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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER: 0-27276
MEDPARTNERS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 63-1151076
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
3000 GALLERIA TOWER, SUITE 1000
BIRMINGHAM, ALABAMA 35244
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(205) 733-8996
Securities Registered Pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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COMMON STOCK, PAR VALUE $.001 PER SHARE THE NEW YORK STOCK EXCHANGE
THRESHOLD APPRECIATION PRICE SECURITIES(TM) THE NEW YORK STOCK EXCHANGE
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the Registrant (1) has filed all Reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such Reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 1, 1998: Common Stock, par value $.001 per
share -- $2,291,503,584.
As of March 1, 1998, the Registrant had 197,860,913 shares of Common Stock,
par value $.001 per share, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information set forth under Items 10, 11, 12 and 13 of Part III of this
Annual Report on Form 10-K is incorporated by reference from the Registrant's
definitive proxy statement for its 1998 Annual Meeting of Stockholders that will
be filed no later than April 30, 1998.
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FORWARD LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS
FORWARD LOOKING STATEMENTS. Statements in this document that are not
historical facts are hereby identified as "forward looking statements" for the
purpose of the safe harbor provided by Section 21E of the Securities Exchange
Act of 1934 (the "Exchange Act") and Section 27A of the Securities Act of 1933
(the "Securities Act"). MedPartners, Inc. ("MedPartners" or the "Company")
cautions readers that such "forward looking statements", including without
limitation, those relating to the Company's future business prospects, revenues,
working capital, liquidity, capital needs, interest costs and income, wherever
they occur in this document or in other statements attributable to the Company,
are necessarily estimates reflecting the best judgment of the Company's senior
management and involve a number of risks and uncertainties that could cause
actual results to differ materially from those suggested by the "forward looking
statements". Such "forward looking statements" should, therefore, be considered
in light of various important factors, including those set forth below and
others set forth from time to time in the Company's reports and registration
statements filed with the Securities and Exchange Commission (the "SEC").
These "forward looking statements" are found at various places throughout
this document. Additionally, the discussions herein under the captions
"Business -- Physician Practice Services", "Business -- Pharmaceutical
Services", "Business -- Contract Medical Services", "Business -- Information
Systems", "Business -- Competition", "Business -- Government Regulation",
"Business -- Corporate Liability and Insurance", "Legal Proceedings" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" are susceptible to the risks and uncertainties discussed below.
Moreover, the Company, through its senior management, may from time to time make
"forward looking statements" about the matters described herein or other matters
concerning the Company.
The Company disclaims any intent or obligation to update "forward looking
statements".
FACTORS THAT MAY AFFECT FUTURE RESULTS. The healthcare industry in general
and the businesses engaged in by the Company in particular are in a state of
significant flux. This, together with the circumstances that the Company has a
relatively short operating history in an industry that also is relatively young
and is the largest physician practice management company in the United States,
makes the Company particularly susceptible to various factors that may affect
future results such as the following:
Risks relating to the Company's growth strategy; risks relating
to integration in connection with the Company's acquisitions; risks
relating to the Company's capital requirements; risks relating to
identification of growth opportunities; risks relating to dependence
on HMO enrollee growth; risks relating to the capitated nature of
revenues; risks relating to utilization of medical services; risks
relating to control of healthcare costs; risks relating to certain
legal matters; risks relating to exposure to professional liability;
risks relating to government regulation; risks relating to pharmacy
licensing operations; risks relating to healthcare reform and proposed
legislation; and risks relating to the volatility and/or decline of
stock price.
For a more detailed discussion of these factors and their potential impact
on future results, see the applicable discussions herein.
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PART I
ITEM 1. BUSINESS.
GENERAL
MedPartners, Inc., a Delaware corporation ("MedPartners" or the "Company"),
is one of the largest healthcare companies in the United States, with net
revenue of approximately $6.3 billion for the year ended December 31, 1997. The
Company operates three separate business divisions: Physician Practice Services,
Pharmaceutical Services and Contract Medical Services. The Physician Practice
Services Division is larger than any other physician practice management company
("PPM") in the United States, based on annual net revenue in that business of
approximately $3.0 billion for the year ended December 31, 1997. The
Pharmaceutical Services Division operates one of the largest independent
prescription benefit management ("PBM") and therapeutic pharmaceutical services
programs in the United States, with revenues of approximately $2.4 billion for
the year ended December 31, 1997. The Contract Medical Services Division
operates one of the largest hospital-based physician management services and one
of the largest corrections and government services managed care businesses, with
combined net revenue of approximately $0.8 billion for the year ended December
31, 1997.
The Company's Physician Practice Services Division affiliates with
physicians who are seeking the resources necessary to function effectively in
healthcare markets that are evolving from fee-for-service to managed care payor
systems. MedPartners also affiliates with physicians who seek greater
efficiencies in operations of traditional fee-for-service practices. The Company
seeks to enhance clinic operations by centralizing administrative functions and
introducing management tools, such as clinical guidelines and medical management
processes. The Company provides affiliated physicians with access to capital and
to management information systems. In addition, the Company contracts with
health maintenance organizations (and other third-party payors that compensate
the Company and its affiliated physicians on a prepaid basis (collectively,
"HMOs")), hospitals and outside providers on behalf of its affiliated
physicians. These relationships provide physicians with the opportunity to
operate under a variety of payor arrangements.
The Company offers medical group practices and independent physicians a
range of affiliation models. These affiliations are carried out by the
acquisition of physician practice services entities or practice assets, either
for cash or equity, or by affiliation on a contractual basis. In all instances,
the Company enters into long-term practice management agreements that provide
for the management of the affiliated physicians by the Company while assuring
the clinical independence of the physicians.
The Company also manages PBM programs for more than 2,194 clients
throughout the United States, including corporations, insurance companies,
unions, government employee groups and managed care organizations. The Company
dispenses an average of 44,800 prescriptions daily through three mail service
pharmacies and manages patients' immediate prescription needs through a network
of approximately 53,000 retail and other pharmacies. The Company's therapeutic
pharmaceutical services are designed to meet the healthcare needs of individuals
with certain chronic diseases or conditions. These services include the design,
development and management of comprehensive programs comprising drug therapy,
physician support and patient education. The Company currently provides
therapies and services for individuals with such conditions as hemophilia,
growth disorders, immune deficiencies, cystic fibrosis and multiple sclerosis.
The Company is in the process of integrating the pharmaceutical services program
with the PPM business by providing pharmaceutical services to affiliated
physicians, clinics and HMOs.
The Contract Medical Services Division organizes and manages physicians and
other healthcare professionals engaged in the delivery of emergency, radiology
and teleradiology services, primary care and temporary staffing and support
services. Through its Team Health subsidiary the Company provides these services
to hospitals, clinics and managed care organizations, and the Company's
Government Services unit provides these services to correctional facilities,
Department of Defense facilities and government-affiliated physician groups
throughout the United States. This Division also provides occupational health
services to corporate industrial clients. Under contracts with hospitals and
other clients, the Contract Medical Services Division identifies and recruits
physicians and other healthcare professionals for admission to a client's
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medical staff and coordinates the ongoing scheduling of staff physicians and
other healthcare professionals who provide clinical coverage in designated areas
of care.
The Company was organized in 1993 with the goal of improving the nation's
healthcare system by building an integrated delivery system that is
physician-led and patient-centered. In pursuing this goal, the Company has grown
quickly, primarily through the acquisition of 287 physician practices with over
6,064 physicians, including the acquisition in November 1995 of Mullikin Medical
Enterprises, L.P. ("MME"), a privately held physician practice management entity
based in Long Beach, California, the acquisition in February 1996 of Pacific
Physician Services, Inc. ("PPSI"), a publicly traded physician practice
management company based in Redlands, California, which had previously acquired
Team Health, the acquisition in September 1996 of Caremark International Inc.
("Caremark"), a publicly traded physician practice management and pharmaceutical
services company based in Northbrook, Illinois and the acquisition in June 1997
of InPhyNet Medical Management Inc. ("InPhyNet"), which, when combined with Team
Health, created one of the largest hospital-based physician groups in the
country. In September 1997, the Company completed the acquisition of Talbert
Medical Management Holdings Corporation ("Talbert") for $187.1 million in cash.
Talbert operated 52 health centers in five Southwestern states with
approximately 258,000 patients in its network.
On October 29, 1997, the Company announced its plan to be acquired by
PhyCor, Inc. in a merger, but the transaction was terminated by mutual agreement
prior to consummation. On January 16, 1998, the Company announced that Richard
M. Scrushy, a Director of the Company and Chairman of the Board and Chief
Executive Officer of HEALTHSOUTH Corporation, had become Chairman of the Board
and acting Chief Executive Officer of the Company. On March 18, 1998, the
Company announced the appointment of Edwin M. Crawford, formerly Chairman of the
Board, President and Chief Executive Officer of Magellan Health Services, Inc.
(formerly Charter Medical Corporation), as President and Chief Executive Officer
and a Director of the Company. On the same date, the Company announced a net
loss for the fourth quarter of 1997 of $840.8 million, which included one-time
pre-tax charges totaling $647 million. See "-- Recent Developments" and Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Having acquired the critical mass attendant to a company with $6.3 billion
in annual net revenue, the Company's new leadership intends to concentrate on
further integration of its existing operations in order to generate internal
growth and capture the opportunities that exist within and across the Company's
three divisions. The Company has identified three business objectives: (i)
operational integration within existing business lines; (ii) business
integration across divisional lines to capitalize on internal opportunities; and
(iii) strategic relationship development, on a regional or national basis, with
payors, providers, suppliers and other related businesses. While it is
anticipated that the Company will continue to make selected, strategic
acquisitions to continue growing the Company during this period of
consolidation, the primary focus of management and the Company's 29,000
employees will be on improving the Company's existing operations.
The Company was incorporated under the laws of Delaware in August 1995 as
"MedPartners/Mullikin, Inc." to be the surviving corporation in the combination
of the businesses of the original MedPartners, Inc., incorporated under the laws
of Delaware in 1993, and MME. In September 1996, the Company changed its name to
"MedPartners, Inc." The executive offices of the Company are located at 3000
Galleria Tower, Suite 1000, Birmingham, Alabama 35244, and its telephone number
is (205) 733-8996.
RECENT DEVELOPMENTS
The Company experienced several adverse events in the fourth quarter of
1997 and in January 1998, including: (i) a fourth quarter pretax charge of
$646.7 million related primarily to the restructuring and impairment of selected
assets of certain of its clinic operations within the Physician Practice
Services Division; (ii) a fourth quarter after-tax charge from discontinued
operations of approximately $15.3 million; (iii) a fourth quarter after-tax
charge of $30.9 million related to the cumulative effect of a change in
accounting principle; (iv) a fourth quarter net loss from continuing operations;
(v) the termination of the merger agreement with PhyCor, Inc.; (vi) a steep drop
in the price of its Common Stock following the announcement
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of the termination of the PhyCor merger and (vii) the filing of various
stockholder class action lawsuits against the Company and certain of its
officers and directors in the aftermath of these events alleging violations of
federal securities laws. See Item 3. "Legal Proceedings".
In response to certain of these setbacks, assembly of a new management team
began in January 1998 when Richard M. Scrushy was named Chairman of the Board
and acting Chief Executive Officer. Another step was taken in March 1998 when
Edwin M. Crawford was named President and Chief Executive Officer. Mr. Scrushy
will remain Chairman of the Board and brings his extensive healthcare
experience, most recently his 13 years as Chairman of the Board and Chief
Executive Officer of HEALTHSOUTH Corporation, to this position. Mr. Crawford has
been credited with successfully turning around Magellan's operations,
transforming the company from a psychiatric provider operation into a managed
care company and expanding the company into the rapidly growing market of
specialty disease management. In addition to these management changes, the
Company reorganized and streamlined its PPM organizational structure to
strengthen management, speed integration, improve operations and facilitate
communications.
HEALTHCARE SERVICES INDUSTRY OVERVIEW
The Health Care Financing Administration ("HCFA") estimates that national
healthcare spending in 1996 was in excess of $1 trillion, or 9% of the gross
domestic product ("GDP"). HCFA projects that annual healthcare spending will
increase at a compound annual growth rate of over 8% to $1.5 trillion, or 16% of
the GDP by year 2000. The American Medical Association reports that
approximately 613,000 physicians are actively involved in patient care in the
United States, and that these physicians control more than 80% of the overall
healthcare industry expenditures. Expenditures directly attributable to
physicians are estimated at $246 billion, of which approximately $20 billion
were revenues for emergency physician services. Expenditures related to
pharmaceuticals are estimated at $90 billion, or 9% of overall expenditures.
Concerns over the cost of healthcare have resulted in the rapid growth of
managed care in the past several years. From 1991 to 1996, HMO enrollment in the
United States increased from 37 million to 60 million. As markets evolve from
traditional fee-for-service medicine to managed care, HMOs and healthcare
providers confront market pressures to provide high quality healthcare in a
cost-effective manner. Employer groups have begun to bargain collectively in an
effort to reduce premiums and to bring about greater accountability of HMOs and
providers with respect to accessibility, choice of provider, quality of care and
other matters that are fundamental to consumer satisfaction. At the same time,
the industry's emphasis on cost efficient treatment alternatives, in addition to
continuing advances in both medical technology and new drug development, has
produced and is expected to continue to produce significant increases in drug
utilization and related costs. These trends have increased the existing need for
more appropriate, efficient and cost-effective provider management and drug
delivery management.
PHYSICIAN PRACTICE SERVICES
The Company's Physician Practice Services Division is the largest PPM in
the United States based on revenues. As of December 31, 1997, this Division had
net revenue of $3.0 billion; had affiliated with 3,588 group physicians and
7,467 independent practice association ("IPA") physicians in 42 states; and
provided services to 1,168,032 professional and 895,980 globally capitated
enrollees.
The Company's Physician Practice Services Division affiliates with
physicians who are seeking the resources necessary to function effectively in
healthcare markets that are evolving from fee-for-service to managed care payor
systems. This Division enhances clinic operations by centralizing administrative
functions and introducing management tools, such as clinical guidelines and
medical management processes. The Company provides affiliated physicians with
access to capital and to advanced management information systems. In addition,
the Company contracts with HMOs, hospitals and outside providers on behalf of
its affiliated physicians. These relationships provide physicians with the
opportunity to operate under a variety of payor arrangements and to increase
their patient flow.
The Physician Practice Services Division's revenues are derived from
contracts with HMOs that compensate the Company and its affiliated physicians on
a prepaid basis and from providing fee-for-service
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medical services. In the prepaid arrangements, the Company, through its
affiliated physicians, typically is paid by HMOs a fixed amount per member
("enrollee") per month ("professional capitation") or a percentage of the
premium per enrollee per month ("percent of premium") paid to the HMOs by
employer groups and other purchasers of healthcare coverage. In return, the
Company, through its affiliated physicians, is responsible for substantially all
of the medical services required by enrollees. In many instances, the Company
and its affiliated physicians accept financial responsibility for hospital and
ancillary healthcare services in return for payments from HMOs on a capitated or
percent of premium basis ("institutional capitation"). In exchange for these
payments (collectively, "global capitation"), the Company, through its
affiliated physicians, provides the majority of covered healthcare services to
enrollees and contracts with hospitals and other healthcare providers for the
balance of the covered services. In March 1996, the California Department of
Corporations ("DOC") issued a healthcare service plan license (the "Restricted
License") to MedPartners Provider Network, Inc. ("MPN") (formerly Pioneer
Provider Network, Inc.), in accordance with the requirements of the Knox-Keene
Act which authorizes MPN to operate as a healthcare service plan in the state of
California. The Company utilizes the Restricted License for a broad range of
healthcare services. See "-- Government Regulation".
Physician Practice Management Industry
Cost-containment initiatives, including reduced reimbursement, have
hindered physician practice profitability while demands for increased clinical
documentation, cost, quality and utilization data have increased physicians'
administrative duties. Small and mid-sized practices generally do not have the
market presence, expertise or cost accounting and management systems required,
and may not have the time necessary, to evaluate and enter into capitated
risk-sharing arrangements or to continue practicing profitably under reduced
reimbursement. In addition, these practices often lack the capital required to
purchase new medical equipment and information systems necessary to enhance the
efficiency and quality of their practices. As a result, individual physicians
and small group practices are increasingly consolidating, either by affiliating
with larger group practices and physician practice management entities or by
forming networks or independent practice associations. By consolidating into
larger organizations, physicians can achieve lower administrative costs, gain
leverage in negotiating with managed care organizations and position themselves
to attract needed capital resources.
Additionally, as HMO enrollment and physician membership in group medical
practices have continued to increase, healthcare providers have sought to
reorganize themselves into healthcare delivery systems that are better suited to
the managed care environment. Physician groups and IPAs are joining with
hospitals, pharmacies and other institutional providers in various arrangements
to create vertically integrated delivery systems that provide medical and
hospital services ranging from community-based primary medical care to
specialized inpatient services. These healthcare delivery systems contract with
HMOs to provide hospital and medical services to enrollees pursuant to full risk
contracts. Under these contracts, generally called global capitation, providers
assume the obligation to provide a broad range of covered healthcare services to
HMO enrollees, including professional, institutional and other healthcare
services such as home healthcare and pharmaceuticals.
While the acceptance of greater responsibility and risk affords the
opportunity to retain and enhance market share and to operate at a higher level
of profitability, the acceptance of global capitation carries with it
significant requirements for capital, enhanced infrastructure, information
systems, network resources and financial and medical management. Physicians are
increasingly abandoning traditional individual or small group private practice
in favor of affiliations with larger organizations such as the Company that
offer skilled and innovative management, sophisticated information systems and
significant capital resources. Many payors and their intermediaries, including
governmental entities and HMOs, are also looking to outside providers of
physician and pharmacy services to develop and maintain healthcare delivery
systems. As a result, physicians are turning to organizations such as the
Company to provide the resources necessary to function effectively in a managed
care environment.
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Strategy
The strategy of the Physician Practice Services Division is to develop
locally prominent, integrated healthcare delivery networks that provide high
quality, cost-effective healthcare in selected geographic markets. The key
elements of this strategy include: (i) having affiliated physicians maintain
responsibility for decisions relating to patient care, thus ensuring the quality
of healthcare services; (ii) developing and implementing effective population
health management tools to improve patient health; (iii) analyzing and
developing best practices and procedures for patients and utilizing them
throughout the Company; (iv) taking the lead in developing and implementing
disease management programs that improve care and control costs for patients
with chronic illnesses; (v) assuming greater responsibility for the entire
spectrum of healthcare services (including hospital care and pharmaceuticals)
provided to patients to ensure they are best coordinated and managed; and (vi)
benefiting from the medical information systems, capital resources,
administrative support, economies-of-scale and sophisticated negotiating
capabilities that the Company develops and offers.
The Company believes it has built strong positions in key sectors of the
healthcare industry, because its strategy addresses two principal needs in the
healthcare marketplace. First is the need of employers, employees and their
families for quality treatment at an affordable price. The Company's ability to
meet this need is evidenced by the fact that in 1997 MedPartners, through its
affiliated physicians, provided primary and specialty healthcare services to
approximately 2.1 million prepaid managed care enrollees and over 5.0 million
fee-for-service patient encounters. Second is the need by physicians for
solutions that allow them to focus on and improve patient care, while at the
same time enhancing the administration of their practices. The Company has
developed a unique management structure in which physicians work side-by-side
with business managers to ensure the physicians' voices are heard and their
issues addressed at decision-making levels. This management model is called
paired-physician leadership, and the Company believes that it is the most
effective mechanism for driving meaningful change. The Company will attempt to
profit from increased revenues and operational efficiencies and synergies
produced by the exchange of ideas among physicians and managers across
geographic boundaries and varied areas of specialization. The Physician Practice
Services Division has established medical management committees that meet
monthly to discuss implementation of the best medical management techniques to
assist the Company's affiliated physicians in delivering the highest quality of
care at lower costs in a consistent fashion. The Physician Practice Services
Division has also created a medical advisory committee, which is developing
procedures for the identification, packaging and dissemination of the best
clinical practices within the Company's medical groups. The medical advisory
committee also provides the Company's affiliated physicians a forum to discuss
innovative ways to improve the delivery of healthcare. By leveraging the
intellectual capital and knowledge of, and providing appropriate tools and
resources to, its affiliated physicians, MedPartners allows physicians to drive
changes in healthcare.
Operations
To meet payor demand for price competitive, quality services, the Company
utilizes a market-based approach that incorporates primary care and specialty
physicians into a network of providers serving a targeted geographic area. The
Company engages in research and market analysis to determine the best network
configuration for a particular market. Primary care includes family practice,
internal medicine, pediatrics and obstetrics/gynecology. Key specialties include
orthopedics, cardiology, oncology, radiology, neurosciences, urology, surgery,
ophthalmology and ear, nose and throat. At certain locations, affiliated
physicians and support personnel operate centers for diagnostic imaging, urgent
care, cancer management, mental health treatment and health education. Network
physicians also treat fee-for-service patients on a per-occurrence basis.
After-hours care is available in several of the Company's clinics. The Company
markets its networks to managed care and third-party payors, referring
physicians and hospitals. Under its global capitation contracts, the Company,
through its affiliated medical practices or Knox-Kneene licensee, is obligated
to pay for inpatient hospitalization and related services for covered enrollees.
The Company has contracted with a network of hospitals in its service area to
provide hospital services to covered enrollees.
The Company operates U.S. Family Care Medical Center ("USFMC"), a 102-bed
acute care hospital in Montclair, California, and Friendly Hills Hospital
("Friendly Hills"), a 274-bed acute care hospital in La
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Habra, California. Many of the physicians on the professional staff rosters of
these hospitals are either employed by an affiliated professional corporation or
are under contract with the Company's IPAs. Other physicians who are
traditionally hospital-based, such as emergency physicians, anesthesiologists,
pathologists, radiologists and cardiologists, provide services through
contractual arrangements with the Company. Several of the Company's medical
clinics are located sufficiently close to hospitals where these physicians are
based to allow enrollees who use the clinics also to use those hospitals.
Approximately 85% of USFMC's and approximately 87% of Friendly Hills' daily
censuses are made up of the Company's affiliated medical group enrollees.
Affiliated Physicians. The Company offers medical group practices and
independent physicians a range of affiliation models. In all instances, the
Company enters into long-term practice management agreements that provide for
the Company's management of the affiliated physician practices while assuring
the clinical independence of the physicians. Under these various types of
agreements, revenue is assigned to the Company by the physician practice. The
Company is responsible for the billing and collection of all revenue for
services provided at its clinics, as well as for paying all expenses, including
physician compensation. The Company is not reimbursed for the clinic expenses,
rather it is responsible and at risk, with its affiliated physicians, for all
such expenses. See Note 1 of the accompanying audited Consolidated Financial
Statements.
IPAs. The Company's networks include 7,467 primary care and specialist IPA
physicians serving approximately 358,000 HMO enrollees. An IPA allows individual
practitioners to access patients in their respective areas through contracts
with HMOs without having to join a group practice. An IPA also coordinates
utilization review and quality assurance programs for its affiliated physicians.
Additionally, an IPA offers other benefits to physicians seeking to remain
independent, including economies of scale in the marketplace, enhanced
risk-sharing arrangements and access to other strategic alliances. The Company
identifies IPAs that need access to capitated HMO contracts, and such IPA
organizations typically agree to assign their existing HMO contracts to the
Company.
HMOs. The Company, through its affiliated physicians, began contracting
with HMOs to provide healthcare on a capitated reimbursement basis in 1975
(through predecessors). Under these contracts, the Company provides virtually
all covered medical services and receives a fixed monthly capitation payment
from HMOs for each member who chooses an affiliate physician as his or her
primary care physician. The capitation amount may be fixed, based upon a
percentage of premium, or adjustable based on the age and sex of the HMO
enrollee. Contracts for prepaid healthcare with HMOs accounted for approximately
32% of the Company's consolidated net revenue for 1997. MedPartners currently
has relationships with Pacificare, Foundation, CIGNA, PCA and California Care
which account for approximately 17.5% of net revenue of MedPartners for the year
ended December 31, 1997.
To the extent that enrollees require more care than is anticipated or
require supplemental medical care that is not otherwise reimbursed by HMOs or
other payors, aggregate capitation payments may be insufficient to cover the
costs associated with the treatment of enrollees. Stop-loss coverage is
maintained for catastrophic events. At December 31, 1997, approximately 2.1
million prepaid HMO enrollees were covered beneficiaries for services in the
Company's networks. These patients are covered under either commercial
(typically employer-sponsored) or senior (Medicare-funded) HMOs. Higher
capitation rates are typically received for senior patients because their
medical needs are generally greater. Consequently, the cost of their covered
care is higher. As of December 31, 1997, the Company's HMO enrollees comprised
approximately 1.7 million commercial enrollees and approximately 0.2 million
senior (over 65) enrollees and approximately 0.2 million Medicaid and other
enrollees. As of December 31, 1997, the Company was receiving institutional
capitation payments for approximately 1.0 million enrollees.
PHARMACEUTICAL SERVICES
The Company's Pharmaceutical Services Division is a national leader in
providing PBM and therapeutic pharmaceutical services to patients with certain
chronic conditions. Annual net revenue for the year ended December 31, 1997, for
this line of business was approximately $2.4 billion. The Division provides PBM
services to approximately 2,194 customer groups representing approximately 15
million managed lives in all 50
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states and therapeutic pharmaceutical services to approximately 13,400 patients
with long-term, chronic or genetic diseases.
Pharmaceutical Services Industry
PBMs initially emerged in the early 1980s primarily to provide cost
effective drug claims processing for the healthcare industry. In the mid-1980s
they evolved to include pharmacy networks and drug utilization review to address
the need to manage the total cost of pharmaceutical services. Through volume
discounts, retail pharmacy networks, mail pharmacy services, formulary
administration, claims processing and drug utilization review, PBMs created an
opportunity for health benefit plan sponsors to deliver drugs to their members
in a more cost-effective manner, while improving physician and patient
compliance with recommended guidelines for safe and effective drug use.
The PBM industry continues to demonstrate substantial growth both in terms
of revenues and lives covered. According to industry sources, PBM market
revenues have grown at an annual rate of approximately 35% for the last three
years. Approximately 50% of the U.S. population was covered by a PBM in 1995,
more than double the lives covered in 1990.
PBMs have focused on cost containment by: (i) obtaining discounted
prescription services through retail pharmacy networks, and from drug
wholesalers and pharmaceutical manufacturers for mail distribution; (ii)
establishing drug utilization review programs to reduce the risk of
inappropriate drug complications; (iii) encouraging substitution of generic for
branded medications; and (iv) generating rebates from pharmaceutical companies.
Over the last several years, in response to increasing payor demand, PBMs have
begun to develop sophisticated formulary management capabilities and
comprehensive, on-line customer decision support tools in an attempt to better
manage the delivery of healthcare and, ultimately, costs. Simultaneously, to
lower overall healthcare costs, health benefit plan sponsors have begun to focus
on the quality and efficiency of care, emphasizing disease prevention, or
wellness, and care management. This has resulted in a rapidly growing demand
among payors for comprehensive disease management programs. By effectively
managing appropriate prescription use, PBMs can positively affect both overall
medical costs and improve clinical outcomes.
The Company believes that future growth in the PBM industry will be driven
by (i) increased use of PBM services currently provided to existing PBM clients,
(ii) a continuing trend toward outsourcing of pharmacy management services by
managed care entities, insurance companies, corporations, labor unions,
government entities, other benefit plan sponsors and physician practice
management entities, (iii) increasing penetration by managed care entities,
which are large consumers of PBM services, into the growing Medicare and
Medicaid market and (iv) demand for comprehensive pharmacy benefit, medication
management and disease management services as healthcare service providers and
physician practice management entities assume medical care risk from managed
care entities.
The distribution of prescription drug therapies to patients with
specialized, long-term, chronic diseases is another area where the competitive
forces in the healthcare environment are challenging providers. In addition to
the Company, home healthcare companies, hospitals and other providers offer
disease management services and programs to these patients. Competitive pricing,
customer service and patient education are factors influencing the competition
for these patients.
Strategy
The strategy of the Pharmaceutical Services Division is to provide
innovative pharmaceutical solutions, quality customer service and clinical
excellence in order to enhance patient outcomes and better manage overall
healthcare costs. The Company intends to increase its market share and extend
its leadership in the pharmaceutical services industry. The Company believes
that its independence from ownership by any pharmaceutical manufacturer is a
competitive advantage, as it is able to make decisions regarding its formularies
free of any potential conflicts of interest.
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Operations
The Division manages outpatient PBM programs throughout the United States
for corporations, managed care organizations, insurance companies, unions,
coalitions, federal and state agencies and other funded benefit plans, as well
as for the Company's affiliated physicians and clinics. Prescription drug
benefit management involves the design and administration of programs for
reducing the costs and improving the safety, effectiveness and convenience of
prescription drugs. The Company dispenses prescription drugs to patients through
a network of approximately 53,000 pharmacies (approximately 95% of all retail
pharmacies in the United States) and through three mail service pharmacies. The
Division negotiates discounts and rebates with pharmaceutical manufacturers and
drug wholesalers and assembles preferred product lists, or formularies, which
help staff and network pharmacists manage customers' pharmaceutical expense.
All prescriptions are analyzed, processed and recorded by the Company's
proprietary prescription management information system and database. This system
assists staff and network pharmacists in processing prescription requests for
member eligibility, authorization, early refills, duplicate dispensing,
appropriateness of dosage, drug interactions or allergies, over-utilization or
potential fraud, and other information. The system collects comprehensive
prescription utilization information data valuable to pharmaceutical
manufacturers, managed care payors and customers. With this information, the
Company offers a full range of drug cost reporting services, including clinical
case management, drug utilization review, formulary management and customized
prescription programs for senior citizens.
The retail pharmacy program allows a member to obtain pharmaceuticals at
any of more than 53,000 pharmacies nationwide. When a member submits a
prescription request, the network pharmacist sends prescription data
electronically to the Company, which sends back a report including relevant
patient data, co-payment information and confirmation that the pharmacy will
receive payment for the prescription. In 1997, the Company processed 39.3
million retail prescriptions.
The Company operates three automated mail order service centers in San
Antonio, Chicago and Ft. Lauderdale. Patients send prescriptions via mail,
telephone and fax to staff pharmacists who review them with the assistance of
the prescription management information systems. This review often involves a
call to the prescribing physician and can result in generic substitution or
other actions to affect cost or to improve quality of treatment. Mail service is
typically less expensive to clients because of these clinical management
strategies and favorable pricing from manufacturers. In 1997, the Company filled
11.3 million mail service prescriptions, representing $964 million in revenue.
Under the Company's PBM quality assurance program, the Company maintains
rigorous quality assurance and regulatory policies and procedures. Each mail
service prescription undergoes a sequence of safety and accuracy checks and is
reviewed and verified by a registered pharmacist before shipment. A panel of
physician specialists who are affiliated with the Company advise it on the
clinical analyses of its intervention strategies and on cost-effective clinical
procedures.
The Company's therapeutic pharmaceutical services include comprehensive
long-term support for high-cost, chronic illnesses in an effort to improve
outcomes for patients and to lower costs. The Company provides therapies and
services to patients with such conditions as hemophilia, growth disorders,
multiple sclerosis, immune deficiencies, and cystic fibrosis. These services are
rendered at the patient's home, office or travel destination and generally
include ongoing injections of bio-pharmaceutical drugs. These drugs are
distributed from the Company's 23 specialty pharmacies throughout the country,
all of which have been accredited by the Joint Commission on Accreditation of
Healthcare Organizations. The programs utilize advanced protocols and offer the
patient greater convenience in working with insurers. Extensive patient
education information is provided to patients through individual instruction and
monitoring, written materials, and around-the-clock availability of customer
assistance via toll-free telephone. The largest components of this business come
from individuals with hemophilia and growth disorders. In 1997, growth came from
the implementation of a new program for multiple sclerosis patients. Major
initiatives such as Care Patterns(R) for disease management and Caremark
Consent(TM) for quick and easy patient access strengthen the Company's
leadership position in these markets.
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CONTRACT MEDICAL SERVICES
The Company's Contract Medical Services Division includes Team Health,
which manages one of the largest hospital-based physician groups in the country,
and the Government Services Division, one of the country's largest correctional
and government services healthcare delivery businesses. These groups produced
combined contract medical services revenue of $806 million in 1997. Team Health
organizes and manages physicians and other healthcare professionals engaged in
the delivery of emergency, radiology and teleradiology, hospital-based primary
care and temporary staffing and support services to hospitals, clinics, managed
care organizations and physician groups throughout the United States. Government
Services provides similar services to medical facilities at correctional
institutions and Department of Defense facilities. As of December 31, 1997, the
Company had 2,476 physicians in 39 states affiliated with its Contract Medical
Services Division.
Contract Medical Services Industry
Hospitals have been greatly affected by changes in the United States
healthcare industry during the last several years, including the increasing use
of capitation and other fixed payment systems that shift financial risk from
payors to providers. The evolving managed care environment requires hospitals to
be more cost-effective in all aspects of their operations, including the
recruiting, scheduling, retaining and managing of physicians, and billing and
collecting for their services. Hospitals have found it increasingly difficult to
recruit, retain and schedule the required emergency physician specialists and to
manage their emergency departments ("EDs") for unscheduled primary care.
Furthermore, the Company believes that EDs, in combination with primary care
clinics, which are often the first point of contact with patients, will play an
increasingly important role as 24-hour gatekeepers of the healthcare system. As
a result, many hospitals have turned to outside contract management
organizations like the Company as a more cost-effective and reliable alternative
to the development of in-house emergency physician staffing. Hospitals also look
to other hospital-based physicians, including radiologists, anesthesiologists
and pathologists to help control cost and improve quality in the new healthcare
environment. Smaller local groups of emergency or other hospital based
physicians find it increasingly difficult to meet these growing expectations,
which requires hospitals to seek alternatives that result in these groups
seeking affiliation and consolidation opportunities.
There are approximately 5,200 hospitals in the United States that operate
EDs. Approximately 80% of these hospitals use outsourced physicians to staff
their EDs. The groups to which ED services are outsourced are either national
groups, regional groups, or small local groups. The national groups serve
approximately 20% of the market. Approximately 40% of EDs use local physician
groups that manage only one or two EDs. The Company believes that these groups
are encountering increasing difficulty in controlling costs and satisfying
recordkeeping and other administrative and management requirements as demanded
in today's evolving health care industry. As a result, the Company believes that
there are significant consolidation opportunities within the emergency physician
practice management industry.
An additional opportunity for consolidation of contract medical services
exists in the area of government-owned facilities such as correctional
facilities and military bases. There are approximately 1.6 million inmates in
correctional facilities in the United States, and this population is growing at
an estimated rate of 5-8% per year. Difficulties in recruiting and managing
physicians and other healthcare professionals have compelled governmental
agencies to contract with management organizations to deliver on-site healthcare
services to inmates. Only approximately 30% of these facilities currently
contract with private companies to manage the delivery of healthcare. Trends
such as cost containment through managed care, increasing inmate populations and
pressure on government agencies to be more efficient are driving more of these
facilities to seek management services from organizations like the Company. The
outsourcing of such healthcare services allows governmental agencies to shift
the financial risk associated with the delivery of medical services to inmates
to private management organizations, which have greater experience in managing
such risks. Also, physician management companies have experience in meeting
federal and state mandated healthcare requirements.
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Strategy
The strategy of the Contract Medical Services Division consists of: (i)
growth through marketing to new hospitals and government entities; (ii) the
expansion of services offered to emergency facilities and departments; (iii)
assisting customers in controlling costs in their emergency facilities and
departments; (iv) assisting contracted physicians within developing managed care
environments; and (v) growth through acquisition of selected hospital and
government facility-based physician practice management entities.
Operations
Under contracts with hospitals and other clients, the Contract Medical
Services Division identifies and recruits physicians and other healthcare
professionals for admission to a client's medical staff and coordinates the
ongoing scheduling of staff physicians and other healthcare professionals who
provide clinical coverage in designated areas of care and facilitates changes to
improve clinical and financial performance in client facilities. To fulfill
these obligations, the Contract Medical Services Division retains the services
of physicians and other healthcare professionals who agree to provide the
necessary clinical coverage.
The management services provided by Team Health and Government Services
under contracts with hospitals, correctional institutions and other clients
include: (i) the identification and recruitment of physicians and other
healthcare professionals, (ii) utilization review of services and administrative
overhead; (iii) case management to assist medical directors and physicians in
the delivery of quality care and proper utilization of services; and (iv)
scheduling of staff physicians and other healthcare professionals who provide
clinical coverage in designated areas of care. The Contract Medical Services
Division also provides support and administrative services including billing and
collection of fees for professional services. Physician recruitment services
provided by the Division include a comprehensive series of interviews and
reference checks. Physicians are licensed to practice medicine and are generally
either board certified or board eligible. As part of the services provided under
its management contracts, the Contract Medical Services Division surveys
physician compensation patterns and programs to ensure that physician
compensation is competitive in the geographic area being serviced.
Emergency Departments. Team Health currently recruits physicians and other
healthcare professionals, coordinates staff scheduling and provides
administrative support services, such as billing and collection, to 263 EDs in
30 states. Team Health generally contracts with a particular ED to provide all
necessary physician coverage 24-hours-a-day throughout the year. Team Health
believes that it has the ability to control ED expenses through cost-effective
staffing, treatment protocols designed to reduce unnecessary testing and the
coordination of EDs and affiliated outpatient primary care clinics to direct
patients to the most appropriate level of care. When providing services to EDs,
Team Health contracts, directly or through affiliated entities, with physicians
and other healthcare professionals who provide all emergency department medical
services. Team Health provides the ED with a medical director who works directly
with the hospital medical staff and administration on such matters as quality
assurance, risk management and departmental accreditation to enhance the quality
and operational success of the ED.
Radiology. Team Health provides physician management services, including
recruiting and retention, management, temporary physician staffing, quality
assurance and billing and collection of professional services to hospital
radiology departments and outpatient imaging centers. Team Health believes that
hospitals will increasingly utilize contract management firms to solve problems
associated with the management of radiology departments, particularly as managed
care trends dictate more cost effective services. Team Health has contracts to
provide physician management services in 58 radiology departments of hospitals
in 14 states.
Team Health believes a key component in the successful management of many
radiology departments is the use of teleradiology technology. In teleradiology,
images are converted into a high-quality digital format and sent over telephone
lines or via satellite to distant locations for interpretation by radiologists.
Technological advances in teleradiology have improved the quality, while
decreasing the expense of required equipment, to the extent that the technology
is now affordable for reliable interpretations in small hospitals.
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Correctional Care. Government Services provides comprehensive medical
services, including mental health and dental services, to inmates in various
state and local correctional institutions. The Company provides primary care
physician services directly and typically subcontracts other services with
hospitals and medical specialists on either a capitated or discounted
fee-for-service basis. At December 31, 1997, the Company had contracts with
correctional institutions and managed the healthcare services provided to
approximately 57,372 inmates at 52 facilities.
Under correctional care contracts, the Company is typically paid monthly on
the basis of each correctional institution's average daily inmate population.
The Company is also entitled to additional reimbursement for any healthcare
related expenditures incurred above a certain dollar amount of outside medical
expenses per inmate per year, as well as reimbursement for the cost of treating
inmates in connection with certain extraordinary events.
Department of Defense. Government Services also provides physicians, nurse
and clerical support services for active duty and retired military personnel and
their dependents in emergency departments, ambulatory care centers and primary
care clinics operated by the Department of Defense. Under Department of Defense
contracts, the Company is generally paid a fixed amount, per patient visit or
per hour of service, without regard to the scope of professional services
provided. Under per patient fixed fee arrangements, the Company assumes the risk
if patient volume is below expectations. At December 31, 1997, the Company's
military medical services were provided under contracts with 15 facilities
generating approximately 300,000 annual patient visits.
INFORMATION SYSTEMS
The Company's overall information systems design is open, modular and
flexible. Given the diversity which has resulted from the Company's growth
through acquisitions, the Company has established an overall integrated
information systems architecture which guides capital investment and operational
improvement. In this effort, the establishment of an integrated eligibility
repository, the implementation of electronic medical record (EMR) functionality,
the commitment to a small number of strategic physician practice management
systems, the selection of an integrated claims management/managed care package
and the development of a patient centric integrated data warehouse are the key
elements of successful operations in the future.
Support for the Pharmaceutical Services Division is provided by an
information system currently in its second year of operation. This integrated
client/server system provides the basis for both mail and retail prescription
benefits management. Its integrated architecture allows all requests for service
(mail order prescription, retail pharmacy claim or customer service contact) to
operate against a complete history of the patient's prescription activity.
Information from this system is then integrated into a data repository, which
allows the merging of prescription claims with medical claims, laboratory
results and eventually clinical records.
Effective and efficient access to key clinical patient and pharmaceutical
data is critical in obtaining quality outcomes and improving costs as the
Company enters into more capitation contracts. The Company uses its existing
information system to measure patient satisfaction and outcomes, improve
productivity, manage complex reimbursement procedures and integrate information
from multiple facilities throughout the healthcare spectrum. These systems allow
the Company to analyze clinical and cost data to determine thresholds of
profitability under various capitation arrangements.
The Company utilizes a number of different computer software programs and
environments in its business, many of which were designed and developed without
considering the impact of the upcoming turn of the century (the "Year 2000
Issue"). MedPartners has assessed the potential impact and costs of addressing
the Year 2000 Issue and is in the process of implementing a plan of action to
address the Year 2000 Issue. See Item 7. "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
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COMPETITION
The healthcare industry is highly competitive and is subject to continuing
changes in the provision of services and the selection and compensation of
providers. The Company competes with national, regional and local entities
including PPMs, ED groups and hospital contract management companies. In
addition, certain companies, including hospitals and insurers, are expanding
their presence in the PPM market. The Company also competes with prescription
drug benefit programs, prescription drug claims processors, regional claims
processors, providers of disease management services and insurance companies.
GOVERNMENT REGULATION
General. As a participant in the healthcare industry, the Company's
operations and relationships are subject to extensive and increasing regulation
by a number of governmental entities at the federal, state and local levels. The
Company believes its operations are in material compliance with applicable laws.
Nevertheless, because the structure of the relationship with the physician
groups is unique and the PPM industry as a whole is relatively young, many
aspects of the Company's business operations have not been the subject of state
or federal regulatory interpretation. Thus, there can be no assurance that a
review of the Company's or the affiliated physicians' businesses by courts or
regulatory authorities will not result in a determination that could adversely
affect the operations of the Company or of its affiliated physicians. Nor can
there be any assurance that the healthcare regulatory environment will not
change so as to restrict the Company's or the affiliated physicians' existing
operations or their growth. Any significant restriction could have a material
adverse effect on the operating results and financial condition of the Company.
Federal Reimbursement, Fraud and Abuse and Referral Laws. Approximately 7%
of the net revenue of the Company's affiliated physician practices are derived
from payments made by government-sponsored healthcare programs (principally,
medicare and state reimbursed programs). As a result, the Company is subject to
the laws and regulations that govern reimbursement under Medicare and Medicaid.
Any change in reimbursement regulations, policies, practices, interpretations or
statutes could adversely affect the operations of the Company. There are also
state and federal civil and criminal statutes imposing substantial penalties
(including civil penalties and criminal fines and imprisonment) on healthcare
providers that fraudulently or wrongfully bill governmental or other third-party
payors for healthcare services. The Company believes it is in material
compliance with such laws, but there can be no assurance that the Company's
activities will not be challenged or scrutinized by governmental authorities or
that any such challenge or scrutiny would not have a material adverse effect on
the operating results and financial condition of the Company.
Certain provisions of the Social Security Act, commonly referred to as the
"Anti-Kickback Statute", prohibit the offer, payment, solicitation, or receipt
of any form of remuneration in return for the referral of Medicare or state
health program patients or patient care opportunities, or in return for the
recommendation, arrangement, purchase, lease or order of items or services that
are covered by Medicare or state health programs. Many states have adopted
similar prohibitions against payments intended to induce referrals of Medicaid
and other third-party payor patients. The Anti-Kickback Statute contains
provisions prescribing civil and criminal penalties to which individuals or
providers who violate such statute may be subjected. The criminal penalties
include fines up to $25,000 per violation and imprisonment for five years or
more. Additionally, the United States Department of Health and Human Services
(the "DHHS") has the authority to exclude anyone, including individuals or
entities, who has committed any of the prohibited acts from participation in the
Medicare and Medicaid programs. If applied to the Company or any of its
subsidiaries or affiliated physicians, such exclusion could result in a
significant loss of reimbursement for the Company, up to a maximum of the
approximately 7% of revenues of the Company's affiliated physician groups, which
could have a material adverse effect on the operating results and financial
condition of the Company. Although the Company believes that it is not in
violation of the Anti-Kickback Statute or similar state statutes, its operations
do not fit within any of the existing or proposed federal safe harbors.
Federal law prohibits, with some exceptions, an entity from filing a claim
for reimbursement under the Medicare or Medicaid programs for certain designated
services if the entity has a financial relationship with the referring
physician. Federal law (the "Medicare Referral Payments Law") also prohibits the
solicitation
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or receipt of remuneration in exchange for, or the offer or payment of
remuneration to induce, the referral of Medicare or Medicaid beneficiaries.
Significant prohibitions against physician referrals were enacted by the United
States Congress in the Omnibus Budget Reconciliation Act of 1993. Subject to
certain exemptions, a physician is prohibited from referring Medicare or
Medicaid patients to an entity providing "designated health services" in which
the physician has an ownership or investment interest or with which the
physician has entered into a compensation arrangement. The provisions of the
Anti-Kickback Statute and the Medicare Referral Payments Law are complex, and
the future interpretations of these provisions and their applicability to the
Company's operations cannot be predicted or analyzed in such a way as to predict
with certainty the effect of such rules and regulations on the Company. Although
the Company seeks to arrange its business relationships to comply with these
healthcare rules and regulations, its operations do not fit within any of the
existing or published proposed federal safe harbors. As a result, there can be
no assurance that the Company's present or future operations will not be
challenged under such provisions. The Company does not believe it is in
violation of the Anti-Kickback Statute or the Medicare Referral Payment law and
associated regulations because the revenues which are assigned to the Company
pursuant to the management agreements between the Company and its affiliated
physician practices represent payments made by the HMO to satisfy claims
submitted through the Company on behalf of the affiliated physician for the
furnishing of healthcare services by the physician to an individual. The monies
retained by the Company do not exceed the aggregate amount due the Company for
the reasonable and necessary physician practice management services provided by
the Company pursuant to the management agreement between the Company and the
affiliated physician or physician practice, i.e., transfer agreement or
management services agreement. The Company believes that such payments do not
fall within the scope or the intent of such rules and regulations. Further, the
Company does not believe it is in violation of the Anti-Kickback Statute and the
Medicare Referral Payment Law because the Company does not refer, or influence
the referral of, patients or services reimbursed under governmental programs to
the physician practices. While the Company believes it is in compliance with
such legislation, future regulations and interpretations of existing regulations
could require the Company to modify the form of its relationship with physician
groups which could have a material adverse effect on the operating results and
financial condition of the Company.
The Office of the Inspector General of DHHS (the "OIG") has promulgated
regulatory "safe harbors" under the Medicare Referral Payments Law that describe
payment practices between healthcare providers and referral sources that will
not be subject to criminal prosecution and that will not provide the basis for
exclusion from the Medicare and Medicaid programs. The Company retains
healthcare professionals to provide advice and non-medical services to the
Company in return for compensation pursuant to employment, consulting or service
contracts. The Company also enters into contracts with hospitals under which the
Company provides products and administrative services for a fee. Many of the
parties with whom the Company contracts refer or are in a position to refer
patients to the Company. The breadth of these federal laws, the paucity of court
decisions interpreting these laws, the limited nature of regulatory
interpretations and the absence of court decisions interpreting the safe harbor
regulations have resulted in ambiguous and varying interpretations of these
federal laws and regulations. The OIG or the United States Department of Justice
(the "DOJ") could seek a determination that the Company's past or current
policies and practices regarding contracts and relationships with healthcare
providers violate federal law. In such event, no assurance can be given that the
Company's interpretation of these laws will prevail, except with respect to
those matters that were the subject of the OIG investigation. See Item 3. "Legal
Proceedings" and Note 13 of the accompanying audited Consolidated Financial
Statements. If the Company's interpretation of these laws should not prevail it
could materially adversely affect the operating results and financial condition
of the Company.
Caremark agreed, in its settlement agreement with the OIG and DOJ prior to
the Caremark Acquisition, to continue to enforce certain compliance-related
oversight procedures. Should the oversight procedures reveal violations of
federal law, Caremark would be required to report such violations to the OIG and
DOJ. Caremark is therefore subject to increased regulatory scrutiny and, in the
event that Caremark commits legal or regulatory violations, it may be subject to
an increased risk of sanctions or penalties, including disqualification as a
provider of Medicare or Medicaid services which could have a material adverse
effect on the operating results and financial condition of the Company. See Item
3. "Legal Proceedings" and Note 13 of the accompanying audited Consolidated
Financial Statements.
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State Referral Payment Laws. The Company is also subject to state statutes
and regulations that prohibit payments for referral of patients and referrals by
physicians to healthcare providers with whom the physicians have a financial
relationship. State statutes and regulations generally apply to services
reimbursed by both governmental and private payors. Violations of these laws may
result in prohibition of payment for services rendered, loss of pharmacy or
health provider licenses as well as fines and criminal penalties. State statutes
and regulations that may affect the referral of patients to healthcare providers
range from statutes and regulations that are substantially the same as the
federal laws and the safe harbor regulations to a simple requirement that
physicians or other healthcare professionals disclose to patients any financial
relationship the physicians or healthcare professionals have with a healthcare
provider that is being recommended to the patients. These laws and regulations
vary significantly from state to state, are often vague, and, in many cases,
have not been interpreted by courts or regulatory agencies. Management believes
the Company's operations are in material compliance with existing law, but there
can be no assurance that the Company's existing business arrangements will not
be successfully challenged in one or more states. The Company is not materially
dependent upon revenues derived from any single state. Adverse judicial or
administrative interpretations of such laws in several states, taken together,
could, however, have a material adverse effect on the operating results and
financial condition of the Company. In addition, expansion of the Company's
operations to new jurisdictions could require structural and organizational
modifications of the Company's relationships with physician groups in order to
comply with new or revised state statutes. Such structural and organizational
modifications could have a material adverse effect on the operating results and
financial condition of the Company.
Corporate Practice of Medicine Laws. The laws of many states prohibit
physicians from splitting fees with non-physicians and prohibit non-physician
entities from practicing medicine. These laws and their interpretations vary
from state to state and are enforced by the courts and by regulatory authorities
with broad discretion. The Company believes that it has perpetual and unilateral
control over the assets and operations of the various affiliated professional
corporations. However, there can be no assurance that regulatory authorities
will not take the position that such control conflicts with state laws regarding
the practice of medicine or other federal restrictions. Although the Company
believes its operations as currently conducted are in material compliance with
existing applicable laws, there can be no assurance that the existing
organization of the Company and its contractual arrangements with affiliated
physicians will not be successfully challenged as constituting the unlicensed
practice of medicine or that the enforceability of the provisions of such
arrangements, including non-competition agreements, will not be limited. There
can be no assurance that review of the business of the Company and its
affiliates by courts or regulatory authorities will not result in a
determination that could adversely affect their operations or that the
healthcare regulatory environment will not change so as to restrict existing
operations or expansion thereof. In the event of action by any regulatory
authority limiting or prohibiting the Company or any affiliate from carrying on
its business or from expanding the operations of the Company and its affiliates
to certain jurisdictions, structural and organizational modifications of the
Company may be required, which could have a material adverse effect on the
operating results and financial condition of the Company.
Antitrust Laws. In connection with the corporate practice of medicine laws
referred to above, the physician practices with which the Company is affiliated
necessarily are organized as separate legal entities. As such, the physician
practice entities may be deemed to be persons separate both from the Company and
from each other under the antitrust laws and, accordingly, subject to a wide
range of laws that prohibit anticompetitive conduct among separate legal
entities. The Company believes it is in compliance with these laws and intends
to comply with any state and federal laws that may affect its development of
integrated healthcare delivery networks. There can be no assurance, however,
that a review of the Company's business by courts or regulatory authorities
would not adversely affect the operations of the Company and its affiliated
physician groups.
Insurance Laws. The assumption of risk on a prepaid basis by health
provider networks is occurring with increasing frequency, and the practice is
being reviewed by various state insurance commissioners as well as the National
Association of Insurance Commissioners ("NAIC") to determine whether the
practice constitutes the business of insurance. The Company believes that it is
currently in material compliance with
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the insurance laws in the states where it is operating, and it intends to comply
with interpretative and legislative changes as they may develop. There can be no
assurance, however, that the Company's activities will not be challenged or
scrutinized by governmental authorities or that future interpretations of the
insurance laws by such governmental authorities will not require licensure or
restructuring of some or all of the Company's operations in any such state. In
the event that the Company is required to become licensed under these laws, the
licensure process can be lengthy and time consuming and, unless the regulatory
authority permits the Company to continue to operate while the licensure process
is progressing, the Company could experience a material adverse change in its
operating results and financial condition while the licensure process is
pending. In addition, many of the licensing requirements mandate strict
financial and other requirements which the Company may not be able to meet.
Further, once licensed, the Company would be subject to continuing oversight by,
and reporting to, the respective regulatory agency.
The NAIC recently adopted the Managed Care Plan Network Adequacy Model Act
(the "Model Act") which is intended to establish standards for the creation and
maintenance of networks by health carriers. The Model Act is also intended to
establish requirements for written agreements between health carriers offering
managed care plans, participating providers and intermediaries, like the
Company, which negotiate provider contracts. An NAIC model insurance act does
not carry the force of law unless it is adopted by applicable state
legislatures. The Company does not know which states, if any, will adopt the
Model Act. There can be no assurance that the Company will be able to comply
with the Model Act if it is adopted in any state in which the Company does
business or that any inability of the Company to so comply would not have a
material adverse effect on the operating results and financial condition of the
Company.
Other State and Local Regulation. In March 1996, the DOC issued the
Restricted License to MPN in accordance with the requirements of the Knox-Keene
Act. The Restricted License authorizes MPN to operate as a healthcare service
plan in the State of California. The Company, through MPN, utilizes the
Restricted License to contract with HMOs for a broad range of healthcare
services, including both institutional and professional medical services. The
Knox-Keene Act and the regulations promulgated thereunder subject entities that
are licensed as healthcare service plans in California to substantial regulation
by the DOC. In addition, licensees under the Knox-Keene Act must file periodic
financial data and other information (that generally become available to the
public), maintain substantial tangible net equity on their balance sheets and
maintain adequate levels of medical, financial and operational personnel
dedicated to fulfilling the licensee's statutory and regulatory requirements.
The DOC is empowered to take enforcement actions against licensees that fail to
comply with such requirements.
The operation of USFMC and Friendly Hills is highly regulated, and each is
accredited by the Joint Commission on Accreditation of Healthcare Organizations.
Accreditation from the Joint Commission on Accreditation of Healthcare
Organizations allows USFMC and Friendly Hills to serve Medicare patients and
provides authorization from the California Department of Health Services and the
Los Angeles County Department of Health to operate as licensed hospital
facilities. Both USFMC and Friendly Hills are licensed and regulated as general
acute care hospitals by the State of California Department of Health Services.
Additionally, each of USFMC and Friendly Hills have a clinical laboratory
license from the State of California Department of Health Services, a clinical
laboratory license for its cardio-pulmonary laboratory and a pharmacy license
for its inpatient pharmacy.
Pharmacy Licensing and Operation. The PBM and therapeutic pharmaceutical
services of the Company are subject to state and federal statutes and
regulations governing the operation of pharmacies, repackaging of drug products,
dispensing of controlled substances, reimbursement under federal and state
medical assistance programs, financial relationships between healthcare
providers and potential referral sources, medical waste disposal, risk sharing
by non-insurance companies and workplace health and safety. The Company's
operations may also be affected by changes in ethical guidelines and changes in
operating standards of professional and trade associations and private
accreditation commissions such as the American Medical Association, the National
Committee for Quality Assurance and the Joint Commission on Accreditation of
Healthcare Organizations. Federal controlled substance laws require the Company
to register its pharmacies with the United States Drug Enforcement
Administration and comply with security, record-keeping, inventory control and
labeling standards in order to dispense controlled substances. State controlled
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substance laws require registration and compliance with the licensing,
registration or permit standards of the state pharmacy licensing authority.
State pharmacy licensing, registration and permit laws impose standards on the
qualifications of an applicant's personnel, the adequacy of its prescription
fulfillment and inventory control practices and the adequacy of its facilities.
In general, pharmacy licenses are renewed annually. Pharmacists employed by each
branch must also satisfy state licensing requirements.
Several states have enacted legislation that requires mail service
pharmacies located outside such state to register with the state board of
pharmacy prior to mailing drugs into the state and to meet certain operating and
disclosure requirements. These statutes generally permit a mail service pharmacy
to operate in accordance with the laws of the state in which it is located. In
addition, various pharmacy associations and state boards of pharmacy have
promoted enactment of laws and regulations directed at restricting or
prohibiting the operation of out-of-state mail service pharmacies by, among
other things, requiring compliance with all laws of certain states into which
the mail service pharmacy dispenses medications whether or not those laws
conflict with the laws of the state in which the pharmacy is located. To the
extent that such laws or regulations are found to be applicable to the Company's
operations, the Company would be required to comply with them. Some states have
enacted laws and regulations which, if successfully enforced, would effectively
limit some of the financial incentives available to plan sponsors that offer
mail service prescription programs. The United States Department of Labor has
commented that such laws and regulations are preempted by the Employee
Retirement Income Security Act of 1974, as amended. The Attorney General in one
state has reached a similar conclusion and has raised additional constitutional
issues. Finally, the Bureau of Competition of the Federal Trade Commission
("FTC") has concluded that such laws and regulations may be anticompetitive and
not in the best interests of consumers. To date, there have been no formal
administrative or judicial efforts to enforce any of such laws against the
Company. To the extent that any of the foregoing laws or regulations prohibit or
restrict the operation of mail service pharmacies and are found to be applicable
to the Company, they could have an adverse effect on the Company's prescription
mail service operations. While United States Postal Service regulations
expressly permit the transmission of prescription drugs through the postal
system, the United States Postal Service has authority to restrict such
transmission.
Future Legislation, Regulation and Interpretation. As a result of the
continued escalation of healthcare costs and the inability of many individuals
to obtain health insurance, numerous proposals have been or may be introduced in
the United States Congress and state legislatures relating to healthcare reform.
There can be no assurance as to the ultimate content, timing or effect of any
healthcare reform legislation, nor is it possible at this time to estimate the
impact of potential legislation, which may be material, on the Company. Further,
although the Company exercises care in structuring its arrangements with
physicians to comply in all material respects with the above-referenced laws,
there can be no assurance that (i) government officials charged with
responsibility for enforcing such laws will not assert that the Company or
certain transactions in which the Company is involved are in violation thereof
and (ii) such laws will ultimately be interpreted by the courts in a manner
consistent with the Company's interpretation. Therefore, it is possible that
future legislation, regulation and the interpretation thereof could have a
material adverse effect on the operating results and financial condition of the
Company.
CORPORATE LIABILITY AND INSURANCE
The Company's business entails an inherent risk of claims of medical
professional liability. In recent years, participants in the healthcare industry
have become increasingly subject to large claims based on theories of medical
malpractice that entail substantial defense costs. Through the ownership and
operation of USFMC and Friendly Hills, both acute care hospitals, the Company
could also be subject to allegations of negligence and wrongful acts. To protect
its overall operations from such potential liabilities, the Company has a
multi-tiered corporate structure and preserves the operational integrity of each
of its operating subsidiaries. In addition, the Company maintains professional
liability insurance, general liability and other customary insurance on a
claims-made and modified occurrence basis, in amounts deemed appropriate by
management based upon historical claims and the nature and risks of the
business, for many of the affiliated physicians, practices and operations. The
Company has accrued for or purchased "tail" coverage for claims against the
Company's affiliated medical organizations to cover incidents which were or are
incurred but not reported
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during the periods for which the related risk was covered by "claims made"
insurance. There can be no assurance that a future claim will not exceed the
limits of available insurance coverage or that such coverage will continue to be
available.
Moreover, the Company requires each physician group with which it
affiliates to obtain and maintain professional liability insurance coverage.
Such insurance would provide coverage, subject to policy limits, in the event
the Company were held liable as a co-defendant in a lawsuit for professional
malpractice against a physician. In addition, generally, the Company is
indemnified under the practice management agreements by the affiliated physician
groups for liabilities resulting from the performance of medical services.
However, there can be no assurance that any future claim or claims will not
exceed the limits of these available insurance coverages or that indemnification
will be available for all such claims.
EMPLOYEES
As of December 31, 1997, the Company employed a total of 29,256 persons and
was affiliated with 13,531 physicians. The Company believes that its relations
with its employees are good.
ITEM 2. PROPERTIES.
The Company leases approximately 150,000 square feet at its corporate
headquarters located at 3000 Galleria Tower in Birmingham, Alabama.
Additionally, the Company has corporate offices in Long Beach, California,
(approximately 73,040 square feet in 5000 Airport Plaza Drive and 49,065 square
feet in 5001 Airport Plaza Drive), Knoxville, Tennessee (approximately 35,000
square feet) and Northbrook, Illinois (approximately 199,116 square feet). The
Company currently owns or leases facilities providing medical services,
including two hospitals, in 42 states, Puerto Rico and two foreign countries.
These facilities range in size from 500 square feet to large multi-story
buildings which house medical clinics. The Company also leases, subleases or
occupies, pursuant to certain acquisition agreements, the clinic facilities of
the affiliated physician groups. The Company anticipates that as the affiliated
practices continue to integrate their operations, existing corporate facilities
should be adequate for the immediate future.
ITEM 3. LEGAL PROCEEDINGS.
The Company is party to certain legal actions arising in the ordinary
course of business. MedPartners is named as a defendant in various legal actions
arising primarily out of services rendered by physicians and others employed by
its affiliated physician entities and the two hospitals it owns, as well as
personal injury and employment disputes. In addition, certain of its affiliated
medical groups are named as defendants in numerous actions alleging medical
negligence on the part of their physicians. In certain of these actions,
MedPartners' and/or the medical group's insurance carrier has either declined to
provide coverage or has provided a defense subject to a reservation of rights.
Management does not view any of these actions as likely to result in an
uninsured award that would have a material adverse effect on the operating
results and financial condition of MedPartners.
In June 1995, Caremark agreed to settle an investigation with certain
agencies of the U.S. government and related state investigative agencies in all
50 states and the District of Columbia (the "OIG Settlement"), as described in
Note 13 of the audited Consolidated Financial Statements. The OIG Settlement
allows Caremark to continue participating in Medicare, Medicaid and other
government healthcare programs. In its agreement with the OIG and the DOJ,
Caremark agreed to continue to maintain certain compliance-related oversight
procedures. Should these oversight procedures reveal credible evidence of legal
or regulatory violations, Caremark is required to report such violations to the
OIG and DOJ. Caremark is, therefore, subject to increased regulatory scrutiny
and, in the event it commits legal or regulatory violations, Caremark may be
subject to an increased risk of sanctions or penalties, including
disqualification as a provider of Medicare or Medicaid services, which would
have a material adverse effect on the operating results and financial condition
of MedPartners.
In connection with the matters described above relating to the OIG
Settlement, Caremark is the subject of various non-governmental claims and may
in the future become subject to additional OIG-related claims.
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Caremark is the subject of, and may be in the future subjected to, various
private suits and claims being asserted in connection with matters relating to
the OIG Settlement by Caremark's stockholders, patients who received healthcare
services from Caremark and such patients' insurers. MedPartners cannot determine
at this time what costs or liabilities may be incurred in connection with future
disposition of non-governmental claims or litigation. Such additional costs or
liabilities, if incurred, could have a material adverse effect on the operating
results and financial condition of MedPartners.
In May 1996, three home infusion companies, purporting to represent a class
consisting of all of Caremark's competitors in the alternate site infusion
therapy industry, filed a complaint against Caremark Inc. and Caremark
International Inc., as well as two other corporations, in the United States
District Court for the District of Hawaii (Case No. 96-00474 ACK) alleging
violations of the federal antitrust laws, the Racketeer Influenced and Corrupt
Organizations Act ("RICO") and California's unfair business practices statute.
In this action, styled Phamacare, et al. v. Caremark Inc., Caremark
International Inc., et al., the plaintiffs seek unspecified treble damages and
attorneys' fees and expenses. MedPartners intends to defend this case
vigorously. Although management believes, based on information currently
available, that the ultimate resolution of this matter is not likely to have a
material adverse effect on the operating results and financial condition of
MedPartners, there can be no assurance that the ultimate resolution of the
matter, if adversely determined, would not have a material adverse effect on the
operating results and financial condition of MedPartners.
In March 1998, a group of 22 private payors filed an action styled Blue
Cross and Blue Shield of Alabama et al. v. Caremark Inc. and Caremark
International Inc. (Case No. 98C-1285) in the United States District Court for
Northern District of Illinois seeking recovery for losses allegedly suffered by
the plaintiffs during the period 1986-1995 as a result of an allegedly
fraudulent scheme conceived and implemented by the defendants to submit and
cause other providers to submit fraudulent claims for payment of healthcare
benefits by the plaintiffs related to Caremark's home infusion business.
Caremark sold its home infusion business in 1995. The plaintiffs allege that
Caremark failed to disclose to the plaintiffs the existence and nature of
certain relationships that Caremark had with various physicians and the fact
that certain funds were paid to such physicians without the plaintiffs'
knowledge or approval. The action prays for an unspecified amount in damages and
for trebled damages under RICO and other related fraud claims. Caremark intends
to defend this lawsuit vigorously. Although management believes, based on
information currently available, that the ultimate resolution of this matter is
not likely to have a material adverse effect on the operating results and
financial condition of MedPartners, there can be no assurance that the ultimate
resolution of this matter, if adversely determined, would not have a material
adverse effect on the operating results and financial condition of MedPartners.
In late August 1994, certain patients of a physician who prescribed human
growth hormone distributed by Caremark and the sponsor of the health insurance
plan of one of those patients filed complaints against Caremark, employees of
Caremark and others in the United States District Court for the District of
Minnesota. The complaint alleged violations of the federal mail and wire fraud
statutes, RICO and the state consumer fraud statute, as well as conspiracy to
breach a fiduciary duty, negligence and fraud. The complaint sought unspecified
treble damages, and attorney's fees and expenses. In July 1996, these plaintiffs
also filed a separate purported class action lawsuit in the Minnesota State
Court in the County of Hennepin against Caremark alleging all of the claims
contained in the federal complaint and sought unspecified damages, attorneys'
fees and expenses and an award of punitive damages. In November 1996, in
response to a motion by the plaintiffs, the Court dismissed the United States
District Court cases without prejudice. On March 28, 1997, the Minnesota state
court lawsuit was dismissed with prejudice, which decision was affirmed by the
Minnesota Court of Appeals on November 4, 1997. On December 31, 1997, the
Minnesota Supreme Court denied plaintiffs' petition for further reconsideration.
This lawsuit is concluded because plaintiffs have no further avenue of appeal.
In July 1995, another patient of this same physician filed a separate complaint
in the District Court of South Dakota against the physician, Caremark and
another corporation alleging violations of the federal laws prohibiting payment
of remuneration to induce referral of Medicare and Medicaid beneficiaries, the
federal mail fraud statutes and RICO. The complaint also alleges the intentional
infliction of emotional distress and seeks trebling of at least $15.9 million in
general damages, attorney's fees and costs, and
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an award of punitive damages. In August 1995, the parties agreed to a stay of
all proceedings until final judgment was entered in a criminal case that was
then pending against this physician. All charges against the physician have been
dismissed. Caremark has moved for the dismissal of the South Dakota case or
transfer of the case to Minnesota. Management believes, based on information
currently available, that the ultimate resolution of this matter is not likely
to have a material adverse effect on the operating results and financial
condition of MedPartners.
In December 1997, a class action was filed in the United States District
Court for the Central District of California styled, Padilla, et al. v.
MedPartners, Inc., et al. (Case No. SACV 97-978). The action purports to be a
class action on behalf of all of the shareholders of Talbert which was acquired
by MedPartners in a cash tender offer transaction closed in September 1997,
pursuant to which each outstanding share of Talbert was acquired for $63 cash
per share. The action alleges that MedPartners violated Rule 14d-10 under the
Securities Exchange Act of 1934, the so-called "all holder, best price" rule, by
reason of provisions in the employment agreements of two senior officers of
Talbert, which provided for a certain contingent payment under certain
circumstances. The complaint requests class certification and claims damages and
interest. The defendants have filed a Motion to Dismiss this action on a number
of grounds, asserting that the complaint fails to state a claim upon which
relief can be granted. Although management believes, based on information
currently available, that the ultimate resolution of this matter is not likely
to have a material adverse effect on the operating results and financial
condition of MedPartners, there can be no assurance that the ultimate resolution
of the matter, if adversely determined, would not have a material adverse effect
on the operating results and financial condition of MedPartners.
On January 7, 1998, MedPartners issued a press release announcing the
termination of its proposed merger with PhyCor, Inc. On that date, MedPartners
also issued another press release announcing certain fourth quarter 1997 charges
and negative earnings estimates, which have since been revised downward. On
January 8, 1998, there was a decline in the market prices for MedPartners'
publicly traded securities. Since then, certain persons claiming to be
stockholders of MedPartners have filed complaints in either state or federal
court against MedPartners and certain officers and directors of MedPartners. To
date, there are two state court actions and 14 federal court actions, all filed
in Birmingham, Alabama. In each of these lawsuits, the plaintiffs purport to
represent a class and generally alleges violations of the Securities Exchange
Act of 1934, fraud and various state law claims in connection with the public
disclosure by MedPartners of the termination of the PhyCor merger and the fourth
quarter 1997 charges and earnings estimates. Four of the lawsuits, one filed in
the Circuit Court of Jefferson County, Alabama, and three filed in the United
States Federal Court for the Northern District of Alabama, were filed against
MedPartners and certain of its officers and directors, purportedly on behalf of
all persons who purchased MedPartners' Threshold Appreciation Price
Securities(TM) in the offering occurring on or about September 16, 1997. The
state complaint also asserts claims under Sections 11 and 15 of the Securities
Act of 1933, as well as Sections 8-6-17(a)(2) and 8-6-19 of the Alabama Code.
Collectively, these complaints seek class certification, damages and interest,
as well as costs and expenses. Exhibit 99-1 attached to this Annual Report on
Form 10-K is a schedule of the stockholder suits of which the Company has
knowledge. MedPartners' management believes that it and MedPartners have acted
properly throughout and intends to defend each of these cases vigorously. All of
these cases are in the most preliminary stages, and their ultimate resolution
cannot be known at this time. Therefore, there can be no assurance that the
ultimate resolution of these matters will not have a material adverse effect on
the operating results and financial condition of MedPartners.
Beginning in September 1994, Caremark was named as a defendant in a series
of lawsuits added to a pending group of actions (including a class action)
brought in 1993 under the antitrust laws by local and chain retail pharmacies
against brand name pharmaceutical manufacturers, wholesalers and prescription
benefit managers other than Caremark. The lawsuits, filed in federal district
courts in at least 38 states (including the United States District Court for the
Northern District of Illinois), allege that at least 24 pharmaceutical
manufacturers provided unlawful price and service discounts to certain favored
buyers and conspired among themselves to deny similar discounts to the
complaining retail pharmacies (approximately 3,900 in number). The complaints
charge that certain defendant prescription benefit managers, including Caremark,
were favored buyers who knowingly induced or received discriminatory prices from
the manufacturers in violation
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of the Robinson-Patman Act. Each complaint seeks unspecified treble damages,
declaratory and equitable relief and attorney's fees and expenses. All of these
actions have been transferred by the Judicial Panel for Multi-district
Litigation to the United States District Court for the Northern District of
Illinois for coordinated pretrial procedures. Caremark was not named in the
class action. In April 1995, the Court entered a stay of pretrial proceedings as
to certain Robinson-Patman Act claims in this litigation, including the
Robinson-Patman Act claims brought against Caremark, pending the conclusion of a
first trial of certain of such claims brought by a limited number of plaintiffs
against five defendants not including Caremark. On July 1, 1996, the district
court directed entry of a partial final order in the class action approving an
amended settlement with certain of the pharmaceutical manufacturers. The amended
settlement provides for a cash payment by the defendants in the class action
(which does not include Caremark) of approximately $351.0 million to class
members in settlement of conspiracy claims as well as a commitment from the
settling manufacturers to abide by certain injunctive provisions. All class
action claims against non-settling manufacturers as well as all opt out and
other claims generally, including all Robinson-Patman Act claims against
Caremark, remain unaffected by the settlement. The district court has scheduled
a trial of the remaining class action claims for the fall of 1998. It is
expected that trials of the remaining individual conspiracy claims will also
precede the trial of any Robinson-Patman Act claims. MedPartners intends to
defend these cases vigorously. Although management believes, based on
information currently available, that the ultimate resolution of this matter is
not likely to have a material adverse effect on the operating results and
financial condition of MedPartners, there can be no assurance that the ultimate
resolution of this matter, if adversely determined, would not have a material
adverse effect on the operating results and financial condition of MedPartners.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of stockholders of the Company
during the fourth quarter of 1997.
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is listed on the New York Stock Exchange (the
"NYSE") under the symbol "MDM". The following table sets forth, for the calendar
periods indicated, the range of high and low sales prices from January 1, 1996.
Prior to February 21, 1996, the Company's Common Stock traded on the NASDAQ
National Market System.
HIGH LOW
------- -------
1996
First Quarter (from February 21)............................ $34.75 $28.50
Second Quarter.............................................. 30.25 20.13
Third Quarter............................................... 23.13 16.63
Fourth Quarter.............................................. 24.50 19.88
1997
First Quarter............................................... $25.00 $18.00
Second Quarter.............................................. 23.50 17.375
Third Quarter............................................... 24.188 19.813
Fourth Quarter.............................................. 28.375 20.00
1998
First Quarter (through March 30)............................ $22.375 $ 7.125
On March 30, 1998, the closing sale price of the Company's Common Stock on
the NYSE was $10.50.
There were 42,109 holders of record of the Company's Common Stock as of
March 1, 1998.
The Company has never paid a cash dividend on its Common Stock. Future
dividends, if any, will be determined by the Company's Board of Directors in
light of circumstances existing from time to time, including the Company's
growth, profitability, financial condition, results of operations, continued
existence of the restrictions described below and other factors deemed relevant
by the Company's Board of Directors. Restrictions contained in the Credit
Facility (as defined in Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations") limit the payment of non-stock
dividends on the Company's Common Stock.
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UNREGISTERED SALES OF SECURITIES
The following table indicates all unregistered sales of the Company's
Common Stock during the last fiscal year that have not previously been reported
on a Quarterly Report on Form 10-Q:
MARKET
TRANSACTION PURPOSE DATE VALUE
- ----------- ----------------- ----------------- -----------
Summit Medical Group, P.A. Merger January 31, 1997 $49,965,496
Georgia Urology, P.A. Contract January 2, 1997 5,250,000
Modification
SOUTHVIEW Medical Group, P.C. Merger January 2, 1997 10,750,000
Hirsch, Strassberg, Kenward & Vizoso, M.D.s, Inc. Acquisition January 27, 1997 787,500
North Carolina Medical Associates, P.A. Contract February 14, 1997 1,724,800
Modification
Chase Dennis Medical Group, Inc. Asset Acquisition February 14, 1997 17,330,000
IMHC Management, Inc. Merger May 14, 1997 7,809,381
Pacific Medical Group Acquisition May 14, 1997 1,573,669
Obstetric & Gynecologic Associates of Columbus, P.C. Contract May 16, 1997 916,000
Modification
Northwest Diagnostic Clinic, P.A. Asset Acquisition May 30, 1997 290,996
Aldine Women's Clinic, P.A. Asset Acquisition May 30, 1997 49,999
L. Stayton Halberdler, Jr., M.D., P.A. Asset Acquisition May 30, 1997 25,010
Alan G. Moore, M.D., P.A. Asset Acquisition May 30, 1997 59,995
Jeffrey C. Lambert, M.D., P.A. Asset Acquisition May 30, 1997 25,010
Herschel Fischer, Inc. Merger July 11, 1997 17,999,980
Karl G. Mangold, Inc. Merger July 11, 1997 26,999,981
Doctor's Essential Services, Inc. Asset Acquisition July 11, 1997 1,000,000
Suburban Heights Medical Center, S.C. Asset Acquisition July 28, 1997 9,700,000
Doctors Medical Associates, Pinola, Inc. Asset Acquisition October 30, 1997 9,600
Health First Medical Group, P.C. Merger December 16, 1997 6,255,052
Kelsey-Seybold Contingent Stock Right Exercises through Stock Right through December 1,576,598
December 31, 1997 Exercises 31, 1997
None of these sales was underwritten, and all of the shares issued were
taken for investment by the entity or individual to whom they were issued. The
Company believes all of the securities issued were exempt from registration
under Section 4(2) of the Securities Act. Approximately 63% of the shares issued
in the above transactions have been registered subsequently, or the Rule 144 one
year holding period restricting the sale of the shares has lapsed.
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ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data for the Company
derived from the Company's Consolidated Financial Statements. The selected
financial data should be read in conjunction with the accompanying Consolidated
Financial Statements and the related Notes thereto.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENTS OF OPERATIONS DATA:
Net revenue.......................... $1,980,967 $2,909,024 $3,908,717 $5,222,019 $6,331,151
Income (loss) from continuing
operations......................... 55,017 63,510 32,189 (76,790) (693,742)
Income (loss) from discontinued
operations......................... 30,808 25,902 (136,528) (68,698) (95,988)
---------- ---------- ---------- ---------- ----------
Income (loss) before cumulative
effect of a change in accounting
principle.......................... 85,825 89,412 (104,339) (145,488) (789,730)
Cumulative effect of a change in
accounting principle............... -- -- -- -- (30,885)
---------- ---------- ---------- ---------- ----------
Net income (loss).................... $ 85,825 $ 89,412 $ (104,339) $ (145,488) $ (820,615)
========== ========== ========== ========== ==========
Earnings (loss) per common share
outstanding(1):
Income (loss) from continuing
operations......................... $ 0.42 $ 0.49 $ 0.21 $ (0.45) $ (3.73)
Income (loss) from discontinued
operations......................... 0.24 0.20 (0.90) (0.40) (0.52)
Cumulative effect of a change in
accounting principle............... -- -- -- -- (0.17)
---------- ---------- ---------- ---------- ----------
Net income (loss) per share.......... $ 0.66 $ 0.69 $ (0.69) $ (0.85) $ (4.42)
========== ========== ========== ========== ==========
Weighted average common shares
outstanding........................ 130,903 130,435 152,453 169,897 185,830
Diluted earnings (loss) per common
share outstanding(2):
Income (loss) from continuing
operations......................... $ 0.42 $ 0.43 $ 0.20 $ (0.45) $ (3.73)
Income (loss) from discontinued
operations......................... 0.24 0.18 (0.86) (0.40) (0.52)
Cumulative effect of a change in
accounting principle............... -- -- -- -- (0.17)
---------- ---------- ---------- ---------- ----------
Net income (loss) per share.......... $ 0.66 $ 0.61 $ (0.66) $ (0.85) $ (4.42)
========== ========== ========== ========== ==========
Weighted average common and dilutive
equivalent shares outstanding...... 130,903 146,773 158,109 169,897 185,830
BALANCE SHEET DATA:
Cash and cash equivalents............ $ 44,852 $ 101,101 $ 87,581 $ 127,397 $ 215,801
Working capital...................... 251,736 180,198 286,166 226,409 75,747
Total assets......................... 1,117,557 1,682,345 1,964,130 2,423,120 2,890,529
Long-term debt, less current
portion............................ 177,141 394,811 541,391 715,996 1,470,622
Total stockholders' equity........... 491,039 644,918 674,442 837,408 90,854
- ---------------
(1) Earnings (loss) per share is computed by dividing net income (loss) by the
number of common shares outstanding during the periods presented in
accordance with the applicable rules of the Commission.
(2) For the computation of diluted earnings (loss) per share, no incremental
shares related to options are included for years with net losses from
continuing operations.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The purpose of the following discussion is to facilitate the understanding
and assessment of significant changes and trends related to the results of
operations and financial condition of the Company, including changes arising
from recent acquisitions by the Company, the timing and nature of which have
significantly affected the Company's results of operations and financial
condition. This discussion should be read in conjunction with the audited
Consolidated Financial Statements and the Notes thereto. Unless the context
otherwise requires, as used herein, the term "MedPartners" or the "Company"
refers collectively to MedPartners, Inc. and its subsidiaries and affiliates.
GENERAL
MedPartners is one of the largest healthcare companies in the United
States, with net revenue of approximately $6.3 billion for the year ended
December 31, 1997. The Company operates three separate business divisions:
Physician Practice Services, Pharmaceutical Services and Contract Medical
Services. The Physician Practice Services Division is larger than any other PPM
in the United States, based on annual revenues in that business of approximately
$3.0 billion for the year ended December 31, 1997. The Pharmaceutical Services
Division operates one of the largest independent PBM and therapeutic
pharmaceutical services programs in the United States, with revenues of
approximately $2.4 billion for the year ended December 31, 1997. The Contract
Medical Services Division operates one of the largest hospital-based physician
management services and one of the largest corrections and government services
managed care businesses, with combined revenues of approximately $806 million
for the year ended December 31, 1997.
The Company's Physician Practice Services Division affiliates with
physicians who are seeking the resources necessary to function effectively in
healthcare markets that are evolving from fee-for-service to managed care payor
systems. MedPartners also affiliates with physicians who seek greater
efficiencies in operations of traditional fee-for-service practices. The Company
enhances clinic operations by centralizing administrative functions and
introducing management tools, such as clinical guidelines and medical management
processes. The Company provides affiliated physicians with access to capital and
to advanced management information systems. In addition, the Company contracts
with health maintenance organizations (and other third-party payors that
compensate the Company and its affiliated physicians on a prepaid basis
(collectively, "HMOs")), hospitals and outside providers on behalf of its
affiliated physicians. These relationships provide physicians with the
opportunity to operate under a variety of payor arrangements and to increase
their patient flow.
The Company offers medical group practices and independent physicians a
range of affiliation models which are described in Note 1 of the accompanying
audited Consolidated Financial Statements. These affiliations are carried out by
the acquisition of PPM entities or practice assets, either for cash or equity,
or by affiliation on a contractual basis. In all instances, the Company enters
into long-term practice management agreements with the affiliated physicians
that provide for both the management of their practices by the Company and the
clinical independence of the physicians.
The Company also manages PBM programs for more than 2,194 clients
throughout the United States, including corporations, insurance companies,
unions, government employee groups and managed care organizations. The Company
dispenses an average of 44,800 prescriptions daily through three mail service
pharmacies and manages patients' immediate prescription needs through a network
of approximately 53,000 retail and other pharmacies. The Company's therapeutic
pharmaceutical services are designed to meet the healthcare needs of individuals
with certain chronic diseases or conditions. These services include the design,
development and management of comprehensive programs comprising drug therapy,
physician support and patient education. The Company currently provides
therapies and services for individuals with such conditions as hemophilia,
growth disorders, immune deficiencies, cystic fibrosis and multiple sclerosis.
The Company is in the process of integrating the pharmaceutical services program
with the PPM business by providing pharmaceutical services to affiliated
physicians, clinics and HMOs.
The Contract Medical Services Division organizes and manages physicians and
other healthcare professionals engaged in the delivery of emergency, radiology
and teleradiology services, primary care and
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temporary staffing and support services. Through its Team Health subsidiary the
Company provides these services to hospitals, clinics and managed care
organizations, and the Company's Government Services unit provides these
services to correctional facilities, Department of Defense facilities and
government-affiliated physician groups throughout the United States. The
Division also provides occupational health services to corporate industrial
clients. Under contracts with hospitals and other clients, the Contract Medical
Services Division identifies and recruits physicians and other healthcare
professionals for admission to a client's medical staff and coordinates the
ongoing scheduling of staff physicians and other healthcare professionals who
provide clinical coverage in designated areas of care.
The Company experienced several adverse events in the fourth quarter of
1997 and the month of January 1998, including: (i) a fourth quarter pretax
charge of $646.7 million related primarily to the restructuring and impairment
of selected assets of certain of its clinic operations within the physician
practice management division; (ii) a fourth quarter after-tax charge from
discontinued operations of approximately $15.3 million; (iii) a fourth quarter
after-tax charge of $30.9 million related to a cumulative effect of a change in
accounting principle; (iv) a fourth quarter net loss from continuing operations,
excluding the impact of restructuring and asset impairment charges of $190.0
million; (v) the termination of the merger agreement with PhyCor, Inc.; (vi) a
steep drop in the price of its Common Stock following the announcement of the
termination of the PhyCor merger; and (vii) the filing of various stockholder
class action lawsuits against the Company and certain of its officers and
directors in the aftermath of these events alleging violations of federal
securities laws. See Item 3. "Legal Proceedings".
In response to certain of these setbacks, assembly of a new management team
began in January 1998 when Richard M. Scrushy was named Chairman of the Board
and acting Chief Executive Officer. Another step was taken in March 1998 when
Edwin M. Crawford was named President and Chief Executive Officer. Mr. Scrushy
will remain Chairman of the Board and brings his extensive healthcare
experience, most recently his 13 years as Chairman of the Board and Chief
Executive Officer of HEALTHSOUTH Corporation, to this position. Mr. Crawford
joins MedPartners from Magellan Health Services, Inc.(formerly Charter Medical
Corporation) where he served as Chairman of the Board, President and Chief
Executive Officer. Mr. Crawford has been credited with successfully turning
around Magellan's operations, transforming the company from a psychiatric
provider operation into a managed care company, and expanding the company into
the rapidly growing market of specialty disease management. In addition to these
management changes, the Company reorganized and streamlined its PPM
organizational structure to strengthen management, speed integration, improve
operations and facilitate communications.
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RESULTS OF OPERATIONS
In June 1997, the Company combined with InPhyNet in a transaction that was
accounted for as a pooling of interests. The financial information referred to
in this discussion reflects the combined operations of this entity and several
other entities accounted for as additional poolings of interests. The following
table sets forth the earnings summary by service area for the periods indicated.
(Operating income (loss) represents earnings (loss) before interest and income
taxes and excludes merger expenses and restructuring and impairment charges.):
YEAR ENDED DECEMBER 31,
--------------------------------------
1995 1996 1997
---------- ---------- ----------
(IN THOUSANDS)
Physician Practice Services
Net revenue................................ $1,646,656 $2,397,120 $3,036,303
Operating income (loss).................... 65,483 102,935 (150,969)
Margin..................................... 3.98% 4.29% (4.97)%
Pharmaceutical Services
Net revenue................................ $1,840,249 $2,159,479 $2,363,404
Operating income........................... 125,484 133,543 122,061
Margin..................................... 6.82% 6.18% 5.16%
Contract Medical Services
Net revenue................................ $ 342,412 $ 567,042 $ 806,350
Operating income........................... 38,045 55,836 46,905
Margin..................................... 11.11% 9.85% 5.82%
International
Net revenue................................ $ 79,400 $ 98,378 $ 125,094
Operating income (loss).................... 1,300 (1,749) 620
Margin..................................... 1.64% (1.78)% 0.50%
Corporate Services
Operating loss............................. $ (30,524) $ (31,555) $ (28,566)
Percentage of total net revenue............ (0.78)% (0.60)% (0.45)%
Physician Practice Services
The Company's PPM revenues have increased substantially over the past three
years primarily due to growth in prepaid enrollment, existing practice growth
and new practice affiliations. Of the total 1997 PPM revenue, $0.4 billion can
be attributed to acquisitions made during the year. The Company's PPM operations
in the western region of the country function in a predominantly prepaid
environment. The Company's PPM operations in the other regions of the country
are in predominantly fee-for-service environments with limited but increasing
managed care penetration. The following table sets forth the breakdown of net
revenue for the PPM services area for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------------
1995 1996 1997
---------- ---------- ----------
(IN THOUSANDS)
Prepaid............................................ $1,030,226 $1,492,672 $1,891,623
Fee-for-Service.................................... 596,804 889,908 1,108,862
Other.............................................. 19,626 14,540 35,818
---------- ---------- ----------
Total net revenue from PPM service
area................................... $1,646,656 $2,397,120 $3,036,303
========== ========== ==========
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The Company's prepaid revenue reflects the number of HMO enrollees for whom
it receives monthly capitation payments. The Company receives professional
capitation to provide physician services and institutional capitation to provide
hospital care and other non-professional services. The table below reflects the
growth in enrollment for professional and global capitation:
AT DECEMBER 31,
---------------------------------
1995 1996 1997
--------- --------- ---------
Professional enrollees................................ 603,391 983,543 1,168,032
Global enrollees (professional and institutional)..... 509,720 678,200 895,980
--------- --------- ---------
Total enrollees............................. 1,113,111 1,661,743 2,064,012
========= ========= =========
During 1997, prepaid revenues increased 27% while prepaid enrollees
increased 24%. The reason for this difference relates to the mix of professional
capitation enrollment to total enrollment (which includes institutional
capitation). The percentage of professional capitation enrollment to total
enrollment was 57% at December 31, 1997 compared to 59% at December 31, 1996.
Revenue per enrollee for professional capitation is substantially lower than
global capitation. Therefore, the lower percentage of professional capitation
enrollment accounts for the higher percentage increase in prepaid revenue as
compared to the percentage increase in total enrollment.
The Company will attempt to profit from increased revenues, operational
efficiencies and synergies produced by the exchange of ideas among physicians
and managers across geographic boundaries and varied areas of specialization.
The PPM service area, for example, has established medical management committees
that meet monthly to discuss implementation of the best medical management
techniques to assist the Company's affiliated physicians in delivering the
highest quality of care at lower costs in a consistent fashion. The PPM service
area has also created a medical advisory committee, which is developing
procedures for the identification, packaging and dissemination of the best
clinical practices within the Company's medical groups. The medical advisory
committee also provides the Company's affiliated physicians a forum to discuss
innovative ways to improve the delivery of healthcare.
During the fourth quarter of 1997, the PPM service area began a difficult
process of restructuring and reorganization which included practice
disassociations, site closings, physician and staff reductions and systems
standardization and conversions. Specifically, the Company closed a total of 60
clinic locations, primarily in southern California. Some closings also occurred
in Nevada, Arizona and northern California. Most of the locations were redundant
in nature due to the rapid acquisition of several group practices in the region.
The closings resulted in the elimination of approximately 114 physicians and 600
employees. The Company has also disassociated with 24 smaller practices, all of
which were in the eastern area of the country. These practices, which represent
approximately 124 physicians, accounted for approximately $54 million in annual
revenue. The disassociations were by mutual agreement and were the result of the
fact that the economics of the practice management agreements were not in the
best interest of the Company or the physicians.
As part of the restructuring process, the West Coast operations were
restructured into three regions: Southern California, Northwest (Idaho, Oregon,
and Washington) and Southwest (Arizona, Nevada, New Mexico, Oklahoma, Texas and
Utah). Each region is headed by a leadership team composed of physicians and
managers. Additionally, the Company moved to strengthen the financial capability
of its West Coast operations, internalize its actuarial capabilities to enhance
risk management functions and strengthen the managed care contracting process.
The Company recorded a pre-tax charge during the fourth quarter of 1997 of
$646.7 million related primarily to the restructuring and impairment of selected
assets of certain of its clinic operations within the PPM division. Of the total
charge, $39.2 million relates to cash charges including employee and physician
severance ($17.1 million), leases ($19.0 million) and other exits costs ($3.1
million), $552.4 million relates to the impairment of goodwill, primarily in the
Southern California and Southwestern markets, and $55.1 million relates to the
write down of various assets. The impairment of goodwill and write down of other
assets are non-cash charges.
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The operating loss for the year ended December 31, 1997, was $151.0 million
compared to an operating profit of $102.9 million for the year ended December
31, 1996. The loss was the result of greater than anticipated costs in the
Company's PPM operations, primarily related to higher than expected medical
utilization, additions to medical claims reserves, additional allowances for
uncollectible receivables, recognition of losses on certain contracts, and
delays in the implementation of certain integration activities.
Pharmaceutical Services
Pharmaceutical Services revenues continue to exhibit sustained growth. This
growth is entirely internal and has not been supplemented by acquisitions. Key
factors contributing to this growth include high customer retention, additional
penetration of retained customers, new customer contracts and drug cost
inflation. These growth factors were partially offset in 1995, 1996 and 1997 by
selective non-renewal of certain accounts not meeting threshold profitability
levels. The preponderance of Pharmaceutical Services revenue is earned on a
fee-for-service basis through contracts covering one to three-year periods.
Revenues for selected types of services are earned based on a percentage of
savings achieved or on a per-enrollee or per-member basis; however, these
revenues are not material to total revenues.
Operating income experienced accelerated growth in 1995 and 1996, and
margins decreased slightly from 6.8% in 1995 to 6.2% in 1996. Operating margin
fell to 5.2% in 1997, due almost entirely to a $20 million loss recognized on a
risk-share contract. This particular contract is the only significant risk-share
contract to which the Pharmaceutical Services Division is a party. Operating
income and margins in 1997 were enhanced by reduced information systems costs
achieved through renegotiations of a contract with an outsource service vendor,
continued improvements in the acquisition costs of drugs, increased penetration
of higher margin value-oriented services and an overall 13% reduction in selling
and administrative expenses.
Contract Medical Services
The Contract Medical Services Division includes Team Health, which manages
one of the largest hospital-based physician groups in the country, and
Government Services, one of the largest correctional and government services
managed care delivery businesses. These groups produced combined contract
medical services revenue of $806 million in 1997. Team Health organizes and
manages physicians and other healthcare professionals engaged in the delivery of
emergency, radiology and teleradiology services, hospital-based primary care and
temporary staffing and support services to hospitals, clinics, managed care
organizations and physician groups throughout the United States. Government
Services provides similar services to medical facilities at correctional
institutions and Department of Defense facilities. As of December 31, 1997, the
Company had 2,476 physicians in 39 states affiliated with its Contract Medical
Services Division.
Team Health. Since becoming part of MedPartners as a result of the PPSI
merger in 1996, Team Health has grown into one of the nation's largest providers
of hospital-based physician management services. Team Health's growth is based
upon a strategy of seeking out high quality, regional hospital-based physician
management groups for affiliation. Beginning in 1996, Team Health acquired
regional groups in New Jersey (Emergency Physician Associates), Florida (The
Emergency Associates for Medicine and Sheer, Ahearn and Associates) and Ohio
(Emergency Professional Services). Team Health also assumed management
responsibility for a hospital-based group that was already part of PPSI in
Washington (Northwest Emergency Physicians) prior to PPSI's acquisition of Team
Health. In 1997, Team Health continued to grow by making significant inroads
into the strategically important California market with the acquisition of
Quantum Plus, followed several months later by the acquisition of Fischer
Mangold. During 1997, MedPartners acquired InPhyNet and Team Health assumed
responsibility for management of the hospital-based division of InPhyNet. Team
Health also continued to expand its radiology line with the acquisition of
Reich, Seidelmann, and Janicki in Ohio in late 1997. In addition to growth by
acquisition of regional groups, Team Health aggressively seeks internal growth
through sales of contract staffing opportunities as well as acquisition of
smaller hospital-based groups that "roll in" to existing regional offices.
Team Health has determined that timely and successful integration of
acquired groups is critical when growing quickly, and places significant
emphasis on integration efforts. Additionally, it is crucial to find ways
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to add value to the practices that choose to affiliate with Team Health. Local
operations are coordinated out of the regional offices under the guidance of a
senior physician leader, but all corporate support functions such as accounting
and payroll are centralized in the Team Health corporate office. Common
information platforms and databases are developed to facilitate the efficient
capture of clinical and operating data. The two major initiatives currently
under way involve migration of all Team Health billing onto a common IDX-based
billing system and creation of a company-wide physician database and management
system. Both initiatives are expected to be significantly complete by the end of
1998. Management effort is also focused on evaluating the best clinical
practices and exporting this knowledge throughout all the affiliates of Team
Health in order to continually improve the quality of patient care provided by
Team Health physicians. Attention is also focused on finding ways to reduce the
cost of the clinical support services. For example, during 1997, the operations
of Quantum Plus and Fischer Mangold were merged together and now operate from
one regional office, thus saving a significant amount of duplicate overhead
costs.
Team Health is currently affiliated with more than 2,100 emergency
physicians and 140 radiologists. As of December 31, 1997, Team Health operates
under 362 hospital-based contracts in 31 states compared to 302 contracts at
December 31, 1996.
Team Health revenue is driven primarily by the number of contracts with
hospitals and other providers (such as outpatient imaging centers) that are
staffed by hospital based physicians. The revenue under these contracts is
almost entirely fee-for-service. Accordingly, the capitated revenue of Team
Health is minimal. Under the Team Health staffing contracts, revenue is
generated either through direct billing of patients and payors, payments from
the hospital or other provider, or a combination of both. Therefore, revenue can
be affected by changes in patient volume and reimbursement levels from payors as
well as changes in the contracted payment rate between the hospital or other
providers and Team Health. Operating income and margins declined in 1997
primarily as a result of increased costs associated with the Company's changes
in malpractice programs and other matters associated with the acquisition of
InPhyNet.
Government Services. Government Services currently has 228 affiliated
physicians working in 52 correctional facilities in 15 states with approximately
57,400 globally capitated lives, making the Company the nation's second largest
provider of correctional medical services ("Correctional Care"). The contracts
with correctional facilities are concentrated mainly on the East Coast (from
Florida to Vermont), the Midwest and in California. Another 195 physicians work
in 15 military facilities, covering 300,000 annual patient visits ("Military
Services"). The revenues under the Correctional Care contracts are generally
capitated while some of the Military Services contacts reimburse the Company on
an hourly basis.
Government Services revenue has increased significantly in the last three
years, primarily as a result of Correctional Care contract growth. The Company
obtained 34 contracts from year-end 1995 through 1997, and increased globally
capitated lives from 21,888 in 1995 to 57,372 in 1997. The stated growth
resulted from individual contract awards and the purchase of National Health
Services, Inc. in July 1996, which contributed $12.3 million in revenue in 1996.
International
Internationally, the Company, through Caremark, had established home care
businesses in the United Kingdom, Canada, Germany, France, the Netherlands,
Puerto Rico and Japan. The international operations are currently in the process
of being sold. The home infusion operations in Germany, the Netherlands and
Canada have been sold to Fresenius A. G. Other international operations in
Puerto Rico, Japan and the Netherlands are being or have been sold to various
parties. Revenue from international operations during 1997 totaled $125.1
million.
Discontinued Operations
During 1995, Caremark divested its Caremark Orthopedic Services, Inc.
subsidiary as well as its Clozaril(R) Patient Management System, home infusion
business and oncology management services business. The Company's Consolidated
Financial Statements present the operating income and net assets of these
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32
discontinued operations separately from continuing operations. Prior periods
have been restated to conform with this presentation. Discontinued operations
for 1995 reflect the net after-tax gain on the disposal of the Clozaril(R)
Patient Management System, the home infusion business and a $154.8 million
after-tax charge for the settlement related to the OIG investigation discussed
in Note 13 of the accompanying audited Consolidated Financial Statements.
Discontinued operations for 1996 reflects a $67.9 million after-tax charge
related to settlements with private payors discussed in Note 13 of the
accompanying audited Consolidated Financial Statements and an after-tax gain on
disposition of the nephrology services business, net of disposal costs, of $2.5
million. During the second quarter of 1997, the Company settled a dispute with
Coram Health Corporation arising from Caremark's sale of its home infusion
therapy business to Coram, and, during the third quarter of 1997, the Company
settled a class action lawsuit also related to Caremark, both of which are
discussed in Note 13 of the accompanying audited Consolidated Financial
Statements. During the fourth quarter of 1997, the Company recorded a charge
related to amounts due from and due to third parties as well as miscellaneous
litigation, all of which resulted from operations previously owned by the
Company's Caremark subsidiary.
Results of Operations for the Years Ended December 31, 1997 and 1996
For the year ended December 31, 1997, net revenue was $6,331.2 million,
compared to $5,222.0 million for 1996, an increase of 21%. The increase in net
revenue resulted primarily from affiliations with new physician practices and
the increase in Pharmaceutical Services' net revenue, which accounted for $371.3
million and $203.9 million of the increase in net revenue, respectively. The
increase in Pharmaceutical Services' net revenue is attributable to
pharmaceutical price increases, the addition of new customers, further
penetration of existing customers and the sale of new products.
The net loss was $820.6 million for the year ended December 31, 1997
compared to a net loss of $145.5 million for the year ended December 31, 1996.
The Company incurred a charge of $646.7 million in 1997 related to restructuring
and impairment. See Note 15 of the accompanying audited Consolidated Financial
Statements. Changes in operations have previously been discussed for each
division.
Included in the pre-tax loss for 1997 were merger expenses totaling $59.4
million related to the business combinations with InPhyNet and several other
entities, the major components of which are listed in Note 11 of the
accompanying audited Consolidated Financial Statements.
In November 1997, the Emerging Issues Task Force ("EITF") issued EITF 97-13
"Accounting for Costs Incurred in Connection with a Consulting Contract or an
Internal Project that Combines Business Process Reengineering and Information
Technology" ("EITF 97-13"). EITF 97-13 requires process reengineering costs, as
defined, which had been previously capitalized as part of an information
technology project to be written off as a cumulative catch-up adjustment in the
fourth quarter of 1997. The Company recorded a charge of $30.9 million, net of
tax of $18.9 million, as a result of EITF 97-13. The Company incurred such costs
primarily in connection with the process reengineering associated with the new
operating systems installed for its PBM operations.
Under Statement of Financial Accounting Standards 109, "Accounting for
Income Taxes" (SFAS 109), the Company is required to record a net deferred tax
asset for the future tax benefits of tax loss and tax credit carryforwards, as
well as for other temporary differences, if realization of such benefits is more
likely than not. In assessing the realizability of deferred tax assets,
management has considered reversing deferred tax liabilities, projected future
taxable income and tax planning strategies. However, the ultimate realization of
the deferred tax assets is dependent upon the generation of future taxable
income during the periods in which temporary differences become deductible and
net operating losses can be carried forward.
Management believes, considering all available information, including the
Company's history of earnings from continuing operations (after adjustments for
nonrecurring items, restructuring charges, permanent differences and other
appropriate adjustments) and after considering appropriate tax planning
strategies, it is more likely than not that the Company will generate sufficient
taxable income in the appropriate carryforward periods to realize the $247.8
million in net deferred tax assets related to net operating losses and future
deductible temporary differences of which $148.3 million was recognized in
fiscal year 1997 (includes the
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current tax benefit from discontinued operations of $51.4 million and the tax
benefit from the change in accounting methods of $18.9 million). The total net
deferred tax assets (both current and noncurrent) have been reduced to the
amount management considers realizable by establishing valuation allowances
aggregating $109.3 million. The valuation allowances have been established due
to the uncertainty associated with forecasting future income. The valuation
allowance also includes $9.3 million related to certain net operating losses of
non-consolidated entities that can only offset future taxable income generated
by those entities.
While management expects the Company to be profitable, future levels of
operating income are dependent upon general economic conditions, including
competitive pressures on sales and profit margins, and other factors beyond the
Company's control. Management has considered these factors in reaching its
conclusion that it is more likely than not that future taxable income will be
sufficient to utilize certain net operating loss carryforwards and other
temporary differences prior to their expiration.
Results of Operations for the Years Ended December 31, 1996 and 1995
For the year ended December 31, 1996, net revenue was $5,222.0 million,
compared to $3,908.7 million for 1995, an increase of 33.6%. The increase in net
revenue resulted primarily from affiliations with new physician practices and
the increase in PBM net revenue, which accounted for $339.9 million and $352.1
million of the increase in net revenue, respectively. The most significant
physician practice acquisition during this period was the CIGNA Medical Group
which was acquired in January 1996. This acquisition accounted for 92% of the
new practice revenue. The increase in PBM net revenue is attributable to
pharmaceutical price increases, the addition of new customers, further
penetration of existing customers and the sale of new products.
Operating income for the PPM and PBM services areas increased 57.2% and
35.3%, respectively, for 1996 compared to 1995. This growth was the result of
higher net revenues in both areas and increases in operating margins resulting
from the spreading of fixed overhead expenses over a larger revenue base and
continued integration of operations in the PPM services area. Operating income
and margins declined in the corresponding periods for the therapeutic services
area as a result of lower volumes in the hemophilia business and continued
pricing pressures for growth hormone products.
Included in the pre-tax loss for 1996 were merger expenses totaling $308.9
million related to the business combinations with Caremark, PPSI and several
other entities, the major components of which are listed in Note 11 of the
accompanying audited Consolidated Financial Statements.
PHYCOR AND AMERICA SERVICE GROUP INC. MERGER AGREEMENTS AND SUBSEQUENT
TERMINATIONS
On October 29, 1997, the Boards of Directors of the Company and PhyCor,
Inc. unanimously approved a merger agreement under which PhyCor would acquire
the Company, with the Company's stockholders receiving 1.18 shares of PhyCor
common stock for each share of the Company's Common Stock. On January 7, 1998,
it was announced that the merger agreement had been terminated by mutual
agreement.
On October 1, 1997, the Company announced that it entered into an agreement
to acquire America Service Group Inc. ("ASG") in a stock transaction valued at
approximately $59 million. On February 26, 1998, it was announced that the
merger agreement had been terminated by mutual consent of both parties and that
a release and settlement agreement had been executed. Due to the exchange of
confidential information, the settlement agreement contains customary
non-competition and non-solicitation provisions and provides for the payment of
certain expenses and costs by the Company.
Other Matters
Year 2000 Compliance. The Company has assessed the potential impact and
costs of addressing the Year 2000 Issue and is in the process of implementing a
plan of action to address the Year 2000 Issue. This plan of action is a
significant undertaking which is expected to require a significant amount of
time and attention of senior management and other personnel to resolve. The
Company estimates that the total cost of
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all of the work to be carried out to resolve its Year 2000 Issue will be
approximately $47.7 million over the years 1998 and 1999. Of this amount,
approximately $31 million was work already budgeted without regard to the Year
2000 Issue. Thus the incremental costs of the Company's efforts to address the
Year 2000 Issue will be approximately $16.7 million. The Company's current plan
of action projects that the program to be carried out will be completed sometime
in mid-1999; however, there can be no assurance that the program will be
implemented as planned and that there will not be adverse effects on the
Company's operations, financial condition and results of operations not
currently anticipated in addressing the Year 2000 Issue. The Year 2000 Issue is
also expected to affect the systems of various entities with which the Company
interacts, including payors, suppliers and vendors. There can be no assurance
that the systems of other companies on which the Company's systems rely will be
timely corrected, or that a failure by another company's systems to be year 2000
compliant would not have a material adverse effect on the company.
EITF 97-2. In 1997, the Emerging Issues Task Force of the Financial
Accounting Standards Board issued EITF 97-2 concerning the consolidation of
physician practice revenues. PPMs will be required to consolidate financial
information of a physician practice where the PPM acquires a "controlling
financial interest" in the practice through the execution of a contractual
management agreement even though the PPM does not own a controlling equity
interest in the physician practice. EITF 97-2 outlines six requirements for
establishing a controlling financial interest. EITF 97-2 is effective for the
Company's financial statements for the year ended December 31, 1998. The Company
does not believe that the implementation of EITF 97-2 will have a material
impact on its financial condition or results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The future operating results and financial condition of the Company are
dependent on the Company's ability to market its services profitably,
successfully increase market share and manage expense growth relative to revenue
growth. The future operating results and financial condition of the Company may
be affected by a number of additional factors, including: the Company's growth
strategy, which involves the ability to raise the capital required to support
growth, competition for expansion opportunities, integration risks and
dependence on HMO enrollee growth; efforts to control healthcare costs; exposure
to professional liability; and pharmacy licensing, healthcare reform and
government regulation. Changes in one or more of these factors could have a
material adverse effect on the future operating results and financial condition
of the Company.
The Company completed its acquisition of Caremark in September 1996. There
are various Caremark legal matters which, if materially adversely determined,
could have a material adverse effect on the Company's operating results and
financial condition. See Note 13 to the accompanying audited Consolidated
Financial Statements of the Company.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had working capital of $75.7 million and
had cash and cash equivalents of $215.8 million. During 1997, the Company
generated $80.4 million from operating activities, which was used primarily to
fund acquisitions as well as liabilities related to restructuring charges.
During 1997 and 1996, the Company incurred cash expenditures in connection
with acquisitions of the assets of physician practices of $415.3 million and
$160.5 million, respectively, capital expenditures for property and equipment
were approximately $123.0 million and $126.9 million, respectively. During 1997
and 1996, the Company paid $120.1 million and $143.3 million, respectively, in
cash for merger costs. During 1997, these expenditures were funded by
approximately $76.6 million derived from capital contributions and net
incremental borrowings of $677.3 million. During 1996, these expenditures were
funded by approximately $271.9 million derived from issuance of common stock and
net incremental borrowings of $124.4 million. Investments in acquisitions and
property and equipment are anticipated to continue to be uses of funds in future
periods.
Effective September 5, 1996, the Company established a $1 billion unsecured
revolving Credit Facility with a final maturity date of September 5, 2001 (the
"Credit Facility"). This Credit Facility replaced the Company's then existing
Credit Facility. The purpose of the facility is to provide funds for working
capital,
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acquisitions and other general corporate purposes. As of December 31, 1997, $524
million was outstanding under the Credit Facility. The Credit Facility contains
affirmative and negative covenants which include requirements that the Company
maintain certain financial ratios (including minimum net worth, minimum fixed
charge coverage ratio and maximum indebtedness to cash flow), and establishes
certain restrictions on investments, mergers and sales of assets. Additionally,
the Company is required to obtain bank consent for acquisitions with an
aggregate purchase price in excess of $75 million and for which more than half
of the consideration is to be paid in cash. The Credit Facility is unsecured but
provides a negative pledge on substantially all assets of the Company.
On January 14, 1998, the Company obtained a waiver of all financial
covenants and ratios contained in Section 8.1 of the Credit Facility. The
financial covenants are currently waived through May 29, 1998. The Company
expects to negotiate an amendment to the Credit Facility or replace it prior to
the expiration of the waiver.
On September 19, 1997, the Company completed a $420 million senior
subordinated note offering. These three year notes carry a coupon rate of
6 7/8%. Interest on the notes is payable semi-annually on March 1 and September
1 of each year. The notes are not redeemable by the Company prior to maturity
and are not entitled to the benefit of any mandatory sinking fund. The notes are
general unsecured obligations of the Company ranking junior in right of payment
to all existing and future senior debt of the Company. In addition, the notes
are effectively subordinated to all existing and future indebtedness of the
Company's subsidiaries. Net proceeds from the offering were used to reduce
amounts outstanding under the Credit Facility.
In September 1997, the Company issued 21.7 million 6 1/2% Threshold
Appreciation Price Securities ("TAPS") with a stated amount of $22.1875 per
security. Each TAPS consists of (i) a stock purchase contract which obligates
the holder to purchase common stock from the Company on the final settlement
date (August 31, 2000) and (ii) 6 1/4% U.S. Treasury Notes due August 31, 2000.
Under each stock purchase contract the Company is obligated to sell, and the
TAPS holder is obligated to purchase on August 31, 2000, between 0.8197 of a
share and one share of the Company's Common Stock. The exact number of common
shares to be sold is dependent on the market value of the Company's Common Stock
in August 2000. The number of shares issued by the Company in conjunction with
this security will not be more than approximately 21.7 million or less than
approximately 17.8 million (subject to certain anti-dilution adjustments). The
Treasury Notes forming a part of the TAPS have been pledged to secure the
obligations of the TAPS holders under the purchase contracts. Pursuant to the
TAPS, TAPS holders receive payments equal to 6 1/2% of the stated amount per
annum consisting of interest on the Treasury Notes at the rate of 6 1/4% per
annum and yield enhancement payments payable semi-annually by the Company at the
rate of 0.25% of the stated amount per annum. Additional paid-in capital has
been reduced by $20.4 million for issuance costs and the present value of the
annual 0.25% yield enhancement payments payable to the holders of the TAPS.
These securities are not included on the Company's balance sheet; an increase in
stockholders' equity will be reflected when cash proceeds of $481.4 million are
received by the Company on August 31, 2000.
On October 8, 1996, the Company completed a $450 million Senior Note
offering. The ten year notes carry a coupon rate of 7 3/8%. Interest on the
notes is payable semi-annually on April 1 and October 1 of each year. The notes
are not redeemable by the Company prior to maturity and are not entitled to the
benefit of any mandatory sinking fund. The notes are general unsecured
obligations of the Company, ranking senior in right of payment to all existing
and future subordinated indebtedness of the Company and pari passu in right of
payment with all existing and future unsubordinated and unsecured obligations of
the Company. The notes are effectively subordinated to all existing and future
secured indebtedness of the Company and to all existing and future indebtedness
and other liabilities of the Company's subsidiaries. Net proceeds from the note
offering were used to reduce amounts under the Credit Facility.
33
36
QUARTERLY RESULTS (UNAUDITED)
The following tables set forth certain unaudited quarterly financial data
for 1996 and 1997. In the opinion of the Company's management, this unaudited
information has been prepared on the same basis as the audited information and
includes all adjustments (consisting of normal recurring items) necessary to
present fairly the information set forth therein. The operating results for any
quarter are not necessarily indicative of results for any future period.
QUARTER ENDED
--------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1996 1996 1996 1997 1997
---------- ---------- ------------- ------------ ---------- ----------
(IN THOUSANDS)
Net revenue.......... $1,237,715 $1,286,692 $1,313,019 $1,384,593 1,467,933 $1,560,600
Operating expenses... 1,181,064 1,226,971 1,246,846 1,308,128 1,386,301 1,467,029
Net interest
expense............ 7,030 4,158 5,395 8,132 9,781 12,549
Merger expenses...... 34,448 250 263,000 11,247 -- 59,434
Restructuring and
impairment
charges............ -- -- -- -- -- --
Other, net........... (107) 51 328 (1,347) -- --
---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing
operations before
income taxes....... 15,280 55,262 (202,550) 58,433 71,851 21,588
Income tax expense
(benefit).......... 8,878 19,271 (53,423) 28,489 27,454 19,540
---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing
operations......... 6,402 35,991 (149,127) 29,944 44,397 2,048
Loss from
discontinued
operations, net of
taxes.............. (68,698) -- -- -- -- (75,434)
Cumulative effects of
a change in
accounting
principle.......... -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Net income (loss).... $ (62,296) $ 35,991 $ (149,127) $ 29,944 $ 44,397 $ (73,386)
========== ========== ========== ========== ========== ==========
QUARTER ENDED
----------------------------
SEPTEMBER 30, DECEMBER 31,
1997 1997
------------- ------------
(IN THOUSANDS)
Net revenue.......... $1,614,062 $1,688,556
Operating expenses... 1,512,142 1,975,628
Net interest
expense............ 13,969 19,449
Merger expenses...... -- --
Restructuring and
impairment
charges............ -- 646,651
Other, net........... -- --
---------- ----------
Income (loss) from
continuing
operations before
income taxes....... 87,951 (953,172)
Income tax expense
(benefit).......... 33,509 (158,543)
---------- ----------
Income (loss) from
continuing
operations......... 54,442 (794,629)
Loss from
discontinued
operations, net of
taxes.............. (5,273) (15,281)
Cumulative effects of
a change in
accounting
principle.......... -- (30,885)
---------- ----------
Net income (loss).... $ 49,169 $ (840,795)
========== ==========
The Company's historical unaudited quarterly financial data have been
restated to include the results of all businesses acquired prior to December 31,
1997 that were accounted for as poolings of interests (collectively, the
"Mergers"). The Company's Quarterly Reports on Form 10-Q were filed prior to the
Mergers and thus, differ from the amounts for the quarters included herein. The
differences caused solely by the operation of the merged companies are
summarized as follows:
QUARTER ENDED
MARCH 31, 1997
------------------------
FORM 10-Q AS RESTATED
---------- -----------
(IN THOUSANDS)
Net revenue................................................. $1,332,271 $1,467,933
Income from continuing operations before income taxes....... 65,411 71,851
Income tax expense.......................................... 24,925 27,454
Net income.................................................. 40,486 44,397
34
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated Financial Statements of the Company meeting the requirements
of Regulation S-X are filed on the succeeding pages of this Item 8 of this
Annual Report on Form 10-K, as listed below:
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... 36
Consolidated Balance Sheets as of December 31, 1996 and
1997...................................................... 37
Consolidated Statements of Operations for the Years Ended
December 31, 1995, 1996 and 1997.......................... 38
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1995, 1996 and 1997.............. 39
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1995, 1996 and 1997.......................... 40
Notes to Consolidated Financial Statements.................. 41
Other financial statements and schedules required under regulation S-X are
listed in Item 14(a)(2) of this Annual Report on Form 10-K.
35
38
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
MedPartners, Inc.
We have audited the accompanying consolidated balance sheets of
MedPartners, Inc. as of December 31, 1996 and 1997, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 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 opinions.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MedPartners,
Inc. at December 31, 1996 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Birmingham, Alabama
March 13, 1998
36
39
MEDPARTNERS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------
1996 1997
---------- ----------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 127,397 $ 215,801
Accounts receivable, less allowances for bad debts of
$143,449 in 1996 and $204,249 in 1997.................. 660,150 763,551
Inventories............................................... 150,586 164,049
Deferred tax assets, net.................................. 52,261 72,203
Income tax receivable..................................... 2,496 10,446
Prepaid expenses and other current assets................. 69,225 86,991
---------- ----------
Total current assets.............................. 1,062,115 1,313,041
Property and equipment, net................................. 516,769 530,033
Intangible assets, net...................................... 686,975 731,586
Deferred tax assets, net.................................... 18,333 175,619
Other assets................................................ 138,928 140,250
---------- ----------
Total assets...................................... $2,423,120 $2,890,529
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 288,023 $ 340,106
Other accrued expenses and liabilities.................... 404,334 670,615
Accrued medical claims payable............................ 114,753 208,937
Current portion of long-term debt......................... 28,596 17,636
---------- ----------
Total current liabilities......................... 835,706 1,237,294
Long-term debt, net of current portion...................... 715,996 1,470,622
Other long-term liabilities................................. 34,010 91,759
Contingencies (Note 13)
Stockholders' equity:
Common stock, $.001 par value; 400,000 shares authorized,
issued-- 183,950 in 1996 and 197,766 in 1997........... 184 198
Additional paid-in capital................................ 855,162 937,233
Notes receivable from stockholders........................ (1,665) (1,367)
Unrealized loss on marketable securities.................. -- (5,035)
Shares held in trust, 9,317 in 1996 and 1997.............. (150,200) (150,200)
Retained earnings (deficit)............................... 133,927 (689,975)
---------- ----------
Total stockholders' equity........................ 837,408 90,854
---------- ----------
Total liabilities and stockholders' equity........ $2,423,120 $2,890,529
========== ==========
See accompanying Notes to Consolidated Financial Statements.
37
40
MEDPARTNERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net revenue.............................................. $3,908,717 $5,222,019 $6,331,151
Operating expenses:
Clinic expenses........................................ 1,785,564 2,683,107 3,690,859
Non-clinic goods and services.......................... 1,688,075 2,019,895 2,254,079
General and administrative expenses.................... 172,896 173,428 275,719
Depreciation and amortization.......................... 62,394 86,579 120,443
Net interest expense................................... 19,114 24,715 55,748
Restructuring and impairment charges (Note 15)......... -- -- 646,651
Merger expenses........................................ 69,064 308,945 59,434
Losses on investments.................................. 86,600 -- --
Other, net............................................. (192) (1,075) --
---------- ---------- ----------
Income (loss) from continuing operations before
income taxes................................. 25,202 (73,575) (771,782)
Income tax expense (benefit)............................. (6,987) 3,215 (78,040)
---------- ---------- ----------
Income (loss) from continuing operations....... 32,189 (76,790) (693,742)
Discontinued operations:
Income (loss) from discontinued operations, net of
taxes of $(72,100), $(35,849) and $(51,352) in 1995,
1996 and 1997, respectively......................... (168,342) (71,221) (95,988)
Net gains on sales of discontinued operations.......... 31,814 2,523 --
---------- ---------- ----------
Loss from discontinued operations.............. (136,528) (68,698) (95,988)
---------- ---------- ----------
Loss before cumulative effect of a change in
accounting principle......................... (104,339) (145,488) (789,730)
Cumulative effect of a change in accounting principle,
net of taxes of $(18,930).............................. -- -- (30,885)
---------- ---------- ----------
Net loss................................................. $ (104,339) $ (145,488) $ (820,615)
========== ========== ==========
Earnings (loss) per common share outstanding:
Income (loss) from continuing operations............... $ 0.21 $ (0.45) $ (3.73)
Loss from discontinued operations...................... (0.90) (0.40) (0.52)
Cumulative effect of a change in accounting
principle........................................... -- -- (0.17)
---------- ---------- ----------
Net loss................................................. $ (0.69) $ (0.85) $ (4.42)
========== ========== ==========
Weighted average common shares outstanding............... 152,453 169,897 185,830
========== ========== ==========
Diluted earnings (loss) per common share outstanding:
Income (loss) from continuing operations............... $ 0.20 $ (0.45) $ (3.73)
Loss from discontinued operations...................... (0.86) (0.40) (0.52)
Cumulative effect of a change in accounting
principle........................................... -- -- (0.17)
---------- ---------- ----------
Net loss................................................. $ (0.66) $ (0.85) $ (4.42)
========== ========== ==========
Weighted average common and dilutive equivalent shares
outstanding............................................ 158,109 169,897 185,830
========== ========== ==========
See accompanying Notes to Consolidated Financial Statements.
38
41
MEDPARTNERS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
--------- --------- ---------
(IN THOUSANDS)
COMMON STOCK:
Balance, beginning of year................................ $ 136 $ 165 $ 184
Beginning balance of immaterial poolings of interests
entities................................................ 1 6 --
Common stock issued and capital contributions............. 10 10 7
PPSI common stock issued during the two months ended
December 31, 1995....................................... -- 1 --
Conversion of preferred stock............................. 7 -- --
Stock issued in connection with acquisitions.............. 2 2 7
Contributions to employee benefit trust................... 9 -- --
--------- --------- ---------
Balance, end of year...................................... 165 184 198
ADDITIONAL PAID-IN-CAPITAL:
Balance, beginning of year................................ 246,494 541,230 855,162
Beginning balance of immaterial poolings of interests
entities................................................ 6 620 2,396
Common stock issued and capital contributions............. 115,027 226,190 --
Exercise of stock options................................. 2,335 46,654 75,964
Stock issued in connection with acquisitions.............. 36,373 39,880 23,466
Issuance costs and present value of yield enhancement
payments payable to holders of Threshold Appreciation
Price Securities........................................ -- -- (20,417)
Contribution to employee benefit trust.................... 150,191 -- --
Conversion of preferred stock............................. 19,994 -- --
Capital distributions..................................... (30,970) -- --
PPSI common stock issued during the two months ended
December 31, 1995....................................... -- 588 --
Transfer of predecessor company retained earnings to
additional paid-in capital upon conversion from an S to
a C corporation......................................... 1,780 -- --
Deferred compensation on issuance of options.............. -- -- 662
--------- --------- ---------
Balance, end of year...................................... 541,230 855,162 937,233
NOTES RECEIVABLE FROM STOCKHOLDERS:
Balance, beginning of year................................ (2,349) (1,930) (1,665)
Net change in notes receivable from stockholders.......... 419 265 298
--------- --------- ---------
Balance, end of year...................................... (1,930) (1,665) (1,367)
UNREALIZED GAIN (LOSS) ON MARKETABLE SECURITIES:
Balance, beginning of year................................ 17 149 --
Unrealized gain (loss) on marketable securities, net of
taxes................................................... 132 (149) (5,035)
--------- --------- ---------
Balance, end of year...................................... 149 -- (5,035)
UNAMORTIZED DEFERRED COMPENSATION:
Balance, beginning of year................................ (3,552) (2,682) --
Amortization of deferred compensation..................... 870 2,682 --
--------- --------- ---------
Balance, end of year...................................... (2,682) -- --
SHARES HELD IN TRUST:
Balance, beginning of year................................ -- (150,200) (150,200)
Contribution to employee benefit trust.................... (150,200) -- --
--------- --------- ---------
Balance, end of year...................................... (150,200) (150,200) (150,200)
RETAINED EARNINGS (DEFICIT):
Balance, beginning of year................................ 404,172 287,710 133,927
Beginning balance of immaterial poolings of interests
entities................................................ 1,472 (238) (3,287)
Net (loss)................................................ (104,339) (145,488) (820,615)
Dividends and distributions paid.......................... (11,815) -- --
Transfer of predecessor company retained earnings to
additional paid-in capital upon conversion from an S to
a C corporation......................................... (1,780) -- --
Net loss for two months ended December 31, 1995 for
PPSI.................................................... -- (8,057) --
--------- --------- ---------
Balance, end of year...................................... 287,710 133,927 (689,975)
--------- --------- ---------
Total stockholders' equity......................... $ 674,442 $ 837,408 $ 90,854
========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
39
42
MEDPARTNERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
--------- ----------- -----------
(IN THOUSANDS)
CASH FLOWS FROM CONTINUING OPERATIONS:
Net (loss).................................................. $(104,339) $ (145,488) $ (820,615)
Adjustments for non-cash items:
Net loss from discontinued operations..................... 136,528 68,698 95,988
Cumulative effect of change in accounting principle, net
of taxes................................................ -- -- 30,885
Restructuring and impairment charges...................... -- -- 646,651
Depreciation and amortization............................. 62,394 86,579 120,443
Deferred tax(benefit)..................................... (68,422) (36,056) (83,428)
Merger expenses........................................... 69,064 308,945 59,434
Loss on sale of investments............................... 86,600 -- --
Other..................................................... 1,505 1,161 (1,513)
Changes in operating assets and liabilities, net of effects
of acquisitions........................................... (36,337) (107,342) 32,532
--------- ----------- -----------
Net cash and cash equivalents provided by continuing
operations............................................ 146,993 176,497 80,377
Investing activities:
Cash paid for merger expense.............................. (53,600) (143,285) (120,054)
Net cash used to fund acquisitions........................ (212,063) (160,485) (415,329)
Additions to intangibles.................................. (7,235) (19,515) (16,969)
Purchase of property and equipment........................ (128,428) (126,873) (123,020)
Proceeds from sale of property and equipment.............. -- -- 15,332
Proceeds from sale of marketable securities............... 1,636 27,558 --
Other..................................................... 1,964 1,083 136
--------- ----------- -----------
Net cash and cash equivalents used in investing
activities............................................ (397,726) (421,517) (659,904)
Financing activities:
Common stock issued and capital contributions............. 100,380 271,882 76,588
Issuance costs related to Threshold Appreciation Price
Securities.............................................. -- -- (18,378)
Capital distributions..................................... (37,771) -- --
Net borrowings (repayments) under Credit Facility......... 72,100 (77,000) 311,500
Proceeds from issuance of senior subordinated notes....... -- -- 420,000
Proceeds from issuance of bonds payable................... -- 450,000 --
Net repayment of other debt............................... (2,638) (248,577) (54,165)
Dividends and distributions paid.......................... (9,355) -- --
Other..................................................... (3) 266 297
--------- ----------- -----------
Net cash and cash equivalents provided by financing
activities............................................ 122,713 396,571 735,842
Cash provided by (used in) discontinued operations.......... 114,500 (115,835) (68,412)
--------- ----------- -----------
Net (decrease) increase in cash and cash equivalents........ (13,520) 35,716 87,903
Cash and cash equivalents at beginning of year.............. 101,101 88,386 127,397
Beginning cash and cash equivalents of immaterial poolings
of interests entities..................................... -- 3,295 501
--------- ----------- -----------
Cash and cash equivalents at end of year.................... $ 87,581 $ 127,397 $ 215,801
========= =========== ===========
Supplemental Disclosure of Cash Flow Information
Cash paid (received) during the period for:
Interest................................................ $ 35,204 $ 42,979 $ 62,175
========= =========== ===========
Income taxes............................................ $ 24,939 $ (16,848) $ 4,513
========= =========== ===========
Non-cash investing activities include notes and other obligations issued
for acquisitions of $30.8 million in 1995, and $123.6 million in notes and other
securities received from divestitures in 1995. Non-cash financing activities
include the issuance of $55.1, $39.9 and $23.5 million of stock for acquisitions
in 1995, 1996 and 1997, respectively.
See accompanying Notes to Consolidated Financial Statements.
40
43
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ACCOUNTING POLICIES
Description of Business
MedPartners, Inc. (The "Original Predecessor") was incorporated in January
1993, and affiliated with its initial physician practice in November 1993.
Mullikin Medical Enterprises, L.P. ("MME") was formed by the merger of several
physician partnerships in 1994, and the original business was organized in 1957.
MedPartners/Mullikin, Inc. was formed as a result of the November 1995 business
combination between the Original Predecessor and MME. In February and September
of 1996, MedPartners/Mullikin, Inc. combined with Pacific Physician Services,
Inc. ("PPSI") and Caremark International Inc. ("Caremark"), respectively. These
business combinations were accounted for as poolings of interests. The combined
companies were renamed MedPartners, Inc. (herein referred to as the "Company" or
"MedPartners") in conjunction with the business combination with Caremark. In
June 1997, MedPartners combined with InPhyNet Medical Management Inc.
("InPhyNet") in a business combination accounted for as a pooling of interests.
The financial information referred to in this discussion reflects the combined
operations of these entities and several additional immaterial entities
accounted for as poolings of interests.
The Company operates three separate business divisions: Physician Practice
Services, Pharmaceutical Services and Contract Medical Services. The Physician
Practice Services Division is larger than any other physician practice
management company ("PPM") in the United States, based on revenues in that
business of approximately $3.0 billion for the year ended December 31, 1997.
Through its network of affiliated group and independent practice association
("IPA") physicians, the Company provides primary and specialty healthcare
services to prepaid enrollees and fee-for-service patients. The Pharmaceutical
Services Division operates one of the largest independent prescription benefit
management ("PBM") and therapeutic pharmaceutical services programs in the
United States, with revenues of approximately $2.4 billion for the year ended
December 31, 1997. The Contract Medical Services Division operates one of the
largest hospital-based physician management service businesses and one of the
largest corrections and government services managed care businesses in the
United States, with revenues of approximately $806 million for the year ended
December 31, 1997.
The Company's Physician Practice Services Division affiliates with
physicians who are seeking the resources necessary to function effectively in
healthcare markets that are evolving from fee-for-service to managed care payor
systems. The Company enhances clinic operations by centralizing administrative
functions and introducing management tools, such as clinical guidelines,
utilization review and medical management processes. The Company provides
affiliated physicians with access to capital and to advanced management
information systems. In addition, the Company contracts with health maintenance
organizations (and other third-party payors that compensate the Company and its
affiliated physicians on a prepaid basis (collectively, "HMOs")), hospitals and
outside providers on behalf of its affiliated physicians. These relationships
provide physicians with the opportunity to operate under a variety of payor
arrangements.
The Company offers medical group practices and independent physicians a
range of affiliation models. These affiliations are carried out by the
acquisition of physician practice services entities or practice assets, either
for cash or equity, or by affiliation on a contractual basis. In all instances,
the Company enters into long-term practice management agreements that provide
for the management of the affiliated physicians by the Company while assuring
the clinical independence of the physicians.
The Company also manages PBM programs for more than 2,194 clients
throughout the United States, including corporations, insurance companies,
unions, government employee groups and managed care organizations. The Company
dispenses approximately 44,222 prescriptions daily through three mail service
pharmacies and manages patients' immediate prescription needs through a network
of approximately 53,000 retail and other pharmacies. The Company's therapeutic
pharmaceutical services are designed to meet the
41
44
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
healthcare needs of individuals with certain chronic diseases or conditions.
These services include the design, development and management of comprehensive
programs comprising drug therapy, physician support and patient education. The
Company currently provides therapies and services for individuals with such
conditions as hemophilia, growth disorders, immune deficiencies, cystic fibrosis
and multiple sclerosis. The Company is in the process of integrating the
pharmaceutical services program with the PPM business by providing
pharmaceutical services to affiliated physicians, clinics and HMOs.
The Contract Medical Services Division organizes and manages physicians and
other healthcare professionals engaged in the delivery of emergency, radiology
and teleradiology services, hospital-based primary care and temporary staffing
and support services. Through its Team Health subsidiary the Company provides
these services to hospitals, clinics and managed care organizations, and the
Company's Government Services unit provides these services to correctional
facilities, Department of Defense facilities and government-affiliated physician
groups throughout the United States. The Division also provides occupational
health services to corporate industrial clients. Under contracts with hospitals
and other clients, the Contract Medical Services division identifies and
recruits physicians and other healthcare professionals for admission to a
client's medical staff, monitors the quality of care and proper utilization of
services and coordinates the ongoing scheduling of staff physicians and other
healthcare professionals who provide clinical coverage in designated areas of
care.
Basis of Presentation
The Consolidated Financial Statements have been prepared on the accrual
basis of accounting and include the accounts of the Company and its
subsidiaries. The Company also consolidates professional corporations (PCs) in
which it obtains a controlling financial interest by virtue of a long-term
practice management agreement (and, in some cases, a transfer agreement) between
a wholly-owned subsidiary of the Company and the PC.
Where there is a transfer agreement with the PC, it enables the Company to
require the stockholder(s) of the PC at any time and for any reason to transfer,
at a nominal price, shares of the PC to a transferee selected by the Company.
Where such agreements exist, the physician-stockholders of the PC are, as a
general rule, designated by the Company and are senior members of the Company's
management. Because each stockholder of the PC is the Company's nominee, whom
the Company can replace at will, the transfer agreement provides the Company
with unilateral control.
Contracts with hospitals and payors for the provision of medical services
which are entered into directly between the hospitals or the payor (e.g., HMOs
and health plans) and the Company or a wholly-owned subsidiary of the Company,
contributed approximately 70% of the Company's 1997 PPM revenue (43% of
consolidated revenue, since PPM revenue comprised 61% of consolidated revenue).
In these cases, the contractual revenue is earned by the Company or a legal
subsidiary of the Company. In some cases, the Company contracts with its PCs to
provide medical services under these payor or hospital contracts. The Company
consolidates these PCs by virtue of its rights under a practice management
agreement and, in most cases, a transfer agreement. The PCs do not have any
external revenue because, as noted above, all revenue is generated through
contracts with the Company. Consolidation of these PCs, therefore, does not
materially affect the Company's Consolidated Financial Statements.
For PCs that have directly entered into contracts with payors and/or that
have the right to receive payment directly from payors for the provision of
medical services in the Company's clinics, the Company consolidates these PCs
because it obtains a controlling financial interest solely by virtue of a
long-term practice management agreement with the PC (the Company generally does
not have a transfer agreement with these types of PCs). The revenue earned by
these PCs represented 30% of PPM revenue (18% of consolidated revenue) during
1997. Practice management agreements with PCs that hold payor contracts
42
45
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and/or the right to receive payment directly from payors provide three general
types of financial arrangements regarding the compensation of the
physician-stockholders of those PCs.
PCs that contributed 2% of PPM revenue (1% of consolidated net revenue)
during 1997 have practice management agreements that provide the
physician-stockholders a negotiated fixed dollar amount. At the Company's sole
discretion, the physicians are eligible to receive a bonus paid by the Company
based on performance criteria and goals. The amount of any discretionary bonus
is determined solely by the Company's management and is not directly correlated
to clinic revenue or gross profit. To the extent the clinic's net revenue
increases or decreases under these practice management agreements, physician
compensation will also increase or decrease, pro rata, based on the practice's
compensation as a percentage of the clinic net revenue.
PCs that contributed 5% of PPM revenue (3% of consolidated net revenue)
during 1997 have practice management agreements that compensate the
physician-stockholder on a fee-for-service basis. The respective clinics
generally earn revenue on a fee for service basis, and physician compensation
typically represents between 40 and 70 percent of the clinic's net revenue.
PCs that contributed 23% of PPM revenue (14% of consolidated net revenue)
during 1997 provided physician-stockholders with a salary, plus bonus, and/or a
profit-sharing payment of a percentage of the clinic's net income (i.e.,
contractual revenue less base physician compensation, bonus and clinic
expenses).
Under these various types of agreements, revenue is assigned to the Company
by the PC. The Company is responsible for the billing and collection of all
revenue for services provided at its clinics, as well as for paying all
expenses, including physician compensation. The Company compensates the PCs,
which in turn compensate the physicians. The Company is not reimbursed for the
clinic expenses, rather it is responsible and at risk for all such expenses. In
effect, the Company retains any residual from the operations of its PCs (and
funds any deficit). No earnings accumulate in its PCs or are available for the
payment of dividends to the physician-stockholders. In addition, the legal
owners of its PCs do not have a substantive capital investment that is at risk,
and the Company has substantially all of the capital at risk. Based on the terms
of the practice management agreement, there is no economic value attributable to
the capital stock of those PCs.
The Company's practice management agreements with its PCs are long-term.
The practice management agreements include the following provisions: (i) the
initial term is 20 to 40 years; (ii) renewal provisions call for automatic and
successive extension periods; (iii) the PCs cannot unilaterally terminate their
agreements with the Company unless the Company fails to cure a breach of its
contractual responsibilities thereunder within 30 days after notification of
such breach; (iv) the Company is obligated to maintain a continuing investment
of capital; (v) the Company employs the non-physician personnel of its PCs; and
(vi) the Company assumes full responsibility for the operating expenses of the
PC in return for an assignment of the PC's revenue.
The Company has unilateral control over its PCs because the practice
management agreements provide the following: (i) the Company has exclusive
authority over all operating decision making (except for the dispensing of
medical services); (ii) the Company has the exclusive authority to negotiate and
execute contracts on behalf of its PCs: (iii) the Company has the exclusive
authority to establish and approve operating and capital budgets of its PCs,
including establishing total amounts to be paid to the physicians (budgets are
established with the advice of an Advisory Board composed of physicians and
members of the Company's management); (iv) the Company has the authority to
hire, assign and terminate non-medical personnel employed by its PCs; (v) the
practice management agreement establishes guidelines for the selection, hiring
and termination of physicians by its PCs, and the Company recruits candidates
for physician openings; (vi) the physician-stockholders of its PCs are required
to cooperate with the Company to expand their respective practices at the
Company's direction; (vii) where the physicians are eligible for bonuses,
determination of the amount of the bonus is within the sole discretion of the
Company; (viii) the Company
43
46
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
manages and administers all business functions of its PCs, including billing and
collecting all medical service revenue, paying all expenses and purchasing all
capital assets; (ix) the Company receives an assignment from its PCs of all
rights to receive revenue from the provision of medical services; (x) the
Company owns all the operational and depository accounts and has total control
of all cash deposits related to clinic revenue; (xi) under an assignment, the
Company owns all of its PCs' accounts receivable; (xii) the Company contracts
for the provision of medical care with each of its PCs and not with individual
physicians; and (xiii) the Company performs the negotiations and controls the
implementation and administration of all payor contracts. The execution of any
contracts on behalf of the Company's PCs by physician-stockholders of those PCs
is simply perfunctory. The approval of the physician-stockholders of the PC is
required with respect to the financial and operational actions of the PC only in
rare and isolated cases. In all circumstances, the rights of the legal owners of
the PC are protective in nature and do not allow the legal owners of the PC to
participate in the control of the PC in any substantive fashion.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the accompanying Consolidated
Financial Statements and Notes thereto. Actual results could differ from those
estimates.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The carrying amounts
of all cash and cash equivalents approximate fair value.
Marketable Securities
Effective August 1, 1994, the Company adopted Statement of Financial
Accounting Standard ("SFAS") 115, "Accounting for Certain Investments in Debt
and Equity Securities," which requires that investments in equity securities
that have readily determinable fair values and investments in debt securities be
classified in three categories: held-to-maturity, trading and
available-for-sale. Based on the nature of the assets held by the Company and
management's investment strategy, the Company's investments have been classified
as available-for-sale.
Available-for-sale securities are carried at fair value, with the
unrealized gains and losses, net of tax, reported in a separate component of
stockholders' equity unless a decline in value is judged other than temporary.
When this is the case, unrealized losses are reflected in the results of
operations. The amortized cost of debt securities in this category is adjusted
for amortization of premiums and accretion of discounts to maturity. Such
amortization is included in interest income. The cost of securities sold is
based on the specific identification method.
Inventories
Inventories, which are primarily finished goods, consist of pharmaceutical
drugs, medical equipment and supplies and are stated at the lower of cost
(first-in, first-out method) or market.
Property and Equipment
Property and equipment are stated at cost, which for the used assets being
acquired is usually determined by an independent appraisal. Depreciation of
property and equipment is calculated using either the declining balance or the
straight-line method over the shorter of the estimated useful lives of the
assets or the term of the underlying leases. Estimated useful lives range from 3
to 10 years for equipment, 10 to 20 years for
44
47
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
leasehold improvements and 10 to 40 years for buildings and improvements based
on type and condition of assets. Routine maintenance and repairs are charged to
expense as incurred, while costs of betterments and renewals are capitalized.
Interest costs associated with the construction of certain capital assets
are capitalized as part of the cost of those assets. Interest costs
approximating $1.5 million were capitalized in 1997. The Company also
capitalizes purchased and internally developed software costs to the extent they
are expected to benefit future operations.
Intangible Assets
Excess of cost over fair value of assets acquired (goodwill) is being
amortized using the straight-line method over terms of the related practice
management agreements, generally 20 to 40 years. The carrying value of goodwill
is reviewed if the facts and circumstances suggest that it may be impaired. If
this review indicates that goodwill will not be recoverable, as determined based
on the undiscounted cash flows of the entity acquired over the remaining
amortization period, the carrying value of the goodwill is reduced by the
estimated shortfall of cash flows. Costs of obtaining practice management
agreements are capitalized as incurred and are amortized using the straight-line
method. These costs include all direct costs of obtaining such agreements, which
include such items as filing fees, legal fees and travel and related development
costs. The Company has elected to amortize these costs over a period not to
exceed the term of the related practice management agreements. Other intangible
assets include costs associated with obtaining long-term financing, which are
being amortized, and included in interest expense, systematically over the terms
of the related debt agreements.
Restatement of Financial Statements
The Company has merged with several entities during 1996 and 1997 in
transactions that were accounted for as poolings of interests. Accordingly, the
financial statements for all periods prior to the effective dates of these
mergers have been restated to include these entities (see Note 11).
Income Taxes
The Company is a corporation subject to federal and state income taxes.
Deferred income taxes are provided for temporary differences between financial
and income tax reporting (see Note 8).
Net Revenue
Net revenue is reported at the estimated realizable amounts from patients,
third-party payors and others for services rendered. Revenue under certain
third-party payor agreements is subject to audit and retroactive adjustments.
Provisions for estimated third-party payor settlements and adjustments are
estimated in the period the related services are rendered and are adjusted in
future periods as final settlements are determined.
During 1995, 1996 and 1997, approximately 7% of net revenue was received
from governmental programs. Governmental programs pay for physician services
based on fee schedules which are determined by the related government agency.
The Company has contracts with various managed care organizations to
provide physician services based on negotiated fee schedules. Under various
contracts with HMOs, capitation is received to cover all physicians and hospital
services needed by the HMO members. Capitation payments are recognized as
revenue on the accrual basis, and represent approximately 28%, 31% and 32% of
the Company's total net revenue in 1995, 1996 and 1997, respectively. A total of
five HMO's, Pacificare, Foundation, CIGNA, PCA and California Care, represent
approximately 17.5% of net revenue of MedPartners for the year ended December
31, 1997. Liabilities for physician services provided and hospital services
incurred are accrued in the month services are
45
48
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
rendered. The provision for accrued claims payable, which represents the amount
payable for services incurred by patients not yet paid, is validated by
actuarial review. Management believes that the provision at December 31, 1997 is
adequate to cover claims which will ultimately be paid.
Reclassifications
Certain prior-year balances have been reclassified to conform with the
current year's presentation. Such reclassifications had no material effect on
the previously reported consolidated financial position, results of operations
or cash flows of the Company.
Fiscal Year
At January 1, 1996, PPSI changed its fiscal year-end from July 31 to
December 31. Amounts consolidated for PPSI prior to January 1, 1996 were based
on an October 31 year-end. As a result, the Consolidated Financial Statements
for the year ended December 31, 1995 include the 12 months of operations of PPSI
for the year ended October 31, 1995.
Stock Option Plans
The Company has elected to follow Accounting Principles Board Opinion 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its stock-based compensation plans. The
Company applies APB 25 and related interpretations in accounting for its plans
because the alternative fair value accounting provided for under FASB Statement
123, "Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
New Accounting Pronouncements
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS 128,
"Earnings per Share". 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 Statement 128 requirements.
In February, 1997, SFAS 129 "Disclosure of Information about Capital
Structure", was issued by the FASB and is effective for fiscal years beginning
after December 15, 1997. The new standard reinstates various securities
disclosure requirements previously in effect under Accounting Principles Board
("APB") 15, which has been superseded by SFAS 128. The Company does not expect
adoption of SFAS 129 to have a material effect, if any, on its financial
condition or results of operations.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income".
SFAS 130 establishes reporting and display requirements with respect to
comprehensive income and its components. This Statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This Statement requires that
an enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet. This Statement is effective
for fiscal years beginning after December 15, 1997 and will require
reclassification of financial statements for prior periods for comparative
purposes. The Company does
46
49
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
not expect adoption of SFAS 130 to have a material effect, if any, on its
financial condition or results of operations.
In June 1997, the FASB issued "Disclosures about Segments of an Enterprise
and Related Information" ("SFAS 131"). SFAS 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements, and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS 131 is
effective for financial statements for fiscal years beginning after December 15,
1997. The adoption of SFAS 131 will have no impact on the Company's results of
operations, financial position or cash flows.
The Emerging Issues Task Force ("EITF") issued guidance during 1997, EITF
97-2, on the consolidation of physician practice revenues. Under EITF 97-2 PPMs
will be required to consolidate financial information of a physician practice
where the PPM acquires a "controlling financial interest" in the practice
through the execution of a contractual management agreement even though the PPM
does not own a controlling equity interest in the physician practice. EITF 97-2
outlines six requirements for establishing a controlling financial interest. The
guidance continued in EITF 97-2 is effective for the Company's financial
statements for the year ended December 31, 1998. The Company does not believe
that the implementation of this guidance will have a material impact on its
financial condition, results of operations or cash flows.
In November 1997, the EITF issued EITF 97-13 "Accounting for Costs Incurred
in Connection with a Consulting Project or an Internal Project that Combines
Business Process Reengineering and Information Technology". EITF 97-13 requires
process reengineering costs, as defined, which had been previously capitalized
as part of an information technology project to be written off by cumulative
catch-up adjustment in the fourth quarter of 1997. The Company incurred such
costs primarily in connection with the process reengineering associated with the
new operating systems installed for its PBM operations.
2. DISCONTINUED OPERATIONS
During 1995, Caremark divested several non-strategic businesses. In
accordance with APB 30, which addresses the reporting for disposition of
business segments, the Company's Consolidated Financial Statements present the
operating results and net assets of discontinued operations separately from
continuing operations. Prior periods have been restated to conform with this
presentation.
Effective March 31, 1995, Caremark sold its Clozaril(R) Patient Management
System to Health Management, Inc. for $23.3 million in cash and notes. This
business involved managing the care of schizophrenia patients nationwide through
the distribution of the Clozaril(R) drug and related testing services to monitor
patients for potentially serious side effects. Net revenue of this business was
$12.3 million for the three months ended March 31, 1995 and $84.0 million for
the year ended December 31, 1994. The after-tax gain on disposition of this
business was $11.1 million.
Effective April 1, 1995, Caremark sold its home infusion business to Coram
Healthcare Corporation ("Coram") for $309 million in cash and securities,
subject to post-closing adjustments based on the net assets transferred. The
sale included Caremark's home intravenous infusion therapy, women's health
services and the Home Care Management System. Certain severance and legal
obligations remained with Caremark (see Note 13). Net revenue of this business
was $96.1 million for the period ended April 1, 1995 and $441.9 million for the
year ended December 31, 1994. The after-tax loss on disposition of this business
was $4.0 million. In 1995 net losses from this business reflected in
discontinued operations include $154.8 million related to the legal settlement
discussed in Note 13.
Effective September 15, 1995, Caremark sold its oncology management
services business to Preferred Oncology Networks of America, Inc., for
securities valued at $3.6 million. The business provides management
47
50
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
services to single-specialty oncology practices. Net revenue of this business
for the 1995 period up to the date of sale was $8.9 million and $29.4 million
for the year ended December 1994. There was no after-tax gain or loss on the
disposition.
Effective December 1, 1995, Caremark sold its Caremark Orthopedic Services,
Inc. subsidiary to HEALTHSOUTH Corporation for $127.0 million in cash, subject
to post-closing adjustments. This business provides outpatient physical therapy
and rehabilitation services. Net revenue of this business for the 1995 period up
to the date of sale was $69.1 million and $55.8 million for the year ended
December 31, 1994. The after-tax gain on disposition of this business was $24.7
million.
Effective February 29, 1996, Caremark sold its Nephrology Services business
to Total Renal Care, Inc. for $49.0 million in cash, subject to certain
post-closing adjustments. The after-tax gain on disposition of this business,
net of disposal costs, was $2.5 million, which was included in discontinued
operations.
In March 1996 Caremark agreed to settle all disputes with a number of
private payors related to its home infusion business which was sold to Coram in
1995. The settlements resulted in an after-tax charge of $43.8 million. In
addition, Caremark agreed to pay $24.1 million after-tax to cover the private
payors' pre-settlement and settlement related expenses. An after-tax charge for
the above amounts has been recorded in 1996 discontinued operations.
In September 1995, Coram filed a complaint in the San Francisco Superior
Court against Caremark, its subsidiary, Caremark Inc., and others. The
complaint, which arose from Caremark's sale to Coram of Caremark's home infusion
therapy business in April 1995 for approximately $209.0 million in cash and
$100.0 million in securities, alleged breach of the sale agreement and made
other related claims seeking compensatory damages of $5.2 billion, in the
aggregate. Caremark filed counterclaims against Coram and also filed a lawsuit
in the United States District Court in Chicago against Coram, claiming
securities fraud. On July 1, 1997, the parties to the Coram litigation announced
that a settlement had been reached pursuant to which Caremark returned for
cancellation all of the securities issued by Coram in connection with the
acquisition and paid Coram $45 million in cash. The settlement agreement also
provided for the termination and resolution of all disputes and issues between
the parties and for the exchange of mutual releases. The settlement resulted in
a 1997 after-tax charge from discontinued operations of approximately $75.4
million.
Also included in discontinued operations for 1997 is a third quarter
after-tax charge of $5.3 million related to the settlement of a class action
lawsuit filed in August and September 1994 against Caremark. In addition, the
Company recorded an after-tax charge from discontinued operations of
approximately $15.3 million in the fourth quarter of 1997. This charge relates
to changes in estimates of amounts due from and due to third parties as well as
various litigation, all of which resulted from operations previously owned by
Caremark.
3. FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents,
investments in marketable and non-marketable securities and debt obligations.
The carrying value of marketable and non-marketable securities, which
approximated fair value, are not material. The carrying value of debt
obligations was $450.0 million and $870.0 million at December 31, 1996 and 1997,
respectively. The fair value of these obligations approximated $451.9 million
and $858.3 million at December 31, 1996 and 1997, respectively. The fair value
of marketable securities is determined using market quotes and rates. The fair
value of non-marketable securities are estimated based on information provided
by these companies. The fair value of long-term debt has been estimated using
market quotes.
48
51
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1995, the Company recorded a pre-tax charge to income of $86.6
million ($52.0 million after tax) to reflect unrealized losses on investments
that were judged other than temporary.
Interest expense totaled $32.9, $35.6 and $67.6 million in 1995, 1996 and
1997, respectively. Interest income totaled $13.8, $10.9 and $11.9 million in
1995, 1996 and 1997, respectively.
4. INTANGIBLE ASSETS
Net intangible assets totaled $687.0 million and $731.6 million at December
31, 1996 and 1997, respectively. As of December 31, 1996 and 1997, accumulated
amortization totaled $55.3 million and $68.1 million, respectively. Goodwill,
which represents the excess of consideration paid for companies acquired in
purchase transactions over the fair value of net assets acquired, and
consideration paid clinic service agreements, represent the primary components
of intangible assets. During the fourth quarter of 1997 the Company reduced the
carrying value of goodwill related to several transactions. See Note 15 for
further discussion.
5. PROPERTY AND EQUIPMENT
PROPERTY AND EQUIPMENT CONSISTED OF THE FOLLOWING:
DECEMBER 31,
---------------------
1996 1997
--------- ---------
(IN THOUSANDS)
Land........................................................ $ 54,340 $ 45,804
Buildings and leasehold..................................... 186,406 191,264
Improvements and equipment.................................. 409,911 482,896
Construction-in-progress.................................... 91,923 83,435
--------- ---------
742,580 803,399
Less accumulated depreciation and amortization.............. (225,811) (273,366)
--------- ---------
$ 516,769 $ 530,033
========= =========
The net book value of capitalized lease property approximated $11.1 and
$10.4 million at December 31, 1996 and 1997, respectively. Capitalized software
costs included in construction-in-progress approximated $56.5 million at
December 31, 1996, the majority of which was placed into service on January 1,
1997.
6. LONG-TERM DEBT
LONG-TERM DEBT CONSISTED OF THE FOLLOWING:
DECEMBER 31,
---------------------
1996 1997
-------- ----------
(IN THOUSANDS)
Advances under Credit Facility, due 2001.................... $213,000 $ 524,500
Bonds Payable with interest at 7 3/8%, interest only paid
semi-annually, due in 2006................................ 450,000 450,000
Senior subordinated notes with interest at 6 7/8%, interest
only paid semi-annually, due in 2000...................... -- 420,000
Other long-term notes payable............................... 63,339 82,091
Capital lease obligations................................... 18,253 11,667
-------- ----------
744,592 1,488,258
Less amounts due within one year............................ (28,596) (17,636)
-------- ----------
$715,996 $1,470,622
======== ==========
49
52
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective September 5, 1996, the Company established a $1 billion unsecured
revolving Credit Facility with a final maturity date of September 5, 2001 (the
"Credit Facility"). This Credit Facility replaced the Company's then existing
Credit Facility. The purpose of the facility is to provide funds for working
capital, acquisitions and other general corporate purposes. As of December 31,
1997, $524.5 million was outstanding under the Credit Facility. The Credit
Facility contains affirmative and negative covenants which include requirements
that the Company maintain certain financial ratios (including minimum net worth,
minimum fixed charge coverage ratio and maximum indebtedness to cash flow), and
establishes certain restrictions on investments, mergers and sales of assets.
Additionally, the Company is required to obtain bank consent for acquisitions
with an aggregate purchase price in excess of $75 million and for which more
than half of the consideration is to be paid in cash. The Credit Facility is
unsecured but provides a negative pledge on substantially all assets of the
Company.
On January 14, 1998, the Company obtained a waiver of all financial
covenants contained in the Credit Facility. The financial covenants are
currently waived through May 29, 1998. The Company expects to negotiate an
amendment to the Credit Facility or replace it prior to the expiration of the
waiver.
Effective September 19, 1997, the Company completed a $420 million senior
subordinated note offering. These three year notes carry a coupon rate of
6 7/8%. Interest on the notes is payable semi-annually on March 1 and September
1 of each year. The notes are not redeemable by the Company prior to maturity
and are not entitled to the benefit of any mandatory sinking fund. The notes are
general unsecured obligations of the Company ranking junior in right of payment
to all existing and future senior debt of the Company. In addition, the notes
are effectively subordinated to all existing and future indebtedness of the
Company's subsidiaries. Net proceeds from the offering were used to reduce
indebtedness outstanding under the Credit Facility.
Effective October 8, 1996, the Company completed a $450 million Senior Note
offering. The ten year notes carry a coupon rate of 7 3/8%. Interest on the
notes is payable semi-annually on April 1 and October 1 of each year. The notes
are not redeemable by the Company prior to maturity and are not entitled to the
benefit of any mandatory sinking fund. The notes are general unsecured
obligations of the Company, ranking senior in right of payment to all existing
and future subordinated indebtedness of the Company and pari passu in right of
payment with all existing and future unsubordinated and unsecured obligations of
the Company. The notes are effectively subordinated to all existing and future
secured indebtedness of the Company and to all existing and future indebtedness
and other liabilities of the Company's subsidiaries. Net proceeds from the note
offering were used to reduce amounts under the Credit Facility.
The following is a schedule of principal maturities of long-term debt as of
December 31, 1997:
(IN THOUSANDS)
--------------
1998........................................................ $ 18,557
1999........................................................ 19,454
2000........................................................ 455,576
2001........................................................ 530,261
2002........................................................ 5,369
Thereafter.................................................. 461,864
Amounts representing interest and discounts................. (2,823)
----------
Total............................................. $1,488,258
==========
To manage interest rates and to lower its cost of borrowing, the Company
entered into an interest rate swap during 1997. The notional principal amount of
the swap is $200 million and is used solely as the basis for which the payment
streams are calculated and exchanged. The notional amount is not a measure of
the exposure to the company through the use of the swap. The interest rate swap
matures in relationship to its existing long-term debt and has a final
expiration of October 1, 2006. The purpose of the interest rate swap was
50
53
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to essentially modify the interest rate characteristics of a portion of the
Company's debt, from fixed to floating rate. Under the terms of the contract,
the Company and a major financial institution agree to pay, on a semi-annual
basis, the differential between a fixed rate and a floating rate index, as
stipulated in its contracts. Amounts to be paid or received under the contracts
are recorded as an adjustment to interest expense. The Company is subject to
market risk as interest rates fluctuate and impact the interest payments due on
the notional principal amount. The fair value of the interest rate swap contract
is determined based on the difference between the contract rate of interest and
the rates currently quoted for contracts of similar terms and maturities. The
market value of the contract at December 31, 1997 if it were to be sold or
unwound was not material.
Operating Leases: Operating leases generally consist of short-term lease
agreements for professional office space where the medical practices are located
and administrative office space. These leases generally have five-year terms
with renewal options. The following is a schedule of future minimum lease
payments under noncancelable operating leases as of December 31, 1997:
(IN THOUSANDS)
--------------
1998........................................................ $123,225
1999........................................................ 111,797
2000........................................................ 99,235
2001........................................................ 73,576
2002........................................................ 64,980
Thereafter.................................................. 269,010
--------
Total............................................. $741,823
========
7. CAPITALIZATION
The Company's Third Restated Certificate of Incorporation provides that the
Company may issue 9.5 million shares of Preferred Stock, par value $0.001 per
share, 0.5 million shares of Series C Junior Participating Preferred Stock, par
value $0.001 per share, and 400 million shares of Common Stock, par value $0.001
per share. As of December 31, 1997 no shares of the preferred stock were
outstanding.
On March 13, 1996, the Company completed a secondary public offering of 6.6
million shares of its common stock. The net proceeds of the offering were $194.0
million. Proceeds of the offering were used to pay outstanding indebtedness
under the then existing Credit Facility. In April 1996, $69 million of the
proceeds were used to repay PPSI's convertible subordinated debentures. The
remainder of the net proceeds were used to fund acquisitions of certain assets
of physician practices, expansion of physician services, working capital and
other general corporate purposes.
In September 1997, the Company issued 21.7 million 6 1/2% Threshold
Appreciation Price Securities ("TAPS") with a stated amount of $22.1875 per
security. Each TAPS consists of (i) a stock purchase contract which obligates
the holder to purchase common stock from the Company on the final settlement
date (August 31, 2000) and (ii) 6 1/4% U.S. Treasury Notes due August 31, 2000.
Under each stock purchase contract the Company is obligated to sell, and the
TAPS holder is obligated to purchase on August 31, 2000, between 0.8197 of a
share and one share of the Company's common stock. The exact number of common
shares to be sold is dependent on the market value of the Company's common
shares in August 2000. The number of shares issued by the Company in conjunction
with this security will not be more than approximately 21.7 million or less than
approximately 17.8 million (subject to certain anti-dilution adjustments). The
Treasury Notes forming a part of the TAPS have been pledged to secure the
obligations of the TAPS holders under the purchase contracts. Pursuant to the
TAPS, TAPS holders receive payments equal to 6 1/2% of the stated amount per
annum consisting of interest on the Treasury Notes at the rate of 6 1/4% per
annum and yield enhancement payments payable semi-annually by the Company at the
rate of 0.25% of the
51
54
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stated amount per annum. Additional paid-in capital has been reduced by
approximately $20.4 million for issuance costs and the present value of the
annual 0.25% yield enhancement payments payable to the holders of the TAPS.
These securities are not included on the Company's balance sheet; an increase in
stockholders' equity will be reflected when cash proceeds of $481.4 million are
received by the Company on August 31, 2000.
The earnings (loss) per common share outstanding computation is calculated
by dividing income available to common stockholders by the weighted average
number of common shares outstanding. For the computation of diluted earnings
(loss) per share, no incremental shares related to options are included for the
years ended December 31, 1996 and 1997, due to losses from continuing
operations. The weighted average common and dilutive equivalent shares
outstanding for the year ended December 31, 1995 of 158.1 million includes 4.5
million common shares issuable on exercise of certain stock options and 1.1
million weighted average shares of redeemable preferred stock.
8. INCOME TAX EXPENSE
At December 31, 1997, the Company had a cumulative net operating loss
("NOL") carryforward for federal income tax purposes of approximately $645
million available to reduce future amounts of taxable income. If not utilized to
offset future taxable income, the net operating loss carryforwards will expire
on various dates through 2012.
Deferred income taxes reflect the net tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities were as follows:
DECEMBER 31,
-------------------
1996 1997
------- ---------
(IN THOUSANDS)
Deferred tax assets:
Merger/acquisition costs.................................. $51,696 $ 22,325
Bad debts................................................. 15,971 14,640
Restructuring............................................. -- 18,900
Malpractice............................................... -- 7,119
Goodwill amortization..................................... -- 128,269
Accrued vacation.......................................... 5,427 9,202
NOL carryforward.......................................... 72,484 215,147
Alternative minimum tax credit carryforward............... 20,195 20,195
Other..................................................... 32,147 55,308
------- ---------
Gross deferred tax assets................................... 197,920 491,105
Valuation allowance for deferred tax assets................. (2,419) (109,278)
Deferred tax liabilities
Malpractice reserves...................................... -- 16,529
Change in accounting method............................... -- 3,390
Prepaid expenses.......................................... -- 4,339
State taxes............................................... 2,264 5,399
Merger reserves........................................... 4,235 --
Legal reserve............................................. 4,400 --
Shared risk receivable.................................... 7,135 4,423
52
55
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31,
-------------------
1996 1997
------- ---------
(IN THOUSANDS)
Securities write-down..................................... 13,449 --
Excess tax depreciation................................... 30,363 15,546
Goodwill.................................................. 9,648 --
Other amortization........................................ 31,115 71,256
Other..................................................... 22,298 13,123
------- ---------
Gross deferred tax liabilities.............................. 124,907 134,005
------- ---------
Net deferred tax asset...................................... $70,594 $ 247,822
======= =========
Management believes, considering all available information, including the
Company's history of earnings from continuing operations (after adjustments for
nonrecurring items, restructuring charges, permanent differences and other
appropriate adjustments) and after considering appropriate tax planning
strategies, it is more likely than not that the Company will generate sufficient
taxable income in the appropriate carryforward periods to realize the $247.8
million in net deferred tax assets. The total net deferred tax assets (both
current and noncurrent) have been reduced to the amount management considers
realizable by establishing valuation allowances aggregating $109.3 million at
December 31, 1997. The valuation allowances have been established due to the
uncertainty associated with forecasting future income. The valuation allowances
also include $9.3 million related to certain net operating losses of
non-consolidated entities that can only offset future taxable income generated
by those entities.
Income tax expense (benefit) on continuing operations is as follows:
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
-------- -------- --------
(IN THOUSANDS)
Current:
Federal.............................................. $ 50,768 $ 34,508 $ 294
State................................................ 10,667 4,763 5,094
-------- -------- --------
61,435 39,271 5,388
Deferred:
Federal.............................................. (58,950) (30,054) (72,173)
State................................................ (9,472) (6,002) (11,255)
-------- -------- --------
(68,422) (36,056) (83,428)
-------- -------- --------
$ (6,987) $ 3,215 $(78,040)
======== ======== ========
The differences between the provision (benefit) for income taxes and the
amount computed by applying the statutory federal income tax rate to income
before taxes were as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
-------- -------- ---------
(IN THOUSANDS)
Federal tax at statutory rate......................... $ 8,821 $(25,751) $(270,123)
Add (deduct):
State income tax, net of federal tax benefit........ (713) (401) (3,879)
Non deductible amortization......................... -- -- 42,272
Non deductible restructuring........................ -- -- 29,387
Increase (decrease) in valuation allowance.......... (14,240) 1,170 106,859
Non deductible merger expense....................... -- 24,786 16,331
Other............................................... (855) 3,411 1,113
-------- -------- ---------
$ (6,987) $ 3,215 $ (78,040)
======== ======== =========
53
56
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK BASED COMPENSATION PLANS
The Company offers participation in stock option plans to certain employees
and individuals. All of the outstanding options under these plans were granted
at 100% of the market value of the stock on the dates of grant. Awarded options
typically vest and become exercisable in incremental installments over four
years and expire no later than ten years and one day from the date of grant. The
number of shares authorized under the various plans was approximately 34.4
million as of December 31, 1997.
The following table summarizes stock option activity for the indicated
years:
1996 1997
--------------------------- ---------------------------
OPTIONS WEIGHTED- OPTIONS WEIGHTED-
(IN AVERAGE (IN AVERAGE
THOUSANDS) EXERCISE PRICE THOUSANDS) EXERCISE PRICE
---------- -------------- ---------- --------------
Outstanding:
Beginning of year............................. 17,008 $13.71 19,294 $14.69
Granted....................................... 12,448 19.11 10,047 19.02
Exercised..................................... (4,281) 10.87 (6,315) 10.26
Canceled/expired.............................. (5,881) 23.98 (1,330) 18.05
------- -------
End of year................................... 19,294 14.69 21,696 17.50
Exercisable at end of year.................... 12,472 13.57 11,755 15.66
Weighted-average fair value of options granted
during the year............................... $12.06 $ 8.19
The following table summarizes information about stock options outstanding
at December 31, 1997:
OPTIONS EXERCISABLE
--------------------------------------------------------------------------------------
OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED-
OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICE RANGE AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
- -------------------- -------------- ---------------- ---------------- -------------- --------------
(IN THOUSANDS) (YEARS) (IN THOUSANDS)
Under $12.00.............. 2,393 3.46 $ 8.77 2,194 $ 9.52
$12.00-$16.99............. 8,090 7.47 16.04 5,446 15.75
$17.00 and above.......... 11,213 9.19 19.15 4,115 18.82
Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its stock-based compensation plans under the fair value method as
described in Statement 123. The fair value for these options was estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions:
1996 1997
----- -----
Risk-free interest rates.................................... 6.21% 6.03%
Expected volatility......................................... 0.442 0.396
Expected option lives (years)............................... 5.4 5.4
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of Statement 123, the
54
57
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's net loss and loss per share would have been reduced to pro forma net
loss from continuing operations of $(123.0) and $(761.1) million and pro forma
net losses of $(191.7) and $(888.0) million for the years ended December 31,
1996 and 1997, respectively. Per share amounts would have been reduced to pro
forma net loss from continuing operations of $(0.72) and $(4.10) and pro forma
net losses per share of $(1.13) and $(4.78) for the years ended December 31,
1996 and 1997, respectively.
10. ACQUISITIONS
During the years ended December 31, 1995, 1996 and 1997, the Company,
through its wholly-owned subsidiaries, acquired certain operating assets of
various medical practices. Simultaneously with each medical practice
acquisition, the Company entered into a practice management agreement which
generally has a 20-40 year term. (See "Basis of Presentation" in Note 1).
In May 1995, Caremark entered into a long-term affiliation agreement with
Friendly Hills HealthCare Network ("Friendly Hills"), an integrated health care
delivery system headquartered in La Habra, California. Friendly Hills operates
18 medical offices and an acute care hospital. Caremark acquired substantially
all of the assets of Friendly Hills for approximately $140 million and agreed to
provide various management and administrative services. The transaction has been
accounted for by the purchase method of accounting. The Company invested
approximately $151.2 million in cash, stock and notes for other acquisitions in
1995.
In January 1996, Caremark completed its agreement with CIGNA Healthcare of
California, a managed healthcare subsidiary of CIGNA Corporation, to acquire
substantially all of the assets of CIGNA Medical Group, CIGNA Healthcare's Los
Angeles area staff model delivery system ("CIGNA") for approximately $80.4
million in cash. The transaction has been accounted for by the purchase method
of accounting. During the year ended December 31, 1996, $160.5 million in cash
and 2 million shares of stock valued at $39.9 million were given in exchange for
the net assets of CIGNA and other entities.
In May 1997, the Company completed an acquisition of Aetna U.S.
Healthcare's PPM business for approximately $56.8 million in cash. The Company's
acquisition of Healthways Family Medical Center included 47 health centers
located in Atlanta, the Baltimore/D.C. and northern Virginia area, Philadelphia,
Dallas, Akron, Chicago and southern California.
In September 1997, the Company completed the acquisition of Talbert Medical
Management Holdings Corporation ("Talbert") for $187.1 million in cash. Talbert
operated 52 health centers in five Southwestern states with approximately
258,000 patients in the network.
In December 1997, the Company completed the acquisition of the Health
Centers Division of Blue Cross Blue Shield of Massachusetts for $103.1 million
in cash. Of this amount, $51.9 million is to be paid in the first quarter of
1998 and is included in other accrued liabilities at December 31, 1997. The
transaction includes 10 health centers locations mainly in the Boston and
Springfield metropolitan areas. The health centers currently provide services to
80,000 patients enrolled with Blue Cross and Blue Shield. The transaction also
includes a 10-year provider agreement that extends to all current and future
MedPartners' affiliated physicians in Massachusetts.
During the year ended December 31, 1997, $415.3 million in cash and 1.1
million shares of stock valued at $23.5 million were given in exchange for the
net assets of these and other entities acquired in purchase transactions.
All of the aforementioned acquisitions have been accounted for by the
purchase method of accounting. As such, operating results of acquired businesses
are included in the Company's Consolidated Financial Statements as of their
respective dates of acquisition.
55
58
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. MERGERS
Effective February 22, 1996, and September 5, 1996, the Company merged with
PPSI and Caremark, respectively, in transactions that were accounted for as
poolings of interests. The Company exchanged 11.0 million and 90.5 million
shares of its common stock for all of the outstanding common stock of PPSI and
Caremark, respectively. During the year ended December 31, 1996, the Company
also exchanged 11.3 million shares of its common stock in additional
transactions accounted for as poolings of interests. Effective June 27, 1997,
the Company merged with InPhyNet in a transaction that was accounted for as a
pooling of interests. The Company exchanged approximately 19.3 million shares of
its common stock for all outstanding common stock of InPhyNet. The Company's
historical financial statements for all periods have been restated to include
the results of all material transactions accounted for as poolings of interests.
COMBINED
MEDPARTNERS INPHYNET (AS REPORTED)
----------- -------- -------------
(IN THOUSANDS)
Year ended December 31, 1995
Net revenue.............................................. $3,583,377 $325,340 $3,908,717
Net (loss) income........................................ (115,627) 11,288 (104,339)
Year ended December 31, 1996
Net revenue.............................................. 4,813,499 408,520 5,222,019
Net (loss) income........................................ (158,529) 13,041 (145,488)
Year ended December 31, 1997
Net revenue.............................................. 5,728,922 602,229 6,331,151
Net loss................................................. (782,449) (38,165) (820,614)
Included in pre-tax loss for the year ended December 31, 1996 are merger
costs totaling $308.9 million. Approximately $32.5 and $251.3 million relate to
the mergers with PPSI and Caremark, respectively. The components of this cost
are as follows (in thousands):
Investment banking fees..................................... $ 30,435
Professional fees........................................... 30,149
Other transaction costs..................................... 30,818
Transition and debt restructuring........................... 27,701
Severance costs for identified employees.................... 53,547
Impairment of assets........................................ 27,373
Abandonment of facilities................................... 13,909
Conforming of accounting policies........................... 39,002
Operational restructuring................................... 42,116
Other charges............................................... 13,895
--------
Total....................................................... $308,945
========
56
59
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Included in pre-tax loss for the year ended December 31, 1997, are merger
costs totaling $59.4 million primarily related to the business combination with
InPhyNet. The components of this costs are as follows (in thousands):
Brokerage fees, professional fees, filing fees and other
transaction costs......................................... $24,739
Conforming of accounting policies........................... 15,971
Severance and related benefits.............................. 5,272
Impairment of assets........................................ 2,824
Operational restructuring................................... 1,500
Transition and debt restructuring........................... 1,112
Other charges............................................... 8,016
-------
Total....................................................... $59,434
=======
Prior to its merger with the Company, PPSI reported on a fiscal year ending
on July 31. The restated financial statements for all periods prior to and
including December 31, 1995, are based on a combination of the Company's results
for its December 31 fiscal year and an October 31 fiscal year for PPSI.
Beginning January 1, 1996, PPSI adopted a December 31 fiscal year end;
accordingly, all Consolidated Financial Statements for periods after December
31, 1995 are based on a consolidation of all of the Company's subsidiaries on a
December 31 year end. PPSI's historical results of operations for the two months
ending December 31, 1995 are not included in the Company's consolidated
statements of operations or cash flows. An adjustment has been made to
stockholders' equity as of January 1, 1996, to adjust for the effect of
excluding PPSI's results of operations for the two months ending December 31,
1995. The net loss for the two month period ended December 31, 1995, relates
primarily to increases in PPSI's reserves to conform to the Company's
methodology of calculating reserves. The following is a summary of operations
and cash flow for the two months ending December 31, 1995 (in thousands):
Statement of Operations Data:
Net revenue............................................... $ 69,850
Net loss.................................................. (8,057)
Statement of Cash Flow Data:
Net cash used by operating activities..................... (3,569)
Net cash provided by investing activities................. 4,455
Net cash used in financing activities..................... (81)
12. RETIREMENT SAVINGS PLAN
The Company and certain subsidiaries have employee benefit plans to provide
retirement, disability and death benefits to substantially all of their
employees and affiliates. The plans primarily are defined contribution plans.
Effective January 1, 1998, the Board of Directors approved a Retirement Savings
Plan for employees and affiliates. The plan is a defined benefit contribution
plan in accordance with the provisions of Section 401(k) of the Internal Revenue
Code. Full-time employees and affiliates are eligible to enroll in the plan in
the first quarter following two months of service. Individuals on a part-time
and per diem basis are eligible to participate in the quarter following
completion of one year of service. For employees, the Company makes a matching
contribution of 50% of the employee's pretax contribution, up to 6% of the
employee's compensation, in any calendar year. Under the plan, no matching
contribution is made for affiliates. The various entities that have been
acquired or merged into the Company have various retirement plans that will be
evaluated for possible termination or incorporation into the Company's Plan.
57
60
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. CONTINGENCIES
In June 1995, Caremark agreed to settle an investigation with the Office of
the Inspector General of the U.S. Department of Health and Human Services (the
"OIG") and the U.S. Department of Justice ("DOJ"), the Veterans Administration,
the Federal Employee Health Benefits Program ("FEHBA"), the Civilian Health and
Medical Program of the Uniformed Services ("CHAMPUS") and related state
investigative agencies in all 50 states and the District of Columbia (the "OIG
Settlement"). Under the terms of the OIG Settlement, which covered allegations
dating back to 1986, a subsidiary of Caremark pled guilty to two counts of mail
fraud -- one each in Minnesota and Ohio. The basis of these guilty pleas was
Caremark's failure to provide certain information to CHAMPUS and FEHBP,
federally funded healthcare benefit programs, concerning financial relationships
between Caremark and a physician in each of Minnesota and Ohio. The OIG
Settlement allows Caremark to continue participating in Medicare, Medicaid and
other government healthcare programs. In its agreement with the OIG and the DOJ,
Caremark agreed to continue to maintain certain compliance-related oversight
procedures. Should these oversight procedures reveal credible evidence of legal
or regulatory violations, Caremark is required to report such violations to the
OIG and DOJ. Caremark is, therefore, subject to increased regulatory scrutiny
and, in the event it commits legal or regulatory violations, Caremark may be
subject to an increased risk of sanctions or penalties, including
disqualification as a provider of Medicare or Medicaid services, which would
have a material adverse effect on the operating results and financial condition
of MedPartners. Caremark took an after-tax charge to discontinued operations of
$154.8 million in 1995 for these settlement payments, costs to defend ongoing
derivative, security and related lawsuits and other associated costs.
In connection with the matters described above relating to the OIG
Settlement, Caremark is the subject of various non-government claims and may in
the future become subject to additional OIG-related claims. Caremark is the
subject of, and may be in the future subjected to, various private suits and
claims being asserted in connection with matters relating to the OIG Settlement
by Caremark's stockholders, patients who received healthcare services from
Caremark and such patients' insurers. The Company does not believe that the
above-referenced settlements or suits will materially affect its ability to
pursue its long-term business strategy. There can be no assurance, however, that
additional costs, claims and damages will not occur or that the ultimate costs
related to the settlements will not exceed estimates in the preceding
paragraphs. MedPartners cannot determine at this time what costs or liabilities
may be incurred in connection with future disposition of non-governmental claims
or litigation. Such additional costs or liabilities, if incurred, could have a
material adverse effect on the operating results and financial condition of
MedPartners.
In May 1996, three home infusion companies, purporting to represent a class
consisting of all of Caremark's competitors in the alternate site infusion
therapy industry, filed a complaint against Caremark, Inc., Caremark
International Inc., and two other corporations in the United States District
Court for the District of Hawaii alleging violations of the federal antitrust
laws, the Racketeer Influenced and Corrupt Organizations Act ("RICO"), the
federal antitrust laws and California's unfair business practices statute. The
complaint seeks unspecified treble damages, attorneys' fees and expenses. The
Company intends to defend this case vigorously. Although management believes,
based on information currently available, that the ultimate resolution is not
likely to have a material adverse effect on the operating results and financial
condition of the Company, there can be no assurance that the ultimate resolution
of the matter, if adversely determined would not have a material adverse effect
on the operating results and financial condition of the Company.
In March 1998, a group of 22 private payors filed an action against
Caremark Inc. and Caremark International Inc. seeking recovery for losses
allegedly suffered by the plaintiffs during the period 1986-1995 as a result of
an allegedly fraudulent scheme conceived and implemented by Caremark Inc. and
Caremark International Inc. to submit and cause other providers to submit
fraudulent claims for payment of healthcare benefits by the plaintiffs related
to Caremark's home infusion business. Caremark sold its home infusion business
in 1995. The plaintiffs allege that Caremark failed to disclose to the
plaintiffs the existence and
58
61
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
nature of certain relationships that Caremark had with various physicians and
the fact that certain funds were paid to such physicians without the plaintiffs'
knowledge or approval. The action prays for an unspecified amount in damages and
for trebled damages under RICO and other related fraud claims. Caremark intends
to defend this lawsuit vigorously. Although management believes, based on
information currently available, that the ultimate resolution of this matter is
not likely to have a material adverse effect on the operating results and
financial condition of MedPartners, there can be no assurance that the ultimate
resolution of this matter, if adversely determined, would not have a material
adverse effect on the operating results and financial condition of MedPartners.
In late August 1994, certain patients of a physician who prescribed human
growth hormone distributed by Caremark and the sponsor of a health insurance
plan of one of those patients filed complaints against Caremark, employees of
Caremark and others in the United States District Court for the District of
Minnesota. The complaint alleged violations of the federal mail and wire fraud
statutes, RICO and the state consumer fraud statute, as well as conspiracy to
breach a fiduciary duty, negligence and fraud. The complaint sought unspecified
treble damages, and attorneys' fees and expenses. In July 1996, these plaintiffs
also filed a separate purported class action lawsuit in the Minnesota State
Court in the County of Hennepin against a subsidiary of Caremark alleging all of
the claims contained in the federal complaint and sought unspecified damages,
attorneys' fees and expenses and an award of punitive damages. In November 1996,
in response to a motion by the plaintiffs, the Court dismissed the United States
District Court cases without prejudice. On March 28, 1997, the Minnesota state
court lawsuit was dismissed with prejudice, which decision was affirmed by the
Minnesota Court of Appeals on November 4, 1997. On December 31, 1997, the
Minnesota Supreme Court denied plaintiffs' petition for further reconsideration.
This action is concluded because plaintiffs have no further avenue of appeal. In
July 1995, another patient of the same physician filed a separate complaint in
the District of South Dakota against the physician, Caremark and another
corporation alleging violations of the federal laws prohibiting payment of
remuneration to induce referral of Medicare and Medicaid beneficiaries, the
federal mail fraud statutes and RICO. The complaint also alleges the intentional
infliction of emotional distress and seeks trebling of at least $15.9 million in
general damages, attorneys' fees and costs, and an award of punitive damages. In
August 1995, the parties agreed to a stay of all proceedings until final
judgment was entered in a criminal case that was then pending against this
physician. All charges against the physician have been dismissed. Caremark has
moved for the dismissal of the South Dakota case or transfer of the case to
Minnesota. Management believes, based on information currently available, that
the ultimate resolution of this matter is not likely to have a material adverse
effect on the operating results and financial condition of MedPartners.
In December 1997, a class action was filed in the United States District
Court for the Central District of California. The action purports to be a class
action on behalf of all of the shareholders of Talbert which was acquired by
MedPartners in a cash tender offer transaction closed in September 1997 pursuant
to which each outstanding share of Talbert was acquired for $63 cash per share.
The action alleges that MedPartners violated Rule 14d-10 under the Securities
Exchange Act of 1934, the so-called "all holder, best price" rule, by reason of
provisions in the employment agreements of two senior officers of Talbert, which
provided for a certain contingent payment under certain circumstances. The
complaint requests a class certification and claims damages and interest. The
defendants have filed a Motion to Dismiss this action on a number of grounds,
asserting that the complaint fails to state a claim upon which relief can be
granted. Although management believes, based on information currently available,
that the ultimate resolution of this matter is not likely to have a material
adverse effect on the operating results and financial condition of MedPartners,
there can be no assurance that the ultimate resolution of the matter, if
adversely determined, would not have a material adverse effect on the operating
results and financial condition of MedPartners.
On January 7, 1998, MedPartners issued a press release announcing the
termination of its proposed merger with PhyCor, Inc. On that date, MedPartners
also issued another press release announcing certain fourth quarter 1997 charges
and negative earnings estimates, which have since been revised downward. On
59
62
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
January 8, 1998, there was a decline in the market prices for MedPartners'
publicly traded securities. Since then, certain persons claiming to be
stockholders of MedPartners have filed complaints in either state or federal
court against MedPartners and certain officers and directors of MedPartners. To
date, there are two state court actions and 14 federal court actions, all filed
in Birmingham, Alabama. In each of these lawsuits, the plaintiff purports to
represent a class and generally alleges violations of the Securities Exchange
Act of 1934, fraud and various state law claims in connection with the public
disclosure by MedPartners of the termination of the PhyCor merger and the fourth
quarter 1997 charges and earnings estimates. Four of the lawsuits, one filed in
the Circuit Court of Jefferson County, Alabama, and three filed in the United
States Federal Court for the Northern District of Alabama, were filed against
MedPartners and certain of its officers and directors, purportedly on behalf of
all persons who purchased MedPartners' Threshold Appreciation Price
Securities(TM) in the offering occurring on or about September 16, 1997. The
state complaint also asserts claims under Sections 11 and 15 of the Securities
Act of 1933, as well as Sections 8-6-17(a)(2) and 8-6-19 of the Alabama Code.
Collectively, these complaints seek class certification, damages and interest,
as well as costs and expenses. MedPartners' management believes that it and
MedPartners have acted properly throughout and intend to defend each of these
cases vigorously. All of these cases are in the preliminary stages, and their
ultimate resolution cannot be known at this time. Therefore, there can be no
assurance that the ultimate resolution of these matters will not have a material
adverse effect on the operating results and financial condition of MedPartners.
Beginning in September 1994, Caremark was named as a defendant in a series
of lawsuits added to a pending group of actions (including a class action)
brought in 1993 under the antitrust laws by local and chain retail pharmacies
against brand name pharmaceutical manufacturers, wholesalers and prescription
benefit managers other than Caremark. The lawsuits, filed in federal district
courts in at least 38 states (including the United States District Court for the
Northern District of Illinois), allege that at least 24 pharmaceutical
manufacturers provided unlawful price and service discounts to certain favored
buyers and conspired among themselves to deny similar discounts to the
complaining retail pharmacies (approximately 3,900 in number). The complaints
charge that certain defendant prescription benefit managers, including Caremark,
were favored buyers who knowingly induced or received discriminatory prices from
the manufacturers, in violation of the Robinson-Patman Act. Each complaint seeks
unspecified treble damages, declaratory and equitable relief, and attorneys'
fees and expenses. All of these actions have been transferred by the Judicial
Panel for Multidistrict Litigation to the United States District Court for the
Northern District of Illinois for coordinated pretrial procedures. Caremark was
not named in the class action. In April 1995, the Court entered a stay of
pretrial proceedings as to certain Robinson-Patman Act claims in this
litigation, including the Robinson-Patman Act claims brought against Caremark,
pending the conclusion of a first trial of certain of such claims brought by a
limited number of plaintiffs against five defendants not including Caremark. On
July 1, 1996, the district court directed entry of a partial final order in the
class action approving an amended settlement with certain of the pharmaceutical
manufacturers. The amended settlement provides for a cash payment by the
defendants in the class action (which does not include Caremark) of
approximately $351.0 million to class members in settlement of conspiracy claims
as well as a commitment from the settling manufacturers to abide by certain
injunctive provisions. All class action claims against non-settling
manufacturers as well as all opt out and other claims generally, including all
Robinson-Patman Act claims against Caremark, remain unaffected by the
settlement. The district court has scheduled a trial of the remaining class
action claims for the fall of 1998. It is expected that trials of the remaining
individual conspiracy claims will also precede the trial of any Robinson-Patman
Act claims. The Company intends to defend these cases vigorously. Although
management believes, based on information currently available, that the ultimate
resolution of this matter is not likely to have a material adverse effect on the
operating results and financial condition of the Company, there can be no
assurance that the ultimate resolution of this matter, if adversely determined,
would not have a material adverse effect on the operating results and financial
condition of the Company.
60
63
MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Although the Company cannot predict with certainty the outcome of
proceedings described above, based on information currently available,
management believes that the ultimate resolution of such proceedings,
individually and in the aggregate, is not likely to have a material adverse
effect on the Company.
The Company is party to various other commitments, claims and routine
litigation arising in the ordinary course of business. Management does not
believe that the result of such commitments, claims and litigation, individually
or in the aggregate, will have a material adverse effect on the Company's
business or its results of operations, cash flows or financial condition.
14. REQUIREMENTS OF REGULATORY AUTHORITIES
MedPartners Provider Network, Inc. ("MPN"), a wholly-owned subsidiary of
the Company, as a licensed Health Care Service Plan is required to comply with
the provisions of the Knox-Keene Act and the rules of the Department of
Corporations within the State of California. In accordance with the Knox-Keene
Act, MPN is required to maintain a minimum amount of depository cash and
tangible net equity. Tangible net equity is computed as the greater of: (i) one
million dollars; (ii) the sum of two percent of the first $150 million of
annualized premium revenues plus one percent of annualized premium revenues in
excess of $150 million; or (iii) an amount equal to four percent of annualized
hospital expenditures paid on a managed hospital payment basis. As of December
31, 1997, MPN was in compliance with all applicable requirements of the
Knox-Keene Act.
15. RESTRUCTURING AND IMPAIRMENT CHARGES
The Company recorded a pretax charge during the fourth quarter of 1997 of
$646.7 million related primarily to the restructuring and impairment of selected
assets of certain of its clinic operations within the PPM division. Of the total
charge, $39.2 million relates to cash charges including employee and physician
severance ($17.1 million), leases ($19.0 million) and other exits costs ($3.1
million), $552.4 million relates to the impairment of goodwill, primarily in the
Southern California and Southwestern markets, and $55.1 million relates to the
write down of various assets. The impairment of goodwill and write down of other
assets are non-cash charges.
The Company has closed or is in the process of closing or disassociating
with 84 clinics. The total number of physicians affected by the closings is 238,
leaving the Company with 13,531 affiliated physicians at December 31, 1997. Many
of the closed locations are the result of combinations of adjacent or nearby
clinic locations, primarily in the Southern California market. Others are the
result of agreements with a number of MedPartners' smaller affiliated groups,
primarily in Eastern United States markets, where the economics of going forward
under the existing practice management agreements were determined to be not in
the best interest of MedPartners or the affected groups. The total number of
employees included in the severance and restructuring approximates 800.
Significant adverse changes in the Company's business climate and
operations, primarily the substantial operating loss in the fourth quarter of
1997 in the Southern California and Southwestern markets, became apparent at the
end of 1997 and continued to be evidenced by factors subsequent to year end. The
substantial operating losses and other factors led to the conclusion that there
was a permanent impairment in the recorded value of goodwill. Accordingly, the
Company wrote off $552.4 million of goodwill during the fourth quarter of 1997,
primarily related to the Southern California and Southwestern markets.
Management estimated the impairment based on an analysis of discounted cash
flows and projected operating earnings.
16. CORPORATE LIABILITY AND INSURANCE
The Company maintains professional liability insurance, general liability
and other customary insurance on a claims-made and modified occurrence basis, in
amounts deemed appropriate by management based upon
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MEDPARTNERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
historical claims and the nature and risks of the business, for many of the
affiliated physicians, practices and operations. The Company has accrued for or
purchased "tail" coverage for claims against the Company's affiliated medical
organizations to cover incidents which were or are incurred but not reported
during the periods for which the related risk was covered by "claims made"
insurance. There can be no assurance that a future claim will not exceed the
limits of available insurance coverage or related accrual or that such coverage
will continue to be available.
Moreover, the Company requires each physician group with which it
affiliates to obtain and maintain professional liability insurance coverage.
Such insurance would provide coverage, subject to policy limits, in the event
the Company were held liable as a co-defendant in a lawsuit for professional
malpractice against a physician. In addition, generally, the Company is
indemnified under the practice management agreements by the affiliated physician
groups for liabilities resulting from the performance of medical services.
However, there can be no assurance that any future claim or claims will not
exceed the limits of these available insurance coverages or that indemnification
will be available for all such claims.
17. SUBSEQUENT EVENTS
On October 29, 1997, the Boards of Directors of the Company and PhyCor,
Inc. unanimously approved a definitive agreement under which PhyCor would
acquire the Company, with the Company's stockholders receiving 1.18 shares of
PhyCor common stock for each share of the Company's common stock. Extensive due
diligence was conducted on and by both companies, and after a lengthy review and
planning process, both boards determined that effective integration of the two
companies would have been extremely difficult due to significant operational and
strategic differences. The termination of the merger was approved by the Boards
of Directors of both companies on January 7, 1998.
On October 1, 1997, the Company announced that it entered into an agreement
to acquire America Service Group Inc. ("ASG") in a stock transaction valued at
approximately $59 million. On February 26, 1998, it was announced that the
merger agreement had been terminated by mutual consent of both parties and that
a release and settlement agreement had been executed. Due to the exchange of
confidential information, the settlement agreement contains customary
non-competition and non-solicitation provisions and provides that certain
expenses and costs be paid by the Company.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Company has not changed independent accountants within the twenty-four
months prior to December 31, 1997.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated herein by reference
to the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS.
1. Financial Statements.
The Consolidated Financial Statements of the Company and its subsidiaries
filed as a part of this Annual Report on Form 10-K are listed in Item 8 of the
Annual Report on Form 10-K, which listing is hereby incorporated herein by
reference.
2. Financial Statement Schedules.
All schedules for which provision is made in the applicable accounting
regulations of the Commission have been omitted because they are not required
under the related instructions, or are inapplicable, or because the information
has been provided in the consolidated financial statements or the Notes thereto.
3. Exhibits.
The Exhibits filed as a part of this Annual Report are listed in Item 14(c)
of this Annual Report on Form 10-K, which is hereby incorporated herein by
reference.
(B) REPORTS ON FORM 8-K.
The following reports on Form 8-K were filed during the fourth quarter of
1997:
(a) Current Report on Form 8-K (Item 5) filed November 3, 1997,
reporting the agreement with PhyCor, Inc. related to a proposed merger,
since terminated.
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(C) EXHIBITS
EXHIBIT
NO. DESCRIPTION
- ------- -----------
(3)-1 -- MedPartners, Inc. Third Restated Certificate of
Incorporation, filed as Exhibit (3)-1 to the Company's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1996, is hereby incorporated herein by
reference.
(3)-2 -- MedPartners, Inc. Second Amended and Restated Bylaws, filed
as Exhibit (3)-2 to the Company's Registration Statement on
Form S-1 (Registration No. 333-12465), is hereby
incorporated herein by reference.
(4)-1 -- MedPartners, Inc. Rights Plan, filed as Exhibit (4)-1 to the
Company's Registration Statement on Form S-4 (Registration
No. 33-00774), is hereby incorporated herein by reference.
(4)-2 -- Amendment No. 1 to the Rights Plan of MedPartners, Inc.,
filed as Exhibit (4)-2 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996, is
hereby incorporated herein by reference.
(4)-3 -- Amendment No. 2 to the Rights Plan of MedPartners, Inc.,
filed as Exhibit (4)-2 to the Company's Registration
Statement on Form S-3 (Registration No. 333-17339), is
hereby incorporated herein by reference.
(10)-1 -- Consulting Agreement, dated as of August 7, 1996, by and
among Caremark International Inc., MedPartners, Inc. and
C.A. Lance Piccolo, filed as Exhibit (10)-1 to the Company's
Registration Statement on Form S-4 (Registration No.
333-09767), is hereby incorporated herein by reference.
(10)-2 -- Consulting Agreement, dated as of November 29, 1995, by and
between MedPartners, Inc. and Walter T. Mullikin, M.D.,
filed as Exhibit (10)-1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-1130), is hereby
incorporated herein by reference.
(10)-3 -- Termination Agreement, dated as of November 29, 1995, by and
between MedPartners/Mullikin, Inc. and Walter T. Mullikin,
M.D., filed as Exhibit (10)-2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-1130), is hereby
incorporated herein by reference.
(10)-4 -- Consulting Agreement, dated as of November 29, 1995, by and
between MedPartners/Mullikin, Inc. and John S. McDonald,
filed as Exhibit (10)-3 to the Company's Registration
Statement on Form S-1 (Registration No. 333-1130), is hereby
incorporated herein by reference.
(10)-5 -- Termination Agreement, dated as of November 29, 1995, by and
between MedPartners/Mullikin, Inc. and John S. McDonald,
filed as Exhibit (10)-4 to the Company's Registration
Statement on Form S-1 (Registration No. 333-1130), is hereby
incorporated herein by reference.
(10)-6 -- Employment Agreement, dated July 24, 1996, by and between
MedPartners, Inc. and Larry R. House, filed as Exhibit
(10)-7 to the Company's Registration Statement on Form S-1
(Registration No. 333-12465), is hereby incorporated herein
by reference.
(10)-7 -- Employment Agreement, dated July 24, 1996, by and between
MedPartners, Inc. and Mark L. Wagar, filed as Exhibit (10)-8
to the Company's Registration Statement on Form S-1
(Registration No. 333-12465), is hereby incorporated herein
by reference.
(10)-8 -- Employment Agreement, dated July 24, 1996, by and between
MedPartners, Inc. and Harold O. Knight, Jr., filed as
Exhibit (10)-9 to the Company's Registration Statement on
Form S-1 (Registration No. 333-12465), is hereby
incorporated herein by reference.
(10)-9 -- Employment Agreement, dated July 24, 1996, by and between
MedPartners, Inc. and Tracy P. Thrasher, filed as Exhibit
(10)-10 to the Company's Registration Statement on Form S-1
(Registration No. 333-12465), is hereby incorporated herein
by reference.
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EXHIBIT
NO. DESCRIPTION
- ------- -----------
(10)-10 -- Credit Agreement, dated September 5, 1996, by and among
MedPartners, Inc., NationsBank, National Association
(South), as administrative agent for the Lenders, The First
National Bank of Chicago, as Documentation Agent for the
Lenders, and the Lenders thereto, filed as Exhibit (10)-17
to the Company's Registration Statement on Form S-1
(Registration No. 333-12465), is hereby incorporated herein
by reference.
(10)-11 -- Amendment No. 1 to Credit Agreement and Consent, dated
September 5, 1996, by and among MedPartners, Inc.,
NationsBank, National Association (South), as Administrative
agent for the Lenders, The First National Bank of Chicago,
as Documentation Agent for the Lenders, and the Lenders
thereto, filed as Exhibit (10)-18 to the Company's
Registration Statement on Form S-1 (Registration No.
333-12465), is hereby incorporated herein by reference.
(10)-12 -- Amendment No. 2 to Credit Agreement, dated July 22, 1997 by
and between MedPartners, Inc., NationsBank, National
Association (successor by merger of NationsBank, National
Association (South)), as Administrative Agent for Lenders,
The First National Bank of Chicago, as Documentation Agent
for Lenders, and the Lenders thereto filed as Exhibit (10)-1
to the Company's Quarterly Report on Form 10-Q for the
Quarter ended September 30, 1997, is hereby incorporated
herein by reference.
(10)-13 -- Amended and Restated MedPartners, Inc. Incentive
Compensation Plan.
(10)-14 -- MedPartners, Inc. 1994 Non-Employee Director Stock Option
Plan.
(10)-15 -- MedPartners, Inc. 1994 Stock Incentive Plan.
(10)-16 -- Amended and Restated MedPartners, Inc. 1993 Stock Option
Plan.
(10)-17 -- Amended and Restated MedPartners, Inc. 1995 Stock Option
Plan.
(10)-18 -- MedPartners, Inc. 1997 Long Term Incentive Compensation
Plan.
(10)-19 -- Consent to Waiver of Sections 8.1 and 8.4(h)(1) of Credit
Agreement dated March 27, 1998, by and between MedPartners,
Inc and NationsBank, National Association, as Administrative
Agent for the Lenders.
(21) -- Subsidiaries of MedPartners, Inc.
(23) -- Consent of Ernst & Young LLP.
(27) -- Financial Data Schedule.
(99)-1 -- Schedule of Class Action Lawsuits against the Company.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MEDPARTNERS, INC.
By /s/ HAROLD O. KNIGHT, JR.
------------------------------------
Harold O. Knight, Jr.
Executive Vice President
and Chief Financial Officer
Date: March 31, 1997
Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE
--------- -------- ----
/s/ RICHARD M. SCRUSHY Chairman of the Board March 31, 1998
- -----------------------------------------------------
Richard M. Scrushy
/s/ EDWIN M. CRAWFORD President, Chief Executive March 31, 1998
- ----------------------------------------------------- Officer and Director
Edwin M. Crawford
/s/ HAROLD O. KNIGHT, JR. Chief Financial Officer March 31, 1998
- -----------------------------------------------------
Harold O. Knight, Jr.
/s/ LARRY D. STRIPLIN, JR. Director March 31, 1998
- -----------------------------------------------------
Larry D. Striplin, Jr.
/s/ CHARLES W. NEWHALL III Director March 31, 1998
- -----------------------------------------------------
Charles W. Newhall III
/s/ TED H. MCCOURTNEY Director March 31, 1998
- -----------------------------------------------------
Ted H. McCourtney
/s/ WALTER T. MULLIKIN, M.D. Director March 31, 1998
- -----------------------------------------------------
Walter T. Mullikin, M.D.
/s/ JOHN S. MCDONALD, J.D. Director March 31, 1998
- -----------------------------------------------------
John S. McDonald, J.D.
/s/ MICHAEL D. MARTIN Director March 31, 1998
- -----------------------------------------------------
Michael D. Martin
/s/ ROSALIO J. LOPEZ, M.D. Director March 31, 1998
- -----------------------------------------------------
Rosalio J. Lopez, M.D.
/s/ C.A. LANCE PICCOLO Director March 31, 1998
- -----------------------------------------------------
C.A. Lance Piccolo
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SIGNATURE CAPACITY DATE
--------- -------- ----
/s/ ROGER L. HEADRICK Director March 31, 1998
- -----------------------------------------------------
Roger L. Headrick
/s/ HARRY M. JANSEN KRAEMER, JR. Director March 31, 1998
- -----------------------------------------------------
Harry M. Jansen Kraemer, Jr.
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