cited as reasons
for their decision concerns relating to the Company's ability to execute
its business strategy. The Special Committee also considered the terms of
two preliminary proposals submitted by bidders other than KKR (which had
been submitted prior to the occurrence of developments relating to the
Tucson Heart Hospital that were reflected in the December Projection), the
withdrawal of one of such proposals and the prospects for consummating such
proposals.
(vi) Goldman Sachs' oral opinions delivered to the Special Committee on
March 12, 1998 and July 6, 1998, both of which Goldman Sachs confirmed in
writing, that the $19 per share to be received by the Public Shareholders
was fair to such holders from a financial point of view. The full text of
the written opinion of Goldman Sachs dated July 6, 1998, which sets forth
assumptions made, matters considered and limitations on the review
undertaken in connection with its opinion, is attached hereto as Appendix B
and is incorporated herein by reference. The Special Committee and the
Board adopted the analyses and findings of Goldman Sachs in their
determination that the Merger is fair to the Public Shareholders. The
Company's shareholders are urged to and should read such opinion in its
entirety.
In addition to the factors referred to in subparagraphs (i) - (vi) above, the
other material factors considered by the Special Committee in reaching its
fairness determination are as follows:
(vii) The proposed terms and conditions of the Merger Agreement. In
particular, the Special Committee considered the fact that the Merger
Agreement does not provide for unreasonable termination fees and expense
reimbursement obligations which would have the effect of unreasonably
discouraging competing bids and that, subject to the satisfaction of
certain conditions, the Board would be able to withdraw or modify its
recommendation to the shareholders regarding the Merger and enter into an
agreement with respect to a more favorable transaction with a third party,
if such a transaction becomes available prior to the consummation of the
Merger. See "THE MERGER."
(viii) The market price of the Common Stock, which as recently as January
and February 1998 had traded at prices below the Company's initial public
offering price of $14, and the premium over such prices (as well as over
the then prevailing market price) represented by the $19 per share to be
received by the Public Shareholders in the Merger. The closing price of the
Common Stock had increased from $14.63 on February 18, 1998 to $16.50 on
March 12, 1998. The Special Committee considered the possibility that the
market price of the Common Stock in the weeks preceding March 12, 1998 may
have reflected speculation concerning a possible sale of the Company. This
possibility was based on rumors reported to management by analysts and
shareholders in early 1998. In addition, the Special Committee considered
Goldman Sachs' analysis of the premiums paid in comparable merger
transactions, which ranged from 25% to 40% of the 90 day average price
prior to announcement of the transaction. See " -- Opinion of Financial
Advisor."
(ix) The unpredictability of the Company's earnings, the effect of such
unpredictability on the market price of the Common Stock, and the effect of
such factors on management's ability to execute the Company's business
strategy. In this connection, the Special Committee considered that the
Company may be capable of being managed more effectively as a private
company not subject to pressures from public shareholders and market
professionals to maintain and grow earnings per share, and that the Company
might be unable to retain certain members of management if the Company were
to remain public. The Special Committee believes that as a private company
the Company would have greater flexibility to consider business strategies
that have long-term benefits but, if the Company were public, would
adversely impact earnings per share and the market price of the Common
Stock in the short term.
(x) The financial ability and willingness of KKR and WCAS VII to
consummate the Merger. The Merger Agreement conditions the Acquiror's
obligations to consummate the Merger on the Acquiror's having obtained
financing for the Merger on terms satisfactory to the Acquiror. In this
connection, the Special Committee reviewed commitment letters for equity
financing supplied by the KKR Partnership and WCAS VII and for debt
financing supplied by the Acquiror's lender. In addition, the Special
Committee, through its financial and legal advisors, discussed the proposed
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financing with the Acquiror and its lender. Based on the foregoing, the
Special Committee viewed as remote the risk that the financing condition of
the Merger Agreement would not be satisfied. Further, the Special Committee
did not consider it to be material that a portion of the financing of the
Merger would be provided under a revolving credit facility to be entered
into by the Company with the Acquiror's lender. The Special Committee
considered the financing risk to be a neutral factor in its determination
that the Merger is fair to the Public Shareholders.
(xi) Actual or potential conflicts of interest to which certain officers
and directors of the Company and their affiliates are subject in connection
with the Merger, as follows:
o The Special Committee considered that members of the Management Group
will own shares of common stock of the Parent and fully vested options
to purchase such shares, representing approximately 8% of the Parent's
fully diluted equity. The Special Committee also considered that the
Parent will reserve for issuance to employees of the Company, pursuant
to future grants of additional options, shares of common stock of the
Parent representing 15% of the fully diluted equity of the Parent, a
substantial portion of which are anticipated to be granted to the
Management Group. The Special Committee further considered that members
of the Management Group will enter into new employment agreements with
the Parent replacing their existing employment agreements with the
Company, and that such new employment agreements will provide for the
payment to them of base salaries, possible annual cash bonuses,
potential severance benefits, and separate payments in respect of the
termination of their previously existing employment agreements and in
respect of a covenant not to compete. The Special Committee considered
these conflicts of interest to be a negative factor in its determination
that the Merger is fair to the Public Shareholders, although the
compensation and benefits payable to members of the Management Group
referred to above and disclosed in more detail elsewhere in this Proxy
Statement are intended primarily to provide for the payment of
compensation and benefits to the Management Group substantially
equivalent to the compensation and benefits they are currently entitled
to receive from the Company.
o The Special Committee considered that the Parent has given each member
of the Management Group an opportunity to roll over up to 100% of his
equity investment in the Company into an investment in the Parent,
provided each member rolls over a minimum of 50%. The Special Committee
considered that the rollover of substantially more than 50% of a
member's current equity investment in the Company would indicate a level
of confidence in the Company's prospects that might be inconsistent with
the Special Committee's assessment of the risks associated with the
Company's Heart Hospital concept. Three members of the Management Group
elected to roll over the minimum 50% investment, and a fourth member
elected to roll over only slightly in excess of the 50% minimum. The
Special Committee viewed this as a neutral factor in its determination
that the Merger is fair to the Public Shareholders.
o The Special Committee considered the foregoing conflicts of interest in
connection with management's preparation of the December Projection and
the March Projection, which, as disclosed elsewhere in this Proxy
Statement, reflect a significantly slower rate of growth for the Company
and supports a significantly lower value for the Company than reflected
in the June Projection. While the Special Committee recognized that the
conflicts of interest to which the Management Group were subject might
be a basis for doubting the reasonableness of the December Projection
and the March Projection, the Special Committee concluded, based on its
discussions with the Management Group during January and March 1998 as
described above, that management's assumptions underlying the December
Projection and the March Projection are reasonable. The Special
Committee considered the Management Group's conflicts of interest in
connection with preparation of the December Projection and the March
Projection to be a negative factor in its determination that the Merger
is fair to the Public Shareholders.
The Special Committee believes that the Company's existing and planned
Heart Hospitals are the dominant factor in determining the value of the
Company.
Except to the extent noted above, the Special Committee did not assign
relative weights to the factors it considered, and it did not consider any
relative weighting to be necessary in reaching its fairness determination.
The Special Committee noted that approximately 24% of the outstanding
shares of Common Stock are held by persons who have committed or expressed
their intention to vote their shares of Common Stock in favor of the Merger,
including members of the Management Group, members of the Board and other
members of the Investor Group. The Special Committee also considered that the
obligation of the Company to consummate the Merger is not conditioned upon the
favorable
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vote of a majority of the Public Shareholders. Notwithstanding the absence of
such a voting requirement, the Special Committee believes that the procedure
that was followed in determining the purchase price to be paid to the
shareholders of the Company was fair to the Public Shareholders. As described
above, the six person Board of Directors of the Company (a majority of whom are
members of the Management Group or affiliated with WCAS VII) appointed as the
only members of the Special Committee two non-employee directors who were
independent of the Management Group and WCAS VII and granted the Special
Committee authority independently to solicit proposals to acquire the Company,
including exclusive authority on behalf of the Board to review, evaluate and
negotiate any transaction proposed by a group which included one or more
members of management or the Board or an affiliate of any member of management
or the Board and any competing offer to acquire the Company not involving a
conflict of interest. The Board retained authority to review, evaluate and
negotiate proposals only in the absence of any proposal which would create a
conflict of interest. Goldman Sachs, the Special Committee's financial advisor,
solicited indications of interest from 18 potential buyers, which resulted in
the submission of three preliminary proposals by financial buyers all of which
required management's participation in the buyout. With the assistance of its
financial advisor and legal counsel, the Special Committee evaluated, and
ultimately rejected, proposals by KKR and WCAS VII that would have paid the
shareholders less than $19 per share in cash. The Merger Agreement negotiated
by the Special Committee contains provisions that would enable the Board to
withdraw or modify its recommendation to the shareholders regarding the Merger
and to enter into an agreement with respect to a more favorable transaction
with a third party, and contains provisions (without which the Special
Committee believes KKR and WCAS VII would not have entered into the Merger
Agreement) imposing upon the Company termination fee and expense reimbursement
obligations that, in the view of the Special Committee, are reasonable and
would not have the effect of unreasonably discouraging competing bids. Further,
the shareholders of the Company may dissent from the Merger and be paid cash
for the "fair value" of their shares as determined in accordance with North
Carolina law. Thus, although the Merger is not structured to require approval
of a majority of the unaffiliated shareholders (which the Special Committee
considered to be a negative factor), the Special Committee nevertheless
believes, as of the date of this Proxy Statement and for the reasons set forth
above, the Merger is procedurally fair to the Public Shareholders.
Based on the foregoing, the Special Committee unanimously determined that
the Merger is substantively and procedurally fair to the Public Shareholders
and recommended to the Board approval of the Merger Agreement and that it be
recommended to the shareholders of the Company.
The Board approved the Merger on March 12, 1998 and reconfirmed, as of the
date of this Proxy Statement, that the Merger is substantively and procedurally
fair to the Public Shareholders. THE BOARD RECOMMENDS THAT THE SHAREHOLDERS
APPROVE THE MERGER. Because of the financial interest in the Merger of four of
the members of the Board (Mr. Puckett, Mr. Crane, Mr. Welsh and Mr. Paul), a
majority of the Board could not independently review and determine the fairness
of the Merger to the Public Shareholders. Mr. Welsh and Mr. Paul did not attend
the meetings of the Board at which the Merger Agreement was considered because
of their conflicts of interest, and Mr. Puckett and Mr. Crane abstained from
voting with respect to the Merger because of their conflicts of interest.
Therefore, the remaining directors (who also constituted the Special Committee)
were the only directors who voted on the Merger. In their consideration of the
Merger, such remaining directors, in their capacities as members of the Board
and not in their capacities as members of the Special Committee, adopted the
analyses and conclusions of the Special Committee.
In considering the fairness of the Merger, the Special Committee and the
Board did not consider such factors as the Company's net book value or
liquidation value, which are not believed to be indicative of the value of the
Company as a going concern. The Company's net book value per share as of March
31, 1998 was $11.92, substantially below the $19.00 purchase price per share to
be paid by the Acquiror in the Merger. The Special Committee further believes
the Company's liquidation value, which takes into account the appreciated value
of the Company's assets, a significant portion of which has been acquired by
the Company since September 30, 1995, also would be substantially below $19.00
per share. In addition, neither the Company nor, to the knowledge of the
Special Committee and the Board, any affiliate of the Company has purchased
securities of the Company (except pursuant to stock option plans of the
Company) since October 1, 1995. Accordingly, the purchase prices paid in such
transactions were not considered by the Special Committee or the Board in their
fairness determinations.
Opinion of Financial Advisor
On March 12, 1998, Goldman Sachs delivered its oral opinion, later
confirmed in writing, to the Special Committee that, as of the date of such
opinion, the Cash Merger Consideration pursuant to the Merger Agreement was
fair from a financial point of view to the Public Shareholders of the Company.
Goldman Sachs subsequently confirmed its earlier opinion by delivery of its
written opinion dated as of July 6, 1998.
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The full text of the written opinion of Goldman Sachs dated July 6, 1998,
which sets forth assumptions made, matters considered and limitations on the
review undertaken in connection with the opinion, is attached hereto as
Appendix B to this Proxy Statement and is incorporated herein by reference.
Shareholders of the Company are urged to, and should, read such opinion in its
entirety.
In connection with its July 6, 1998 opinion, Goldman Sachs reviewed, among
other things, (i) the Merger Agreement; (ii) the draft Schedule 14A containing
the draft Proxy Statement dated June 23, 1998; (iii) the Annual Reports to
Shareholders and Annual Reports on Form 10-K of the Company for the three
fiscal years ended September 30, 1997; (iv) the Company's Prospectus for its
initial public offering of the Common Stock dated December 6, 1994; (v) certain
interim reports to shareholders and Quarterly Reports on Form 10-Q of the
Company; (vi) certain other communications from the Company to its
shareholders; and (vii) certain internal financial analyses and projections for
the Company prepared by its management. Goldman Sachs also held discussions
with members of the management of the Company regarding its past and current
business operations, financial condition, and future prospects . Goldman Sachs
also discussed with members of the Special Committee their views as to the
risks and uncertainties associated with achieving management's projections for
the Company. In addition, Goldman Sachs reviewed the reported price and trading
activity for the Common Stock, compared certain financial and stock market
information for the Company with similar information for certain other
companies, the securities of which are publicly traded, reviewed the financial
terms of certain recent business combinations in the hospital industry and the
physician practice management industry specifically and in other industries
generally and performed such other studies and analyses as it considered
appropriate.
Goldman Sachs relied upon the accuracy and completeness of all of the
financial and other information reviewed by it and has assumed such accuracy
and completeness for purposes of rendering its opinion. In addition, Goldman
Sachs has not made an independent evaluation or appraisal of the assets and
liabilities of the Company or any of its subsidiaries and Goldman Sachs has not
been furnished with any such evaluation or appraisal. The opinion of Goldman
Sachs referred to herein was provided for the information and assistance of the
Special Committee in connection with its consideration of the transaction
contemplated by the Merger Agreement and such opinion does not constitute a
recommendation as to how any holder of Common Stock should vote with respect to
such transaction.
The following is a summary of the material financial analyses used by
Goldman Sachs in connection with providing its opinion to the Special Committee
on March 12, 1998 (the "March Analyses") and on July 6, 1998 (the "July
Analyses"). All implied per share values referred to below reflect the value of
the Company as a whole, including all of its divisions.
(i) Historical Stock Trading Analysis. Goldman Sachs reviewed the
historical trading prices and volumes for the Common Stock both separately
and in comparison to the S&P 500 index and to the Selected Hospital and PPM
Companies (each as defined herein) for the six-month, one-year and
three-year periods prior to March 12, 1998. In addition, Goldman Sachs
analyzed the consideration to be received by holders of the Common Stock
pursuant to the Merger Agreement in relation to the market price of the
Common Stock prior to the announcement of the proposed Merger. Such
analysis indicated that the price per share to be paid pursuant to the
Merger Agreement represented a premium of 23% based on the closing price of
$15.50 per share on March 4, 1998, and a premium of 29% based on the 90-day
average market price of $14.77 per share.
(ii) Discounted Cash Flow Analysis. Goldman Sachs performed a discounted
cash flow analysis using the March Projection prepared by management.
Goldman Sachs created separate discounted cash flow models for each of the
three divisions of the Company: the Diagnostics Division, the Practice
Management Division and the Hospital Division.
For the Diagnostics Division and the Practice Management Division,
Goldman Sachs calculated a net present value of free cash flows for the
years 1998 through 2003 using discount rates ranging from 11% to 13%.
Goldman Sachs calculated the two divisions' terminal values in the year
2003 based on terminal perpetuity growth rates ranging from 2% to 5%. These
terminal values were then discounted to present value using discount rates
from 11% to 13%.
For the Hospital Division, Goldman Sachs analyzed separately each of
fifteen hospitals, which were classified in three groups based on the
development stage: those already completed, those under development and
those planned for the future. The operational results of each hospital were
projected for each year up to the year when its operation was deemed to
have reached a steady state (the "Steady State Year"). The Steady State
Year for the fifteen hospitals ranged from 2001 to 2008. Goldman Sachs
calculated a net present value of free cash flows of each hospital for the
years 1998 through the Steady State Year of that hospital using discount
rates ranging from 11% to 13%, from 13% to 15%, or
21
<PAGE>
from 15% to 17% depending on the development stage of that hospital.
Goldman Sachs calculated such hospital's terminal value in its Steady State
Year based on terminal perpetuity growth rates ranging from 2% to 5%. These
terminal values were then discounted to present value using discount rates
ranging from 11% to 13%, from 13% to 15%, or from 15% to 17% depending on
the development stage of that hospital.
The various ranges for discount rates and terminal perpetuity growth
rates were chosen to reflect appropriate risk of capital deployed. Based on
this analysis, the implied per share values in both the March analyses and
the July analyses ranged from $15 to $23.
(iii) Selected Companies Analysis. Goldman Sachs reviewed and compared
certain financial information relating to the Company to corresponding
financial information, ratios and public market multiples of:
(a) six publicly traded corporations in the hospital industry:
Columbia/HCA Healthcare Corporation, Health Management Associates, Inc.,
Paracelsus Healthcare Corporation, Quorum Health Group, Inc., Tenet
Healthcare Corporation and Universal Health Services, Inc. (the "Selected
Hospital Companies"); and
(b) eighteen publicly traded corporations in the physician practice
management industry, seven of which are primary/multispecialty physician
practice management companies: Advanced Health Corporation, Coastal
Physician Group, Inc., FPA Medical Management, Inc., MedPartners, Inc.,
PhyCor, Inc., PhyMatrix Corp. and Sheridan Healthcare, Inc. (the
"Selected Primary PPM Companies"); and eleven of which are specialty
physician practice management companies: American Oncology Resources,
Inc., Apogee, Inc., Complete Management, Inc., EquiMed, Inc., Concentra
Managed Care, Inc., Omega Health Systems, Inc., Orthodontic Centers of
America, Inc., Pediatrix Medical Group, Inc., Physician Reliance Network,
Inc., Physicians Resource Group, Inc. and Specialty Care Network, Inc.
(the "Selected Specialty PPM Companies", and together with the Selected
Primary PPM Companies, the "Selected PPM Companies"; the Selected PPM
Companies and the Selected Hospital Companies being the "Selected
Companies").
The Selected Hospital Companies and the Selected PPM Companies were
chosen because they are publicly traded companies with operations that for
purposes of analysis may be considered similar to the Hospital Division and
the Practice Management Division, respectively, of the Company. There was
only one publicly traded company comparable to the Diagnostics Division:
Raytel Medical Corporation. Goldman Sachs calculated and compared various
financial multiples and ratios. The multiples of the Company were
calculated in the March Analyses using a price of $15.50 per share, the
closing price of the Common Stock on the Nasdaq National Market on March 4,
1998 and in the July Analyses using a price of $18.25, the closing price of
the Common Stock on July 1, 1998. The multiples and ratios for the Company
were based on information provided by the Company's management and the
multiples for each of the Selected Companies were based on the then most
recent publicly available information.
Goldman Sachs considered, among other ratios, levered market
capitalization (i.e., market value of common equity plus estimated market
value of debt less cash) as a multiple of earnings before interest, taxes,
depreciation and amortization ("EBITDA") for the latest twelve-month
("LTM") period. The March Analyses indicated multiples ranging from 6.3x to
17.2x with a median of 9.8x for the Selected Hospital Companies, multiples
ranging from 3.1x to 62.7x with a median of 8.8x for the Selected Primary
PPM Companies, and multiples ranging from 2.5x to 46.5x with a median of
15.0x for the Selected Specialty PPM Companies. The July Analyses indicated
multiples ranging from 8.8x to 23.1x with a median of 10.0x for the
Selected Hospital Companies, multiples ranging from 0.4x to 26.6x with a
median of 7.9x for the Selected Primary PPM Companies, and multiples
ranging from 1.0x to 33.4x with a median of 9.8x for the Selected Specialty
PPM Companies.
Goldman Sachs also considered for the Selected Hospital Companies, the
Selected Primary PPM Companies, and the Selected Specialty PPM Companies
estimated price/earnings ratios (based on Institutional Broker Estimate
System (IBES) median estimates as of February 27, 1998 for the March
Analyses and as of June 24, 1998 for the July Analyses), which in the March
Analyses ranged from 12.5x to 31.3x, from 18.4x to 26.3x, and from 7.1x to
30.4x, respectively, for the 1998 calendar year, and from 6.3x to 24.9x,
from 12.3x to 19.3x, and from 8.0x to 23.5x, respectively, for the 1999
calendar year and in the July Analyses ranged from 16.6x to 60.0x, from
4.6x to 39.4x and from 1.9x to 50.7x, respectively, for the 1998 calendar
year, and from 15.8x to 29.5x, from 2.0x to 13.5x, and from 4.2x to 21.6x,
respectively, for the 1999 calendar year; estimated LTM EBITDA margins and
LTM earnings before interest and taxes ("EBIT") margins, which in the March
Analyses ranged from 8.2% to 26.5% and 3.3% to 22.4%, respectively, for the
Selected Hospital Companies, from 1.4% to 22.6% and 6.3% to 17.1%,
respectively, for the Selected Primary PPM Companies, and from 2.9% to
68.7% and 0.8% to 61.3%, respectively, for the Selected Specialty PPM
Companies and
22
<PAGE>
in the July Analyses ranged from 10.5% to 24.7% and 5.8% to 20.5%,
respectively, for the Selected Hospital Companies, from 1.7% to 16.1% and
4.4% to 11.6%, respectively, for the Selected Primary PPM Companies, and
from 3.0% to 54.8% and 1.6% to 47.9%, respectively, for the Selected
Specialty PPM Companies; and price/book value ratios, which in the March
Analyses ranged from 1.9x to 7.2x for the Selected Hospital Companies, from
0.2x to 6.7x for the Selected Primary PPM Companies, and from 0.4x to 6.2x
for the Selected Specialty PPM Companies and in the July Analyses ranged
from 2.5x to 7.9x for the Selected Hospital Companies, from 0.3x to 22.8x
for the Selected Primary PPM Companies, and from 0.4x to 5.6x for the
Selected Specialty PPM Companies. Applied to the Common Stock and the March
Projection, including management's estimated earnings per share for 1998,
the above median range of EBITDA and price/earnings multiples in the March
Analyses implied a price per share of the Common Stock in the range of $9
to $13 and in the July Analyses implied a price per share of the Common
Stock in the range of $9 to $18.
(iv) Selected Transactions Analysis. Goldman Sachs analyzed certain
information relating to selected transactions in the hospital industry
since 1989 (the "Selected Hospital Transactions") and selected transactions
in the physician practice management industry since 1991 (the "Selected PPM
Transactions"). The Selected Hospital Transactions used in the March
Analyses included the following: the acquisition of Deaconess Incarnate
Word Health System by Tenet Healthcare Corporation announced in January
1997, the acquisition of OrNda HealthCorp by Tenet Healthcare Corp.
announced in October 1996, the acquisition of Champion Healthcare Corp. by
Paracelsus Healthcare Corp. announced in April 1996, the acquisition of
HealthTrust Inc. - The Hospital Co. by Columbia/HCA Healthcare Corp.
announced in October 1994, the acquisition of American Medical Holdings
Inc. by National Medical Enterprises Inc. announced in September 1994, the
acquisition of EPIC Healthcare Group Inc. by HealthTrust Inc. - The
Hospital Co. announced in January 1994, the acquisition of Summit Health
Ltd. by OrNda HealthCorp announced in December 1993, the acquisition of
American Healthcare Management Inc. by OrNda HealthCorp announced in
November 1993, the acquisition of HCA Hospital Corp of America by Columbia
Healthcare Corp. announced in October 1993, the acquisition of 10 Hospitals
of Charter Medical Corp. by Quorum Health Group Inc. announced in October
1993, the acquisition of Galen Health Care Inc. by Columbia Hospital Corp.
announced in June 1993, the acquisition of American Medical International
Inc. by IMA Holdings Corp. announced in July 1989, and the acquisition of
Hospital Corp. of America by a management group announced in March 1989.
The July Analyses used the following additional Selected Hospital
Transactions: the acquisition of certain hospitals of Columbia/HCA
Healthcare Corp. by a hospital consortium announced in May 1998, the
acquisition of National Surgery Centers, Inc. by HealthSouth Corporation
announced in May 1998, and the acquisition of certain outpatient surgery
centers of Columbia/HCA Healthcare Corp. by HealthSouth Corporation
announced in April 1998. The Selected PPM Transactions used in the March
Analyses constituted a total of 97 transactions and reflect selected
acquisitions in the physician practice management industry entered into
since September 1991 for which information was available. The Selected PPM
Transactions used in the July Analyses constituted seven transactions in
addition to the 97 transactions used in the March Analyses. No minimum
consideration paid threshold was used in identifying such transactions.
Such analysis indicated that, for the Selected Hospital Transactions and
the Selected PPM Transactions used for the March Analyses, the median of
the levered consideration (i.e., the price paid for the equity securities
acquired plus the estimated market value of any debt less cash assumed)
was: as a multiple of LTM sales, 1.1x for the Selected Hospital
Transactions and 0.7x for the Selected PPM Transactions; as a multiple of
LTM EBIT, 11.9x for the Selected Hospital Transactions and 21.7x for the
Selected PPM Transactions; and as a multiple of LTM EBITDA, 6.9x for the
Selected Hospital Transactions and 17.4x for the Selected PPM Transactions.
For the Selected Hospital Transactions and the Selected PPM Transactions
used for the July Analyses, the median of the levered consideration was: as
a multiple of LTM sales, 1.3x for the Selected Hospital Transactions and
0.7x for the Selected PPM Transactions; as a multiple of LTM EBIT, 12.5x
for the Selected Hospital Transactions and 21.4x for the Selected PPM
Transactions; and as a multiple of LTM EBITDA, 7.1x for the Selected
Hospital Transactions and 17.0x for the Selected PPM Transactions. Applied
to the Common Stock and the March Projection, including management's
estimate of earnings per share for 1998, the median range of transaction
multiples used in the March Analyses implied a price per share of the
Common Stock in the range of $7 to $10 and the median range of transaction
multiples used in the July Analyses implied a price per share of the Common
Stock in the range of $7 to $18.
Goldman Sachs also analyzed the premiums paid in such merger
transactions, which ranged from 25% to 40% of the 90 day average price
prior to announcement of the transaction. Applied to the Common Stock of
the Company and the March Projection, including management's estimate of
earnings per share for 1998, these merger premiums in the case of both the
March Analyses and the July Analyses implied a price per share of $14 to
$18 when transaction premium analysis is combined with the trading
multiples analysis as described in Section (iii) above.
23
<PAGE>
(v) Implied Future Prices Analysis. Goldman Sachs calculated implied
future prices of the Common Stock at the end of each year for the five-year
period ending in 2003 on the basis of the management's earnings estimates
in the March Projection and the assumption of a price/earnings ratio of
21.0x in the March Analyses and 23.1x in the July Analyses (the median of
price/earnings ratio in 1998 for the Selected Hospital Companies). The
implied future prices of the Common Stock reflected an average compound
annual growth rate of 34.0% for the price of the Common Stock between 1998
and 2003. Goldman Sachs then discounted the implied future prices of the
Common Stock at a discount rate of 12% to arrive at implied per share
values ranging from $9 to $21 in the March Analyses and from $9 to $23 in
the July Analyses.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. Selecting
portions of the analyses or of the summary set forth above, without considering
the analyses as a whole, could create an incomplete view of the processes
underlying Goldman Sachs' opinion. In arriving at its fairness determination,
Goldman Sachs considered the results of all such analyses. No company or
transaction used in the above analyses as a comparison is directly comparable
to the Company or the contemplated transaction. The analyses were prepared
solely for purposes of Goldman Sachs' providing its opinion to the Special
Committee as to the fairness from a financial point of view of the Cash Merger
Consideration pursuant to the Merger Agreement to the Public Shareholders of
the Company and do not purport to be appraisals or necessarily reflect the
prices at which businesses or securities actually may be sold. Analyses based
upon projections of future results are not necessarily indicative of actual
future results, which may be significantly more or less favorable than
suggested by such analyses. Because such analyses are inherently subject to
uncertainty, being based upon numerous factors or events beyond the control of
the parties or their respective advisors, none of the Company, Goldman Sachs or
any other person assumes responsibility if future results are materially
different from those projected. As described above, Goldman Sachs' opinion to
the Special Committee was one of many factors taken into consideration by the
Special Committee in making its determination to approve the Merger Agreement.
The foregoing summary does not purport to be a complete description of the
analyses performed by Goldman Sachs and is qualified in its entirety by
reference to the written opinion of Goldman Sachs set forth in Appendix B
hereto.
Goldman Sachs, as part of its investment banking business, is continually
engaged in the valuation of businesses and their securities in connection with
mergers and acquisitions, negotiated underwritings, competitive biddings,
secondary distributions of listed and unlisted securities, private placements,
and valuations for estate, corporate and other purposes. The Special Committee
selected Goldman Sachs as its financial advisor because it is a nationally
recognized investment banking firm that has substantial experience in
transactions similar to the Merger. Goldman Sachs has provided certain
investment banking services to KKR, WCAS VII and their affiliates from time to
time and may provide investment banking services to KKR, WCAS VII and their
affiliates from time to time in the future.
Pursuant to a letter agreement dated August 8, 1997 (the "Engagement
Letter"), the Special Committee engaged Goldman Sachs to act as its financial
advisor in connection with the contemplated transaction. Pursuant to the terms
of the Engagement Letter, the Company has agreed to pay Goldman Sachs upon
consummation of the Merger a transaction fee of 1% of the aggregate
consideration (the total value of the Common Stock at $19 per share plus the
outstanding debt of MedCath assumed by Acquiror), subject to a minimum of $3.25
million. The Company has agreed to reimburse Goldman Sachs for its reasonable
out-of-pocket expenses, including attorney's fees, and to indemnify Goldman
Sachs against certain liabilities, including certain liabilities under the
federal securities laws.
Purpose and Reasons of the Affiliates for the Merger
The purpose of the Affiliates for engaging in the transactions
contemplated by the Merger Agreement is to acquire, together with any
participating Physicians and Employees, 100% of the ownership of the Company.
The Affiliates believe that as a private company MedCath will have greater
operating flexibility to focus on enhancing value by emphasizing growth and
operating cash flow without the constraint of the public market's emphasis on
quarterly earnings and the potentially disruptive effect associated with losses
in connection with the construction and start-up of new Heart Hospitals.
The members of the Management Group beneficially own, in the aggregate,
approximately 15.2% of the outstanding Common Stock. The two WCAS Directors may
be deemed to beneficially own, in the aggregate, approximately 8.2% and 7.7%,
respectively, of the outstanding Common Stock, including 7.5% that is held of
record by WCAS V. See "PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF
MANAGEMENT."
Prior to consummation of the Merger, members of the Management Group have
agreed to contribute a portion of their equity interests in MedCath to the
Parent, representing an investment of approximately $17 million in the Parent
(based on the $19 per share to be received by shareholders in the Merger), in
exchange for 668,016 shares of common stock of the
24
<PAGE>
Parent and options to purchase 329,422 shares of common stock of the Parent.
The WCAS Investors have agreed to contribute an aggregate of 262,474 shares of
Common Stock to the Parent (of which 88,385 will be contributed by the WCAS
Directors) in exchange for an equivalent number of shares of common stock of
the Parent.
As a result of the Merger, the KKR Partnership will acquire, indirectly
through the Parent for an investment of up to approximately $106 million, up to
approximately 46% of the equity interest in the Company; the WCAS Investors
will acquire, indirectly through the Parent for an investment of up to
approximately $106 million, up to approximately 46% of the equity interest in
the Company; and the Management Group will acquire, indirectly through the
Parent for an investment in kind of approximately $17 million of their equity
interest in Medcath, approximately 8% of the equity interest in the Company.
See "SPECIAL FACTORS -- Background of the Merger." Members of the Management
Group and the WCAS Investors will also receive the Cash Merger Consideration
for the remainder of their investment in the Company on the same terms as other
shareholders.
Position of the Affiliates as to Fairness of the Merger
Each of the Affiliates has considered the analyses and findings of the
Special Committee and the Board (described in detail in "SPECIAL FACTORS -- The
Special Committee's and the Board's Recommendation") with respect to the
fairness of the Merger to the unaffiliated shareholders of the Company. As of
the date of this Proxy Statement, each of the Affiliates adopts the analyses
and findings of the Special Committee and the Board with respect to the
fairness of the Merger and believes that the Merger is both procedurally and
substantively fair to the Company's unaffiliated shareholders; provided that no
opinion is expressed as to the fairness to any shareholder making an investment
in the Parent. None of the Affiliates makes any recommendation as to how the
Company's shareholders should vote on the Merger Agreement. The WCAS Directors
have financial interests in the Merger and the members of the Management Group
have financial and employment interests in the Merger. See "SPECIAL FACTORS --
Conflicts of Interest."
Conflicts of Interest
In considering the recommendations of the Board with respect to the
Merger, shareholders should be aware that certain officers and directors of
MedCath and affiliates, and associates and persons related to the officers and
directors are members of the Investor Group or otherwise have interests in
connection with the Merger which may present them with actual or potential
conflicts of interest as summarized below. The Special Committee and the Board
were aware of these interests and considered them among the other matters
described under " -- The Special Committee's and the Board's Recommendation."
The Special Committee considered the Management Group's conflicts of interest
to be a negative factor in its determination that the Merger is fair to the
Public Shareholders, even though the compensation and benefits payable to
members of the Management Group are intended to provide for the payment of
compensation and benefits to the Management Group substantially equivalent to
the compensation and benefits they are currently entitled to receive from the
Company.
Voting Agreement. As a condition to the Merger Agreement, the members of
the Management Group have entered into an agreement with the Acquiror and the
Parent pursuant to which they have agreed to vote their shares of Common Stock
(i) in favor of the adoption and approval of the Merger Agreement and the
transactions contemplated thereby and (ii) except as otherwise agreed to in
writing by the Parent, against any extraordinary corporate transaction
involving MedCath or its subsidiaries; any reorganization, recapitalization,
dissolution or liquidation of MedCath or its subsidiaries; any change in a
majority of the directors, material amendment to MedCath's Articles of
Incorporation or Bylaws; or any other action involving MedCath or its
subsidiaries that has the effect of impeding, delaying or impairing the
consummation of the Merger or the transactions contemplated thereby.
Post-Merger Ownership and Control of the Parent. It is anticipated that
immediately after the Merger the following individuals and entities will
beneficially own the number of shares of common stock of the Parent shown in the
following table. The table does not reflect the beneficial ownership of any
shares of common stock of the Parent by Physicians or Employees. To the extent
any of the Physicians accept the Parent's offer to issue to them shares of
common stock of the Parent in exchange for shares of Common Stock, the share
numbers and percentages shown in the following table for WCAS VII, WCAS
Healthcare Partners, L.P., the WCAS Directors and the other WCAS Investors will
decrease, and to the extent that any of the Employees accept the Parent's offer
to grant them stock options in exchange for the cancellation of their options to
purchase shares of Common Stock, all of the share numbers and percentages
(except those of the Management Group) will decrease.
25
<PAGE>
<TABLE>
<CAPTION>
Number of Shares of Percentage of Parent
Parent Common Stock Common Stock
Name of Beneficial Owner Beneficially Owned Beneficially Owned
- -------------------------------- --------------------- ----------------------
<S> <C> <C>
The KKR Partnership 5,573,684 45.89%
WCAS VII 5,232,370 43.08
WCAS Healthcare Partners, L.P. 52,632 0.43
WCAS Directors(1)
Patrick J. Welsh 72,595 0.60
Andrew M. Paul 15,790 0.13
Other WCAS Investors 200,298 1.65
Management Group(1)(2)
Stephen R. Puckett 677,009 5.57
David Crane 152,054 1.25
Charles W. (Todd) Johnson 146,777 1.21
Richard J. Post 21,598 0.19
</TABLE>
- ---------
(1) See "PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF MANAGEMENT" for number
of shares of Common Stock and percentage of Common Stock beneficially
owned before the Merger by these persons and entities.
(2) Includes an aggregate of 329,422 shares of common stock of the Parent
issuable upon exercise of options to be received in exchange for MedCath
stock options held by members of the Management Group, which will be fully
vested and immediately exercisable. Does not include any shares of common
stock of the Parent issuable upon exercise of New Options expected to be
granted to the Management Group at the Effective Time. See " -- Grant of
New Options of the Parent to the Management Group."
Following consummation of the Merger, the members of the Management Group
will continue as the executive officers of the Company, and the Management
Group will designate Stephen R. Puckett and David Crane to serve on the Board
of Directors of the Company. In addition, the Management Group will become the
executive officers of the Parent.
The Board of Directors of the Parent will have ten members. The Management
Group will designate Stephen R. Puckett and David Crane to serve on the Board
of Directors of the Parent. The WCAS Investors will designate three persons to
serve on such board.
Contribution to the Parent of Equity Interests in MedCath by the
Management Group and WCAS Directors. Each member of the Management Group has
agreed to contribute in kind at least 50% of the value of his equity interest
in MedCath, including both shares of Common Stock and the Aggregate Unrealized
Gain on options held by him to purchase shares of Common Stock. In exchange for
shares of Common Stock contributed, each member of the Management Group will
receive shares of common stock of the Parent. In exchange for the Aggregate
Unrealized Gain on MedCath stock options, each member of the Management Group
will receive options to purchase shares of common stock of the Parent that will
be fully vested and immediately exercisable. This contribution will occur prior
to consummation of the Merger. If the Merger is consummated, the Management
Group will not receive any cash in the Merger for their shares of Common Stock
contributed to the Parent or the Aggregate Unrealized Gain on their MedCath
stock options exchanged for Parent stock options, but, instead, will receive
common stock of the Parent and options to purchase shares of such common stock
and, therefore, will continue to have indirect ownership interests in MedCath
following the Merger. Shares of Common Stock held by the Management Group that
are not contributed to the Parent will be converted into the right to receive
the same Cash Merger Consideration as shares of Common Stock held by other
shareholders of the Company. The Management Group will also receive cash on the
same basis as all other optionees for the Aggregate Unrealized Gain on any
stock options they do not agree to exchange for substantially equivalent
options to purchase shares of common stock of the Parent.
Prior to the Effective Time, MedCath has agreed, pursuant to the terms of
the Merger Agreement, to take all necessary action to cancel all outstanding
options to purchase Common Stock, whether or not exercisable, other than
options exchanged by the Management Group and the Employees for similar options
to purchase shares of common stock of the Parent. See "THE MERGER -- Cash-out
of MedCath Stock Options" and "PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF
MANAGEMENT." As of June 22, 1998, there were options outstanding to purchase an
aggregate of 1,189,195 shares of Common Stock at a weighted average exercise
price of $13.05 per share, all but 28,255 of which have an exercise price per
share of less than $19.
The following table sets forth information as of June 22, 1998 as to the
shares of Common Stock and the options to purchase shares of Common Stock held
by members of the Management Group for which cash payments will be received
26
<PAGE>
upon consummation of the Merger.
<TABLE>
<CAPTION>
Amount of Cash
to be Received
Shares Not for Shares Not
Management Group Member Contributed to Parent Contributed to Parent
- ------------------------- ----------------------- -----------------------
<S> <C> <C>
Stephen R. Puckett 605,000 $11,495,000
David Crane 102,117 1,940,223
Charles W. (Todd)
Johnson 129,504 2,460,576
Richard J. Post -- --
<CAPTION>
Shares Amount of Cash Total Amount of Cash
Underlying to be Received to be Received
Stock Options for Stock Options upon Consummation
Management Group Member Not Contributed Not Contributed of the Merger
- ------------------------- ----------------- ------------------- ---------------------
<S> <C> <C> <C>
Stephen R. Puckett -- -- $11,495,000
David Crane 42,837 $282,999 2,223,222
Charles W. (Todd)
Johnson -- -- 2,460,576
Richard J. Post 32,959 180,162 180,162
</TABLE>
Certain of the WCAS Investors have agreed to contribute to the Parent an
aggregate of 262,474 shares of Common Stock, of which an aggregate of 88,385
shares will be contributed by the WCAS Directors, in exchange for shares of
common stock of the Parent. The value (at $19 per share) of the shares of
Common Stock contributed (approximately $5 million) plus cash contributed to
the Parent by the WCAS Investors will aggregate approximately $106 million
(reduced by the aggregate value (at $19 per share) of any shares of Common
Stock contributed to the Parent by the Physicians and by an amount equal to
one-half of the Aggregate Unrealized Gain on the stock options contributed to
the Parent by the Employees).
Grant of New Options of Parent to the Management Group. The Board of
Directors of the Parent will reserve shares of the Parent's common stock
representing 15% of the fully diluted equity of the Parent for the grant of
Parent stock options at an exercise price of $19 per share (the "New Options").
Fifty percent of the New Options will vest in equal portions annually over the
four years following the grant. The remaining fifty percent of the New Options
will become exercisable after the eighth anniversary of grant, subject to
acceleration if the Parent achieves certain performance targets, which will be
consistent with the June Projection, to be established by the Board of
Directors of the Parent. The New Options are also subject to a number of other
conditions. See "CERTAIN FORWARD LOOKING INFORMATION."
The New Options will be granted as follows:
o the Management Group will receive between 70% and 80% of the New Options
upon consummation of the Merger;
o other key employees of the Company will receive approximately 90% of the
remaining New Options upon consummation of the Merger; and
o the approximately 10% of the remaining New Options will remain available
for grant to future employees of the Parent.
No determination has yet been made as to the number of New Options to be
granted to any individual.
"Change of Control" Payments to Members of the Management Group. The
consummation of the Merger will constitute a "Change in Control" of the Company
pursuant to the terms of the respective employment agreements between the
members of the Management Group and the Company. Upon such a Change in Control,
each of them becomes entitled to a lump-sum payment equal to two times the
total cash compensation earned by such employee during the immediately
preceding fiscal year of the Company, plus the present value of two years of
normal health, life insurance and retirement benefits. Each member of the
Management Group has agreed to forego such payment, however, in consideration
of the payments to be received pursuant to the new employment agreements
described immediately below. If they had not agreed to forego such payments,
then Stephen R. Puckett, David Crane, Charles W. (Todd) Johnson and Richard J.
Post would have been entitled to receive $778,337, $613,321, $530,147 and
$444,977, respectively, under their current employment agreements upon the
occurrence of a "Change of Control."
New Employment Agreements with the Management Group. Upon consummation of
the Merger, the employment agreements that each member of the Management Group
currently has with the Company will terminate. At such time, each member of the
Management Group will enter into a new employment agreement with the Parent.
The principal terms of the employment agreements are summarized below:
o each agreement will have a term of four years with an extension for an
additional year, unless terminated or not renewed in accordance with the
agreement's terms;
o each agreement will provide for compensation consisting of base salary
(the amount of which is intended to be, at all times, no less than the
median base salary for each of the four highest paid officers of
companies of similar size and character as the Parent), and a potential
cash bonus (the eligibility formula for which is intended to be
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<PAGE>
comparable to the current cash bonus formula of the Company and based
upon performance targets to be determined by the Board of Directors of
the Parent); and
o each agreement will provide for a severance payment in the event of
termination by the Parent without cause or resignation by the employee
for good reason, consisting of two years' payment of base salary and
bonus and continuation of normal health, life insurance, retirement and
other benefits.
The initial base salaries for Stephen R. Puckett, David Crane, Charles W.
(Todd) Johnson and Richard J. Post pursuant to their new employment agreements
with the Parent will be $325,680, $263,172, $189,996 and $157,992,
respectively. The possible annual cash bonuses for each of the members of the
Management Group will equal a percentage of each of their base salaries, be
calculated using a bonus formula comparable to the bonus formula in effect
immediately prior to the Merger, and will depend upon the Company meeting or
exceeding certain performance targets to be established yearly by the Board.
See "MANAGEMENT -- Executive Compensation -- Employment Agreements."
Each member of the Management Group will also be entitled to a separate
payment in respect of the termination of his previously existing employment
agreement and a separate payment in respect of a covenant not to compete. For
each member of the Management Group, the covenant not to compete will be in
effect during the period of his employment and for one year thereafter. Without
prior written consent of the Parent, while the covenant not to compete is in
effect, a member of the Management Group may not, directly or indirectly, in
any capacity carry on, be engaged in or have any financial interest in (with
the exception of a less than 5% interest in a public company) any business
which is in competition (as defined in the employment agreement) with the
existing business of the Company. The amounts of such payments to be received
by each member of the Management Group immediately after consummation of the
Merger are set forth in the table below.
<TABLE>
<CAPTION>
Management Group Member Termination Payment Non-Compete Payment
- -------------------------------- --------------------- --------------------
<S> <C> <C>
Stephen R. Puckett $378,342 $400,000
David Crane 298,326 315,000
Charles W. (Todd) Johnson 265,155 265,000
Richard J. Post 221,982 220,000
</TABLE>
Stockholders' Agreement. The Parent and the members of the Management Group
will enter into a stockholders' agreement that will restrict the Management
Group's ability to transfer the shares of common stock of the Parent to be owned
by them and create certain other rights and obligations with respect to such
shares.
Payments to Investment Adviser of WCAS VII. Upon consummation of the
Merger, MedCath will pay a financial advisory fee to WCA Management of not more
than $2.25 million for services rendered in connection with the financing of
the Merger and related transactions. In addition, WCA Management will receive
annually a monitoring fee in an amount to be determined after consummation of
the Merger for ongoing financial advisory services.
Indemnification and Insurance. The Merger Agreement requires that MedCath
provide indemnification to its current and former directors and officers
against liabilities (including reasonable attorneys' fees) relating to actions
or omissions arising out of their being a director, officer, employee or agent
of the Company at or prior to the Effective Time (including the transactions
contemplated by the Merger Agreement). In addition, MedCath is obligated for a
period of six years from the Effective Time to continue in effect directors'
and officers' liability insurance with respect to matters occurring prior to
the Effective Time, which insurance must contain terms and conditions no less
advantageous than are contained in MedCath's current directors' and officers'
liability insurance policy; provided that MedCath is not obligated to expend
annually more than 200% of the current cost of such coverage.
Special Committee. As compensation for serving on the Special Committee,
which met on more than 20 occasions between July 28, 1997 and the date of this
Proxy Statement, the members of the Special Committee each received fees in the
amount of approximately $20,000 pursuant to the Board's standard policy for
compensating directors for attendance at committee meetings.
Each member of the Special Committee, as an outside director,
automatically received on the date of each annual meeting options to purchase
2,000 shares of Common Stock at the market price of the Common Stock on such
date. Dr. Duncan and Mr. McKinnon each received a total of 4,000 such options,
none of which have been exercised. In addition, Dr. Duncan
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was granted upon appointment to the Board options to purchase 3,531 shares of
Common Stock at an exercise price of $7.51 per share, of which 1,177 have not
been exercised. Under the terms of the Merger Agreement, the options held by
the members of the Special Committee will be terminated and each holder thereof
will receive an amount in cash equal to the Aggregate Unrealized Gain on such
options on the same basis as other holders of MedCath stock options.
In addition to the options described in the preceding paragraph, Dr.
Duncan owns 2,354 shares of Common Stock, and Mr. McKinnon owns 60,000 shares
of Common Stock, all of which will, upon consummation of the Merger, be
canceled and for which they will receive the Cash Merger Consideration.
Accordingly, upon consummation of the Merger, the members of the Special
Committee will receive the following cash payments: Dr. Duncan will receive
$20,774 for the Aggregate Unrealized Gain on his stock options and $44,726 for
his shares of Common Stock, for a total cash payment of $65,500. Mr. McKinnon
will receive $7,250 for the Aggregate Unrealized Gain on his stock options and
$1,140,000 for his shares of Common Stock, for a total cash payment of
$1,147,250.
Members of the Special Committee will also be entitled to certain
indemnification rights granted under the Merger Agreement to the current and
former directors and officers of the Company. See " -- Conflicts of Interest --
Indemnification and Insurance."
Certain Effects of the Merger
As a result of the Merger, other than the Management Group, the
Physicians, the Employees and the WCAS Investors, the current shareholders of
MedCath will not have an opportunity to continue their equity interest in
MedCath as an ongoing corporation and therefore will not share in the future
earnings and potential growth of MedCath. Upon consummation of the Merger, the
Common Stock will no longer be traded on the Nasdaq National Market, price
quotations will no longer be available and the registration of the Common Stock
under the Exchange Act will be terminated. The termination of registration of
the Common Stock under the Exchange Act will eliminate the requirement to
provide information to the Commission and will make most of the provisions of
the Exchange Act, such as the short-swing profit recovery provisions of Section
16(b) and the requirement of furnishing a proxy or information statement in
connection with shareholders' meetings, no longer applicable.
The members of the Management Group, the Physicians, the Employees and the
WCAS Directors will own an equity interest in the Parent that will allow them
indirectly to share in the future earnings and potential growth of MedCath,
which will upon consummation of the Merger become a wholly-owned subsidiary of
the Parent. An investment in MedCath (indirectly through an equity investment
in the Parent) following the Merger involves substantial risk resulting from
the limited liquidity of any such investment and the increased leverage
associated with future borrowings that will be necessary to fund the
substantial capital expenditures required to execute the Company's business
strategy. Nonetheless, if the Company is able to successfully implement its
business strategy, the value of such an equity investment would be considerably
greater than the original cost thereof. See "CERTAIN FORWARD LOOKING
INFORMATION."
The receipt of cash pursuant to the Merger will be a taxable transaction.
See "FEDERAL INCOME TAX CONSEQUENCES."
Conduct of MedCath's Business After the Merger
The Parent is continuing to evaluate MedCath's business, assets,
practices, operations, properties, corporate structure, capitalization,
management and personnel and discuss what changes, if any, will be desirable.
Subject to the foregoing, the Parent expects that the day-to-day business and
operations of MedCath will be conducted substantially as they are currently
being conducted by MedCath. The Parent does not currently intend to dispose of
any assets of MedCath, other than in the ordinary course of business.
Additionally, the Parent does not currently contemplate any material change in
the composition of MedCath's current management, although after the Merger, the
Board will consist of four designees of the KKR Partnership, three designees of
the WCAS Investors, Stephen R. Puckett and David Crane of the Management Group
and one independent director to be elected by the other directors.
Certain Forward Looking Information
Certain projections prepared by management of MedCath are included
elsewhere in this Proxy Statement under the heading "CERTAIN FORWARD LOOKING
INFORMATION."
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THE SPECIAL MEETING
Proxy Solicitation
This Proxy Statement is being delivered to MedCath's shareholders in
connection with the solicitation by the Board of proxies to be voted at the
Special Meeting to be held July 30, 1998 at 10:00 a.m., local time, at Raintree
Country Club, located at 8600 Raintree Lane, Charlotte, North Carolina. All
expenses incurred in connection with solicitation of the enclosed proxy will be
paid by the Company. Officers, directors and regular employees of the Company,
who will receive no additional compensation for their services, may solicit
proxies by telephone or personal call. In addition, the Company has retained
Georgeson & Company Inc. to solicit proxies for a fee of $7,000 plus expenses.
The Company has requested brokers and nominees who hold stock in their names to
furnish this proxy material to their customers and the Company will reimburse
such brokers and nominees for their related out-of-pocket expenses. This Proxy
Statement and the accompanying proxy card are being mailed to shareholders on
or about July , 1998.
Record Date and Quorum Requirement
The Common Stock is the only outstanding voting security of the Company.
The Board has fixed the close of business on June 22, 1998 as the record date
(the "Record Date") for the determination of shareholders entitled to notice
of, and to vote at, the Special Meeting and any adjournment or adjournments
thereof. Each holder of record of Common Stock at the close of business on the
Record Date is entitled to one vote for each share then held on each matter
submitted to a vote of shareholders. At the close of business on the Record
Date, there were 11,813,404 shares of Common Stock issued and outstanding held
by 217 holders of record and by approximately 3,900 persons or entities holding
in nominee name.
The holders of a majority of the outstanding shares entitled to vote at
the Special Meeting must be present in person or represented by proxy to
constitute a quorum for the transaction of business. Abstentions are counted
for purposes of determining the presence or absence of a quorum for the
transaction of business.
Voting Procedures
Approval of the Merger Agreement, which is attached as Appendix A hereto,
will require the affirmative vote of the holders of a majority of the
outstanding shares of Common Stock entitled to vote at the Special Meeting. A
failure to vote or a vote to abstain will have the same legal effect as a vote
cast against approval. Brokers and, in many cases, nominees will not have
discretionary power to vote on the proposal to be presented at the Special
Meeting. Accordingly, beneficial owners of shares should instruct their brokers
or nominees how to vote. A broker non-vote will have the same effect as a vote
against the Merger.
Under North Carolina law, holders of Common Stock who do not vote in favor
of the Merger Agreement and who comply with certain notice requirements and
other procedures will have the right to dissent and to be paid cash for the
"fair value" of their shares as finally determined under such procedures, which
may be more or less than the consideration to be received by other shareholders
of MedCath under the terms of the Merger Agreement. Failure to follow such
procedures precisely may result in loss of Dissenters' Rights. See "RIGHTS OF
DISSENTING SHAREHOLDERS."
Voting and Revocation of Proxies
A shareholder giving a proxy has the power to revoke it at any time before
it is exercised by (i) filing with the Secretary of MedCath an instrument
revoking it, (ii) submitting a duly executed proxy bearing a later date or
(iii) voting in person at the Special Meeting. Subject to such revocation, all
shares represented by each properly executed proxy received by the Secretary of
MedCath will be voted in accordance with the instructions indicated thereon,
and if no instructions are indicated, will be voted to approve the Merger and
in such manner as the persons named on the enclosed proxy card in their
discretion determine upon such other business as may properly come before the
Special Meeting or any adjournment thereof.
The shares represented by the accompanying proxy card and entitled to vote
will be voted if the proxy card is properly signed and received by the
Secretary of the Company prior to the Special Meeting.
Effective Time
The Merger will be effective as soon as practicable following shareholder
approval of the Merger Agreement and upon the filing of articles of merger with
the Secretary of State of the State of North Carolina. The Effective Time is
currently expected to occur as soon as practicable after the Special Meeting,
subject to approval of the Merger Agreement at the Special Meeting and
satisfaction or waiver of the terms and conditions set forth in the Merger
Agreement. See "THE MERGER -- Conditions."
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<PAGE>
THE MERGER
The Merger Agreement provides that the Acquiror, a newly-formed North
Carolina corporation which is an indirect, wholly-owned subsidiary of the
Parent, will be merged with and into MedCath, and that following the Merger,
the separate existence of the Acquiror will cease and MedCath will continue as
the surviving corporation.
The terms of and conditions to the Merger are contained in the Merger
Agreement which is included in full as Appendix A to this Proxy Statement and
is incorporated herein by reference. The discussion in this Proxy Statement of
the Merger and the summary description of the principal terms of the Merger
Agreement are subject to and qualified in their entirety by reference to the
more complete information set forth in the Merger Agreement.
Conversion of Securities
At the Effective Time, subject to the terms, conditions and procedures set
forth in the Merger Agreement, each share of Common Stock issued and
outstanding immediately prior to the Effective Time (other than the Dissenting
Shares and shares held by the Acquiror) will, by virtue of the Merger, be
converted into the right to receive the Cash Merger Consideration. Except for
the right to receive the Cash Merger Consideration, from and after the
Effective Time, all shares (other than the Dissenting Shares and shares held by
the Acquiror), by virtue of the Merger and without any action on the part of
the holders, will no longer be outstanding and will be canceled and retired and
will cease to exist. Each holder of a certificate formerly representing any
shares (other than the Dissenting Shares and shares held by the Acquiror) will
after the Effective Time cease to have any rights with respect to such shares
other than the right to receive the Cash Merger Consideration for such shares
upon surrender of the certificate.
No interest will be paid or accrued on the amount payable upon the
surrender of any certificate. Payment to be made to a person other than the
registered holder of the certificate surrendered is conditioned upon the
certificate so surrendered being properly endorsed and otherwise in proper form
for transfer, as determined by the Disbursing Agent. Further, the person
requesting such payment will be required to pay any transfer or other taxes
required by reason of the payment to a person other than the registered holder
of the certificate surrendered or establish to the satisfaction of the
Disbursing Agent that such tax has been paid or is not payable. Six months
following the Effective Time, MedCath will be entitled to cause the Disbursing
Agent to deliver to it any funds (including any interest received with respect
thereto) made available to the Disbursing Agent which have not been disbursed
to holders of certificates formerly representing shares outstanding prior to
the Effective Time, and thereafter such holders will be entitled to look to
MedCath only as general creditors with respect to cash payable upon due
surrender of their certificates. Notwithstanding the foregoing, neither the
Disbursing Agent nor any party to the Merger Agreement will be liable to any
holder of certificates formerly representing shares for any amount paid to a
public official pursuant to any applicable abandoned property, escheat or
similar law. Except as described in this paragraph, MedCath will pay all
charges and expenses, including those of the Disbursing Agent, in connection
with the exchange of shares for the Cash Merger Consideration.
Each share of the Acquiror's common stock that is issued and outstanding
immediately prior to the Merger will be converted at the Effective Time into
one share of Common Stock of MedCath.
Cash-out of MedCath Stock Options
In general, outstanding stock options to purchase shares of MedCath shall
be canceled or terminated as of the Effective Time. Holders of such options
shall receive cash equal to the Aggregate Unrealized Gain on such options.
Options contributed by the Management Group to the Parent for similar options
to purchase shares of common stock of the Parent will be canceled, and the
members of the Management Group will not receive any cash payment upon the
cancellation thereof.
Transfer of Shares
No transfers of shares of Common Stock will be made on the stock transfer
books at or after the Effective Time. If, after the Effective Time,
certificates representing such shares are presented to MedCath, such shares
will be canceled and exchanged for the Cash Merger Consideration.
Conditions
Each party's respective obligation to effect the Merger is subject to the
satisfaction, at or prior to the Effective Time, of each of the following
conditions, any or all of which may be waived (other than those appearing in
(i) and (iii) below) at the appropriate party's discretion, to the extent
permitted by applicable law:
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<PAGE>
(i) the Merger Agreement and the transactions contemplated therein shall
have been approved in the manner required by applicable law by the holders
of a majority of the outstanding shares entitled to vote thereon;
(ii) there is no action, suit or proceeding pending before any court or
governmental body that may have the effect of making illegal or otherwise
preventing, prohibiting or substantially delaying consummation of the
Merger or would result in an award of damages that would have a material
adverse effect on MedCath; and
(iii) the waiting period applicable to the consummation of the Merger
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), shall have expired or terminated.
The obligations of MedCath to effect the Merger are subject to the
satisfaction, at or prior to the Effective Time, of each of the following
conditions, unless waived by MedCath:
(i) the representations and warranties of the Acquiror and the Parent in
the Merger Agreement shall be true and correct in all material respects as
of the date of execution thereof and as of the Effective Time as though
made at the Effective Time, except for changes specifically permitted by
the Merger Agreement;
(ii) the Acquiror and the Parent shall have performed in all material
respects their agreements contained in the Merger Agreement required to be
performed at or prior to the Effective Time; and
(iii) MedCath shall have received a certificate of the President and a
Vice President of the Acquiror and the Parent certifying to the effect of
the preceding clauses (i) and (ii).
The obligations of the Acquiror and the Parent to effect the Merger are
subject to the satisfaction at or prior to the Effective Time of each of the
following conditions, unless waived by the Acquiror:
(i) the representations and warranties of MedCath contained in the Merger
Agreement shall be true and correct in all material respects as of the date
of execution thereof and, except as contemplated by the Merger Agreement,
as of the Effective Time, as though all of such representations were made
by MedCath at the Effective Time;
(ii) MedCath shall have performed in all material respects its agreements
contained in the Merger Agreement required to be performed at or prior to
the Effective Time;
(iii) the Acquiror shall have received a certificate of the President and
a Vice President of MedCath certifying, as applicable, to the effect of the
preceding clauses (i) and (ii);
(iv) the Acquiror shall have obtained the financing for the Merger on
terms satisfactory to the Acquiror;
(v) all consents, approvals or notices to any governmental authority or
other person or entity whose consent or approval or to whom notice is
required in connection with the execution or delivery and performance of
the Merger Agreement and the transactions contemplated by those agreements
shall have been obtained or made;
(vi) the Management Group shall have invested in the Parent at least 50%
of the value of their equity interest in the Company, including both shares
of Common Stock and the Aggregate Unrealized Gain or MedCath stock options
held by them;
(vii) the directors of MedCath, other than those who are also directors
of the Acquiror, shall have resigned; and
(viii) to MedCath's knowledge, no investigation of MedCath for any
violation of the "Stark" laws, anti-kickback laws or laws or regulations
relating to Medicare, Medicaid or CHAMPUS shall be pending.
After approval of the Merger Agreement by the shareholders of MedCath, no
condition may be waived that reduces the amount or changes the form of the Cash
Merger Consideration to be received by the shareholders or that would adversely
affect the shareholders of MedCath unless a waiver of such condition is
approved by the shareholders.
Representations and Warranties
MedCath has made representations and warranties in the Merger Agreement
regarding, among other things, its organization and good standing, authority to
enter into the transaction, its capitalization, its financial statements, the
absence of certain changes in the business of MedCath since September 30, 1997,
the content and submission of forms and reports required to be filed by MedCath
with the Commission, requisite governmental and other consents and approvals,
compliance with all applicable laws, including without limitation those
relating to billing and coding for healthcare services, absence of litigation
to which MedCath is a party, brokers and finders, requisite tax filings,
absence of defaults under material contracts, employee benefits and coding and
environmental matters.
32
<PAGE>
The Parent and the Acquiror have made representations and warranties in
the Merger Agreement regarding, among other things, their organization and good
standing, authority to enter the transaction, the Acquiror's capitalization,
compliance with all applicable laws, requisite governmental and other consents
and approvals, accuracy of information supplied by the Acquiror for submission
on forms and reports required to be filed by MedCath with the Commission,
financing for the Merger, brokers and finders, the absence of prior activities
and absence of litigation to which the Acquiror or the Parent is a party.
The representations and warranties of the parties in the Merger Agreement
will expire upon consummation of the Merger, and upon such expiration none of
such parties or their respective officers, directors or principals will have
any liability whatsoever with respect to any such representations or
warranties.
Covenants
In the Merger Agreement, MedCath has agreed that prior to the Effective
Time, unless otherwise agreed to in writing by the Acquiror or as otherwise
contemplated by the Merger Agreement, MedCath and each of its subsidiaries will
conduct business only in the ordinary course substantially consistent with past
practice and will not:
(i) amend its articles of incorporation or bylaws or the organizational
documents of any of MedCath's subsidiaries;
(ii) declare, set aside or pay any dividend or make any other
distribution in respect of any of its shares of capital stock;
(iii) issue, grant, sell, pledge, or transfer any shares of its capital
stock, stock options, warrants, securities or rights to acquire any such
shares, securities or rights of MedCath or propose or agree to do any of
the foregoing or acquire directly or indirectly any shares of its capital
stock or make any other changes in its equity capital structure;
(iv) incur any indebtedness, directly or through guarantees or otherwise,
other than under existing credit facilities for current operations in the
ordinary course of its business or make loans other than to its
subsidiaries;
(v) acquire directly or indirectly by redemption or otherwise any shares
of the capital stock of MedCath of any class or any options, warrants or
other rights to purchase any such shares, fail to use their reasonable best
efforts to conduct their relations with employees and their employee
benefit plans only in the ordinary and usual course consistent with past
practices;
(vi) amend, or enter into any additional, employment agreements with
officers or directors of MedCath or make increases in employee compensation
or benefits except as permitted by the Merger Agreement;
(vii) fail to use their reasonable best efforts to keep in place its
current insurance policies which are material;
(viii) make any investment of a capital nature or otherwise enter into
any material transaction;
(ix) make any material tax election or settle or compromise any material
tax liability;
(x) not make any change in its accounting principles or methods except
insofar as may be required by a change in generally accepted accounting
principles;
(xi) split, combine or reclassify any of the capital stock of MedCath or
issue other securities in respect of or in substitution for such existing
capital stock;
(xii) acquire any other business or entity whether by acquisition of
assets or stock, merger or consolidation;
(xiii) agree to engage in any new developments;
(xiv) sell, lease, mortgage or otherwise encumber any of its assets other
than in the ordinary course of business;
(xv) make capital expenditures in amounts which exceed MedCath's annual
capital expenditure budget for fiscal year 1998;
(xvi) pay, discharge or satisfy material claims other than in the
ordinary course of business;
(xvii) adopt a plan of complete or partial liquidation or merger with
respect to MedCath or any of its subsidiaries;
(xviii) enter into any new collective bargaining agreement;
(xix) settle or compromise any litigation against MedCath or its
subsidiaries;
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<PAGE>
(xx) engage in any transaction or enter into any agreement with any
affiliate or other person covered under Item 404 of the Commission's
Regulation S-K;
(xxi) adopt new, or amend existing, employee benefit plans;
(xxii) grant employees any new or modified severance;
(xxiii) effectuate a plant closing or mass layoff without complying with
applicable law;
(xxiv) fail to grant to the Acquiror and its representatives, on a
confidential basis, access to the records and facilities of MedCath; and
(xxv) fail to use its reasonable best efforts to cooperate with and
assist the Acquiror with respect to financing necessary to effect the
Merger.
The Merger Agreement also provides that the Acquiror will use its
reasonable best efforts to consummate the financing necessary to effect the
Merger and pay the expenses related to the Merger. See "THE MERGER --
Financing."
MedCath has also agreed to provide prompt notice to the Acquiror upon
obtaining knowledge of:
(i) material litigation and claims;
(ii) notices of default under agreements and instruments where the
default would have a material adverse effect;
(iii) notice from a third party claiming that its consent is required in
connection with the transactions contemplated by the Merger Agreement; and
(iv) any material adverse change in the condition (financial or
otherwise), results of operations, properties, assets, liabilities or
business of MedCath and its subsidiaries, taken as a whole, or the
occurrence of an event which could result in any such change.
Nonsolicitation Covenant
Under the terms of the Merger Agreement, MedCath has agreed not to permit
any of its officers, directors, affiliates, representatives or agents to,
directly or indirectly, solicit, initiate or knowingly encourage any
Acquisition Proposal or participate in any discussions or negotiations with any
other party to facilitate an Acquisition Proposal. Further, the Merger
Agreement provides that all of MedCath's representatives will be instructed to
cease these activities. However, MedCath may furnish information and
participate in discussions and negotiations with a party who has made an
unsolicited Acquisition Proposal if either MedCath's Board or its Special
Committee has determined in good faith, based upon the reasonably concluded
written advice of outside counsel, that failing to take such action would
violate fiduciary duties under applicable law. MedCath is obligated to inform
the Acquiror immediately of any Acquisition Proposal, provide the Acquiror
notice of its material terms and conditions and keep the Acquiror advised of
all material developments.
Indemnification and Insurance
The Merger Agreement provides that the current and former directors and
officers of MedCath and any of its subsidiaries (including the members of the
Special Committee) will be indemnified by MedCath, to the fullest extent
permitted by applicable law, against any costs, expenses, judgments, fines,
losses, claims, damages, liabilities and amounts paid in settlement in
connection with any pending, threatened or completed claim, action, suit,
proceeding or investigation, and will be advanced reasonable costs and expenses
(including attorneys' fees), in connection with any claim, action, suit,
proceeding or investigation arising out of or pertaining to the approval and
consummation of the transactions contemplated by the Merger Agreement. In
addition, MedCath is required to maintain in effect, for a period of six years
after the Effective Time, MedCath's policies of directors' and officers'
liability insurance (provided that MedCath may substitute therefor policies of
at least the same amounts and comparable coverage). However, in no event will
MedCath be required to pay premiums for such insurance in excess of 200% of
premiums currently paid by MedCath.
Expenses
The parties have agreed to pay their own costs and expenses in connection
with the Merger Agreement and the transactions contemplated thereby. MedCath
has agreed, however, to pay or reimburse the Acquiror for all reasonable
out-of-pocket expenses incurred by or on behalf of the Acquiror in connection
with the Merger Transaction upon certain events. See "THE MERGER -- Termination
Fee."
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Termination, Amendment and Waiver
At any time prior to the Effective Time, the Merger Agreement may be
terminated by the mutual consent of the Boards of Directors of MedCath and the
Acquiror.
Any of the parties may terminate the Merger Agreement prior to the
Effective Time by written notice to the other parties if (i) the conditions
precedent to closing have not occurred by August 31, 1998 unless the failure to
close results from such party's breach of any representation, warranty or
covenant, (ii) approval of the shareholders of MedCath necessary to consummate
the Merger has not been obtained or (iii) any court of competent jurisdiction
or other governmental entity issues an order, decree or ruling or takes any
action enjoining, restraining or prohibiting the Merger and such order, decree,
ruling or action becomes final and nonappealable.
In addition, the Acquiror may terminate the Merger Agreement prior to the
Effective Time by written notice to MedCath if (i) MedCath breaches any
representation, warranty or covenant and fails to cure such breach within
thirty days after written notice, (ii) the Board withdraws or modifies its
approval or recommendation of the Merger Agreement or the Merger, (iii) MedCath
enters into a definitive agreement with any party regarding an Acquisition
Proposal or (iv) a third party commences a tender or exchange offer for 25% or
more of the Common Stock and the Board has recommended that MedCath's
shareholders tender their shares in connection with such offer.
MedCath may terminate the Merger Agreement prior to the Effective Time by
written notice to the Acquiror if (i) the Board or the Special Committee
withdraws or modifies its approval or recommendation of the Merger Agreement or
the Merger after having determined in good faith, and based upon the reasonably
concluded written advice of counsel, that continuing to recommend the Merger
Agreement and the Merger would violate fiduciary duties of the Board, (ii) the
Board or the Special Committee has determined that MedCath has entered into a
definitive agreement with any party with respect to a transaction the proposal
of which qualifies as an Acquisition Proposal, provided that the Board or the
Special Committee has first determined in good faith based upon reasonably
concluded written advice of counsel that failing to take such action would
violate the Board's fiduciary duties or (iii) a third party commences a tender
or exchange offer for 25% or more of the Common Stock which has not been
solicited by MedCath and the Board has recommended that the shareholders of
MedCath tender their shares in connection with such offer, provided that the
Board or the Special Committee has first determined in good faith based upon
the reasonably concluded written advice of counsel that failing to take such
action would violate the Board's fiduciary duties.
Subject to the provisions of applicable law, the Merger Agreement may be
modified or amended, and provisions thereof waived, by written agreement of the
parties. However, after approval of the principal terms of the Merger Agreement
by the shareholders of MedCath, no amendment or waiver of a provision may be
made which reduces the amount or changes the form of the Cash Merger
Consideration to be received by the shareholders or that would adversely affect
the shareholders of MedCath unless such amendment or waiver of a provision is
approved by the shareholders. With respect to any decision regarding a material
modification, amendment or waiver of the Merger Agreement, the Board, in the
exercise of its fiduciary duty and in accordance with any applicable law or
regulation, will make a determination as to whether resolicitation of
shareholders is required.
Termination Fee
In the event that the Merger Agreement is terminated by MedCath due to (i)
the Board or the Special Committee withdrawing or modifying its approval or
recommendation of the Merger Agreement or the Merger in connection with the
exercise of its fiduciary duties, (ii) MedCath entering into a definitive
agreement with any party with respect to an Acquisition Proposal following a
determination that the Company's failure to do so would violate the Board's
fiduciary duty or (iii) the commencement by a third party of a tender offer for
25% or more of the Common Stock which the Board has recommended to MedCath's
shareholders, then in any of such events, MedCath is required to promptly pay
to the Acquiror $6,774,640 plus the Acquiror's reasonable out-of-pocket fees
and expenses (the "Termination Fee").
The Termination Fee shall also be due in the event that (i) the Merger
Agreement is terminated by the Acquiror due to the Board's withdrawal or
modification of its approval or recommendation of the Merger Agreement or the
Merger, (ii) MedCath enters into a definitive agreement with any party with
respect to an Acquisition Proposal or (iii) a third party commences a tender or
exchange offer for 25% or more of the Common Stock which has been recommended
by the Board to MedCath's shareholders.
Additionally, the Termination Fee will be due to the Acquiror if an
Acquisition Proposal is made to MedCath at any time after the date of the
Merger Agreement and either five months following the termination of the Merger
Agreement due
35
<PAGE>
to the failure of the shareholders of MedCath to approve the Merger Agreement,
or one year after termination of the Merger Agreement for any other reason
(other than a default by the Acquiror), MedCath consummates a transaction the
proposal of which qualifies as an Acquisition Proposal.
Further, in the event that the Merger Agreement is terminated due to the
failure of the shareholders of MedCath to approve the transaction, MedCath
shall be obligated to reimburse the Acquiror for its reasonable out-of-pocket
fees and expenses. Upon a breach of the Merger Agreement by either party which
is not cured within thirty days following written notice, the breaching party
shall be obligated to reimburse the other party hereto for its reasonable
out-of-pocket fees and expenses incurred in connection with the Merger
Agreement.
Financing
Cash Financing for the Merger. Financing for the Merger and the initial
working capital needs of MedCath after the Merger will be provided as follows:
<TABLE>
<CAPTION>
Source of Funds Amount
- ------------------------------------------------------------------ ---------------
<S> <C>
Cash contribution to the Parent by the KKR Partnership(1) ... $105,900,000
Cash contribution to the Parent by the WCAS Investors(2) .... 100,900,000
Revolving credit agreement of MedCath ....................... 31,000,000
------------
$237,800,000
============
</TABLE>
- ---------
(1) The amount of the cash contribution of the KKR Partnership will be reduced
by an amount equal to one-half of the Aggregate Unrealized Gain on the
stock options contributed to the Parent by the Employees.
(2) The amount of the cash contribution of the WCAS Investors will be reduced
by the aggregate value (at $19 per share) of any shares of Common Stock
contributed to the Parent by the Physicians and by an amount equal to
one-half of the Aggregate Unrealized Gain on the stock options contributed
to the Parent by the Employees.
Contributed Equity Financing. Members of the Management Group will invest
at least 50% of the value of their equity interest in MedCath in shares of
common stock of the Parent and in options to purchase shares of common stock of
the Parent in the respective amounts shown below and thereby relieve the Parent
of the need to finance the payment of Cash Merger Consideration for equity
interests in MedCath totaling approximately $17 million. The WCAS Investors
will invest a portion of the value of their equity interest in MedCath in
shares of common stock of the Parent as also set forth in the table below.
<TABLE>
<CAPTION>
Value of
Portion of Percentage of
Value of Equity Interest Equity Interest
Total Equity in MedCath in MedCath
Interest in Contributed to Contributed
Investor Group Member MedCath(1) Parent(1) to Parent
- ----------------------------- -------------- ----------------- ----------------
<S> <C> <C> <C>
Management Group
Stephen R. Puckett $23,523,807 $12,028,807 51.13%
David Crane 4,446,442 2,223,220 50.00
Charles W. (Todd) Johnson 4,921,131 2,460,555 50.00
Richard J. Post 360,313 180,151 50.00
WCAS Directors
Patrick J. Welsh 1,545,612 1,379,305 89.24
Andrew M. Paul 445,322 300,010 67.37
Other WCAS Investors 4,080,801 3,307,691 81.05
</TABLE>
- ---------
(1) Includes, in the case of the members of the Management Group, the Aggregate
Unrealized Gain on options to purchase shares of Common Stock that will be
exchanged for options to purchase shares of common stock of the Parent.
36
<PAGE>
Expenses of the Transaction
Assuming the Merger is consummated, the estimated costs and fees in
connection with the Merger, financing and the related transactions, which will
be paid by MedCath, are as follows:
<TABLE>
<CAPTION>
Cost or Fee Estimated Amount
- -------------------------------------------------- -----------------
<S> <C>
Financial advisory fees .................. $ 8,800,000
Bank commitment fees ..................... 1,600,000
Legal fees ............................... 2,500,000
Termination and non-compete payments ..... 2,363,805
Accounting fees .......................... 700,000
Printing and mailing fees ................ 70,000
Solicitation expenses .................... 7,000
Commission filing fees ................... 44,891
Other regulatory filing fees ............. 90,000
Miscellaneous ............................ 624,304
-----------
$16,800,000
===========
</TABLE>
See "SPECIAL FACTORS -- Opinion of Financial Advisor" for a description of
the fees to be paid to Goldman Sachs in connection with its engagement. For a
description of certain fees payable to the members of the Special Committee,
see "SPECIAL FACTORS -- Conflicts of Interest."
For a description of MedCath's obligation, even if the Merger is not
consummated, to pay or reimburse the Acquiror for expenses incurred by the
Acquiror in connection with the Merger, see "THE MERGER -- Expenses" and " --
Termination Fee."
Regulatory Approvals
Under the HSR Act, and the rules promulgated thereunder by the FTC, the
Merger cannot be consummated until certain notifications are given and certain
information is furnished to the FTC and the Antitrust Division of the
Department of Justice and specified waiting period requirements are satisfied.
The applicable waiting period expired on May 15, 1998.
MedCath is not aware of any license or regulatory permit which is material
to the business of MedCath and which is likely to be adversely affected by the
Merger or of any approval or other action by any state, federal or foreign
government or governmental agency that would be required prior to effecting the
Merger.
Accounting Treatment
The Merger will be treated as a purchase business combination for
accounting purposes.
RIGHTS OF DISSENTING SHAREHOLDERS
Under North Carolina law, holders of Common Stock who do not vote in favor
of the Merger and who comply with certain notice requirements and other
procedures will have the right to dissent and to be paid cash for the "fair
value" of their shares. The "fair value" of the Common Stock as finally
determined under such procedures may be more or less than the $19 per share
cash which will be paid in respect of shares held by non-dissenting
shareholders in the Merger. Failure to follow such procedures precisely may
result in loss of Dissenters' Rights.
The following discussion is not a complete statement of the law pertaining
to Dissenters' Rights under Article 13 and is qualified in its entirety by the
full text of Article 13 which is reprinted in its entirety as Appendix C to
this Proxy Statement.
A record shareholder may assert Dissenters' Rights as to fewer than all
the shares of Common Stock registered in his name only if he dissents with
respect to all shares beneficially owned by any one person and notifies the
Company in writing of the name and address of each person on whose behalf he
asserts Dissenters' Rights. The rights of a partial dissenter will be
determined as if the shares as to which he dissents and his other shares were
registered in the names of different shareholders. A beneficial owner may
assert Dissenters' Rights as to shares of Common Stock held on his behalf only
if he:
37
<PAGE>
(a) submits to the Company the record shareholder's written consent to the
dissent not later than the time the beneficial shareholder asserts Dissenters'
Rights and (b) asserts Dissenters' Rights with respect to all shares of which
he is the beneficial owner.
A holder of shares of Common Stock wishing to exercise Dissenters' Rights
must: (a) give to the Company, and the Company must actually receive before the
vote on the Merger is taken, written notice of the holder's intent to demand
payment for his shares if the Merger is consummated, and (b) must not vote his
shares in favor of the Merger. Such notice may be sent to the Company at the
following address: 7621 Little Avenue, Suite 106, Charlotte, North Carolina
28226, Attention: Richard J. Post, Secretary. If the Merger Agreement is
approved by holders of the requisite number of outstanding shares of Common
Stock, the Company will, no later than 10 days following the consummation of
the Merger, mail a written dissenters' notice to all of its shareholders who
gave the aforementioned notice of intent to demand payment. Such dissenters'
notice will: (a) state where the payment demand must be sent and where and when
certificates for shares must be deposited; (b) supply a form for demanding
payment; (c) set a date by which the Company must receive the payment demand,
which date may not be fewer than 30 nor more than 60 days after the date on
which the dissenters' notice is sent; and (d) be accompanied by a copy of
Article 13. To exercise his Dissenters' Rights, a shareholder sent a
dissenters' notice must demand payment and deposit his share certificates in
accordance with the terms of the notice. A shareholder failing to do so will
not be entitled to payment for his shares under Article 13. A shareholder who
demands payment and deposits his share certificates in accordance with the
terms of the notice will retain all other rights of a shareholder until
consummation of the Merger.
As soon as the Merger is completed, or within 30 days after the Company's
receipt of a payment demand by a shareholder made in compliance with the
above-described procedures, the Company will pay such shareholder the amount
the Company estimates to be the value of his shares, plus interest accrued to
the date of payment. Such payment will be accompanied by: (a) the Company's
balance sheet as of the fiscal year ended September 30, 1997, an income
statement and a statement of cash flows for that year and the latest available
interim financial statements; (b) an explanation of how the Company estimated
the fair value of the shares; (c) an explanation of how the interest was
calculated; (d) a statement of the dissenter's right to notify the Company of
his own estimate of the value of his shares and the amount of interest due if
(i) he believes the amount paid by the Company is less than the fair value of
his shares or that the interest due was incorrectly calculated, (ii) the
Company fails to make a payment within the time period described in the first
sentence of this paragraph, or (iii) the Company, having failed to consummate
the Merger, fails to return deposited share certificates within 60 days after
the date set for demanding payment; and (iv) a copy of Article 13.
If: (a) a dissenter believes that the amount paid by the Company is less
than the fair value of his shares, or that the interest due is incorrectly
calculated; (b) the Company fails to make payment within the time period set
forth in the first sentence of the immediately preceding paragraph; or (c) the
Company, having failed to consummate the Merger, fails to return deposited
stock certificates to a dissenter within 60 days after the date set for
demanding payment, the dissenter may notify the Company in writing of his own
estimate of the fair value of his shares and amount of interest due and demand
payment of the amount in excess of the Company's payment to him. Such notice
and demand may be sent to the Company at the address set forth in the second
immediately preceding paragraph. A dissenter will waive his right to demand
payment as described in this paragraph, and will be deemed to have withdrawn
his dissent and demand for payment, unless he notifies the Company of his
demand in writing within 30 days after the Company (x) made payment for his
shares or (y) fails to take the actions described in clauses (b) and (c) of
this paragraph, as the case may be.
If a demand for payment as described above remains unsettled, a
shareholder may commence a proceeding within 60 days after the earlier of (i)
the date of the Company's payment to him as described in the second immediately
preceding paragraph, or (ii) the date of his payment demand as described in the
immediately preceding paragraph and file a complaint with the Superior Court
Division of the North Carolina Court of Justice to determine the fair value of
the shares and accrued interest. A dissenter who does not commence a proceeding
within this 60-day period will be deemed to have withdrawn his dissent and
demand for payment.
The court may, in its discretion, make all dissenters whose demands remain
unsettled parties to the proceeding as in an action against their shares and
all parties must be served with a copy of the complaint. The jurisdiction of
the Superior Court is plenary and exclusive. The court may appoint one or more
appraisers to receive evidence and recommend a decision on the question of fair
value. Parties to the proceeding are entitled to the same discovery rights as
parties in other civil proceedings. The proceeding will be tried as in other
civil actions; however, since the Company is a "public corporation," no party
to any proceeding described herein will have the right to trial by jury.
38
<PAGE>
Each dissenter made a party to the proceeding by the court will be
entitled to judgment for the amount, if any, by which the court finds that the
fair value of his shares, plus interest, exceeds the amount paid by the
Company. The court may assess the costs of a proceeding described above,
including the compensation and expenses of appointed appraisers, as it finds
equitable. With respect to the fees and expenses of counsel and experts for the
parties to the proceeding, the court may assess such costs as it finds
equitable (a) against the Company, and in favor of any or all dissenters, if it
finds that the Company did not substantially comply with the above-described
procedures or (b) against either the Company or a dissenter or in favor of
either or any other party, if it finds that the party against whom such costs
are assessed acted arbitrarily, vexatiously, or not in good faith with respect
to the Dissenters' Rights provided under Article 13. In addition, if the court
finds that the services of counsel to any dissenter were of substantial benefit
to other dissenters and that the costs of such services should not be assessed
against the Company, the court may award to such counsel reasonable fees to
paid out of the amounts owed to the dissenters who were benefited.
The provisions of Article 13 are technical in nature and complex.
Shareholders desiring to exercise Dissenters' Rights and to obtain a
determination of the fair value of their shares should consult counsel, since
the failure to comply strictly with the provisions of Chapter 13 may result in
a waiver or forfeiture of their Dissenters' Rights.
FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes the material federal income tax
considerations relevant to the Merger that are generally applicable to holders
of Common Stock. This discussion is based on currently existing provisions of
the Internal Revenue Code of 1986, as amended (the "Code"), existing and
proposed Treasury Regulations thereunder and current administrative rulings and
court decisions, all of which are subject to change. Any such change, which may
or may not be retroactive, could alter the tax consequences to the holders of
Common Stock as described herein. Special tax consequences not described below
may be applicable to particular classes of taxpayers, including financial
institutions, broker-dealers, persons who are not citizens or residents of the
United States or who are foreign corporations, foreign partnerships or foreign
estates or trusts as to the United States and holders who acquired their stock
through the exercise of an employee stock option or otherwise as compensation.
The receipt of the Cash Merger Consideration in the Merger by holders of
Common Stock will be a taxable transaction for federal income tax purposes.
Each holder's gain or loss per share will be equal to the difference between
$19 and the holder's basis per share in the Common Stock. Such gain or loss
generally will be a capital gain or loss. In the case of individuals, trusts
and estates, such capital gain will be subject to a maximum federal income tax
rate of 20% for shares of Common Stock held for more than 18 months prior to
the date of disposition and 28% for Common Stock held for more than one year
but for not more than 18 months prior to the date of disposition.
A holder of Common Stock may be subject to backup withholding at the rate
of 31% with respect to Cash Merger Consideration received pursuant to the
Merger, unless the holder (a) is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact or (b) provides a
correct taxpayer identification number ("TIN"), certifies as to no loss of
exemption from backup withholding and otherwise complies with applicable
requirements of the backup withholdings rules. To prevent the possibility of
backup federal income tax withholding on payments made to certain holders with
respect to shares of Common Stock pursuant to the Merger, each holder must
provide the Disbursing Agent with his correct TIN by completing a Form W-9 or
Substitute Form W-9. A holder of Common Stock who does not provide MedCath with
his or her correct TIN may be subject to penalties imposed by the Internal
Revenue Service (the "IRS"), as well as backup withholding. Any amount withheld
under these rules will be creditable against the holder's federal income tax
liability. MedCath (or its agent) will report to the holders of Common Stock
and the IRS the amount of any "reportable payments," as defined in Section 3406
of the Code, and the amount of tax, if any, withheld with respect thereto.
The foregoing tax discussion is included for general information only and
is based upon present law. Each holder of Common Stock should consult such
holder's own tax advisor as to the specific tax consequences of the Merger to
such holder, including the application and effect of federal, state, local and
other tax laws and the possible effect of changes in such tax laws.
39
<PAGE>
BUSINESS OF THE COMPANY
Overview
MedCath provides cardiology and cardiovascular services through the
development, operation and management of Heart Hospitals and other specialized
cardiac care facilities and provides practice management services. The Company
affiliates with leading cardiologists and cardiovascular and vascular surgeons
in targeted geographic markets in the U.S. and provides state-of-the-art
facilities, financial resources and management services. The Company partners
with cardiologists and cardiovascular and vascular surgeons to develop, co-own
and operate specialty Heart Hospitals dedicated to providing comprehensive
professional services to diagnose and treat heart disease. MedCath operates
Heart Hospitals in McAllen, Texas (since January 1996); Little Rock, Arkansas
(since March 1997); Tucson, Arizona (since October 1997); and in Phoenix,
Arizona (since June 1998). In addition, MedCath plans to open Heart Hospitals
in Austin, Texas; Bakersfield, California; Dayton, Ohio; and Albuquerque, New
Mexico over the next two fiscal years. Two of the Company's four existing Heart
Hospitals have experienced unanticipated problems during the ramp-up period.
For a discussion of these unanticipated problems and their effect on the
Company's current and projected results of operations, see "SPECIAL FACTORS --
Background of the Merger."
The Company has long-term contracts to manage six physician group
practices, which include leading cardiologists and cardiovascular surgeons
("Managed Practices"), located in Arizona, Virginia, Texas and Ohio. In
addition, MedCath manages eight fixed-site cardiac diagnostic and therapeutic
facilities ("Fixed-Site Facilities") located in Arizona, New Jersey,
Massachusetts, North Carolina, and Alabama and operates 23 mobile cardiac
diagnostic centers ("Mobile Cath Labs"), principally serving networks of
hospitals located in smaller communities throughout the United States.
Business Segments
Financial information about the Company's operations by business segment
at September 30, 1995, 1996 and 1997 and for the fiscal years then ended is set
forth in Note 15 of Notes to Consolidated Financial Statements, included
elsewhere herein.
Hospital Division
General. The Company structures its ownership of Heart Hospitals through
limited liability companies and limited partnerships with local cardiologists,
cardiovascular and vascular surgeons and other physicians. MedCath owns a
majority or substantial interest in each limited liability company or
partnership and serves as its manager.
Information concerning the Company's four operating Heart Hospitals and
its four Heart Hospitals under development is presented in the tables below:
Operating Heart Hospitals
<TABLE>
<CAPTION>
Licensed Cath Operating MedCath
Hospital Location Opening Date Beds Labs Rooms Ownership %
- -------------------------- ----------------------- -------------- ---------- ------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
McAllen Heart Hospital McAllen, Texas January 1996 60 3 3 51%
Arkansas Heart Hospital Little Rock, Arkansas March 1997 84 6 3 51%
Tucson Heart Hospital(1) Tucson, Arizona October 1997 66 4 3 51%
Arizona Heart Hospital Phoenix, Arizona June 1998 56 4 3 51%
</TABLE>
- ---------
(1) The Tucson Heart Hospital has four cardiac catheterization laboratories
that are separately owned and operated by CCT, LLC in which the Company
owns a majority interest and which the Company manages.
Heart Hospitals Under Development
<TABLE>
<CAPTION>
Expected Licensed Cath Operating MedCath
Hospital Location Opening Date Beds Labs Rooms Ownership %
- ------------------------------ ------------------------- ------------------ ---------- ------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Heart Hospital of Austin Austin, Texas October 1998 58 4 3 51%
Bakersfield Heart Hospital Bakersfield, California Fiscal Year 1999 48 4 3 51%
Dayton Heart Hospital Dayton, Ohio Fiscal Year 1999 48 4 3 35%
Heart Hospital of New Mexico Albuquerque, New Mexico Fiscal Year 1999 55 4 3 24%
</TABLE>
40
<PAGE>
Recent Developments in the Hospital Division. The Company intends to
develop future Heart Hospitals in selected markets as three-way ventures, which
involve an existing local hospital as well as local physicians. In the typical
three-way venture, the local hospital partner would close its existing heart
program and become a substantial investor in MedCath's Heart Hospital. The
MedCath Heart Hospital would generally purchase a wide range of existing
services from the hospital partner, including emergency department services,
pharmacy services, lab services, social services and rehabilitation care. The
Company will account for its three-way ventures by the equity method of
accounting. Under this method, the Company's share of the earnings or losses of
the venture will be shown in the Company's Consolidated Statements of Income as
a single amount. Accordingly, no revenues, expenses, assets or liabilities of
the three-way ventures will be recorded in the Consolidated Financial
Statements of the Company.
Dayton Heart Hospital. In January 1998, MedCath announced that it had
entered into an agreement with Franciscan Health System of Ohio Valley, Inc.
("FHSOV") to locate MedCath's previously announced Dayton Heart Hospital on the
grounds of the Franciscan Medical Center - Dayton Campus. FHSOV has
subsequently become a 30% investor in the hospital, with MedCath and local
physician partners holding the remaining interests. MedCath is the managing
partner, with responsibility for the day-to-day operation of the hospital.
FHSOV will close its existing heart program.
Heart Hospital of New Mexico. In February 1998, MedCath announced that it
had formed a venture to construct a new Heart Hospital to be located in
Albuquerque, New Mexico. The hospital will be a three-way venture between
MedCath, two leading local physician groups and St. Joseph Healthcare System, a
leading not-for-profit system in Albuquerque. Under the terms of the agreement,
St. Joseph Healthcare System will close its existing heart program, and the
Heart Hospital of New Mexico, which will be located adjacent to the St. Joseph
Medical Center, will purchase a wide variety of existing services from St.
Joseph. MedCath, as manager, will be responsible for the day-to-day operations
of the hospital.
Tucson Heart Hospital. The Company has experienced unforeseen problems
during the start-up period at the Tucson Heart Hospital which opened in October
1997. For a discussion of these problems and their impact on the current and
future operating results of the Company, see "SPECIAL FACTORS -- Background of
the Merger." On April 7, 1998, MedCath signed a non-binding letter of intent
with Carondelet Health Systems, Inc., a not-for-profit healthcare provider
("Carondelet"), pursuant to which Carondelet may become an investor in
MedCath's Tucson Heart Hospital. If the transaction is completed, all or part
of the heart programs of the Tucson Heart Hospital and Carondelet's two
hospitals may be consolidated. The letter of intent with Carondelet is
non-binding and does not obligate either party to complete the transaction. The
successful negotiation and closing of a definitive agreement would be subject
to the satisfaction of numerous and material conditions. It is entirely
possible that MedCath and Carondelet will not proceed beyond the letter of
intent stage of negotiations, or even if they do, that they will not complete
the proposed transaction.
Arizona Heart Hospital. On June 10, 1998, the Arizona Department of Health
Services completed its inspection of the Arizona Heart Hospital, located in
Phoenix, and determined that all conditions of compliance regarding Medicare
certification were met. Concurrent with receiving the Medicare certification,
the Company officially opened the hospital. Upon processing of the
certification by the Health Care Financing Administration (HCFA) regional
office, the hospital will receive its Medicare provider number that will allow
the hospital to begin billing the Medicare program for its services retroactive
to the certification date of June 10, 1998. The Company expects that the
hospital will receive its Medicare provider number during the fiscal quarter
ending September 30, 1998.
Practice Management Division
General. As part of the Company's strategy of establishing and maintaining
fully integrated cardiac care networks, the Company enters into long-term
management services agreements with established physician groups that include
leading local cardiologists and cardiovascular and vascular surgeons. Under
these management services agreements, the Company performs the principal
financial and administrative functions for physician groups, including billing,
recruiting, record keeping, and negotiating with HMOs and other managed care
plans for the services of the physicians. In some cases, the Company makes
advances for working capital purposes to these practices. The Company's
management fee for the services provided to all but one of the Managed
Practices is a percentage of operating income of the practice, ranging from 15%
to 20%, plus reimbursement of certain operating expenses incurred in managing
the practice. In one of the Managed Practices, the Company's management fee for
the services provided is approximately 4% of the net revenue of the practice,
plus reimbursement of certain operating expenses incurred in managing the
practice. The Company recognizes revenue under such contracts on the basis of
reimbursable costs incurred during the period plus the fee earned. Set forth
below is a brief description of each of the Managed Practices.
41
<PAGE>
Arizona Medical Clinic. In October 1994, MedCath acquired PhysMed
Management Services, Inc., which, under a 40-year agreement, manages the
Arizona Medical Clinic ("AMC"), a 57-physician multi-specialty medical clinic
that serves the Sun City, Arizona area. Approximately one-half of the
physicians at AMC are primary care specialists, and the balance practice
various medical and surgical specialties. The group represents approximately
one half of all primary care physicians in the Sun City market. Two AMC
cardiologists were among the founders of the Sun City Cardiac Center, a
Fixed-Site Facility that the Company has managed since November 1992. The
Company's fee for the services provided is approximately 4% of the net revenue
of AMC, plus reimbursement of certain operating expenses incurred in managing
AMC. On June 19, 1998, the Company received a letter from AMC informing the
Company of AMC's desire to terminate the management agreement. The Company does
not believe AMC has any grounds on which to terminate the agreement.
Furthermore, even if such grounds were to exist, AMC must give the Company a
minimum of 90 days to cure any performance default. In view of the
uncertainties associated with predicting the outcome of a contract
interpretation dispute of this nature, however, the Company cannot predict what
the eventual outcome of AMC's desire to terminate this agreement will be.
Mid-Atlantic Medical Specialists. In January 1996, the Company acquired
MedCath Physician Management of Virginia, Inc., which under a 40-year agreement
manages Mid-Atlantic Medical Specialists, Inc. ("Mid-Atlantic"), a 12-physician
practice that includes two cardiologists and is located in southwest Virginia.
Heart Clinic. In October 1996, the Company acquired a 40-year contract to
manage Heart Clinic, P.A. ("Heart Clinic"), a nine member cardiologist group
located in McAllen, Texas that has four offices throughout the Rio Grande
Valley of South Texas.
Pima Heart Associates. In October 1997, the Company acquired a management
service organization which changed its name to MedCath Physician Management,
Inc. ("MPM"). MPM has a 40-year contract to manage Pima Heart Associates ("Pima
Heart"), a 17-member cardiologist group located in Tucson, Arizona.
Recent Developments in the Practice Management Division. In January 1998,
the Company announced that it had completed a transaction with McAllen,
Texas-based Valley Cardiology, P.A. ("Valley Cardiology") under which MedCath
would provide long-term management services to this group of seven
cardiologists. In April 1998, MedCath announced that it had completed a
transaction with Dayton, Ohio-based Dayton Heart Center, Inc. ("Dayton Heart")
under which MedCath would provide long-term management services to this group
of 11 cardiologists.
Diagnostics Division
Fixed-Site Facilities. Through affiliations with physician groups or
medical facilities, the Company either manages or co-owns eight Fixed-Site
Facilities. Physicians practicing in each Fixed-Site Facility may perform
either invasive or non-invasive diagnostic procedures, and two of the
facilities also offer a broad range of invasive therapeutic procedures. The
Company's Fixed-Site Facilities operate under various fixed-fee per case
contracts. In the Fixed-Site Facilities under management, the Company's
management fee is based on a percentage of the Facilities' net income ranging
from 55% to 90%, plus the reimbursement of certain operating expenses. The
co-owned Fixed-Site Facilities are included in the Consolidated Financial
Statements of the Company because the Company's ownership percentage of those
facilities ranges from 51% to 60%. Information concerning the eight Fixed-Site
Facilities is presented in the table below:
<TABLE>
<CAPTION>
Commencement of
Year Operations or Managed or
Name of Fixed-Site Facility Location Founded Management Co-Owned
- -------------------------------------- ---------------------------- --------- ---------------- -----------
<S> <C> <C> <C> <C>
Sun City Cardiac Center Sun City, Arizona 1985 November 1992 Managed
Cardiac Testing Centers New Providence, New Jersey 1986 July 1992 Managed
Cardiac Testing Centers Summit, New Jersey 1994 January 1994 Managed
Heart Institute of Northern Arizona Kingman, Arizona 1994 August 1994 Managed
Cape Cod Cardiology Services Hyannis, Massachusetts 1996 September 1996 Co-owned
Cardiac Diagnostic Center Raleigh, North Carolina 1996 October 1996 Managed
Gaston Cardiology Services Gastonia, North Carolina 1996 November 1996 Co-owned
Southeastern Cardiology Heart Center Montgomery, Alabama 1998 April 1998 Co-owned
</TABLE>
The Company expects to open its ninth and tenth Fixed-Site Facilities to
be located in Colorado Springs, Colorado and Dakota Dunes, South Dakota by the
end of fiscal year 1999.
MedCath serves as manager in all of the Fixed-Site Facilities and the
management services include providing all non-physician personnel required to
deliver patient care at these Fixed-Site Facilities and the administrative,
management and
42
<PAGE>
support functions required in their operation. MedCath co-owns two Fixed-Site
Facilities through limited liability companies and limited partnerships with
acute care hospitals. MedCath owns a majority interest in the respective
venture and serves as manager. Each Fixed-Site Facility has an agreement to
provide cardiology and cardiovascular services to the hospital investor under
agreements having initial terms of 20 to 32 years, subject to extension at the
option of the investors.
Mobile Cath Labs. The Company owns or operates 23 Mobile Cath Labs that
serve networks of hospitals throughout the United States or are leased to
hospitals and other medical facilities that directly operate such laboratories
on their campuses. The Mobile Cath Labs operated by the Company to service
hospital networks are moved, usually on a daily basis, from one hospital to
another within each network and are fully equipped and operated by highly
skilled, non-physician MedCath technologists and nurses to enable cardiologists
to perform cardiac catheterization procedures for hospital patients. The
cardiac catheterization procedures are performed by cardiologists located in
the communities served by the hospitals or, in some instances, by cardiologists
with whom MedCath has contracted or arranged to perform, as independent
contractors, such procedures. Under the Company's existing contracts, the
hospitals typically pay for the use of the Mobile Cath Labs on a
fixed-fee-per-procedure basis and reimburse MedCath for certain costs incurred
in performing procedures. In most instances, the hospitals are obligated to pay
a minimum monthly amount, regardless of the number of procedures performed,
while the Mobile Cath Lab is made available to the hospital.
Competition
The fundamental restructuring of the health care system currently underway
in the United States is leading to consolidation of the existing, highly
fragmented health care delivery system into larger and more organized groups
and networks of health care service providers. In executing its business
strategy, MedCath competes with other management services organizations, PPMs,
hospitals, HMOs and others, some of which are seeking to form strategic
alliances with cardiologists and cardiovascular surgeons or provide management
services to physicians or to diagnostic and therapeutic facilities owned by
them. An increasing number of PPMs offer services similar to those the Company
provides to its Managed Practices and plans to provide to cardiology group
practices or other multi-specialty group practices with practicing
cardiologists. The Company is not aware of any other company actively pursuing
a strategy of establishing fully integrated cardiac care delivery systems
incorporating specialty heart hospitals, affiliations with cardiologists and
cardiovascular surgeons and physician practice management services.
The Company expects to encounter competition from general acute care
hospitals and free-standing cardiac diagnostic and therapeutic facilities
serving the same markets the Company operates in or seeks to enter, but
believes it will have substantial cost advantages over these competitors. In
addition, the Company believes that to compete successfully in the delivery of
low cost, high quality cardiology and cardiovascular services requires the
establishment of capital intensive facilities, such as its Heart Hospitals,
which imposes a significant barrier to entry for new competitors. Furthermore,
the Company believes that it would have a significant lead over any competitor
adopting a similar strategy.
Employees
As of June 30, 1998, the Company employed 1,951 people, of which 204 were
engaged in managing and operating the Company's Mobile Cath Labs and Fixed-Site
Facilities, 302 in managing physician practices, 1,311 in operating or
developing the Company's eight Heart Hospital projects and the remainder in
management, development, finance and administrative capacities. None of the
Company's employees is represented by a labor union.
Properties
The Company leases approximately 23,200 square feet of space in Charlotte,
North Carolina, where its executive offices are located. The lease expires in
2002, and the Company is evaluating its continued occupancy of this space in
light of anticipated growth.
The Company currently operates the McAllen, Arkansas, Tucson and Arizona
Heart Hospitals. The Company owns the real property for each of these hospitals
and the sites range from 6 to 12 acres. The Company leases the five acres of
land on which the Heart Hospital of Austin is being constructed. Each of these
facilities is subject to a mortgage, and substantially all the real estate and
equipment located at these facilities is pledged as collateral to secure
long-term debt. The Company owns the property on which the Bakersfield and
Dayton Heart Hospital will be constructed. The Company expects to own the
property on which the Heart Hospital of New Mexico and any future Heart
Hospitals will be constructed.
43
<PAGE>
The six physician group practices that are managed by the Company each own
or lease the office space in which they are located. The Company has no
ownership interest in these facilities. The Company owns or leases certain
medical and office equipment used in the practices.
The Company co-owns two Fixed-Site Facilities through limited liability
companies or partnerships with general acute care hospitals. These hospitals
lease the building space in which the facility is located to the limited
liability companies or partnerships through operating leases.
The Company co-owns or manages six Fixed-Site Facilities and in connection
with the co-ownership or management of these facilities, the Company leases
certain of the facilities and office space through operating leases.
Legal Proceedings
In February 1996, Hospital Corporation of Arizona, the owner of the
hospital at which the Heart Institute of Tucson is located in Tucson, Arizona,
instituted an action against the Company and the Tucson Company. The plaintiff
claims that MedCath and the Tucson Company interfered with its contractual
rights by inducing the physician owners of the Heart Institute of Tucson to
violate noncompetition covenants between those individuals and the plaintiff.
The physician owners of the Heart Institute of Tucson are five of the 23
physician members of the Tucson Company. In November 1995, the Heart Institute
of Tucson notified the hospital, in accordance with the terms of the applicable
agreements giving the Heart Institute of Tucson the right to do so, that the
Heart Institute of Tucson would be terminating its relationship with the
hospital effective in July 1997. The lawsuit is pending in Superior Court of
Pima County, Arizona, and seeks unspecified monetary damages, costs and
attorneys' fees. Management believes that there is no basis for these claims,
and MedCath and the Tucson Company are defending this action vigorously. In the
opinion of management of the Company, it is unlikely that the ultimate outcome
of this litigation will have a material adverse effect on the Tucson Heart
Hospital, the Tucson Cath Lab Company, the Company's operations or its
financial condition. There can be no assurance, however, that an adverse
outcome of any such litigation would not have a material adverse effect on the
Company, the Tucson Company or the Tucson Cath Lab Company.
On July 18, 1997, Murray Michael, filing individually and as the President
of South Texas Extracorporeal Professionals, Inc., and South Texas
Extracorporeal Professionals, Inc., filed suit in the 93rd District Court in
Hidalgo County, Texas, against the McAllen Partnership, the McAllen Heart
Hospital, McAllen Perfusion Associations, Inc. and several physicians. The
Plaintiff's Original Petition alleges that South Texas Extracorporeal
Professionals, Inc. contracted to be the exclusive provider of perfusion
services for all heart surgeries performed at the McAllen Heart Hospital for a
three year term. Plaintiff's Original Petition alleges that the named
physicians and McAllen Perfusion Associates, Inc. tortiously interfered with
that contract. The Plaintiff's Original Petition asserts other causes of action
against the defendant, including libel. Against the McAllen Heart Hospital the
McAllen Partnership Plaintiff's Original petition alleges breach of that
contract. Plaintiff's Original Petition seeks compensatory and punitive damages
as well as an accounting. The litigation is currently pending in the 93rd
District Court, Hidalgo County, Texas. The McAllen Partnership and McAllen
Heart Hospital have retained counsel to defend this litigation and are
defending it. No trial date has been set. The litigation is proceeding through
the discovery and pretrial motion process. In the opinion of management of the
Company, it is unlikely that the ultimate outcome of this litigation will have
a material adverse effect on the Company's operations or its financial
condition. There can be no assurance, however, that an adverse outcome of any
such litigation would not have a material adverse effect on the Company, the
McAllen Partnership, or the McAllen Heart Hospital.
There are no other pending legal proceedings to which the Company is a
party, which the Company believes, if adversely determined, would have a
material adverse effect on the Company.
44
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(Dollars in thousands, except per share data)
The following table sets forth selected historical financial data and
other operating information of the Company for the five fiscal years ended
September 30, 1997, which are derived from the audited consolidated financial
statements of the Company. The consolidated financial statements for the five
fiscal years ended September 30, 1997 have been audited by Ernst & Young LLP,
independent auditors, except that the financial statements for the two years
ended December 31, 1994 of HealthTech Corporation, a consolidated subsidiary
acquired in April 1995 in a business combination accounted for as a pooling of
interests, have been audited by other independent auditors. The historical
financial data of the Company for the six month periods ended March 31, 1997
and 1998 are derived from unaudited condensed consolidated financial
statements. The unaudited condensed consolidated financial statements include
all adjustments, consisting of normal recurring accruals, which the Company
considers necessary for a fair presentation of the consolidated financial
position and consolidated results of operations for these periods. Operating
results for the six months ended March 31, 1998 are not necessarily indicative
of the results that may be expected for the entire fiscal year ending September
30, 1998. The data are qualified by reference to, and should be read in
conjunction with, the Consolidated Financial Statements, related Notes and
other financial information included herein.
Income Statement Data (1)
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------
1993 1994 1995(2) 1996 1997
----------- ----------- -------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Net revenue ..................................... $ 17,635 $ 25,892 $ 40,106 $ 66,191 $ 110,910
Medical supplies, personnel and other
operating expenses ............................. 9,113 13,239 23,586 43,502 73,109
Depreciation and amortization expense ........... 2,179 2,767 3,633 6,649 12,855
Provision for doubtful accounts ................. -- -- -- 735 2,083
Marketing, general and administrative
expense ........................................ 2,601 3,492 4,438 5,408 7,037
-------- -------- -------- -------- ---------
Income from operations .......................... 3,742 6,394 8,449 9,897 15,826
Interest expense, net ........................... (1,235) (1,632) (8) (523) (3,018)
Minority interest in earnings of consolidated
entities ....................................... (654) (893) (1,530) (979) (1,539)
Equity in net earnings of unconsolidated
joint venture .................................. -- 93 117 104 --
-------- -------- --------- -------- ---------
Income before income taxes and
extraordinary item ............................. 1,853 3,962 7,028 8,499 11,269
Provision for income taxes ...................... (551) (1,497) (2,777) (3,297) (4,315)
-------- -------- --------- -------- ---------
Income before extraordinary item ................ 1,302 2,465 4,251 5,202 6,954
Extraordinary loss .............................. -- -- (228) -- (230)
-------- -------- --------- -------- ---------
Net income ...................................... $ 1,302 $ 2,465 $ 4,023 $ 5,202 $ 6,724
======== ======== ========= ======== =========
Net income per weighted average share: (3)
Income before extraordinary item ............... $ 0.38 $ 0.73 $ 0.55 $ 0.53 $ 0.62
Extraordinary loss ............................. -- -- ( 0.03) -- ( 0.02)
-------- -------- --------- -------- ---------
Net income ..................................... $ 0.38 $ 0.73 $ 0.52 $ 0.53 $ 0.60
======== ======== ========= ======== =========
Shares used in computation ..................... 3,388 3,395 7,760 9,875 11,149
======== ======== ========= ======== =========
Net income per share assuming dilution: (3)
Income before extraordinary item ............... $ 0.22 $ 0.42 $ 0.51 $ 0.51 $ 0.60
Extraordinary loss ............................. -- -- ( 0.03) -- ( 0.02)
-------- -------- --------- -------- ---------
Net income ..................................... $ 0.22 $ 0.42 $ 0.48 $ 0.51 $ 0.58
======== ======== ========= ======== =========
Shares used in computation ..................... 5,832 5,918 8,381 10,193 11,686
======== ======== ========= ======== =========
<CAPTION>
Six Months Ended
March 31,
-----------------------
1997 1998
----------- -----------
<S> <C> <C>
Net revenue ..................................... $ 49,564 $ 90,511
Medical supplies, personnel and other
operating expenses ............................. 32,547 62,151
Depreciation and amortization expense ........... 4,955 10,682
Provision for doubtful accounts ................. 938 2,842
Marketing, general and administrative
expense ........................................ 3,699 4,118
-------- --------
Income from operations .......................... 7,425 10,718
Interest expense, net ........................... (279) (4,111)
Minority interest in earnings of consolidated
entities ....................................... (840) (1,758)
Equity in net earnings of unconsolidated
joint venture .................................. -- 12
-------- --------
Income before income taxes and
extraordinary item ............................. 6,306 4,861
Provision for income taxes ...................... (2,454) (1,896)
-------- --------
Income before extraordinary item ................ 3,852 2,965
Extraordinary loss .............................. -- --
-------- --------
Net income ...................................... $ 3,852 $ 2,965
======== ========
Net income per weighted average share: (3)
Income before extraordinary item ............... $ 0.35 $ 0.25
Extraordinary loss ............................. -- --
-------- --------
Net income ..................................... $ 0.35 $ 0.25
======== ========
Shares used in computation ..................... 11,141 11,669
======== ========
Net income per share assuming dilution: (3)
Income before extraordinary item ............... $ 0.33 $ 0.24
Extraordinary loss ............................. -- --
-------- --------
Net income ..................................... $ 0.33 $ 0.24
======== ========
Shares used in computation ..................... 11,667 12,286
======== ========
</TABLE>
45
<PAGE>
Balance Sheet Data
<TABLE>
<CAPTION>
September 30, March 31,
--------------------------------------------------------- ----------
1993 1994 1995 1996 1997 1998
---------- ---------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Cash and short-term investments .................... $ 3,452 $ 5,466 $ 18,525 $ 61,693 $ 42,951 $ 18,531
Working capital .................................... 2,186 2,893 17,240 64,816 47,498 27,947
Total assets ....................................... 23,034 37,905 78,372 181,681 259,008 333,494
Long-term debt and capital leases, excluding current
maturities ....................................... 5,810 13,198 15,734 45,896 98,863 149,498
Subordinated debt .................................. 3,766 3,842 -- -- -- --
Redeemable convertible preferred stock ............. 6,763 6,763 -- -- -- --
Shareholders' equity ............................... 1,479 4,256 50,494 120,245 127,137 139,040
</TABLE>
Cash Flow and Other Data (1)
<TABLE>
<CAPTION>
Six Months Ended
Year Ended September 30, March 31,
----------------------------------------------------------- -------------------------
1993 1994 1995(2) 1996 1997 1997 1998
---------- ---------- ------------ ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net cash provided by operating activities $ 4,237 $ 6,061 $ 7,963 $ 7,115 $ 14,992 $ 3,903 $ 2,193
Net cash used in investing activities .... (7,273) (9,572) (31,299) (98,693) (55,016) (24,699) (62,281)
Net cash provided by financing activities 5,255 3,524 26,496 89,782 52,605 26,646 55,402
EBITDA (4) ............................... 5,921 9,161 12,082 16,456 28,681 12,380 21,400
</TABLE>
- ---------
(1) The ratio of earnings to fixed charges for the fiscal years ended September
30, 1996 and 1997 was 2.60x and 2.09x, respectively. The ratio of earnings
to fixed charges for the six month periods ended March 31, 1997 and 1998
was 2.75x and 1.66x, respectively. The book value per share as of September
30, 1997 and March 31, 1998 was $11.38 and $11.92 per share, respectively.
(2) Includes the results of operations of PhysMed Management Services, Inc.,
which was acquired in a purchase business combination effective October 1,
1994. See Note 3 of Notes to Consolidated Financial Statements for the year
ended September 30, 1997.
(3) The net income per share amounts prior to the three months ended December
31, 1997, have been restated to comply with Statement of Financial
Accounting Standard No. 128, "Earnings Per Share" ("SFAS 128"). For further
discussion of earnings per share and the impact of SFAS 128, see Note 16 of
Notes to Consolidated Financial Statements for the year ended September 30,
1997.
(4) EBITDA represents income from operations before depreciation, amortization,
interest, minority interests, equity in income of unconsolidated
subsidiaries and income taxes. While EBITDA should not be construed as a
substitute for income from operations or a better indicator of liquidity
than cash flows from operating activities, which are determined in
accordance with generally accepted accounting principles, it is included
herein to provide additional information with respect to the ability of the
Company to meet its future debt service, capital expenditures and working
capital requirements. EBITDA is not necessarily a measure of the Company's
ability to fund its cash needs.
46
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
The following discussion and analysis is provided to increase the
understanding of, and should be read in conjunction with, the Consolidated
Financial Statements and accompanying Notes thereto included elsewhere herein.
All references to 1995, 1996 and 1997 refer to the respective fiscal years
ended September 30, 1995, 1996 and 1997.
Hospital Division
Since 1994, the Company has formed numerous ventures for the purpose of
constructing and operating its specialty Heart Hospitals. The Company
structures its ownership of Heart Hospitals through limited liability companies
and limited partnerships in which MedCath owns a substantial or majority
interest and also serves as manager. Other investors in the ventures typically
include cardiologists and cardiovascular and vascular surgeons as well as other
physicians who will practice at the hospital. For those ventures in which the
Company owns a majority interest, the financial statements of these ventures
are included in the Company's consolidated financial statements, and the
ventures' profits and losses are allocated to its partners or members on a pro
rata basis. However, if the cumulative losses of a venture exceed its initial
capitalization, the Company, as the only general partner or managing member, is
required to recognize 100% of the ventures' losses that otherwise would be
allocated on a pro rata basis. The Company will continue to recognize 100% of
the ventures' profits and losses to the extent it has previously recognized a
disproportionate share of the ventures losses.
The Company has developed and intends to develop future Heart Hospitals in
selected markets as three-way ventures, which involve an existing local
hospital as well as local physicians. The Dayton Heart Hospital and the Heart
Hospital of New Mexico are both three-way ventures. In the typical three-way
venture, the local hospital partner would close its existing heart program and
become a substantial investor in MedCath's Heart Hospital. The MedCath Heart
Hospital would generally purchase a wide range of existing services from the
hospital partner, including emergency department services, pharmacy services,
lab services, social services and rehabilitation care. The Company will account
for its three-way ventures by the equity method of accounting. Under this
method, the Company's share of the earnings or losses of the venture will be
shown in the Company's Consolidated Statements of Income as a single amount.
Accordingly, no revenues, expenses, assets or liabilities of the three-way
ventures will be recorded in the Consolidated Financial Statements of the
Company.
As of March 31, 1998, the Company operated three Heart Hospitals; the
McAllen Heart Hospital, located in McAllen, Texas, which opened in January
1996, the Arkansas Heart Hospital, located in Little Rock, Arkansas, which
opened in March 1997 and the Tucson Heart Hospital, located in Tucson, Arizona,
which opened in October 1997. In June 1998, the Company opened the Arizona
Heart Hospital, located in Phoenix, Arizona. Each is a licensed general
acute-care hospital having from 56 to 84 beds, three to six cardiac
catheterization labs and three surgery suites.
The Company has four additional Heart Hospitals in various stages of
development. The Heart Hospital of Austin, located in Austin, Texas, the
Bakersfield Heart Hospital, located in Bakersfield, California and the Dayton
Heart Hospital, located in Dayton, Ohio are each expected to open in fiscal
year 1999. The Heart Hospital of New Mexico, located in Albuquerque, New Mexico
is expected to open in fiscal year 2000.
Practice Management and Diagnostics Divisions
As of March 31, 1998, the Company managed five physician group practices
comprised of approximately 105 physicians under long-term management
agreements. In April 1998, the Company acquired a contract to manage Dayton
Heart, an 11-cardiologist group practice, the Company's sixth Managed Practice,
through the issuance of cash and common stock valued at approximately $3.8
million. The Company provides most non-physician personnel required to operate
the practices and performs the primary administrative and financial services.
The Company does not enter into direct contracts with managed care companies as
it pertains to these long-term management contracts with the physicians. The
Company's risk associated with any managed care contracts entered into by the
practices is limited to the Company's participation in the practices' net
revenue or net income. The Company's fees for the services provided include
reimbursement of operating expenses plus a percentage of the net revenue or
operating income of the practices.
The Company currently operates 30 Mobile Cath Labs and Fixed-Site
Facilities located throughout the United States, including two additional
Fixed-Site Facilities that opened in 1997. The Company expects to open two
additional Fixed-Site Facilities to be located in Colorado Springs, Colorado
and Dakota Dunes, South Dakota by the end of fiscal year 1999.
47
<PAGE>
Results of Operations
The following table sets forth the percentages of net revenue represented
by certain items reflected in the Company's Consolidated Statements of Income
and Unaudited Condensed Consolidated Statements of Income included elsewhere
herein.
<TABLE>
<CAPTION>
Six Months Ended
Year Ended September 30, March 31,
-------------------------------- ---------------------
1995 1996 1997 1997 1998
---------- ---------- ---------- ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net Revenue:
Diagnostics Division ........................................... 75.6% 51.5% 33.0% 38.7% 19.4%
Practice Management Division ................................... 24.4 22.2 17.0 19.7 17.9
Hospital Division .............................................. -- 26.3 49.6 41.6 61.9
Other .......................................................... -- -- .4 -- 0.8
----- ----- ----- ----- -----
Total Net Revenue ............................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Operating Expenses:
Medical Supplies, Personnel & Other Operating Expenses ......... 58.8 65.7 65.9 65.6 68.7
Depreciation and Amortization Expense .......................... 9.1 10.0 11.6 10.0 11.8
Provision for Doubtful Accounts ................................ -- 1.1 1.9 1.9 3.1
Marketing, General and Administrative Expenses ................. 11.0 8.2 6.3 7.5 4.6
----- ----- ----- ----- -----
Total Operating Expenses ..................................... 78.9 85.0 85.7 85.0 88.2
----- ----- ----- ----- -----
Income From Operations .......................................... 21.1 15.0 14.3 15.0 11.8
Interest Expense, Net ........................................... -- ( .8) ( 2.7) ( 0.6) ( 4.5)
Minority Interest in Earnings of Consolidated Entities .......... ( 3.8) ( 1.5) ( 1.4) ( 1.7) ( 1.9)
Equity in Earnings of Unconsolidated Subsidiaries ............... .2 .2 -- -- --
----- ----- ----- ----- -----
Income Before Income Taxes and Extraordinary Item ............... 17.5 12.9 10.2 12.7 5.4
Provision for Income Taxes ...................................... ( 6.9) ( 5.0) ( 3.9) ( 4.9) ( 2.1)
----- ----- ----- ----- -----
Income Before Extraordinary Item ................................ 10.6 7.9 6.3 7.8 3.3
Extraordinary Loss on Early Extinguishment of Debt .............. ( .6) -- ( .2) -- --
----- ----- ----- ----- -----
Net Income ...................................................... 10.0% 7.9% 6.1% 7.8% 3.3%
===== ===== ===== ===== =====
</TABLE>
Six Months Ended March 31, 1998 Compared to the Six Months Ended March 31,
1997.
Net Revenue. Consolidated net revenue for the six months ended March 31,
1998, increased $40.9 million, or 82.6%, to $90.5 million over the comparable
prior year period due primarily to increased net revenue in the Hospital
Division. The increase in net revenue in the Hospital Division is due primarily
to the March 1997 opening of the Company's second Heart Hospital, the Arkansas
Heart Hospital, which generated net revenue of $25.6 million for the six months
ended March 31, 1998. Additionally, net revenue at the McAllen Heart Hospital
for the six months ended March 31, 1998, increased 17.0% to $22.7 million over
the comparable prior year period, due primarily to increased procedure volumes.
The Tucson Heart Hospital, which opened in October 1997 generated net revenue
of $7.7 million for the six months ended March 31, 1998, and provided the
remaining increase in net revenue in the Hospital Division.
Net revenue in the Practice Management Division for the six months ended
March 31, 1998, increased $6.5 million, or 66.3%, to $16.2 million over the
comparable prior year period, due primarily to the October 1997 acquisition of
the contract to manage Pima Heart and to the January 1998 acquisition of the
contract to manage Valley Cardiology. All other changes in net revenue of
individual Managed Practices over the prior period were not significant.
Net revenue in the Diagnostics Division for the six months ended March 31,
1998, decreased $1.8 million, or 9.4%, to $17.5 million over the comparable
prior year period. The decrease is partially due to the scheduled July 1997
closing of the Fixed-Site Facility located in Tucson, Arizona, and also due to
lower procedure volumes at several of the Company's other diagnostic
facilities.
Operating Expenses and Income from Operations. Consolidated operating
expenses for the six months ended March 31, 1998, increased 89.4% to $79.8
million over the comparable prior year period and was due primarily to
operating expenses in the Hospital Division. Consolidated income from
operations for the six months ended March 31, 1998, increased 44.3% to $10.7
million over the comparable prior year period due to an overall increase in
consolidated net revenue. Consolidated operating and EBITDA margins for the six
months ended March 31, 1998, decreased to 11.8% from 15.0% and
48
<PAGE>
to 23.6% from 25.0%, respectively, over the comparable prior year period. These
decreases were primarily attributable to the substantial growth in the Practice
Management and Hospital Divisions which operate at lower margins than those
realized in the Diagnostics Division.
Income from operations at the Hospital Division for the six months ended
March 31, 1998, increased 205.2% to $5.7 million over the comparable prior year
period, due primarily to the opening of the Arkansas Heart Hospital in March
1997 and improved operating results at the McAllen Heart Hospital. The Hospital
Division's operating and EBITDA margins for the six months ended March 31,
1998, increased to 10.1% from 9.0% and to 23.8% from 21.5%, respectively, over
the comparable prior year period. The Tucson Heart Hospital, which opened in
October 1997, continues to experience operating losses during its initial
months of operation. The operating profits at the McAllen and Arkansas Heart
Hospitals offset the operating losses at the Tucson Heart Hospital resulting in
the overall increase to operating and EBITDA margins. The McAllen and Arkansas
Heart Hospitals had EBITDA margins of 25.7% and 32.4%, respectively, for the
six months ended March 31, 1998.
Income from operations in the Practice Management Division for the six
months ended March 31, 1998, increased 22.0% to $1.4 million over the
comparable prior year period, due primarily to income from the contracts to
manage Pima Heart and Valley Cardiology, which were acquired in October 1997
and January 1998, respectively. The Practice Management Division's operating
and EBITDA margins for the six months ended March 31, 1998, decreased to 8.8%
from 12.0% and to 11.5% from 14.4%, respectively, over the comparable prior
year period. These decreases are due to the structure of the contract to manage
Pima Heart which includes in its revenue the reimbursement of expenses incurred
in managing the practice thus impacting the overall margins of the Division.
Income from operations in the Diagnostics Division for the six months
ended March 31, 1998, decreased 11.1% to $6.2 million over the comparable prior
year period due primarily to lower procedure volumes at several of the
Company's diagnostic facilities. Operating margins in the Diagnostics Division
for the six months ended March 31, 1998, decreased to 35.2% from 35.9% over the
comparable prior year period. This decrease is primarily due to the additional
depreciation expense incurred from new equipment added throughout fiscal years
1997 and 1998. EBITDA margins in the Diagnostics Division for the six months
ended March 31, 1998, increased to 48.9% from 46.6% over the comparable prior
year period due primarily to an increase in consulting and management fee
income.
Marketing, general and administrative expenses for the six months ended
March 31, 1998, increased 11.3% over the comparable prior year period primarily
as a result of the Company's continued investment in corporate infrastructure
to accommodate growth. In fiscal year 1998, the Company has continued to add
personnel to the Human Resources, Information Systems and Accounting
departments. These expenses as a percent of consolidated net revenue for the
six months ended March 31, 1998, have decreased to 4.6%, from 7.5% over the
comparable prior year period demonstrating the Company's ability to accommodate
growth without a corresponding increase in corporate overhead.
Interest Expense and Interest Income. Interest expense for the six months
ended March 31, 1998, increased 226.8% to $5.0 million over the comparable
prior year period primarily as the result of interest incurred on borrowings at
the Tucson and Arkansas Heart Hospitals which opened during the last 12 months.
Substantially all of the property, plant and equipment at the hospitals is
financed using borrowings that bear interest at rates ranging from 8.5% to
11.54%. Interest income for the six months ended March 31, 1998, decreased 28%
to $911,000 over the comparable prior year period due to a decrease in average
short-term investment balances.
1997 Compared to 1996
Net Revenue. Consolidated net revenue increased 67.6% to $110.9 million in
1997 from $66.2 million in 1996. Of this $44.7 million increase, $37.6 million
was attributable to increased net revenue in the Hospital Division, which more
than tripled in 1997 to $55.0 million from $17.4 million in 1996. In March
1997, the Company opened its second Heart Hospital, the Arkansas Heart
Hospital, which generated net revenue of $19.5 million and accounted for
approximately 17.6% of the consolidated net revenue. Additionally, the McAllen
Heart Hospital generated net revenue of $35.5 million in its first full year of
operations, and accounted for 32.0% of the consolidated net revenue.
Net revenue in the Practice Management Division increased 28.2% to $18.8
million in 1997 from $14.7 million in 1996 accounting for $4.1 million of the
increase in consolidated net revenue. This increase was partially attributable
to the October 1996 acquisition of a contract to manage Heart Clinic and also
to an increase in net revenue from existing contracts to manage AMC and
Mid-Atlantic. All other changes in net revenue of individual Managed Practices
over the prior year were not significant. The total number of physicians under
management in the Practice Management Division increased to 79 in 1997 compared
with 66 in 1996.
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Net revenue in the Diagnostics Division increased 7.2% to $36.6 million in
1997 from $34.1 million in 1996 and accounted for $2.5 million of the total
increase in net revenue. This increase was attributable primarily to revenue at
two new Fixed-Site Facilities that opened in 1997. This increase in net revenue
was partially offset by the scheduled July 1997 closing of the Fixed-Site
Facility located in Tucson, Arizona.
Operating Expenses and Income from Operations. Total operating expenses
increased 68.9% to $95.1 million in 1997 from $56.3 million in 1996. The
increase was attributable primarily to operating expenses at the Arkansas and
McAllen Heart Hospitals and expenses incurred in managing physician practices
in the Practice Management Division. Income from operations increased 59.9% to
$15.8 million in 1997 from $9.9 million in 1996 due to an overall increase in
consolidated net revenue. Operating margins decreased to 14.3% in 1997 from
15.0% in 1996. This decrease was primarily attributable to the substantial
growth in the Hospital Division which operates at lower margins than those
realized in the Company's other operating divisions and to a slight decrease in
margins in the Diagnostics Division.
Income from operations at the Hospital Division in 1997 was $5.3 million
as compared to a loss from operations of $616,000 in 1996. EBITDA was
approximately $13.0 million or 23.7% of hospital net revenue in 1997 as
compared to $2.2 million, or 12.8% of hospital net revenue in 1996. The McAllen
and Arkansas Heart Hospitals both had positive operating income during 1997.
The Arkansas Heart Hospital experienced operating profits before interest and
minority interest beginning in April 1997, its second month of operations.
Although the Arkansas Heart Hospital had operating income in 1997, the Company
expects each of its future Heart Hospitals in development will experience
operating losses in the first six to nine months of operations, but also
expects they will generate positive EBITDA margins during this period. In 1997,
the Hospital Division's total operating loss after interest and minority
interest was approximately $.07 per share, as compared to $.16 per share in
1996.
Income from operations in the Practice Management Division increased 48.2%
to $2.2 million in 1997 from $1.5 million in 1996. The increase is attributable
primarily to income from the contract to manage Heart Clinic, which was
acquired in October 1996, and increased operating income from managing Mid
Atlantic, which was acquired in February 1996. Operating margins in the
Practice Management Division increased to 11.8% in 1997 from 10.2% in 1996,
primarily due to the structure of the contract to manage Heart Clinic.
Income from operations in the Diagnostics Division was $13.0 million in
both 1997 and 1996. Operating margins in the Diagnostics Division decreased to
35.4% in 1997 from 37.5% in 1996 and EBITDA margins were 47.6% in both 1996 and
1997. The decrease in operating margins is due to additional depreciation
expense incurred on capital expenditures made for new equipment for several
mobile cath labs.
Marketing, general and administrative expenses in 1997 increased 30.1%
over 1996 primarily as a result of the Company's continued investment in
corporate infrastructure to accommodate growth. In 1997, the Company continued
to add personnel to the Human Resources and Information Systems department, as
well as additional finance and development personnel. The remainder of the
increase was attributable to increased professional fees associated with
pursuing business development opportunities, the addition of administrative and
accounting personnel to support growth and increases in salaries. As a
percentage of consolidated net revenue, marketing, general and administrative
expenses decreased to 6.3% in 1997 from 8.2% in 1996, demonstrating the
Company's ability to continue growth without a corresponding increase in
additional administrative costs.
Interest Expense and Interest Income. Interest expense in 1997 increased
$3.1 million over 1996 primarily as the result of interest incurred on
borrowings at the Arkansas and McAllen Heart Hospitals. Substantially all of
the property, plant and equipment at the hospitals was financed using
borrowings that bear interest at rates ranging from 8.50% to 11.54%.
Consolidated long-term debt and capital leases increased to $105.0 million in
1997 from $48.2 million in 1996 primarily due to borrowings in the Hospital
Division. Interest income increased $634,000 in 1997 compared with 1996 due to
investment income earned on an increase in average short-term investment
balances.
1996 Compared to 1995
Net Revenue. Consolidated net revenue increased 65.0% to $66.2 million in
1996 from $40.1 million in 1995. Of this $26.1 million increase, $17.4 million
was attributable to net revenue at the McAllen Heart Hospital.
In January 1996, the Company opened its first Heart Hospital, the McAllen
Heart Hospital, located in McAllen, Texas. The hospital generated net revenue
of $17.4 million and accounted for approximately 26% of the consolidated net
revenue. Operating expenses incurred at the McAllen Heart Hospital accounted
for a majority of the increase in consolidated operating expenses from 1995.
Loss from operations in 1996, before interest and minority interest, was
approximately $616,000.
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Although the hospital experienced operating losses, EBITDA at the hospital was
approximately $2.2 million, or 12.8% of net revenue. In 1996, the McAllen Heart
Hospital's total operating loss after interest and minority interest was
approximately $.16 per share. Included in this total operating loss was
approximately $.05 per share which represented the required recognition of a
disproportionate share of the hospital's losses because the cumulative losses
of the hospital exceeded its initial capitalization.
Net revenue in the Practice Management Division increased 50.1% to $14.7
million in 1996 from $9.8 million in 1995 accounting for $4.9 million of the
increase in consolidated net revenue. This increase was attributable to the
acquisition in February 1996 of a contract to manage Mid-Atlantic and also to
an increase in net revenue from the existing contract to manage AMC. All other
changes in net revenue of individual Managed Practices over the prior year were
not significant. The total number of physicians under management in the
Practice Management Division increased to 66 in 1996 compared with 51 in 1995.
Net revenue in the Diagnostics Division increased 12.5% to $34.1 million
in 1996 from $30.3 million in 1995 and accounted for $3.8 million of the
increase in consolidated net revenue. This was the result of higher procedure
volumes performed at the Fixed-Site Facilities and Mobile Cath Labs as well as
the addition of several new hospital contracts on several Mobile Cath Labs. The
number of Fixed-Site Facilities and Mobile Cath Labs operated by the Company
increased to 29 in 1996 compared with 28 in 1995.
Operating Expenses and Income from Operations. Consolidated operating
expenses increased 77.8% to $56.3 million in 1996 from $31.7 million in 1995.
The increase was attributable primarily to operating expenses at the McAllen
Heart Hospital and expenses incurred in managing Mid-Atlantic. Income from
operations increased 17.1% to $9.9 million in 1996 from $8.4 million in 1995.
Operating margins decreased to 15% in 1996 from 21.1% in 1995 and was
attributable to the operating losses experienced at the McAllen Heart Hospital
during the first nine months of operations.
Income from operations in the Practice Management Division increased 49.5%
to $1.5 million in 1996 from $1.0 million in 1995. The increase is attributable
to income from managing Mid-Atlantic and increased operating income from
managing AMC. Operating margins in the Practice Management Division were 10.2%
in both 1996 and 1995.
Income from operations in the Diagnostics Division increased 22.2% to
$13.0 million in 1996 from $10.6 million in 1995. The increase is due primarily
to increased procedure volumes in the Mobile Cath Labs and Fixed-Site
Facilities managed by the Company in both years. Operating margins in the
Diagnostics Division improved to 37.5% in 1996 from 34.7% in 1995 and EBITDA
margins improved to 47.6% in 1996 from 45.8% in 1995. This overall improvement
in margins was due to continuing efficiencies in operating Mobile Cath Labs
resulting from the April 1995 acquisition of HealthTech.
Marketing, general and administrative expenses in 1996 increased 21.9%
over 1995 primarily as a result of the Company's continued investment in
corporate infrastructure to accommodate growth. In 1996, the Company added both
a Human Resources and an Information Systems department, as well as additional
finance and development personnel. The remainder of the increase was
attributable to increased professional fees associated with pursuing business
development opportunities, the addition of administrative and accounting
personnel to support growth and increases in salaries.
Interest Expense and Interest Income. Interest expense in 1996 increased
$1.2 million over 1995 primarily as the result of interest incurred on
borrowings at the McAllen Heart Hospital. Substantially all of the property,
plant and equipment at the hospital was financed using borrowings that bear
interest at rates ranging from 8.54% to 10.19%. The increase in interest
expense at the McAllen Heart Hospital was offset partially by a reduction in
interest expense on capital leases and corporate borrowings due to the
retirement of these obligations using a portion of the proceeds from a public
offering of common stock in April 1996. Interest income increased $636,000 in
1996 compared with 1995 due to additional investment income earned on the
remaining proceeds.
Liquidity and Capital Resources
Operating Cash Flows. Net cash provided by operating activities was $2.2
million for the six months ended March 31, 1998. Accounts receivable increased
$15.8 million during the six months ended March 31, 1998, primarily as a result
of the opening of the Tucson Heart Hospital and increased revenue at the
McAllen and Arkansas Heart Hospitals. At March 31, 1998, the Company had
working capital of $27.9 million, including $18.5 million of cash and
short-term investments and $38.1 million in accounts receivable.
Net cash provided by operating activities was $8.0 million, $7.1 million
and $15.0 million in 1995, 1996 and 1997, respectively. Accounts receivable
increased $12.0 million in 1997, due primarily to operations at the Arkansas
and McAllen
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Heart Hospitals. At September 30, 1997, the Company had working capital of
$47.5 million, including $43.0 million of cash and short-term investments and
$22.4 million of accounts receivable.
Investing Cash Flows. During the six months ended March 31, 1998, the
Company utilized a net of $62.3 million in investing activities primarily for
the construction and development of Heart Hospitals consisting of $10.2 million
for the Tucson Heart Hospital, $37.9 million for the Arizona Heart Hospital,
$10.0 million for the Heart Hospital of Austin and $5.1 million for the
Company's other Heart Hospitals. The Diagnostics Division purchased $4.2
million of new equipment during the six months ended March 31, 1998. The
additional acquisition of management contracts in the Practice Management
Division totaled $5.7 million, and additional physician advances totaled $2.7
million during the six month period. The Company utilized a net of $4.6 million
in other operations. Offsetting these outflows was $18.1 million provided from
the sale of short-term investments.
The Company used $31.3 million, $98.7 million, and $55.0 million in
investing activities in 1995, 1996 and 1997, respectively. In 1995, the Company
used $15.2 million for construction and start-up costs related to the McAllen
Heart Hospital, purchased $9.7 million of short-term investments and used $6.4
million to expand the Practice Management and Diagnostics Divisions through
capital expenditures, additional investments and working capital advances.
In 1996, the Company used $17.0 million, $21.7 million and $5.1 million in
the McAllen, Arkansas and Tucson Heart Hospitals, respectively, in 1996 for
land and equipment acquisitions, construction costs incurred and start-up and
other development costs incurred prior to opening the hospitals. The remaining
investing activities consisted of $9.9 million to further expand the Company's
Practice Management and Diagnostics Divisions and $45.0 million to purchase
short-term investments using the remaining proceeds of a public offering of
common stock in April 1996.
In 1997, the Company invested $80.6 million in the Hospital Division,
primarily at the Arkansas, Tucson, and Arizona Heart Hospitals for land
acquisition, construction costs, equipment purchases and pre-opening and other
development costs. The remaining investing activities consisted of $5.7 million
used to further expand the Company's Practice Management and Diagnostics
Divisions. A significant portion of these investing activities was provided for
by the Company's sale of short-term investments totaling $31.3 million.
Financing Cash Flows. In 1995, the Company issued 2.3 million shares of
common stock through its initial public offering and used the proceeds of
approximately $28.9 million to retire existing debt and to fund a portion of
the development and construction costs of the McAllen Heart Hospital. In
addition, the Company used proceeds of the long-term borrowings to fund a
portion of the land acquisition and construction costs of the McAllen Heart
Hospital.
In 1996, the Company issued 2.3 million shares of common stock through a
public offering and used a portion of the net proceeds of approximately $62.5
million to retire existing debt and obligations under capital leases. The
remaining proceeds have been and will be used to fund (i) a portion of the
construction and pre-opening expenses of Heart Hospitals and Fixed-Site
Facilities, (ii) potential future acquisitions, (iii) working capital and (iv)
general corporate purposes.
In July 1997, the Company terminated its existing revolving credit
facility and entered into a $20 million, unsecured revolving credit facility
(the "Revolver") with a bank, the proceeds of which are to be used for general
corporate purposes. The Revolver matures on July 28, 1999. Borrowings under the
Revolver bear interest at variable rates based, at the Company's option, on the
bank's base rate plus 1/2% or the London Interbank Offered Rate ("LIBOR") plus
1 1/2%. Amounts available under the Revolver are subject to a borrowing base
which includes, as its primary component, a percentage of the Company's
eligible accounts receivable. Under this borrowing base, at September 30, 1997,
there was approximately $18 million available under the Revolver. The Company
has no outstanding balance.
The Company entered into mortgage loans with real estate investment trusts
("REITs") from 1994 to 1998 for the purpose of financing the land acquisition
and construction costs of the McAllen, Arkansas, and Tucson Heart Hospitals and
the Heart Hospital of Austin (collectively the "REIT Loans"). The Company
entered into the REIT Loan for the Heart Hospital of Austin in November of
1997. The interest rates on the REIT Loans are based on a fixed premium above
the seven-year Treasury note rate and the principal and interest is payable
monthly over a seven year term using extended period amortization schedules. As
of March 31, 1998, the interest rates on the REIT Loans ranged from 9.50% to
11.54%.
In August 1997, the Company entered into a mortgage loan with a bank for
the purpose of financing a portion of the land acquisition and construction
costs of the Arizona Heart Hospital (the "Phoenix Loan"). Borrowings of up to
$28 million are available and the term is for three years, subject to extension
for an additional year, at the option of the Company. Principle and interest
are payable monthly beginning in the third year using an extended period
amortization schedule. The interest rate on the Phoenix Loan is based on a
premium above LIBOR. As of March 31, 1998, the rate was 8.50%.
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In December 1997, the Company obtained a financing commitment for up to
$29 million for the purpose of financing the land acquisition, construction and
a portion of the working capital costs of the Bakersfield Heart Hospital. The
interest rate will be at a fixed premium above LIBOR and the outstanding
principal balance will be due and payable in full three years from closing of
the note, if the Company's optional extension of one year is not exercised. The
transaction was completed in the Company's third fiscal quarter.
The Company has acquired substantially all of the medical and other
equipment for the McAllen, Arkansas and Tucson Heart Hospitals under
installment notes payable to equipment lenders secured by the related
equipment. Amounts borrowed under these notes are payable in monthly
installments of principal and interest over five to seven year terms. Interest
is at fixed rates ranging from 8.50% to 10.75%.
In January 1998, the Company obtained financing from an equipment lender
providing up to $18 million for the purpose of financing certain medical
equipment at the Arizona Heart Hospital located in Phoenix, Arizona. The term
of the borrowing is for seven years and the interest rate is based on a fixed
premium above the seven-year Treasury note rate and the principal and interest
is payable monthly. As of March 31, 1998, the interest rate was 9.07%.
Borrowings under the financing agreement are secured by a pledge of the
Company's interest in the financed medical equipment.
The Company anticipates that the cost of its Heart Hospitals currently
under development will range from $32 to $52 million, and will be financed
through a combination of (i) REIT financing, (ii) bank financing, (iii) notes
payable to various equipment lenders and (iv) available cash reserves.
The Company expects that each of its Heart Hospitals will require working
capital advances to fund a portion of the pre-opening costs and to fund the
operations subsequent to opening in the initial start-up phase of the hospital.
Substantial investments will be required during the development phase, and the
Company expects operating losses and negative cash flow will be incurred during
the initial months of operation of each Heart Hospital.
In October 1996, the Company entered into a 40-year contract to manage
Heart Clinic, a multi-physician cardiologist group located in McAllen, Texas.
Total consideration given in connection with the acquisition of the management
contract was approximately $6.4 million (subject to increase if certain base
performance levels are exceeded by the physicians) and consisted of fixed and
contingent promissory notes that are partially convertible into shares of the
Company's common stock.
In December 1997, the Company obtained financing from an equipment lender
in the amount of $7 million for the purpose of financing certain medical
equipment and fixtures in the Diagnostics Division. The term of the borrowing
is for six years and the interest rate is based on a fixed premium above the
four-year Treasury note rate and the principal and interest is payable monthly.
As of March 31, 1998, the interest rate was 8.09%. Borrowings under the
financing agreement are secured by a pledge of the Company's interest in the
financed medical equipment and fixtures.
The Company anticipates financing its future operations through a
combination of amounts available under the Revolver, financing from other real
estate lenders and various equipment lenders, capital contributions by minority
partners, cash reserves and operating cash flows. The Company believes the
combination of these sources will be sufficient to meet the Company's currently
anticipated Heart Hospital development, acquisition and working capital needs
through fiscal year 1998. In addition, in order to provide funds necessary for
the continued pursuit of its business strategy, the Company expects to incur,
from time to time, additional indebtedness to banks and other financial
institutions and to issue, in public or private transactions, equity and debt
securities. The availability and terms of any such financing will depend upon
market and other conditions. There can be no assurance that such additional
financing will be available on terms acceptable to the Company.
General Trends and Business Outlook
Revenue trends. Future trends for revenue and profitability are difficult
to predict; however, the Company believes that there will be continuing
pressure to reduce costs and develop integrated healthcare delivery systems
with geographically concentrated service capabilities. The largest disease
category is cardiovascular disease which, according to the American Heart
Association, is estimated to account for approximately $158 billion in total
medical treatment costs in 1997. The Company believes that the demand for
cardiology and cardiovascular services will increase in the future as people
age 55 and older, the primary users of such services, represent a growing
proportion of the total population. By focusing on cardiovascular disease,
through the operation of Heart Hospitals, Fixed-Site Facilities, Mobile Cath
Labs and Managed Practices, the Company believes it is well positioned to adapt
to these demands by providing fully-integrated cost effective networks focused
on cardiovascular disease.
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The Company expects each of its future Heart Hospitals will experience
negative cash flow during the development phase, and operating losses in the
first six to nine months of operations. Some Heart Hospitals are expected to
become profitable faster than others, however, the Company expects each will
generate positive EBITDA margins during this period.
Health care reform. In recent years, there have been intense national,
state and private industry efforts to reform the healthcare delivery and
payment systems and as such, the healthcare industry faces increased
uncertainty. While the Company is unable to predict which, if any, proposals
for healthcare reform will be adopted, it continues to monitor their progress
and analyze their potential impacts in order to formulate its future business
strategies.
Seasonality. The Company's business experiences some degree of seasonality
due to the location of significant operations. Several of the Company's
Fixed-Site Facilities and Managed Practices, as well as the McAllen Heart
Hospital, are located in regions subject to seasonal population shifts to and
from warmer climates. In addition, because patients and physicians have some
discretion in scheduling elective diagnostic or therapeutic procedures, volumes
are generally affected by vacation schedules of both the patients and the
physicians. Consequently, the Company's third and fourth fiscal quarter
procedure volumes and net revenues tend to be lower at these facilities.
Technological advances. The market for cardiovascular care is rapidly
growing and subject to rapid technological change. As pressures from third
party payors to contain costs continue, technological advances in the delivery
of cardiac care will impact the Company's strategy. The Company believes that
cash flows generated by the Company's operations together with borrowings
available under the Revolver and other third party financing sources will be
sufficient to meet the Company's cash needs to adapt to any major technological
changes.
In July 1996, the Emerging Issues Task Force of the Financial Accounting
Standards Board reached a consensus on issue 96-14, "Accounting for the Costs
Associated with Modifying Computer Software for the Year 2000," which provides
that costs associated with modifying computer software for the year 2000 be
expensed as incurred. The Company is assessing the extent of the necessary
modifications to its computer software.
Inflation. The healthcare industry is very labor intensive and salaries
and benefits are subject to inflationary pressures as are supply costs which
tend to escalate as vendors pass on the rising costs through price increases.
There can be no assurance that the Company will not be affected by inflation in
the future. Management believes that by adhering to cost containment policies,
labor management, and reasonable price increases, the effects of inflation,
which has not had a material impact on the results of operations during the
last three years, on future operating margins should be manageable.
Newly Issued Accounting Standards
In June 1997, Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"), was issued and will be adopted by the Company on October 1, 1998. SFAS
131 requires that a public company report financial and descriptive information
about its reportable operating segments pursuant to criteria that differ from
current accounting practice. Operating segments, as defined, are components of
an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. The financial information to
be reported include segment profit or loss, certain revenue and expense items
and segment assets and reconciliations to corresponding amounts in the general
purpose financial statements. SFAS 131 also requires information about products
and services, geographic areas of operation, and major customers. The Company
has not completed its analysis of the effect of adoption on its financial
statement disclosure, however, the adoption of SFAS 131 will not effect results
of operations or financial position.
In November 1997, the Emerging Issues Task Force of the Financial
Accounting Standards Board reached a consensus on issue 97-2, "Consolidation of
Physicians' Practice Entities." This pronouncement provides guidance on the
issue of consolidating a physician practice if an owning member meets all of
several criteria concerning control over the physician practice and a financial
interest in the physician practice. The consensus requires that it be applied
to existing investments no later than for financial statements issued for
fiscal years ending after December 15, 1998.
The Company does not have exclusive authority over all decision making
related to ongoing, major, or central operations of the Managed Practices,
compensation of the licensed medical professionals, and does not have the
ability to establish and implement guidelines for the selection, hiring, and
firing of the licensed medical professionals. Accordingly, the Company does not
have a controlling financial interest in the Managed Practices as defined by
Emerging Issues Task Force No. 97-2, "Consolidation of Physicians' Practice
Entities," and therefore does not include the Managed Practices in the
Consolidated Financial Statements of the Company.
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In April 1998, the AICPA issued its Statement of Position 98-5 "Reporting
on the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5 requires that costs
incurred during start-up activities, including organization costs, be expensed
as incurred. SOP 98-5 is effective for financial statements for fiscal years
beginning after December 15, 1998, although early application is encouraged.
Initial application of SOP 98-5 should be as of the beginning of the fiscal
year in which it is first adopted and should be reported as a cumulative effect
of a change in accounting principle.
The Company currently intends to early adopt SOP 98-5 on October 1, 1998.
Upon adoption, the Company estimates it will incur a cumulative effect of a
change in accounting principle that will range from $12.0 to $18.0 million.
This estimate includes net cost capitalized as of March 31, 1998, costs to be
capitalized from April 1, 1998 through September 30, 1998, and is net of
additional amortization expected to be incurred from April 1, 1998 through
September 30, 1998.
Other
Statements contained herein which are not historical facts may be
considered forward-looking statements as that term is defined in the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements are
subject to risks and uncertainties which could cause actual results to differ
materially from those projected. Such risks and uncertainties include
construction and development risks associated with heart hospitals, including
without limitation, unanticipated delays in construction and licensing;
increased construction costs; operating losses and negative cash flows during
the initial operation of heart hospitals continuing longer than anticipated;
dependence on physician relationships; increased competition from existing
hospitals in the marketplace; dependence on the availability and terms of
long-term management contracts; fluctuations in quarterly operating results
from seasonality, population shifts and other factors; dependence on key
management; as well as other risks detailed in the Company's filings with the
Securities and Exchange Commission.
CERTAIN FORWARD LOOKING INFORMATION
The Company does not, as a matter of course, make public projections as to
future financial results. However, management of the Company, in connection
with the possible sale of the Company, prepared at various times during fiscal
years 1997 and 1998 and provided to KKR, WCAS VII, the Special Committee and
Goldman Sachs certain projections for fiscal years 1997 through 2003. None of
these projections were prepared with a view to public disclosure or compliance
with published guidelines of the Commission or the guidelines established by
the American Institute of Certified Public Accountants regarding projections.
Ernst & Young LLP, the Company's independent auditors, have not performed any
procedures with respect to the projections and assume no responsibility for
them. Such forward looking statements are subject to risks and uncertainties
which could cause actual results to differ materially from those projected.
Such risks and uncertainties include construction and development risks
associated with Heart Hospitals, including, without limitation, unanticipated
delays in construction and licensing; increased construction costs; operating
losses and negative cash flows during the initial operation of Heart Hospitals
continuing longer than anticipated; dependence on physician relationships;
increased competition from existing hospitals in the marketplace; the lack of
managed care arrangements or agreements for the Company's Heart Hospitals and
other facilities, especially during their start-up periods; dependence on the
availability and terms of long-term management contracts; fluctuations in
quarterly operating results from seasonality, population shifts and other
factors; and dependence on key management. Nevertheless, the Company believes
that the assumptions underlying these projections were reasonable at the time
the projections were prepared.
The June Projection
In June 1997, MedCath's management prepared a projected income statement
(the "June Projection") for the balance of the fiscal year ending September 30,
1997 and for each of the fiscal years in the five year period ending September
30, 2002 (the "Projection Period"). Projections for the fiscal year ending
September 30, 1997 were based upon the Company's actual performance through
June 30 of that year and the Company's budgeted financial performance for the
fourth quarter. For subsequent periods, management projected revenue and EBITDA
separately for each of the Company's operating divisions and then calculated
the resulting net income and earnings per share. Management assumed that
corporate overhead would increase at a rate necessary to support the growth in
the Company's three principal operating divisions. The June Projection was
included in the Offering Memorandum provided by Goldman Sachs to potential
purchasers of the Company.
With respect to the Diagnostics Division of the Company, management made
the following assumptions:
o Revenue would increase at a rate consistent with historical financial
performance.
o The division's EBITDA margins would remain stable.
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o The Company would develop two new Fixed-Site Labs annually.
o Beginning in fiscal year 1999, the division would begin receiving
additional revenue both from consulting and management agreements and
the development of therapeutic procedures in diagnostic labs.
With respect to the Practice Management Division of the Company,
management made the following assumptions:
o Revenue would increase at a rate consistent with the division's
historical financial performance.
o The division's EBITDA margins would remain stable.
o The Company would make two new practice acquisitions annually.
The projection for the Hospital Division of the Company was prepared by
management as follows:
o Revenue and EBITDA margins for Heart Hospitals in operation (McAllen and
Little Rock) were projected based on the Company's previous revenue and
EBITDA assumptions for those hospitals as revised to reflect their
historical financial performance.
o For each Heart Hospital under development other than Tucson, management
prepared a market-specific "base year" projection of revenue and EBITDA
margin based upon projected patient census levels and procedure volumes
for the hospital. Management assumed for each new hospital that the
hospital would operate for two full fiscal quarters (the "Ramp-up
Period") before reaching the base year level and that the hospital would
then operate at the base year level for four fiscal quarters.
Thereafter, each new hospital would enter a growth period during which
revenue would increase at a 20% annual rate for ten fiscal quarters.
Management assumed that revenue would increase thereafter at a more
modest rate reflecting overall market (as opposed to hospital-specific)
growth and inflation. In the case of the Tucson Heart Hospital,
management made all of the same assumptions described above except that
management assumed that revenue of the Tucson Heart Hospital would
increase during the growth period at only a 5% annual rate for ten
fiscal quarters.
o Management assumed that the hospitals under development which the
Company had previously announced (the "Specific Hospitals") would open
in accordance with their construction schedules.
o Management assumed that hospitals to be announced in the future (the
"Generic Hospitals") would open at a rate such that the Company would
open three hospitals per year during the Projection Period.
Set forth below is a summary of the June Projection:
<TABLE>
<CAPTION>
Fiscal Year Ending September 30,
-----------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2002
------------- ------------- ------------- ------------- ------------- -------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Revenue ................................ $ 109,328 $ 200,578 $ 351,805 $ 506,710 $ 679,838 $ 863,627
EBITDA ................................. 28,436 57,462 104,244 152,169 206,063 262,887
Net income (before extraordinary items) 7,023 9,553 15,447 23,386 33,801 45,646
Earnings per share (assuming dilution) . 0.60 0.78 1.19 1.67 2.26 2.85
</TABLE>
The December Projection
The December Projection reflected the following changes in the assumptions
management made when it prepared the June Projection:
o The Company's operating budget for fiscal year 1998 (as updated to
reflect actual results in October and November and estimated results for
December of such fiscal year) was used in lieu of the projections for
fiscal year 1998 that were used in the June Projection.
o The projection for the Tucson Heart Hospital for the entire Projection
Period was revised based upon the actual performance of the hospital in
its first two months of operations and an estimate of its performance in
December 1997. In its revised projection for the hospital, management
projected average daily patient census would increase gradually to 50%
of capacity by the end of fiscal year 1998 and remain at that level
through the entire Projection Period.
56
<PAGE>
o The assumed opening dates of the Arizona Heart Hospital and the Heart
Hospital of Austin were moved to March 1998 and October 1998,
respectively, to reflect delays in their construction schedules.
o The growth rate assumptions made for both Specific Hospitals and Generic
Hospitals were revised as follows: The Ramp-up Period was increased from
two to four quarters to track more closely the Company's actual
experience with its three operating hospitals. The rate of increase in
revenue during the ten quarters immediately following the four-quarter
long base year was reduced from 20% to 10% annually to take into account
the possibility that the Company may experience problems in operating
future hospitals similar to those experienced at the Tucson Heart
Hospital.
o Beginning in fiscal year 2000, the number of Generic Hospitals opening
each year was reduced from three to two to reflect anticipated
difficulties in attracting physicians to participate in future hospitals
resulting in part from public perception of the Company's experience
with the Tucson Heart Hospital.
o Management revised its assumptions about Generic Hospitals to provide
that, beginning in fiscal year 2000, one of the two Generic Hospitals
projected to open each year in the Projection Period would be a
three-way venture between MedCath (with a 33% ownership interest), local
physicians and an established local hospital.
o The revenue projection for the Diagnostics Division beginning in fiscal
year 1999 from consulting fees and therapeutic procedures was removed.
Set forth below is a summary of the December Projection:
<TABLE>
<CAPTION>
Fiscal Year Ending September 30,
-----------------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003
------------- ------------- ------------- ------------- ------------- -------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Revenue ................................ $ 200,282 $ 315,018 $ 399,254 $ 469,082 $ 546,927 $ 621,623
EBITDA ................................. 47,839 84,140 109,472 129,140 151,545 170,788
Net income (before extraordinary items) 4,829 9,698 15,054 19,763 26,005 31,146
Earnings per share (assuming dilution) . 0.39 0.73 1.06 1.30 1.60 1.81
</TABLE>
The March Projection
The March Projection reflected (in addition to the changes in the
assumptions management made when it prepared the December Projection) the
following changes:
o Adjustments to reflect actual operating performance for the month of
December 1997, which, as the result of factors not related to the
performance of Tucson, were more favorable than had been estimated when
management prepared the December Projection.
o Projected performance of McAllen and Little Rock for fiscal year 1998
was revised to reflect management's expectations that their results of
operations would exceed those projected for them in the Company's fiscal
year 1998 operating budget and in the December Projection.
o The projection for Tucson was revised to reflect revised expectations
for patient census and procedure volumes. Management assumed that census
would be in the high teens for the remainder of fiscal year 1998 and
that certain cost savings would be achieved in the latter months of the
fiscal year. Management further assumed that a slight increase in
patient census levels would occur in fiscal year 1999 and that the
hospital would operate at an approximately break-even level beginning in
fiscal year 2000.
o As the result of a burst water pipe during construction, the opening of
the Arizona Heart Hospital was moved to July 1998 and the projected
results during the Ramp-up Period of the hospital were revised to
reflect the lower patient census and procedure volume associated with
the opening of a hospital in the Southwest during the summer.
o To reflect a revised construction schedule, the opening of the
Bakersfield Heart Hospital was moved to June 1999.
o The projection for the Dayton Heart Hospital was revised to reflect the
Company's announcement in January that Franciscan Health System of Ohio
Valley, Inc. would become a 30% investor in the Dayton Heart Hospital
and the Company's interest would be reduced to 35%. To reflect a revised
construction schedule, the opening of the Dayton Heart Hospital was
moved to the third quarter of fiscal year 1999.
57
<PAGE>
Set forth below is a summary of the March Projection:
<TABLE>
<CAPTION>
Fiscal Year Ending September 30,
-----------------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003
------------- ------------- ------------- ------------- ------------- -------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Revenue ................................ $ 187,992 $ 290,289 $ 372,764 $ 440,525 $ 514,914 $ 587,371
EBITDA ................................. 45,263 77,170 101,466 120,380 141,803 160,389
Net income (before extraordinary items) 5,276 9,951 15,693 20,543 26,887 31,999
Earnings per share (assuming dilution) . 0.43 0.75 1.10 1.35 1.65 1.86
</TABLE>
MANAGEMENT
Directors and Executive Officers of MedCath
The Board of Directors of MedCath currently consists of six directors. The
following table sets forth certain information regarding the executive officers
and directors of the Company.
<TABLE>
<CAPTION>
Name Age Position
- ----------------------------- ----- ------------------------------------------------------
<S> <C> <C>
Stephen R. Puckett 45 Chairman of the Board of Directors, President and
Chief Executive Officer
David Crane 41 Executive Vice President and Chief Operating Officer
Charles W. (Todd) Johnson 40 Senior Vice President -- Development and Managed Care
Richard J. Post 42 Chief Financial Officer, Secretary and Treasurer
Thomas K. Hearn III 36 President -- Diagnostics Division
R. William Moore, Jr. 47 President -- Hospital Division
A. Kenneth Petronis 38 President -- Practice Management Division
Patrick J. Welsh 54 Director
Andrew M. Paul 41 Director
W. Jack Duncan 55 Director
John B. McKinnon 62 Director
</TABLE>
Stephen R. Puckett was a founder of the Company in 1988 and has served as
Chairman of the Board of Directors, President and Chief Executive Officer of
the Company since that time. From 1984 to 1989, Mr. Puckett served as Executive
Vice President and Chief Operating Officer of Charlotte Mecklenburg Hospital
Authority (the "Authority"), a 1,677-bed multi-hospital system, and from 1981
to 1983, he served as Senior Vice President of the Authority. Carolinas Medical
Center, an 853-bed hospital and the largest facility in the Authority's system,
operates one of the largest heart programs in the Southeast. While he was
associated with the Authority, Mr. Puckett was active in managing many of the
additions to the Carolinas Medical Center, including an 80,000 square foot
institute with four surgical suites and several cardiac diagnostic and
therapeutic laboratories. From 1976 to 1981, Mr. Puckett worked for the
University of Alabama hospital and served in a variety of management positions
with increasing responsibilities for hospital operations. Mr. Puckett serves as
a director of Cardiovascular Diagnostics, Inc. Mr. Puckett received a B.A. and
an M.S. in Health Management from the University of Alabama.
David Crane has served as a director and Chief Operating Officer of the
Company since 1989 and Executive Vice President since 1997. From 1985 to 1989,
Mr. Crane was employed by MediVision, Inc., an owner/manager of ophthalmic
outpatient surgery centers and private ophthalmic surgical practices, and he
served as Chief Operating Officer of MediVision from 1987 to 1989. While he was
associated with MediVision, Mr. Crane managed the construction of several
ophthalmic outpatient surgical centers. From 1982 to 1985, he was a business
and health care consultant with Bain & Company, a consulting firm. Mr. Crane
received a B.A. from Yale University and an M.B.A. from Harvard Business
School.
Charles W. (Todd) Johnson has served as a Vice President of the Company
since April 1995 when the Company acquired all of the outstanding shares of
HealthTech Corporation and as Senior Vice President-Development and Managed
Care since 1997. Mr. Johnson was the founder and President of HealthTech
Corporation, a company whose principal business was the ownership and operation
of mobile cardiac catheterization laboratories. Prior to founding HealthTech
Corporation in July 1991, Mr. Johnson was a partner in Paragon Group, a
national real estate development and investment company. Mr. Johnson received a
B.A. from the University of North Carolina and an M.B.A. from Wake Forest
University.
58
<PAGE>
Richard J. Post joined MedCath in September 1996 as Chief Financial
Officer, Secretary and Treasurer. From 1986 to 1996, Mr. Post was employed as
an investment banker, assisting clients in the execution of a wide variety of
public and private debt and equity financings and merger and acquisition
transactions. He served as a Senior Vice President, Corporate Finance with
Price Waterhouse LLP from 1994 to 1996. From 1992 to 1994, he was a Senior
Manager in the Corporate Finance Department of Ernst & Young LLP and from 1988
to 1992, he was a Vice President in the Investment Banking Department of Bear,
Stearns & Co. Inc. From 1986 to 1988, he was an Associate in the Corporate
Finance Group at The First Boston Corporation. Mr. Post served as a Military
Intelligence Officer in the United States Army from 1977 to 1986. He received a
B.A. in English and Philosophy from the University of Notre Dame and an M.B.A.
from Harvard Business School.
Thomas K. Hearn III, has served as President -- Diagnostics Division since
joining the Company in November 1995. From August 1993 until he joined the
Company, Mr. Hearn served as President of Decision Support Systems, Inc., a
health care software and consulting firm that he co-founded. Prior to
co-founding that company, he was employed from 1987 to 1993 by the Charlotte
Mecklenburg Hospital Authority where he served as Vice President of
Administration and Administrator of the Authority's Carolinas Heart Institute,
one of the busiest centers for the treatment of cardiovascular disease in the
Southeast. From 1985 to 1987 Mr. Hearn developed managed care products for VHA.
Mr. Hearn received a B.A. from the College of William and Mary, and the M.P.H.
and M.B.A. degrees from the University of Alabama at Birmingham.
R. William Moore, Jr. has served as President -- Hospital Division of the
Company since November 1995. He joined the Company in April 1994 and from that
date until he was appointed to his current position, he served as President of
the Company's first specialty heart hospital, the McAllen Heart Hospital in
McAllen, Texas. From 1989 until he joined the Company, Mr. Moore was
Administrator of University Hospital, a 130-bed hospital in the Charlotte
Mecklenburg Hospital Authority multi-hospital system. Prior thereto, he held
other top management positions for eight years in the Charlotte Mecklenburg
Hospital Authority system and with Memorial Mission Hospital in Asheville,
North Carolina. Mr. Moore received a B.A. from Ohio Northern University and an
M.B.A. from Western Carolina University.
A. Kenneth Petronis, joined MedCath in August 1997 as President --
Practice Management Division. Prior to joining MedCath, Mr. Petronis was a Vice
President of PHP, Inc., a subsidiary of United HealthCare, where he was
responsible for all physician provider network negotiations and interface and
was instrumental in contracting with over 2,000 physicians. From 1990 to 1993
he was Chief Executive Officer of a large, cardiology-focused, multi-specialty
physician group practice. From 1983 to 1990, Mr. Petronis was employed by Ernst
& Young LLP where he served in a number of capacities, including a Senior
Manager in the Healthcare Consulting Group.
Patrick J. Welsh, a director of the Company since 1991, serves as a
general partner of the respective sole general partner of WCAS V, WCAS VII and
other associated partnerships. Mr. Welsh has been a general partner of the sole
general partner of associated limited partnerships since 1979. Prior to 1979,
Mr. Welsh was President and a director of Citicorp Venture Capital, Ltd., an
affiliate of Citicorp engaged in venture capital investing. Mr. Welsh serves as
a director of Walsh International, Inc., Pharmaceutical Marketing Services Inc.
and several privately-held companies.
Andrew M. Paul has been a director of the Company since 1991. He has
served as a general partner of the sole general partner of WCAS V, WCAS VII and
other associated partnerships since 1984. From 1983 to 1984, he was an
associate in Hambrecht & Quist's venture capital group. From 1978 to 1981, he
was a systems engineer and then a marketing representative for IBM. Mr. Paul
received a B.A. from Cornell University and an M.B.A. from Harvard Business
School. Mr. Paul serves as a director of Lincare, Inc., Centennial Healthcare,
Inc., Housecall Medical Resources, Inc. and several privately-held companies.
W. Jack Duncan has served as a director of the Company since September
1994. Since 1987, he has been a Professor and University Scholar in Management
in the Graduate School of Management and Professor of Health Care Organization
and Policy and a Senior Scholar in the Lister Hill Center for Health Policy in
the School of Public Health at the University of Alabama at Birmingham. Dr.
Duncan received a B.S. in Economics from Howard College and an M.B.A. and a
Ph.D. from Louisiana State University.
John B. McKinnon has been a director of the Company since February 1996.
From 1989 until his retirement in 1995, he served as the Dean of the Babcock
Graduate School of Management at Wake Forest University. From 1986 to 1988 he
served as President of Sara Lee Corporation. Mr. McKinnon also serves as a
director of Premark International, Morrison's Health Care, Inc., Ruby Tuesday,
Inc., and two privately-held companies. He received an A.B. from Duke
University and an M.B.A. from Harvard Business School.
59
<PAGE>
Executive Compensation
The following table sets forth certain information for each of the last
three fiscal years concerning the compensation of the Company's President and
Chief Executive Officer and the Company's other four most highly compensated
executive officers who were serving as executive officers at September 30, 1997
(the "Named Executive Officers").
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
---------------
Number of
Annual Compensation Securities All Other
--------------------------------------- Underlying Compensation
Name and Principal Position Year Salary ($) Bonus ($) Options (#)(1) ($)(2)
- ---------------------------------------------- ------------- ------------ ----------- --------------- -------------
<S> <C> <C> <C> <C> <C>
Stephen R. Puckett 1997 $259,980 $127,500 52,143 $ 2,250
Chairman of the Board, President and 1996 192,344 67,247 77,671 2,461
Chief Executive Officer ..................... 1995 183,185 116,000 100,000 2,481
David Crane 1997 $204,972 $100,000 30,000 $ 2,250
Executive Vice President and 1996 160,287 56,039 51,276 2,439
Chief Operating Officer ..................... 1995 152,654 84,000 60,000 2,435
Charles W. (Todd) Johnson 1997 $170,904 $ 90,000 8,306 $ 2,370
Senior Vice President -- Development and 1996 155,925 54,511 29,001 3,086
Managed Care ................................ 1995(3) 65,058 47,000 20,000 400
Richard J. Post 1997 $147,372 $ 72,500 50,000 $ 184
Chief Financial Officer, 1996 -- -- -- --
Secretary and Treasurer ..................... 1995 -- -- -- --
R. William Moore, Jr. 1997 $148,800 $ 50,000 -- $22,893
President -- Hospital Division .............. 1996 141,639 14,000 7,500 2,125
1995 115,000 52,500 -- 1,688
</TABLE>
- ---------
(1) The Company's executive compensation program consists of three principal
components: base salary, cash bonuses and long-term incentive compensation
in the form of stock options. Stock options granted in a particular fiscal
year may in fact be based upon each Named Executive Officer's
contributions to the Company's performance in the prior fiscal year. The
number of options granted is based upon provisions of a Named Executive
Officer's employment agreement or an evaluation of the Named Executive
Officer's performance by the Chief Executive Officer or the Compensation
Committee of the Board.
(2) For fiscal year 1997, consists of (i) matching contributions to the
Company's 401(k) Plan and (ii) life insurance premiums paid in the amount
of $1,110 on behalf of Mr. Johnson and (iii) a moving allowance in the
amount of $21,093 paid to Mr. Moore. For fiscal year 1996, consists of
matching contributions to the Company's 401(k) Plan and (ii) life
insurance premiums paid in the amount of $1,000 on behalf of Mr. Johnson.
For fiscal year 1995, consists of (i) matching contributions to the
Company's 401(k) Plan and (ii) life insurance premiums in the amounts of
$60, $41 and $24 paid on behalf of Messrs. Puckett, Crane and Johnson,
respectively.
(3) For fiscal year 1995, represents compensation earned for the period from
April 24, to September 30, 1995, the date Mr. Johnson became an executive
officer of the Company.
Stock Options Granted During the Fiscal Year Ended September 30, 1997
The following table provides certain information concerning grants of
options to purchase shares of Common Stock made during the fiscal year ended
September 30, 1997 to the Named Executive Officers. These option grants were
made under the Company's Omnibus Stock Plan, and represented, in each instance,
a replacement grant upon cancellation of previously-granted stock options. In
connection with these replacement grants, the exercise prices of the stock
options previously awarded to the Named Executive Officers were adjusted to
reflect the replacement grant-date market price. The vesting provisions of
these replacement stock options did not, however, provide the Named Executive
Officers with any credit for the periods of time they held the stock options
that were canceled in connection with the replacement grants.
60
<PAGE>
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------------
Potential Realizable
Value
% of Total at Assumed Annual Rates
Number of Options of Stock Price
Securities Granted to Appreciation
Underlying Employees Exercise for Option Term (2)
Options in Fiscal Price Expiration -------------------------
Name Granted (#) Year (1) ($/Sh) Date 5% ($) 10% ($)
- ------------------------------- --------------- ----------- ----------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Stephen R. Puckett 4,533(3) 1.7% $ 14.44 4/28/02 $ 10,523 $ 30,496
47,590(4) 17.9 13.13 4/28/07 392,819 995,481
David Crane 30,000(5) 11.3% $ 13.13 4/28/07 $247,627 $ 627,536
Charles W. (Todd) Johnson 8,306(6) 3.1% $ 13.13 4/28/07 $ 68,560 $ 173,744
Richard J. Post 50,000(7) 18.8% $ 13.13 4/28/07 $412,712 $1,045,893
R. William Moore, Jr. -- -- -- -- -- --
</TABLE>
- ---------
(1) In fiscal 1997, options to purchase an aggregate of 266,449 shares of
Common Stock were granted to all employees.
(2) Represents potential net gain of the exercise price before income taxes
associated with the exercise of the options. For the options expiring on
April 28, 2002 assumes a stock price per share of $16.75 for the 5% and of
$21.14 for the 10% rate. For the options expiring on April 28, 2007,
assumes a stock price per share of $21.38 for the 5% rate and of $34.04
for the 10% rate. For the options expiring on April 28, 2007, assumes a
stock price per share of $21.38 for the 5% rate and of $34.04 for the 10%
rate. The Common Stock price on April 28, 1997 (the date of grant for all
options granted to the Named Executive Officers during the year) was
$13.13.
(3) These shares of Common Stock are issuable upon exercise of incentive stock
options that vest and become exercisable as follows: 1,294 and 3,259
shares in equal monthly installments over January, 2000 through December,
2000, and January, 2001 through March, respectively.
(4) These shares of Common Stock are issuable upon exercise of non-qualified
stock options that vest and become exercisable as follows: 35,848 and
11,742 shares in equal monthly installments over April, 1997 through
December, 1999, and January, 2000 through December, 2000, respectively.
(5) These shares of Common Stock are issuable upon exercise of incentive and
non-qualified stock options that vest and become exercisable as follows:
2,923 and 1,875 incentive stock options in equal monthly installments from
January, 2000 through December, 2000, and January, 2001 through March,
2001, respectively; and 20,625 and 4,577 non-qualified stock options in
equal monthly installments from April, 1997 through December, 1999, and
January, 2000 through December, 2000, respectively.
(6) These shares of Common Stock are issuable upon exercise of incentive and
non-qualified stock options that vest and become exercisable as follows:
1,558, 3,046 and 520 incentive stock options in equal monthly installments
from April, 1997 through December, 1997, January, 1998 through December,
1999 and January, 2001 through March, 2001, respectively; and 1,106 and
2,076 non-qualified stock options in equal monthly installments from
January, 1998 through December, 1999, and January, 2000 through December,
2000, respectively.
(7) These shares of Common Stock are issuable upon exercise of incentive and
non-qualified stock options that vest and become exercisable as follows:
7,619, 22,857 and 3,125 incentive stock options in equal monthly
installments from April, 1997 through December, 1997, January, 1998
through December, 2000 and January, 2001 through March, 2001,
respectively; and 1,756 and 14,643 non-qualified stock options in equal
monthly installments from April, 1997 through December, 1997, and January,
1998 through December, 2000, respectively.
Option Exercises and Year-end Values for Fiscal Year Ended September 30,
1997
The following table provides certain information concerning shares
acquired and value realized on exercise of options, the number of shares of
Common Stock underlying unexercised options held by each of the Named Executive
Officers and the value of such officers' unexercised options at September 30,
1997.
61
<PAGE>
Aggregated Option Exercises in Last Fiscal Year and
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised In-the-
Shares Underlying Unexercised Money Options at Fiscal
Acquired Options at Fiscal Year End (#) Year End ($)(1)
on Value ----------------------------- -----------------------------
Name Exercise (#) Realized ($)(2) Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------- -------------- ----------------- ------------- --------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Stephen R. Puckett ............ -- -- 30,095 147,596 $ 88,580 $557,489
David Crane ................... -- -- 89,995 128,259 1,089,034 752,953
Charles W. (Todd) Johnson ..... -- -- 5,746 43,255 4,022 128,164
Richard J. Post ............... -- -- 6,249 43,751 24,215 169,535
R. William Moore, Jr. ......... -- -- 11,925 23,229 111,688 80,224
</TABLE>
- ---------
(1) The value of the unexercised in-the-money options is based on the
difference between the closing sales price of the Common Stock on
September 30, 1997 of $17.00 per share and the exercise price of the
options.
(2) The value realized upon exercise of stock options is based on the
difference between the fair market value of the shares of Common Stock
underlying the options and the exercise price of the options at the date
of exercise.
Employment Agreements
Pursuant to employment agreements dated October 1, 1997 (the "Employment
Agreements"), Messrs. Puckett, Crane and Johnson are currently entitled to base
annual salaries of $325,680, $263,172, and $189,996, respectively, which
amounts are reviewed and adjusted from time to time. Under the Employment
Agreements, Messrs. Puckett, Crane and Johnson are also entitled to receive
annual cash bonuses if the Company's actual earnings per share equals or
exceeds 80% of the target earnings per share for the year established in
advance by the Board of Directors. The amount of the cash bonus is, in each
case, an amount equal to the comparative percentage of the Company's actual
earnings per share to the target earnings per share (subject to a cap 120%)
times an amount equal to 50% of the executive officer's base salary.
Messrs. Puckett, Crane and Johnson are also entitled to awards of
incentive stock options annually with the number of shares issuable upon
exercise thereof to be determined in accordance with a formula designed to
increase the number of shares issuable when the actual rate of growth in
earnings per share exceeds the percentage growth target established in advance
by the Board of Directors. Any incentive stock options awarded pursuant to the
Employment Agreements will vest 25% in the year awarded and 25% in each year
for the following three years. Each of the Employment Agreements provides that
the executive officer may receive such increases to his base salary and his
cash bonus as the Board of Directors may determine from time to time based upon
recommendations of the Compensation Committee of the Board of Directors. The
initial term of each of the Employment Agreements is three years, and each of
the agreements is renewable automatically upon expiration for consecutive one
year terms unless either party gives notice of nonrenewal at least 90 days in
advance of the end of the current term.
The Company may terminate the Employment Agreements at any time for cause.
The Company may also terminate them without cause for any reason but must pay
the terminated executive officer, upon termination, an amount equal to two
times the total cash compensation earned by him during the immediately
preceding fiscal year plus an amount equal to the then present value of two
years of normal health, life insurance and retirement benefits. The Employment
Agreements further provide for automatic termination of employment upon a
"change of control" of the Company, and in such event, for Messrs. Puckett,
Crane and Johnson to receive the same payments they would have received if the
Company had terminated their employment without cause. In the event of an
automatic termination upon a "change of control" of the Company, all incentive
stock options previously granted to Messrs. Puckett, Crane and Johnson will
vest immediately. The Employment Agreements, which may be terminated by the
executive officers on 90 day's notice to the Company; also contain
geographically-broad, one-year covenants not to compete and provisions
restricting the right of the executive officers to use confidential information
gained while in the employ of the Company.
Pursuant to an employment agreement dated September 24, 1996, as amended
April 29, 1997, Richard J. Post is currently entitled to a base annual salary
of $157,992 (which amount is reviewed and adjusted from time to time) and is
eligible to participate in an annual bonus compensation plan each year in
accordance with the Company's senior executive compensation formula plan as
implemented from time to time by the Compensation Committee of the Board of
Directors. The employment agreement does not have a fixed term. The termination
provisions of Mr. Post's employment agreement are the same as the termination
provisions of the Employment Agreements with Messrs. Puckett, Crane and
Johnson, including a provision with respect to a payment in the event of
automatic termination of employment upon a "change of control" of the Company.
Mr. Post's employment agreement also contains a geographically-broad, one-year
covenant not to compete and provisions restricting his use of confidential
information gained while in the employ of the Company.
62
<PAGE>
Pursuant to an employment agreement dated March 9, 1994, R. William Moore,
Jr. is currently entitled to an annual salary of $189,996, which amount is
reviewed and adjusted from time to time. Mr. Moore is also entitled to
participate in an annual bonus compensation plan each year of his employment.
The employment agreement with Mr. Moore does not have a fixed term. If the
Company terminates his employment for any reason other than cause, the Company
must continue to pay his salary on a monthly basis and all accrued bonus for a
period of nine months following the date of termination unless he shall become
employed during such nine-month period and begin earning an amount equal to at
least 75% of his annual salary under the agreement. Mr. Moore's employment
agreement contains a 18-month covenant no to compete and provisions restricting
his use of confidential information gained while in the employ of the Company.
Directors' Compensation
With the exception of Messrs. Duncan and McKinnon, who each receives
$1,000 for each Board or Committee meeting attended, directors do not receive
any cash compensation from the Company for their service as members of the
Board of Directors. All directors are reimbursed for reasonable expenses
incurred by them in attending Board and Committee meetings.
Directors who are not employees of the Company (excluding Messrs. Welsh
and Paul) are entitled to participate in the Company's Outside Directors' Stock
Option Plan (the "Directors' Plan"). On the date of each annual meeting, the
Company grants an option under the Directors' Plan to purchase 2,000 shares of
Common Stock to each of W. Jack Duncan and John B. McKinnon at an exercise
price per share equal to the fair market value on such date.
PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF MANAGEMENT
The following table sets forth certain information with respect to the
beneficial ownership of the Common Stock as of June 22, 1998 by: (i) each
person known to the Company to beneficially own more than 5% of the Common
Stock, (ii) each director of the Company, (iii) each of the Named Executive
Officers and (iv) all executive officers and directors of the Company as a
group.
<TABLE>
<CAPTION>
Amount and Nature Percentage of
of Common
Name of Beneficial Owner Beneficial Ownership(1) Stock
- ----------------------------------------------------------------------- ------------------------- --------------
<S> <C> <C>
Stephen R. Puckett (2) ............................................... 1,258,311 10.6%
Patrick J. Welsh (3) ................................................. 966,177 8.2
Andrew M. Paul (3) ................................................... 908,267 7.7
Welsh, Carson, Anderson & Stowe V, L.P. (4) .......................... 884,829 7.5
The Northwestern Mutual Life Insurance Company (5) ................... 981,905 8.3
Crown Advisors, Ltd. (6) ............................................. 748,629 6.3
The TCW Group, Inc. (7) .............................................. 600,600 5.1
Charles W. (Todd) Johnson (8) ........................................ 265,526 2.2
David Crane (8) ...................................................... 254,886 2.1
John B. McKinnon (8) ................................................. 61,999 *
R. William Moore (8) ................................................. 20,882 *
Richard J. Post (8) .................................................. 19,793 *
W. Jack Duncan (8) ................................................... 5,530 *
All executive officers and directors as a group (11 persons) (9) ..... 2,884,233 24.4
</TABLE>
- ---------
* Less than 1%
(1) Except as indicated in the footnotes to this table, the persons named in
the table have sole voting and investment power with respect to all shares
of Common Stock shown as beneficially owned by them, subject to community
property laws where applicable.
(2) The address of Mr. Puckett is 7621 Little Avenue, Suite 106, Charlotte,
North Carolina 28226. Includes 1,165,650 shares held by two limited
partnerships of which Mr. Puckett is the sole general partner and 92,661
shares issuable upon exercise of options that are exercisable within 60
days of June 22, 1998.
(3) Includes 884,829 shares of Common Stock held by WCAS V. Each of Mr. Welsh
and Mr. Paul is a general partner of the sole general partner of WCAS V.
The address of Mr. Welsh and Mr. Paul is 320 Park Avenue, Suite 2500, New
York, New York 10022.
(4) The address of WCAS V is 320 Park Avenue, Suite 2500, New York, New York
10022. Mr. Welsh and Mr. Paul each serves as a general partner of the sole
general partner of WCAS V.
63
<PAGE>
(5) The address of The Northwestern Mutual Life Insurance Company is 720 E.
Wisconsin Avenue, Milwaukee, Wisconsin 53202. The number of shares shown as
beneficially owned is based upon a statement on Schedule 13G filed February
4, 1998, which indicates the reporting person has sole voting and
dispositive power over 521,605 shares and shared voting and dispositive
power over an additional 460,300 shares.
(6) The address of Crown Advisors, Ltd. is 60 East 42nd Street, New York, New
York 10165. The number of shares shown as beneficially owned is based upon
a statement on Schedule 13G filed February 19, 1998 and information
provided to the Company by Crown Advisors, Ltd. Includes 402,400 shares
held by certain investment partnerships for which Crown Advisors, Ltd.
serves as investment advisor, and as to which Crown Advisors, Ltd. has
shared voting and investment power, 294,100 shares held by a co-advisor to
such partnerships and 52,129 shares held by an affiliate of Crown Advisors,
Ltd.
(7) The address of The TCW Group, Inc. is 865 South Figueroa Street, Los
Angeles, California 90017. The number of shares shown as beneficially owned
is based upon a statement on Schedule 13G filed February 12, 1998, which
indicates the reporting person has sole voting and dispositive power over
600,600 shares.
(8) Includes for each of these beneficial owners the number of shares set forth
below that are issuable upon exercise of options that are exercisable
within 60 days of June 22, 1998:
<TABLE>
<S> <C> <C> <C>
Charles W. (Todd) Johnson ... 28,656 R. William Moore ......... 19,372
David Crane ................. 152,769 Richard J. Post .......... 19,793
John B. McKinnon ............ 1,999 W. Jack Duncan ........... 3,176
</TABLE>
(9) Includes 326,177 shares of Common Stock issuable upon exercise of options
that are exercisable within 60 days of June 22, 1998.
CERTAIN INFORMATION CONCERNING THE
PARENT, HOLDINGS, THE ACQUIROR AND OTHER AFFILIATES
Parent, Holdings and the Acquiror. The Parent is a newly-formed Delaware
corporation organized at the direction of (i) the KKR Partnership, an affiliate
of KKR, and (ii) WCAS VII, each of which is a private investment partnership.
Holdings is a newly-formed Delaware corporation organized at the direction of
the Parent. The Acquiror is a newly-formed North Carolina Corporation organized
at the direction of Holdings. The principal executive offices of each of the
Parent, Holdings and the Acquiror are located at 2800 Sand Hill Road, Suite
200, Menlo Park, California 94025. The telephone number for each of them is
(650) 233-6560.
KKR Partnership. The KKR Partnership, a Delaware limited partnership, is
principally engaged in the business of investing in other companies. Its
principal executive offices are located at 9 West 57th Street, New York, New
York 10019. The sole general partner of the KKR Partnership is KKR Associates
1996 L.P., a Delaware limited partnership principally engaged in the business
of investing through partnerships in other companies with its principal
executive offices at 9 West 57th Street, New York, New York 10019.
KKR Associates 1996 L.P. The sole general partner of KKR Associates 1996
L.P. is KKR 1996 GP LLC, a Delaware limited liability company principally
engaged in the business of investing through partnerships in other companies
with its principal executive offices at 9 West 57th Street, New York, New York
10019.
KKR 1996 GP LLC. The managing members of KKR 1996 GP LLC are Henry R.
Kravis and George R. Roberts. The other members of KKR 1996 GP LLC are Robert
I. MacDonnell, Paul E. Raether, Michael W. Michelson, James H. Greene, Jr.,
Michael T. Tokarz, Perry Golkin, Clifton S. Robbins, Scott M. Stuart and Edward
A. Gilhuly. Each such individual is a citizen of the United States, and the
principal occupation of each is as a managing member or member of KKR & Co.
L.L.C., which is the general partner of KKR. The principal business address of
each of Messrs. Kravis, Raether, Golkin, Tokarz, Robbins and Stuart is 9 West
57th Street, New York, New York 10019. The principal business address of each
of Messrs. Roberts, MacDonnell, Michelson, Greene and Gilhuly is 2800 Sand Hill
Road, Suite 200, Menlo Park, California 94025.
WCAS VII. The principal business of WCAS VII, a Delaware limited
partnership, is that of a private investment partnership. Its principal
executive offices are located at 320 Park Avenue, Suite 2500, New York, New
York 10022. The sole general partner of WCAS VII is WCAS VII Partners, L.P., a
Delaware limited partnership.
WCAS VII Partners, L.P. The principal business of WCAS VII Partners, L.P.
is that of acting as the general partner of WCAS VII and its principal
executive offices are located at 320 Park Avenue, Suite 2500, New York, New
York 10022.
64
<PAGE>
Each of the general partners of WCAS VII Partners, L.P. is a citizen of the
United States and each of their principal occupations is as a general partner
of WCAS VII Partners, L.P. and other associated partnerships. The general
partners are Patrick J. Welsh, Russell L. Carson, Bruce K. Anderson, Richard H.
Stowe, Andrew M. Paul, Thomas E. McInerney, Laura VanBuren, Robert A.
Minicucci, Anthony J. deNicola and Paul B. Queally. The principal business
address of each of them is c/o Welsh, Carson, Anderson & Stowe VII, L.P., 320
Park Avenue, Suite 2500, New York, New York 10022.
WCAS Directors. The WCAS Directors are Patrick J. Welsh and Andrew M.
Paul. See "MANAGEMENT -- Directors and Executive Officers of MedCath." The
principal business address of each of them is c/o Welsh, Carson, Anderson &
Stowe VII, L.P., 320 Park Avenue, New York, New York 10022. Each of the WCAS
Directors is a citizen of the United States.
Management Group. The members of the Management Group are the following
executive officers of MedCath: Stephen R. Puckett, Chairman of the Board,
President and Chief Executive Officer; David Crane, Executive Vice President
and Chief Operating Officer; Charles W. (Todd) Johnson, Senior Vice President -
Development and Managed Care; and Richard J. Post, Chief Financial Officer,
Secretary and Treasurer. See "MANAGEMENT -- Directors and Executive Officers of
MedCath." The business address for each member of the Management Group is the
principal executive offices of MedCath, 7621 Little Avenue, Suite 106,
Charlotte, North Carolina 28226. Each member of the Management Group is a
citizen of the United States.
SHAREHOLDER PROPOSALS
MedCath's annual meeting of shareholders is normally held in February of
each year. In February 1998, management postponed the date of the annual
meeting of shareholders to April 1998. When the proposed Merger was announced
in March, management again postponed the annual meeting of shareholders. If the
proposal to approve the Merger is not approved at the Special Meeting, the
annual meeting of shareholders will be held in November 1998. Proposals of
shareholders intended to be presented at the 1998 annual meeting of
shareholders must be submitted, by registered or certified mail, to the
attention of the Company's secretary at its principal executive offices by
September 1, 1998 in order to be considered for inclusion in the Company's
proxy statement and form of proxy for such meeting. If the Merger is
consummated, the annual meeting of shareholders may be scheduled for an earlier
or later date consistent with the Company's organizational documents.
INDEPENDENT AUDITORS
The Consolidated Balance Sheets as of September 30, 1997 and September 30,
1996, and the related Consolidated Statements of Income, Shareholders' Equity
and Cash Flows for each of the three fiscal years in the period ended September
30, 1997, included in this Proxy Statement have been audited by Ernst & Young
LLP, independent auditors, as stated in their report. A representative of Ernst
& Young LLP will be at the Special Meeting to answer appropriate questions from
shareholders and will have the opportunity to make a statement if so desired.
OTHER MATTERS
Management knows of no other business to be presented at the Special
Meeting. If other matters do properly come before the meeting, or any
adjournment or adjournments thereof, it is the intention of the persons named
in the proxy to vote on such matters according to their best judgment unless
the authority to do so is withheld in such proxy.
65
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
-----
<S> <C>
Financial Statements of MedCath Incorporated
March 31, 1998 Unaudited Condensed Consolidated Financial Statements:
Unaudited Condensed Consolidated Statements of Income for the Three and Six Months
Ended March 31, 1997 and 1998 ............................................................ F-2
Unaudited Condensed Consolidated Balance Sheets as of September 30, 1997 and March 31,
1998.................................................................................... F-3
Unaudited Condensed Consolidated Statements of Cash Flows for the Three and Six Months
Ended March 31, 1997 and 1998 ............................................................ F-4
Notes to Unaudited Condensed Consolidated Financial Statements ........................ F-5
September 30, 1997 Consolidated Financial Statements:
Report of Ernst & Young LLP, Independent Auditors ..................................... F-9
Consolidated Statements of Income for the Years Ended September 30, 1995, 1996 and
1997.................................................................................... F-10
Consolidated Balance Sheets at September 30, 1996 and 1997 ............................ F-11
Consolidated Statements of Shareholders' Equity for the Years Ended September 30,
1995, 1996 and 1997..................................................................... F-12
Consolidated Statements of Cash Flows for the Years Ended September 30, 1995, 1996 and
1997.................................................................................... F-13
Notes to Consolidated Financial Statements ............................................ F-14
</TABLE>
F-1
<PAGE>
MEDCATH INCORPORATED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended March
March 31, 31,
--------------------- ---------------------
1997 1998 1997 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenue ................................................ $ 26,709 $ 49,713 $ 49,564 $ 90,511
Operating expenses:
Medical supplies and other ................................ 10,814 20,112 19,410 36,965
Personnel costs ........................................... 6,992 13,708 13,137 25,186
Depreciation .............................................. 1,783 3,324 3,273 6,395
Amortization .............................................. 932 2,281 1,682 4,287
Provision for doubtful accounts ........................... 487 1,409 938 2,842
Marketing, general and administrative ..................... 1,797 2,180 3,699 4,118
-------- -------- -------- --------
Total operating expenses ................................ 22,805 43,014 42,139 79,793
-------- -------- -------- --------
Income from operations ..................................... 3,904 6,699 7,425 10,718
Interest expense ........................................... (834) (2,665) (1,536) (5,022)
Interest income ............................................ 582 401 1,257 911
Equity in net earnings of unconsolidated subsidiaries ...... -- 12 -- 12
Minority interest in earnings of consolidated entities ..... (270) (1,572) (840) (1,758)
-------- -------- -------- --------
Income before income taxes ................................. 3,382 2,875 6,306 4,861
Provision for income taxes ................................. (1,285) (1,121) (2,454) (1,896)
-------- -------- -------- --------
Net income ................................................. $ 2,097 $ 1,754 $ 3,852 $ 2,965
======== ======== ======== ========
Net income per weighted average share ...................... $ 0.19 $ 0.15 $ 0.35 $ 0.25
======== ======== ======== ========
Net income per share assuming dilution ..................... $ 0.18 $ 0.14 $ 0.33 $ 0.24
======== ======== ======== ========
Weighted average number of common and common equivalent
shares outstanding (in thousands) ......................... 11,147 11,669 11,141 11,669
======== ======== ======== ========
Weighted average number of common and common equivalent
shares outstanding assuming dilution (in thousands) ....... 11,664 12,368 11,667 12,286
======== ======== ======== ========
</TABLE>
See accompanying notes.
F-2
<PAGE>
MEDCATH INCORPORATED
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value)
<TABLE>
<CAPTION>
September 30, March 31,
1997 1998
--------------- ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents .............................................................. $ 17,607 $ 12,921
Short-term investments ................................................................. 25,344 5,610
Accounts receivable, net of allowance .................................................. 22,360 38,148
Medical supplies ....................................................................... 3,168 4,319
Prepaid expenses and other current assets .............................................. 668 1,067
--------- ---------
Total current assets ................................................................. 69,147 62,065
Property, plant and equipment, net of accumulated depreciation .......................... 139,185 194,482
Other assets ............................................................................ 2,470 6,611
Organization and start-up costs, net of accumulated amortization ........................ 13,737 17,123
Advances to physician groups ............................................................ 8,194 10,679
Intangible assets, net of accumulated amortization ...................................... 26,275 42,534
--------- ---------
Total assets ............................................................................ $ 259,008 $ 333,494
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ....................................................................... $ 4,818 $ 5,569
Distribution payable to minority interests ............................................. 1,081 2,251
Accrued liabilities .................................................................... 9,648 12,330
Current portion of long-term debt ...................................................... 5,503 13,357
Current portion of obligations under capital leases .................................... 599 611
--------- ---------
Total current liabilities ............................................................ 21,649 34,118
Deferred income taxes ................................................................... 3,731 4,298
Long-term debt .......................................................................... 96,703 147,644
Obligations under capital leases ........................................................ 2,160 1,854
--------- ---------
Total liabilities ....................................................................... 124,243 187,914
Minority interests in equity of consolidated entities ................................... 7,628 6,540
Shareholders' equity ....................................................................
Common stock, $.01 par value, 20,000,000 shares authorized, and 11,168,603 and
11,669,359 shares issued and outstanding at September 30, 1997 and March 31, 1998,
respectively ......................................................................... 112 117
Paid-in capital ........................................................................ 109,065 117,998
Retained earnings ...................................................................... 17,960 20,925
--------- ---------
Total shareholders' equity .............................................................. 127,137 139,040
--------- ---------
Total liabilities, minority interests and shareholders' equity .......................... $ 259,008 $ 333,494
========= =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
MEDCATH INCORPORATED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
March 31,
-------------------------
1997 1998
------------ ------------
<S> <C> <C>
Operating Activities
Net Income .......................................................................... $ 3,852 $ 2,965
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ...................................................... 5,040 10,680
Equity in net earnings of unconsolidated subsidiaries .............................. -- (12)
Minority interest .................................................................. (404) (374)
Deferred income taxes .............................................................. 78 567
(Increase) decrease in current assets:
Accounts receivable .............................................................. (8,503) (14,588)
Medical supplies ................................................................. (1,107) (1,151)
Prepaid expenses and other current assets ........................................ (267) (549)
Increase (decrease) in current liabilities:
Accounts payable ................................................................. 412 787
Distribution payable to minority interest ........................................ 764 1,171
Accrued liabilities .............................................................. 4,081 2,682
Other .............................................................................. (43) 15
--------- ---------
Net cash provided by operating activities ........................................... 3,903 2,193
Investing Activities
Purchases of property, plant and equipment ......................................... (38,496) (61,779)
Start-up and organization costs .................................................... (4,852) (9,010)
Advances to physician groups ....................................................... (1,114) (2,689)
Repayments of advances to physician groups ......................................... 664 204
Net sales of short-term investments ................................................ 19,099 18,126
Acquisition of management contracts ................................................ -- (5,667)
Other investing activities ......................................................... -- (1,466)
--------- ---------
Net cash used in investing activities ............................................... (24,699) (62,281)
Financing Activities
Proceeds from issuance of long-term debt ........................................... 26,671 59,447
Repayments of long-term debt ....................................................... (2,988) (4,035)
Repayments of obligations under capital leases ..................................... (233) (294)
Investments by minority partners ................................................... 3,106 716
Other financing activities ......................................................... 90 (432)
--------- ---------
Net cash provided by financing activities ........................................... 26,646 55,402
--------- ---------
Net increase (decrease) in cash and equivalents ..................................... 5,850 (4,686)
Cash and cash equivalents, beginning of period ...................................... 5,026 17,607
--------- ---------
Cash and cash equivalents, end of period ............................................ $ 10,876 $ 12,921
========= =========
</TABLE>
See accompanying notes.
F-4
<PAGE>
MEDCATH INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1998
NOTE 1 -- GENERAL
The accompanying unaudited condensed consolidated financial statements of
MedCath Incorporated (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions for Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, the statements of the unaudited interim periods
include all adjustments necessary for fair presentation of results for the
periods and all such adjustments are of a normal recurring nature. The
accompanying unaudited condensed consolidated results of operations for the
three and six month periods ended March 31, 1998, are not necessarily
indicative of the results that may be expected for the year ending September
30, 1998. For further information, refer to the audited Consolidated Financial
Statements and Notes thereto included elsewhere herein. Unless otherwise
specified, capitalized terms used herein are used as defined in such audited
Consolidated Financial Statements and Notes thereto.
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 and
assumptions.
NOTE 2 -- NET INCOME PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants,
and convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated to
conform to the SFAS 128 requirements.
NOTE 3 -- NEWLY ISSUED ACCOUNTING STANDARD
In April 1998, the AICPA issued its Statement of Position 98-5 "Reporting
on the Costs of Start-Up Activities" ("SOP 98-5"),. SOP 98-5 requires that
costs incurred during start-up activities, including organization costs, be
expensed as incurred. SOP 98-5 is effective for financial statements for fiscal
years beginning after December 15, 1998, although early application is
encouraged. Initial application of SOP 98-5 should be as of the beginning of
the fiscal year in which it is first adopted and should be reported as a
cumulative effect of a change in accounting principle.
The Company currently intends to early adopt SOP 98-5 on October 1, 1998.
Upon adoption, the Company estimates it will incur a cumulative effect of a
change in accounting principle that will range from $12.0 to $18.0 million.
This estimate includes net cost capitalized as of March 31, 1998, costs to be
capitalized from April 1, 1998 through September 30, 1998, and is net of
additional amortization expected to be incurred from April 1, 1998 through
September 30, 1998.
F-5
<PAGE>
MEDCATH INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
NOTE 4 -- LONG-TERM DEBT
Long-term debt consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30, March 31,
1997 1998
--------------- ------------
<S> <C> <C>
The REIT Loans (as defined below) .............. $ 58,781 $ 74,043
The Phoenix Loan ............................... 11,133 27,643
Convertible Subordinated Debt .................. 4,452 6,019
Notes payable to various equipment lenders ..... 27,638 53,164
Other notes payable ............................ 202 131
-------- ---------
102,206 161,001
Less current portion ........................... (5,503) (13,357)
-------- ---------
$ 96,703 $ 147,644
======== =========
</TABLE>
The Company entered into mortgage loans with real estate investment trusts
("REITs") from 1994 to 1998 for the purpose of financing the land acquisition
and construction costs of the McAllen, Arkansas, and Tucson Heart Hospitals and
the Heart Hospital of Austin (collectively the "REIT Loans"). The Company
entered into the REIT Loan for the Heart Hospital of Austin in November of
1997. The interest rates on the REIT Loans are based on a fixed premium above
the seven-year Treasury note rate and the principal and interest is payable
monthly over a seven year term using extended period amortization schedules. As
of March 31, 1998, the interest rates on the REIT Loans ranged from 9.50% to
11.54%.
In December 1997, the Company obtained financing from an equipment lender
in the amount of $7 million for the purpose of financing certain medical
equipment and fixtures in the Diagnostics Division. The term of the borrowing
is for six years and the interest rate is based on a fixed premium above the
four-year Treasury note rate and the principal and interest is payable monthly.
As of March 31, 1998, the interest rate was 8.09%. Borrowings under the
financing agreement are secured by a pledge of the Company's interest in the
financed medical equipment and fixtures.
In January 1998, the Company obtained financing from an equipment lender
providing up to $18 million for the purpose of financing certain medical
equipment at the Arizona Heart Hospital located in Phoenix, Arizona. The term
of the borrowing is for seven years and the interest rate is based on a fixed
premium above the seven-year Treasury note rate and the principal and interest
is payable monthly. As of March 31, 1998, the interest rate was 9.07%.
Borrowings under the financing agreement are secured by a pledge of the
Company's interest in the financed medical equipment.
F-6
<PAGE>
MEDCATH INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
NOTE 5 -- EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------
1997 1998
------------ ------------
<S> <C> <C> <C>
Numerator:
Net income ................................................. (A) $ 2,097 $ 1,754
Interest Expense -- Convertible Subordinated Debt .......... 28 27
-------- --------
Adjusted net income ...................................... (B) $ 2,125 $ 1,781
======== ========
Denominator:
Weighted Average Common Shares Outstanding ................. (C) 11,147 11,669
Dilutive effect of stock options ........................... 199 204
Assumed issuance of Contingently Issuable Shares ........... -- 115
Assumed conversion of Convertible Subordinated Debt into
Common Shares ............................................ 318 380
-------- --------
Adjusted weighted average shares ........................... (D) 11,664 12,368
======== ========
Basic earnings per share .................................... (A)/(C) $ 0.19 $ 0.15
======== ========
Diluted earnings per share .................................. (B)/(D) $ 0.18 $ 0.14
======== ========
<CAPTION>
Six Months Ended
March 31,
-------------------------
1997 1998
------------ ------------
<S> <C> <C>
Numerator:
Net income ................................................. $ 3,852 $ 2,965
Interest Expense -- Convertible Subordinated Debt .......... 54 54
-------- --------
Adjusted net income ...................................... $ 3,906 $ 3,019
======== ========
Denominator:
Weighted Average Common Shares Outstanding ................. 11,141 11,669
Dilutive effect of stock options ........................... 208 210
Assumed issuance of Contingently Issuable Shares ........... -- 58
Assumed conversion of Convertible Subordinated Debt into
Common Shares ............................................ 318 349
-------- --------
Adjusted weighted average shares ........................... 11,667 12,286
======== ========
Basic earnings per share .................................... $ 0.35 $ 0.25
======== ========
Diluted earnings per share .................................. $ 0.33 $ 0.24
======== ========
</TABLE>
NOTE 6 -- BUSINESS COMBINATIONS AND NEW OPERATIONS
In October 1997, the Company acquired a management service organization,
through the issuance of common stock valued at approximately $7 million, which
changed its name to MedCath Physician Management, Inc., ("MPM"). MPM has a
40-year contract to manage Pima Heart Associates ("Pima Heart"), the Company's
fourth Managed Practice. Pima Heart is a 17-member cardiologist group located
in Tucson, Arizona. The intangible asset represented by the management contract
acquired is being amortized over a 40-year period, which is the remaining term
of the management contract. The Company accounted for the acquisition as a
purchase business combination. The Company's consolidated results of operations
and financial position include the operating results, which are not
significant, of MPM from the date of acquisition.
In October 1996, the Company agreed to issue a contingent convertible
subordinated promissory note in connection with the acquisition of a 40-year
contract to manage Heart Clinic, P.A. ("Heart Clinic") a multi-physician
cardiologist group located in McAllen, Texas. The $1,567,000 note was issued in
January 1998. The amount of this note was calculated based on "Standard Net
Production Levels" for each physician practicing in Heart Clinic and was
required to be made regardless of the employment status with the practice at
the time of payment, assuming that the production levels were met, and was not
a profit sharing agreement. Accordingly, this additional amount was considered
an addition to the acquisition cost of the management contract, is recorded as
an intangible asset and is being amortized over the remaining term of the
management contract.
The Tucson Heart Hospital, located in Tucson, Arizona, is owned and
operated by MedCath of Tucson L.L.C. (the "Tucson Company"), in which MedCath
owns a majority interest and serves as manager. The Tucson Heart Hospital,
which was completed and opened in October 1997 after a Medicare and Medicaid
certification survey was completed, is a 66-bed hospital with three surgery
suites. The Tucson Heart Hospital has four cardiac catheterization laboratories
that are separately owned and operated by CCT, L.L.C. (the "Tucson Cath Lab
Company"). The Company owns a majority interest in and manages the Tucson Cath
Lab Company. The remaining interests in the Tucson Cath Lab Company are owned
by local cardiologists.
In January 1998, the Company announced that it had entered into an
agreement with Franciscan Health System of Ohio Valley, Inc. ("FHSOV") to
locate the Company's previously announced Dayton Heart Hospital on the grounds
of the Franciscan
F-7
<PAGE>
MEDCATH INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
NOTE 6 -- BUSINESS COMBINATIONS AND NEW OPERATIONS -- (Continued)
Medical Center - Dayton Campus. FHSOV will become a 30% investor in the
hospital, with the Company and local physician investors holding the remaining
interest. Under the terms of the agreement, the Company will be managing
member, with responsibility for the day-to-day operations of the hospital.
The Company has announced plans to open two new Fixed-Site Facilities by
the end of fiscal year 1998. The Company has agreed to partner with local
cardiologists and own a majority interest in the first facility located in
Colorado Springs, Colorado, and has entered into a long-term agreement to
develop and manage the second facility located in Dakota Dunes, South Dakota.
These two cath labs, in addition to the previously announced cath lab under
development in Montgomery, Alabama, will bring the total number of mobile and
fixed-site cath labs operated by the Company to 33.
In January 1998, MPM acquired a 40-year contract to manage a
seven-physician cardiology practice, Valley Cardiology, Inc. ("Valley
Cardiology"), located in McAllen, Texas, for approximately $5.5 million in cash
and equity. Valley Cardiology is the Company's fifth Managed Practice. The
intangible asset represented by the management contract acquired is being
amortized over a 40-year period, which is the remaining term of the management
contract. The Company's consolidated results of operations and financial
position include the management fees earned under this contract from the date
of its acquisition.
In February 1998, the Company announced that is had formed a joint venture
to construct a new heart hospital to be located in Albuquerque, New Mexico,
which will be the Company's eighth heart hospital. To be named the Heart
Hospital of New Mexico, the hospital will be a three-way venture between
MedCath, two leading local physician groups and St. Joseph Healthcare System, a
leading not-for-profit system in Albuquerque.
In April 1998, the Company announced that it had completed a transaction
with Dayton, Ohio-based Dayton Heart Center, Inc., under which MedCath would
provide long-term management services to the group of 11 cardiologists. Dayton
Heart Center, Inc. is the Company's sixth Managed Practice.
NOTE 7 -- PENDING TRANSACTION
In March 1998, MedCath, Kohlberg Kravis Roberts & Co. ("KKR") and Welsh
Carson, Anderson & Stowe ("Welsh, Carson") jointly announced that they had
signed a definitive agreement pursuant to which a new company formed by KKR and
Welsh, Carson, in which certain members of MedCath's senior management will be
investors, will acquire MedCath in a merger for $19 per share in cash. The
Company expects to hold a special meeting of its shareholders in July to vote
on a proposal to approve the merger.
F-8
<PAGE>
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
MEDCATH INCORPORATED
We have audited the accompanying consolidated balance sheets of MedCath
Incorporated as of September 30, 1996 and 1997, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the
three years in the period ended September 30, 1997. 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MedCath
Incorporated at September 30, 1996 and 1997, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended September 30, 1997, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Charlotte, North Carolina
November 7, 1997, except for
Note 16, as to which the date is April 9, 1998.
F-9
<PAGE>
MEDCATH INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------
1995 1996 1997
----------- ----------- ------------
<S> <C> <C> <C>
Net revenue ......................................................... $ 40,106 $ 66,191 $ 110,910
Operating expenses:
Medical supplies and other ......................................... 14,611 25,192 43,123
Personnel costs .................................................... 8,975 18,310 29,986
Depreciation ....................................................... 2,886 4,543 8,385
Amortization ....................................................... 747 2,106 4,470
Provision for doubtful accounts .................................... -- 735 2,083
Marketing, general and administrative .............................. 4,438 5,408 7,037
-------- -------- ---------
Total operating expenses ......................................... 31,657 56,294 95,084
-------- -------- ---------
Income from operations .............................................. 8,449 9,897 15,826
Interest expense .................................................... (956) (2,107) (5,236)
Interest income ..................................................... 948 1,584 2,218
Minority interest in earnings of consolidated entities .............. (1,530) (979) (1,539)
Equity in net earnings of unconsolidated joint venture .............. 117 104 --
-------- -------- ---------
Income before income taxes and extraordinary item ................... 7,028 8,499 11,269
Provision for income taxes .......................................... (2,777) (3,297) (4,315)
-------- -------- ---------
Income before extraordinary item .................................... 4,251 5,202 6,954
Extraordinary loss on early extinguishment of debt (net of tax) ..... (228) -- (230)
-------- -------- ---------
Net income .......................................................... $ 4,023 $ 5,202 $ 6,724
======== ======== =========
Net income per weighted average share:
Income before extraordinary item ................................... $ 0.55 $ 0.53 $ 0.62
Extraordinary loss ................................................. ( 0.03) -- ( 0.02)
-------- -------- ---------
Net income ......................................................... $ 0.52 $ 0.53 $ 0.60
======== ======== =========
Net income per share assuming dilution:
Income before extraordinary item ................................... $ 0.51 $ 0.51 $ 0.60
Extraordinary loss ................................................. ( 0.03) -- ( 0.02)
-------- -------- ---------
Net Income ......................................................... $ 0.48 $ 0.51 $ 0.58
======== ======== =========
</TABLE>
See accompanying notes.
F-10
<PAGE>
MEDCATH INCORPORATED
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value)
<TABLE>
<CAPTION>
As of September 30,
----------------------
1996 1997
---------- -----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents ............................................................... $ 5,026 $ 17,607
Short-term investments .................................................................. 56,667 25,344
Accounts receivable, net of allowance of $417 and $1,489 in 1996 and 1997, respectively . 10,402 22,360
Medical supplies ........................................................................ 1,549 3,168
Prepaid expenses and other current assets ............................................... 610 668
-------- --------
Total current assets .................................................................. 74,254 69,147
Property, plant and equipment, net of accumulated depreciation ........................... 72,304 139,185
Other assets ............................................................................. 1,910 2,470
Organization and start-up costs, net of accumulated amortization of $1,470 and $4,881 in
1996 and 1997, respectively .............................................................. 7,628 13,737
Advances to physician groups ............................................................. 6,363 8,194
Intangible assets, net of accumulated amortization of $1,781 and $2,308 in 1996 and 1997,
respectively ............................................................................ 19,222 26,275
-------- --------
Total assets ............................................................................. $181,681 $259,008
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ........................................................................ $ 2,861 $ 4,818
Distribution payable to minority interests .............................................. 629 1,081
Accrued liabilities ..................................................................... 3,624 9,648
Current portion of long-term debt ....................................................... 1,931 5,503
Current portion of obligations under capital leases ..................................... 393 599
-------- --------
Total current liabilities ............................................................. 9,438 21,649
Deferred income taxes .................................................................... 2,625 3,731
Long-term debt ........................................................................... 43,842 96,703
Obligations under capital leases ......................................................... 2,054 2,160
-------- --------
Total liabilities ........................................................................ 57,959 124,243
Minority interests in equity of consolidated entities .................................... 3,477 7,628
Shareholders' equity:
Common stock, $.01 par value, 20,000,000 shares authorized, and 11,121,326 and 11,168,603
shares issued and outstanding at September 30, 1996 and 1997, respectively ............ 111 112
Paid-in capital ......................................................................... 108,898 109,065
Retained earnings ....................................................................... 11,236 17,960
-------- --------
Total shareholders' equity ............................................................ 120,245 127,137
-------- --------
Total liabilities, minority interests and shareholders' equity ........................... $181,681 $259,008
======== ========
</TABLE>
See accompanying notes.
F-11
<PAGE>
MEDCATH INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Common Stock
-----------------
Shares Par
Description (000's) Value
- ------------------------------------------------------------------------- --------- -------
<S> <C> <C>
Balance at September 30, 1994 ........................................... 3,395 $ 34
Net income ............................................................. --
Issuance of Common Stock ............................................... 650 6
Issuance of Common Stock ............................................... 2,300 23
Conversion of redeemable convertible preferred stock ................... 2,288 23
Exercise of stock options .............................................. 52 1
Equity distribution of pooled entity ................................... --
Pro forma tax provision of pooled entity ............................... --
Adjustments to conform fiscal year end and accounting policies of
pooled entity ........................................................ --
Transfer of undistributed S Corporation earnings of pooled entity to
paid-in capital ...................................................... --
----- -----
Balance at September 30, 1995 ........................................... 8,685 87
Net income ............................................................. --
Issuance of Common Stock ............................................... 96 1
Issuance of Common Stock ............................................... 2,300 23
Exercise of stock options .............................................. 41 --
----- -----
Balance at September 30, 1996 ........................................... 11,122 111
Net income ............................................................. --
Exercise of stock options .............................................. 47 1
------ -----
Balance at September 30, 1997 ........................................... 11,169 $ 112
====== =====
<CAPTION>
Paid-in Retained
Description Capital Earnings Total
- ------------------------------------------------------------------------- ------------ ------------ -------------
<S> <C> <C> <C>
Balance at September 30, 1994 ........................................... $ 1,177 $ 3,046 $ 4,257
Net income ............................................................. -- 4,023 4,023
Issuance of Common Stock ............................................... 6,994 -- 7,000
Issuance of Common Stock ............................................... 28,904 -- 28,927
Conversion of redeemable convertible preferred stock ................... 6,740 -- 6,763
Exercise of stock options .............................................. 188 -- 189
Equity distribution of pooled entity ................................... -- (318) (318)
Pro forma tax provision of pooled entity ............................... -- 212 212
Adjustments to conform fiscal year end and accounting policies of
pooled entity ........................................................ -- (558) (558)
Transfer of undistributed S Corporation earnings of pooled entity to
paid-in capital ...................................................... 371 (371) --
--------- -------- ---------
Balance at September 30, 1995 ........................................... 44,374 6,034 50,495
Net income ............................................................. -- 5,202 5,202
Issuance of Common Stock ............................................... 1,899 -- 1,900
Issuance of Common Stock ............................................... 62,467 -- 62,490
Exercise of stock options .............................................. 158 -- 158
--------- -------- ---------
Balance at September 30, 1996 ........................................... 108,898 11,236 120,245
Net income ............................................................. -- 6,724 6,724
Exercise of stock options .............................................. 167 -- 168
--------- -------- ---------
Balance at September 30, 1997 ........................................... $ 109,065 $ 17,960 $ 127,137
========= ======== =========
</TABLE>
See accompanying notes.
F-12
<PAGE>
MEDCATH INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------
1995 1996 1997
------------ ------------ --------------
<S> <C> <C> <C>
Operating activities
Income before extraordinary item .................................................... $ 4,251 $ 5,202 $ 6,954
Adjustments to reconcile income before extrordinary item to net cash provided by
operating activities:
Depreciation and amortization ..................................................... 3,732 6,771 12,892
Equity in net earnings of unconsolidated joint venture ............................ (117) (104) --
Minority interest ................................................................. -- (765) (765)
Deferred income taxes ............................................................. 483 327 1,107
Current tax benefit of extraordinary loss ......................................... 140 -- 143
Pro forma tax provision of pooled entity .......................................... 212 -- --
(Increase) decrease in current assets: ............................................
Accounts receivable .............................................................. (1,281) (5,530) (11,943)
Medical supplies ................................................................. 126 (1,137) (1,619)
Prepaid expenses and other current assets ........................................ 150 (366) (5)
Increase (decrease) in current liabilities:
Accounts payable ................................................................. 274 1,897 1,919
Distribution payable to minority interest ........................................ 471 (182) 452
Accrued liabilities .............................................................. (301) 1,067 5,962
Other ............................................................................. (177) (65) (105)
--------- --------- ----------
Net cash provided by operating activities .................................... 7,963 7,115 14,992
Investing activities
Purchases of property, plant and equipment .......................................... (16,233) (44,978) (75,452)
Proceeds from sale of assets ........................................................ 353 804 542
Organization and Start-up costs ..................................................... (2,368) (6,562) (9,598)
Advances to physician groups ........................................................ (2,693) (3,456) (2,624)
Repayments of advances to physician groups .......................................... -- 463 793
Net (purchases) sales of short-term investments ..................................... (9,703) (44,964) 31,323
Acquisition of management contracts ................................................. (655) -- --
--------- --------- ----------
Net cash used in investing activities ........................................ (31,299) (98,693) (55,016)
Financing activities
Proceeds from issuance of long-term debt ............................................ 11,824 38,181 53,718
Repayments of long-term debt ........................................................ (9,915) (6,252) (4,646)
Repayments of obligations under capital leases ...................................... (1,876) (4,194) (530)
Proceeds from issuance of common stock .............................................. 29,116 62,648 168
Investments by minority partners .................................................... 2,445 376 4,916
Payment of loan acquisition costs and deferred loan fees ............................ (472) (977) (1,021)
Repayments of subordinated debt ..................................................... (4,225) -- --
Distributions to shareholders of pooled entity ...................................... (318) -- --
Distributions to minority partners .................................................. (83) -- --
--------- --------- ----------
Net cash provided by financing activities .................................... 26,496 89,782 52,605
--------- --------- ----------
Net increase (decrease) in cash and equivalents ...................................... 3,160 (1,796) 12,581
Adjustment for the effect on cash flows of pooled entity's different fiscal year ..... 196 -- --
Cash and cash equivalents, beginning of year ......................................... 3,466 6,822 5,026
--------- --------- ----------
Cash and cash equivalents, end of year ............................................... $ 6,822 $ 5,026 $ 17,607
========= ========= ==========
</TABLE>
See accompanying notes.
F-13
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1997
1. ORGANIZATION
MedCath Incorporated ("MedCath" or the "Company") provides cardiology and
cardiovascular services through the development, operation and management of
heart hospitals and other specialized cardiac care facilities and provides
physician practice management services. The Company affiliates with leading
cardiologists and cardiovascular and vascular surgeons in targeted geographic
markets in the U.S. and provides state-of-the-art facilities, financial
resources and management services. The Company's strategy is to establish and
maintain localized, fully-integrated networks to provide comprehensive
diagnostic and therapeutic cardiac care services. Key elements of the Company's
strategy are to (i) focus exclusively on cardiology and cardiovascular
services, (ii) develop and operate full-service heart hospitals, co-owned with
leading local cardiac care physicians, that are designed to have a
substantially lower cost structure than conventional acute care hospitals
("Heart Hospitals"), (iii) acquire and manage physician group practices which
include cardiologists and cardiovascular surgeons with leading local market
positions ("Managed Practices") and (iv) acquire, develop and operate
fixed-site cardiac diagnostic and therapeutic facilities ("Fixed-Site
Facilities") and mobile cardiac diagnostic centers ("Mobile Cath Labs") in
selected markets.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its 50% or greater owned subsidiaries which the Company controls. All
intercompany accounts and transactions have been eliminated in consolidation.
Investments in unconsolidated affiliates in which the Company owns 20% or
more and has significant influence over the affiliates' operating and financial
policies are accounted for using the equity method of accounting and other
investments are stated at cost.
The Company does not have exclusive authority over all decision making
related to ongoing, major, or central operations of the Managed Practices,
compensation of the licensed medical professionals, and does not have the
ability to establish and implement guidelines for the selection, hiring, and
firing of the licensed medical professionals. Accordingly, the Company does not
have a controlling financial interest in the Managed Practices as defined by
Emerging Issues Task Force No. 97-2 "Consolidation of Physicians' Practice
Entities", and therefore does not include the Managed Practices in the
Consolidated Financial Statements of the Company.
Cash and Cash Equivalents
The Company considers investments in highly liquid instruments with
maturities of three months or less to be cash equivalents.
Short-Term Investments
Short-term investments are recorded at fair value and consist of
investments in pooled investment accounts, managed by financial institutions,
which invest primarily in government-backed debt securities. On October 1,
1994, the Company adopted Statement of Financial Accounting Standard No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS
115"). In accordance with the provisions of SFAS 115, such securities would be
classified as "available for sale" and, accordingly, would be reflected at
estimated market value, with a corresponding adjustment to stockholders'
equity. The difference between the estimated market value and cost for these
securities at September 30, 1995, 1996 and 1997, was not significant.
Medical Supplies
Medical supplies consist primarily of laboratory and surgical supplies,
contrast media and catheters and are stated at the lower of first-in, first-out
(FIFO) cost or market.
F-14
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation is
provided for on the straight-line method over estimated useful lives of three
to nine years for equipment and forty years for buildings and improvements.
Interest expense incurred in connection with the construction of Heart
Hospitals is capitalized as part of the cost of the building until the facility
is operational, at which time depreciation begins using the straight-line
method over the life of the building.
Other Assets
Other assets consist primarily of the costs associated with obtaining
long-term financing, net of accumulated amortization, and are amortized to
interest expense over the life of the related debt agreements.
Organization and Start-Up Costs
Organization costs are amortized using the straight-line method over five
years. Start-up costs incurred prior to the opening of Heart Hospitals and
other new facilities are capitalized and amortized using the straight-line
method over two to three years beginning with the commencement of operations.
Advances to Physician Groups
Advances to physician groups consist of working capital advances made to
unconsolidated physician groups managed by the Company in accordance with the
terms of the related management agreements.
Intangible Assets
Intangible assets consist of amounts paid to acquire certain contracts to
manage Fixed-Site Facilities and Managed Practices, the value assigned to a
Certificate of Need ("CON") exemption and the excess of cost of acquired assets
over fair value ("goodwill"). Amortization is provided for using the
straight-line method. Intangible assets relating to management contracts are
amortized over the terms of the respective contracts, which range from 30 to 40
years, the CON exemption is amortized over eight years, and goodwill is
amortized over 40 years. The carrying value of intangible assets is reviewed if
the facts and circumstances suggest that the asset may be impaired. If this
review indicates that the value of the intangible asset will not be
recoverable, as determined based on the undiscounted cash flows of the entity
or management agreement acquired over the remaining amortization period, the
Company's carrying value of the intangible asset is reduced by the estimated
shortfall of cash flows. In addition, the Company assesses long-lived assets
for impairment under Statement of Financial Accounting Standards 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of " ("SFAS 121"). Under those rules, intangibles associated
with assets acquired in a purchase business combination are included in
impairment evaluations when events or circumstances exist that indicate the
carrying amount of those assets may not be recoverable.
Income Taxes
Deferred income taxes are provided for under the liability method based on
temporary differences that arise due to differences between tax bases of assets
or liabilities and their reported amounts in the financial statements.
Revenue Recognition
The Company's Mobile Cath Labs, Fixed-Site Facilities and Managed
Practices operate under various fixed-price and cost-reimbursement-plus fee
contracts. Revenue on fixed-price contracts is recognized as services are
rendered based on contracted rates. Revenue on cost-reimbursement-plus-fee
contracts is recognized on the basis of costs incurred during the period plus
the fee earned.
In the Company's Fixed-Site Facilities under management, the Company's
management fee is based on a percentage of the facilities' net income, ranging
from 55% to 90%, plus the reimbursement of certain operating expenses. The
total net revenue derived from the Company's Fixed-Site Facilities under
management represented 22%, 15%, and 9% of the Company's consolidated net
revenue for the fiscal years ended September 30, 1995, 1996, and 1997,
respectively. The financial
F-15
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
statements of the co-owned Fixed-Site Facilities are included in the
Consolidated Financial Statements since the Company's ownership percentage in
the facilities ranges from 51% to 60%.
The Company's management fee for the services provided to all but one of
the Managed Practices is calculated as a percentage of operating income of the
practice, ranging from 15% to 20%, plus reimbursement of certain expenses
incurred in managing the practice. In one of the Managed Practices, the
Company's management fee for the services provided is calculated as
approximately 4% of the net revenue of the practice, plus reimbursement of
certain expenses incurred in managing the practice. The total net revenue
derived from the Company's Managed Practices represented 24%, 22%, and 17% of
the Company's consolidated net revenue for the fiscal years ended September 30,
1995, 1996, and 1997, respectively. The Company's risk associated with any
managed care contracts entered into by the practices is limited to the
Company's participation in the practices' net revenue or net income.
The Company's Heart Hospitals have agreements with third party payors that
provide for payments to the hospitals at amounts different from their
established rates. Payment arrangements include prospectively determined rates
per discharge, reimbursed costs, and discounted charges. Net revenue is
reported at the estimated net realizable amounts from patients, third-party
payors, and others as services are rendered, including estimated retroactive
adjustments under reimbursement agreements with third-party payors. Retroactive
adjustments are accrued on an estimated basis in the period that the related
services are rendered and adjusted in future periods as final settlements are
determined. In 1996 and 1997, net revenue from Medicare and Medicaid patients
represented approximately 19% and 36% of consolidated net revenue,
respectively.
Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. The Company believes that it is in
compliance with all applicable laws and regulations and it is not aware of any
pending or threatened investigations involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and Medicaid programs.
Net Income Per Share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants,
and convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated to
conform to the SFAS 128 requirements.
Newly Issued Accounting Standards
In June 1997, Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"), was issued and will be adopted by the Company on October 1, 1998. SFAS
131 requires that a public company report financial and descriptive information
about its reportable operating segments pursuant to criteria that differ from
current accounting practice. Operating segments, as defined, are components of
an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. The financial information to
be reported include segment profit or loss, certain revenue and expense items
and segment assets and reconciliations to corresponding amounts in the general
purpose financial statements. SFAS 131 also requires information about products
and services, geographic areas of operation, and major customers. The Company
has not completed its analysis of the effect of adoption on its financial
statement disclosure, however, the adoption of SFAS 131 will not effect results
of operations or financial position.
Use of 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.
F-16
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
3. BUSINESS COMBINATIONS
In October 1994, the Company acquired all the outstanding stock of PhysMed
Management Services Inc. ("PhysMed"), a newly formed management services
organization, in exchange for 650,424 shares of the Company's common stock
valued at approximately $7 million. PhysMed has a 40-year contract to manage
Arizona Medical Clinic ("AMC"), a multi-physician practice which includes
several cardiologists serving the Sun City, Arizona area. Under the terms of
the management contract, the Company's fees include reimbursement of expenses
plus a percentage of the net revenue of AMC.
This acquisition has been accounted for under the purchase method of
accounting, and the results of operations have been included in the
consolidated financial statements since the acquisition date.
In April 1995, the Company acquired all of the outstanding shares of
HealthTech Corporation ("HealthTech"), which operated ten Mobile Cath Labs, in
exchange for 1 million shares of the Company's common stock in a transaction
accounted for as a pooling-of-interests.
Net revenue, net income and net income per share for the Company and
HealthTech for the period presented prior to the pooling are as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
Six Months Ended
March 31, 1995
-----------------
(unaudited)
<S> <C>
Net revenue:
MedCath ........................................... $ 16,076
HealthTech ........................................ 3,980
--------
Combined .......................................... $ 20,056
========
Net income:
MedCath ........................................... $ 1,494
HealthTech ........................................ 556
Pro forma tax provisions .......................... (212)
--------
Combined .......................................... $ 1,838
========
Combined per share data assuming dilution: .........
Income before extraordinary item .................. $ 0.26
========
Net Income ......................................... $ 0.23
========
</TABLE>
Prior to the pooling, HealthTech was an S Corporation and was therefore
not subject to U.S. Federal and State income taxes. A pro forma income tax
provision is reflected to provide for additional federal and state income taxes
which would have been incurred had HealthTech been taxed as a C Corporation. An
adjustment to retained earnings of $300,000 was recorded in 1995 to conform
accounting policies by recording deferred taxes upon HealthTech's termination
of S Corporation status.
Costs and other expenses related to the pooling amounting to approximately
$315,000 were charged to expense and decreased net income and net income per
share for the year ended September 30, 1995, by approximately $190,000 and
$.02, respectively.
F-17
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
--------------------------
1996 1997
------------ -------------
<S> <C> <C>
Land ........................................ $ 8,057 $ 16,237
Building .................................... 15,733 42,528
Medical equipment ........................... 39,233 66,972
Equipment held under capital leases ......... 2,447 1,284
Office equipment ............................ 1,759 4,754
Construction in progress .................... 17,072 27,352
--------- ---------
84,301 159,127
Less accumulated depreciation ............... (11,997) (19,942)
--------- ---------
$ 72,304 $ 139,185
========= =========
</TABLE>
Substantially all of the Company's property, plant and equipment is
pledged as collateral for various long-term obligations as described in Note 6.
Effective May 1, 1995, the Company changed its estimate of the remaining
useful lives of certain lab and x-ray equipment acquired through the
pooling-of-interest with HeathTech from five years to nine years. The Company
believes this change better reflects the actual economic life of the assets,
conforms to American Hospital Association guideline lives for these assets and
is consistent with the lives used for similar equipment by the Company. This
change in estimate increased income before extraordinary item and net income
for the year ended September 30, 1995 by approximately $182,000 ($.02 per
share).
5. SUPPLEMENTARY INFORMATION
Accounts Receivable
Accounts receivable, net consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
---------------------
1996 1997
---------- ----------
<S> <C> <C>
Receivables, principally from billings to hospitals for various cardiology procedures $ 2,272 $ 2,896
Receivables, principally from patients and third party payors ........................ 4,983 14,130
Amounts under management contracts ................................................... 1,870 3,283
Other ................................................................................ 1,277 2,051
-------- --------
$ 10,402 $ 22,360
======== ========
</TABLE>
Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
---------------------
1996 1997
---------- ----------
<S> <C> <C>
Compensation and other payroll related benefits ......... $ 2,514 $ 3,448
Vendor accruals ......................................... 343 1,915
Property taxes .......................................... 206 773
Other ................................................... 561 3,512
------- -------
$ 3,624 $ 9,648
======= =======
</TABLE>
F-18
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
6. LONG-TERM DEBT
Long-term debt consisted of the following (in thousands):
<TABLE>
<CAPTION>
September 30,
-----------------------
1996 1997
----------- -----------
<S> <C> <C>
The REIT Loans (as defined below) ........................ $ 34,570 $ 58,781
The Phoenix Loan (as defined below) ...................... -- 11,133
Convertible Subordinated Debt (as defined below) ......... -- 4,452
Notes payable to various equipment lenders ............... 10,689 27,638
Other notes payable ...................................... 514 202
-------- --------
45,773 102,206
Less current portion ..................................... (1,931) (5,503)
-------- --------
$ 43,842 $ 96,703
======== ========
</TABLE>
In July 1997, the Company terminated its existing revolving credit
facility and entered into a $20 million, unsecured revolving credit facility
(the "Revolver") with a bank, the proceeds of which are to be used for general
corporate purposes. The Revolver matures on July 28, 1999. Borrowings under the
Revolver bear interest at variable rates based, at the Company's option, on the
bank's base rate plus 1/2% or the London Interbank Offered Rate ("LIBOR") plus
1 1/2%. Amounts available under the Revolver are subject to a borrowing base
which includes a percentage of the Company's eligible accounts receivable.
Under the borrowing base, at September 30, 1997, there was approximately $18
million available under the Revolver and the Company had no outstanding
balance.
In connection with the termination of its existing revolving credit
facility, the Company recorded an extraordinary loss on early extinguishment of
debt of approximately $230,000 (net of income tax benefit of $143,000), which
represented the unamortized loan origination fees.
From 1994 to 1996, the Company entered into mortgage loans with real
estate investment trusts ("REITs") for the purpose of financing the land
acquisition and construction costs of the McAllen, Arkansas and Tucson Heart
Hospitals (collectively the "REIT Loans"). The interest rate on the REIT Loans
is at 3 1/2% to 4 1/4% above a rate index tied to U.S. Treasury Notes, that is
determined on the completion date of the hospital, and subsequently increases
by 22 to 27 basis points per year. As of September 30, 1997, the interest rates
on the REIT Loans ranged from 9.50% to 11.54%. The principal and interest is
payable monthly over a seven year term through 2005 using extended period
amortization schedules and include balloon payments at the end of each
respective term. Each are subject to extension for an additional seven years at
the option of the Company. Borrowings under the REIT Loans are secured by a
pledge of the Company's interest in the respective partnerships or limited
liability companies, the land on which the hospital stands, the hospital
building and fixtures and certain other hospital assets.
In August 1997, the Company entered into a mortgage loan with a bank for
the purpose of financing a portion of the land acquisition and construction
costs of the Arizona Heart Hospital (the "Phoenix Loan"). Borrowings of up to
$28 million are available and the term is for three years, subject to extension
for an additional year at the option of the Company. Principal amortization
begins in September 1999 using an extended amortization schedule and becomes
due and payable in September 2000, unless the term is extended by the Company.
Interest is payable monthly based on LIBOR plus 3 1/4% decreasing to LIBOR
plus 2 3/4% upon the attainment of certain financial ratios. As of September
30, 1997, the interest rate on the Phoenix Loan was 8.50%. Borrowings under the
Phoenix Loan are secured by a pledge of the Company's interest in the
Partnership, the land on which the hospital stands, the hospital building and
fixtures and certain other hospital assets.
The Company has acquired substantially all of the medical and other
equipment for the McAllen, Arkansas and Tucson Heart Hospitals under
installment notes payable to equipment lenders secured by the related
equipment. Amounts borrowed under these notes are payable in monthly
installments of principal and interest over five to seven year terms. Interest
is at fixed rates ranging from 8 1/2% to 10 3/4%.
In October 1996, the Company entered into a 40-year contract to manage
Heart Clinic, P.A. ("Heart Clinic") a multi-physician cardiologist group
located in McAllen, Texas. The Company issued a convertible subordinated
promissory note in
F-19
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
6. LONG-TERM DEBT -- (Continued)
the amount of $6.4 million in connection with the acquisition. In November
1996, $1.9 million of the outstanding principal balance was paid in accordance
with the terms of the note. The remaining principal amount of the note is due
and payable on October 1, 1998, in cash or in shares of common stock of the
Company (at the option of the noteholder) at a conversion price of $14 per
share. Interest is payable annually at a rate of 4% on the outstanding
principal. A contingent convertible subordinated promissory note was also
issued in October 1996 and the amount of the note will be based on performance
levels of the Heart Clinic physicians for the 1997 calendar year. The note is
not a profit sharing agreement and if the production levels are met, the note
will be issued regardless of the physicians' employment status with the
practice. Accordingly, additional amounts provided under the note, if any, will
be considered an addition to the acquisition cost of the management contract,
will be recorded as an intangible asset and will be amortized over the
remaining term of the management contract.
Covenants related to long-term debt prohibit the payment of dividends and
require the maintenance of specific financial ratios and amounts. The Company
was in compliance with these covenants at September 30, 1997.
In July 1997, the Company obtained a financing commitment from a REIT for
up to $35 million for the purpose of financing the land acquisition and
construction costs of the Heart Hospital of Austin. The interest rate is based
on a fixed premium above the seven-year treasury note rate and the principal
and interest is payable monthly over a seven year term using an extended period
amortization schedule.
Future maturities of long-term debt as of September 30, 1997 are as
follows (in thousands):
<TABLE>
<S> <C>
Fiscal Year
1998 ........................ $ 5,503
1999 ........................ 10,162
2000 ........................ 17,272
2001 ........................ 6,117
2002 ........................ 4,540
2003 and thereafter ......... 58,612
---------
$ 102,206
=========
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
The Company currently leases several Mobile Cath Labs, Fixed Site
Facilities, office space, computer software, and certain vehicles under
noncancelable capital and operating leases expiring through fiscal year 2002.
Some of these leases contain provisions for annual rental adjustments based on
increases in the consumer price index, renewal options and options to purchase
during the lease terms. Amortization of the capitalized amounts are included in
depreciation and amortization expense in the accompanying consolidated
financial statements through the retirement date of the leases.
F-20
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
7. COMMITMENTS AND CONTINGENCIES -- (Continued)
Total future minimum payments under leases with initial terms of one year
or more as of September 30, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
Capital Operating
----------- ----------
<S> <C> <C>
Fiscal Year
1998 ................................................ $ 838 $ 764
1999 ................................................ 838 676
2000 ................................................ 838 529
2001 ................................................ 785 442
2002 ................................................ 32 369
2003 and thereafter ................................. -- 50
------- -------
Total future minimum lease payments ................. 3,331 $ 2,830
=======
Less: amounts representing interest ................. (572)
-------
Present value of net minimum lease payments ......... 2,759
Less: current portion ............................... (599)
-------
$ 2,160
=======
</TABLE>
Rent expense under all operating leases was $1.2 million, $1.3 million and
$1.6 million for the years ended September 30, 1995, 1996 and 1997,
respectively.
The Company has entered into agreements to provide networks of hospitals
with Mobile Cath Labs and related catheterization services through 2001. In
addition, the Company leases several Mobile Cath Labs to hospitals under lease
agreements of various lengths. These are accounted for as operating leases, and
the rental income is included in revenue in the consolidated statements of
income when earned.
Total future minimum revenue to be earned under these agreements as of
September 30, 1997 is as follows (in thousands):
<TABLE>
<S> <C>
Fiscal Year
1998 ......... $ 6,126
1999 ......... 1,994
2000 ......... 774
2001 ......... 7
-------
$ 8,901
=======
</TABLE>
At September 30, 1997, the Company was contingently liable for outstanding
letters of credit of $2 million relating to the REIT Loans.
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of the matters will not have a material adverse effect, if any, on
the Company's consolidated financial position or results of operations.
F-21
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
8. INCOME TAXES
The components of the provision for income taxes were as follows (in
thousands):
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Current tax expense:
Federal ......................................... $ 1,732 $ 2,296 $ 2,466
State ........................................... 350 674 742
Deferred tax expense:
Federal ......................................... 443 253 825
State ........................................... 40 74 282
Pro forma tax provision of pooled entity ......... 212 -- --
------- ------- -------
$ 2,777 $ 3,297 $ 4,315
======= ======= =======
</TABLE>
The components of net deferred taxes were as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
---------------------------
1996 1997
------------- -------------
<S> <C> <C>
Deferred tax liabilities:
Excess of book over tax bases of property and .........
equipment ........................................... $ (1,700) $ (4,423)
Tax over book amortization ............................ (697) (64)
Other ................................................. (468) (167)
Deferred tax assets:
Nondeductible reserves ................................ 120 813
Other ................................................. 120 110
--------- ---------
Net deferred tax liability ............................. $ (2,625) $ (3,731)
========= =========
</TABLE>
The differences between the U.S. federal statutory tax rate and the
Company's effective rate were as follows:
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Statutory federal income tax rate ......... 34.0% 34.0% 34.0%
State income taxes ........................ 4.1 6.0 6.1
Tax exempt interest income ................ -- (3.3) (4.9)
Other ..................................... 1.4 2.1 3.4
---- ---- ----
Effective income tax rate ................. 39.5% 38.8% 38.6%
==== ==== ====
</TABLE>
9. SHAREHOLDERS' EQUITY AND STOCK OPTIONS
In 1995, the Company completed an initial public offering of 2.3 million
shares of its common stock netting proceeds of approximately $28.9 million. A
portion of the proceeds was used to repay $4.2 million of subordinated debt and
$9.6 million of bank financing. The remainder of the proceeds were used to fund
the development of new Heart Hospitals and Fixed-Site Facilities and ongoing
capital expenditures.
Upon the retirement of subordinated debt, the Company incurred an
extraordinary loss on the early extinguishment of debt of approximately
$228,000 (net of the income tax benefit of $140,000), which represented the
unamortized portion of the original issue debt discount. Assuming the Company
had issued the necessary shares of common stock and used the proceeds to retire
the debt on October 1, 1994, the pro forma net income per share would not have
differed from the reported amount.
F-22
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
9. SHAREHOLDERS' EQUITY AND STOCK OPTIONS -- (Continued)
In April 1996, the Company completed a public offering of 2.3 million
shares of its common stock netting proceeds of approximately $62.5 million. A
portion of the proceeds was used to repay $5.0 million outstanding under the
Revolver and $3.3 million was used to retire obligations under capital leases.
The remainder of the proceeds were used to fund (i) a portion of the
construction and start-up costs of Heart Hospitals and Fixed-Site Facilities,
(ii) potential future acquisitions, (iii) working capital and (iv) general
corporate purposes.
Assuming the Company had issued the necessary shares of common stock and
used the net proceeds to retire the Revolver and the capitalized leases on
October 1, 1995, the pro forma net income per share for the year ended
September 30, 1996, would not have differed from the reported amount.
On October 2, 1996, the Company's Board of Directors adopted a Shareholder
Rights Plan under which common stockholders have the right to purchase Series A
Participating Preferred Stock in the event of an accumulation of or tender
offer for at least 15% of the Company's common stock. The rights will expire on
October 15, 2006, unless redeemed or exchanged earlier by the Company. The
rights will be represented by existing common stock certificates until they
become exercisable and no rights are exercisable under the plan.
In August 1992, the Company adopted an Incentive Stock Option Plan (the
"ISO Plan") for key employees. The Company has reserved 296,587 shares of
common stock for issuance under the ISO Plan.
In October 1994, the Board of Directors adopted the 1994 Omnibus Stock
Plan (the "Omnibus Plan"). The Omnibus Plan is intended to encourage high
levels of performance from key employees and enable the Company to retain their
services on a basis competitive with industry practices. Through September 30,
1997, awards under the Omnibus Plan consisted of options to purchase common
stock. The Company has reserved 1,300,000 shares of common stock for issuance
under the Omnibus Plan.
In October 1994, the Board of Directors adopted the Outside Directors'
Stock Option Plan (the "Directors' Plan"). Under the Directors' Plan, each
outside director joining the Board will automatically be granted a
non-qualified option to purchase 2,000 shares of common stock at fair market
value on the date of grant. On each anniversary of an outside director's
election to the Board, an additional option to purchase 2,000 shares of common
stock will be granted at the then fair market value. The Company has reserved
50,000 shares of common stock for issuance under the Directors' Plan.
In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123") was issued. SFAS 123
encourages a fair value based method of accounting for employee stock options
and similar equity instruments, which generally would result in the recording
of additional compensation expense in an entity's financial statements. SFAS
123 also allows an entity to continue to account for stock-based employee
compensation using the intrinsic value for equity instruments under APB Opinion
No. 25. The company has adopted the disclosure-only provisions of SFAS 123.
Accordingly, no compensation cost has been recognized for the stock option
plans. Had compensation expense for the various stock option plans been
determined consistent with the provisions of SFAS 123, the Company's net income
and net income per share would have been the pro forma amounts indicated below
(in thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------
1996 1997
------------ ------------
<S> <C> <C>
Net Income:
As Reported ......................... $ 5,202 $ 6,724
Pro Forma ........................... $ 5,109 $ 6,252
Net Income Per Weighted Average Share
As Reported ......................... $ .53 $ .60
Pro Forma ........................... $ .52 $ .56
Net Income Per Share Assuming Dilution
As Reported ......................... $ .51 $ .58
Pro Forma ........................... $ .50 $ .56
</TABLE>
F-23
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
9. SHAREHOLDERS' EQUITY AND STOCK OPTIONS -- (Continued)
Because SFAS 123 is applicable only to options granted after September 30,
1995, only those subsequent years are presented.
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following range of
assumptions used for the option grants which occurred during 1996 and 1997:
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------
1996 1997
--------------- --------------
<S> <C> <C>
Volatility .................... 23.0% - 24.2% 23.0% - 24.2%
Interest rate ................. 6.0% - 6.9% 6.0% - 7.1%
Expected life (years) ......... 6 - 10 6 - 10
</TABLE>
Stock-based compensation costs on a pro forma basis would have reduced
pretax income by $153,000 ($93,000 after tax) and $768,000 ($472,000 after tax)
in 1996 and 1997, respectively. Because the SFAS 123 method of accounting has
not been applied to options granted prior to January 1, 1995, the resulting pro
forma disclosures may not be representative of that to be expected in future
years.
Option plan activity for the years ended September 30, 1995, 1996 and 1997
is set forth below:
<TABLE>
<CAPTION>
Weighted
Average Option
Number of Shares Price Price Per Share
------------------ --------------- ----------------
<S> <C> <C> <C>
Outstanding options, September 30, 1994 ..... 300,118 $ 3.91 $ 3.54-7.51
Granted ..................................... 310,000 12.31 12.00-14.00
Exercised ................................... (52,020) 3.63 3.54-7.51
Canceled .................................... -- -- --
-------
Outstanding options, September 30, 1995 ..... 558,098 $ 8.60 $ 3.54-14.00
Granted ..................................... 475,448 17.32 12.00-34.75
Exercised ................................... (40,721) 3.88 3.54-7.51
Canceled .................................... (92,500) 19.89 13.50-34.75
-------
Outstanding options, September 30, 1996 ..... 900,325 $ 12.26 $ 3.54-24.00
Granted ..................................... 270,449 14.50 13.13-19.50
Exercised ................................... (47,277) 3.54 3.54
Canceled .................................... (205,870) 16.57 3.54-18.25
--------
Outstanding options, September 30, 1997 ..... 917,627 $ 12.40 $ 3.54-24.00
========
</TABLE>
Options to purchase 26,481, 105,455 and 180,294 shares of common stock
were exercisable as of September 30, 1995, 1996 and 1997, respectively. Total
common shares reserved for future issuance under these plans were 844,567,
1,053,846 and 1,506,569 as of September 30, 1995, 1996 and 1997, respectively.
The weighted average fair value for options granted in 1996 and 1997 with an
exercise price equal to the stock price at the grant date was $7.76 and $6.49,
respectively. The weighted average fair value for options granted in 1996 and
1997 with an exercise price greater than the stock price at the grant date was
$3.32 and $6.75, respectively.
F-24
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
9. SHAREHOLDERS' EQUITY AND STOCK OPTIONS -- (Continued)
Options outstanding at September 30, 1997 consisted of the following:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------- ----------------------------
Weighted Average Weighted Average
Remaining Contractual Life Number Exercise Price Number Exercise Price
- ---------------------------- --------- ------------------ ---------- -----------------
<S> <C> <C> <C> <C>
5 Years .................... 121,140 $ 3.54 81,713 $ 3.54
6 Years .................... 23,539 7.51 15,300 7.51
8 Years .................... 286,500 12.34 29,286 13.23
9 Years .................... 254,999 15.35 33,318 15.69
10 Years ................... 231,499 14.36 20,677 13.13
------- ------
917,627 180,294
======= =======
</TABLE>
10. SUPPLEMENTAL CASH FLOW INFORMATION
The Company gave non-cash consideration totaling approximately $7.0
million, $1.9 million and $7.3 million for the years ended September 30, 1995,
1996 and 1997, respectively, for acquisitions of net assets and management
contracts.
Interest paid, net of amounts capitalized, during the years ended
September 30, 1995, 1996 and 1997 was $1.7 million, $2.0 million and $4.9
million, respectively. Total interest capitalized during the years ended
September 30, 1995, 1996 and 1997 was $0.6 million, $1.3 million and $2.3
million, respectively.
Income taxes paid, net of refunds, during the years ended September 30,
1995, 1996 and 1997 were $2.4 million, $3.4 million and $1.8 million,
respectively.
The Company entered into capital lease obligations during the years ended
September 30, 1995, 1996 and 1997 totaling $0.2 million, $2.4 million and $0.7
million, respectively.
11. MALPRACTICE INSURANCE COVERAGE
The Company is subject to claims arising in the course of providing
services. The Company maintains malpractice insurance coverage on a "claims
made" basis, with coverage being contingent on a policy being in effect when a
claim is made, regardless of when the events which gave rise to the claim
occurred.
12. EMPLOYEE BENEFIT PLAN
In January 1994, the Company adopted a defined contribution retirement
savings plan (the "401(k) Plan") which covers all employees who meet minimum
service requirements. The 401(k) Plan allows eligible employees to contribute
from 1% to 15% of their annual compensation on a pre-tax basis. The Company, at
its discretion, may make an annual contribution of up to 25% of an employee's
pre-tax contribution, up to a maximum of 6% of compensation. The Company's
contributions to the 401(k) Plan for the years ended September 30, 1995, 1996
and 1997 were approximately $38,000, $54,000 and $143,000, respectively.
13. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company considers the carrying amounts of significant classes of
financial instruments on the consolidated balance sheets, including cash,
short-term investments, loans to affiliates, long-term debt, obligations under
capital leases and other long-term obligations to be reasonable estimates of
fair value. Fair value of the Company's debt and obligations under capital
leases was estimated using discounted cash flow analysis, based on the
Company's current incremental borrowing rates for similar types of
arrangements.
F-25
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial results were as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Fiscal Year 1996:
- ---------------------------------------------------------------
Net revenue $ 11,209 $ 17,284 $ 18,376 $ 19,322
Operating expenses 8,846 14,631 16,108 16,709
--------- --------- --------- ---------
Income from operations 2,363 2,653 2,268 2,613
Net income 1,226 1,302 1,172 1,502
Net income per weighted average share $ .14 $ .15 $ .11 $ .13
========= ========= ========= =========
Net income per share assuming dilution $ .14 $ .14 $ .10 $ .13
========= ========= ========= =========
Fiscal Year 1997:
- ---------------------------------------------------------------
Net revenue 22,854 26,709 29,915 31,432
Operating expenses 19,333 22,805 25,880 27,066
--------- --------- --------- ---------
Income from operations 3,521 3,904 4,035 4,366
Income before extraordinary loss 1,754 2,097 1,546 1,557
Extraordinary loss -- -- -- (230)
--------- --------- --------- ---------
Net income $ 1,754 $ 2,097 $ 1,546 $ 1,327
========= ========= ========= =========
Income per weighted average share before extraordinary item $ .16 $ .19 $ .14 $ .13
========= ========= ========= =========
Income per share before extraordinary item assuming dilution $ .15 $ .18 $ .13 $ .14
========= ========= ========= =========
Net income per weighted average share $ .16 $ .19 $ .14 $ .12
========= ========= ========= =========
Net income per share assuming dilution $ .15 $ .18 $ .13 $ .12
========= ========= ========= =========
</TABLE>
F-26
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
15. SEGMENT INFORMATION
The Company provides cardiology and cardiovascular services through the
development, operation and management of heart hospitals (the "Hospital
Division"), the development, operation and management of Fixed-Site Facilities
and Mobile Cath Labs (the "Diagnostics Division") and provides physician
practice management services (the "Practice Management Division"). Financial
information concerning the Company's operations by business segment as of and
for the periods indicated are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended September 30
---------------------------------------
1995 1996 1997
----------- ------------- -------------
<S> <C> <C> <C>
Net revenue:
Diagnostics Division ................. $ 30,308 $ 34,085 $ 36,612
Practice Management Division ......... 9,798 14,706 18,848
Hospital Division .................... -- 17,400 54,966
Corporate and other .................. -- -- 484
-------- --------- ---------
Consolidated totals ................ $ 40,106 $ 66,191 $ 110,910
======== ========= =========
Income from operations:
Diagnostics Division ................. $ 10,611 $ 12,972 $ 12,978
Practice Management Division ......... 1,003 1,499 2,222
Hospital Division .................... -- (616) 5,267
Corporate and other .................. (3,165) (3,958) (4,641)
-------- --------- ---------
Consolidated totals ................ $ 8,449 $ 9,897 $ 15,826
======== ========= =========
Depreciation and amortization:
Diagnostics Division ................. $ 3,405 $ 3,474 $ 4,452
Practice Management Division ......... 184 251 466
Hospital Division .................... -- 2,838 7,745
Corporate and other .................. 44 86 192
-------- --------- ---------
Consolidated totals ................ $ 3,633 $ 6,649 $ 12,855
======== ========= =========
Capital expenditures:
Diagnostics Division ................. $ 3,020 $ 6,611 $ 3,334
Practice Management Division ......... -- 72 343
Hospital Division .................... 13,043 37,978 70,940
Corporate and other .................. 170 317 835
-------- --------- ---------
Consolidated totals ................ $ 16,233 $ 44,978 $ 75,452
======== ========= =========
Aggregate identifiable assets:
Diagnostics Division ................. $ 31,378 $ 37,641 $ 48,259
Practice Management Division ......... 10,289 15,089 21,484
Hospital Division .................... 21,947 68,740 158,722
Corporate and other .................. 14,758 60,211 30,543
-------- --------- ---------
Consolidated totals ................ $ 78,372 $ 181,681 $ 259,008
======== ========= =========
</TABLE>
Substantially all of the Company's revenue in its Diagnostics and Hospital
Divisions is derived directly or indirectly from patient services, and
substantially all of the Company's revenue in its Practice Management Division
is derived from management fees. The amounts presented for "Corporate and
other" include, general overhead expenses, certain cash and cash equivalents,
short-term investments, prepaid expenses, other assets and other operations of
the business not subject to segment reporting.
F-27
<PAGE>
MEDCATH INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
16. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
<S> <C>
Numerator:
Income before extraordinary item ........................................... (A)
Interest Expense -- Convertible Subordinated Debt ..........................
Adjusted income before extraordinary item .................................. (B)
Net income ................................................................. (C)
Interest Expense -- Convertible Subordinated Debt ..........................
Adjusted net income ........................................................ (D)
Denominator:
Weighted Average Common Shares Outstanding ................................. (E)
Assumed conversion of Redeemable Preferred Stock into Common Shares at
beginning of year ........................................................
Dilutive effect of stock options ...........................................
Assumed conversion of Convertible Subordinated Debt into Common Shares .....
Adjusted weighted average shares and assumed conversions ................... (F)
Basic earnings per share:
Net income before extraordinary item ....................................... (A)/(E)
Net income ................................................................. (C)/(E)
Diluted earnings per share:
Net income before extraordinary item ....................................... (B)/(F)
Net income ................................................................. (D)/(F)
<CAPTION>
Year Ended September 30,
--------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Numerator:
Income before extraordinary item ........................................... $ 4,251 $ 5,202 $ 6,954
Interest Expense -- Convertible Subordinated Debt .......................... -- -- 112
-------- -------- --------
Adjusted income before extraordinary item .................................. $ 4,251 $ 5,202 $ 7,066
======== ======== ========
Net income ................................................................. $ 4,023 $ 5,202 $ 6,724
Interest Expense -- Convertible Subordinated Debt .......................... -- -- 112
-------- -------- --------
Adjusted net income ........................................................ $ 4,023 $ 5,202 $ 6,836
======== ======== ========
Denominator:
Weighted Average Common Shares Outstanding ................................. 7,760 9,875 11,149
Assumed conversion of Redeemable Preferred Stock into Common Shares at
beginning of year ........................................................ 410 -- --
Dilutive effect of stock options ........................................... 211 318 219
Assumed conversion of Convertible Subordinated Debt into Common Shares ..... -- -- 318
-------- -------- --------
Adjusted weighted average shares and assumed conversions ................... 8,381 10,193 11,686
======== ======== ========
Basic earnings per share:
Net income before extraordinary item ....................................... $ 0.55 $ 0.53 $ 0.62
======== ======== ========
Net income ................................................................. $ 0.52 $ 0.53 $ 0.60
======== ======== ========
Diluted earnings per share:
Net income before extraordinary item ....................................... $ 0.51 $ 0.51 $ 0.60
======== ======== ========
Net income ................................................................. $ 0.48 $ 0.51 $ 0.58
======== ======== ========
</TABLE>
F-28
<PAGE>
APPENDIX A
AGREEMENT AND PLAN OF MERGER
Dated as of March 12, 1998
by and among
MEDCATH INCORPORATED,
MCTH ACQUISITION, INC.
AND
MEDCATH HOLDINGS, INC.
AGREEMENT AND PLAN OF MERGER (the "Agreement") dated as of March 12, 1998
by and among MEDCATH INCORPORATED, a North Carolina corporation ("MedCath"),
MCTH ACQUISITION INC., a North Carolina corporation ("Acquiror"), and MEDCATH
HOLDINGS, INC., a Delaware corporation (the "Parent"), which is the sole
shareholder of Acquiror.
RECITALS
The board of directors of MedCath and Acquiror deem it advisable for the
mutual benefit of MedCath and Acquiror and their respective shareholders,
respectively, that Acquiror be merged with and into MedCath (the "Merger") upon
the terms and subject to the conditions set forth in the Plan of Merger (the
"Plan of Merger"), which is set forth in the Articles of Merger in
substantially the form attached hereto as Exhibit A (the "Articles of Merger"),
and in accordance with the North Carolina Business Corporation Act ("North
Carolina Law").
The boards of directors of the Parent and Acquiror have approved and
adopted this Agreement. The board of directors and Strategic Options Committee
of MedCath have adopted this Agreement and have resolved, subject to the terms
of this Agreement, to recommend to the shareholders of MedCath to vote to
approve this Agreement in conjunction with their approval of the Plan of
Merger.
In consideration of the mutual covenants, agreements, representations and
warranties contained herein, and for the purpose of setting forth certain terms
and conditions of the Merger, and the mode of carrying the same into effect,
MedCath, the Parent and Acquiror hereby agree as follows:
ARTICLE 1
MERGER AND ORGANIZATION
Section 1.1 The Merger.
Acquiror shall be merged with and into MedCath at the Effective Time (as
defined below), upon the terms and subject to the conditions hereinafter set
forth, as permitted by and in accordance with North Carolina Law. Acquiror and
MedCath are herein sometimes referred to as the "Constituent Corporations", and
MedCath, which shall be the surviving corporation following the effectiveness
of the Merger, is sometimes referred to herein as the "Surviving Corporation".
Section 1.2 Effective Time.
If this Agreement is not terminated pursuant to Article 8 hereof, as soon
as practicable after all conditions to the Merger set forth in Article 7 hereof
shall have been satisfied or waived, MedCath and Acquiror shall cause the
Articles of Merger to be executed, acknowledged and filed with the Secretary of
State of the State of North Carolina as provided in North Carolina Law. The
Merger shall be consummated and the closing of the transactions contemplated by
this Agreement (the "Closing") shall occur immediately upon the filing of the
Articles of Merger with the Secretary of State of the State of North Carolina
(the date and time of such filing and Closing being referred to herein as the
"Effective Time"). The Closing shall take place at Simpson Thacher & Bartlett,
425 Lexington Avenue, New York, New York 10017, or at such other place as the
parties may mutually agree.
Section 1.3 Effect of Merger.
The parties agree to the following provisions with respect to the Merger:
(a) The name of the Surviving Corporation shall from and after the
Effective Time be and continue to be "MedCath Incorporated" until changed in
accordance with applicable law.
A-1
<PAGE>
(b) The articles of incorporation of MedCath shall be amended and restated
to conform to the articles of incorporation of Acquiror as in effect
immediately prior to the Effective Time; provided, however, that, at the
Effective Time, Article I of the articles of incorporation of the Surviving
Corporation shall be amended to read as follows: "The name of the corporation
is MedCath Incorporated" and Article II shall be amended to provide that the
number of authorized shares of common stock of the corporation shall be 100.
(c) The bylaws of Acquiror, as in effect immediately prior to the
Effective Time, shall be the bylaws of the Surviving Corporation until
thereafter amended in accordance with law, the articles of incorporation of the
Surviving Corporation and such bylaws.
(d) At the Effective Time, the separate corporate existence of Acquiror
shall cease, and MedCath as the surviving corporation and successor shall
succeed to Acquiror as set forth in Section 55-11-06 of the North Carolina Law.
(e) The directors of Acquiror immediately prior to the Effective Time will
be the initial directors of the Surviving Corporation, and the officers of
MedCath immediately prior to the Effective Time will be the initial officers of
the Surviving Corporation, in each case until their successors are elected and
qualified.
(f) If at any time after the Effective Time the Surviving Corporation
shall consider or be advised that any deeds, bills of sale, assignments or
assurances or any other acts or things are necessary, desirable or proper (i)
to vest, perfect or confirm, of record or otherwise, in the Surviving
Corporation its right, title or interest in, to or under any of the rights,
properties or assets of the Constituent Corporations acquired or to be acquired
as a result of the Merger, or (ii) otherwise to carry out the purposes of this
Agreement, the Surviving Corporation and its proper officers and directors or
their designees shall be authorized to execute and deliver, in the name and on
behalf of the Constituent Corporations, all such deeds, bills of sale,
assignments and assurances and do, in the name and on behalf of the Constituent
Corporations, all other acts and things necessary, desirable or proper to vest,
perfect or confirm its right, title or interest in, to or under any of the
rights, properties or assets of the Constituent Corporations acquired or to be
acquired as a result of the Merger and otherwise to carry out the purposes of
this Agreement.
ARTICLE 2
CONVERSION OF SECURITIES AT THE EFFECTIVE TIME
Section 2.1 Conversion of Securities of MedCath and Acquiror.
At the Effective Time, pursuant to this Agreement and by virtue of the
Merger and without any action on the part of MedCath, Acquiror or the holders
of any of the following securities:
(a) Each share of common stock, par value $.01 per share, of MedCath
("MedCath Common Stock") (shares of MedCath Common Stock being hereinafter
collectively referred to as "MedCath Shares" and individually as a "MedCath
Share") issued and outstanding immediately prior to the Effective Time (other
than any MedCath Shares to be cancelled pursuant to Section 2.1(b) and any
Dissenting Shares (as defined in Section 2.1(d)) shall be cancelled,
extinguished and shall be converted automatically into the right to receive an
amount equal to $19.00 in cash, without interest (the "Cash Merger
Consideration"), payable to the holder thereof, as provided in Section 2.2,
upon surrender of the certificate formerly representing the MedCath Shares
being converted into the right to receive the Cash Merger Consideration, less
any required withholding taxes;
(b) Each MedCath Share held in the treasury of MedCath and each MedCath
Share owned by Acquiror (including MedCath Shares contributed to the Parent by
agreement with the Parent which are in turn contributed by Parent to Acquiror),
if any, immediately prior to the Effective Time shall be cancelled without any
conversion thereof and no payment or distribution shall be made with respect
thereto;
(c) Each share of Acquiror's common stock, $.01 par value ("Acquiror
Common Stock"), that is issued and outstanding immediately prior to the
Effective Time shall be converted into one newly issued, fully paid and
nonassessable share of common stock of the Surviving Corporation;
(d) Notwithstanding anything in this Agreement to the contrary, shares of
MedCath Common Stock issued and outstanding immediately prior to the Effective
Time held by a holder who has the right, if any, under North Carolina Law, to
demand payment for an appraisal of such shares in accordance with Article 13 of
the North Carolina Law (or any successor provision) ("Dissenting Shares") shall
not be converted into a right to receive the Cash Merger Consideration (but
shall have the rights set forth in Article 13 of the North Carolina Law (or any
successor provision), if applicable) unless such holder fails to perfect or
otherwise loses such holder's right to such payment or appraisal, if any,
pursuant to Article 13 of
A-2
<PAGE>
the North Carolina Law. If, after the Effective Time, such holder fails to
perfect or loses any such right to appraisal, each such share of such holder
shall be treated as a share that had been converted as of the Effective Time
into the right to receive the Cash Merger Consideration in accordance with this
Section 2.1. MedCath shall give prompt notice to Acquiror of any notices of
dissent, demands for payment of fair value or other communications or actions
received by MedCath with respect to shares of MedCath Common Stock, and
Acquiror shall have the right to participate in and approve all negotiations
and proceedings with respect thereto. MedCath shall not, except with the prior
written consent of Acquiror, make any payment with respect to, or settle or
offer to settle, any such demands.
Section 2.2 Payment of Cash for MedCath Common Stock.
(a) At the Effective Time, the Parent or Acquiror shall irrevocably
deposit or cause to be deposited with a bank or trust company to be designated
by Acquiror and reasonably satisfactory to MedCath which is organized and doing
business under the laws of the United States or any state thereof and has a
combined capital and surplus of at least $100,000,000 (the "Disbursing Agent"),
as agent for the holders of shares of MedCath Common Stock, cash in the
aggregate amount required to effect conversion of shares of MedCath Common
Stock into the Cash Merger Consideration at the Effective Time pursuant to
Section 2.1(a) hereof. Pending distribution pursuant to Section 2.2(b) hereof
of the cash deposited with the Disbursing Agent, such cash shall be held in
trust for the benefit of the holders of MedCath Common Stock and the fund shall
not be used for any other purposes, and Acquiror and Surviving Corporation may
direct the Disbursing Agent to invest such cash, provided that such investments
(i) shall be obligations of or guaranteed by the United States of America,
commercial paper obligations receiving the highest rating from either Moody's
Investors Services, Inc. or Standard & Poor's Corporation, or certificates of
deposit, bank repurchase agreements or bankers acceptances of domestic
commercial banks with capital exceeding $250,000,000 (collectively "Permitted
Investments") or money market funds which are invested solely in Permitted
Investments and (ii) shall have maturities that will not prevent or delay
payments to be made pursuant to Section 2.2(b) hereof. Each holder of a
certificate or certificates representing shares of MedCath Common Stock
cancelled on the Effective Time pursuant to Section 2.1(a) hereof may
thereafter surrender such certificate or certificates to the Disbursing Agent,
as agent for such holder of shares of MedCath Common Stock, which shall effect
the exchange of such certificate or certificates on such holder's behalf for a
period ending six months after the Effective Time. Any interest and other
income resulting from such investments shall be paid to Acquiror.
(b) After surrender to the Disbursing Agent of any certificate which prior
to the Effective Time shall have represented any shares of MedCath Common
Stock, the Disbursing Agent shall promptly distribute to the person in whose
name such certificate shall have been registered a check representing the
amount of cash into which such shares of MedCath Common Stock shall have been
converted at the Effective Time pursuant to Section 2.1(a) hereof. Until so
surrendered and exchanged, each such certificate shall, after the Effective
Time, be deemed to represent only the right to receive such cash, and until
such surrender and exchange, no cash shall be paid to the holder of such
outstanding certificate in respect thereof. The Surviving Corporation shall
promptly after the Effective Time cause to be distributed to such holders
appropriate materials to facilitate such surrender.
(c) If any cash deposited with the Disbursing Agent for purposes of
payment in exchange for shares of MedCath Common Stock remains unclaimed
following the expiration of six (6) months after the Effective Time, such cash
shall be delivered to the Surviving Corporation by the Disbursing Agent, and
thereafter the Disbursing Agent shall not be liable to any persons claiming any
amount of such cash, and the surrender and exchange shall be effected directly
with the Surviving Corporation (subject to applicable abandoned property,
escheat and similar laws). No interest shall accrue or be payable with respect
to any amounts which any such holder shall be so entitled to receive. The
Surviving Corporation or the Disbursing Agent shall be authorized to pay the
cash attributable to any certificate theretofore issued which has been lost or
destroyed, upon receipt of satisfactory evidence of ownership of the shares of
MedCath Common Stock represented thereby and of appropriate indemnification.
(d) None of Acquiror, the Surviving Corporation or the Disbursing Agent
shall be liable to any person in respect of any shares of retained MedCath
Common Stock (or dividends or distributions with respect thereto) or cash
delivered to a public official pursuant to any applicable abandoned property,
escheat or similar law. If any certificates representing shares of MedCath
Common Stock shall not have been surrendered prior to two years after the
Effective Time (or immediately prior to such earlier date on which any cash, if
any, in lieu of fractional shares of retained MedCath Common Stock or any
dividends or distributions with respect to retained MedCath Common Stock in
respect of such certificate would otherwise escheat to or become the property
of any governmental entity), any such cash, dividends or distributions in
respect of such certificate shall, to the extent permitted by applicable law,
become the property of the Surviving Corporation, free and clear of all claims
or interest of any person previously entitled thereto.
A-3
<PAGE>
(e) If payment is to be made to a person other than the person in whose
name a surrendered certificate, which prior to the Effective Time shall have
represented any shares of MedCath Common Stock, is registered, it shall be a
condition to such payment that the certificate so surrendered shall be endorsed
or shall otherwise be in proper form for transfer, and that the person
requesting such payment shall have paid any transfer and other taxes required
by reason of such payment in a name other than that of the registered holder of
the certificate surrendered or shall have established to the satisfaction of
the Surviving Corporation or the Disbursing Agent that such tax either has been
paid or is not payable.
(f) From and after the Effective Time, the holders of shares of MedCath
Common Stock outstanding immediately prior to the Effective Time shall cease to
have any rights with respect to such shares of MedCath Common Stock except as
otherwise provided herein or by law.
(g) After the Effective Time, there shall be no transfers on the stock
transfer books of the Surviving Corporation of any shares of MedCath Common
Stock which were outstanding immediately prior to the Effective Time. If, after
the Effective Time, certificates for shares of MedCath Common Stock are
presented to the Surviving Corporation, they shall be cancelled and promptly
exchanged for Cash Merger Consideration except as provided in Section 2.2(d).
Section 2.3 Exchange of Acquiror Common Stock Certificate.
Immediately after the Effective Time, upon surrender by the record holder
of the certificate, duly endorsed in blank, representing the shares of Acquiror
Common Stock outstanding immediately prior to the Effective Time, the Surviving
Corporation shall deliver to such record holder a share certificate, registered
in such holder's name, representing the number of shares of common stock of the
Surviving Corporation to which such record holder is so entitled by virtue of
Section 2.1(c). Such certificate will bear a legend restricting the
transferability of such shares of the Surviving Corporation except in
accordance with applicable federal and state securities laws.
ARTICLE 3
ADDITIONAL AGREEMENTS IN CONNECTION WITH THE MERGER
Section 3.1 Shareholders' Approval.
MedCath shall take all actions reasonably necessary in accordance with
applicable law and its articles of incorporation and bylaws to convene a
meeting of its shareholders as soon as reasonably practicable for the purpose
of considering and approving this Agreement and the Merger (the "Special
Meeting"). In connection with the Special Meeting, the board of directors of
MedCath shall recommend that the shareholders of MedCath vote to approve this
Agreement and the Merger unless the Strategic Options Committee of such board
of directors (the "Strategic Options Committee") has determined at any time
prior to the Special Meeting in good faith, after consultation with and based
upon the reasonably concluded written advice of counsel to the Strategic
Options Committee, that making such recommendation would violate the fiduciary
duties of the board of directors under applicable law.
Section 3.2 Proxy Materials and Schedule 13E-3.
(a) In connection with the Special Meeting, MedCath shall prepare and file
a preliminary proxy statement relating to the transactions contemplated by this
Agreement and the Merger (the "Preliminary Proxy Statement") with the United
States Securities and Exchange Commission (the "SEC") and shall use its
reasonable best efforts to respond to the comments of the SEC and to cause a
definitive proxy statement to be mailed to MedCath's shareholders (the
"Definitive Proxy Statement") all as soon as reasonably practicable; provided,
that prior to the filing of each of the Preliminary Proxy Statement and the
Definitive Proxy Statement, MedCath shall consult with Acquiror with respect to
such filings and shall afford Acquiror reasonable opportunity to comment
thereon. Acquiror shall provide MedCath with any information for inclusion in
the Preliminary Proxy Statement and the Definitive Proxy Statement which may be
required under applicable law and which is reasonably requested by MedCath.
(b) MedCath and any Person that may be deemed to be an affiliate of
MedCath shall prepare and file concurrently with the filing of the Preliminary
Proxy Statement a Statement on Schedule 13E-3 ("Schedule 13E-3") with the SEC.
If at any time prior to the Special Meeting any event should occur which is
required by applicable law to be set forth in an amendment of, or supplement
to, the Schedule 13E-3, MedCath and such Person shall file such amendments or
supplements.
Section 3.3 Termination of MedCath Stock Option Plans.
Except as disclosed in Item 3.3 of the Disclosure Schedules, all
outstanding stock options issued by MedCath (collectively, the "Stock
Options"), including without limitation those issued under the MedCath
Incorporated Omnibus Stock Plan,
A-4
<PAGE>
the 1992 Incentive Stock Option Plan and the Outside Director's Stock Option
Plan shall terminate upon the Merger. With respect to each Stock Option not
otherwise terminated by its terms upon the effectiveness of the Merger, MedCath
shall obtain at the earliest practicable date and prior to the Effective Time
the written consent of each holder to the cancellation of such holders' Stock
Options (irrespective of their exercise price and whether or not then currently
exercisable) to take effect on the Effective Time or shall take appropriate
action to amend the relevant plans to provide for such cancellation. At the
Effective Time, the Surviving Corporation shall pay each holder of Stock
Options, to the extent such Stock Options have not been previously exercised or
cancelled, (x) cash in an amount equal to the product of (i) the difference
between $19.00 and the exercise price of such Stock Options (but in no event
less than 0), multiplied by (ii) the number of shares of MedCath Common Stock
subject to such Stock Options, less (y) the amount of all applicable
withholding taxes; provided, that those holders of Stock Options that have
agreed in writing with Acquiror to accept options to purchase common stock of
the Parent shall not receive any cash payment with respect to cancelled Stock
Options.
Section 3.4 Reasonable Best Efforts; Consents; Other Filings.
Upon the terms and subject to the conditions herein provided, and subject
to the duties of the board of directors of MedCath under applicable law, as it
or the Strategic Options Committee may be advised in writing by counsel, each
party hereto shall use its reasonable best efforts to take, or cause to be
taken, all reasonable action and to do, or cause to be done and to assist and
cooperate with the other parties hereto in doing, all things necessary, proper
or advisable under applicable laws and regulations and their respective
articles or certificates of incorporation and bylaws to consummate and make
effective, as soon as reasonably practicable, the transactions contemplated by
this Agreement, subject, however, to the requisite vote of shareholders of
MedCath. Such actions shall include, without limitation, using its reasonable
best efforts to (i) defend any lawsuits or other legal proceedings, whether
judicial or administrative and whether brought derivatively or on behalf of
third parties (including governmental agencies or officials), challenging this
Agreement, or the consummation of the transactions contemplated thereby or
hereby and (ii) effect all necessary registrations and filings, including but
not limited to any filings required under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the rules and regulations promulgated
thereunder (the "HSR Act"), and submissions of information requested by
governmental authorities. Upon the terms and subject to the conditions hereof,
and subject to the duties of the board of directors of MedCath under applicable
law, as it, or the Strategic Options Committee, may be advised in writing by
counsel, each of the parties hereto shall use its reasonable best efforts to
take, or cause to be taken, all reasonable actions and to do, or cause to be
done, all things necessary to satisfy the other conditions of Closing set forth
herein and to cooperate with all reasonable requests made by the other party.
Without limiting the generality of the foregoing, and notwithstanding anything
in this Agreement to the contrary, MedCath shall, except with respect to the
agreements as set forth on Item 3.4 of the Disclosure Schedules, obtain all
consents, amendments to or waivers from other parties under the terms of all
leases and other agreements between MedCath and such parties required as a
result of the transactions contemplated by this Agreement (including the
agreements listed in Item 3.8 of the Disclosure Schedules) the failure of which
to obtain would have a Material Adverse Effect and obtain all necessary
consents, approvals and authorizations as are required to be obtained under any
federal or state law or regulation.
Section 3.5 Financing.
MedCath shall use its reasonable best efforts to cooperate and assist
Acquiror with respect to the Financing (as defined in Section 6.7).
Section 3.6 Conduct of Business by MedCath Pending the Merger.
MedCath covenants and agrees that, prior to the Effective Time or earlier
termination of this Agreement as provided herein, unless Acquiror shall
otherwise agree in writing and except as contemplated by this Agreement:
(a) MedCath shall, and shall cause its subsidiaries to, act and carry on
their respective businesses in the ordinary course of business substantially
consistent with past practice and use its and their respective reasonable best
efforts to preserve substantially intact their current material business
organizations, keep available the services of their current officers and
employees (except for terminations of employees in the ordinary course of
business) and preserve their material relationships with others having
significant business dealings with them;
(b) MedCath shall not (i) amend its articles of incorporation or bylaws,
or (ii) declare, set aside or pay any dividend or other distribution or payment
in cash, stock or property in respect of any of its shares of capital stock;
(c) Neither MedCath nor any of its subsidiaries shall (i) except as set
forth in Item 3.6(c) of the Disclosure Schedules, issue, grant, sell, pledge or
transfer or agree or propose to issue, grant, sell, pledge or transfer any
shares of capital stock, stock options, warrants, securities or rights of any
kind or rights to acquire any such shares, securities or rights of MedCath,
A-5
<PAGE>
any of its subsidiaries or any successor thereto, (ii) acquire directly or
indirectly by redemption or otherwise any shares of the capital stock of
MedCath of any class or any options, warrants or other rights to purchase any
such shares except as otherwise provided in this Agreement, or (iii) enter into
or modify any contract, agreement, commitment or arrangement with respect to
any of the foregoing;
(d) Except as disclosed in Item 3.6(d) of the Disclosure Schedules,
neither MedCath nor any of its subsidiaries shall (i) incur any indebtedness
for borrowed money or guarantee any such indebtedness of another person, issue
or sell any debt securities or warrants or other rights to acquire any debt
securities of MedCath or any of its subsidiaries, guarantee any debt securities
of another person, enter into any "keep well" or other agreement to maintain
any financial statement condition of another person or enter into any
arrangement having the economic effect of any of the foregoing, except for
short-term borrowings incurred in the ordinary course of business consistent
with past practice under existing indebtedness agreements, or (ii) make any
loans, advances or capital contributions to, or investments in, any other
person, other than to MedCath or any direct or indirect wholly-owned subsidiary
of MedCath;
(e) Each of MedCath and its subsidiaries shall use its reasonable best
efforts to keep in place its current insurance policies which are material
(either individually or in the aggregate) to the conduct of their business; and
notwithstanding such efforts, if any such policy is cancelled, MedCath shall
use its reasonable best efforts to replace such policy or policies;
(f) Neither MedCath nor any of its subsidiaries shall make any material
tax election, file any amended Tax Returns or settle or compromise any material
federal, state, local or foreign income tax liability;
(g) Neither MedCath nor any of its subsidiaries shall make any material
change in its accounting principles or methods except insofar as may be
required by a change in generally accepted accounting principles;
(h) Neither MedCath nor any of its subsidiaries shall split, combine or
reclassify any capital stock of MedCath or any subsidiary or issue or authorize
the issuance of any other securities in respect of, in lieu of or substitution
for shares of capital stock of MedCath or any subsidiary;
(i) Neither MedCath nor any of its subsidiaries shall acquire or agree to
acquire by merging or consolidating with, or by purchasing a substantial
portion of the stock or assets of, or by any other manner, any business or any
corporation, partnership, joint venture, association or other business
organization or division thereof having a value in excess of $250,000;
(j) Neither MedCath nor any of its subsidiaries shall agree to any
development deals, except to the extent such deals would require an investment
of less than $100,000 individually and $250,000 in the aggregate;
(k) Except as set forth in Item 3.6(k) of the Disclosure Schedules,
neither MedCath nor any of its subsidiaries shall sell, lease, license,
mortgage or otherwise encumber or subject to any lien or otherwise dispose of
any of its properties or assets other than any such properties or assets the
value of which do not exceed $250,000 individually and $1,000,000 in the
aggregate, except sales of inventory and receivables in the ordinary course of
business consistent with past practice;
(l) Neither MedCath nor any of its subsidiaries shall acquire or agree to
acquire any assets, other than inventory in the ordinary course of business
consistent with past practice, that are material, individually or in the
aggregate, to MedCath and its subsidiaries taken as a whole, or make or agree
to make any capital expenditures except capital expenditures which,
individually or in the aggregate and taken together with any capital
expenditure made between October 1, 1997 and the date hereof (inclusive), do
not exceed the amount budgeted therefor in MedCath's annual capital
expenditures budget for 1998 previously provided to Acquiror;
(m) Neither MedCath nor any of its subsidiaries shall (x) pay, discharge
or satisfy any material claims (including claims of stockholders), liabilities
or obligations (absolute, accrued, asserted or unasserted, contingent or
otherwise), except for the payment, discharge or satisfaction of (i)
liabilities or obligations in the ordinary course of business consistent with
past practice or in accordance with their terms as in effect on the date hereof
including without limitation all liabilities disclosed in Item 3.6(d) of the
Disclosure Schedules or (ii) claims settled or compromised to the extent
permitted by Section 3.6(p), or (y) waive, release, grant, or transfer any
rights of material value or modify or change in any material respect any
existing material license, lease, contract or other document, other than in the
ordinary course of business consistent with past practice;
(n) Neither MedCath nor any of its subsidiaries shall adopt a plan of
complete or partial liquidation or resolutions providing for or authorizing
such a liquidation or a dissolution, merger, consolidation, restructuring,
recapitalization or reorganization;
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<PAGE>
(o) Neither MedCath nor any of its subsidiaries shall enter into any new
collective bargaining agreement or any successor collective bargaining
agreement to any collective bargaining agreement;
(p) Neither MedCath nor any of its subsidiaries shall settle or compromise
any litigation (whether or not commenced prior to the date of this Agreement)
other than settlements or compromises of litigation where the settlement is
limited solely to monetary payment and the release of claims and the amount
paid (after giving effect to insurance proceeds actually received) in
settlement or compromise does not exceed $250,000, provided that the aggregate
amount paid in connection with the settlement or compromise of all such
litigation matters shall not exceed $350,000;
(q) Neither MedCath nor any of its subsidiaries shall engage in any
transaction with, or enter into any agreement, arrangement, or understanding
with, directly or indirectly, any of MedCath's affiliates, including, without
limitation, any transactions, agreements, arrangements or understandings with
any affiliate or other Person covered under Item 404 of SEC Regulation S-K that
would be required to be disclosed under such Item 404 other than such
transactions of the same general nature, scope and magnitude as are disclosed
in documents filed by MedCath with the SEC as described in Section 4.6;
(r) Neither MedCath nor any of its subsidiaries shall adopt or amend
(except as may be required by law) any bonus, profit sharing, compensation,
stock option, pension, retirement, deferred compensation, employment or other
employee benefit plan, agreement, trust, fund or other arrangement for the
benefit or welfare of any employee, director or former director or employee or,
other than increases for individuals and arrangements for new employees (other
than, in each case, officers and directors) in the ordinary course of business
consistent with past practice, increase the compensation or fringe benefits of
or loan or advance money or other property to any director, employee or former
director or employee or pay any benefit not required by any existing plan,
arrangement or agreement;
(s) Neither MedCath nor any of its subsidiaries shall grant to employees
any new or modified severance (except for increases in severance granted to
employees other than officers in the ordinary course of business which are
immaterial individually and in the aggregate) or termination arrangement or
increase or accelerate any benefits payable under its severance or termination
pay policies in effect on the date hereof;
(t) Neither MedCath nor any of its subsidiaries shall effectuate a "plant
closing" or "mass layoff", as those terms are defined in the Worker Adjustment
and Retraining Notification Act of 1988 ("WARN"), affecting in whole or in part
any site of employment, facility, operating unit or employee of MedCath or any
subsidiary, without notifying Acquiror or its affiliates in advance and without
complying with the notice requirements and other provisions of WARN; and
(u) Neither MedCath nor any of its subsidiaries shall authorize any, or
commit or agree to do any of the things described in clauses (a) through (t) or
anything which would make any representation or warranty of MedCath in this
Agreement untrue or incorrect in any material respect as of the date hereof and
as of the Effective Time, as if made on such date, except to the extent such
representations and warranties expressly relate to a specific date (in which
case such representations and warranties shall be true and correct as of such
date).
Section 3.7 MedCath's Notification of Certain Matters.
MedCath shall, promptly upon obtaining knowledge of any of the following
occurring subsequent to the date of this Agreement and prior to the Effective
Time, notify Acquiror of: (a) any material claims, actions, proceedings, tax
audits or investigations commenced or, to its knowledge, threatened in writing,
involving or affecting MedCath or any of its subsidiaries or any of their
properties or assets, which if adversely resolved would have a Material Adverse
Effect or which could reasonably be expected to prevent, hinder or materially
delay the ability of MedCath to consummate the Merger or the transactions
contemplated by this Agreement, (b) any notice of, or other communication
relating to, a default or event which, with notice or lapse of time or both,
would become a default, received by MedCath or any of its subsidiaries, under
any agreement, lease, indenture or instrument to which MedCath or any of its
subsidiaries is a party or is subject where such a default would have a
Material Adverse Effect on MedCath or (c) any notice or other communication
from any third party alleging that the consent of such third party is or may be
required in connection with the transactions contemplated by this Agreement.
Section 3.8 Access to MedCath's Books and Records.
Upon reasonable notice, MedCath shall afford Acquiror and its
representatives and representatives of all prospective sources of Financing
reasonable access during normal business hours to the properties, books,
records and personnel of MedCath and its subsidiaries and such additional
information concerning the business and properties of MedCath and its
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subsidiaries as Acquiror and its representatives may reasonably request. Unless
and until MedCath otherwise agrees, Acquiror will obtain appropriate
undertakings from the representatives of all prospective sources of Financing
to hold in confidence all confidential information and not use any confidential
information except in connection with the transactions contemplated hereby and
the Financing, all in accordance with that certain letter agreement dated
October 1, 1997 by and between Kohlberg Kravis Roberts & Co., L.P. and MedCath,
the terms of which are incorporated herein by reference (the "Confidentiality
Agreement"). The parties acknowledge that the Confidentiality Agreement shall
remain in full force and effect until the Closing.
Section 3.9 Acquisition Proposals.
Any offer or proposal by any corporation, partnership, person or other
entity or group concerning any tender or exchange offer, proposal for a merger,
share exchange, recapitalization, consolidation or other business combination
involving MedCath or any of its subsidiaries or divisions, or any proposal or
offer to acquire in any manner, directly or indirectly, a significant equity
interest in, or a substantial portion of the assets of, MedCath or any of its
subsidiaries, other than pursuant to the transactions contemplated by this
Agreement, is hereby defined as an "Acquisition Proposal". MedCath shall not,
nor shall it permit any of its officers, directors, affiliates, representatives
or agents to, directly or indirectly, (a) take any action to solicit, initiate
or knowingly encourage any Acquisition Proposal, or (b) participate in any
discussions or negotiations with or encourage any effort or attempt by any
other person or entity or take any other action to facilitate an Acquisition
Proposal. From and after the date hereof, MedCath, its subsidiaries and all
officers, directors, employees of, and all investment bankers, attorneys and
other advisors and representatives of, MedCath and its subsidiaries shall cease
doing any of the foregoing. Notwithstanding the foregoing, MedCath or any such
persons may, directly or indirectly, subject to a confidentiality agreement
substantially no less favorable taken as a whole to MedCath than the
Confidentiality Agreement, furnish to any party information and access in
response to a request for information or access made incident to an Acquisition
Proposal made after the date hereof and may participate in discussions and
negotiate with such party concerning any written Acquisition Proposal made
after the date hereof (provided neither MedCath nor any such Person, after the
date hereof, solicited, initiated or encouraged such Acquisition Proposal), if
the board of directors of MedCath, or in the event of an Acquisition Proposal
in which a member of such Board of Directors or any affiliate thereof has an
interest which would be adverse to MedCath (an "Interested Party Proposal"),
then the Strategic Options Committee, shall have determined in good faith based
upon the reasonably concluded written advice of outside counsel to MedCath or
counsel to the Strategic Options Committee, as the case may be, that failing to
take such action would violate MedCath's board of directors' fiduciary duty
under applicable law. During the term of this Agreement, the board of directors
of MedCath shall notify Acquiror immediately if any Acquisition Proposal is
made and shall in such notice indicate in reasonable detail the identity of the
offeror and the terms and conditions of such Acquisition Proposal and shall
keep Acquiror promptly advised of all material developments which could
reasonably be expected to culminate in the board of directors withdrawing,
modifying or amending its recommendation of the Merger and the other
transactions contemplated by this Agreement. During the term of this Agreement,
MedCath shall not waive or modify any provisions contained in any
confidentiality agreement entered into relating to a possible acquisition
(whether by merger, stock purchase, asset purchase or otherwise) or
recapitalization of MedCath.
Section 3.10 Director and Officer Protection.
The Surviving Corporation shall indemnify, defend and hold harmless the
present and former directors, officers, employees and agents of MedCath and its
subsidiaries (each an "Indemnified Party") against all costs and expenses
(including reasonable attorney's fees), judgments, fines, losses, claims,
damages, liabilities and settlement amounts relating to actions or omissions
arising out of the Indemnified Party's being a director, officer, fiduciary,
employee or agent of MedCath at or prior to the Effective Time (including the
transactions contemplated by this Agreement) to the fullest extent permitted
under applicable law, whether or not the Surviving Corporation is insured
against any such matter (and shall pay any expenses in advance of the final
disposition of such action or proceeding to each Indemnified Party as such
expenses are incurred to the fullest extent permitted under applicable law,
provided MedCath or the Surviving Party, as the case may be, receives from the
Indemnified Party to whom expenses are advanced an undertaking to repay such
advances required under applicable law). Without limiting the foregoing, in any
case in which approval by the Surviving Corporation is required to effectuate
any indemnification, the Surviving Corporation shall direct, at the election of
the Indemnified Party, that the determination of any such approval shall be
made by independent counsel mutually agreed to by the Surviving Corporation and
the Indemnified Party. The Surviving Corporation shall maintain in effect for a
period of six years after the Effective Time directors' and officers' liability
insurance with respect to matters occurring prior to the Effective Time which
insurance shall contain terms and conditions no less advantageous than are
contained in MedCath's current directors' and officers' liability insurance
policy; provided, the Surviving Corporation shall not be required to pay an
annual premium for such insurance in
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excess of two times the current annual premium. In the event MedCath or the
Surviving Corporation or any of their respective successors or assigns (i)
consolidates with or merges into any other person and shall not be the
continuing or surviving corporation or entity of such consolidation or merger
or (ii) transfers all or substantially all of its properties and assets to any
person, then, and in each case, proper provision shall be made so that the
successors and assigns of MedCath or the Surviving Corporation, as the case may
be, or, at the Parent's option, the Parent shall assume the obligations set
forth in this Section 3.10.
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF MEDCATH
MedCath represents and warrants to Acquiror and Parent as follows:
Section 4.1 Organization and Good Standing.
Each of MedCath and its subsidiaries is a duly organized and validly
existing corporation in good standing under the laws of the state of its
incorporation with all requisite power and authority (corporate and other) to
own, lease and operate its properties and conduct its business and is duly
qualified and in good standing as a foreign corporation authorized to do
business in each of the jurisdictions in which the character of the properties
owned or held under lease by it or the nature of the business transacted by it
makes such qualification necessary, except where the failure to be so qualified
would not have a Material Adverse Effect on MedCath and its subsidiaries, taken
as a whole. MedCath has heretofore delivered to Acquiror accurate and complete
copies of its and its subsidiaries' certificates or articles of incorporation
and bylaws, as currently in effect. For the purposes of this Agreement
"Material Adverse Change" or "Material Adverse Effect" means any change or
effect that either individually or in the aggregate is materially adverse to
the business, assets, operations, properties, financial condition or results of
operations of MedCath and its subsidiaries taken as a whole and is exclusive of
any claims or litigation involving MedCath and its subsidiaries relating to the
absence of the consents, waivers or approvals relating to the Merger with
respect to the agreements set forth in Item 3.4 of the schedules provided by
MedCath to Acquiror and Parent ("Disclosure Schedules"); provided that for the
purposes of this Agreement, "Material Adverse Effect" shall exclude the effect
on the business, assets, operations, properties, financial condition or results
in operations (i) from the delay until July 1, 1998 in the opening of the heart
hospital in Phoenix, to the extent such delay was caused by the flood that
occurred on January 18, 1998 and (ii) from the financial performance of the
heart hospital in Tucson, other than changes in financial performance from and
after the date hereof when compared to the financial performance prior to the
date hereof; provided that nothing in the immediately prior proviso shall be
interpreted to mean that delays in the opening of the heart hospital in Phoenix
beyond July 1, 1998 or further changes in the financial performance of the
Tucson heart hospital are per se Material Adverse Changes or Material Adverse
Effects.
Section 4.2 Authorization; Binding Agreement.
MedCath has all requisite corporate power and authority to execute and
deliver this Agreement and to consummate the transactions contemplated hereby.
The execution and delivery of this Agreement and the consummation of the
transactions contemplated hereby have been duly and validly authorized by
MedCath's board of directors and, except for the approval of this Agreement and
the Merger by the shareholders of MedCath in accordance with the North Carolina
Law and the articles of incorporation and bylaws of MedCath, no other corporate
proceedings on the part of MedCath are necessary to authorize this Agreement
and the transactions contemplated hereby. This Agreement has been duly and
validly executed and delivered by MedCath, and subject to the requisite
approval of the shareholders of MedCath, constitutes the legal, valid and
binding agreement of MedCath, enforceable against MedCath in accordance with
its terms, except as such enforceability may be limited by (a) bankruptcy,
insolvency, reorganization, moratorium or other laws, now or hereafter in
effect, relating to or limiting creditors' rights generally, and (b) general
principles of equity (whether considered in an action in equity or at law)
which provide, among other things, that the remedies of specific performance
and injunctive and other forms of equitable relief are subject to equitable
defenses and to the discretion of the court before which any proceedings
therefor may be brought.
Section 4.3 Capitalization.
The authorized capital stock of MedCath consists of 20,000,000 shares of
MedCath Common Stock, and 2,348,167 shares of Preferred Stock, 300,000 of which
have been designated as Series A Preferred Stock, 200,000 of which have been
designated as Series A Junior Participating Preferred Stock, 20,000 of which
have been designated as Series B Preferred Shares and 28,167 of which have been
designated as Series C Preferred Shares "North Carolina Preferred Stock"). As
of
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March 12, 1998, 11,669,359 shares of MedCath Common Stock and no shares of
North Carolina Preferred Stock were outstanding. As of the date hereof,
1,506,569 shares of MedCath Common Stock were reserved for issuance upon
exercise of outstanding Stock Options. All of the outstanding shares of capital
stock of MedCath and the subsidiaries of MedCath have been duly authorized and
validly issued and are fully paid and nonassessable. All issued and outstanding
shares of capital stock of the subsidiaries of MedCath are owned by MedCath or
a subsidiary of MedCath free and clear of all liens, charges, encumbrances,
claims and options of any nature. Except as contemplated by this Agreement and
the Rights Agreement of MedCath dated as of October 15, 1996 (the "Rights
Agreement") and except for the Stock Options and as set forth on Item 3.6(c) of
the Disclosure Schedules, neither MedCath nor any subsidiary of MedCath has or
as of the Effective Time will have granted any outstanding security, call,
option, warrant, subscription or other right, or entered into any agreement or
commitment which either (a) obligates MedCath or any of its subsidiaries to
issue, sell or transfer or cause to be issued, delivered or sold any shares of
the capital stock of MedCath or any subsidiary of MedCath or (b) restricts the
transfer of, or otherwise encumbers, shares of MedCath Common Stock.
Section 4.4 Financial Statements.
All consolidated financial statements of MedCath and its subsidiaries
(including the notes to such financial statements) included in MedCath's Annual
Report on Form 10-K for the year ended September 30, 1997 (the "Year End
Financial Statements") filed pursuant to the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), (a) are in accordance with the books and
records of MedCath and its subsidiaries in all material respects, (b) present
fairly in all material respects the consolidated financial position, results of
operations, changes in shareholders' equity and cash flow (as applicable) of
MedCath and its subsidiaries as of the respective dates and for the respective
periods indicated and (c) have been prepared in conformity with generally
accepted accounting principles applied in all material respects on a consistent
basis through all the periods involved. MedCath has no material liabilities
that are required by generally accepted accounting principles to be disclosed
on a balance sheet other than (i) those disclosed in the Year End Financial
Statements, and (ii) those arising in the ordinary course of business since
September 30, 1997 or as disclosed in Items 3.6(c) and (d) of the Disclosure
Schedules.
Section 4.5 Absence of Certain Changes or Events.
Since September 30, 1997, (a) there has not been any Material Adverse
Change, (b) there has not been any damage, destruction or loss, whether covered
by insurance or not, having a Material Adverse Effect, (c) there has not been
any condition, event or occurrence which, individually or in the aggregate,
could reasonably be expected to have a Material Adverse Effect or give rise to
a Material Adverse Change, (d) MedCath and its subsidiaries have conducted
their respective businesses only in the ordinary course, taken as a whole, (e)
MedCath has not changed its accounting principles or methods in any material
respect except insofar as may be required by a change in generally accepted
accounting principles, (f) there has been no condition, event or occurrence
which could reasonably be expected to prevent, materially hinder or materially
delay the ability of MedCath to consummate the Merger or the transactions
contemplated by this Agreement, (g) there has not been any declaration, setting
aside or payment of any dividend or other distribution (whether in cash, stock
or property) with respect to the equity interests of MedCath or any of its
subsidiaries, other than dividends paid by wholly-owned subsidiaries and (h)
MedCath and its subsidiaries have not (i) increased the compensation or fringe
benefits of any present or former director, officer or employee of MedCath or
its subsidiaries (except for increases in salary or wages in the ordinary
course of business consistent with past practice), (ii) granted any severance
or termination pay to any present or former director or officer of MedCath or
its subsidiaries or, other than in the ordinary course of business, to any
other employee of MedCath or its subsidiaries; (iii) loaned or advanced money
or other property by MedCath or its subsidiaries to any of their present or
former directors, officer or employees or (iv) established, adopted, entered
into, amended or terminated any Company Benefit Plan.
Section 4.6 SEC Reports and other Documents.
Since January 1, 1995, MedCath has filed all reports required to be filed
by it with the SEC and all such reports complied as to form in all material
respects with the applicable requirements of law. Each report required to be
filed by MedCath with the SEC since January 1, 1995 did not on the date of
filing of such reports and, except to the extent revised or superseded by a
subsequent filing with the SEC prior to the date hereof does not, contain an
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.
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Section 4.7 Governmental and Other Consents and Approvals.
Except as set forth in Item 4.7 of the Disclosure Schedules, subject to
the approval of this Agreement and the Merger by the shareholders of MedCath,
no consent, waiver, approval, license or authorization of or designation,
declaration or filing with any governmental agency or authority or other public
persons or entities in the United States is required in connection with the
execution or delivery by MedCath of this Agreement or the consummation by
MedCath of the transactions contemplated hereby, other than (a) filing in the
State of North Carolina articles of merger in accordance with the North
Carolina Law, (b) filings required under the HSR Act, (c) filings required
under the Exchange Act and (d) such other consents, waivers, approvals,
licenses or authorizations, the failure of which to be obtained will not have a
Material Adverse Effect or will not materially and adversely affect the ability
of MedCath to consummate the transactions contemplated hereby.
Section 4.8 No Violation.
Except as set forth in Item 4.8 of the Disclosure Schedules, the execution
and delivery of this Agreement, the filing by MedCath of articles of merger in
connection with the Merger in the State of North Carolina in accordance with
the North Carolina Law, the consummation by MedCath of the transactions
contemplated hereby, or compliance by MedCath with any of the provisions
hereof, will not:
(a) violate any provision of the articles of incorporation or bylaws of
MedCath or any comparable charter or organizational documents of its
subsidiaries;
(b) cause MedCath or any of its subsidiaries to violate in any material
respect (i) any statute or law or any judgment, decree, order, regulation or
rule of any court or governmental authority applicable to MedCath or any of its
subsidiaries or any of their respective properties or (ii) the award of any
arbitrator or panel of arbitrators;
(c) cause the acceleration of the maturity of any debt or obligation which
is material to MedCath and its subsidiaries, taken as a whole; or
(d) with or without notice or lapse of time, or both, violate, or be in
conflict with, or constitute a material default under, or permit the
termination of, or give rise to a right of termination, cancellation or
acceleration of or "put" right with respect to any obligation or to loss of a
material benefit under, or, except as contemplated by this Agreement, require
the consent of any person under, or result in the creation of any material lien
upon any property of MedCath or any of its subsidiaries under, any agreement,
indenture, lease, instrument, permit, concession, franchise, or license
applicable to MedCath or any of its subsidiaries or to which MedCath or any of
its subsidiaries is a party or by which MedCath or any of its subsidiaries (or
their respective properties) may be bound, which individually or in the
aggregate would have a Material Adverse Effect.
Section 4.9 Litigation.
Except as set forth in Item 4.9 of the Disclosure Schedules, there is no
legal action, suit, arbitration or other legal, administrative or other
governmental investigation, inquiry or proceeding (whether federal, state,
local or foreign) pending or, to the knowledge of MedCath, threatened against
or affecting MedCath, any of its subsidiaries or any of their respective
properties, assets, business, franchises or governmental approvals before any
court or governmental department, commission, board, bureau, agency,
instrumentality or arbitrator, which, individually or in the aggregate, could
reasonably be expected (a) to have a Material Adverse Effect, or (b) to
materially and adversely affect the ability of MedCath to carry out, or prevent
or make unduly burdensome, the Merger or the transactions contemplated by this
Agreement nor is there any judgment, decree, injunction, rule or order of any
governmental entity or arbitrator outstanding against MedCath or any of its
subsidiaries having, or which in the future could have, any such effect.
Section 4.10 Governmental Approvals; Compliance with Law.
MedCath and its subsidiaries possess from the appropriate agency,
commission, board or governmental authority, whether federal, state or local,
all licenses, permits, authorizations, approvals, franchises and rights
("Government Approvals") that are necessary for MedCath and its subsidiaries to
engage in the business currently conducted by them, except in those instances
in which failure to possess Government Approvals, individually or in the
aggregate, would not have a Material Adverse Effect. MedCath and its
subsidiaries have been, are and as of the Effective Time will be in compliance
with all applicable federal, state and local laws, statutes, ordinances, rules
and regulations except where the failure to so comply would not constitute a
material violation of law compliance with which is material to MedCath and its
subsidiaries, taken as a whole.
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Section 4.11 Brokers and Finders.
Except for Goldman, Sachs & Co. ("Goldman Sachs"), which has been engaged,
pursuant to an engagement letter dated August 8, 1997, a true and complete copy
of which has been delivered to Acquiror, to provide financial advisory services
to the Strategic Options Committee of MedCath and, as requested by the
Strategic Options Committee, to provide advice to the board of directors of
MedCath with respect to whether the consideration to be received by the holders
of MedCath Common Stock is fair to them, no broker, finder or investment banker
is entitled to any brokerage, finder's or other fee or commission in connection
with the Merger or in connection with any transaction involving MedCath based
upon arrangements made by or on behalf of MedCath.
Section 4.12 Fairness Opinions and Approval by Strategic Options Committee.
On or prior to the date hereof, the Strategic Options Committee approved
the terms of this Agreement and received an opinion from Goldman Sachs as of
such date, which opinion shall be confirmed in writing substantially to the
effect that, from a financial point of view, the consideration to be received
by the holders of MedCath Common Stock pursuant to the Merger is fair to them
(which opinion shall be updated in writing to the date of the Definitive Proxy
Statement), a true and complete copy of which written opinion has been or will
promptly be delivered to Acquiror following its receipt by the Strategic
Options Committee.
Section 4.13 Taxes.
(a) All Returns (as hereinafter defined) required to be filed by or with
respect to MedCath and Tax Affiliates (as hereinafter defined) have been filed
on a timely basis, except where the failure to file such Returns would not have
a Material Adverse Effect. All such Returns were correct and complete in all
material respects. There are no deficiencies for Taxes that have been proposed,
asserted or assessed against MedCath or Tax Affiliates that remain unpaid.
MedCath and its Tax Affiliates have paid or made adequate provision in all
material respects in the Financial Statements (other than reserves for deferred
income Taxes established to reflect differences between book basis and Tax
basis of assets and liabilities) for the payment of all Taxes, whether or not
shown on any Return. As used in this Section 4.13, the term "Tax" or "Taxes"
means all federal, state, local, foreign and other net income, gross income,
gross receipts, franchise, sales, use, withholding, employment, property
alternative or add-on minimum, environmental (including Taxes under Section 59A
of the Internal Revenue Code of 1986, as amended (the "Code")) or other taxes,
fees, assessments or charges of any kind whatsoever, together with any interest
and any penalties, additions to tax or additional amounts with respect thereto;
the term "Returns" means all returns, declarations, reports, statements and
other documents required to be filed in respect of Taxes, including any
schedule or attachment thereto, and including any amendment thereof; and the
term "Tax Affiliate" means any subsidiaries of MedCath and any individual or
entity for whose Taxes MedCath or any of its subsidiaries is or could be held
liable, whether by reason of being a member of an affiliated, consolidated,
combined, unitary, or other similar group for Tax purposes, by reason of being
a successor, member or general partner, by agreement, or otherwise (but only
with respect to the Taxes and taxable periods(s) or portions thereof with
respect to which MedCath or such subsidiaries is or could be held liable for
such Taxes).
(b) Item 4.13 of the Disclosure Schedules lists all Returns that have been
audited, and indicates all Returns that are currently the subject of audit.
Neither MedCath nor any Tax Affiliate has granted any extension or waiver of
the statute of limitations period on the assessment of any material Taxes,
which period (after giving effect to such extension or waiver) has not expired.
Neither MedCath nor any Tax Affiliate has granted a power of attorney with
respect to any matter relating to any material Tax. No claim has been made by
an authority in a jurisdiction where MedCath or any Tax Affiliate does not file
Returns that it is or may be subject to Tax in that jurisdiction.
(c) MedCath and each Tax Affiliate has withheld and paid all Taxes
required to have been paid in connection with amounts paid or owing to any
employee, independent contractor, stockholder, partner, or other third party.
(d) Neither MedCath nor any Tax Affiliate is a party to any Tax
allocation, sharing, or similar agreement. Neither MedCath nor any Tax
Affiliate has been a member of an affiliated group filing a consolidated
federal income tax Return (other than a group the common parent of which was
MedCath).
(e) Except as disclosed to Acquiror prior to the date of this Agreement,
neither MedCath nor any Tax Affiliate has made any payments, is obligated to
make any payments, or is a party to any agreement that under certain
circumstances could obligate it to make any payments that will not be
deductible under Code Section 280G or would constitute compensation in excess
of the limitation set forth in Section 162(m) of the Code.
(f) No consent under Section 341(f) of the Code has been filed with
respect to MedCath or any Tax Affiliates.
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(g) Neither MedCath nor any Tax Affiliate has been a United States real
property holding corporation within the meaning of Section 897(c)(2) of the
Code during the applicable period specified in Section 897(c)(1)(A)(ii) of the
Code.
(h) No material claim for unpaid Taxes has become a lien or encumbrance of
any kind against the property of MedCath or any Tax Affiliates.
Section 4.14 Employee Benefits.
(a) A list of all employee benefit plans, programs, arrangements, funds,
policies, practices, or contracts and samples of representative employment
agreements with respect to which, through which, or under which the MedCath or
any of MedCath's subsidiaries has any liability to provide benefits or
compensation to or on behalf of employees, former employees, or independent
contractors of MedCath or any of MedCath's subsidiaries, whether formal or
informal, whether or not written, including but not limited to any employee
benefit plan (within the meaning of Section 3(3) of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA")), any multiemployer plan (as
defined in Section 3(37) and Section 4001(a)(3) of ERISA), stock purchase,
stock option, severance, employment, change in control, fringe benefit,
collective bargaining, bonus, incentive, and deferred compensation arrangement
(collectively, the "Company Benefit Plans"), have been disclosed in writing to
Acquiror. MedCath has made available to Acquiror a true and complete copy of
the following documents, if applicable, with respect to each Company Benefit
Plan: (i) all documents setting forth the terms of the Company Benefit Plan, or
if there are no such documents evidencing the Company Benefit Plan, a full
description of the Company Benefit Plan, (ii) the ERISA summary plan
description and any other written summary of plan provisions provided to
participants or beneficiaries for each such Company Benefit Plan, (iii) the
annual report (Form 5500 series), required under ERISA or the Code, filed for
the most recent plan year and most recent financial statements or periodic
accounting of related plan assets with respect to each Company Benefit Plan,
and (iv) the most recent favorable determination letter, opinion, or ruling
from the Internal Revenue Service for each Company Benefit Plan, the assets of
which are held in trust, to the effect that such trust is exempt from federal
income tax.
(b) Each Company Benefit Plan has at all times been maintained, by its
terms and in operation, in accordance with the Code, ERISA, and other
applicable laws, except where the failure to so comply is not reasonably likely
to have a Material Adverse Effect. Each Company Benefit Plan that is intended
to be qualified under Section 401(a) of the Code, and related trust that is
intended to be tax-exempt under Section 501(a) of the Code, has received a
favorable determination letter from the Internal Revenue Service to the effect
that such plan is qualified under the Code and such trust is tax-exempt, and
any such determination letter remains in effect and has not been revoked. All
contributions required to be made prior Closing under the terms of each Company
Benefit Plan, the Code, ERISA, or other applicable law have been or will be
timely made, and adequate reserves have been provided for by MedCath with
respect to all accrued benefits attributable to service on or prior to the
Closing. No Company Benefit Plan provides for an increase in benefits on or
after the Closing.
(c) Each Company Benefit Plan may be amended or terminated at any time
without any obligation or liability other than for benefits accrued prior to
such amendment or termination, or as required to be vested pursuant to
applicable law as a result of such amendment or termination. There are no
actions, audits, suits, or claims which are pending or threatened, to the
knowledge of MedCath against any Company Benefit Plan, except claims for
benefits made in the ordinary course of the operation of such plans. MedCath
will promptly notify Acquiror in writing of any such actions, audits, suits, or
claims arising between the date hereof and the Closing. Neither MedCath nor any
of its subsidiaries is subject to any material liability, tax, or penalty
whatsoever to any person whomsoever as a result of MedCath or any of its
subsidiaries engaging in a prohibited transaction under ERISA or the Code. To
the knowledge of MedCath, no event has occurred and no condition exists that
would subject MedCath, either directly or by reason of its affiliation with any
trade or business (whether or not incorporated) which together with the Company
is treated as a single employer under Section 414(b), (c), (m), or (o) of the
Code ("Company ERISA Affiliate"), to any material liability, tax, or penalty
imposed by ERISA, the Code, or other applicable law.
(d) Neither MedCath nor any Company ERISA Affiliate maintains, nor has at
any time established or maintained, nor has at any time been obligated to make,
or made, contributions to or under any plan subject to Title IV of ERISA.
Section 4.15 Environmental Matters.
Except for such items of non-compliance that could not, individually or in
the aggregate, reasonably be expected to have a Material Adverse Effect:
(i) MedCath and its subsidiaries, taken as a whole, hold and formerly
held, and, to the knowledge of MedCath, are and have been in compliance
with, all Environmental Permits, and MedCath and its subsidiaries are and
have been,
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otherwise in compliance with all applicable Environmental Laws and there
are no circumstances that might prevent or interfere with such compliance
in the future;
(ii) None of MedCath or its subsidiaries has received any Environmental
Claim, and none of MedCath or its subsidiaries is aware after reasonably
inquiry of any threatened material Environmental Claim or of any
circumstances, conditions or events that could reasonably be expected to
give rise to an Environmental Claim that could result in a Material Adverse
Effect;
(iii) None of MedCath or its subsidiaries has entered into or agreed to
any consent decree, order or agreement under any Environmental Law, and
none of MedCath or its subsidiaries is subject to any material judgment,
decree, order or other material requirement relating to compliance with any
Environmental Law or to investigation, cleanup, remediation or removal of
regulated substances under any Environmental Law;
(iv) To the knowledge of MedCath, there are no (a) underground storage
tanks, (B) polychlorinated biphenyls, (C) asbestos or asbestos-containing
materials, (D) urea-formaldehyde insulation, (E) sumps, (F) surface
impoundments, (G) landfills, (H) sewers or septic systems or (I) Hazardous
Materials present at any facility currently or formerly owned, leased,
operated or otherwise used by MedCath or any of its subsidiaries that could
reasonably be expected to give rise to a Material Adverse Effect;
(v) There are no past (including, without limitation, with respect to
assets or businesses formerly owned, leased or operated by MedCath or any
of its subsidiaries) or present actions, activities, events, conditions or
circumstances, with respect to or against MedCath or its subsidiaries
including without limitation the release, threatened release, emission,
discharge, generation, treatment, storage or disposal of Hazardous
Materials, that could reasonably be expected to give rise to a Material
Adverse Effect under any Environmental Laws or any contract or agreement;
(vi) No modifications, revocation, reissuance, alteration, transfer, or
amendment of the Environmental permits, or any review by, or approval of,
any third party of the Environmental Permits is required in connection with
the execution or delivery of this Agreement or the consummation of the
transactions contemplated hereby or the continuation of the business of
MedCath or its subsidiaries following such consummation;
(vii) Hazardous Materials have not been generated, transported, treated,
stored, disposed of, released or threatened to be released at, on, from or
under any of the properties or facilities currently or formerly owned,
leased or otherwise used by MedCath or any of its subsidiaries, in
violation of, or in a manner or to a location that could give rise to a
Material Adverse Effect, under any Environmental Laws;
(viii) For purposes of this Agreement, the following terms shall have the
following meanings:
"Environmental Claim" means any written or oral notice, claim, demand,
action, suit, complaint, proceeding or other communication by any person
alleging liability or potential liability (including without limitation
liability or potential liability for investigatory costs, cleanup costs,
governmental response costs, natural resource damages, property damage,
personal injury, fines or penalties) arising out of, relating to, based on
or resulting from (i) the presence, discharge, emission, release or
threatened release of any Hazardous Materials at any location, either
owned, leased or operated by MedCath or any of its subsidiaries or (ii)
circumstances forming the basis of any violation or alleged violation of
any Environmental Law or Environmental Permit or (iii) otherwise relating
to obligations or liabilities under any Environmental Laws.
"Environmental Permits" means all permits, licenses, registrations and
other governmental authorizations required for MedCath and the operations
of MedCath's and its subsidiaries' facilities and otherwise to conduct its
business under Environmental Laws.
"Environmental Laws" means all applicable federal, state and local
statutes, rules, regulations, ordinances, orders, decrees and common law in
effect as of the date hereof relating in any manner to contamination,
pollution or protection of human health or the environment, including
without limitation the Comprehensive Environmental Response, Compensation
and Liability Act, the Solid Waste Disposal Act, the Clean Air Act, the
Toxic Substances Control Act, the Occupational Safety and Health Act, the
Emergency Planning and Community-Right-to-Know Act, the Safe Drinking Water
Act, all as amended, and similar state laws.
"Hazardous Materials" means all hazardous or toxic substances, wastes,
materials or chemicals, petroleum (including crude oil or any fraction
thereof) and petroleum products, asbestos and asbestos-containing
materials, pollutants, contaminants and all other materials, substances and
forces, including but not limited to electromagnetic fields, regulated
pursuant to, or that could form the basis of liability under, any
Environmental Law.
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Section 4.16 Board Recommendation.
The board of directors of MedCath, at a meeting duly called and held, has
by unanimous vote of those directors present (who constituted 100% of the
directors then in office exclusive of directors who recused themselves from
such vote because of their interest in the Parent or Acquiror) (i) determined
that this Agreement and the transactions contemplated hereby are fair to and in
the best interests of the shareholders of MedCath and (ii) resolved to
recommend that the holders of the shares of MedCath Common Stock approve this
Agreement and the transactions contemplated herein, including the Merger.
Section 4.17 Required Company Vote.
The affirmative vote of a majority of the shares of MedCath Common Stock
is the only vote of the holders of any class or series of MedCath's securities
necessary to approve this Agreement and the Merger under the North Carolina
Law.
Section 4.18 State Takeover Statutes.
No state takeover statute or similar statute or regulation of the State of
North Carolina (and, to the knowledge of MedCath after due inquiry, of any
other state or jurisdiction) applies or purports to apply to this Agreement,
the Merger, or any of the other transactions contemplated hereby. No provision
of the articles of organization, by-laws or other governing instruments of
MedCath or any of its subsidiaries would, directly or indirectly, restrict or
impair the ability of Acquiror or its affiliates to vote, or otherwise to
exercise the rights of a shareholder with respect to, securities of MedCath and
its subsidiaries that may be acquired or controlled by Acquiror or its
affiliates or permit any shareholder to acquire securities of MedCath on a
basis not available to Acquiror in the event that Acquiror were to acquire
securities of MedCath, and neither MedCath nor any of its subsidiaries has any
rights plan (except the Rights Agreement), preferred stock or similar
arrangement which have any of the aforementioned consequences. The board of
directors of MedCath has duly and validly approved and taken all corporate
action required to be taken by the board of directors for the consummation of
the transactions contemplated by this Agreement.
Section 4.19 Material Contract Defaults.
Neither MedCath nor any of its subsidiaries is, or has received any notice
or has any knowledge that any other party is, in default in any respect under
any material contract, agreement, commitment, arrangement, lease, policy or
other instrument to which it or any of its subsidiaries is a party or by which
it or any such subsidiary is bound ("Material Contracts"), except for those
defaults which could not reasonably be expected, either individually or in the
aggregate, to have a Material Adverse Effect; and there has not occurred any
event that with the lapse of time or the giving of notice or both would
constitute such a material default.
Section 4.20 Information in Proxy Statement.
The Definitive Proxy Statement (or any amendment thereof or supplement
thereto), at the date mailed to MedCath shareholders and at the time of the
Special Meeting, will not 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, provided, however, that no representation is
made by MedCath with respect to statements made therein based on information
supplied by the Parent or Acquiror for inclusion in the Definitive Proxy
Statement. The Definitive Proxy Statement will comply in all material respects
with the provisions of the Exchange Act and the rules and regulations
thereunder.
Section 4.21 Rights Agreement.
The Rights Agreement has been amended so as to provide that neither the
Parent nor Acquiror will become an "Acquiring Person" or an "Adverse Person"
and that no "Triggering Event", "Stock Acquisition Date" or "Distribution Date"
(as such terms are defined in the Rights Agreement) will occur as a result of
the approval, execution or delivery of this Agreement or the consummation of
the Merger.
Section 4.22 Properties.
(a) Except with respect to liens securing indebtedness evidenced by the
agreements listed on Item 3.6(d) of the Disclosure Schedules or reflected in
the Year End Financial Statements of MedCath, each of MedCath and its
subsidiaries have good and sufficient, valid and marketable title to its owned
real property free and clear of all liens and other encumbrances that,
individually or in the aggregate, would have a Material Adverse Effect. Except
as set forth in Item 4.22 of the Disclosure Schedules, there are no outstanding
contracts for the purchase of any real property.
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(b) MedCath and its subsidiaries hold good and valid leasehold title to
leased real property they occupy, free of all liens except for liens which,
individually or in the aggregate, would not have a Material Adverse Effect or
liens securing indebtedness evidenced by the agreements listed on Item 3.6(d)
of the Disclosure Schedules or reflected in the Year End Financial Statements
of Medcath. Other than such exceptions which as would not have a Material
Adverse Effect, all real property leases are in full force and effect and grant
in all respects the leasehold estates or rights of occupancy or use they
purport to grant. There are no existing defaults (either on the part of MedCath
or any of its subsidiaries or, to the knowledge of MedCath, any other party
thereto) under any real property lease and no event has occurred which, with
notice or the lapse of time, or both, would constitute a default (either on the
part of MedCath or any of its subsidiaries or, to the knowledge of MedCath, any
other party thereto) under any of the real property leases, except for any of
the foregoing which, individually or in the aggregate, would not have a
Material Adverse Effect. The consummation of the Merger will not result in the
occurrence of a default under any of the real property leases (whether pursuant
to a "change in control" provision in the real property leases or otherwise).
Section 4.23 Billing and Coding.
MedCath and its subsidiaries have, whether directly or indirectly through
contractual arrangements with others, billed third party payers (including, but
not limited to, Medicare, Medicaid, CHAMPUS, and private payers) for health
care services rendered by MedCath, its subsidiaries, or any of its or their
employees, professional staff, or other persons or entities on behalf of whom
or for which MedCath or any of its subsidiaries is authorized to bill for
health care services, in accordance in all material respects with all federal,
state, and local laws, rules, and regulations, and all agreements, applicable
with respect thereto. Without limiting the generality of the foregoing, for
said purposes all such services have been properly documented and coded all
except to the extent the failure to so comply or to do so would not be material
individually or in the aggregate.
Section 4.24 Other Confidentiality Agreements.
MedCath has entered into a confidentiality agreement not substantially
less favorable taken as a whole to it than the Confidentiality Agreement with
each Person (as defined in Section 8.6) that, since January 1, 1997, has been
provided confidential information with respect to MedCath and its subsidiaries
with a view to a possible acquisition (whether by merger, stock purchase, asset
purchase or otherwise) or recapitalization of MedCath. Each such agreement is
in full force and effect, MedCath has not modified or waived or agreed to
modify or waive any provisions of any such agreement and, to the knowledge of
MedCath none of the other parties thereto is in default thereunder.
ARTICLE 5
[INTENTIONALLY OMITTED]
ARTICLE 6
REPRESENTATIONS AND WARRANTIES OF ACQUIROR AND PARENT
Acquiror and Parent hereby represent and warrant to MedCath as follows:
Section 6.1 Organization and Good Standing.
Each of Acquiror and Parent is a duly organized and validly existing
corporation in good standing under the laws of the state of its incorporation.
Each of Acquiror and Parent has heretofore delivered to MedCath accurate and
complete copies of its articles or certificate of incorporation and bylaws as
currently in effect. Neither Acquiror nor Parent has any subsidiary (other than
Acquiror, in the case of Parent) or owns or holds any capital stock, security
or investment in any other Person other than bank accounts, certificates of
deposit, money market or similar short-term investments.
Section 6.2 Authorization; Binding Agreement.
Parent and Acquiror have all requisite corporate power and authority to
execute and deliver this Agreement and to consummate the Merger and the
transactions contemplated hereby. The execution and delivery of this Agreement
and the consummation of the Merger and the transactions contemplated hereby
have been duly and validly authorized by its respective board of directors, and
this Agreement has been adopted by the shareholders of Acquiror in accordance
with North Carolina Law and its articles or certificate of incorporation and
bylaws. No other corporate proceedings on the part of Acquiror or Parent are
necessary to authorize this Agreement, the Merger and the transactions
contemplated hereby. This Agreement
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has been duly and validly executed and delivered by Parent and Acquiror and
constitutes a legal, valid and binding agreement of Acquiror and Parent,
enforceable against Parent and Acquiror in accordance with its terms except as
such enforceability may be limited by (a) bankruptcy, insolvency,
reorganization, moratorium or other similar laws, now or hereafter in effect,
relating to or limiting creditors, rights generally, and (b) general principles
of equity (whether considered in an action in equity or at law) which provide,
among other things, that the remedies of specific performance and injunctive
and other forms of equitable relief are subject to equitable defenses and to
the discretion of the court before which any proceedings therefor may be
brought.
Section 6.3 Capitalization.
The authorized capital stock of Acquiror consists of a single class of
20,000,000 shares of common stock, par value $.01 per share, (which class of
stock is herein called "Acquiror Common Stock"), of which 100 are issued and
outstanding on the date hereof and are beneficially owned by the Parent. All of
the shares of Acquiror Common Stock outstanding at the Effective Time (i) will
have been duly authorized, validly issued, fully paid and nonassessable and
free of preemptive rights, and (ii) will be beneficially owned by Parent.
Acquiror has not granted any outstanding option, warrant, subscription or other
right, or entered into any agreement or commitment which either (a) obligates
Acquiror to issue, sell, repurchase or transfer any shares of the capital stock
of Acquiror or (b) restricts the transfer of, or otherwise encumbers, shares of
Acquiror Common Stock. Acquiror has no treasury stock.
Section 6.4 No Violation.
Neither the execution and delivery of this Agreement, the filing of the
Articles of Merger nor the consummation by Acquiror and Parent of the
transactions contemplated hereby, nor compliance by Acquiror with any of the
provisions hereof, will:
(a) violate any provision of the charter documents or bylaws of Acquiror
or Parent;
(b) violate any statute or law or any judgment, decree, order, regulation
or rule of any court or governmental authority applicable to Acquiror or
Parent or any of their properties;
(c) cause the acceleration of the maturity of any debt or obligation of
Acquiror or Parent; or
(d) with or without notice or lapse of time, or both, violate, or be in
conflict with, or constitute a default under, or permit the termination of,
or give rise to a right of termination, cancellation or acceleration of or
"put" right with respect to any obligation or to loss of a material benefit
under, or except as contemplated by this Agreement, require the consent of
any person under, or result in the creation of any lien upon any property
of Acquiror or the Parent under, any agreement, indenture, lease or
instrument, permit, concession, franchise, or license applicable to
Acquiror or Parent to which Acquiror or Parent is a party or by which
Acquiror or the Parent (or its properties) may be bound, which in the
aggregate would have a material adverse effect on Acquiror or Parent.
Section 6.5 Governmental and Other Consents and Approvals.
Except as provided in Item 4.7 in the Disclosure Schedules, no consent,
waiver, approval, license or authorization of or designation, declaration or
filing with any governmental agency or authority or other public persons or
entities in the United States is required in connection with the execution or
delivery by Acquiror of this Agreement or the consummation by Parent or
Acquiror of the Merger or the transactions contemplated hereby, other than (a)
filings in the State of North Carolina in accordance with the North Carolina
Law, (b) filings required under the HSR Act, (c) filings required under the
Exchange Act and (d) such other consents, waivers, approvals, licenses or
authorizations, the failure of which to be obtained will not have a material
adverse effect on Parent or Acquiror or on the ability of Parent or Acquiror to
consummate the transactions contemplated hereby.
Section 6.6 Proxy and Schedule 13E-3 Information.
The information furnished to MedCath by Acquiror and Parent specifically
for inclusion in the Definitive Proxy Statement and the Schedule 13E-3, or any
amendment or supplement thereto, or specifically for inclusion in any other
documents filed with the SEC by MedCath in connection with the Merger, shall,
with respect to the Definitive Proxy Statement at the time the Definitive Proxy
Statement is mailed and at the time of the Special Meeting, and, with respect
to the Schedule 13E-3 and such other documents, at the time of filing with the
SEC and at the time of such Special Meeting, 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.
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Section 6.7 Financing.
Acquiror has obtained commitments for equity and debt financing necessary
or appropriate to consummate the Merger in an amount no less than the Cash
Merger Consideration plus the expenses related to the Merger and obtaining the
financing therefor (the "Financing"). A true and correct copy of the letters or
other documents evidencing such commitments (the "Financing Letters") have been
delivered to the Strategic Options Committee.
Section 6.8 Brokers and Finders.
Except for Kohlberg Kravis Roberts & Co., L.P. and Welsh, Carson, Anderson
& Stowe VII, L.P., the fees and expenses of which shall be paid by Acquiror,
Acquiror has not engaged any broker, finder or investment banker which
engagement would require the payment of any brokerage, finder's or other fees
by MedCath in connection with the transaction contemplated hereby.
Section 6.9 No Prior Activities.
Acquiror and Parent have not incurred, and will not incur, directly or
through any subsidiary, any liabilities or obligations, except those incurred
in connection with its organization or with the negotiation of this Agreement
and the Financing. Except as contemplated by this Agreement and the Financing
Letters, Acquiror and Parent have not engaged in any business activities of any
type or kind whatsoever, or entered into any agreements or arrangements with
any person or entity, or become subject to or bound by any obligation or
undertaking.
Section 6.10 Litigation.
There is no legal action, suit, arbitration or other legal, administrative
or other governmental investigation, inquiry or proceeding (whether federal,
state, local or foreign) pending or, to the knowledge of Acquiror or Parent,
threatened against or affecting Acquiror or Parent or any of its properties,
assets, business, franchises or governmental approvals before any court or
governmental department, commission, board, bureau, agency, instrumentality or
arbitrator, which, individually or in the aggregate, could reasonably be
expected (a) to have a material adverse effect upon Acquiror or Parent or (b)
to materially and adversely affect the ability of Acquiror or Parent to carry
out, or prevent or make unduly burdensome, the Merger or the transactions
contemplated by this Agreement.
ARTICLE 7
CONDITIONS
Section 7.1 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 satisfaction at or prior to the Effective Time of the following
conditions unless waived in accordance with Section 8.4:
(a) This Agreement and the Merger shall have been approved at or prior to
the Effective Time by the holders of a majority of the outstanding shares
of MedCath Common Stock entitled to vote thereon;
(b) No action, suit or proceeding shall be pending before any court or
governmental body in which an unfavorable judgment or decree would prevent
or substantially delay the consummation of the Merger, cause the Merger to
be rescinded or, with respect to any litigation in connection with the
Merger, result in an award of damages that would have a Material Adverse
Effect; and
(c) Any applicable waiting period under the HSR Act shall have expired or
early termination shall have been granted.
Section 7.2 Conditions to Obligation of MedCath to Effect the Merger.
The obligations of MedCath to effect the Merger shall be subject to the
satisfaction at or prior to the Effective Time of the following additional
conditions, unless waived by MedCath:
(a) The representations and warranties of Acquiror and the Parent set
forth in Article 6 hereof shall be true and correct in all material
respects (except that any such representation and warranty that is
qualified as to materiality by reference to "Material Adverse Effect" or
any similar term shall be true and correct) as of the date of this
Agreement
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and as of the Effective Time as though made on and as of the Effective
Time, and MedCath shall have received a certificate from each of Acquiror
and Parent signed by its President and a Vice President, respectively, to
that effect, provided that such signatories shall not have any personal
liability in connection therewith; and
(b) Acquiror and Parent shall have performed in all material respects all
obligations required to be performed by them under this Agreement prior to
the Effective Time, and MedCath shall have received a certificate from each
of Acquiror and the Parent signed by its President and a Vice President,
respectively, to that effect, provided that such signatories shall not have
any personal liability in connection therewith.
Section 7.3 Conditions to Obligations of Acquiror to Effect the Merger.
The obligations of Acquiror and the Parent to effect the Merger shall be
subject to the satisfaction at or prior to the Effective Time of the following
additional conditions, unless waived by Acquiror or the Parent:
(a) The representations and warranties of MedCath set forth in Article 4
hereof shall be true and correct in all material respects (except that any
such representation and warranty that is qualified as to materiality by
reference to "Material Adverse Effect" or any similar term shall be true
and correct) as of the date of this Agreement and as of the Effective Time
as though all of such representations were made on and as of the Effective
Time by MedCath, and Acquiror shall have received a certificate of MedCath
signed by the President, the Chief Financial Officer or a Vice President of
MedCath to that effect, provided that such signatories shall not have any
personal liability in connection therewith;
(b) MedCath shall have performed in all material respects all obligations
required to be performed by it under this Agreement prior to the Effective
Time and Acquiror shall have received a certificate of MedCath signed by
the President, the Chief Financial Officer or a Vice President of MedCath
to that effect, provided that such signatories shall not have any personal
liability in connection therewith;
(c) Acquiror shall have obtained financing necessary to satisfy its
obligations to pay the Cash Merger Consideration pursuant to Section 2.1
hereof on terms and conditions satisfactory to Acquiror in its sole
discretion. Acquiror acknowledges that its obtaining financing from parties
satisfactory to it and on substantially the same terms and conditions as
set forth in the Financing Letters shall satisfy this condition.
(d) MedCath and Acquiror shall have been furnished with evidence
satisfactory to them of the timely consent or approval of, or notice to,
each governmental authority or other person or entity whose consent or
approval, or to whom notice, is required in connection with the execution
or delivery by MedCath or Acquiror of this Agreement or consummation of the
transactions contemplated hereby or the absence of which would result in a
default or acceleration under or right to terminate any contract or
agreement, except with respect to consents, waivers or approvals relating
to the Merger with respect to agreements set forth in Item 3.4 of the
Disclosure Schedules;
(e) The persons named in Item 7.3 of the Disclosure Schedules will have
invested in Parent an amount equal to at least 50% of the value of the
MedCath Common Stock and the spread on the Stock Options (assuming a value
of $19.00 per share) held by such persons, which investment will be made
substantially on the terms of the letter agreement of even date herewith
between Acquiror and such persons;
(f) The directors of MedCath shall have, other than those who are also
directors of Acquiror, tendered to MedCath their resignations effective as
of the Effective Time; and
(g) To MedCath's knowledge, neither it nor any of its subsidiaries shall
be under investigation for any violation of the "Stark" laws, anti-kickback
laws or the laws relating to Medicare, Medicaid, Champus or any rules or
regulations related thereto.
ARTICLE 8
TERMINATION; NON-SURVIVAL OF REPRESENTATIONS, WARRANTIES
AND COVENANTS; WAIVER AND AMENDMENT
Section 8.1 Termination.
This Agreement may be terminated, and the Merger abandoned, at any time
prior to the Effective Time, by:
(a) mutual written consent of the boards of directors of the Constituent
Corporations;
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(b) Acquiror may terminate this Agreement by giving written notice to
MedCath at any time prior to the Effective Time (i) in the event MedCath
has breached any representation, warranty, or covenant contained in this
Agreement in any material respect, Acquiror has notified MedCath of the
breach, and the breach has continued without cure for a period of thirty
(30) days after the notice of breach or (ii) if the Closing shall not have
occurred on or before August 31, 1998, by reason of the failure of any
condition precedent under Section 7.1 or 7.3 hereof (unless the failure
results primarily from Acquiror breaching any representation, warranty, or
covenant contained in this Agreement);
(c) MedCath may terminate this Agreement by giving written notice to
Acquiror at any time prior to the Effective Time (i) in the event Acquiror
has breached any representation, warranty, or covenant contained in this
Agreement in any material respect, MedCath has notified Acquiror of the
breach, and the breach has continued without cure for a period of thirty
(30) days after the notice of breach or (ii) if the Closing shall not have
occurred on or before August 31, 1998, by reason of the failure of any
condition precedent under Sections 7.1 or 7.2 hereof (unless the failure
results primarily from MedCath breaching any representation, warranty, or
covenant contained in this Agreement);
(d) MedCath, by written notice to Acquiror, if (i) the board of directors
of MedCath or the Strategic Options Committee has withdrawn or modified its
approval or recommendation of this Agreement or the Merger in accordance
with Section 3.1; (ii) the board of directors of MedCath or the Strategic
Options Committee has determined that MedCath has entered into a definitive
agreement with a Person with respect to a transaction the proposal of which
qualifies as an Acquisition Proposal; provided that the board of directors
of MedCath or the Strategic Options Committee, as the case may be, has
first determined in good faith based upon the reasonably concluded written
advice of outside counsel to MedCath or counsel to the Strategic Options
Committee, as the case may be, that failing to take such action would
violate MedCath's board of directors' fiduciary duty under applicable law;
or (iii) (A) a third party commences a tender offer or exchange offer for
25% or more of the outstanding shares of MedCath Common Stock and that
tender offer or exchange offer is not solicited, initiated or encouraged
after the date hereof by MedCath and (B) the board of directors of MedCath
has recommended that the shareholders of MedCath tender their shares in
such tender of exchange offer; provided that the board of directors of
MedCath or the Strategic Options Committee has first determined in good
faith upon the reasonably concluded written advice of outside counsel to
MedCath or counsel to the Strategic Options Committee, as the case may be,
that failing to take such action would violate MedCath's board of
directors' fiduciary duty under applicable law; and provided further, that
termination under this Section 8.1(d) shall be of no effect unless and
until MedCath pays the fees and expenses referred to in Section 8.6(a);
(e) Acquiror, by written notice to MedCath, if (i) the board of directors
of MedCath has withdrawn or modified its approval or recommendation of this
Agreement or the Merger, (ii) MedCath enters into a definitive agreement
with a Person with respect to a transaction the proposal of which qualifies
as an Acquisition Proposal or (iii) (A) a third party commences a tender
offer or exchange offer for 25% or more of the outstanding shares of
MedCath Common Stock and (B) the board of directors of MedCath has
recommended that the shareholders of MedCath tender their shares in such
tender or exchange offer;
(f) MedCath or Acquiror, by written notice to the other, if upon a vote
at the Special Meeting, any approval of the shareholders of MedCath
necessary to consummate the Merger and the transactions contemplated hereby
shall not have been obtained; or
(g) any of the parties, by written notice, if any court of competent
jurisdiction or other governmental entity shall have issued an order,
decree or ruling or taken any other action permanently enjoining,
restraining or otherwise prohibiting the Merger and such order, decree,
ruling or other action shall have become final and nonappealable.
Any action to be taken to terminate this Agreement under this Section
shall be taken by, or pursuant to authority granted by, the boards of directors
of MedCath or Acquiror, as applicable. Any such action by MedCath shall be
authorized by the Strategic Options Committee, provided a termination by
MedCath pursuant to Section 8.1(d) as a result of an Acquisition Proposal that
is not an Interested Party Proposal may be authorized by the board of directors
of MedCath without the action of the Strategic Options Committee.
Section 8.2 Non-Survival of Representations, Warranties and Covenants.
The respective representations and warranties of MedCath and Acquiror
contained herein or in any certificate delivered pursuant hereto shall expire
with, and be terminated and extinguished upon, consummation of the Merger, and
thereafter neither Surviving Corporation nor MedCath or Acquiror or any
officer, director or principal thereof shall be under any liability whatsoever
with respect to any such representation or warranty. This Section 8.2 shall
have no effect upon any other covenant or agreement of the parties hereto,
whether to be performed before or after the consummation of the Merger.
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Section 8.3 Amendment.
This Agreement may not be amended except by an instrument in writing
signed on behalf of each of the parties hereto; provided, however, that after
approval of this Agreement by the shareholders of MedCath, no amendment may be
made which reduces the amount or changes the form of consideration to be
received in the Merger or otherwise changes or effects any change which would
adversely affect the holders of MedCath Common Stock without the further
approval of the shareholders of MedCath in accordance with Section 7.1(a).
Section 8.4 Waiver.
At any time prior to the Effective Time, whether before or after the
Special Meeting, any party hereto, by action taken by its board of directors,
may (i) extend the time for the performance of any of the obligations or other
acts of any other party hereto or (ii) subject to the proviso contained in
Section 8.3, waive compliance with any of the agreements of any other party or
with any conditions (other than those appearing in Section 7.1(a) and (c)) to
its own obligations. Any agreement on the part of a party hereto to any such
extension or waiver shall be valid only if set forth in an instrument in
writing signed on behalf of such party by a duly authorized officer, and, in
the case of MedCath, authorized by the Strategic Options Committee.
Section 8.5 Effect of Termination.
In the event of the termination of this Agreement under Section 8.1, this
Agreement shall thereafter become void and have no effect and no party hereto
shall have any liability to any other party hereto or its shareholders or
directors or officers in respect thereof, except that the provisions of Section
3.8 and the Confidentiality Agreement, and Section 8.6 and Article 9 shall
survive any such termination if such obligations arose at or before the time of
such termination.
Section 8.6 Certain Payments.
(a) In the event that:
(i) this Agreement is terminated pursuant to Section 8.1(d) or (e);
(ii) an Acquisition Proposal is commenced, publicly proposed, publicly
disclosed or communicated to MedCath at any time after the date of this
Agreement and MedCath, either on or prior to the date which is five (5)
months after the termination of this Agreement pursuant to Section 8.1(f)
or one year after the termination of this Agreement for any other reason
other than by MedCath under 8.1(c), consummates with any individual,
corporation, partnership, joint venture, association, joint stock company,
trust, fund, unincorporated association or organization (a "Person") a
transaction the proposal of which would otherwise qualify as an Acquisition
Proposal or enters into a definitive agreement with a Person with respect
to a transaction the proposal of which would otherwise qualify as an
Acquisition Proposal; or
(iii) the board of directors of MedCath, withdraws or modifies its
approval or recommendation of this Agreement or the Merger;
then in any such event, MedCath shall pay Acquiror Six Million Seven Hundred
Seventy Four Thousand Six Hundred and Forty Dollars ($6,774,640), plus an
amount equal to Acquiror's actual and reasonably documented out-of-pocket fees
and expenses incurred by Acquiror, Parent or shareholders of Parent in
connection with this Agreement and the proposed consummation of the
transactions contemplated hereby, exclusive in all events of any fee due to
Parent or any of its stockholders or affiliates, which amounts shall be payable
in immediately available funds and within three business days after such event
has occurred (or in the case of fees and expenses, within three business days
after MedCath's receipt of reasonable documentation thereof).
(b) (i) In the event that this Agreement is terminated by Acquiror or
MedCath pursuant to Section 8.1(b)(i) or 8.1(c)(i) the breaching party shall
pay the non-breaching party, in immediately available funds within three
business days after the breaching party's receipt of reasonable documentation
thereof, an amount equal to the actual and documented fees and expenses
incurred by such non-breaching party in connection with this Agreement and the
proposed consummation of the transactions contemplated hereby (exclusive of any
fees due to the Parent or any of its stockholders or affiliates in the event
Acquiror is the non-breaching party).
(ii) In the event that any approval of the shareholders of MedCath
necessary to consummate the Merger and the transactions contemplated
thereby shall not have been obtained, MedCath shall pay Acquiror in
immediately available funds an amount equal to the actual and documented
fees and expenses incurred by Acquiror, Parent and shareholders
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of Parent in connection with this Agreement and the proposed consummation
of the transactions contemplated hereby (exclusive of any fees due to the
Parent or any of its stockholders or affiliates).
(c) The payments made by Acquiror to MedCath, or by MedCath to Acquiror,
as set forth above shall represent the sole and exclusive remedy at law or in
equity to which either party and its officers, directors, representatives and
affiliates shall be entitled in the event this Agreement shall be terminated in
the circumstances contemplated by subsection (a) or (b) above. Such payments
shall be made without duplication. Accordingly, Acquiror shall not be entitled
to payments under Section 8.6(a) in more than one instance, and if Acquiror is
entitled to payments under Section 8.6(a) it shall not be entitled to payments
under Section 8.6(b); provided, however, that if Acquiror is entitled to
payments under Section 8.6(b) it shall be entitled to payments under Section
8.6(a) to the extent applicable and not duplicative.
ARTICLE 9
GENERAL AGREEMENTS
Section 9.1 Notice.
All notices, requests and other communications to any party shall be in
writing (including telecopy or similar writing) and shall be given,
(a) If to Acquiror:
c/o Kohlberg Kravis Roberts & Co.
2800 Sand Hill Road, Suite 200
Menlo Park, California 94025
Attention: Edward A. Gilhuly
Facsimile No.: (415) 233-6561
and
c/o Welsh, Carson, Anderson & Stowe VII, L.P.
320 Park Avenue
Suite 2500
New York, New York 10022-6815
Attention: Paul B. Queally
Facsimile No.: (212) 893-9575
with copies to:
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, New York 10017
Attention: Gary I. Horowitz
Facsimile No.: (212) 455-2502
and
Reboul, MacMurray, Hewitt, Maynard & Kristol
45 Rockefeller Plaza
New York, N.Y. 10111
Attention: Karen C. Wiedemann
Facsimile No.: (212) 841-5725
(b) If to MedCath, to:
MedCath Incorporated
7621 Little Avenue,
Suite 106
Charlotte, North Carolina 28226
Attention: Stephen R. Puckett
Facsimile No.: (704) 541-2615
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with copies to:
Moore & Van Allen, PLLC
100 N. Tryon Street, Floor 47
Charlotte, North Carolina 28202
Attention: Hal A. Levinson
Facsimile No. (704) 331-1159
and to:
Strategic Options Committee
c/o John B. McKinnon
2020 Virginia Road
Winston-Salem, North Carolina 27104
Facsimile No.: (910) 777-8510
and to:
Womble Carlyle Sandridge & Rice, PLLC
3300 One First Union Center
Charlotte, North Carolina 28202
Attention: Garza Baldwin, III
Facsimile No.: (704) 338-7816
or to such other address or telecopier number as such party may hereafter
specify for the purpose of notice to the other parties. Any such notice,
request or other communication shall be deemed to have been given and received
on the day on which it is delivered or telecopied (or, if such day is not a
business day in North Carolina or if the notice or other communication is not
telecopied during business hours, at the place of receipt, on the next
following business day); provided that if notice or other communication is
given by telecopy, such notice or communication shall also be given by
certified mail or by overnight courier.
Section 9.2 Entire Agreement.
This Agreement (including the documents and instruments referred to
herein) and the Confidentiality Agreement constitute the entire agreement and
supersedes all other prior agreements and understandings, both written and
oral, among the parties with respect to the subject matter hereof.
Section 9.3 Parties in Interest.
This Agreement shall be binding upon and inure solely to the benefit of
each party hereto, and, except as provided in Section 3.10 with respect to the
obligations of Parent thereunder, nothing in this Agreement, express or
implied, is intended to confer upon any other person any rights or remedies of
any nature whatsoever under or by reason of this Agreement.
Section 9.4 Publicity.
The written release to the public by any party of any information relating
to the Merger shall be approved in advance by the other parties, which approval
shall not be unreasonably withheld or delayed.
Section 9.5 Headings.
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.
Section 9.6 Interpretation.
As used herein, "knowledge" (or words to such effect) of MedCath shall
mean actual knowledge of the officers of MedCath, as the case may be, and
"knowledge" (or words to such effect) of Acquiror shall mean the actual
knowledge of its officers or actual knowledge of any partner, managing director
or employee of Acquiror.
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Section 9.7 Subsidiaries.
When a reference is made in this Agreement to subsidiaries of MedCath, the
word "subsidiaries", means any corporation all of whose outstanding voting
securities are directly or indirectly owned by MedCath.
Section 9.8 Successors and Assigns.
This Agreement shall be binding upon and inure to the benefit of and be
enforceable by the respective successors and assigns of the parties hereto.
Section 9.9 Governing Law.
This Agreement shall be governed in all respects, including validity,
interpretation and effect, by the internal laws of the State of North Carolina,
without giving effect to the principles of conflict of laws thereof, except the
laws of the state of incorporation of a party shall govern its internal
corporate affairs.
Section 9.10 Costs and Expenses.
Except as provided in Section 8.6, 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 9.11 Counterparts.
This Agreement may be executed in any number of counterparts, each of
which shall be an original, but all of which together shall constitute one and
the same agreement.
Section 9.12 Specific Performance.
The parties hereto agree that irreparable damage would occur in the event
any provision of this Agreement was not performed in accordance with the terms
hereof and that the parties shall be entitled to the remedy of specific
performance of the terms hereof, in addition to any other remedy at law or
equity.
Section 9.13 Conciliation and Arbitration.
(a) If any dispute, claim or difference arises out of or relates to this
Agreement (a "Dispute"), such Dispute shall be finally settled by arbitration
in accordance with the Commercial Arbitration Rules of the American Arbitration
Association ("AAA") effective as of the commencement of the arbitration (the
"Rules"), except as such Rules may be modified as provided herein. The
arbitration shall be held in Charlotte, North Carolina, unless the parties
mutually agree to have the arbitration held elsewhere, and judgment upon the
award made therein may be entered by any court having jurisdiction thereof. The
arbitral tribunal shall be composed of three arbitrators, who shall be
experienced commercial litigators admitted to practice law in the State of New
York or the State of North Carolina. Parent and the Company shall each appoint
one arbitrator. If such parties fail to nominate an arbitrator in accordance
with the preceding sentence within thirty days from the date when the notice of
intention to arbitrate referred to in Rule 6 of the Rules (the "Commencement
Notice") has been received by the Respondent (as defined in the Rules) such
appointment shall, upon written request by either party to the AAA, be made in
accordance with Rule 14 of the Rules. The two arbitrators thus appointed shall
attempt to agree upon the third arbitrator to act as chairperson of the
arbitration tribunal. If said two arbitrators fail to appoint the chairperson
within thirty days from the date of appointment of the second arbitrator, upon
written request of either party to the AAA, such appointment shall be made in
accordance with Rule 15 of the Rules. The arbitrators shall have no power to
waive, alter, amend, revoke or suspend any of the provisions of this Agreement,
provided, however, that the arbitrators shall have the power to decide all
questions with respect to the interpretation and validity of this Section 9.13.
The arbitration shall be conducted, and the award shall be rendered, in the
English language. An arbitrator may not act as an advocate for the party
nominating him, and all three arbitrators shall be impartial and unbiased. A
majority vote by the three arbitrators shall be required on any decision made
by them. The arbitrators shall permit such discovery as they shall determine is
appropriate in the circumstances, taking into account the needs of the parties
and the desirability of making discovery expeditious and cost-effective. Any
such discovery shall be limited to information directly relevant to the
controversy or claim in arbitration and shall be concluded within thirty days
after the appointment of the arbitration panel. This agreement to arbitrate
shall be binding upon the heirs, successors and assigns and any trustee,
receiver or executor of any party hereto. Except to the extent required by law
or court or administrative order, no party, arbitrator, representative, counsel
or witness shall disclose or confirm to any person not present at the
arbitration hearings any information about the arbitration proceeding or
hearings,
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including the names of the parties and arbitrators, the nature and amount of
the claims, the financial condition of any party, the expected date of hearing
or the award made.
(b) Subject to and not in any way limiting the preceding Section 9.13(a),
each of the parties hereto irrevocably consents and submits to the jurisdiction
in any action brought in connection with this Agreement in the United States
District Court for the Southern District of New York or for the District of
North Carolina, including, but not limited to, any action to enforce an award
rendered pursuant to the preceding Section 9.13(a). Parent hereby appoints CT
Corporation System as their agent for service of process in New York.
SIGNATURE PAGE FOLLOWS
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IN WITNESS WHEREOF, the parties have executed this Agreement by their duly
authorized officers as of the date first above written.
MEDCATH INCORPORATED,
a North Carolina corporation
By: /s/ STEPHEN PUCKETT
------------------------------------
Name: Stephen R. Puckett
Title: President
MCTH ACQUISITION INC.,
a North Carolina corporation
By: /s/ EDWARD GILHULY
------------------------------------
Name: Edward A. Gilhuly
Title: President
MEDCATH HOLDINGS, INC.,
a Delaware corporation
By: /s/ EDWARD GILHULY
------------------------------------
Name: Edward A. Gilhuly
Title: President
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APPENDIX B
OPINION OF GOLDMAN, SACHS & CO.
[GOLDMAN SACHS LOGO APPEARS HERE]
PERSONAL AND CONFIDENTIAL
- -------------------------
July 6, 1998
Strategic Options Committee of the Board of Directors
MedCath Incorporated
7621 Little Avenue
Suite 106
Charlotte, NC 28226
Gentlemen:
You have requested our opinion as to the fairness from a financial point
of view to the holders (excluding KKR 1996 Fund, L.P., an affiliate of Kohlberg
Kravis Roberts & Co., L.P. ("KKR"), Welsh, Carson, Anderson & Stowe VII, L.P.
("WCAS VII"), an affiliate of Welsh, Carson, Anderson & Stowe ("WCAS" and,
together with WCAS VII and other investment partnerships and individuals
affiliated with WCAS, the "WCAS Investors"), the WCAS Investors, MCTH
Acquisition, Inc. ("Buyer") and certain participating officers and directors of
MedCath Incorporated (the "Company")) (the "Holders") of the outstanding shares
of Common Stock, par value $.01 per share (the "Shares"), of the Company of the
$19.00 per Share in cash to be received by the Holders pursuant to the
Agreement and Plan of Merger (the "Merger Agreement"), dated as of March 12,
1998, by and among MedCath Holdings, Inc. ("Parent"), Buyer, a wholly-owned
subsidiary of Parent, and the Company.
Goldman, Sachs & Co., as part of its investment banking business, is
continually engaged in the valuation of businesses and their securities in
connection with mergers and acquisitions, negotiated underwritings, competitive
biddings, secondary distributions of listed and unlisted securities, private
placements and valuations for estate, corporate and other purposes. We are
familiar with the Company having acted as financial advisor to the Special
Committee of the Board of Directors of the Company in connection with, and
having participated in certain of the negotiations leading to, the Merger
Agreement. We also have provided certain investment banking services to KKR,
WCAS and their affiliates from time to time and may provide investment banking
services to KKR, WCAS and their affiliates in the future.
In connection with this opinion, we have reviewed, among other things, the
Merger Agreement; the draft Schedule 14A containing the draft Proxy Statement
dated June 23, 1998; Annual Reports to Stockholders and Annual Reports on Form
10-K of the Company for the three fiscal years ended September 30, 1997; the
Company's Prospectus for its initial public offering of Shares dated December
6, 1994; certain interim reports to stockholders and Quarterly Reports on Form
10-Q of the Company; certain other communications from the Company to its
stockholders; and certain internal financial analyses and forecasts for the
Company prepared by its management. We also have held discussions with members
of the management of the Company regarding its past and current business
operations, financial condition and future prospects. We also discussed with
you your views as to the risks and uncertainties associated with achieving
management's forecasts for the Company. In addition, we have reviewed the
reported price and trading activity for the Shares, compared certain financial
and stock market information for the Company with similar information for
certain other companies, the securities of which are publicly traded, reviewed
the financial terms of certain recent business combinations in the hospital
industry and the physician practice management industry specifically and in
other industries generally and performed such other studies and analyses as we
considered appropriate.
We have relied upon the accuracy and completeness of all of the financial
and other information reviewed by us and have assumed such accuracy and
completeness for purposes of rendering this opinion. In that regard, with
respect to the financial forecasts for the Company provided to us by management
of the Company for purposes of our analysis in connection with this opinion, we
have assumed, with your consent, that such forecasts have been reasonably
prepared on a basis reflecting the best currently available estimates and
judgments. In addition, we have not made an independent evaluation or appraisal
of the assets and liabilities of the Company or any of its subsidiaries and we
have not been furnished with any such evaluation or appraisal. Our advisory
services and the opinion expressed herein are provided for the information and
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assistance of the Strategic Options Committee of the Board of Directors of the
Company in connection with its consideration of the transaction contemplated by
the Merger Agreement and such opinion does not constitute a recommendation as
to how any holder of Shares should vote with respect to such transaction.
Based upon and subject to the foregoing and based upon such other matters
as we consider relevant, it is our opinion that as of the date hereof the
$19.00 per Share in cash to be received by the Holders pursuant to the Merger
Agreement is fair from a financial point of view to such Holders.
Very truly yours,
/s/ GOLDMAN, SACHS & CO.
- --------------------------
(GOLDMAN, SACHS & CO.)
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APPENDIX C
TEXT OF CHAPTER 55, ARTICLE 13 OF THE GENERAL STATUTES OF NORTH CAROLINA
DISSENTER'S RIGHTS.
PART I. RIGHT TO DISSENT AND OBTAIN PAYMENT FOR SHARES.
ss. 55-13-01. Definitions.
In this Article:
(1) "Corporation" means the issuer of the shares held by a dissenter
before the corporate action, or the surviving or acquiring corporation by
merger or share exchange of that issuer.
(2) "Dissenter" means a shareholder who is entitled to dissent from
corporate action under G.S. 55-13-02 and who exercises that right when and in
the manner required by G.S. 55-13-20 through 55-13-28.
(3) "Fair value," with respect to a dissenter's shares, means the value of
the shares immediately before the effectuation of the corporate action to which
the dissenter objects, excluding any appreciation or depreciation in
anticipation of the corporate action unless exclusion would be inequitable.
(4) "Interest" means interest from the effective date of the corporate
action until the date of payment, at a rate that is fair and equitable under
all the circumstances, giving due consideration to the rate currently paid by
the corporation on its principal bank loans, if any, but not less than the rate
provided in G.S. 24-1.
(5) "Record shareholder" means the person in whose name shares are
registered in the records of a corporation or the beneficial owner of shares to
the extent of the rights granted by a nominee certificate on file with a
corporation.
(6) "Beneficial shareholder" means the person who is a beneficial owner of
shares held in a voting trust or by a nominee as the record shareholder.
(7) "Shareholder" means the record shareholder or the beneficial
shareholder.
ss. 55-13-02. Right to Dissent.
(a) In addition to any rights granted under Article 9, a shareholder is
entitled to dissent from, and obtain payment of the fair value of his
shares in the event of, any of the following corporate actions:
(1) Consummation of a plan of merger to which the corporation (other
than a parent corporation in a merger under G.S. 55-11-04) is a party
unless (i) approval by the shareholders of that corporation is not
required under G.S. 55-11-03(g) or (ii) such shares are then redeemable
by the corporation at a price not greater than the cash to be received in
exchange for such shares;
(2) Consummation of a plan of share exchange to which the corporation
is a party as the corporation whose shares will be acquired, unless such
shares are then redeemable by the corporation at a price not greater than
the cash to be received in exchange for such shares;
(3) Consummation of a sale or exchange of all, or substantially all,
of the property of the corporation other than as permitted by G.S.
55-12-01, including a sale in dissolution, but not including a sale
pursuant to court order or a sale pursuant to a plan by which all or
substantially all of the net proceeds of the sale will be distributed in
cash to the shareholders within one year after the date of sale;
(4) An amendment of the articles of incorporation that materially and
adversely affects rights in respect of a dissenter's shares because it
(i) alters or abolishes a preferential right of the shares; (ii) creates,
alters, or abolishes a right in respect of redemption, including a
provision respecting a sinking fund for the redemption or repurchase, of
the shares; (iii) alters or abolishes a preemptive right of the holder of
the shares to acquire shares or other securities; (iv) excludes or limits
the right of the shares to vote on any matter, or to cumulate votes; (v)
reduces the number of shares owned by the shareholder to a fraction of a
share if the fractional share so created is to be acquired for cash under
G.S. 55-6-04; or (vi) changes the corporation into a nonprofit
corporation or cooperative organization;
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(5) Any corporate action taken pursuant to a shareholder vote to the
extent the articles of incorporation, bylaws, or a resolution of the
board of directors provides that voting or nonvoting shareholders are
entitled to dissent and obtain payment for their shares.
(b) A shareholder entitled to dissent and obtain payment for his shares
under this Article may not challenge the corporate action creating his
entitlement, including without limitation a merger solely or partly in
exchange for cash or other property, unless the action is unlawful or
fraudulent with respect to the shareholder or the corporation.
(c) Notwithstanding any other provision of this Article, there shall be
no right of dissent in favor of holders of shares of any class or series
which, at the record date fixed to determine the shareholders entitled to
receive notice of and to vote at the meeting at which the plan of merger or
share exchange or the sale or exchange of property is to be acted on, were
(i) listed on a national securities exchange or (ii) held by at least 2,000
recorded shareholders, unless in either case:
(1) The articles of incorporation of the corporation issuing the
shares provide otherwise;
(2) In the case of a plan of merger or share exchange, the holders of
the class or series are required under the plan of merger or share
exchange to accept for the shares anything except:
a. Cash;
b. Shares, or shares and cash in lieu of fractional shares of the
surviving or acquiring corporation, or of any other corporation which,
at the record date fixed to determine the shareholders entitled to
receive notice of and vote at the meeting at which the plan of merger
or share exchange is to be acted on, were either listed subject to
notice of issuance on a national securities exchange or held of record
by at least 2,000 record shareholders; or
c. A combination of cash and shares as set forth in
sub-subdivisions a. and b. of this subdivision.
ss. 55-13-03. Dissent by Nominees and Beneficial Owners.
(a) A record shareholder may assert dissenters' rights as to fewer than
all the shares registered in his name only if he dissents with respect to
all shares beneficially owned by any one person and notifies the
corporation in writing of the name and address of each person on whose
behalf he asserts dissenters' rights. The rights of a partial dissenter
under this subsection are determined as if the shares as to which he
dissents and his other shares were registered in the names of different
shareholders.
(b) A beneficial shareholder may assert dissenters' rights as to shares
held on his behalf only if:
(1) He submits to the corporation the record shareholder's written
consent to the dissent not later than the time the beneficial shareholder
asserts dissenters' rights; and
2) He does so with respect to all shares of which he is the beneficial
shareholder.
ss. 55-13-04 TO 55-13-19. Reserved for Future Codification Purposes.
PART 2. PROCEDURE FOR EXERCISE OF DISSENTERS' RIGHTS.
ss. 55-13-20. Notice of Dissenters' Rights.
(a) If proposed corporate action creating dissenters' rights under G.S.
55-13-02 is submitted to a vote at a shareholders' meeting, the meeting
notice must state that shareholders are or may be entitled to assert
dissenters' rights under this Article and be accompanied by a copy of this
Article.
(b) If corporate action creating dissenters' rights under G.S. 55-13-02
is taken without a vote of shareholders, the corporation shall no later
than 10 days thereafter notify in writing all shareholders entitled to
assert dissenters' rights that the action was taken and send them the
dissenters' notice described in G.S. 55-13-22.
(c) If a corporation fails to comply with the requirements of this
section, such failure shall not invalidate any corporate action taken; but
any shareholder may recover from the corporation any damage which he
suffered from such failure in a civil action brought in his own name within
three years after the taking of the corporate action creating dissenters'
rights under G.S. 55-13-02 unless he voted for such corporate action.
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ss. 55-13-21. Notice of Intent to Demand Payment.
(a) If proposed corporate action creating dissenters' rights under G.S.
55-13-02 is submitted to a vote at a shareholders' meeting, a shareholder
who wishes to assert dissenters' rights:
(1) Must give to the corporation, and the corporation must actually
receive, before the vote is taken written notice of his intent to demand
payment for his shares if the proposed action is effectuated; and
(2) Must not vote his shares in favor of the proposed action.
(b) A shareholder who does not satisfy the requirements of subsection (a)
is not entitled to payment for his shares under this Article.
ss. 55-13-22. Dissenters' Notice.
(a) If proposed corporate action creating dissenters' rights under G.S.
55-13-02 is authorized at a shareholders' meeting, the corporation shall
mail by registered or certified mail, return receipt requested, a written
dissenters' notice to all shareholders who satisfied the requirement of
G.S. 55-13-21.
(b) The dissenters' notice must be sent no later than 10 days after
shareholder approval, or if no shareholder approval is required, after
approval of the board of directors, of the corporate action creating
dissenters' rights under 6.S.55-13-02, and must:
(1) State where the payment demand must be sent and where and when
certificates for certificated shares must be deposited;
(2) Inform holders of uncertificated shares to what extent transfer of
the shares will be restricted after the payment demand is received;
(3) Supply a form for demanding payment;
(4) Set a date by which the corporation must receive the payment
demand, which date may not be fewer than 30 nor more than 60 days after
the date the subsection (a) notice is mailed; and
(5) Be accompanied by a copy of this Article.
ss. 55-13-23. Duty to Demand Payment.
(a) A shareholder sent a dissenters' notice described in G.S. 55-13-22
must demand payment and deposit his share certificates in accordance with
the terms of the notice.
(b) The shareholder who demands payment and deposits his share
certificates under subsection (a) retains all other rights of a shareholder
until these rights are canceled or modified by the taking of the proposed
corporate action.
(c) A shareholder who does not demand payment or deposit his share
certificates where required, each by the date set in the dissenters'
notice, is not entitled to payment for his shares under this Article.
ss. 55-13-24. Share Restriction.
(a) The corporation may restrict the transfer of uncertificated shares
from the date the demand for their payment is received until the proposed
corporate action is taken or the restrictions released under G.S. 55-13-26.
(b) The person for whom dissenters' rights are asserted as to
uncertificated shares retains all other rights of a shareholder until these
rights are canceled or modified by the taking of the proposed corporate
action.
ss. 55-13-25. Payment.
(a) As soon as the proposed corporate action is taken, or within 30 days
after receipt of a payment demand, the corporation shall pay each dissenter
who complied with G.S. 55-13-23 the amount the corporation estimates to be
the fair value of his shares, plus interest accrued to the date of payment.
(b) The payment shall be accompanied by:
(1) The corporation's most recent available balance sheet as of the
end of a fiscal year ending not more than 16 months before the date of
payment, an income statement for that year, a statement of cash flows for
that year, and the latest available interim financial statements, if any;
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(2) As explanation of how the corporation estimated the fair value of
the shares;
(3) An explanation of how the interest was calculated;
(4) A statement of the dissenter's right to demand payment under G.S.
55-13-28; and
(5) A copy of this Article.
ss. 55-13-26. Failure to Take Action.
(a) If the corporation does not take the proposed action within 60 days
after the date set for demanding payment and depositing share certificates,
the corporation shall return the deposited certificates and release the
transfer restrictions imposed on uncertificated shares.
(b) If after returning deposited certificates and releasing transfer
restrictions, the corporation takes the proposed action, it must send a new
dissenters' notice under G.S. 55-13-22 and repeat the payment demand
procedure.
ss. 55-13-27. Reserved for Future Codification Purposes.
ss. 55-13-28. Procedure if Shareholder Dissatisfied with Corporation's Offer or
Failure to Perform.
(a) A dissenter may notify the corporation in writing of his own estimate
of the fair value of his shares and amount of interest due, and demand
payment of the amount in excess of the payment by the corporation under
G.S. 55-13-25 for the fair value of his shares and interest due, if;
(1) The dissenter believes that the amount offered under G.S. 55-13-25
is less than the fair value of his shares or that the interest due is
incorrectly calculated;
(2) The corporation fails to make payment under G.S. 55-13-25; or
(3) The corporation, having failed to take the proposed action, does
not return the deposited certificates or release the transfer
restrictions imposed on uncertificated shares within 60 days after the
date set for demanding payment.
(b) A dissenter waives his rights to demand payment under this section
unless he notifies the corporation of his demand in writing (i) under
subdivision (a)(1) within 30 days after the corporation made payment for
his shares or (ii) under subdivisions (a)(2) and (a)(3) within 30 days
after the corporation has failed to perform timely. A dissenter who fails
to notify the corporation of his demand under subsection (a) within such
30-day period shall be deemed to have withdrawn his dissent and demand for
payment.
ss. 55-13-29. Reserved for Future Codification Purposes.
PART 3. JUDICIAL APPRAISAL OF SHARES.
ss. 55-13-30. Court Action.
(a) If a demand for payment under G.S. 55-13-28 remains unsettled, the
dissenter may commence a proceeding within 60 days after the earlier of (i)
the date payment is made under G.S. 55-13-25, or (ii) the date of the
dissenter's payment demand under G.S. 55-13-28 by filing a complaint with
the Superior Court Division of the General Court of Justice to determine
the fair value of the shares and accrued interest. A dissenter who takes no
action within the 60-day period shall be deemed to have withdrawn his
dissent and demand for payment.
(a)(1) Repealed by Session Laws 1997-202, s.4, effective October 1, 1997.
(b) Reserved for future codification purposes.
(c) The court shall have the discretion to make all dissenters (whether
or not residents of this State) whose demands remain unsettled parties to
the proceeding as in an action against their shares and all parties must be
served with a copy of the complaint. Nonresidents may be served by
registered or certified mail or by publication as provided by law.
(d) The jurisdiction of the court in which the proceeding is commenced
under subsection (a) is plenary and exclusive. The court may appoint one or
more persons as appraisers to receive evidence and recommend decision on
the question of fair value. The appraisers have the powers described in the
order appointing them, or any amendment to it. The parties are entitled to
the same discovery rights as parties in other civil proceedings. The
proceeding shall be tried
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as in other civil actions. However, in a proceeding by a dissenter in a
corporation that was a public corporation immediately prior to consummation
of the corporate action giving rise to the right of dissent under G.S.
55-13-02, there is no right to a trial by jury.
(e) Each dissenter made a party to the proceeding is entitled to judgment
for the amount, if any, by which the court finds the fair value of his
shares, plus interest, exceeds the amount paid by the corporation.
ss. 55-13-31. Court Costs and Counsel Fees.
(a) The court in an appraisal proceeding commenced under G.S. 55-13-30
shall determine all costs of the proceeding, including the reasonable
compensation and expenses of appraisers appointed by the court, and shall
assess the costs as it finds equitable.
(b) The court may also assess the fees and expenses of counsel and
experts for the respective parties, in amount the court finds equitable;
(1) Against the corporation and in favor of any or all dissenters if
the court finds the corporation did not substantially comply with the
requirements of G.S. 55-13-20 through 55-13-28; or
(2) Against either the corporation or a dissenter, in favor of either
or any other party, if the court finds that the party against whom the
fees and expenses are assessed acted arbitrarily, vexatiously, or not in
good faith with respect to the rights provided by this Article.
(c) If the court finds that the services of counsel for any dissenter
were of substantial benefit to other dissenters similarly situated, and
that the fees for those services should not be assessed against the
corporation, the court may award to these counsel reasonable fees to be
paid out of the amounts awarded the dissenters who were benefited.
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