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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-6639
MAGELLAN HEALTH SERVICES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 58-1076937
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(State or other jurisdiction of (I.R.S. Employer
Identification
incorporation or organization) No.)
3414 PEACHTREE ROAD, N.E.
SUITE 1400
ATLANTA, GEORGIA 30326
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(Address of principal executive
offices) (Zip Code)
Registrant's telephone number, including area code: (404) 841-9200
See Table of Additional Registrants below.
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Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock ($0.25 par value) New York Stock Exchange
11 1/4% Series A Senior Subordinated Notes due 2004 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. / /
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at November 30, 1997 was approximately $600 million.
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes / / No / /
The number of shares of the Registrant's Common Stock outstanding as of
November 30, 1997 was 29,065,821.
DOCUMENTS INCORPORATED BY REFERENCE: None
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ADDITIONAL REGISTRANTS(1)
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Behavioral Heath Systems of Indiana,
Inc................................ Indiana 35-1990127 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Beltway Community Hospital, Inc...... Texas 58-1324281 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Blue Grass Physician Management
Group, Inc......................... Kentucky 66-1294402 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
C.A.C.O. Services, Inc............... Ohio 58-1751511 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
CCM, Inc............................. Nevada 58-1662418 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
CMCI, Inc............................ Nevada 88-0224620 1061 East Flamingo Road
Suite One
Las Vegas, NV 89119
(702) 737-0282
CMFC, Inc............................ Nevada 88-0215629 1061 East Flamingo Road
Suite One
Las Vegas, NV 89119
(702) 737-0282
CMSF, Inc............................ Florida 58-1324269 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
CPS Associates, Inc.................. Virginia 58-1761039 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
i
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Alvarado Behavioral Health
System, Inc........................ California 58-1394959 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Asheville Behavioral Health
System, Inc........................ North Carolina 58-2097827 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Arbor Indy Behavioral
Health System, LLC................. Delaware 58-2265776 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Augusta Behavioral Health
System, Inc........................ Georgia 58-1615676 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Bay Harbor Behavioral Health
System, Inc........................ Florida 58-1640244 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
The Charter Beacon Behavioral Health
System, LLC........................ Delaware 35-1994155 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Corporation....... Delaware 91-1819015 1061 E. Flamingo Road
Suite One
Las Vegas, NV 89119
(702) 737-0282
Charter Behavioral Health System at
Fair Oaks, Inc..................... New Jersey 58-2097832 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
ii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Behavioral Health System at
Hidden Brook, Inc.................. Maryland 52-1866212 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System at
Los Altos, Inc..................... California 33-0606642 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System at
Manatee Adolescent Treatment
Services, Inc...................... Florida 65-0519663 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System at
Potomac Ridge, Inc................. Maryland 52-1866221 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health Systems,
Inc................................ Delaware 58-2213642 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Athens, Inc........................ Georgia 58-1513304 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Austin, Inc........................ Texas 58-1440665 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Baywood, Inc....................... Texas 76-0430571 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
iii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Behavioral Health System of
Bradenton, Inc..................... Florida 58-1527678 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Central Georgia, Inc............... Georgia 58-1408670 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavorial Health System of
Central Virginia, Inc.............. Virginia 54-1765921 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Charleston, Inc.................... South Carolina 58-1761157 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Charlottesville, Inc............... Virginia 58-1616917 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Chicago, Inc....................... Illinois 58-1315760 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Chula Vista, Inc................... California 58-1473063 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Columbia, Inc...................... Missouri 61-1009977 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
iv
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Behavioral Health System of
Corpus Christi, Inc................ Texas 58-1513305 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Dallas, Inc........................ Texas 58-1513306 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Delmarva, Inc...................... Maryland 52-1866214 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Behavioral Health System
of Evansville, LLC................. Delaware 35-1994080 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Fort Worth, Inc.................... Texas 58-1643151 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Jackson, Inc....................... Mississippi 58-1616919 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Jacksonville, Inc.................. Florida 58-1483015 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Behavioral Health System
of Jefferson, LLC.................. Delaware 35-1994087 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
v
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Behavioral Health System of
Kansas City, Inc................... Kansas 58-1603154 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Lafayette, Inc..................... Louisiana 72-0686492 302 Dulles Drive
Lafayette, LA 70506
(318) 233-9024
Charter Behavioral Health System of
Lake Charles, Inc.................. Louisiana 62-1152811 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Maryland, Inc...................... Maryland 52-2026699 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Behavioral Health System
of Michigan City, LLC.............. Delaware 35-1994736 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Mississippi, Inc................... Mississippi 58-2138622 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Mobile, Inc........................ Alabama 58-1569921 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Nashua, Inc........................ New Hampshire 02-0470752 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
vi
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Behavioral Health System of
Nevada, Inc........................ Nevada 58-1321317 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
New Mexico, Inc.................... New Mexico 58-1479480 5901 Zuni Road, SE
Albuquerque, NM 87108
(505) 265-8800
Charter Behavioral Health System of
Northern California, Inc........... California 58-1857277 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Northwest Arkansas, Inc............ Arkansas 58-1449455 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Behavioral Health System
of Northwest Indiana, LLC.......... Delaware 35-1994154 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Paducah, Inc....................... Kentucky 61-1006115 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health of Puerto
Rico, Inc.......................... Georgia 66-0523678 Caso Bldg., Suite 1504
1225 Ponce de Leon Avenue
Santurce, PR 00907
Charter Behavioral Health System of
San Jose, Inc...................... California 58-1747020 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
vii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
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Charter Behavioral Health System of
Savannah, Inc...................... Georgia 58-1750583 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Texarkana, Inc..................... Arkansas 71-0752815 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
the Inland Empire, Inc............. California 95-2685883 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Toledo, Inc........................ Ohio 58-1731068 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Tucson, Inc........................ Arizona 86-0757462 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Visalia, Inc....................... California 33-0606644 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Waverly, Inc....................... Minnesota 41-1775626 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health System of
Winston-Salem, Inc................. North Carolina 56-1050502 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
viii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Behavioral Health System of
Yorba Linda, Inc................... California 33-0606646 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Behavioral Health Systems of
Atlanta, Inc....................... Georgia 58-1900736 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Talbott Behavioral Health
System, Inc........................ Georgia 58-0979827 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter By-The-Sea Behavioral Health
System, Inc........................ Georgia 58-1351301 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Call Center, Inc............. Georgia 58-2318455 2151 Peachford Road
Atlanta, GA 30338
Charter Call Center of Texas, Inc.... Texas 75-2709908 920 South Main Street
Suite 250
Grapevine, TX 76051
Charter Canyon Behavioral Health
System, Inc........................ Utah 58-1557925 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Canyon Springs Behavioral
Health System, Inc................. California 33-0606640 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Centennial Peaks Behavioral
Health System, Inc................. Colorado 58-1761037 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
ix
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Community Hospital, Inc...... California 58-1398708 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Contract Services, Inc....... Georgia 58-2100699 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Cove Forge Behavioral Health
System, Inc........................ Pennsylvania 25-1730464 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Fairmount Behavioral Health
System, Inc........................ Pennsylvania 58-1616921 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Fenwick Hall Behavioral
Health System, Inc................. South Carolina 57-0995766 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Financial Offices, Inc....... Georgia 58-1527680 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Forest Behavioral Health
System, Inc........................ Louisiana 58-1508454 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Advantage, LLC............... Delaware 58-2292977 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Grapevine Behavioral Health
System, Inc........................ Texas 58-1818492 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
x
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Greensboro Behavioral Health
System, Inc........................ North Carolina 58-1335184 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Health Management of Texas,
Inc................................ Texas 58-2025056 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of Columbus, Inc.... Ohio 58-1598899 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of Denver, Inc...... Colorado 58-1662413 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of Ft. Collins,
Inc................................ Colorado 58-1768534 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of Laredo, Inc. Texas 58-1491620 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
xi
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Hospital of
Miami, Inc......................... Florida 61-1061599 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of
Mobile, Inc........................ Alabama 58-1318870 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of Santa Teresa,
Inc................................ New Mexico 58-1584861 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of St. Louis,
Inc................................ Missouri 58-1583760 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Hospital of Torrance, Inc.... California 58-1402481 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Indiana BHS Holding, Inc..... Indiana 58-2247985 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Indianapolis Behavioral
Health
System, LLC........................ Delaware 35-1994923 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter Lafayette Behavioral
Health System, LLC................. Delaware 35-1994151 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
xii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Lakehurst Behavioral Health
System, Inc........................ New Jersey 22-3286879 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Lakeside Behavioral Health
Network, Inc....................... Tennessee Applied for 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Lakeside Behavioral Health
System, Inc........................ Tennessee 62-0892645 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Laurel Heights Behavioral
Health
System, Inc........................ Georgia 58-1558212 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Linden Oaks Behavioral Health
System, Inc........................ Illinois 36-3943776 852 West Street
Naperville, IL 60540
(708) 305-5500
Charter Little Rock Behavioral Health
System, Inc........................ Arkansas 58-1747019 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Louisiana Behavioral Health
System, Inc........................ Louisiana 72-1319231 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Louisville Behavioral Health
System, Inc........................ Kentucky 58-1517503 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
xiii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Managed Care Services, LLC... Georgia 58-2324879 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Meadows Behavioral Health
System, Inc........................ Maryland 52-1866216 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical--California,
Inc................................ Georgia 58-1357345 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical--Clayton County,
Inc................................ Georgia 58-1579404 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical--Cleveland,
Inc................................ Texas 58-1448733 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical--Long Beach, Inc..... California 58-1366604 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical--New York,
Inc................................ New York 58-1761153 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical (Cayman Islands) Cayman Islands, 58-1841857 Caledonian Bank & Trust
Ltd................................ BWI Swiss Bank Building
Caledonian House
Georgetown-Grand Cayman
Cayman Islands
(809) 949-0050
xiv
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Medical Information Services,
Inc................................ Georgia 58-1530236 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical International, Cayman Islands, N/A Caledonian Bank & Trust
Inc................................ BWI Swiss Bank Building
Caledonian House
Georgetown-Grand Cayman
Cayman Islands
(809) 949-0050
Charter Medical International, S.A.,
Inc................................ Nevada 58-1605110 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Managed Care Sales and
Services, Inc...................... Georgia 58-1195352 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical of East Valley,
Inc................................ Arizona 58-1643158 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical of England Limited... United Kingdom N/A 111 Kings Road
Box 323
London SW3 4PB
London, England
44-71-351-1272
Charter Medical of North Phoenix,
Inc................................ Arizona 58-1643154 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Medical of Puerto Rico, Commonwealth of 58-1208667 Caso Building, Suite 1504
Inc................................ Puerto Rico 1225 Ponce De Leon Avenue
Santurce, P.R. 00907
(809) 723-8666
xv
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Milwaukee Behavioral Health
System, Inc........................ Wisconsin 58-1790135 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Mission Viejo Behavioral
Health System, Inc................. California 58-1761156 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter MOB of Charlottesville,
Inc................................ Virginia 58-1761158 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter North Behavioral Health
System, Inc........................ Alaska 58-1474550 2530 DeBarr Road
Anchorage, AK 99508-2996
(907) 258-7575
Charter Northbrooke Behavioral Health
System, Inc........................ Wisconsin 39-1784461 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter North Counseling Center,
Inc................................ Alaska 58-2067832 2530 DeBarr Road
Anchorage, AK 99508-2996
(907) 258-7575
Charter Northridge Behavioral Health
System, Inc........................ North Carolina 58-1463919 400 Newton Road
Raleigh, NC 27615
(919) 847-0008
Charter Oak Behavioral Health System,
Inc................................ California 58-1334120 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter of Alabama, Inc.............. Alabama 63-0649546 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
xvi
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Palms Behavioral Health
System, Inc........................ Texas 58-1416537 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Peachford Behavioral Health
System, Inc........................ Georgia 58-1086165 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Pines Behavioral Health
System, Inc........................ North Carolina 58-1462214 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Plains Behavioral Health
System, Inc........................ Texas 58-1462211 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter-Provo School, Inc............ Utah 58-1647690 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Real Behavioral Health
System, Inc........................ Texas 58-1485897 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Ridge Behavioral Health
System, Inc........................ Kentucky 58-1393063 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Rivers Behavioral Health
System, Inc........................ South Carolina 58-1408623 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
xvii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Charter Rockford Behavioral Health
System, Inc........................ Delaware 51-0374617 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter San Diego Behavioral Health
System, Inc........................ California 58-1669160 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Charter Sioux Falls Behavioral Health
System, Inc........................ South Dakota 58-1674278 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
The Charter South Bend Behavioral
Health System,
LLC................................ Delaware 35-1994307 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Springs Behavioral Health
System, Inc........................ Florida 58-1517461 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Springwood Behavioral Health
System, Inc........................ Virginia 58-2097829 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Suburban Hospital of
Mesquite, Inc...................... Texas 75-1161721 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter System, LLC.................. Nevada 91-1819015 1061 E. Flamingo Road
Suite One
Las Vegas, NV 89119
(702) 737-0282
xviii
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
The Charter Terre Haute Behavioral
Health System,
LLC................................ Delaware 35-1994308 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Thousand Oaks Behavioral
Health System,
Inc................................ California 58-1731069 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Westbrook Behavioral Health
System, Inc........................ Virginia 54-0858777 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter White Oak Behavioral Health
System, Inc........................ Maryland 52-1866223 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Wichita Behavioral Health
System, Inc........................ Kansas 58-1634296 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Charter Woods Behavioral Health
System, Inc........................ Alabama 58-1330526 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Correctional Behavioral Solutions,
Inc................................ Delaware 58-2180940 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Correctional Behavioral Solutions of
Indiana, Inc....................... Indiana 35-1978792 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
xix
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Correctional Behavioral Solutions of
New Jersey, Inc.................... New Jersey 22-3436964 3000 Atrium Way
Suite 410
Mount Laurel, NJ
(609) 235-2339
Correctional Behavioral Solutions of
Ohio, Inc.......................... Ohio 34-1826431 Allen Correctional Institute
2338 North West Street
Lima, OH 45801
(419) 224-8000
Desert Springs Hospital, Inc......... Nevada 88-0117696 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, Georgia 30326
(404) 841-9200
Employee Assistance Services, Inc.... Georgia 58-1501282 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Florida Health Facilities, Inc....... Florida 58-1860493 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Gulf Coast EAP Services, Inc......... Alabama 58-2101394 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Hospital Investors, Inc.............. Georgia 58-1182191 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Illinois Mentor, Inc................. Illinois 36-3643670 313 Congress St.
Boston, MA 02210
(617) 790-4800
Magellan Executive
Corporation........................ Georgia 58-2310891 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Magellan Public Solutions, Inc....... Delaware 58-2227841 222 Berkley Street
Boston, MA 02117
(617) 437-6400
xx
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
Mandarin Meadows, Inc................ Florida 58-1761155 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Magellan Public Network, Inc......... Delaware 51-0374654 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Magellan Public Solutions of Ohio,
Inc................................ Ohio Applied for 222 Berkley Street
Boston, MA 02117
(617) 437-6400
Massachusetts Mentor, Inc............ Massachusetts 04-2799071 313 Congress St.
Boston, MA 02210
(617) 790-4800
Metroplex Behavioral Healthcare
Services, Inc...................... Texas 58-2138596 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
National Mentor, Inc................. Delaware 04-3250732 313 Congress St.
Boston, MA 02210
(617) 790-4800
National Mentor Healthcare,
Inc................................ Massachusetts 04-2893910 313 Congress St.
Boston, MA 02210
(617) 790-4800
NEPA--Massachusetts, Inc............. Massachusetts 58-2116751 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
NEPA--New Hampshire, Inc............. New Hampshire 58-2116398 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Ohio Mentor, Inc..................... Ohio 31-1098345 313 Congress St.
Boston, MA 02210
(617) 790-4800
Pacific-Charter Medical, Inc......... California 58-1336537 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
xxi
ADDRESS INCLUDING ZIP CODE,
STATE OR OTHER I.R.S. AND TELEPHONE NUMBER
JURISDICTION OF EMPLOYER INCLUDING AREA CODE,
EXACT NAME OF REGISTRANT INCORPORATION IDENTIFICATION OF REGISTRANT'S PRINCIPAL
AS SPECIFIED IN ITS CHARTER OR ORGANIZATION NUMBER EXECUTIVE OFFICES
- ------------------------------------- ------------------ -------------- -------------------------------------
South Carolina Mentor, Inc........... South Carolina 57-0782160 313 Congress St.
Boston, MA 02210
(617) 790-4800
Southeast Behavioral Systems, Inc.... Georgia 58-2100700 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Schizophrenia Treatment and
Rehabilitation, Inc................ Georgia 58-1672912 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Sistemas De Terapia Respiratoria,
S.A., Inc.......................... Georgia 58-1181077 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Western Behavioral
Systems, Inc....................... California 58-1662416 3414 Peachtree Rd., N.E.
Suite 1400
Atlanta, GA 30326
(404) 841-9200
Wisconsin Mentor, Inc................ Wisconsin 39-1840054 313 Congress St.
Boston, MA 00210
(617) 790-4800
- ------------------------
(1) The Additional Registrants listed are wholly-owned subsidiaries of the
Registrant and are guarantors of the Registrant's 11 1/4% Series A Senior
Subordinated Notes due 2004. The Additional Registrants have been
conditionally exempted, pursuant to Section 12(h) of the Securities Exchange
Act of 1934, from filing reports under Section 13 of the Securities Exchange
Act of 1934.
xxii
MAGELLAN HEALTH SERVICES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
PART I PAGE
-----
ITEM 1. Business.................................................................... 2
ITEM 2. Properties.................................................................. 40
ITEM 3. Legal Proceedings........................................................... 41
ITEM 4. Submission of Matters to a Vote of Security Holders......................... 41
PART II
ITEM 5. Market Price for Registrant's Common Equity and Related Stockholder
Matters..................................................................... 42
ITEM 6. Selected Financial Data..................................................... 42
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................. 44
ITEM 8. Financial Statements and Supplementary Data................................. 53
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................. 53
PART III
ITEM 10. Directors and Executive Officers of the Registrant.......................... 54
ITEM 11. Executive Compensation...................................................... 54
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.............. 54
ITEM 13. Certain Relationships and Related Transactions.............................. 54
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 55
PART I
ITEM 1. BUSINESS
Magellan Health Services, Inc. (the "Company"), which was incorporated in
1969 under the laws of the State of Delaware, is an international behavioral
healthcare company. The Company operates through four principal segments
engaging in (i) the managed care business, (ii) the public sector business,
(iii) the healthcare franchising business and (iv) the provider business. The
Company's executive offices are located at Suite 1400, 3414 Peachtree Road,
N.E., Atlanta, Georgia 30326, and its telephone number at that location is (404)
841-9200.
RECENT DEVELOPMENTS
ALLIED HEALTH GROUP, INC. ACQUISITION.
On December 5, 1997, the Company purchased the assets of Allied Health
Group, Inc. and certain affiliates ("Allied"). Allied provides specialty
risk-based products and administrative services to a variety of insurance
companies and other customers, including CIGNA, Blue Cross of New Jersey and
NYLCare, for approximately 25 million equivalent covered lives, determined by
multiplying Allied's 3.4 million members by the number of Allied's specialty
products covering each member. Allied manages over 80 physician networks across
the eastern United States. Allied's networks include physicians specializing in
cardiology, oncology and diabetes. The Company paid $70 million in cash for
Allied, of which $50 million was paid to the sellers at closing with the
remaining $20 million placed in escrow. The escrowed amount is payable if Allied
achieves specified earnings targets during the three years following the
closing. Additionally, the purchase price may be increased during the three year
period by $40 million, if Allied's performance exceeds specified earnings
targets. The maximum purchase price payable is $110 million. See "Item 7.--
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Pro Forma Liquidity and Capital Resources."
HUMAN AFFAIRS INTERNATIONAL, INC. ACQUISITION.
On December 4, 1997, the Company consummated the purchase of Human Affairs
International, Incorporated ("HAI"), formerly a unit of Aetna/U.S. Healthcare
("Aetna"), for approximately $122.1 million, which the Company funded from cash
on hand. HAI manages the care of over 15 million covered lives through employee
assistance programs ("EAPs") and other managed behavioral healthcare plans. The
Company may be required to make additional annual contingent payments of up to
$60 million annually to Aetna over the five-year period subsequent to closing.
The amount and timing of the payments will be contingent upon net increases in
the number of HAI's covered lives in specified products. See "Item
7.--Management's Discussion and Analysis of Financial Condition and Results of
Operations--Pro Forma Liquidity and Capital Resources."
HISTORY
During the late 1980's and the early to mid 1990's, the healthcare provider
business began a rapid consolidation. The consolidation of the healthcare
provider business was necessitated by the need of hospitals to reduce costs
through economies of scale as a result of pressure on reimbursement rates and
average length of hospital stay by third-party payors. At the time, the Company
had a presence in both the psychiatric hospital industry and the general
hospital industry.
In fiscal 1993, the Company decided to focus solely on the psychiatric
hospital industry and to attempt to acquire additional behavioral healthcare
businesses. Accordingly, the Company sold its general hospitals and related
assets in fiscal 1993 for $338 million with the net proceeds used to reduce
long-term debt. In 1994, the Company acquired 40 psychiatric hospitals
("Acquired Hospitals") for approximately $171 million. The purchase of the
Acquired Hospitals included the refinancing of most of the Company's then
2
outstanding long-term debt, including the issuance of $375 million of 11 1/4%
Series A Senior Subordinated Notes, which mature on April 15, 2004 (the
"Magellan Outstanding Notes").
The Company has historically derived the majority of its revenue and
earnings from providing healthcare services in an inpatient setting. Payments
from third-party payors are the principal source of revenue for most healthcare
providers. In the early 1990's, many third-party payors sought to control the
cost of providing care to their patients by instituting managed care programs or
seeking the assistance of managed care companies. Providers participating in
managed care programs agree to provide services to patients for a discount from
established rates, which generally results in pricing concessions by the
providers and lower margins. Additionally, managed care programs generally
encourage alternatives to inpatient treatment settings and reduce utilization of
inpatient services. Third-party payors established managed care programs or
engaged managed care companies in many areas of healthcare, including behavioral
healthcare. The Company, which, until June 1997, was the largest operator of
psychiatric hospitals in the United States, was adversely affected by the
adoption of managed care programs as the principal cost control measure of the
third party payors.
Prior to the first quarter of fiscal 1996, the Company was not a provider of
behavioral managed care services. During the first quarter of fiscal 1996, the
Company acquired a 61% ownership interest in Green Spring Health Services, Inc.,
a managed care company specializing in mental health and substance abuse/
dependence services ("Green Spring"). At that time, the Company intended to
become a fully integrated behavioral healthcare provider by combining the
managed behavioral healthcare products offered by Green Spring with the direct
treatment services offered by the Company's psychiatric hospitals. The Company
believed that an entity that participated in both the managed care and provider
segments of the behavioral healthcare industry could more efficiently provide
and manage behavioral healthcare for insured populations than an entity that was
solely a managed care company. The Company also believed that earnings from its
managed care business would offset, in part, the negative impact on the
financial performance of its psychiatric hospitals caused by managed care. Green
Spring was the Company's first significant involvement in managed behavioral
healthcare.
Subsequent to the Company's acquisition of Green Spring, the growth of the
managed behavioral healthcare industry accelerated. Under the Company's majority
ownership, Green Spring increased its base of covered lives from 12.0 million as
of the end of calendar year 1995 to 16.6 million as of the end of fiscal 1997, a
compound annual growth rate of over 17%. Over the same period, Green Spring's
revenue increased from $205 million in fiscal 1995 to $364 million in fiscal
1997, a compound annual growth rate of over 33%. While growth in the industry
was accelerating, the managed behavioral healthcare industry also began to
consolidate. The Company concluded that consolidation presented an opportunity
for the Company to increase its participation in the managed behavioral
healthcare industry, which the Company believed offered growth and earnings
prospects superior to those of the psychiatric hospital industry. Therefore, the
Company decided to sell its domestic psychiatric facilities to obtain capital
for expansion in the managed behavioral healthcare business.
The Company took a significant step toward implementing this strategy during
the third quarter of fiscal 1997, when it sold substantially all of its domestic
acute-care psychiatric hospitals and residential treatment facilities
(collectively, the "Psychiatric Hospital Facilities") to Crescent Real Estate
Equities Limited Partnership ("Crescent") for $417.2 million in cash (before
costs of approximately $16.0 million) and certain other consideration.
Simultaneously with the sale of the Psychiatric Hospital Facilities, the Company
and Cresent Operating, Inc., an affiliate of Cresent ("COI"), formed Charter
Behavioral Health Systems, LLC ("CBHS") to conduct the operations of the
Psychiatric Hospital Facilities and certain other facilities transfered to CBHS
by the Company. The Company retained a 50% ownership of CBHS; the other 50% of
the equity of CBHS is owned by COI.
In related transactions, (i) Crescent leased the Psychiatric Hospital
Facilities to CBHS and (ii) the Company entered into a master franchise
agreement (the "Master Franchise Agreement") with CBHS and a franchise agreement
with each of the Psychiatric Hospital Facilities and other facilities operated
by
3
CBHS (collectively, the "Franchise Agreements"). The Company's sale of the
Psychiatric Hospital Facilities and the related transactions described above are
referred to as the "Crescent Transactions." Pursuant to the Franchise
Agreements, the Company franchises the "CHARTER" System of behavioral healthcare
to each of the Psychiatric Hospital Facilities and the other facilities operated
by CBHS. In exchange, CBHS agreed to pay the Company, pursuant to the Master
Franchise Agreement, annual franchise fees (the "Franchise Fees") of
approximately $78.3 million. However, CBHS's obligation to pay the Franchise
Fees is subordinate to its obligation to pay rent for the Psychiatric Hospital
Facilities to Crescent.
The sale of the Psychiatric Hospital Facilities provided the Company with
approximately $200 million of net cash proceeds, after debt repayment, for use
in implementing its business strategy. The Company used the proceeds to finance
the acquisitions of HAI and Allied in December 1997. The Company continues to
pursue a strategy of expanding its managed care operations and of reducing its
dependence on the psychiatric hospital business for its earnings. The Company
intends to further implement its business strategy through the announced
acquisition (the "Acquisition") of Merit Behavioral Care Corporation ("Merit").
See "--The Transactions."
THE TRANSACTIONS
GENERAL.
In connection with the Acquisition, the Company will consummate certain
related transactions (together with the Acquisition, collectively, the
"Transactions"), as follows: (i) the repayment of all amounts outstanding
pursuant to, and the termination of, the Existing Credit Agreements (as
defined); (ii) the consummation of the Debt Tender Offers (as defined); (iii)
the execution and delivery of the New Credit Agreement (as defined); and (v) the
issuance of the Notes (as defined). The Transactions are described in more
detail below. All of the Transactions must be consummated for the Company to
consummate the Acquisition.
THE ACQUISITION.
On October 24, 1997, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with respect to the acquisition of Merit. Under
the Merger Agreement, Merit will become a wholly-owned subsidiary of the Company
and the Company will pay an amount of cash equal to approximately $458.3
million, subject to an adjustment based on the fees and expenses incurred by
Merit in connection with the transactions contemplated by the Merger Agreement
at the closing (the "Direct Cash Merger Consideration"). The Company is also
obligated, pursuant to the Merger Agreement, to cause Merit to repay all amounts
outstanding under the Merit Existing Credit Agreement (as defined) and to
perform Merit's obligations under the indenture governing the Merit Outstanding
Notes (as defined) and to purchase the Merit Outstanding Notes following the
consummation of the Acquisition. The Company is further obligated by the Merger
Agreement to provide sufficient funds to Merit to permit it to take such
actions. The Company estimates that the total consideration it will pay to
acquire Merit will be approximately $750 million, excluding transaction costs.
Pursuant to the Merger Agreement, Merit made representations and warranties
customary for transactions of this type. None of Merit's representations and
warranties and agreements survive the consummation of the Transactions.
Therefore, if any of the representations and warranties prove to be inaccurate,
the Company will not be able to recover from Merit's former owners the amount of
any damage resulting from the inaccuracy.
Merit is one of the leading managed behavioral healthcare providers in the
nation, arranging for the provision of managed behavioral healthcare services to
more than 21 million people. Merit manages behavioral healthcare programs for
approximately 800 clients across all segments of the healthcare industry, with
particularly strong positions in the corporate and HMO segment. Merit is also a
leading
4
provider to Blue Cross/Blue Shield organizations and other insurance companies,
labor unions, federal, state and local governmental agencies and various state
Medicaid programs.
TERMINATION OF EXISTING CREDIT AGREEMENTS.
It is a condition to the Company's lenders' obligation to advance loans
pursuant to the New Credit Agreement (as defined) that the Magellan Existing
Credit Agreement (as defined) be terminated. Furthermore, Magellan has agreed,
in connection with the Acquisition, to repay all amounts outstanding pursuant to
the Merit Existing Credit Agreement (as defined). Such transactions will be
consummated simultaneously with the Offering (as defined).
The Magellan Existing Credit Agreement is that certain Amended and Restated
Credit Agreement, dated as of June 16, 1997, among the Company, Charter
Behavioral Health System of New Mexico, Inc., the lenders named therein, Chase
Manhattan Bank, N.A. as administrative agent, and First Union National Bank, as
syndication agent. Simultaneously with the consummation of the Offering, the
Magellan Existing Credit Agreement will be terminated. The Magellan Existing
Credit Agreement provides for a five-year senior secured revolving credit
facility in an aggregate committed amount of $200 million and also provides for
the support of letters of credit for general corporate purposes. At November 30,
1997, there were no loans outstanding under the Magellan Existing Credit
Agreement other than one letter of credit issued in the amount of approximately
$6.6 million. Any loans outstanding under the Magellan Existing Credit Agreement
bear interest (subject to certain potential adjustments) at a rate per annum
equal to one, two, three or six-month LIBOR plus 1.25% or the Alternate Base
Rate ("ABR"), as defined, plus 0.25%.
The Merit Existing Credit Agreement is that certain Credit Agreement, dated
as of October 6, 1995, among Merit and the lenders named therein. Simultaneously
with the consummation of the Transactions, the Merit Existing Credit Agreement
will be terminated.
DEBT TENDER OFFERS.
The Company agreed, in connection with the Acquisition, to pay on behalf of
Merit an amount sufficient to permit Merit to repurchase its $100 million,
11 1/2% Senior Subordinated Notes due 2005 (the "Merit Outstanding Notes".)
Furthermore, borrowings pursuant to the New Credit Agreement (as defined) and
the Notes (as defined) required to effect the Transactions would result in
events of default with respect to the Merit Outstanding Notes and the Magellan
Outstanding Notes ( the Merit Outstanding Notes and the Magellan Outstanding
Notes are hereinafter referred to, collectively, as the "Oustanding Notes").
Accordingly, the Company and Merit will commence tender offers for the
Outstanding Notes. Each tender offer will be conditioned upon, among other
things, (i) the receipt by the Company or Merit, as the case may be, of a
majority of the Merit Outstanding Notes and 66 2/3% of the Magellan Outstanding
Notes; (ii) the receipt by the Company or Merit, as the case may be, of valid
consents to certain amendments to the indentures for the Outstanding Notes from
the holders of two-thirds of the Magellan Outstanding Notes and of a majority of
the Merit Outstanding Notes; (iii) the consummation of the Offering (as
defined), the receipt of advances pursuant to the New Credit Agreement (as
defined) or the receipt of proceeds from borrowings pursuant to such other
arrangements as the Company determines are appropriate in an aggregate amount
that is sufficient to consummate the Debt Tender Offers; and (iv) the
consummation of the Acquisition. Any Outstanding Notes that are not tendered
will remain outstanding and will be general unsecured obligations of the Company
or Merit, as the case may be.
THE OFFERING.
The Company intends to issue $400 million of Senior Subordinated Notes due
2008 (the "Notes") in connection with the Transactions. The interest rate on the
Notes will depend on market conditions upon consummation of the Offering. The
Offering is conditioned upon consummation of the Transactions.
5
THE NEW CREDIT AGREEMENT.
The Company has obtained a commitment from a lender pursuant to which said
lender has agreed, subject to the satisfaction of certain conditions, to make
available to the Company credit facilities of $900 million (the "New Credit
Agreement"). Execution and delivery of the New Credit Agreement and satisfaction
of the conditions to an advance under the New Credit Agreement are conditions to
the consummation of the Offering.
The following table sets forth the sources and uses of funds for the
Transactions, as if they had been completed on September 30, 1997, and assuming
that all Outstanding Notes are purchased pursuant to the Debt Tender Offers.
SEPTEMBER 30, 1997
---------------------
(DOLLARS IN MILLIONS)
SOURCES:
Cash and cash equivalents.............................................. $ 137.6
New Credit Agreement
Revolving Credit Facility(1)......................................... 12.8
Term Loans........................................................... 750.0
The Notes.............................................................. 400.0
--------
Total Sources...................................................... $ 1,300.4
--------
--------
USES:
Direct Cash Merger Consideration, net(2)............................... $ 458.3
Repayment of Merit Existing Credit Agreement........................... 229.5
Purchase of Magellan Outstanding Notes................................. 375.0
Purchase of Merit Outstanding Notes.................................... 100.0
Transaction costs(3)................................................... 137.6
--------
Total Uses......................................................... $ 1,300.4
--------
--------
- ------------------------
(1) The Revolving Credit Facility under the New Credit Agreement will provide
for borrowings of up to $150 million.
(2) The amount shown is net of the aggregate exercise price of certain options
to purchase shares of Merit common stock.
(3) Transaction costs include, among other things, tender and consent expenses
associated with the Debt Tender Offers and the Offering, accrued interest on
the Outstanding Notes and costs associated with the Acquisition and the New
Credit Agreement.
INDUSTRY
OVERVIEW.
Behavioral healthcare costs have increased significantly in the United
States in recent years. According to industry sources, direct medical costs of
behavioral health problems, combined with the indirect costs, such as lost
productivity due to mental illness and alcohol and drug abuse, were estimated at
more than $300 billion in 1990, the latest year for which statistics are
available. In addition, according to industry sources, in 1994, direct
behavioral healthcare services treatment costs amounted to approximately $81
billion, or 8% of total healthcare industry spending. These direct costs have
grown, in part, as society has begun to recognize and address behavioral health
concerns and employers have realized that rehabilitation of employees suffering
from substance abuse and relatively mild mental health problems can reduce
losses due to absenteeism and decreased productivity.
In response to these escalating costs, managed behavioral healthcare
companies such as Green Spring, HAI and Merit have been formed. These companies
focus on care management techniques with the goal of arranging for the provision
of an appropriate level of care in a cost-efficient and effective manner by
improving early access to care and assuring an effective match between the
patient and the behavioral healthcare provider's specialty. As the growth of
managed behavioral healthcare has increased, there has
6
been a significant decrease in occupancy rates and average lengths of stay for
inpatient psychiatric facilities and an increase in outpatient treatment and
alternative care services.
According to "Managed Behavioral Health Market Share in the United States
1997-1998," published by OPEN MINDS ("Open Minds"), as of January 1997,
approximately 149.0 million beneficiaries were covered by some form of managed
behavioral healthcare plan and an additional 19.5 million beneficiaries were
enrolled in internally-managed behavioral healthcare programs within health
maintenance organizations ("HMOs"). The number of covered beneficiaries has
grown from approximately 86.0 million beneficiaries in 1993 to approximately
149.0 million in 1997, representing an approximate 14% compound annual growth
rate since 1993. In addition, according to OPEN MINDS, beneficiaries covered
under risk-based programs are growing even more rapidly, from approximately 13.6
million as of January 1993 to approximately 38.9 million as of January 1997,
representing a compound annual growth rate of over 30%. OPEN MINDS estimates
that the revenues of managed behavioral healthcare companies totaled
approximately $3.5 billion in 1996.
SEGMENTATION.
OPEN MINDS divides the managed behavioral healthcare industry as of January
1997 into the following categories of care, based on services provided, extent
of care management and level of risk assumption:
BENEFICIARIES PERCENT
CATEGORY OF CARE (IN MILLIONS) OF TOTAL
- ------------------------------------------------------------------------------------------ ------------- -----------
Utilization Review/Care Management Programs............................................... 39.2 26.3%
Risk-Based Network Products............................................................... 38.9 26.1
Non-Risk-Based Network Products........................................................... 31.9 21.4
Employee Assistance Programs ("EAPs")..................................................... 28.3 19.0
Integrated Programs....................................................................... 10.7 7.2
----- -----
Total............................................................................. 149.0 100.0%
----- -----
----- -----
Management believes the current trends in the behavioral healthcare industry
include increased utilization of risk-based network managed care products and
the integration of EAPs with such managed care products. Management believes
that these trends have developed in response to the attempt by payors to reduce
rapidly escalating behavioral healthcare costs and to limit their risk
associated with such costs while continuing to provide access to high quality
care. According to OPEN MINDS, risk-based network products, integrated programs
and EAPs are the most rapidly growing segments of the managed behavioral
healthcare industry.
UTILIZATION REVIEW/CARE MANAGEMENT PRODUCTS. Under utilization review/care
management products, a managed behavioral healthcare company manages and often
arranges for treatment, but does not maintain a network of providers or assume
any of the responsibility for the cost of providing treatment services. The
Company categorizes its products within this segment of the managed behavioral
healthcare industry (as it is defined by OPEN MINDS) as Administrative Service
Only ("ASO") products. The Company does not expect this segment of the industry
to experience significant growth, given the growth of risk-based products.
NON-RISK-BASED NETWORK PRODUCTS. Under non-risk-based network products, the
managed behavioral healthcare company provides a full array of managed care
services, including selecting, credentialing and managing a network of providers
(such as psychiatrists, psychologists, social workers and hospitals), and
performs utilization review, claims administration and care management
functions. The third-party payor remains responsible for the cost of providing
the treatment services rendered. The Company categorizes its products within
this segment of the managed behavioral healthcare industry (as it is defined by
OPEN MINDS) as ASO products.
RISK-BASED NETWORK PRODUCTS. Under risk-based network products, the managed
behavioral healthcare company assumes all or a portion of the responsibility for
the cost of providing a full or specified
7
range of behavioral healthcare treatment services. Most of these programs have
payment arrangements in which the managed care company agrees to provide
services in exchange for a fixed fee per member per month that varies depending
on the profile of the beneficiary population or otherwise shares the
responsibility for providing all or some portion of the treatment services at a
specific cost per person. Under these products, the managed behavioral
healthcare company not only approves and monitors a course of treatment, but
also arranges and pays for the provision of patient care (either through its
third-party network providers or staff providers or some combination of network
and staff providers). Therefore, the managed behavioral healthcare company must
be proficient in contracting with, credentialing and managing a network of
specialized providers and facilities that covers the complete continuum of care.
The managed behavioral healthcare company must also ensure that the appropriate
level of care is delivered in the appropriate setting. Given the ability of
payors of behavioral healthcare benefits to reduce their risk with respect to
the cost of treatment services through risk-based network products while
continuing to provide access to high quality care, this market segment has grown
rapidly in recent years. In addition to the expected growth in total
beneficiaries covered under managed behavioral healthcare products, this shift
of beneficiaries into risk-based network products should further contribute to
revenue growth for the managed behavioral healthcare industry because such
contracts generate significantly higher revenue than ASO contracts. The higher
revenue is intended to compensate the managed behavioral healthcare company for
bearing the financial responsibility for the cost of delivering care. The
Company's risk based products are risk-based network products as defined by OPEN
MINDS.
EMPLOYEE ASSISTANCE PROGRAMS. An EAP is a worksite-based program designed
to assist in the early identification and resolution of productivity problems
associated with behavioral conditions or other personal concerns of employees.
Under an EAP, staff or network providers or other affiliated clinicians provide
assessment and referral services to employee beneficiaries. These services
consist of evaluating a patient's needs and, if indicated, providing limited
counseling and/or identifying an appropriate provider, treatment facility or
other resource for more intensive treatment services. The EAP industry developed
largely out of employers' efforts to combat alcoholism and substance abuse
problems afflicting workers. A 1990 industry survey estimated the total costs of
this dependency at approximately $98.6 billion per year. Many businesses have
implemented alcoholism and drug abuse treatment programs in the workplace, and
in some cases have expanded those services to cover a wider spectrum of personal
problems experienced by workers and their families. As a result, EAP products
now typically include consultation services, evaluation and referral services,
employee education and outreach services. The Company believes that federal and
state "drug-free workplace" measures and Federal Occupational Health and Safety
Act requirements, taken together with the growing public perception of increased
violence in the workplace, have prompted many companies to implement EAPs.
Although EAPs originated as a support tool to assist managers in dealing with
troubled employees, payors increasingly regard EAPs as an important component in
the continuum of behavioral healthcare services.
INTEGRATED EAP/MANAGED BEHAVIORAL HEALTHCARE PRODUCTS. EAPs are utilized in
a preventive role and in facilitating early intervention and brief treatment of
behavioral healthcare problems before more extensive treatment is required.
Consequently, EAPs often are marketed and sold in tandem with managed behavioral
healthcare programs through "integrated" product offerings. Integrated products
offer employers comprehensive management and treatment of all aspects of
behavioral healthcare. In an effort to both reduce costs and increase
accessibility and ease of treatment, employers are increasingly attempting to
consolidate EAP and managed behavioral healthcare services into a single
product. Although integrated EAP/managed behavioral healthcare products are
currently only a small component of the overall industry, the Company expects
this market segment to grow.
AREAS OF GROWTH.
Management believes that the growth of the managed behavioral healthcare
industry will continue, as payors of behavioral healthcare benefits attempt to
reduce the costs of behavioral healthcare while
8
maintaining high quality care. Management also believes that a number of
opportunities exist in the managed behavioral healthcare industry for continued
growth, primarily for risk-based products. The following paragraphs discuss
factors contributing to the growth of risk-based products and the increase in
the number of covered lives in certain markets.
RISK-BASED PRODUCTS. According to OPEN MINDS, industry enrollment in
risk-based products has grown from approximately 14 million covered lives in
1993 to approximately 38.9 million covered lives in 1997, a compound annual
growth rate of over 30%. Despite this growth, only approximately 26% of total
managed behavioral healthcare covered lives are enrolled in risk-based products.
The Company believes that the market for risk-based products has grown and will
continue to grow as payors attempt to reduce their responsibility for the cost
of providing behavioral healthcare while ensuring an appropriate level of access
to care. Risk-based products can generate significantly greater revenue per
covered life than other non-risk product types. According to the OPEN MINDS
survey, risk-based products account for nearly two-thirds of managed behavioral
healthcare industry premiums, but, as stated above, account for only
approximately 26% of total covered lives.
MEDICAID. Medicaid is a joint state and federal program to provide
healthcare benefits to approximately 33 million low income individuals,
including welfare recipients. According to the Health Care Financing
Administration of the United States Department of Health and Human Services
("HCFA"), federal and state Medicaid spending increased from $69 billion in 1990
to an estimated $160 billion in 1996, at an average annual rate of almost twice
as fast as the annual increase in overall healthcare spending. Furthermore,
according to HCFA, from 1991 to 1996 the number of Medicaid beneficiaries
covered under full managed contracts grew at a compound annual rate of
approximately 40% per year. The Company expects that the Balanced Budget Act of
1997, which was adopted by Congress in August 1997 (the "Budget Act"), will slow
the growth of Medicaid spending by accelerating the trend of state Medicaid
programs toward shifting beneficiaries into managed care programs in order to
control rising costs.
Despite the recent increase in managed care enrollment of Medicaid
beneficiaries, Medicaid managed care enrollment as a percentage of all Medicaid
beneficiaries remains small. As of June 1996, according to the National
Institute for Health Care Management, only approximately 35% of all Medicaid
beneficiaries were enrolled in some form of managed care program, and less than
7% were enrolled in risk-based programs. The Company expects the number of
Medicaid recipients enrolled in managed behavioral healthcare programs to
increase through two avenues: (i) subcontracts with HMOs and (ii) direct
contracts with state agencies. As HMOs increase their penetration of the
Medicaid market, the Company expects that many HMOs will continue to (or begin
to) subcontract with managed behavioral healthcare companies to provide services
for Medicaid beneficiaries. State agencies have also begun to contract directly
with managed behavioral healthcare companies to provide behavioral healthcare
services to their Medicaid beneficiaries. Iowa, Massachusetts, Nebraska,
Maryland, Tennessee and Montana have decided to "carve out" behavioral
healthcare from their overall Medicaid managed care programs and have contracted
or are expected to contract directly with managed behavioral healthcare
companies to provide such services. The Company expects that the Budget Act will
accelerate the trend of states contracting directly with managed behavioral
healthcare companies.
MEDICARE. Medicare is a federally funded healthcare program for the
elderly. Medicare has experienced an increase in its beneficiary population over
the past several years, as well as rapidly escalating healthcare costs.
According to HCFA, as of January 1, 1997, only approximately 4.9 million, or
13%, of the approximately 38 million eligible Medicare beneficiaries were
enrolled in managed care programs. Although enrollment has increased from
approximately 7% of the eligible Medicare beneficiaries in 1993, it is still
considerably below that of the commercial population. The Budget Act contains
provisions designed to increase enrollment of Medicare beneficiaries in managed
care plans as a means of achieving projected savings in Medicare expenditures.
Management believes that in response to increased healthcare costs and the
Budget Act, the Medicare market will shift into managed care programs in the
future, representing an opportunity for growth among managed behavioral
healthcare companies.
9
BUSINESS
OVERVIEW.
The Company is a leading provider of managed behavioral healthcare services,
offering a broad array of cost-effective managed behavioral healthcare products.
The Company (including HAI) has an estimated 35 million covered lives under
managed behavioral healthcare contracts and manages behavioral healthcare
programs for approximately 4,000 customers. Through its current network of over
33,000 providers and 2,000 treatment facilities, the Company manages behavioral
healthcare programs for Blue Cross/Blue Shield organizations, HMOs and other
insurance companies, corporations, federal, state and local governmental
agencies, labor unions and various state Medicaid programs. In addition to the
Company's managed behavioral healthcare products, the Company offers specialty
products related to the management of chronic medical conditions. The Company
also offers a broad continuum of behavioral healthcare services to approximately
2,800 individuals who receive healthcare benefits funded by state and local
governmental agencies through its public-sector provider. Furthermore, the
Company franchises the "CHARTER" System of behavioral healthcare to the
Psychiatric Hospital Facilities and other facilities operated by CBHS, an entity
in which the Company owns a 50% equity interest.
The Company's professional care managers coordinate and manage the delivery
of behavioral healthcare treatment services through the Company's network of
providers, which includes psychiatrists, psychologists, licensed clinical social
workers, marriage and family therapists and licensed clinical professional
counselors. The treatment services provided by the Company's extensive provider
network include outpatient programs (such as counseling and therapy),
intermediate care programs (such as sub-acute emergency care, intensive
outpatient programs and partial hospitalization services), inpatient treatment
services and alternative care services (such as residential treatment, home and
community-based programs and rehabilitative and support services). The Company
provides these services through: (i) risk-based products, (ii) EAPs, (iii) ASO
products and (iv) products that combine features of some or all of these
products. Under risk-based products, the Company arranges for the provision of a
full range of behavioral healthcare services for beneficiaries of its customers'
healthcare benefit plans through fee arrangements under which the Company
assumes all or a portion of the responsibility for the cost of providing such
services in exchange for a fixed per member per month fee. Under EAPs, the
Company provides assessment services to employees and dependants of its
customers, and if required, referral services to the appropriate behavioral
healthcare service provider. Under ASO products, the Company provides services
such as utilization review, claims administration and provider network
management. The Company does not assume the responsibility for the cost of
providing healthcare services pursuant to its ASO products. For its fiscal year
ended September 30, 1997, risk-based, EAP and ASO products accounted for 74%, 6%
and 20% of the Company's managed care net revenues, respectively.
The Company conducts operations in four segments: managed care operations,
public sector operations, franchise operations and provider operations. The
following describes the Company's business segments:
MANAGED CARE OPERATIONS. The managed care segment is the Company's primary
operating segment. The Company's managed care subsidiaries are Green Spring, HAI
and Allied and, following the Acquisition, will include Merit.
Green Spring is one of the largest companies in the managed behavioral
healthcare industry and is the largest managed behavioral healthcare provider to
the Blue Cross/Blue Shield networks. It covered approximately 16.6 million lives
(34% of them pursuant to risk-based products) as of September 30, 1997. Green
Spring currently covers over 20 million lives through a network of more than
33,000 providers. Green Spring's client base includes 25 Blue Cross/Blue Shield
plans, major HMOs and PPOs, state
employee programs, Fortune 1000 corporations, labor unions and a growing number
of state Medicaid programs.
10
Merit, which the Company expects to acquire in the second quarter of fiscal
1998, is one of the leading managed behavioral healthcare providers in the
nation, arranging for the provision of managed behavioral healthcare services to
more than 21 million people. Merit manages behavioral healthcare programs for
approximately 800 clients across all segments of the healthcare industry, with
particularly strong positions in the corporate and HMO segment. Merit is also a
leading provider to Blue Cross/Blue Shield organizations and other insurance
companies, labor unions, federal, state and local governmental agencies and
various state Medicaid programs.
HAI was one of the first and is one of the largest providers of EAP
products. It currently provides managed behavioral healthcare services to over
15 million lives. HAI has providers in all 50 states, operating through nine
regional service centers. It serves many of the nation's largest companies,
including Aetna, Avis, Exxon, JP Morgan, MCI, Northwest Airlines and Sears.
The Company recently acquired Allied to establish its presence in the
management of specialty healthcare services. Allied provides specialty
risk-based products and administrative services to a variety of insurance
companies and other customers, including CIGNA, Blue Cross of New Jersey and
NYLCare, for 25 million equivalent covered lives, determined by multiplying
Allied's 3.4 million members by the number of Allied's specialty products
covering each member. Allied manages over 80 physician networks across the
eastern United States. Allied's networks include physicians specializing in
cardiology, oncology and diabetes.
PUBLIC SECTOR OPERATIONS. The Company's public sector business provides
specialty home-based behavioral healthcare services through National Mentor,
Inc. ("Mentor") to over 2,800 individuals in 84 programs in 20 states from 70
branches as of September 30, 1997. Mentor was founded in 1983 and was acquired
by the Company in January 1995. Mentor's services include specialty home-based
behavioral healthcare services, which feature individualized home and
community-based health and human services delivered in highly structured and
professionally monitored family environments or "mentor" homes. The mentor homes
serve clients with chronic behavioral disorders and disabilities requiring
long-term care, including children and adolescents with behavioral problems,
individuals with mental retardation or developmental disabilities, and
individuals with neurological impairment or other medical and behavioral
frailties. Public sector operations includes correctional behavioral healthcare
services, which feature the management and provision of behavioral healthcare to
the prison population of government-run correctional facilities in Ohio and New
Jersey.
FRANCHISE OPERATIONS. The Company's wholly-owned subsidiary, Charter
Advantage, LLC ("Charter Advantage"), franchises the "CHARTER" System of
behavioral healthcare to the Psychiatric Hospital Facilities and other
facilities operated by CBHS. See "--Charter Advantage."
PROVIDER OPERATIONS. The Company's provider operations include the
ownership and operation of two psychiatric hospitals in London, England (a
45-bed hospital and a 78-bed hospital) and a 69-bed psychiatric hospital in
Nyon, Switzerland. The Company's provider operations also include its interest
in six hospital-based joint ventures (the "Joint Ventures") and the 50%
ownership of CBHS. The Company's Joint Venture partner in four of the Joint
Ventures is Columbia/HCA Healthcare Corporation. Although the Company is the
managing member of each Joint Venture, it has delegated its management
responsibilities to CBHS. The Company pays CBHS a fee for managing the Joint
Ventures equal to the Company's share of the earnings of the Joint Ventures.
COMPETITIVE STRENGTHS.
The Company believes it benefits from the competitive strengths described
below with respect to its managed behavioral healthcare business, which should
allow it to increase its revenues and cash flow. Furthermore, the Company
believes it can leverage its competitive strengths to expand its service
offerings into other specialty managed care products.
11
INDUSTRY LEADERSHIP. The Company (including HAI) has approximately 35
million covered lives under managed behavioral healthcare contracts. Following
the Acquisition, the Company will be the nation's largest provider of managed
behavioral healthcare services in the United States with over 56 million covered
lives. The Company believes it will also have the number one market position in
each of the major product markets in which it competes. The Company believes its
industry leading position will enhance its ability to: (i) provide a consistent
level of high quality service on a nationwide basis; (ii) enter into favorable
agreements with behavioral healthcare providers that allow it to effectively
control healthcare costs for its customers; and (iii) effectively market its
managed-care products to large corporate, HMO and insurance customers, which,
the Company believes, increasingly prefer to be serviced by a single-source
provider on a national basis.
BROAD PRODUCT OFFERING AND NATIONWIDE PROVIDER NETWORK. The Company offers
a full spectrum of behavioral managed care products that can be designed to meet
specific customer needs, including risk-based and partial risk-based products,
integrated EAPs, stand-alone EAPs and ASO products. The Company's nationwide
provider network encompasses over 33,000 providers and 2,000 treatment
facilities in all 50 states. The combination of broad product offerings and a
nationwide provider network allows the Company to meet virtually any customer
need for managed behavioral healthcare on a nationwide basis, and positions the
Company to capture incremental revenue opportunities resulting from the
continued growth of the managed behavioral healthcare industry and the continued
migration of its customers from ASO and EAP products to higher revenue
risk-based products.
BROAD BASE OF STRONG CUSTOMER RELATIONSHIPS. The Company enjoys strong
customer relationships across all its markets, as evidenced by Green Spring and
HAI's contract renewal rate of over 90% during the last three fiscal years.
Management believes that its strong customer relationships are attributable to
the Company's broad product offering, nationwide provider network, commitment to
quality care and ability to manage behavioral healthcare costs effectively.
Following the Acquisition, the Company's leading customers will include: (i)
Blue Cross/Blue Shield organizations; (ii) national HMOs and other large
insurers such as Aetna/US Healthcare, Humana and Prudential; (iii) large
corporations, such as IBM, Federal Express and AT&T; (iv) state and local
governmental agencies through commercial, Medicaid and other programs; and (v)
the federal government through contracts pursuant to CHAMPUS and with the U.S.
Postal Service. This broad base of strong customer relationships provides the
Company with stable and diverse sources of revenue and cash flow and an
established base from which to continue to increase covered lives and revenue.
PROVEN RISK MANAGEMENT EXPERIENCE. The Company (including HAI) has over 6
million covered lives under risk-based contracts. Following the Acquisition, the
Company will have over 17 million covered lives under risk-based contracts,
making it the nation's industry leader in at-risk managed behavioral healthcare
products. The Company's experience with risk-based products covering a large
number of lives has given it a broad base of data from which to analyze
utilization rates. This broad database provides the Company with a competitive
advantage by permitting it to estimate utilization trends and costs, which
allows it to bid effectively. The Company has also developed effective measures
for controlling the cost of providing a unit of care to its covered lives. Among
other cost-control measures, the Company has developed or acquired clinical
protocols, which permit the Company to assist its network providers to
administer effective treatment in a cost efficient manner, and claims-management
technology, which permits the Company to reduce the cost of processing claims.
Following the Acquisition, the Company, as it integrates its managed care
operations, will be able to select from the best practices of its subsidiaries
to enhance further its utilization and cost-control methodologies.
BUSINESS STRATEGY.
INCREASE ENROLLMENT IN RISK-BASED PRODUCTS. The Company believes that it
has a significant opportunity to increase revenues and cash flow by increasing
lives covered by its risk-based products. Following the
12
Acquisition, the Company will be the industry's leading provider of risk-based
products and will be well positioned to benefit from the continuing shift to
risk-based products. According to OPEN MINDS, industry enrollment in risk-based
products has grown from approximately 13.6 million in 1993 to approximately 38.9
million in 1997, representing a compound annual growth rate of over 30%. Despite
this growth, only approximately 26% of total managed behavioral healthcare
enrollees are in risk-based products. The Company believes that the market for
risk-based products has grown and will continue to grow as payors attempt to
reduce their responsibility for the cost of providing behavioral healthcare
while ensuring a high quality of care and an appropriate level of access to
care. The Company believes it has a significant opportunity to increase
enrollment in risk-based products through growth in new covered lives and
through the transition of covered lives in ASO and EAP products to higher
revenue risk-based products. For fiscal 1997, risk-based products accounted for
34% of the Company's covered lives but accounted for 74% of its total managed
behavioral healthcare revenue.
ACHIEVE SIGNIFICANT INTEGRATION EFFICIENCIES. The Company believes that the
Acquisition will create opportunities for the Company to achieve significant
costs savings. Management believes that cost saving opportunities will result
from leveraging fixed overhead over a larger revenue base and an increased
number of covered lives and from reducing duplicative corporate and regional
selling, general and administrative expenses. The Company also intends to
assemble national vendor and supplier programs, resulting in additional savings.
PURSUE ADDITIONAL SPECIALTY MANAGED CARE OPPORTUNITIES. Management believes
that significant demand exists for specialty managed care products. The Company
believes its large number of covered lives, information systems infrastructure
and demonstrated expertise in managing behavioral healthcare programs position
the Company to provide customers with specialty managed care products. As a
first major step in implementing this component of the strategy, the Company
recently acquired Allied, a provider of managed care for cardiology, oncology
and diabetes patients. See "--Recent Developments."
MANAGED BEHAVIORAL HEALTHCARE PRODUCTS AND SERVICES.
GENERAL. The following table sets forth the approximate number of covered
lives as of September 30, 1997, and revenue for each type of managed behavioral
healthcare program offered by Green Spring:
PROGRAMS COVERED LIVES PERCENT REVENUE PERCENT
- ------------------------------------------------------------------- --------------- ----------- --------- -----------
(IN MILLIONS, EXCEPT PERCENTAGES)
Risk-Based Products................................................ 5.7 34.5% $ 269.4 74.0%
EAPs............................................................... 1.1 6.7 10.1 2.8
Integrated Products................................................ 0.8 4.6 11.3 3.1
ASO Products....................................................... 9.0 54.2 73.1 20.1
--- ----- --------- -----
Total.......................................................... 16.6 100.0% $ 363.9 100.0%
--- ----- --------- -----
--- ----- --------- -----
The number of the Company's covered lives fluctuates based on the number of the
Company's customer contracts and as employee, HMO and insurance company
subscriber and government program enrollee populations change from time to time.
On November 8, 1997, the Company announced that Green Spring had been selected
by Blue Cross/Blue Shield of Michigan to manage behavioral healthcare services
for over 2.3 million covered lives. This contract, which became effective as of
December 1, 1997, primarily relates to utilization review services.
RISK-BASED PRODUCTS. Under the Company's risk-based products, the Company
typically arranges for the provision of a full range of outpatient, intermediate
and inpatient treatment services to beneficiaries of its customers' healthcare
benefit plans, primarily through arrangements in which the Company assumes all
or a portion of the responsibility for the cost of providing such services in
exchange for a per member per month fee. The Company's experience with
risk-based contracts (including the experience of Green Spring
13
and HAI) covering a large number of lives has given it a broad base of data from
which to analyze utilization rates. This broad database provides the Company
with a competitive advantage by permitting it to estimate utilization trends and
costs, which allows it to bid effectively. The Company has also developed
effective measures for controlling the cost of providing a unit of care to its
covered lives. Among other cost-control measures, the Company has developed or
acquired clinical protocols, which permit the Company to assist its network
providers to administer effective treatment in a cost efficient manner, and
claims-management technology, which permits the Company to reduce the cost of
processing claims. The Company's care managers are an essential element in its
provision of cost-effective care. Except in emergencies, treatment is required
to be authorized by a Company care manager. Care managers, in consultation with
treating professionals, and using the Company's clinical protocols, authorize an
appropriate level and intensity of services that can be delivered in a
cost-efficient manner. See
" --Industry--Segmentation--Risk-Based Network Programs."
EMPLOYEE ASSISTANCE PROGRAMS. The Company's EAP products typically provide
assessment and referral services to employees and dependants of the Company's
customers in an effort to assist in the early identification and resolution of
productivity problems associated with the employees who are impaired by
behavioral conditions or other personal concerns. For many EAP customers, the
Company also provides limited outpatient therapy (typically limited to eight or
fewer sessions) to patients requiring such services. For these services, the
Company typically is paid a fixed fee per member per month; however, the Company
is usually not responsible for the cost of providing care beyond these services.
If further services are necessary beyond limited outpatient therapy, the Company
will refer the beneficiary to an appropriate provider or treatment facility.
INTEGRATED PRODUCTS. Under its integrated programs, the Company typically
establishes an EAP to function as the "front end" of a managed care program that
provides a full range of services, including more intensive treatment services
not covered by the EAP. The Company typically manages the EAP and accepts all or
some of the responsibility for the cost of any additional treatment required
upon referral out of the EAP, thus integrating the two products and using both
the Company's care management and clinical care techniques to manage the
provision of care. See "--Industry--Segmentation--Integrated EAP/ Managed
Behavioral Healthcare Programs."
ASO PRODUCTS. Under its ASO programs, the Company provides services ranging
from utilization review and claims administration to the arrangement for and
management of a full range of patient treatment services, but does not assume
any of the responsibility for the cost of providing treatment services. Services
include member assistance, management reporting and claims processing in
addition to utilization review and care management. See
"--Industry--Segmentation--Utilization Review/Care Management Programs" and
"--Non-Risk-Based Network Programs."
MANAGED BEHAVIORAL HEALTHCARE CUSTOMERS.
GENERAL The following table sets forth the approximate number of covered
lives as of September 30, 1997 and revenue in each of the Green Spring's market
segments:
MARKET COVERED LIVES PERCENT REVENUE PERCENT
- ---------------------------------------------------------------------- --------------- ----------- ----------- -----------
(IN MILLIONS, EXCEPT PERCENTAGES)
Corporations and Labor Unions......................................... 1.6 9.5% $ 18.2 5.0%
Blue Cross/Blue Shield and Other Insurance Companies.................. 12.1 73.0 210.0 57.7
Medicaid Programs..................................................... 1.5 8.8 91.1 25.0
Governmental Agencies (including CHAMPUS)............................. 1.4 8.7 44.6 12.3
--- ----- ----------- -----
Total............................................................. 16.6 100.0% $ 363.9 100.0%
--- ----- ----------- -----
--- ----- ----------- -----
14
CORPORATIONS AND LABOR UNIONS. Corporations and, to a lesser extent, labor
unions, account for a large number of the Company's contracts to provide managed
behavioral healthcare services and, in particular, EAP and integrated
EAP/managed care services. The Company has structured a variety of fee
arrangements with corporate customers to cover all or a portion of the
responsibility of the cost of providing treatment services. In addition, the
Company operates a number of programs for corporate customers on an ASO basis.
Management believes the corporate market is an area of potential growth for the
Company, as corporations are anticipated to increase their utilization of
managed behavioral healthcare services.
HMOS. Upon acquiring HAI, the Company became a leader in the HMO market,
providing managed behavioral healthcare services to HMO beneficiaries. HMO
contracts are full, limited or shared risk contracts in which the Company
accepts a fixed fee per member per month from the HMO in exchange for providing
a full or specified range of behavioral healthcare services for a specific
portion of the HMO's beneficiaries. Although certain large HMOs provide their
own managed behavioral healthcare services, many HMOs "carve out" behavioral
healthcare from their general healthcare services and subcontract such services
to managed behavioral healthcare companies such as the Company. The Company
anticipates that its business with HMOs will continue to grow.
BLUE CROSS/BLUE SHIELD ORGANIZATIONS AND OTHER INSURANCE COMPANIES. The
Company is the nation's leading provider of managed behavioral healthcare
services to Blue Cross/Blue Shield organizations. Green Spring derived
approximately $194 million, or 53%, of its revenue in fiscal 1997 from contracts
with Blue Cross/Blue Shield organizations. The Company recently expanded its
Blue Cross/Blue Shield relationships by entering into a contract with Blue
Cross/Blue Shield of Michigan relating to 2.3 million covered lives.
HAI has contracts with its former owner, Aetna, pursuant to which HAI
provides managed behavioral healthcare products to Aetna, including focused
psychiatric review (a type of utilization review product), risk based HMO
products, administrative services for Aetna's "Managed Choice" product and
provider network management services. For the twelve months ended September 30,
1997, HAI would have derived approximately $58.9 million of revenue, or
approximately 58% of its total revenue, from its contracts with Aetna, on a pro
forma basis. Approximately 71% of HAI's covered lives are attributable to its
contracts with Aetna.
MEDICAID PROGRAMS. The Company provides managed behavioral healthcare
services to Medicaid recipients through both direct contracts with state and
local governmental agencies and through subcontracts with HMOs focused on
Medicaid beneficiary populations. In addition to the Medicaid population, other
public entitlement programs, such as Medicare and state insurance programs for
the uninsured, offer the Company areas of potential future growth. The Company
expects that governmental agencies will continue to implement a significant
number of managed care Medicaid programs through contracts with HMOs and that
many HMOs will subcontract with managed behavioral healthcare organizations,
such as the Company, for behavioral healthcare services. The Company also
expects that other states will continue the trend of "carving-out" behavioral
healthcare services from their general healthcare benefit plans and contracting
directly with managed behavioral healthcare companies such as the Company. See
" --Industry--Areas of Growth," and "--Regulation--Other Proposed Legislation."
GOVERNMENTAL AGENCIES. The Company provides EAPs and other managed care
products for employees and their dependents who are beneficiaries of federal,
state and local governmental agencies' healthcare benefit plans. Governmental
agencies' healthcare benefit plans have historically contracted for managed
behavioral healthcare services as part of their general healthcare contracts
with HMOs or indemnity insurers. In turn, HMOs or indemnity insurers have either
provided managed behavioral healthcare services directly or subcontracted such
services to managed behavioral healthcare companies such as the Company. The
Company currently provides services to a number of government employees either
directly pursuant to a contract with the government agency or as a subcontractor
to HMOs. More
15
recently, governmental agencies have begun to contract directly with managed
behavioral healthcare companies to provide these services. In addition, the
Company currently manages contracts for beneficiaries of the Civilian Health and
Medical Program for the Uniformed Services ("CHAMPUS") and is actively pursuing
new contracts and subcontracts under the CHAMPUS program. In this market, the
Company often bids for such contracts together with HMOs to provide the
behavioral healthcare services portion of the overall CHAMPUS healthcare
contract.
MANAGED BEHAVIORAL HEALTHCARE CONTRACTS.
Green Spring's contracts with customers typically have terms of one to three
years, and in certain cases contain renewal provisions (at the customer's
option) for successive terms of between one and two years (unless terminated
earlier). Substantially all of these contracts are immediately terminable with
cause and many are terminable without cause by the customer or Green Spring
either upon the giving of requisite notice and the passage of a specified period
of time (typically between 60 and 180 days) or upon the occurrence of other
specified events. In addition, Green Spring's contracts with federal, state and
local governmental agencies, under both direct contract and subcontract
arrangements with HMOs, generally are conditioned on legislative appropriations.
These contracts, notwithstanding terms to the contrary, generally can be
terminated or modified by the customer if such appropriations are not made.
HAI's customer contracts have substantially similar terms to those described
above.
MANAGED BEHAVIORAL HEALTHCARE NETWORK.
The Company's managed behavioral healthcare and EAP treatment services are
provided by a network of third-party providers. The number and type of providers
in a particular area depend upon customer preference, site, geographic
concentration and demographic make-up of the beneficiary population in that
area. Network providers include a variety of specialized behavioral healthcare
personnel, such as psychiatrists, psychologists, licensed clinical social
workers, substance abuse counselors and other professionals.
As of September 30, 1997, the Company had contractual arrangements covering
over 33,000 individual third-party network providers. The Company's network
providers are independent contractors located throughout the local areas in
which the Company's customer's beneficiary population resides. Network providers
work out of their own offices, although the Company's personnel are available to
assist them with consultation and other needs. Network providers include both
individual practitioners, as well as individuals who are members of group
practices or other licensed centers or programs. Network providers typically
execute standard contracts with the Company for which they are typically paid by
the Company on a fee-for-service basis. In some cases, network providers are
paid on a "case rate" basis, whereby the provider is paid a set rate for an
entire course of treatment, or through other risk sharing arrangements. A
network provider's contract with the Company typically has a one-year term, with
automatic renewal at the Company's option for successive one-year terms, and
generally may be terminated without cause by the Company or the provider upon 30
to 90 days notice.
As of September 30, 1997, the Company's managed behavorial healthcare
network included contractual arrangements with approximately 2,000 third-party
treatment facilities, including inpatient psychiatric and substance abuse
hospitals, intensive outpatient facilities, partial hospitalization facilities,
community health centers and other community-based facilities, rehabilitative
and support facilities, and other intermediate care and alternative care
facilities or programs. This variety of facilities enables the Company to offer
patients a full continuum of care and to refer patients to the most appropriate
facility or program within that continuum. Typically, the Company contracts with
facilities on a per diem or fee-for-service basis and, in some cases, on a "case
rate" or capitated basis. The contracts between the Company and inpatient and
other facilities typically are for one year terms and, in some cases, are
automatically renewable at the Company's option. Facility contracts are usually
terminable by the Company or the facility owner upon 30 to 120 days notice. The
Psychiatric Hospital Facilities and other facilities operated by CBHS are
members of the Company's hospital provider network on the same terms as
generally applicable to unaffiliated third-party treatment facilities.
16
COMPETITION.
Each segment of the Company's business is highly competitive. With respect
to its managed care business, the Company competes with large insurance
companies, HMOs, preferred provider organizations ("PPOs"), third-party
administrators ("TPAs"), IPAs, multi-disciplinary medical groups and other
managed care companies. Many of the Company's competitors are significantly
larger and have greater financial, marketing and other resources than the
Company, and some of the Company's competitors provide a broader range of
services. The Company may also encounter substantial competition in the future
from new market entrants. Many of the Company's customers that are managed care
companies may, in the future, seek to provide managed behavioral healthcare and
EAP services to their employees or subscribers directly, rather than by
contracting with the Company for such services. Because of competition, the
Company does not expect to be able to rely on price increases to achieve revenue
growth and expects to continue experiencing pressure on direct operating
margins.
The Company's public sector operations compete with various for profit and
not-for-profit entities, including, but not limited to: (i) managed behavioral
healthcare companies that have started managing human services for governmental
agencies; (ii) home health care organizations; (iii) proprietary nursing home
companies; and (iv) proprietary corrections companies. The Company believes that
the most significant factors in a customer's selection of services include price
and quality of services and outcomes. The pricing aspect of such services is
especially important to attract public sector agencies looking to outsource
public services to the private sector as demand for quality services escalates
while budgeted dollars for healthcare services are reduced. The Company's
management believes that it competes effectively with respect to these factors.
The competitive environment affecting the Company's franchise and provider
operations are discussed elsewhere. See "--Charter Advantage--Competition."
INSURANCE.
The Company maintains a general and professional liability insurance policy
with an unaffiliated insurer. The policy is written on a "claims made or
circumstances reported" basis, subject to a $500,000 deductible per occurrence
and an aggregate deductible of $1.5 million.
INTELLECTUAL PROPERTY.
The Company has developed and is marketing applications and systems for
managing the delivery of care and measuring the outcome of treatment, including
an integrated suite of applications that includes a "Speciality Care Management"
component and an "Advanced Call Center" component. The Speciality Care
Management component includes a suite of proprietary clinical protocols called
"Specifications for Acceptable Care."
These protocols were developed and are supported by recognized physician
experts in the relevant specialities. Clinical protocols are detailed treatment
plans for specific medical conditions. The Advanced Call Center component
includes a nurse advice line application, which permits nurses to answer calls
from managed care beneficiaries and to provide health information and care
decision counseling. It also includes an application that initiates calls to
managed care beneficiaries requiring information on care of chronic conditions,
other information or screening. Finally, the Advanced Call Center component
includes an application that facilitates precertification of beneficiaries,
program referral or enrollment and after-hours back-up of the Speciality Care
Management component. The Advanced Call Center assists the Company and other
users to control costs by reducing unnecessary emergency room visits and by
assisting network providers to monitor compliance with treatment plans. Green
Spring and HAI have also developed or licensed clinical protocols and
proprietary software applications for use in providing managed behavorial
healthcare products.
17
MANAGEMENT INFORMATION SYSTEMS.
In March 1997, the Company hired a Chief Information Officer and established
the Corporate Information Technology Department (the "IT Department"). The Chief
Information Officer reports to the Chief Executive Officer of the Company. Each
operating unit of the Company also has a chief information officer who reports
to the chief executive officer of the operating unit. The IT Department provides
strategic technical direction, consultation and implementation coordination to
each of the operating units.
Currently, each of the Company's operating units maintains its own
information systems. The systems maintained and the applications software used
varies depending on the business processes performed by the operating units.
Green Spring processes all claims on a centralized system using its proprietary
"Claims Adjudication and Tracking System" software and two Compaq Proliant
servers. Green Spring conducts utilization review functions on a decentralized
client/server system, using proprietary "Care Utilization and Review Expediter"
software. Each regional Green Spring office maintains its own complement of data
base servers. Green Spring's information systems are relatively new and
management believes that they have sufficient remaining capacity to accommodate
Green Spring's foreseeable needs.
The Company's information technology strategy is to establish and implement
a common company-wide infrastructure in an attempt to facilitate the integration
of future acquisitions, reduce information technology costs and enhance the
Company's ability to share information internally and with its customers and
business partners. The Company will also attempt to standardize software,
equipment, training and support. An enterprise architecture standards working
group has been formed to implement the strategy. The working group is currently
developing the architecture and migration approach toward a Microsoft Windows NT
environment and standards and implementation plans for hardware and software
platforms and a wide-area network. Management believes that it could achieve
significant cost savings by implementing common system architectures, shared
applications systems and common business operating procedures throughout the
Company, by consolidating back-office functions and by minimizing redundant
systems. The Company expects to be able to implement the plan by the end of
calendar year 1999 and without material expenditures in excess of historical
capital requirements.
The IT Department has also organized a working group to develop a plan for
effectively integrating Merit's information technology into the Company. The
group includes senior level information technology personnel from the Company,
Green Spring and Merit. The working group will complete a plan for integrating
Merit by January 1998. The focus of this working group will be expected to
include HAI in the near future.
REGULATION.
GENERAL. The managed behavioral healthcare industry and the provision of
behavioral healthcare services are subject to extensive and evolving state and
federal regulation. The Company is subject to certain state laws and
regulations, including those governing: (i) the licensing of insurance
companies, HMOs, PPOs, TPAs and companies engaged in utilization review and (ii)
the licensing of healthcare professionals, including restrictions on business
corporations from practicing, controlling or exercising excessive influence over
behavioral healthcare services through the direct employment of psychiatrists
or, in a few states, psychologists and other behavioral healthcare
professionals. These laws and regulations vary considerably among states and the
Company may be subject to different types of laws and regulations depending on
the specific regulatory approach adopted by each state to regulate the managed
care business and the provision of behavioral healthcare treatment services. In
addition, the Company is subject to certain federal laws as a result of the role
the Company assumes in connection with managing its customers' employee benefit
plans. The regulatory scheme generally applicable to the Company's managed care
operations is described in this section. The Company's managed care operations
are also indirectly affected by laws and regulations applicable to the
operations of behavioral healthcare clinics and facilities. See "--Charter
Advantage--Regulation."
18
The Company believes its operations are structured to comply with applicable
laws and regulations, in all material respects, and that it has received, or is
in the process of applying for, all licenses and approvals that are material to
the operation of its business. However, regulation of the managed healthcare
industry is evolving, with new legislative enactments and regulatory initiatives
at the state and federal levels being implemented on a regular basis.
Consequently, it is possible that a court or regulatory agency may take a
position under existing or future laws or regulations, or as a result of a
change in the interpretation thereof, that such laws or regulations apply to the
Company in a different manner than the Company believes such laws or regulations
apply. Moreover, any such position may require significant alterations to the
Company's business operations in order to comply with such laws or regulations,
or interpretations thereof. Expansion of the Company's business to cover
additional geographic areas, to serve different types of customers, to provide
new services or to commence new operations could also subject the Company to
additional licensure requirements and/or regulation.
LICENSURE. Certain regulatory agencies having jurisdiction over the Company
possess discretionary powers when issuing or renewing licenses or granting
approval of proposed actions such as mergers, a change in ownership, transfer or
assignment of licenses and certain intracorporate transactions. One or multiple
agencies may require as a condition of such licensure or approval that the
Company cease or modify certain of its operations in order to comply with
applicable regulatory requirements or policies. In addition, the time necessary
to obtain licensure or approval varies from state to state, and difficulties in
obtaining a necessary licensure or approval may result in delays in the
Company's plans to expand operations in a particular state and, in some cases,
lost business opportunities. Compliance activities, mandated changes in the
Company's operations, delays in the expansion of the Company's business or lost
business opportunities as a result of regulatory requirements or policies could
have a material adverse effect on the Company.
INSURANCE, HMO AND PPO ACTIVITIES. To the extent that the Company operates
or is deemed to operate in one or more states as an insurance company, HMO, PPO
or similar entity, it may be required to comply with certain laws and
regulations that, among other things, may require the Company to maintain
certain types of assets and minimum levels of deposits, capital, surplus,
reserves or net worth. In many states, entities that assume risk under contracts
with licensed insurance companies or HMOs have not been considered by state
regulators to be conducting an insurance or HMO business. As a result, the
Company has not sought licensure as either an insurer or HMO in certain states.
The National Association of Insurance Commissioners (the "NAIC") has undertaken
a comprehensive review of the regulatory status of entities arranging for the
provision of healthcare services through a network of providers that, like the
Company, may assume risk for the cost and quality of healthcare services, but
that are not currently licensed as an HMO or similar entity. As a result of this
review, the NAIC developed a "health organizations risk-based capital" formula,
designed specifically for managed care organizations, that establishes a minimum
amount of capital necessary for a managed care organization to support its
overall operations, allowing consideration for the organization's size and risk
profile. The NAIC initiative also may result in the adoption of a model NAIC
regulation in the area of health plan standards, which could be adopted by
individual states in whole or in part, and could result in the Company being
required to meet additional or new standards in connection with its existing
operations. Individual states have also recently adopted their own regulatory
initiatives that subject entities such as the Company to regulation under state
insurance laws. This includes, but is not limited to, requiring licensure as an
insurance company or HMO and requiring adherence to specific financial solvency
standards. State insurance laws and regulations may limit the ability of the
Company to pay dividends, make certain investments and repay certain
indebtedness. Licensure as an insurance company, HMO or similar entity could
also subject the Company to regulations governing reporting and disclosure,
mandated benefits, and other traditional insurance regulatory requirements. PPO
regulations to which the Company may be subject may require the Company to
register with a state authority and provide information concerning its
operations, particularly relating to provider and payor contracting. Based on
the information presently available to it, the Company does not believe that the
imposition of requirements related to maintaining certain types of assets,
19
prescribed levels of deposits, capital, surplus, reserves or net worth, or
complying with other regulatory requirements applicable to its insurance
company, HMO, PPO or similar operations, would have a material adverse effect on
the Company. Notwithstanding the foregoing, the imposition of such requirements
could increase the Company's cost of doing business and could delay the
Company's conduct or expansion of its business in some areas. The licensure
process under state insurance laws can be lengthy and, unless the applicable
state regulatory agency allows the Company to continue to operate while the
licensure process is ongoing, the Company could experience a material adverse
effect on its operating results and financial condition while its licensure
application is pending. In addition, failure by the Company to obtain and
maintain required licenses typically also constitutes an event of default under
the Company's contracts with its customers. The loss of business from one or
more of the Company's major customers as a result of such an event of default or
otherwise could have a material adverse effect on the Company.
UTILIZATION REVIEW AND THIRD-PARTY ADMINISTRATOR ACTIVITIES. Numerous
states in which the Company does business have adopted, or are expected to
adopt, regulations governing entities engaging in utilization review and TPA
activities. Utilization review regulations typically impose requirements with
respect to the qualifications of personnel reviewing proposed treatment,
timeliness and notice of the review of proposed treatment, and other matters.
TPA regulations typically impose requirements regarding claims processing and
payments and the handling of customer funds. Utilization review and TPA
regulations may increase the Company's cost of doing business in the event that
compliance requires the Company to retain additional personnel to meet the
regulatory requirements and to take other required actions and make necessary
filings. Although compliance with utilization review regulations has not had a
material adverse effect on the Company, there can be no assurance that specific
regulations adopted in the future would not have such a result, particularly
since the nature, scope and specific requirements of such provisions vary
considerably among states that have adopted regulations of this type.
There is a trend among states to require licensure or certification of
entities performing utilization review or TPA activities; however, certain
federal courts have held that such licensure requirements are preempted by the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"). ERISA
preempts state laws that mandate employee benefit structures or their
administration, as well as those that provide alternative enforcement
mechanisms. The Company believes that its TPA activities performed for its
self-insured employee benefit plan customers are exempt from otherwise
applicable state licensing or registration requirements based upon federal
preemption under ERISA and has relied on this general principle in determining
not to seek licensure for certain of its activities in many states. Existing
case law is not uniform on the applicability of ERISA preemption with respect to
state regulation of utilization review or TPA activities. There can be no
assurance that additional licensure will not be required with respect to
utilization review or TPA activities in certain states.
"ANY WILLING PROVIDER" LAWS. Several states in which the Company does
business have adopted, or are expected to adopt, "any willing provider" laws.
Such laws typically impose upon insurance companies, PPOs, HMOs or other types
of third-party payors an obligation to contract with, or pay for the services
of, any healthcare provider willing to meet the terms of the payor's contracts
with similar providers. Compliance with any willing provider laws could increase
the Company's costs of assembling and administering provider networks and could,
therefore, have a material adverse effect on its operations.
LICENSING OF HEALTHCARE PROFESSIONALS. The provision of behavioral
healthcare treatment services by psychiatrists, psychologists and other
providers is subject to state regulation with respect to the licensing of
healthcare professionals. The Company believes that the healthcare professionals
who provide behavioral healthcare treatment on behalf of or under contracts with
the Company are in compliance with the applicable state licensing requirements
and current interpretations thereof; however, there can be no assurance that
changes in such state licensing requirements or interpretations thereof will not
adversely affect the Company's existing operations or limit expansion. With
respect to the Company's crisis
20
intervention program, additional licensure of clinicians who provide telephonic
assessment or stabilization services to individuals who are calling from
out-of-state may be required if such assessment or stabilization services are
deemed by regulatory agencies to be treatment provided in the state of such
individual's residence. The Company believes that any such additional licensure
could be obtained; however, there can be no assurance that such licensing
requirements will not adversely affect the Company's existing operations or
limit expansion.
PROHIBITION ON FEE SPLITTING AND CORPORATE PRACTICE OF PROFESSIONS. The
laws of some states limit the ability of a business corporation to directly
provide, control or exercise excessive influence over behavioral healthcare
services through the direct employment of psychiatrists, psychologists, or other
behavioral healthcare professionals. In addition, the laws of some states
prohibit psychiatrists, psychologists, or other healthcare professionals from
splitting fees with other persons or entities. These laws and their
interpretations vary from state to state and enforcement by the courts and
regulatory authorities may vary from state to state and may change over time.
The Company believes that its operations as currently conducted are in material
compliance with the applicable laws, however, there can be no assurance that the
Company's existing operations and its contractual arrangements with
psychiatrists, psychologists and other healthcare professionals will not be
successfully challenged under state laws prohibiting fee splitting or the
practice of a profession by an unlicensed entity, or that the enforceability of
such contractual arrangements will not be limited. The Company believes that it
could, if necessary, restructure its operations to comply with changes in the
interpretation or enforcement of such laws and regulations, and that such
restructuring would not have a material adverse effect on its operations.
DIRECT CONTRACTING WITH LICENSED INSURERS. Regulators in several states in
which the Company does business have adopted policies that require HMOs or, in
some instances, insurance companies, to contract directly with licensed
healthcare providers, entities or provider groups, such as independent practice
associations ("IPAs"), for the provision of treatment services, rather than with
unlicensed intermediary companies. In such states, the Company's customary model
of contracting directly with its customers may need to be modified so that, for
example, the IPAs (rather than the Company) contract directly with the HMO or
insurance company, as appropriate, for the provision of treatment services. The
Company intends to work with a number of these HMO customers to restructure
existing contractual arrangements, upon contract renewal or in renegotiations,
so that the entity which contracts with the HMO directly is an IPA. The Company
does not expect this method of contracting to have a material adverse effect on
its operations.
OTHER REGULATION OF HEALTHCARE PROVIDERS. The Company's business is
affected indirectly by regulations imposed upon healthcare providers.
Regulations imposed upon healthcare providers include provisions relating to the
conduct of, and ethical considerations involved in, the practice of psychiatry,
psychology, social work and related behavioral healthcare professions and, in
certain cases, the common law duty to warn others of danger or to prevent
patient self-injury. Confidentiality and patient privacy requirements are
particularly strict in the field of behavioral healthcare services, and
additional legislative initiatives relating to confidentiality are expected. The
Health Insurance Portability and Accountability Act of 1996 ("HIPAA") included a
provision that prohibits the wrongful disclosure of certain "individually
identifiable health information." HIPAA requires the Secretary of the United
States Department of Health and Human Services (the "Department") to adopt
standards relating to the transmission of such health information by healthcare
providers and healthcare plans. Although the Company believes that such
regulations do not at present materially impair the Company's operations, there
can be no assurance that such indirect regulation will not have a material
adverse effect on the Company in the future.
REGULATION OF CUSTOMERS. Regulations imposed upon the Company's customers
include, among other things, benefits mandated by statute, exclusions from
coverages prohibited by statute, procedures governing the payment and processing
of claims, record keeping and reporting requirements, requirements for and
payment rates applicable to coverage of Medicaid and Medicare beneficiaries,
provider contracting
21
and enrollee rights, and confidentiality requirements. Although the Company
believes that such regulations do not at present materially impair the Company's
operations, there can be no assurance that such indirect regulation will not
have a material adverse effect on the Company in the future.
ERISA. Certain of the Company's services are subject to the provisions of
ERISA. ERISA governs certain aspects of the relationship between
employer-sponsored healthcare benefit plans and certain providers of services to
such plans through a series of complex laws and regulations that are subject to
periodic interpretation by the Internal Revenue Service and the Department of
Labor. In some circumstances, and under certain customer contracts, the Company
may be expressly named as a "fiduciary" under ERISA, or be deemed to have
assumed duties that make it an ERISA fiduciary, and thus be required to carry
out its operations in a manner that complies with ERISA requirements in all
material respects. Although the Company believes that it is in material
compliance with the applicable ERISA requirements and that such compliance does
not currently have a material adverse effect on the Company's operations, there
can be no assurance that continuing ERISA compliance efforts or any future
changes to the applicable ERISA requirements will not have a material adverse
effect on the Company.
THE BUDGET ACT. In August 1997, Congress enacted the Budget Act. The
Medicare-related provisions of the Budget Act are designed to reduce Medicare
expenditures over the next five years by $115 billion, compared to projected
Medicare expenditures before adoption of the Budget Act. The Congressional
Budget Office projected in July 1997 that $43.8 billion of the reductions would
come from reduced payments to hospitals, $21.8 billion from increased enrollment
in managed care plans and $11.7 billion from reduced payments to physicians and
ambulatory care providers. The five-year savings in projected Medicare payments
to physicians and hospitals would be achieved under the Budget Act by reduced
fee-for-service reimbursement and by changes in managed care programs designed
to increase enrollment of Medicare beneficiaries in managed care plans. The
increase in Medicare enrollment in managed care plans would be achieved in part
by allowing provider-sponsored organizations and preferred provider
organizations to compete with Medicare health maintenance organizations for
Medicare enrollees.
Prior to adoption of the Budget Act, the states were prohibited from
requiring Medicaid recipients to enroll in managed care products that covered
only Medicaid recipients. The Medicaid laws required that the states enroll
Medicaid recipients in products that also covered a specific number of
commercial enrollees. This requirement of the Medicaid laws was intended to
limit the ability of states to reduce coverage levels for Medicaid recipients
below those offered to commercial enrollees. Under prior law, the Secretary of
the Department of Health and Human Services could waive the prohibition. The
Medicaid-related provisions of the Budget Act give states broad flexibility to
require most Medicaid recipients to enroll in managed care products that only
cover Medicaid recipients, without obtaining a waiver from the Secretary of the
Department. The Budget Act also allows states to limit the number of managed
care organizations with which the state will contract to deliver care to
Medicaid beneficiaries. These changes could have a positive impact on the
Company's business, if they result in increased enrollment of Medicaid
beneficiaries in managed care organizations and increased Medicaid spending on
managed care. However, these changes also may have an adverse effect on the
Company if a number of states decide to limit the number of managed care
organizations with which they will contract and to select the organization
solely on the basis of the cost of care, which could result in increased cost
competition for state contracts.
The Company cannot predict the effect of the Budget Act, or other healthcare
reform measures that may be adopted by Congress or state legislatures, on its
managed care operations and no assurance can be given that either the Budget Act
or other healthcare reform measures will not have an adverse effect on the
Company.
OTHER PROPOSED LEGISLATION. In the last five years, legislation has
periodically been introduced at the state and federal level providing for new
regulatory programs and materially revising existing regulatory programs. Any
such legislation, if enacted, could materially adversely affect the Company's
business, financial condition or results of operations. Such legislation could
include both federal and state bills
22
affecting the Medicaid programs which may be pending in or recently passed by
state legislatures and which are not yet available for review and analysis. Such
legislation could also include proposals for national health insurance and other
forms of federal regulation of health insurance and healthcare delivery. It is
not possible at this time to predict whether any such legislation will be
adopted at the federal or state level, or the nature, scope or applicability to
the Company's business of any such legislation, or when any particular
legislation might be implemented. No assurance can be given that any such
federal or state legislation will not have a material adverse effect on the
Company.
CAUTIONARY STATEMENTS--THE COMPANY.
This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Although
the Company believes that its plans, intentions and expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
such plans, intentions or expectations will be achieved. Important factors that
could cause actual results to differ materially from the Company's
forward-looking statements are set forth below and elsewhere in this Form 10-K.
All forward-looking statements attributable to the Company or persons acting on
behalf of the Company are expressly qualified in their entirety by the
cautionary statements set forth below. Additional cautionary statements
regarding the Company's franchise operations business are set forth below. See
"--Charter Advantage--Cautionary Statements--CBHS."
SUBSTANTIAL LEVERAGE AND DEBT SERVICE OBLIGATIONS. As a result of the
Transactions, the Company will be highly leveraged, with indebtedness that is
substantial in relation to its stockholder's equity. The Company's high degree
of leverage could have the following consequences to the Company: (i) the
Company's ability to obtain additional financing for working capital, capital
expenditures, acquisitions, general corporate purposes or other purposes may be
impaired in the future; (ii) a substantial portion of the Company's cash flow
must be dedicated to the payment of principal and interest on its indebtedness;
(iii) the Company will be substantially more leveraged than certain of its
competitors, which might place the Company at a competitive disadvantage; (iv)
the Company may be hindered in its ability to adjust rapidly to changing market
conditions; and (v) the Company's high degree of leverage could make it more
vulnerable in the event of a downturn in general economic conditions or its
business or in the event of adverse changes in the regulatory environment
applicable to the Company.
The Company's ability to repay or to refinance its indebtedness and to pay
interest on its indebtedness will depend on its financial and operating
performance, which, in turn, is subject to prevailing economic and competitive
conditions and to certain financial, business and other factors, many of which
are beyond the Company's control. These factors could include operating
difficulties, increased operating costs, the actions of competitors, regulatory
developments and delays in implementing strategic projects. The Company's
ability to meet its debt service and other obligations may depend in significant
part on the extent to which the Company can successfully implement its business
strategy. There can be no assurance that the Company will be able to implement
its strategy fully or that the anticipated results of its strategy will be
realized. See "--Business--Business Strategy."
If the Company's cash flow and capital resources are insufficient to fund
its debt service obligations, the Company may be forced to reduce or delay
capital expenditures, sell assets or seek to obtain additional equity capital or
to restructure its debt. There can be no assurance that the Company's cash flow
and capital resources will be sufficient for payment of principal of and
interest on its indebtedness in the future, or that any such alternative
measures would be successful or would permit the Company to meet its scheduled
debt service obligations.
RISK-BASED PRODUCTS. Revenues under risk-based contracts will be, following
the consummation of the Transactions, the primary source of the Company's
revenue from its managed behavioral care business. In order for such contracts
to be profitable, the Company must accurately estimate the rate of service
utilization by beneficiaries enrolled in programs managed by the Company and
control the unit cost of
23
such services. There can be no assurance that the Company's assumptions as to
service utilization rates and costs will accurately and adequately reflect
actual utilization rates and costs, nor can there be any assurance that
increases in behavioral healthcare costs or higher-than-anticipated utilization
rates, significant aspects of which are outside the Company's control, will not
cause expenses associated with such contracts to exceed the Company's revenue
for such contracts. The Company will attempt to increase membership in its
risk-based products following the Acquisition. If the Company is successful in
this regard, the Company's exposure to potential losses from its risk-based
products will also be increased. Furthermore, certain of such contracts and
certain state regulations require the Company or certain of its subsidiaries to
reserve a specified amount of cash as financial assurance that it can meet its
obligations thereunder. Such amounts will not be available to the Company for
general corporate purposes. Furthermore, certain state regulations restrict the
ability of subsidiaries that offer risk-based products to pay dividends to the
Company.
RELIANCE ON CUSTOMER CONTRACTS. The Company's managed care contracts
typically have terms of one to three years, and in certain cases contain renewal
provisions providing for successive terms of between one and two years (unless
terminated earlier). Substantially all of these contracts are immediately
terminable with cause and many, including some of the Company's most significant
contracts, are terminable without cause by the customer upon the provision of
requisite notice and the passage of a specified period of time (typically
between 60 and 180 days), or upon the occurrence of certain other specified
events. There can be no assurance that any of the Company's contracts will be
extended or successfully renegotiated or that the terms of any new contracts
will be comparable to those of existing contracts. In addition, price
competition in bidding for contracts can significantly affect the financial
terms of any new or renegotiated contract. There can be no assurance that some
of the Company's customers will not reevaluate their contractual arrangements
with the Company as a result of the consummation of the Transactions.
DEPENDENCE ON GOVERNMENT SPENDING FOR MANAGED HEALTHCARE; POSSIBLE IMPACT OF
HEALTHCARE REFORM. A significant portion of the Company's managed-care revenue
is derived, directly or indirectly, from federal, state and local governmental
agencies, including state Medicaid programs. Reimbursement rates vary from state
to state, are subject to periodic negotiation and may limit the Company's
ability to maintain or increase rates. The Company is unable to predict the
impact on the Company's operations of future regulations or legislation
affecting Medicaid or Medicare programs, or the healthcare industry in general,
and there can be no assurance that future regulations or legislation will not
have a material adverse effect on the Company. Moreover, any reduction in
government spending for such programs could also have a material adverse effect
on the Company. In addition, the Company's contracts with federal, state and
local governmental agencies, under both direct contract and subcontract
arrangements, generally are conditioned upon financial appropriations by one or
more governmental agencies, especially with respect to state Medicaid programs.
These contracts generally can be terminated or modified by the customer if such
appropriations are not made. Finally, some of the Company's contracts with
federal, state and local governmental agencies, under both direct contract and
subcontract arrangements, require the Company to perform additional services if
federal, state or local laws or regulations imposed after the contract is signed
so require, in exchange for additional compensation to be negotiated by the
parties in good faith. Government and other third-party payors are generally
seeking to impose lower reimbursement rates and to renegotiate reduced contract
rates with service providers in a trend toward cost control. See
"--Industry--Areas of Growth" and "--Business--Business Strategy."
In August 1997, Congress enacted the Budget Act. The Medicare-related
provisions of the Budget Act are designed to reduce Medicare expenditures over
the next five years by $115 billion, compared to projected Medicare expenditures
before adoption of the Budget Act. The Congressional Budget Office projected in
July 1997 that $43.8 billion of the reductions would come from reduced payments
to hospitals, $21.8 billion from increased enrollment in managed care plans and
$11.7 billion from reduced payments to physicians and ambulatory care providers.
The five-year savings in projected Medicare payments to
24
physicians and hospitals would be achieved under the Budget Act by reduced
fee-for-service reimbursement and by changes in managed care programs designed
to increase enrollment of Medicare beneficiaries in managed care plans. The
increase in Medicare enrollment in managed care plans would be achieved in part
by allowing provider-sponsored organizations and preferred provider
organizations to compete with Medicare HMOs for Medicare enrollees.
The Medicaid-related provisions of the Budget Act are designed to achieve
net federal Medicaid savings of $14.6 billion over the next five years and $56.4
billion over the next ten years. The Budget Act achieves federal Medicaid
savings in three areas. First, two-thirds of the savings over the next ten years
are attributable to limitations on federal matching payments to states for
reimbursements to "disproportionate share" hospitals. The next largest source of
federal savings is a provision allowing states to shift the cost of Medicare
deductibles and coinsurance requirements for low-income Medicare beneficiaries
from their Medicaid programs to physicians and other providers. Most of the
remaining savings derive from the repeal of the "Boren Amendment" and other
minimum payment guarantees for hospitals, nursing homes and community health
centers that serve Medicaid patients. These changes may have an adverse effect
on the Company if they result in reduced payment levels for providers of managed
behavioral healthcare services.
The Medicaid-related provisions of the Budget Act give states broad
flexibility to require most Medicaid recipients to enroll in managed care
products that only cover Medicaid recipients, without obtaining a waiver from
the Secretary of the Department that was required under prior law. The Budget
Act also allows states to limit the number of managed care organizations with
which the state will contract to deliver care to Medicaid beneficiaries. These
changes could have a positive impact on the Company's business, if they result
in increased enrollment of Medicaid beneficiaries in managed care organizations
and increased Medicaid spending on managed care. However, these changes also may
have an adverse effect on the Company if a number of states decide to limit the
number of managed care organizations with which they will contract and to select
the organization solely on the basis of the cost of care, which could result in
increased cost competition for state contracts.
The Company cannot predict the effect of the Budget Act, or other healthcare
reform measures that may be adopted by Congress or state legislatures, on its
managed care operations and no assurance can be given that either the Budget Act
or other healthcare reform measures will not have an adverse effect on the
Company.
REGULATION. The managed behavioral healthcare industry and the provision of
behavioral healthcare services are subject to extensive and evolving state and
federal regulation. The Company is subject to certain state laws and
regulations, including those governing: (i) the licensing of insurance
companies, HMOs, PPOs, TPAs and companies engaged in utilization review and (ii)
the licensing of healthcare professionals, including restrictions on business
corporations from practicing, controlling or exercising excessive influence over
behavioral healthcare services through the direct employment of psychiatrists
or, in a few states, psychologists and other behavioral healthcare
professionals. The Company's managed care operations are also indirectly
affected by regulations applicable to the establishment and operation of
behavioral healthcare clinics and facilities.
The Company believes its operations are structured to comply with applicable
laws and regulations, in all material respects, and that it has received, or is
in the process of applying for, all licenses and approvals material to the
operation of its business. In many states, entities that assume risk under
contracts with licensed insurance companies or HMOs have not been considered by
state regulators to be conducting an insurance or HMO business. As a result, the
Company has not sought licensure as either an insurer or HMO in certain states.
Regulators in some states, however, have determined that risk assuming activity
by entities that are not themselves providers of care is an activity that may
require some form of licensure. There can be no assurance that other states in
which the Company operates will not adopt a similar view, thus requiring the
Company to obtain additional licenses. Such additional licensure might require
the
25
Company to maintain minimum levels of deposits, net worth, capital, surplus or
reserves, or limit the Company's ability to pay dividends, make investments or
repay indebtedness. The imposition of these additional licensure requirements
could increase the Company's cost of doing business or delay the Company's
conduct or expansion of its business.
In addition, utilization review and TPA activities conducted by the Company
are regulated by many states, which states impose requirements upon the Company
which increase its business costs. The Company believes that its TPA activities
performed for its self-insured employee benefit plan customers are exempt from
otherwise applicable state licensing or registration requirements based upon
federal preemption under ERISA, and has relied on this general principle in
determining not to seek licensure for certain of its activities in many states.
Existing case law is not uniform on the applicability of ERISA preemption with
respect to state regulation of utilization review or TPA activities. There can
be no assurance that additional licensure will not be required with respect to
utilization review or TPA activities in certain states. See
"--Business--Regulation--Insurance, HMO, and PPO Activities" and "--Utilization
Review and Third-Party Administrator Activities."
State regulatory agencies responsible for the administration and enforcement
of the laws and regulations to which the Company's operations are subject have
broad discretionary powers. A regulatory agency or a court in a state in which
the Company operates could take a position under existing or future laws or
regulations, or change its interpretation or enforcement practices with respect
thereto, that such laws or regulations apply to the Company differently than the
Company believes such laws and regulations apply or should be enforced. The
resultant compliance with, or revocation of, or failure to obtain, required
licenses and governmental approvals could result in significant alteration to
the Company's business operations, delays in the expansion of the Company's
business and lost business opportunities, any of which, under certain
circumstances, could have a material adverse effect on the Company. See "--
Business--Regulation--General," "--Licensure," "--Insurance, HMO and PPO
Activities" and "-- Utilization Review and Third-Party Administrator
Activities."
The laws of some states limit the ability of a business corporation to
directly provide, control or exercise excessive influence over behavioral
healthcare services through the direct employment of psychiatrists,
psychologists, or other behavioral healthcare professionals. In addition, the
laws of some states prohibit psychiatrists, psychologists, or other healthcare
professionals from splitting fees with other persons or entities. These laws and
their interpretations vary from state to state and enforcement by the courts and
regulatory authorities may vary from state to state and may change over time.
The Company believes that its operations as currently conducted are in material
compliance with the applicable laws, however there can be no assurance that the
Company's existing operations and its contractual arrangements with
psychiatrists, psychologists and other healthcare professionals will not be
successfully challenged under state laws prohibiting fee splitting or the
practice of a profession by an unlicensed entity, or that the enforceability of
such contractual arrangements will not be limited. The Company believes that it
could, if necessary, restructure its operations to comply with changes in the
interpretation or enforcement of such laws and regulations, and that such
restructuring would not have a material adverse effect on its operations.
Several states in which the Company does business have adopted, or are
expected to adopt, "any willing provider" laws. Such laws typically impose upon
insurance companies, PPOs, HMOs or other types of third-party payors an
obligation to contract with, or pay for the services of, any healthcare provider
willing to meet the terms of the payor's contracts with similar providers.
Compliance with any willing provider laws could increase the Company's costs of
assembling and administering provider networks and could, therefore, have a
material adverse effect on its operations.
The Company's managed care operations are also generally affected by
regulations applicable to the operations of healthcare clinics and facilities.
See "--Charter Advantage--Regulation."
26
INTEGRATION OF OPERATIONS. As a result of the Acquisition and the
acquisition of HAI, the Company expects to be the largest provider of managed
behavioral healthcare services in the United States. The Company's ability to
operate its acquired managed care businesses successfully depends on how well
and how quickly it integrates the acquired businesses with its existing
operations. As the Company implements the integration process, it may need to
implement enhanced operational, financial and information systems and may
require additional employees and management, operational and financial
resources. There can be no assurance that the Company will be able to implement
and maintain such operational, financial and information systems successfully or
successfully obtain, integrate and utilize the required employees and
management, operational and financial resources to achieve the successful
integration of the acquired businesses with its existing operations. Failure to
implement such systems successfully and to use such resources effectively could
have a material adverse effect on the Company. Furthermore, implementing such
operational, financial and information systems or obtaining such employees and
management could reduce the cost savings the Company expects to achieve. See
"--Business--Business Strategy."
HIGHLY COMPETITIVE INDUSTRY. The industry in which the Company conducts its
managed-care business is highly competitive. The Company competes with large
insurance companies, HMOs, PPOs, TPAs, EAPs, provider groups and other managed
care companies. Many of the Company's competitors are significantly larger and
have greater financial, marketing and other resources than the Company, and some
of the Company's competitors provide a broader range of services. The Company
may also encounter substantial competition in the future from new market
entrants. Many of the Company's customers that are managed care companies may,
in the future, seek to provide managed behavioral healthcare services to their
employees or subscribers directly, rather than contracting with the Company for
such services. See "--Business--Competition."
SUBORDINATION OF FRANCHISE FEES. The Company owns a 50% equity interest in
CBHS, from which it receives the Franchise Fees. The Franchise Fees represent a
significant portion of the Company's earnings and cash flows. The Franchise Fees
payable to the Company by CBHS are subordinated in right of payment to the $41.7
million annual base rent, 5% minimum escalator rent and, in certain
circumstances, certain additional rent due Crescent. See "--Charter Advantage --
Franchise Operations -- Franchise Fees; Subordination." If CBHS encounters a
decline in earnings or financial difficulties, such amounts due Crescent will be
paid before any Franchise Fees are paid. The remainder of CBHS's available cash
will then be applied in such order of priority as CBHS may determine, in the
reasonable discretion of the CBHS governing board, to all other operating
expenses of CBHS, including the current and accumulated Franchise Fees. The
Company will be entitled to pursue all available remedies for breach of the
Master Franchise Agreement, except that the Company does not have the right to
take any action that could reasonably be expected to force CBHS into bankruptcy
or receivership.
Based on projections of fiscal 1998 operations prepared by management of
CBHS, the Company believes that CBHS will be unable to pay the full amount of
the Franchise Fees it is contractually obligated to pay the Company during
fiscal 1998. The Company currently estimates that CBHS will be able to pay
approximately $58 to $68 million of the Franchise Fees in fiscal 1998, a $10 to
$20 million shortfall relative to amounts payable under the Master Franchise
Agreement. See "Item 7. --Management's Discussion and Analysis of Financial
Condition and Results of Operations--Impact of Crescent Transactions."
As a result of the Crescent Transactions, the Company no longer controls the
operations of the Psychiatric Hospital Facilities and the other facilities
operated by CBHS. Accordingly, factors that the Company does not control will
likely influence the amount of the equity in the earnings of CBHS that the
Company will realize in the future. For example, CBHS may pursue acquisitions in
markets where it does not currently have a presence and in markets where it has
existing hospital operations. Furthermore, CBHS may consolidate services in
selected markets by closing additional facilities depending on market conditions
and evolving business strategies. If CBHS closes additional psychiatric
hospitals, it could result in charges to income for the costs attributable to
the closure, which would result in lower equity in earnings of CBHS for the
Company.
27
PROFESSIONAL LIABILITY; INSURANCE. The management and administration of the
delivery of managed behavioral healthcare services, like other healthcare
services, entail significant risks of liability. The Company is regularly
subject to lawsuits alleging malpractice and related legal theories, some of
which involve situations in which participants in the Company's programs have
committed suicide. The Company is also subject to claims of professional
liability for alleged negligence in performing utilization review activities, as
well as for acts and omissions of independent contractors participating in the
Company's third-party provider networks. The Company is subject to claims for
the costs of services denied. There can be no assurance that the Company's
procedures for limiting liability have been or will be effective, or that one or
more lawsuits will not have a material adverse effect on the Company in the
future. See "--Business --Legal Proceedings."
The Company carries professional liability insurance, subject to certain
deductibles. There can be no assurance that such insurance will be sufficient to
cover any judgments, settlements or costs relating to present or future claims,
suits or complaints or that, upon expiration thereof, sufficient insurance will
be available on favorable terms, if at all. If the Company is unable to secure
adequate insurance in the future, or if the insurance carried by the Company is
not sufficient to cover any judgments, settlements or costs relating to any
present or future actions or claims, there can be no assurance that the Company
will not be subject to a liability that could have a material adverse effect on
the Company. See "--Business-Insurance."
CHARTER ADVANTAGE
OVERVIEW.
On June 17, 1997, the Company consummated the Crescent Transactions,
pursuant to which, among other things, it sold the Psychiatric Hospital
Facilities to Crescent. In addition, the Company and COI, an affiliate of
Crescent, formed a joint venture known as CBHS to operate the Psychiatric
Hospital Facilities and other facilities transferred by the Company to CBHS. The
Company and COI each own 50% of the equity interest of CBHS. The Company
obtained its equity capital interest by contributing approximately $5 million of
net assets, including five psychiatric hospitals, to CBHS. In fiscal 1997,
subsequent to the initial capitalization of CBHS, the Company and COI each
contributed an additional $20 million to the capital of CBHS. The Company has no
obligation to make additional capital contributions to CBHS. The Company
accounts for its 50% investment in CBHS under the equity method of accounting.
In connection with the Crescent Transactions, the Company received approximately
$417.2 million in cash (before costs of approximately $16 million) and warrants
for the purchase of 2.5% of COI's common stock, exercisable over 12 years. The
Company also issued 1,283,311 warrants to purchase shares of the Company's
Common Stock to each of Crescent and COI at an exercise price of $30 per share.
In related agreements, Crescent and CBHS entered into the facilities lease
described below and the Company, CBHS and the Psychiatric Hospital Facilities
and other facilities entered into the franchise agreements described below.
Following the consummation of the Crescent Transactions, the Company formed
a new business unit, "Charter Advantage," to franchise the "CHARTER" system of
behavioral healthcare to operators of behavioral healthcare facilities.
Currently, its sole customer is CBHS. The following discussion of Charter
Advantage's operations, CBHS's facilities and the psychiatric hospital industry
in general is relevant to an assessment of the factors having a bearing on
CBHS's ability to pay Franchise Fees to the Company, the value of the Company's
interest in the equity of CBHS and the future business prospects of CBHS.
FRANCHISE OPERATIONS.
FRANCHISE AGREEMENTS. Charter Advantage franchises the "CHARTER" System of
behavioral healthcare to the Psychiatric Hospital Facilities and other
facilities operated by CBHS. See "-- CBHS." Each facility has entered into a
separate franchise agreement with Charter Advantage. Each franchisee is granted
the right to engage in the business of providing behavioral healthcare utilizing
the "CHARTER"
28
System from facilities in a defined territory. Each franchisee is authorized to
conduct a "Hospital/RTC Based Behavioral Healthcare Business," which is defined
as the business of the operation of an acute care psychiatric hospital, part of
an acute care general hospital operating an acute care psychiatric unit, a
behavioral healthcare residential treatment center, a part of a facility
operating a behavioral healthcare residential treatment center, or other similar
facility providing 24-hour behavioral healthcare and the delivery of behavioral
healthcare from such facility or other affiliated facilities; such behavioral
healthcare to include inpatient hospitalization, partial hospitalization
programs, outpatient therapy, intensive outpatient therapy, residential
treatment, ambulatory detoxification, behavioral modification programs and
related services. The "CHARTER" System is a system for the operation of
Hospital/RTC Based Behavioral Healthcare Businesses under the "CHARTER" names
and marks, and includes the right to use computer software, treatment programs
and procedures, quality standards, quality assessment methods, performance
improvement and monitoring programs, as well as advertising and marketing
assistance, promotional materials, consultation and other matters relating to
the operation of Hospital/RTC Based Behavioral Healthcare Businesses.
The rights granted under each franchise agreement relate solely to a defined
territory. The rights are non-exclusive except that Charter Advantage may not
grant a franchise for, or itself operate, a facility located within a
franchisee's territory using the "CHARTER" System. Charter Advantage, however,
may grant franchises or licenses to individual physicians, psychologists or
other mental healthcare professionals, to operate businesses for the delivery of
behavioral healthcare utilizing the "CHARTER" System at facilities in the
franchisee's territory other than at an in-patient facility. Charter Advantage
also reserves the right to grant franchises to others to operate behavioral
healthcare businesses utilizing the "CHARTER" System other than in the
franchisee's territory and to otherwise use and grant to others the right to use
the "CHARTER" name or any other name for other businesses. In addition, Charter
Advantage reserves the right to: (i) provide behavioral healthcare services
incidental to the managed behavioral healthcare businesses or any other business
the principal purpose of which is not the operation of a Hospital/RTC Based
Behavioral Healthcare Business and (ii) pursuant to contracts with federal,
state and local governmental agencies, provide health and human services,
including behavioral healthcare services, to the mentally retarded, the
developmental disabled, the elderly, persons under the control or supervision of
criminal/juvenile systems and other designated populations.
During the term of each franchise agreement, Charter Advantage provides
franchisees with: (i) advertising and marketing assistance, including
consultation, access to media buying programs and access to broadcast and other
advertising materials produced by Charter Advantage; (ii) risk management
services, including risk financial planning, loss control and claims management;
(iii) outcomes monitoring; (iv) national and regional contracting services; and
(v) consultation by telephone or at Charter Advantage's offices with respect to
matters relating to the franchisee's business in which Charter Advantage has
expertise, including reimbursement, government relations, clinical strategies,
regulatory matters, strategic planning and business development.
FRANCHISE FEES; SUBORDINATION. The Company and CBHS are parties to a Master
Franchise Agreement pursuant to which CBHS pays the Company annual Franchise
Fees for granting the right to utilize the "CHARTER" System to the facilities
operated by CBHS. CBHS is required by the Master Franchise Agreement to pay a
Franchise Fee equal to the greater of (i) $78.3 million, subject to increases
for inflation, and (ii) $78.3 million, plus 3% of CBHS's gross revenues over $1
billion and not in excess of $1.2 billion and 5% of CBHS' gross revenues over
$1.2 billion. The Company, CBHS and Crescent have entered into a Subordination
Agreement pursuant to which the Franchise Fees are subordinated to base rent,
minimum escalator rent and the first $10 million of additional rent under the
lease between Crescent and CBHS with respect to the facilities operated by CBHS
(the "Facilities Lease"). If CBHS (with the consent of the Company) informs
Crescent that capital expenditures in excess of $10 million are required and
Crescent funds or makes an irrevocable commitment to fund capital expenditures
in excess of $10
29
million, then Franchise Fees are also subordinated to such expenditures or
commitments in excess of $10 million.
Based on projections of fiscal 1998 operations prepared by management of
CBHS, the Company believes that CBHS will be unable to pay the full amount of
the Franchise Fees it is contractually obligated to pay the Company during
fiscal 1998. The Company currently estimates that CBHS will be able to pay
approximately $58 to $68 million of the Franchise Fees in fiscal 1998, a $10 to
$20 million shortfall relative to amounts payable under the Master Franchise
Agreement. If CBHS defaults in payment of the Franchise Fees, the Company has
the following remedies available to it under the Master Franchise Agreement. If
the amount of Franchise Fees not paid exceeds $6 million, but is less than $18
million, the Company will have the right to prohibit CBHS from paying any
incentive compensation to CBHS's management and may prohibit the vesting of any
equity in CBHS to which management of CBHS may be entitled during the period
when Franchise Fees remain unpaid. If the amount of Franchise Fees not paid
exceeds $18 million, but is less than $24 million, the Company will have the
right to prohibit any salary increases for key personnel of CBHS, to prohibit
any additional hiring by CBHS and to prohibit CBHS from making any hospital
acquisitions or entering into any hospital joint ventures directly or indirectly
during such period. If the amount of Franchise Fees not paid exceeds $24
million, the Company may require CBHS to reduce by 5% the expenses approved in
its current budget, to seek approval of expenditures, including capital and
operating expenditures, on a monthly basis, and to transfer control and
management of CBHS and the Psychiatric Hospital Facilities to the Company.
Notwithstanding the foregoing, the Company does not have the right to take any
action, in connection with the exercise of remedies against CBHS, that could
reasonably be expected to force CBHS into bankruptcy or receivership, or similar
proceedings, with respect to any dispute that may arise among the parties with
respect to payment or nonpayment of the Franchise Fees.
The initial term of the Facilities Lease is twelve years. CBHS has the right
to renew the lease for four additional terms of five years each. The base rent
for the first year of the initial term is $41.7 million, which increases each
year during the initial term by five percent compounded annually. CBHS is
required by the Facilities Lease to pay Crescent in each lease year additional
rent in the amount of $20 million. Crescent is obligated to use at least $10
million of the additional rent to pay for capital expenditures with respect to
the Psychiatric Hospital Facilities in the time and manner directed by CBHS.
Furthermore, CBHS has the right to require Crescent to use up to $10 million of
additional rent to pay property taxes, insurance premiums and Franchise Fees.
CBHS's failure to pay additional rent pursuant to the Facilities Lease is not a
default with respect to the Facilities Lease, except to the extent that Crescent
has made capital expenditures or advanced sums to pay taxes, insurance premiums,
assessments or Franchise Fees that have not been reimbursed by additional rent
payments.
Notwithstanding the foregoing, if the accrued and unpaid Franchise Fees,
including interest thereon, if any, equal or exceed $15 million, then CBHS's
available cash would thereafter first be applied to base rent and minimum
escalator rent, but not to additional rent, under the Facilities Lease. The
remainder of CBHS's available cash would then be applied in such order of
priority as CBHS may determine, in the reasonable discretion of its Board of
Directors (half the members of which are appointed by the Company), to all other
operating expenses of CBHS, including, without limitation, the current and
accumulated Franchise Fees, additional rent due under the Facilities Lease and
any other operating expenses. If CBHS (with the consent of the Company) informs
Crescent that capital expenditures are required and Crescent funds or makes an
irrevocable commitment to fund such capital expenditures, then CBHS's available
cash will first be applied to base rent, minimum escalator rent and the amount
of additional rent necessary to fund such capital expenditures; and further
provided that Crescent will have no obligation to refund any amounts paid by
CBHS as additional rent.
30
CBHS.
OVERVIEW. CBHS is the nation's largest operator of acute-care psychiatric
hospitals and other behavioral care treatment facilities. CBHS's psychiatric
hospitals are located in well-populated urban and suburban locations in 32
states. Seven of CBHS's hospitals are affiliated with medical schools for
residency and other post-graduate teaching programs. Most of CBHS's hospitals
offer a full continuum of behavioral care in their service area. The continuum
includes inpatient hospitalization, partial hospitalization, intensive
outpatient services and, in some markets, residential treatment services.
CBHS's hospitals provide structured and intensive treatment programs for
mental health and alcohol and drug dependency disorders in children, adolescents
and adults. The specialization of programs enables the clinical staff to provide
care that is specific to the patient's needs and facilitates monitoring of the
patient's progress. A typical treatment program at a CBHS facility integrates
physicians and other patient-care professionals with structured activities,
providing patients with testing, adjunctive therapies (occupational,
recreational and other), group therapy, individual therapy and educational
programs. A treatment program includes one or more of the types of treatment
settings provided by CBHS's continuum of care. For those patients who do not
have a personal psychiatrist or other specialist, the hospital refers the
patient to a member of its medical staff.
A significant portion of hospital admissions are provided by referrals from
former patients, local marketplace advertising, managed care organizations and
physicians. Professional relationships are an important aspect of the ongoing
business of a behavioral care facility. Management believes the quality of
CBHS's treatment programs, staff employees and physical facilities are important
factors in maintaining good professional relationships.
CBHS's hospitals work closely with mental health professionals,
non-psychiatric physicians, emergency rooms and community agencies that come in
contact with individuals who may need treatment for mental illness or substance
abuse. A portion of the Company's marketing efforts is directed at increasing
general awareness of mental health and addictive disease and the services
offered by the Company's franchisees.
INDUSTRY TRENDS. CBHS's hospitals have been adversely affected by factors
influencing the entire psychiatric hospital industry. Such factors include: (i)
the imposition of more stringent length of stay and admission criteria and other
cost containment measures by payors; (ii) the failure of reimbursement rate
increases from certain payors that reimburse on a per diem or other discounted
basis to offset increases in the cost of providing services; (iii) an increase
in the percentage of business that CBHS derives from payors that reimburse on
per diem or other discounted basis; (iv) a trend toward higher deductibles and
co-insurance for individual patients; (v) a trend toward limited employee
behavioral health benefits, such as reductions in annual and lifetime limits on
behavioral health coverage; and (vi) pricing pressure related to an increasing
rate of claims denials by third party payors. In response to these conditions,
the Company believes that CBHS will (i) strengthen controls to minimize costs
and capital expenditures; (ii) review its portfolio of hospitals and sell, close
or lease hospitals or consolidate operations in certain locations; (iii) develop
strategies to increase outpatient services and partial hospitalization programs
to meet the demands of the marketplace; (iv) implement programs to contest third
party denials relating to valid pre-certified treatment and admissions; and (v)
renegotiate contracts with managed care organizations at increased rates.
SOURCES OF REVENUE. Payments are made to CBHS by patients, by insurance
companies and self-insured employers, by the federal and state governments under
Medicare, Medicaid, CHAMPUS and other programs and by HMOs, PPOs and other
managed care programs. Amounts received from most payors are less than the
hospital's established charges. The approximate percentages of gross patient
revenue (which is revenue before deducting contractual allowances and discounts
from established
31
charges) derived by CBHS and the Company from various payment sources for the
last three fiscal years were as follows:
PERCENTAGE OF HOSPITAL GROSS
PATIENT
REVENUE FOR THE YEAR ENDED
SEPTEMBER 30,
-------------------------------
1995 1996 1997
--------- --------- ---------
Medicare............................................................................ 26% 28% 27%
Medicaid............................................................................ 17 17 18
--- --- ---
43 45 45
HMOs and PPOs....................................................................... 17 21 24
CHAMPUS............................................................................. 4 3 2
Other Government Programs........................................................... 6 6 7
Other (primarily Blue Cross and other commercial insurance)......................... 30 25 22
--- --- ---
Total............................................................................. 100% 100% 100%
--- --- ---
--- --- ---
Most private insurance carriers reimburse their policyholders or make direct
payments to the hospitals for charges at rates specified in their policies. The
patient remains responsible to the hospital for any difference between the
insurance proceeds and the total charges. Certain Blue Cross programs have
negotiated reimbursement rates with certain of CBHS's hospitals which are less
than the hospital's established charges.
Most of CBHS's facilities have entered into contracts with HMOs, PPOs,
certain self-insured employers and other managed care plans which provide for
reimbursement at rates less than the hospital's normal charges. In addition to
contracts entered into by individual hospitals with such managed care plans,
CBHS has entered into regional and national contracts with HMOs, PPOs,
self-insured employers and other managed care plans that apply to all of such
franchisees in the geographic areas covered by a contract. CBHS is seeking to
obtain additional regional and national contracts. The Company expects the
percentage of revenue obtained by CBHS from these payor sources to increase in
the future.
Under the Medicare provisions of the Tax Equity and Fiscal Responsibility
Act of 1982 ("TEFRA"), costs per Medicare case are determined for each of the
Company's franchisees. A target cost per case is established for each year (the
"Target Rate"). If a hospital's costs per case are less than the Target Rate,
the hospital receives a bonus of 50% of the difference between its actual costs
per case and the Target Rate (limited to 5% of the Target Rate). Hospitals with
costs which exceed the Target Rate are paid an additional amount equal to 50% of
the excess, up to 10% of the Target Rate. These limits apply only to operating
costs and do not apply to capital costs, including lease expense, depreciation
and interest associated with capital expenditures. The Target Rate for each
hospital is increased annually by the application of an "update factor." The
Budget Act establishes caps on a hospital's Target Rate for cost reporting
periods beginning on or after October 1, 1997 and before October 1, 2002 equal
to no more than the 75th percentile of the Target Rate for cost reporting
periods ending during fiscal year 1996, subject to certain subsequent updates.
Most of CBHS's hospitals participate in state-operated Medicaid programs.
Current federal law prohibits Medicaid funding for inpatient services in
freestanding psychiatric hospitals for patients between the ages of 21 and 64.
Each state is responsible for establishing the Medicaid eligibility and coverage
criteria, payment methodology and funding mechanisms which apply in that state,
subject to federal guidelines. Accordingly, the level of Medicaid payments
received by CBHS's hospitals varies from state to state. In addition to the
basic payment level for patient care, several state programs include a financial
benefit for hospitals which treat a disproportionately large volume of Medicaid
patients as a percentage of the total patient population. The Company received
approximately $11 million, $9 million and $5 million in Medicaid
disproportionate share payments in fiscal 1994, 1995 and 1996, respectively,
when it owned the facilities now operated by CBHS. The Company and CBHS received
approximately $3 million in such payments in fiscal 1997. Disproportionate share
payments will not apply to services rendered in fiscal 1998 and thereafter.
32
Within the statutory framework of the Medicare and Medicaid programs, there
are substantial areas subject to administrative rulings and interpretations
which may affect payments made under either or both of such programs. In
addition, federal or state governments could reduce the future funds available
under such programs or adopt additional restrictions on admissions and more
stringent requirements for utilization of services. These types of measures
could adversely affect CBHS's operations. Final determination of amounts payable
under Medicare and certain Medicaid programs are subject to review and audit.
Most of CBHS's hospitals receive revenues from the CHAMPUS program. Under
various CHAMPUS programs, payments can either be based on contractually agreed
upon rates or rates determined by regulatory formulas. CHAMPUS patients are
subject to annual limits on the number of psychiatric days covered by CHAMPUS.
Covered inpatient services are generally limited to 30 days for adult acute
patients, 45 days for child and adolescent acute patients, and 150 days for
residential treatment center patients.
MEDICAL STAFFS. At September 30, 1997, approximately 1,300 licensed
physicians were active members of the medical staffs of CBHS's hospitals. Many
of these physicians also serve on the medical staffs of other hospitals. A
number of physicians are independent contractors who have private practices in
addition to their duties for CBHS, while certain of these physicians are
employees of CBHS. The medical and professional affairs of each hospital are
supervised by the medical staff of the hospital, under the control of its board
of trustees. CBHS recruits physicians to serve in administrative capacities at
its hospitals and to engage in private practice in communities where CBHS's
hospitals are located. Registered nurses and certain other hospital employees
are required to be licensed under the professional licensing laws of most
states. CBHS's hospital subsidiaries require such employees to maintain such
professional licenses as a condition of employment.
COMPETITION.
Each of CBHS's hospitals competes with other hospitals, some of which are
larger and have greater financial resources. Some competing hospitals are owned
and operated by governmental agencies, others by nonprofit organizations
supported by endowments and charitable contributions and others by proprietary
hospital corporations. The hospitals frequently draw patients from areas outside
their immediate locale and, therefore, CBHS's hospitals may, in certain markets,
compete with both local and distant hospitals. In addition, CBHS's hospitals
compete not only with other psychiatric hospitals, but also with psychiatric
units in general hospitals, and outpatient services provided by CBHS compete
with private practicing mental health professionals, publicly funded mental
health centers and partial hospitalization and other intensive outpatient
services programs and facilities. The competitive position of a hospital is, to
a significant degree, dependent upon the number and quality of physicians who
practice at the hospital and who are members of its medical staff. The Company
believes that CBHS competes effectively with respect to the aforementioned
factors. However, there can be no assurance that CBHS will be able to compete
successfully in the provider business in the future.
Competition among hospitals and other healthcare providers for patients has
intensified in recent years. During this period, hospital occupancy rates for
inpatient behavioral care patients in the United States have declined as a
result of cost containment pressures, changing technology, changes in
reimbursement, changes in practice patterns from inpatient to outpatient
treatment and other factors. In recent years, the competitive position of
hospitals has been affected by the ability of such hospitals to obtain contracts
with PPO's, HMO's and other managed care programs to provide inpatient and other
services. Such contracts normally involve a discount from the hospital's
established charges, but provide a base of patient referrals. These contracts
also frequently provide for pre-admission certification and for concurrent
length of stay reviews. The importance of obtaining contracts with HMO's, PPO's
and other managed care companies varies from market to market, depending on the
individual market strength of the managed care companies. In certain states,
certificate of need laws place limitations on CBHS's and its competitors'
ability to build new hospitals and to expand existing hospitals and services. As
of September 30, 1997, the
33
Company had Joint Ventures, which are managed by CBHS, that operated three
hospitals in two states (Louisiana and New Mexico) and CBHS operated 34
hospitals in ten states (Arizona, Arkansas, California, Colorado, Indiana,
Kansas, Louisiana, Nevada, Texas and Utah) that do not have certificate of need
laws applicable to hospitals.
REGULATION.
The operation of psychiatric hospitals and other behavioral healthcare
facilities and the provision of behavioral healthcare services are subject to
extensive federal, state and local laws and regulations. These laws and
regulations provide for periodic inspections or other reviews by state agencies,
the Department and CHAMPUS to determine compliance with their respective
standards of medical care, staffing, equipment and cleanliness necessary for
continued licensing or participation in the Medicare, Medicaid or CHAMPUS
programs. The admission and treatment of patients at psychiatric hospitals is
also subject to substantial state regulation relating to involuntary admissions,
confidentiality of patient medical information, patients' rights and federal
regulation relating to confidentiality of medical records of substance abuse
patients. Although CBHS believes that its facilities are currently in compliance
with these federal, state, and local requirements, there can be no assurance
that all facilities will continuously be operated in full compliance with the
applicable requirements. The failure to obtain or renew any required regulatory
approvals, the failure to satisfy the requirements for continued participation
in the Medicare, Medicaid or CHAMPUS programs, or the failure to satisfy other
state and federal regulatory requirements relating to the operation of
psychiatric hospitals and other behavioral healthcare facilities and the
provision of behavioral healthcare services could have a materially adverse
effect on the operations of CBHS.
A number of states have adopted hospital rate review legislation, which
generally provides for state regulation of rates charged for various hospital
services. Such laws are in effect in the State of Florida, in which CBHS
operates seven hospitals. In Florida, the Health Care Board approves a budget
for each hospital, which establishes a permitted level of revenues per
discharge. If this level of permitted revenues per discharge is exceeded by a
hospital in a particular year by more than a specified amount, certain
penalties, including cash penalties, can be imposed. Although the Company
believes that CBHS's facilities in Florida currently are in compliance with the
state hospital rate review laws, there can be no assurance that such facilities
will not be subject to penalties under the hospital rate review laws in the
future.
CBHS is also subject to state certificate of need laws that regulate the
construction of new hospitals and the expansion of existing hospital facilities
and services. These laws require that the approval of a state agency be obtained
prior to the construction of a new hospital or the expansion of the facilities
or services of an existing hospital. Such approvals may require a finding of
community need for the additional hospital facilities and services. In recent
years, many states have repealed certificate of need laws or limited the scope
of the facilities and services to which such certificate of need laws apply.
There can be no assurance that state certificate of need laws will not limit
CBHS's future expansion, or that increased competition as a result of the repeal
or limitation in scope of existing certificate of need laws will not have a
materially adverse effect on the existing operations of CBHS.
Federal law contains numerous provisions designed to insure that services
rendered by hospitals to Medicare and Medicaid patients are medically necessary
and are of a quality that meets professionally recognized standards, and to
insure that claims for reimbursement under the Medicare and Medicaid programs
are properly filed. Among other things, services provided at CBHS's psychiatric
hospitals are subject to periodic review by Peer Review Organizations ("PROs").
All hospitals which participate in the Medicare program are subject to review by
PROs. PRO activities include review of certain admissions and services to
determine medical necessity and to determine whether quality of care meets
professionally recognized standards. PROs have the authority to recommend to the
Department that a provider who is in substantial noncompliance with the medical
necessity and quality of care standards of a PRO or who has grossly and
flagrantly violated an obligation to render care be excluded from participation
in the Medicare program or be required to reimburse the federal government for
certain payments previously made to the provider under the Medicare program. The
Company believes that CBHS's facilities are in material
34
compliance with the applicable medical necessity and quality of care standards
for Medicare and Medicaid patients, however, there can be no assurance that all
CBHS facilities will continuously remain in material compliance with such
standards.
CBHS is subject to federal and state laws that govern financial and other
arrangements between healthcare providers. Such laws include the illegal
remuneration provisions of the Social Security Act (the "Anti-Kickback Statute")
and the physician self-referral provisions of the Omnibus Budget Reconciliation
Act of 1993 ("Stark II").
The Anti-Kickback Statute prohibits, among other things, the offer, payment,
solicitation or receipt of any form of remuneration, in exchange for or which is
intended to induce the referral of patients for services that will be paid for
in whole or in part under any Federal health care program, including Medicare
and Medicaid. A violation of the Anti-Kickback Statute is a felony, punishable
by a fine of up to $25,000, a term of imprisonment for up to five years, or
both. In addition, an individual or entity convicted of a violation of the
Anti-Kickback Statute may be subject to civil monetary penalties in an amount
equal to $50,000 for each prohibited act, plus damages up to three times the
total amount of remuneration offered, paid, solicited or received, and may be
subject to exclusion from participation in any Federal healthcare program.
In order to provide guidance with respect to the Anti-Kickback Statute,
Congress required the Department to issue regulations outlining business
arrangements that would not be subject to prosecution under the Anti-Kickback
Statute. These regulations include "safe harbors" for certain investment
interests, leases of space and equipment, personal service arrangements,
employment arrangements, personal services and management contracts, sale of
physician practices, discounts, and waiver of beneficiary copayments and
deductibles. Certain transactions and agreements of CBHS do not satisfy all of
the applicable criteria contained in the safe harbor regulations that relate to
such transactions and agreements. The Company believes that such transactions
and agreements do not violate the Anti-Kickback Statute, however, there can be
no assurance that (i) government enforcement agencies will not assert that
certain of these arrangements are in violation of the Anti-Kickback Statute or
(ii) the Anti-Kickback Statute and safe harbor regulations will not ultimately
be interpreted by the courts in a manner inconsistent with CBHS's business
practices.
In 1989, Congress passed legislation, commonly referred to as the "Stark
Law," which prohibits physicians who have a financial relationship with entities
that furnish clinical laboratory services from referring patients to such
entities for Medicare-reimbursed clinical laboratory services and which
prohibits the entities for billing for services provided pursuant to such
prohibited referrals. The Stark Law, which contains a number of exceptions to
its general referral prohibition, became effective January 1, 1992. Proposed
regulations implementing the Stark Law were first issued in March 1992, however,
the final Stark regulations were issued on August 14, 1995.
In 1993, Congress passed legislation commonly referred to as "Stark II,"
which expanded the prohibitions of the Stark Law to include referrals from
physicians for a wide variety of designated health services, including
inpatient/outpatient hospital services, and extended the referral prohibition to
include services reimbursed under Medicaid. The limitations on referrals
outlined in Stark II became effective January 1, 1995. A violation of Stark II
may result in the imposition of civil monetary penalties of up to $15,000 for
each service billed in violation of the statute and exclusion from participation
in any federal healthcare program. Although the regulations implementing Stark
II have not been issued it is anticipated that they will be similar to the
original Stark regulations. The Company believes that the financial
relationships between CBHS's hospitals and physicians do not violate the Stark
Law and regulations. There can be no assurance however that (i) government
enforcement agencies will not contend that certain of these financial
relationships are in violation of the Stark legislation; (ii) that the Stark
legislation will not ultimately be interpreted by the courts in a manner
inconsistent with CBHS's practices; or (iii) regulations
35
will be issued in the future that will result in an interpretation of the Stark
Law or Stark II that is inconsistent with CBHS's practices.
CBHS is also subject to state illegal remuneration and self-referral
statutes and regulations that prohibit payments in exchange for referrals and
referrals by physicians or other healthcare providers to persons or entities
with which the physician or healthcare provider has a financial relationship.
These state statutes generally apply to services reimbursed under both
government programs and private health insurance plans. Violations of these laws
may result in payment not being made for the items or services rendered, loss of
the healthcare provider's license, fines, or criminal penalties. These statutes
and regulations vary widely from state to state, are often vague and, in many
states, have not been interpreted by courts or regulatory agencies. Although the
Company has no reason to believe that CBHS is in violation of any such state
statutes, there can be no assurance that CBHS's existing business arrangements
will not be subject to challenge under these types of laws in one or more
states.
The Medicare and Medicaid Patient and Program Protection Act of 1987
expanded the authority of the Department to exclude from participation in the
Medicare and Medicaid programs those individuals and entities that engage in
defined prohibited activities. The Department is required under this Act to
exclude from participation in the Medicare and Medicaid programs any individual
or entity that has been convicted of a criminal offense relating to the delivery
of services under Medicare and Medicaid or to the neglect of abuse or patients.
In addition, the Department may exclude from participation in the Medicare and
Medicaid programs individuals and entities under certain other circumstances.
These include engaging in illegal remuneration arrangements with physicians and
other healthcare providers, license revocation, exclusion from other government
programs (such as CHAMPUS), filing claims for excessive charges or for
unnecessary services, failure to comply with the Medicare conditions of
participation and failure to disclose certain required information or to grant
proper access to hospital books and records.
The Department's exclusion authority was recently expanded under HIPAA and
the Budget Act, which added additional grounds for exclusion, established
minimum exclusion periods for certain offenses, and expanded the scope of the
exclusion to include exclusion for all other federal and state health care
programs, other than the Federal Employees Health Benefit Program.
The Department also has the authority to impose civil monetary penalties for
certain listed prohibited activities, including filing claims that are false or
fraudulent claims or are for services that were not rendered as claimed. HIPAA
increased the amount of authorized penalties from $2,000 per item or service
claimed to $10,000 per item or service claimed and increased the assessment to
which a person may be subject in lieu of damages from two times the amount
claimed for each item or service to three times the amount claimed. Both HIPAA
and the Budget Act also expanded the Department's authority to impose civil
monetary penalties. Among other things, the new legislation prohibits the
knowing submission of a claim for reimbursement that will result in a greater
payment than is applicable to the item or service actually provided, and
prohibits submitting claims to Medicare or Medicaid for a pattern of medical or
other items or services that a person knows or should know are not medically
necessary. The legislation also prohibits offering any inducements to
beneficiaries in order to influence them to order or receive Medicare or
Medicaid covered items or services from a particular provider or practitioner.
Provisions contained in HIPAA and the Budget Act also created new criminal
healthcare fraud offenses that are applicable to both government programs and
private health insurance plans and added new programs and increased funding for
fraud and abuse detection and enforcement activities. The new offenses created
by HIPAA and the Budget Act, as well as the greater spending on healthcare fraud
and abuse enforcement which will result from this legislation, may significantly
increase the likelihood that any particular healthcare company will be
scrutinized by federal, state and/or local law enforcement officials. In
addition, the increased penalties will strengthen the ability of enforcement
agencies to effect more numerous and larger monetary settlements with healthcare
providers and businesses than was previously the case. Although the Company
believes that CBHS's billing practices are consistent with the applicable
36
Medicare and Medicaid requirements, those requirements are often vague and
subject to interpretation. The Company also believes that CBHS is in compliance
with the applicable federal laws described above; however, there can be no
assurance that aggressive anti-fraud enforcement activities will not adversely
affect the business of CBHS.
Finally, CHAMPUS regulations authorize CHAMPUS to exclude from the CHAMPUS
program any provider that has committed fraud or engaged in abusive practices.
The regulations permit CHAMPUS to make its own determination of abusive
practices without reliance on any actions of the Department. The term "abusive
practices" is defined broadly to include, among other things, the provision of
medically unnecessary services, the provision of care of inferior quality and
the failure to maintain adequate medical or financial records. Although the
Company believes that CBHS is in compliance with the applicable CHAMPUS
regulations, exclusion from the CHAMPUS program could have a material adverse
effect on the operations and financial condition of CBHS.
GENERAL AND PROFESSIONAL LIABILITY.
CBHS maintains a general and hospital professional liability insurance
policy with an unaffiliated insurer. The policy is written on a "claims made or
circumstances reported" basis, subject to a $1.5 million retention limit per
occurrence and an aggregate retention limit of $8.8 million. The amount of
expense relating to CBHS's malpractice insurance is based on estimated ultimate
losses incurred during the year and may materially increase or decrease from
year to year depending, among other things, on the nature and number of new
reported claims against CBHS and amounts of settlements of previously reported
claims. To date, CBHS has not experienced a loss in excess of policy limits.
Management believes that its coverage limits are adequate. However, losses in
excess of the limits described above or for which insurance is otherwise
unavailable could have a material adverse effect upon the Company.
CAUTIONARY STATEMENTS--CBHS.
This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Although
the Company believes that its plans, intentions and expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
such plans, intentions or expectations will be achieved. Important factors that
could cause actual results to differ materially from the Company's
forward-looking statements are set forth below and elsewhere in this Form 10-K.
All forward-looking statements attributable to the Company or persons acting on
behalf of the Company are expressly qualified in their entirety by the
cautionary statements set forth below. Additional cautionary statements
regarding the Company's managed care business and franchise operations business
are set forth elsewhere in this Form 10-K. See "--Business--Cautionary
Statements--The Company."
POTENTIAL REDUCTIONS IN REIMBURSEMENT BY THIRD-PARTY PAYORS AND CHANGES IN
HOSPITAL PAYOR MIX. CBHS's hospitals have been adversely affected by factors
influencing the entire psychiatric hospital industry. Such factors include: (i)
the imposition of more stringent length of stay and admission criteria and other
cost containment measures by payors; (ii) the failure of reimbursement rate
increases from certain payors that reimburse on a per diem or other discounted
basis to offset increases in the cost of providing services; (iii) an increase
in the percentage of business that CBHS derives from payors that reimburse on a
per diem or other discounted basis; (iv) a trend toward higher deductibles and
co-insurance for individual patients; (v) a trend toward limiting employee
behavioral health benefits, such as reductions in annual and lifetime limits on
behavioral health coverage; and (vi) pricing pressure related to an increasing
rate of claims denials by third party payors. Any of these factors may result in
reductions in the amounts that CBHS's hospitals can expect to collect per
patient day for services provided or the number of equivalent patient days.
For the fiscal year ended September 30, 1997, CBHS derived approximately 24%
of its gross psychiatric patient service revenue from managed care organizations
(primarily HMOs and PPOs), 22% from other private payors (primarily commercial
insurance and Blue Cross), 27% from Medicare, 18%
37
from Medicaid, 2% from CHAMPUS and 7% from other government programs. Changes in
the mix of CBHS's patients among the private-pay, Medicare and Medicaid
categories, and among different types of private-pay sources, could
significantly affect the profitability of CBHS's hospital operations. Moreover,
there can be no assurance that payments under governmental and private
third-party payor programs will remain at levels comparable to present levels or
will, in the future, be sufficient to cover the costs of providing care to
patients covered by such programs.
GOVERNMENTAL BUDGETARY CONSTRAINTS AND HEALTHCARE REFORM. In the 1995 and
1996 sessions of the United States Congress, the focus of healthcare legislation
was on budgetary and related funding mechanism issues. Both the Congress and the
Clinton Administration have made proposals to reduce the rate of increase in
projected Medicare and Medicaid expenditures and to change funding mechanisms
and other aspects of both programs. The Budget Act, which was signed into law by
President Clinton in August 1997, reduces federal spending by an estimated $140
billion. The majority of the spending reduction will come from Medicare cuts of
$115 billion and Medicaid cuts of $14 billion over the next five years.
Physicians and hospitals are expected to absorb the majority of these spending
cuts. Budget cuts affecting behavioral healthcare organizations include
reductions in reimbursement related to TEFRA, bad debt and capital costs.
The Medicaid-related provisions of the Budget Act are designed to achieve
net federal Medicaid savings of $14.6 billion over the next five years and $56.4
billion over the next ten years. The Budget Act achieves federal Medicaid
savings in three areas. First, two-thirds of the savings over the next ten years
are attributable to limitations on federal matching payments to states for
reimbursements to "disproportionate share" hospitals. The next largest source of
federal savings is a provision allowing states to shift the cost of Medicaid
deductibles and coinsurance requirements for low-income Medicaid beneficiaries
from their Medicaid programs to physicians and other providers. Most of the
remaining savings derive from the repeal of the "Boren Amendment" and other
minimum payment guarantees for hospitals, nursing homes and community health
centers that service Medicaid patients.
CBHS management estimates that the Budget Act will reduce the amount of
revenue and earnings that CBHS will receive for the treatment of Medicare and
Medicaid patients. CBHS management estimates that such reductions will
approximate $10 million in fiscal 1998, and due to the phase-in effects of the
bill, approximately $15 million annually in subsequent fiscal years.
A number of states in which CBHS has operations have either adopted or are
considering the adoption of healthcare reform proposals of general applicability
or Medicaid reform proposals. Where adopted, these state reform laws have often
not yet been fully implemented. The Company cannot predict the effect of these
state healthcare reform proposals on CBHS's operations. The Company cannot
predict the effect of other healthcare reform measures that may be adopted by
Congress, on the operations of CBHS and no assurance can be given that other
federal healthcare reform measures will not have an adverse effect on CBHS.
DEPENDENCE ON HEALTHCARE PROFESSIONALS. Physicians traditionally have been
the source of a significant portion of the patients treated at CBHS's hospitals.
Therefore, the success of CBHS's hospitals is dependent in part on the number
and quality of the physicians on the medical staffs of the hospitals and their
admission practices. A small number of physicians account for a significant
portion of patient admissions at some of CBHS's hospitals. There can be no
assurance that CBHS can retain its current physicians on staff or that
additional physician relationships will be developed in the future. Furthermore,
hospital physicians generally are not employees of CBHS and, in general, CBHS
does not have contractual arrangements with hospital physicians restricting the
ability of such physicians to practice elsewhere.
POTENTIAL GENERAL AND PROFESSIONAL LIABILITY. In recent years, physicians,
hospitals, and other healthcare professionals and providers have become subject
to an increasing number of lawsuits alleging medical malpractice and related
legal theories. Many of these lawsuits involve large claims and substantial
defense
38
costs. CBHS maintains a general and hospital professional liability insurance
policy with an unaffiliated insurer. In addition, CBHS' hospitals require all
physicians on each hospital's medical staff to maintain professional liability
coverage. Management believes that its coverage limits are adequate, however,
there can be no assurance that a future claim or claims will not exceed the
limits of these existing insurance policies or that a loss or losses for which
insurance is unavailable will not have a material adverse effect on CBHS.
GOVERNMENT REGULATION. The operation of psychiatric hospitals and other
behavioral healthcare facilities and the provision of behavioral healthcare
services are subject to extensive federal, state and local laws and regulations.
These laws and regulations provide for periodic inspections or other reviews by
state agencies, the Department and CHAMPUS. The admission and treatment of
patients at psychiatric hospitals is also subject to substantial state
regulation relating to involuntary admissions, confidentiality of patient
medical information, patients' rights and federal regulation relating to
confidentiality of medical records of substance abuse patients. CBHS is also
subject to state certificate of need laws that regulate the construction of new
hospitals and the expansion of existing hospital facilities and services.
CBHS also is subject to federal and state laws that govern financial and
other arrangements between healthcare providers. Such laws include the
Anti-Kickback Statute, Stark II and state illegal remuneration and self-referral
statutes and regulations that prohibit payments in exchange for referrals and
referrals by physicians or other healthcare providers to persons or entities
with which the physician or other healthcare provider has a financial
relationship.
The Medicare and Medicaid Patient and Program Protection Act of 1987
expanded the authority of the Department to exclude from participation in the
Medicare and Medicaid programs those individuals and entities that engage in
defined prohibited activities. The Department's exclusion authority was recently
expanded under HIPAA and the Budget Act, which added additional grounds for
exclusion, established minimum exclusion periods for certain offenses and
expanded the scope of the exclusion to include all federal healthcare programs.
The Department also has the authority to impose civil monetary penalties for
certain prohibited activities. HIPAA increased the amount of authorized
penalties from $2,000 per item or service claimed to $10,000 per item or service
claimed, and increased the assessment to which a person may be subject in lieu
of damages from two times the amount claimed for each item or service to three
times the amount claimed. Both HIPAA and the Budget Act expanded the
Department's authority to impose civil monetary penalties by adding additional
activities for which civil monetary penalties may be imposed.
Provisions contained in HIPAA and the Budget Act also created new criminal
healthcare fraud offenses that are applicable to both government programs and
private health insurance plans and added new programs and increased funding for
fraud and abuse detection and prevention.
CHAMPUS regulations also authorize the exclusion of providers from the
CHAMPUS program, if the provider has committed fraud or engaged in certain
"abusive practices," which are defined broadly to include, among other things,
the provision of medically unnecessary services, the provision of care of
inferior quality and the failure to maintain adequate medical or financial
records.
INTELLECTUAL PROPERTY.
The Company owns certain intellectual property which is important to its
franchise operations. The Company has registered as trademarks both the
"CHARTER" name and "800-CHARTER." The Company also owns the "Charter System,"
which is a system for the operation of businesses specializing in the delivery
of behavioral healthcare under the "CHARTER" names and marks. The Charter System
includes treatment programs and procedures, quality standards, quality
assessment methods, performance improvement and monitoring programs, advertising
and marketing assistance, promotional materials, consultation and other matters
related to the operation of businesses specializing in the delivery of
behavioral healthcare.
39
EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AND AGE POSITION WITH THE COMPANY AND PRINCIPAL
OF EXECUTIVE OFFICER OCCUPATIONS DURING THE PAST FIVE YEARS
--------------------- --------------------------------------------------------------------------
E. Mac Crawford Chairman of the Board of Directors, President and Chief Executive Officer
48 (since 1993); President and Chief Operating Officer (1992-1993) and
Director (since 1990)
Henry T. Harbin M.D. Executive Vice President of the Company (since December 1995); President
51 and Chief Executive Officer of Green Spring Health Services, Inc. (since
1994); Executive Vice President and Chief Clinical Officer of Green Spring
(1993-1994)
Danna Mauch, Ph.D. Executive Vice President of the Company and President and Chief Operating
47 Officer of Magellan Public Solutions, Inc. (since May 1996); President,
Integrated Health Strategies, Inc. (1990-April 1996)
Craig L. McKnight Executive Vice President and Chief Financial Officer (since October 1995);
46 Executive Vice President--Office of the President and Chairman (March
1995-September 1995); Partner, Coopers & Lybrand L.L.P. (1985-1995)
Jack D. Williams Executive Vice President of the Company (since December 1997) and
57 President and Chief Executive Officer of HAI (since 1993)
Integrated Health Strategies, Inc. ("IHS") was a consulting firm for health
and human services organizations. As president of IHS, Dr. Mauch assisted health
and human services executives, boards of directors and clinical leaders with
strategic planning, policy analysis and program development.
Coopers & Lybrand L.L.P is an international accounting firm that provides
accounting and auditing services, tax services and consulting services. As an
audit partner at Coopers & Lybrand L.L.P. from 1985 to 1995, Mr. McKnight had
responsibility for a wide range of hospital and managed care engagements, as
well as assisting clients with formulating financing options, financial
restructuring and the purchase/sale of health plans and facilities.
EMPLOYEES OF THE REGISTRANT
At September 30, 1997, the Company had approximately 5,000 full-time and
part-time employees, which excludes CBHS. The Company believes it has
satisfactory relations with its employees.
INTERNATIONAL OPERATIONS
The Company owns and operates two psychiatric hospitals in London, England
(a 45-bed hospital and a 78-bed hospital) and a 69-bed psychiatric hospital in
Nyon, Switzerland. The Company's international hospital operations are not
material to the Company's overall operations.
ITEM 2. PROPERTIES
GENERAL. The Company's principal executive offices are located in Atlanta,
Georgia; the lease for the Company's headquarters expires in 1999.
MANAGED CARE BUSINESS. Green Spring leases its 83 offices with terms
expiring between 1997 and 2020. Green Springs' headquarters are leased and are
located in Columbia, Maryland with lease terms expiring between 1998 and 2002.
PUBLIC SECTOR BUSINESS. Mentor and Public Solutions lease their 68 offices
with terms expiring between 1998 and 2002. Mentor and Public Solutions'
headquarters are leased and are located in Boston, Massachusetts with lease
terms expiring in 2002.
40
PROVIDER AND FRANCHISE BUSINESS. The Company has a controlling interest in
six hospital-based Joint Ventures that operate or manage 10 behavioral
healthcare facilities ("JV Hospitals"). The Joint Ventures own six of the JV
Hospitals and lease two of the JV Hospitals from the respective Joint Venture
owners. The remaining two JV Hospitals are owned by the respective Joint Venture
owners.
The Company owns two behavioral healthcare facilities in the United Kingdom
and one in Switzerland. One of the United Kingdom facilities is subject to a
land-lease that expires in 2069.
ITEM 3. LEGAL PROCEEDINGS
The management and administration of the delivery of managed behavioral
healthcare services, and the direct provision of behavioral health treatment
services, entail significant risks of liability. In recent years, the Company
and its network providers have been subject to a number of actions and claims
alleging malpractice, professional negligence and other related legal theories.
Many of these actions and claims seek substantial damages and therefore require
the Company to incur significant fees and costs related to their defense.
From time to time, the Company is subject to various actions and claims
arising from the acts or omissions of its employees, its network providers or
other parties. In the normal course of its business, the Company receives
reports relating to suicides and other serious incidents involving patients
enrolled in the Company's programs. Such incidents may give rise to malpractice,
professional negligence and other related actions and claims against the
Company, its employees and its network providers. As the number of lives covered
by the Company grows, the number of providers under contract with the Company
increases and the nature and scope of services provided by the Company in its
managed care and EAP business expands, actions and claims against the Company
(and, in turn, possible legal liability) predicated on malpractice, professional
negligence or other related legal theories can be expected to increase. See
"Item 1. Business--Regulation--General."
To the extent the Company's customers are entitled to indemnification under
their contracts with the Company relating to liabilities they incur arising from
the operation of the Company's programs, such indemnification may not be covered
under the Company's insurance policies. In addition, to the extent that certain
actions and claims seek punitive and compensatory damages arising from alleged
intentional misconduct by the Company, such damages, if awarded, may not be
covered, in whole or in part, by the Company's insurance policies. In the
ordinary course of business, the Company is also subject to actions and claims
with respect to its employees, network providers and suppliers of services. The
Company does not believe that any pending action against the Company, HAI or
Allied will have a material adverse effect on the Company. To date, claims and
actions against the Company, HAI or Allied alleging professional negligence have
not resulted in material liabilities to the Company, HAI or Allied; however,
there can be no assurance that pending or future actions or claims for
professional liability (including any judgments, settlements or costs associated
therewith) will not have a material adverse effect on the Company. See "Item 1.
Business--Insurance."
Certain of the Company's subsidiaries are subject to or parties to claims,
civil suits and governmental investigations and inquiries relating to their
operations and certain alleged business practices. In the opinion of management,
based on consultation with counsel, resolution of these matters will not have a
material adverse effect on the Company's financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
41
PART II
ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company has one class of Common Stock, $0.25 par value per share, which
was listed for trading on the American Stock Exchange through December 30, 1996
(ticker symbol "MGL"), and on the New York Stock Exchange, effective December
31, 1996. As of November 30, 1997, there were 9,597 holders of record of the
Company's Common Stock. The following table sets forth the high and low sales
prices of the Company's Common Stock from October 1, 1995 through the fiscal
year ended September 30, 1997 as reported by the American Stock Exchange
(through December 30, 1996) and the New York Stock Exchange (since December 31,
1996):
COMMON STOCK SALES
PRICES
--------------------
CALENDAR YEAR HIGH LOW
--------------------------- --------- ---------
1995
Fourth Quarter.......................................................... $ 24 1/4 $ 17 3/8
1996
First Quarter........................................................... 25 21 3/8
Second Quarter.......................................................... 24 7/8 21
Third Quarter........................................................... 21 5/8 14 3/4
Fourth Quarter.......................................................... 22 5/8 17 1/2
1997
First Quarter........................................................... 26 20 5/8
Second Quarter.......................................................... 29 1/2 24 1/2
Third Quarter........................................................... 33 3/4 29 9/16
The Company has not declared any cash dividends during fiscal 1996 or 1997.
As of November 30, 1997, the Company was prohibited from paying dividends on its
Common Stock under the terms of the Magellan Existing Credit Agreement.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical consolidated financial
information of the Company for each of the five years in the period ended
September 30, 1997. In 1993, the Company restated its consolidated financial
statements to reflect the sale of certain subsidiaries as discontinued
operations. The summary of operations and balance sheet data for the five years
ended and as of September 30, 1997, presented below, have been derived from, and
should be read in conjunction with, the Company's audited consolidated financial
statements and the related notes thereto. The following financial information
should be read in conjunction "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
of the Company included elsewhere herein for the year ended September 30, 1997.
42
SUMMARY OF OPERATIONS
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
SUMMARY OF OPERATIONS DATA:
Net revenue....................................... $ 897,907 $ 904,646 $ 1,151,736 $ 1,345,279 $ 1,210,696
Salaries, cost of care and other operating
expenses........................................ 640,847 661,436 863,598 1,064,445 978,513
Bad debt expense.................................. 67,300 70,623 92,022 81,470 46,211
Depreciation and amortization..................... 26,382 28,354 38,087 48,924 44,861
Amortization of reorganization value in excess of
amounts allocable to identifiable assets........ 42,678 31,200 26,000 -- --
Interest, net..................................... 74,156 39,394 55,237 48,017 45,377
ESOP expense...................................... 45,874 49,197 73,257 -- --
Stock option expense (credit)..................... 38,416 10,614 (467) 914 4,292
Equity in loss of CBHS............................ -- -- -- -- 8,122
Loss on Crescent Transactions..................... -- -- -- -- 59,868
Unusual items..................................... -- 71,287 57,437 37,271 357
Income (loss) from continuing operations before
income taxes, minority interest and
extraordinary items............................. (37,746) (57,459) (53,705) 64,238 23,095
Provision for (benefit from) income taxes......... 1,874 (10,504) 11,082 25,695 9,238
Income (loss) from continuing operations before
minority interest and extraordinary items....... (39,620) (46,955) (42,623) 38,543 13,857
Minority interest................................. -- 48 340 6,160 9,102
Income (loss) before discontinued operations and
extraordinary items............................. (39,620) (47,003) (42,963) 32,383 4,755
Discontinued operations:
Loss from discontinued operations............... (14,703) -- -- -- --
Gain on disposal of discontinued operations..... 10,657 -- -- -- --
Income (loss) before extraordinary items........ (43,666) (47,003) (42,963) 32,383 4,755
Extraordinary items-losses on early
extinguishments or discharge of debt.......... (8,561) (12,616) -- -- (5,253)
Net income (loss)............................... $ (52,227) $ (59,619) $ (42,963) 32,383 $ (498)
Income (loss) per common share--primary:
Income (loss) from continuing operations before
extraordinary item............................ $ (1.59) $ (1.78) $ (1.54) $ 1.04 $ 0.16
Loss from discontinued operations and disposal
of discontinued operations.................... (0.16) -- -- -- --
Income (loss) before extraordinary items.......... (1.75) (1.78) (1.54) 1.04 0.16
Net income (loss)............................... $ (2.10) $ (2.26) $ (1.54) $ 1.04 $ (0.02)
Income (loss) per common share--fully diluted:
Income (loss) from continuing operations before
extraordinary items........................... $ (1.59) $ (1.78) $ (1.54) $ 1.04 $ 0.16
Loss from discontinued operations and disposal
of discontinued operations.................... (0.16) -- -- -- --
Income (loss) before extraordinary items........ (1.75) (1.78) (1.54) 1.04 0.16
Net income (loss)............................... $ (2.10) $ (2.26) $ (1.54) $ 1.04 $ (0.02)
43
SEPTEMBER 30,
-------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- ----------- ---------
(IN THOUSANDS)
BALANCE SHEET DATA (END OF PERIOD):
Current assets....................................... $ 231,915 $ 324,627 $ 305,575 $ 338,150 $ 507,038
Current liabilities.................................. 272,598 215,048 214,162 274,316 219,376
Property and equipment net........................... 444,786 494,345 488,767 495,390 109,214
Total assets......................................... 838,186 961,480 983,558 1,140,137 895,620
Total debt and capital lease obligations............. 421,162 536,129 541,569 572,058 395,294
Stockholders' equity................................. 57,298 56,221 88,560 121,817 158,250
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Although
the Company believes that its plans, intentions and expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
such plans, intentions or expectations will be achieved. Important factors that
could cause actual results to differ materially from the Company's
forward-looking statements are set forth elsewhere in this Form 10-K. All
forward-looking statements attributable to the Company or persons acting on
behalf of the Company are expressly qualified in their entirety by the
cautionary statements set forth elsewhere in this Form 10-K. See
"--Business--Cautionary Statements--The Company" and "--Charter Advantage--
Cautionary Statements--CBHS."
OVERVIEW
The Company has historically derived the majority of its revenue and
earnings from providing healthcare services in an inpatient setting. Payments
from third-party payors are the principal source of revenue for most healthcare
providers. In the early 1990's, many third-party payors sought to control the
cost of providing care to their patients by instituting managed care programs or
seeking the assistance of managed care companies. Providers participating in
managed care programs agree to provide services to patients for a discount from
established rates, which generally results in pricing concessions by the
providers and lower margins. Additionally, managed care programs generally
encourage alternatives to inpatient treatment settings and reduce utilization of
inpatient services. Third-party payors established managed care programs or
engaged managed care companies in many areas of healthcare, including behavioral
healthcare. The Company, which, until June 1997, was the largest operator of
psychiatric hospitals in the United States, was adversely affected by the
adoption of managed care programs as the principal cost control measure of the
third-party payors.
Prior to the first quarter of fiscal 1996, the Company was not a provider of
behavioral managed care services. During the first quarter of fiscal 1996, the
Company acquired a 61% ownership interest in Green Spring. At that time, the
Company intended to become a fully integrated behavioral healthcare by combining
the managed behavioral healthcare products offered by Green Spring with the
direct treatment services offered by the Company's psychiatric hospitals. The
Company believed that an entity that participated in both the managed care and
provider segments of the behavioral healthcare industry could more efficiently
provide and manage behavioral healthcare for insured populations than an entity
that was solely a managed care company. The Company also believed that earnings
from its managed care business would offset, in part, the negative impact on the
financial performance of its psychiatric hospitals caused by managed care. Green
Spring was the Company's first significant involvement in managed behavioral
healthcare.
Subsequent to the Company's acquisition of Green Spring, the growth of the
managed behavioral healthcare industry accelerated. Under the Company's majority
ownership, Green Spring increased its base of covered lives from 12.0 million as
of the end of calendar year 1995 to 16.6 million as of the end of fiscal 1997, a
compound annual growth rate of over 17%. While growth in the industry was
accelerating,
44
the managed behavioral healthcare industry also began to consolidate. The
Company concluded that consolidation presented an opportunity for the Company to
increase its participation in the managed behavioral healthcare industry, which
the Company believed offered growth and earnings prospects superior to those of
the psychiatric hospital industry. Therefore, the Company decided to sell its
domestic psychiatric facilities to obtain capital for expansion in the managed
behavioral healthcare business.
During the third quarter of fiscal 1997, the Company sold the Psychiatric
Hospital Facilities, which comprised substantially all of its domestic
acute-care psychiatric hospitals and residential treatment facilities, to
Crescent for $417.2 million in cash (before costs of approximately $16.0
million) and certain other consideration. The sale of the Psychiatric Hospital
Facilities provided the Company with approximately $200 million of net cash
proceeds, after debt repayment, for use in implementing its business strategy.
The Company used the net cash proceeds to finance the acquisitions of HAI and
Allied in December 1997. The Company intends to further implement its business
strategy through the Acquisition. See "Item 1. Business--The Transactions."
The Company generates a significant portion of its revenue and earnings from
its managed care business. A significant portion of the Company's managed care
revenue and earnings are generated from risk-based products, and such portion
will increase following the Acquisition. The Company believes enrollment in
risk-based products will continue to grow through new covered lives and the
transition of covered lives in ASO and EAP products to higher revenue risk-based
products. Risk-based products typically generate significantly higher amounts of
revenue than other managed behavioral healthcare products. Because the Company
is responsible for the cost of care, risk-based products typically have lower
margins than non-risk-based products. The Company continually focuses on
reducing its cost of care.
RESULTS OF OPERATIONS
GENERAL
For fiscal years prior to 1996, the Company did not have any material
operations other than the provider business. The following table summarizes, for
the periods indicated, operating results by business segment (in thousands):
MANAGED PUBLIC HEALTHCARE
CARE SECTOR FRANCHISING PROVIDER CORPORATE
1996 BUSINESS BUSINESS BUSINESS BUSINESS OVERHEAD CONSOLIDATED
- --------------------------------------- --------- --------- ----------- ----------- ----------- ------------
Net revenue............................ $ 229,859 $ 70,709 $ -- $ 1,044,711 $ -- $1,345,279
--------- --------- ----------- ----------- ----------- ------------
Salaries, cost of care and other
operating expenses................... 202,690 60,840 -- 766,129 34,786 1,064,445
Bad debt expense....................... 1,192 347 -- 79,931 -- 81,470
Depreciation and amortization.......... 9,111 2,580 -- 34,201 3,032 48,924
Stock Option Expense................... -- -- -- -- 914 914
Unusual items (1)...................... -- -- -- 36,050 1,221 37,271
--------- --------- ----------- ----------- ----------- ------------
212,993 63,767 -- 916,311 39,953 1,233,024
--------- --------- ----------- ----------- ----------- ------------
Operating profit................... $ 16,866 $ 6,942 $ -- $ 128,400 $ (39,953) $ 112,255
--------- --------- ----------- ----------- ----------- ------------
--------- --------- ----------- ----------- ----------- ------------
MANAGED PUBLIC HEALTHCARE
CARE SECTOR FRANCHISING PROVIDER CORPORATE
1997 BUSINESS BUSINESS BUSINESS BUSINESS OVERHEAD CONSOLIDATED
- --------------------------------------- --------- --------- ----------- ----------- ----------- ------------
Net revenue............................ $ 363,883 $ 94,422 $ 22,739 $ 729,652 $ -- $1,210,696
--------- --------- ----------- ----------- ----------- ------------
Salaries, cost of care and other
operating expenses................... 323,814 86,709 3,652 538,760 25,578 978,513
Bad debt expense....................... 192 (126) -- 46,145 -- 46,211
Depreciation and amortization.......... 13,016 2,904 160 24,528 4,253 44,861
Stock Option Expense................... -- -- -- -- 4,292 4,292
Unusual items (1)...................... -- -- -- 5,745 -- 5,745
--------- --------- ----------- ----------- ----------- ------------
337,022 89,487 3,812 615,178 34,123 1,079,622
--------- --------- ----------- ----------- ----------- ------------
Operating profit................... $ 26,861 $ 4,935 $ 18,927 $ 114,474 $ (34,123) $ 131,074
--------- --------- ----------- ----------- ----------- ------------
--------- --------- ----------- ----------- ----------- ------------
- ------------------------
(1) Includes charges for insurance settlements, facility closures, asset
impairments and other amounts.
45
FISCAL 1996 COMPARED TO FISCAL 1997
REVENUE. Managed care business revenue increased 58.3%, or $134.0 million,
in fiscal 1997 compared to fiscal 1996. The increase resulted primarily from the
inclusion of a full year of Green Spring operations in fiscal 1997 results.
Managed care business revenue was also positively impacted by the award of
several new contracts to Green Spring in the fourth quarter of fiscal 1996 and
in fiscal 1997, resulting in a 22% increase in covered lives on September 30,
1997 as compared to September 30, 1996.
Public sector business revenue increased 33.5%, or $23.7 million, in fiscal
1997 compared to fiscal 1996. The increase was primarily attributable to a 23%
increase in placements in Mentor homes and $5.2 million in additional revenues
from correctional contracts awarded in fiscal 1996 and fiscal 1997.
Healthcare franchising business revenue was $22.7 million for fiscal 1997.
The healthcare franchising business revenue consisted of Franchise Fees paid by
CBHS pursuant to the Master Franchise Agreement since the consummation of the
Crescent Transactions.
Provider business revenue decreased 30.2%, or $315.1 million, in fiscal 1997
compared to fiscal 1996. The decrease resulted primarily from: (i) the effect of
the consummation of the Crescent Transactions on June 17, 1997, following which
revenue from the Psychiatric Hospital Facilities and other facilities
transferred to CBHS was no longer recorded as part of the Company's revenue;
(ii) the closure of hospitals in fiscal 1996 and 1997; and (iii) reduced
equivalent patient days at the Company's operating hospitals as a result of
reduced average length of stay. During fiscal 1996 and 1997, the Company
recorded revenue of $28.3 million and $27.4 million, respectively, for
settlements and adjustments related to reimbursement issues with respect to
psychiatric hospital facilities owned by the Company. The settlements and
adjustments related primarily to certain reimbursement issues associated with
the Company's financial reorganization in fiscal 1992 and early extinguishment
of long-term debt in fiscal 1994. Management anticipates that revenue related to
such settlements will decline significantly for fiscal 1998.
SALARIES, COST OF CARE AND OTHER OPERATING EXPENSES. Salaries, cost of care
and other operating expenses attributable to the managed care business increased
59.8%, or $121.1 million, in fiscal 1997 compared to fiscal 1996 as a result of
the acquisition of Green Spring and its growth during the period.
With respect to the public sector business, salaries, cost of care and other
operating expenses increased 42.5%, or $25.9 million, in fiscal 1997 compared to
fiscal 1996 due to internal growth, increases in costs related to expansion and
approximately $1.2 million of expenditures related to new product development.
The Company recorded no expenses with respect to the healthcare franchising
business during fiscal 1996 because the Crescent Transactions were not
consummated until the third quarter of fiscal 1997.
Salaries, cost of care and other operating expenses attributable to the
provider business decreased 29.7%, or $227.4 million, in fiscal 1997 compared to
fiscal 1996. The decrease resulted primarily from: (i) the effect of the
consummation of the Crescent Transactions, following which operating expenses of
the Psychiatric Hospital Facilities and other facilities transferred to CBHS
were no longer accounted for as part of the Company's operating expenses and
(ii) the closure of hospitals during fiscal 1996 and 1997. During fiscal 1996
and 1997, the Company recorded reductions of expenses of approximately $15.3
million and $7.5 million, respectively, as a result of updated actuarial
estimates related to malpractice claim reserves. These reductions resulted
primarily from updates to actuarial assumptions regarding the Company's expected
losses for more recent policy years. These revisions are based on changes in
expected values of ultimate losses resulting from the Company's claim
experience, and increased reliance on such claim experience. While management
and its actuaries believe that the present reserve is reasonable, ultimate
settlement of losses may vary from the amount recorded and result in additional
fluctuations in income in future periods.
46
Salaries and other operating expenses attributable to the Company's
headquarters' decreased 26.5%, or $9.2 million, due primarily to the transfer of
personnel and overhead to CBHS and the healthcare franchising business as a
result of the Crescent Transactions.
BAD DEBT EXPENSE. Bad debt expense, which is primarily attributable to the
provider business, decreased 43.3%, or $35.3 million, in fiscal 1997 compared to
fiscal 1996. The decrease was primarily attributable to: (i) the effect of the
consummation of the Crescent Transactions, following which the bad debt expense
incurred by the Psychiatric Hospital Facilities and other facilities transferred
to CBHS was no longer accounted for as part of the Company's bad debt expense;
(ii) improved accounts receivable aging and turnover compared to prior periods;
and (iii) a shift towards governmental and managed care payors, which reduced
the Company's credit risk associated with individual patients.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
8.3%, or $4.1 million, in fiscal 1997 compared to fiscal 1996. The decrease was
primarily attributable to the effect of the consummation of the Crescent
Transactions, whereby the Psychiatric Hospital Facilities were sold to Crescent,
offset by increases in depreciation and amortization resulting from the Green
Spring acquisition.
INTEREST, NET. Interest expense, net, decreased 5.5%, or $2.6 million, in
fiscal 1997 compared to fiscal 1996. The decrease was primarily the result of
lower interest expense due to lower average borrowings and higher interest
income due to temporary investments of the cash received in the Crescent
Transactions. Fiscal 1996 included approximately $5.0 million of interest income
related to income tax refunds from the State of California for the Company's
income tax returns for fiscal 1982 through 1989.
OTHER ITEMS. Stock option expense for fiscal 1997 increased $3.4 million
from fiscal 1996 primarily due to fluctuations in the market price of the
Company's Common Stock.
The Company recorded equity in the loss of CBHS of $8.1 million in fiscal
1997, representing the Company's proportionate (50%) loss in CBHS for the 106
days ended September 30, 1997.
The Company recorded a loss on the Crescent Transactions of approximately
$59.9 million during fiscal 1997.
The Company recorded unusual items, net, of $0.4 million during fiscal 1997,
which consisted of: (i) a $5.4 million net pre-tax gain on the sales of
previously closed psychiatric hospitals; (ii) a $4.2 million charge for the
closure of three psychiatric hospitals and one general hospital; and (iii) a
$1.6 million charge related to the termination of an agreement to sell the
Company's European hospitals.
Minority interest increased $2.9 million during fiscal 1997 compared to
fiscal 1996. The increase was primarily due to: (i) the Company acquiring a
controlling interest in Green Spring in December 1995; (ii) Green Spring's
internal growth subsequent to the acquisition date; and (iii) increased net
income from hospital-based joint ventures.
The Company recorded extraordinary losses on early extinguishment of debt,
net of tax, of $5.3 million during fiscal 1997.
The fourth quarter of fiscal 1997 included increases to income before income
taxes and minority interest of approximately $6.4 million for revenue and bad
debt adjustments related to accounts receivable retained by the Company that
were generated by the hospitals operated by CBHS. Such adjustments reflect a
change in estimates of contractual allowances and allowance for doubtful
accounts of such receivables based on the collection activity subsequent to the
completion of the Crescent Transactions.
FISCAL 1995 COMPARED TO FISCAL 1996.
REVENUE. The Company's net revenue for fiscal 1996 increased 16.8%, or
$193.5 million, compared to fiscal 1995. The increase resulted primarily from
the acquisitions of Green Spring and Mentor offset in part by: (i) the effect of
hospitals closed during fiscal 1995 and 1996 and (ii) the decrease in revenue
per
47
equivalent patient day in fiscal 1996. Net revenue per equivalent patient day at
the Company's psychiatric hospitals decreased in 1996 by 4.5% compared to fiscal
1995. The decreases were primarily due to: (i) continued shift in payor mix from
private payor sources to managed care payors and governmental payors; (ii)
pricing pressure from certain payors, primarily related to the denial of claims
payable to the hospitals; (iii) lower settlements of reimbursement issues; (iv)
shifts in program mix to residential treatment settings from acute care
settings; and (v) the elimination of ESOP expense in fiscal 1996, which resulted
in lower Medicare reimbursement levels.
Managed care business revenue was $229.9 million in 1996, as a result of the
acquisition of Green Spring during the first quarter of fiscal 1996.
Public sector business revenue increased from $44.8 million in fiscal 1995
to $70.7 million in fiscal 1996 as a result of the inclusion of a full year of
operations of Mentor, which was acquired in January 1995.
During fiscal 1995 and 1996, the Company recorded revenue of $35.6 million
and $28.3 million, respectively, for settlements and adjustments related to
reimbursement issues with respect to psychiatric hospital facilities owned by
the Company. The settlements in fiscal 1995 and 1996 related primarily to
certain reimbursable costs associated with the Company's financial
reorganization in fiscal 1992 and costs related to the early extinguishment of
long-term debt in fiscal 1994.
SALARIES, COST OF CARE AND OTHER OPERATING EXPENSES. The Company's
salaries, cost of care and other operating expenses increased 23.3%, or $200.8
million, in fiscal 1996 compared to fiscal 1995. The increase resulted primarily
from the acquisitions of Green Spring and Mentor, offset in part by: (i) the
effect of hospitals closed in fiscal 1995 and 1996 and (ii) adjustments, as a
result of updated actuarial estimates to malpractice claim reserves, which
resulted in a reduction of expenses of approximately $15.3 million during fiscal
1996.
Managed care business salaries, cost of care and other operating expenses
were $202.7 million during fiscal 1996 as a result of the Green Spring
acquisition.
Public sector business salaries, cost of care and other operating expenses
increased from $38.1 million in fiscal 1995 to $60.8 million during fiscal 1996
as a result of the Mentor acquisition.
BAD DEBT EXPENSE. The Company's bad debt expense decreased 11.5%, or $10.6
million, during fiscal 1996 compared to fiscal 1995. The decrease was primarily
due to (i) the shift in the provider business to managed care payors, which
reduces the Company's credit risk associated with individual patients, and (ii)
the number of reduced days of net revenue in its hospital receivables at
September 30, 1996.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
28.5%, or $10.8 million, during fiscal 1996 compared to fiscal 1995. The
increase resulted primarily from depreciation and amortization related to the
acquisition of Green Spring.
Reorganization value in excess of amounts allocable to identifiable assets
("Reorganization Value") and ESOP expense were not recorded in fiscal 1996 as a
result of the completion of the amortization of Reorganization Value in fiscal
1995 and the Company's decision to allocate all existing shares held by the ESOP
to the participants as of September 30, 1995.
INTEREST, NET. Interest expense, net, decreased 13.1%, or $7.2 million,
during fiscal 1996 compared to fiscal 1995. The decrease resulted primarily from
approximately $5.0 million of interest income recorded during fiscal 1996
related to income tax refunds due from the State of California for the Company's
income tax returns for fiscal 1982 through 1989.
OTHER ITEMS. Stock option expense for fiscal 1996 increased $1.4 million
from the previous year due to fluctuations in the market price of the Company's
Common Stock.
48
During fiscal 1996, the Company recorded unusual items of $37.3 million.
Included in the unusual charges was the resolution of a billing dispute in
August 1996 between the Company and a group of insurance carriers that arose in
fiscal 1996 related to matters originating in the 1980's. As part of the
settlement of these claims, certain related payor matters and associated legal
fees, the Company recorded a charge of approximately $30.0 million. The Company
is paying the insurance settlement in twelve installments over a three-year
period. The Company's obligation to make the settlement payments is supported by
a cash collateralized letter of credit. Other unusual items included: (i)
charges of approximately $4.1 million during fiscal 1996 related to the closure
of psychiatric hospitals; (ii) a charge of approximately $1.2 million related to
impairment losses; and (iii) charges of approximately $2.0 million related to
severance costs for personnel reductions.
During fiscal 1995, the Company recorded unusual items of $57.4 million. The
unusual charges include the resolution in March 1995 of disputes between the
Company and a group of insurance carriers that arose in fiscal 1995 related to
claims paid predominantly in the 1980's. As part of the resolution, the Company
agreed to pay the insurance carriers approximately $29.8 million in five
installments over a three-year period. Other unusual items included: (i) a
charge of approximately $3.6 million related to the closure of five psychiatric
hospitals; (ii) a charge of approximately $27.0 million related to the adoption
and implementation of Statement of Financial Accounting Standards No. 121; and
(iii) a gain of approximately $3.0 million on the sale of three psychiatric
hospitals.
In fiscal 1995, the Company recorded an income tax benefit because it had a
net operating loss during the period. The Company's effective tax rate was 40.0%
during fiscal 1996. The change in the effective tax rate was primarily
attributable to: (i) the elimination of non-deductible amortization of
Reorganization Value in fiscal 1996 and (ii) the reduction in the Company's
effective tax rate as a result of the favorable resolution of the Company's
California income tax returns for fiscal 1982 through 1989, partially offset by
the increase in non-deductible intangible amortization in fiscal 1996 as a
result of the acquisitions of Mentor and Green Spring.
Minority interest increased $5.8 million during fiscal 1996 compared to
fiscal 1995. The increase was primarily due to the Company acquiring a
controlling interest in Green Spring in December 1995 and obtaining a
controlling interest in other businesses during fiscal 1995 and 1996.
IMPACT OF CRESCENT TRANSACTIONS
The Company owns a 50% equity interest in CBHS, from which it receives the
Franchise Fees. The Franchise Fees represent a significant portion of the
Company's earnings and cash flows. The following is a discussion of certain
matters related to the Company's ownership of CBHS that may have a bearing on
the Company's future results of operations.
CBHS may consolidate services in selected markets by closing facilities
depending on market conditions and evolving business strategies. For example,
during fiscal 1995 and 1996, the Company consolidated, closed or sold 15 and 9
psychiatric hospitals, respectively. During fiscal 1997, the Company
consolidated or closed three psychiatric hospitals, exclusive of the Crescent
Transactions. If CBHS closes additional psychiatric hospitals, it could result
in charges to income for the costs attributable to the closures, which would
result in lower equity in earnings of CBHS for the Company.
The Company's JV Hospitals and CBHS' hospitals continue to experience a
shift in payor mix to managed care payors from other payors, which contributed
to a reduction in revenue per equivalent patient day in fiscal 1996 and a
decline in average length of stay in fiscal 1995, 1996 and 1997. Management
anticipates a continued shift in hospital payor mix towards managed care payors
as a result of changes in the healthcare marketplace. Future shifts in hospital
payor mix to managed care payors could result in lower revenue per equivalent
patient day and lower average length of stay in future periods for the Company's
JV Hospitals and CBHS' hospitals, which could result in lower equity in earnings
from CBHS for the Company. The hospitals currently managed or operated by CBHS,
including hospitals closed or
49
sold in 1997, reported a 10% reduction in equivalent patient days, a 7%
reduction in average length of stay and a 4% decrease in admissions in fiscal
1997 compared to fiscal 1996.
The Budget Act, which was enacted in August 1997, includes provisions that
eliminated the TEFRA bonus payment and reduced reimbursement of certain costs
previously paid by Medicare and eliminated the Medicaid "disproportionate share"
program. These provisions, along with other provisions in the Budget Act, will
reduce the amount of revenue and earnings that CBHS hospitals will receive for
the treatment of Medicare patients. CBHS management estimates that such
reductions will approximate $10 million in fiscal 1998, and due to the phase-in
effects of the bill, approximately $15 million annually in subsequent fiscal
years.
Based on projections of fiscal 1998 operations prepared by management of
CBHS, the Company believes that CBHS will be unable to pay the full amount of
the Franchise Fees it is contractually obligated to pay the Company during
fiscal 1998. The Company currently estimates that CBHS will be able to pay
approximately $58 to $68 million of the Franchise Fees in fiscal 1998, a $10 to
$20 million shortfall relative to amounts payable under the Master Franchise
Agreement. The Company may be required to record bad debt expense related to
Franchise Fees receivable from CBHS, if any, in fiscal 1998 or future periods if
CBHS's operating performance does not improve to levels achieved prior to the
consummation of the Crescent Transactions. If CBHS defaults in payment of the
Franchise Fees, the Company will pursue all remedies available to it under the
Master Franchise Agreement. See "Item 1. Business--Charter Advantage--Franchise
Operations."
HISTORICAL LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. The Company's net cash provided by operating
activities was $101.9 million and $73.6 million for fiscal 1996 and fiscal 1997,
respectively. The decrease in net cash provided by operating activities in
fiscal 1997 compared to fiscal 1996 was primarily the result of: (i) higher
income tax payments ($9.3 million and $18.4 million in fiscal 1996 and fiscal
1997, respectively); (ii) $5.0 million of interest income related to income tax
refunds from the State of California in fiscal 1996; (iii) higher insurance
settlement payments ($24.6 million in fiscal 1996 and $28.5 million in fiscal
1997); and (iv) reduced cash flows from the provider business, net of franchise
fees received.
INVESTING ACTIVITIES. The Company acquired a 61% ownership interest in
Green Spring during the first quarter of fiscal 1996. The consideration paid for
Green Spring and related acquisition costs resulted in the use of cash of
approximately $87.2 million compared to approximately $50.9 million for
acquisitions and investments in businesses, including CBHS, during fiscal 1997.
The Crescent Transactions resulted in net proceeds of $380.4 million, during
fiscal 1997, consisting of $393.7 million related to the sale of property and
equipment to Crescent and CBHS, less $13.3 million in costs and construction
obligations incurred to date.
The Company made $20.0 million of cash capital contributions to CBHS during
fiscal 1997. The Company expects to fund an additional $10.9 million in
transaction costs and construction costs in fiscal 1998 related to the Crescent
Transactions. The Company has no present intention of making any additional
capital contributions to CBHS.
FINANCING ACTIVITIES. The Company borrowed approximately $104.8 million and
$203.6 million during fiscal 1996 and 1997, respectively. The fiscal 1996
borrowings primarily funded the Green Spring acquisition and $35.0 million of
treasury stock purchases. The fiscal 1997 borrowings primarily funded the
repayment of variable rate secured notes and other long-term debt (including the
refinancing of a previous revolving credit agreement), acquisitions and working
capital needs.
The Company repaid approximately $85.8 million and $390.3 million of debt
and capital lease obligations during fiscal 1996 and 1997, respectively. The
fiscal 1997 repayments related primarily to a
50
previous revolving credit agreement and repaying other indebtedness as a result
of the Crescent Transactions.
On January 25, 1996, the Company sold 4.0 million shares of Common Stock and
a warrant to purchase an additional 2.0 million shares at an exercise price of
$26.15 per share in a private placement transaction. Such warrant, which expires
in January, 2000, became exercisable on January 25, 1997. The Company received
proceeds of approximately $68.6 million, net of issuance costs, from such
private placement. Approximately $68.0 million of the proceeds were used to
repay outstanding borrowings related to the Green Spring acquisition.
The Company issued approximately 2.6 million warrants to Crescent and COI
for $25.0 million in cash as part of the Crescent Transactions during fiscal
1997.
On September 27, 1996, the Company repurchased approximately 4.0 million
shares of its Common Stock for approximately $73.5 million, including
transaction costs, pursuant to a "Dutch Auction" self-tender offer to its
stockholders. On November 1, 1996, the Company announced that its board of
directors approved the repurchase of an additional 3.0 million shares of its
Common Stock from time to time subject to the terms of the Magellan Existing
Credit Agreement.
As of September 30, 1997, the Company had $193.4 million of availability
under the Magellan Existing Credit Agreement. The Company was in compliance with
all debt covenants at September 30, 1997.
PRO FORMA LIQUIDITY AND CAPITAL RESOURCES
Following the consummation of the Transactions, interest payments on the
Notes and interest and principal payments on indebtedness to be outstanding
pursuant to the New Credit Agreement will represent significant liquidity
requirements for the Company. Borrowings under the New Credit Agreement will
bear interest at floating rates and will require interest payments on varying
dates depending on the interest rate option selected by the Company. Borrowings
pursuant to the New Credit Agreement will include $750 million in term loans and
up to $150 million under the Revolving Credit Facility.
The Company is in the process of formulating its plans for, and determining
the costs of, the integration of the businesses of Green Spring, HAI and Merit.
The Company expects to implement its integration plan in fiscal 1998 after
consummation of the Transactions. The Company expects to incur costs associated
with reducing duplicative personnel in its managed care organizations,
contractual terminations for eliminating excess real estate (primarily locations
under operating leases) and other related costs in connection with the
integration plan. Furthermore, the Company expects to record an extraordinary
loss of approximately $30 million to $35 million, net of tax benefits, in
connection with refinancing of the Company's debt in connection with the
Transactions.
During December 1997, the Company purchased HAI and Allied for approximately
$122.1 million and $70.0 million, respectively, excluding transaction costs. In
addition, the Company incurred the obligation to make contingent payments to the
former owners of HAI and Allied. With respect to HAI, the Company may be
required to make additional annual contingent payments of up to $60 million to
Aetna during each of the next five years. The Company is obligated to make
contingent payments under two separate calculations. Under the first
calculation, the amount and timing of the contingent payments will be based on
growth in the number of covered lives during the next five years. The Company
may be required to make contingent payments of up to $25 million per year for
each of the five years following the HAI acquisition depending on the net annual
growth in the number of lives covered by certain HAI products. The former owner
of HAI will receive a specified amount per net incremental life covered by such
products. The amount to be paid per incremental covered life decreases during
the five-year term of the Company's contingent payment obligation, reflecting
the added value to the Company of obtaining a covered life in the early years of
the period. Under the second calculation, the Company may also be required to
make contingent payments of up to $35 million per year for each of five years
based on the net
51
cumulative growth in the number of lives covered by certain other HAI products.
The former owner of HAI will receive a specified amount per net incremental life
covered by such products. The amount to be paid per incremental covered life
increases with the number of incremental covered lives.
The Company may be required to pay up to $40 million during the three years
following the closing of the Allied acquisition based on Allied's performance
relative to certain earnings targets. In connection with Merit's acquisition of
CMG Health, Inc. ("CMG"), the Company, by acquiring Merit, may be required to
make certain future contingent cash payments over the next two years to the
former shareholders of CMG based upon the performance of certain CMG customer
contracts. Such contingent payments are subject to an aggregate maximum of $23.5
million.
The Company believes that the cash flow generated from its operations,
including implementation of the integration plan, together with amounts
available for borrowing under the New Credit Agreement, should be sufficient to
fund its debt service requirements, anticipated capital expenditures, contingent
payments, if any, with respect to HAI, Allied and CMG and other investing and
financing activities.
The Company's ability to make capital expenditures and to incur additional
indebtedness are restricted by its debt instruments. Such restrictions, together
with the highly leveraged financial condition of the Company subsequent to the
Transactions, could limit the Company's ability to respond to market
opportunities. The covenants contained in the New Credit Agreement will also,
among other things, restrict the ability of the Company to dispose of assets,
repay other indebtedness, amend other debt instruments (including the Indenture)
pay dividends, create liens on assets, enter into sale and leaseback
transactions, make investments, loans or advances, repurchase common stock and
make acquisitions.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
FAS 128, which applies to entities with publicly held common stock or potential
common stock. FAS 128 replaces APB Opinion 15, "Earnings per Share" and related
interpretations. APB Opinion 15 required that entities with simple capital
structures present a single "earnings per common share" ("EPS") on the face of
the income statement, whereas those with complex capital structures present both
"primary" and "fully diluted" EPS. Primary EPS shows the amount of income
attributed to each share of common stock if every common stock equivalent were
converted into common stock. Fully diluted EPS considers common stock
equivalents and all other securities that could be converted into common stock.
FAS 128 simplifies the computation of EPS by replacing the presentation of
primary EPS with a presentation of basic EPS. FAS 128 requires dual presentation
of basic and diluted EPS by entities with complex capital structures. Basic EPS
includes no dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution of securities that could
share in the earnings of an entity, similar to fully diluted EPS under APB
Opinion 15.
FAS 128 becomes effective for financial statements for both interim and
annual periods ending after December 15, 1997. Earlier application is not
permitted. The Company will adopt FAS 128 during the quarter ended December 31,
1997, which is the first quarter of the fiscal year ended September 30, 1998.
The Company has disclosed pro forma EPS amounts computed using FAS 128 in Note 9
to the financial statements for the years ended September 30, 1995, 1996 and
1997. After the effective date, all prior-period EPS data presented will be
restated to conform with the provisions of FAS 128.
The primary effect of FAS 128 on the Company's financial statements is the
required dual presentation of basic and diluted income per common share for each
interim and annual reporting period. APB Opinion No. 15 allowed entities with
complex capital structures to present income per common share excluding common
stock equivalents and other potentially dilutive securities if the dilution was
less than three percent.
52
MODIFICATION OF COMPUTER SOFTWARE FOR THE YEAR 2000
The Company and its subsidiaries have internally developed computer software
systems that process transactions based on storing two digits for the year of a
transaction (i.e., "97 " for 1997) rather than four digits, which will be
required for year 2000 transaction processing. CBHS expects to spend $1 million
in the aggregate during fiscal 1998 and fiscal 1999 to modify internal use
software. Green Spring expects to spend $0.5 million in the aggregate during
fiscal 1998 and fiscal 1999 to modify internal use software. The Company does
not anticipate incurring any other significant costs for year 2000 software
modification. The cost of modifying internal use software for the year 2000 is
charged to expense as incurred.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to this item is contained in the Company's
Consolidated Financial Statements and financial statement schedule indicated in
the Index on Page F-1 of this Annual Report on Form 10-K and is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
53
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the Company's executive officers is contained
under "Item 1. Business-- Executive Officers of the Registrant." Pursuant to
General Instruction G(3) to Form 10-K, the information required by this item
with respect to directors has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction G(3) to Form 10-K, the information required
with respect to this item has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instruction G(3) to Form 10-K, the information required
with respect to this item has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction G(3) to Form 10-K, the information required
with respect to this item has been omitted inasmuch as the Company files with
the Securities and Exchange Commission a definitive proxy statement not later
than 120 days subsequent to the end of its fiscal year. Such information is
incorporated herein by reference.
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THE REPORT:
1. FINANCIAL STATEMENTS
Information with respect to this item is contained on Pages F-1 to F-57 of
this Annual Report on Form 10-K.
2. FINANCIAL STATEMENT SCHEDULES
Information with respect to this item is contained on page S-1 to S-2 of
this Annual Report on Form 10-K.
3. EXHIBITS
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
2(a) Asset Sale Agreement (First Facilities), dated March 29, 1994, between National Medical Enterprises,
Inc., as Seller, and the Company, as Buyer, which was filed as Exhibit 2(d) to the Company's Amendment
No. 1 to Registration Statement on Form S-4 (No. 33-53701) filed July 1, 1994, and is incorporated
herein by reference.
2(b) Asset Sale Agreement (Subsequent Facilities), dated March 29, 1994, between National Medical
Enterprises, Inc., as Seller, and the Company, as Buyer, which was filed as Exhibit 2(e) to the
Company's Amendment No. 1 to Registration Statement on Form S-4 (No. 33-53701) filed July 1, 1994, and
is incorporated herein by reference.
2(c) Amendment No. 1, dated September 12, 1994, to Asset Sale Agreement (First Facilities), dated March 29,
1994, between National Medical Enterprises, Inc., as Seller and the Company, as Buyer, which was filed
as Exhibit 2(c) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994, and
is incorporated herein by reference.
2(d) Amendment No. 1, dated September 12, 1994, to Asset Sale Agreement (Subsequent Facilities), dated March
29, 1994, between National Medical Enterprises, Inc., as Seller and the Company, as Buyer, which was
filed as Exhibit 2(d) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994,
and is incorporated herein by reference.
2(e) Amendment No. 2, dated September 29, 1994, to Asset Sale Agreement (Subsequent Facilities), dated March
29, 1994, between National Medical Enterprises, Inc., as Seller and the Company, as Buyer, which was
filed as Exhibit 2(e) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994,
and is incorporated herein by reference.
2(f) Amendment No. 3, dated November 15, 1994, to Asset Sale Agreement (Subsequent Facilities), dated March
29, 1994, between National Medical Enterprises, Inc., as Seller and the Company, as Buyer, which was
filed as Exhibit 2(f) to the Company's Annual Report on Form 10-K for the year ended September 30, 1994,
and is incorporated herein by reference.
2(g) Stock Purchase Agreement, dated November 14, 1995, among Blue Cross and Blue Shield of New Jersey, Inc.
Health Care Service Corporation, Independence Blue Cross, Medical Service Association of Pennsylvania,
Pierce County Medical Bureau, Inc., Veritus, Inc., Green Spring Health Services, Inc. and the Company,
which was filed as Exhibit 10(e) to the Company's Quarterly Report on Form 10-Q for the Quarterly period
ended December 31, 1995, and is incorporated herein by reference.
2(h) GPA Stock Exchange Agreement, dated November 14, 1995, between Green Spring Health Services, Inc. and
the Company, which was filed as Exhibit 10(f) to the Company's Quarterly Report on Form 10-Q for the
Quarterly period ended December 31, 1995, and is incorporated herein by reference.
55
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
2(i) Real Estate Purchase and Sale Agreement, dated January 29, 1997, between the Company and Crescent Real
Estate Equities Limited Partnership, which was filed as Exhibit 2(a) to the Company's current report on
Form 8-K filed on April 23, 1997, and is incorporated herein by reference.
2(j) Amendment No. 1, dated February 28, 1997, to the Real Estate Purchase and Sale Agreement, dated January
29, 1997, between the Company and Crescent Real Estate Equities Limited Partnership, which was filed as
Exhibit 2(b) to the Company's current report on Form 8-K filed on April 23, 1997, and is incorporated
herein by reference.
2(k) Amendment No. 2, dated May 29, 1997, to the Real Estate Purchase and Sale Agreement, dated January 29,
1997, between the Company and Crescent Real Estate Equities Limited Partnership, which was filed as
Exhibit 2(c) to the Company's current report on Form 8-K, which was filed on June 30, 1997, and is
incorporated herein by reference.
2(l) Contribution Agreement, dated June 16, 1997, between the Company and Crescent Operating, Inc., which was
filed as Exhibit 2(d) to the Company's current report on Form 8-K which was filed on June 30, 1997, and
is incorporated herein by reference.
2(m) Stock Purchase Agreement, dated August 5, 1997, between the Company and Aetna Insurance Company of
Connecticut, which was filed as Exhibit 2(a) to the Company's current report on Form 8-K, which was
filed on December 17, 1997, and is incorporated herein by reference.
2(n) Master Service Agreement, dated August 5, 1997, between the Company, Aetna U.S. Healthcare, Inc. and
Human Affairs International, Incorporated, which was filed as Exhibit 2(b) to the Company's current
report on Form 8-K, which was filed on December 17, 1997, and is incorporated herein by reference.
2(o) Amendment to Stock Purchase Agreement, dated December 4, 1997, between the Company and Aetna Insurance
Company of Connecticut, which was filed as Exhibit 2(c) to the Company's current report on Form 8-K,
which was filed on December 17, 1997, and is incorporated herein by reference.
2(p) First Amendment to Master Services Agreement, dated December 4, 1997, between the Company, Aetna U.S.
Healthcare, Inc. and Human Affairs International, Incorporated, which was filed as Exhibit 2(d) to the
Company's current report on Form 8-K, which was filed on December 17, 1997, and is incorporated herein
by reference.
3(a) Restated Certificate of Incorporation of the Company, as filed in Delaware on October 16, 1992, which
was filed as Exhibit 3(a) to the Company's Annual Report on Form 10-K for the year ended September 30,
1992, and is incorporated herein by reference.
3(b) Bylaws of the Company, as amended, effective May 19, 1995, which was filed as Exhibit 3(a) to the
Company's Quarterly Report on Form 10-Q for the Quarterly Period ended June 30, 1995, and is
incorporated herein by reference.
3(c) Certificate of Ownership and Merger merging Magellan Health Services, Inc. (a Delaware corporation) into
Charter Medical Corporation (a Delaware corporation), as filed in Delaware on December 21, 1995, which
was filed as Exhibit 3(c) to the Company's Annual Report on Form 10-K for the year ended September 30,
1995, and is incorporated herein by reference.
4(a) Indenture, dated as of May 2, 1994, among the Company, the Guarantors listed therein and Marine Midland
Bank, as Trustee, relating to the 11 1/4% Senior Subordinated Notes due April 15, 2004 of the Company,
which was filed as Exhibit 4(a) to the Company's Registration Statement on Form S-4 (No. 33-53701) filed
May 18, 1994, and is incorporated herein by reference.
56
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
4(b) Second Amended and Restated Credit Agreement, dated as of May 2, 1994, among the Company, the financial
institutions listed therein, Bankers Trust Company, as Agent, and First Union National Bank of North
Carolina, as Co-Agent, which was filed as Exhibit 4(e) to the Company's Registration Statement on Form
S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by reference.
4(c) Second Amended and Restated Subsidiary Credit Agreement, dated as of May 2, 1994, among certain
subsidiaries of the Company, the financial institutions listed therein, Bankers Trust Company, as Agent,
and First Union National Bank of North Carolina, as Co-Agent, which was filed as Exhibit 4(f) to the
Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated
herein by reference.
4(d) Second Amended and Restated Company Stock and Notes Pledge Agreement, dated as of May 2, 1994, between
the Company and Bankers Trust Company, as Collateral Agent, which was filed as Exhibit 4(g) to the
Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated
herein by reference.
4(e) Second Amended and Restated Subsidiary Stock and Notes Pledge Agreement, dated as of May 2, 1994, among
various subsidiaries of the Company and Bankers Trust Company, as Collateral Agent, which was filed as
Exhibit 4(h) to the Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and
is incorporated herein by reference.
4(f) Second Amended and Restated Subsidiary Pledge and Security Agreement, dated as of May 2, 1994, among
various subsidiaries of the Company and Bankers Trust Company, as Collateral Agent, which was filed as
Exhibit 4(i) to the Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and
is incorporated herein by reference.
4(g) Second Amended and Restated Subsidiary Pledge and Security Agreement (ESOP collateral), dated as of May
2, 1994, between the Company and Bankers Trust Company, as Collateral Agent, which was filed as Exhibit
4(j) to the Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is
incorporated herein by reference.
4(h) Second Amended and Restated FINCO Pledge and Security Agreement I, dated as of May 2, 1994, between
CMFC, Inc. and Bankers Trust Company, as Collateral Agent, which was filed as Exhibit 4(k) to the
Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated
herein by reference.
4(i) Second Amended and Restated Subsidiary Guaranty, dated as of May 2, 1994, executed by various
subsidiaries of the Company, which was filed as Exhibit 4(l) to the Company's Registration Statement on
Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by reference.
4(j) Second Amended and Restated Company Collateral Accounts Assignment Agreement, dated as of May 2, 1994,
between the Company and Bankers Trust Company, as agent, which was filed as Exhibit 4(m) to the
Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated
herein by reference.
4(k) Company Pledge and Security Agreement, dated as of May 2, 1994, between the Company and Bankers Trust
Company, as Collateral Agent, which was filed as Exhibit 4(n) to the Company's Registration Statement on
Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by reference.
4(l) Second Amended and Restated FINCO Pledge and Security Agreement II, dated as of May 2, 1994, between
CMCI, Inc. and Bankers Trust Company, as Collateral Agent, which was filed as Exhibit 4(o) to the
Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated
herein by reference.
57
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
4(m) Second Amended and Restated Company Guaranty, dated as of May 2, 1994, executed by the Company, which
was filed as Exhibit 4(p) to the Company's Registration Statement on Form S-4 (No. 33-53701) filed May
18, 1994, and is incorporated herein by reference.
4(n) Second Amended and Restated Subsidiary Collateral Accounts Assignment Agreement, dated as of May 2,
1994, among various subsidiaries of the Company and Bankers Trust Company, as Agent, which was filed as
Exhibit 4(q) to the Company's Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and
is incorporated herein by reference.
4(o) Form of Indenture of Mortgage, Deed to Secure Debt, Deed of Trust, Security Agreement and Assignment of
Leases and Rents; Amended Indenture of Mortgage, Deed to Secure Debt, Deed of Trust, Security Agreement
and Assignment of Leases and Rents; and Consolidated Agreement, executed as of May 2, 1994, by 71
subsidiaries of the Company and Bankers Trust Company, as Agent, and various trustees as shown on
individual subsidiary cover pages attached, which was filed as Exhibit 4(t) to the Company's
Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by
reference.
4(p) Purchase Agreement, dated April 22, 1994, between the Company and Bear, Stearns & Co. Inc. and BT
Securities Corporation, which was filed as Exhibit 4(u) to the Company's Registration Statement on Form
S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by reference.
4(q) Exchange and Registration Rights Agreement, dated April 22, 1994 between the Company and Bear, Stearns &
Co. Inc. and BT Securities Corporation, which was filed as Exhibit 4(v) to the Company's Registration
Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by reference.
4(r) Amendment No. 1, dated as of June 9, 1994, to Second Amended and Restated Credit Agreement, dated as of
May 2, 1994, among the Company, the financial institutions listed therein, Bankers Trust Company, as
Agent, and First Union National Bank of North Carolina, as Co-Agent, which was filed as Exhibit 4(w) to
the Company's Amendment No. 1 to Registration Statement on Form S-4 (No. 33-53701) filed July 1, 1994,
and is incorporated herein by reference.
4(s) Amendment No. 2, dated September 30, 1994, to Second Amended and Restated Credit Agreement, dated as of
May 2, 1994, among the Company, the financial institutions listed therein, Bankers Trust Company, as
Agent, and First Union National Bank of North Carolina, as Co-Agent, which was filed as Exhibit 4(s) to
the Company's Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated
herein by reference
4(t) Amendment No. 3, dated as of December 12, 1994, to Second Amended and Restated Credit Agreement, dated
as of May 2, 1994, among the Company, the financial institutions listed herein, Bankers Trust Company,
as Agent, and First Union National Bank of North Carolina, as Co-Agent, which was filed as Exhibit 4(a)
to the Company's Quarterly Report on Form 10-Q for the Quarterly Period ended December 31, 1994, and is
incorporated herein by reference.
4(u) Amendment No. 4, dated as of January 11, 1995, to Second Amended and Restated Credit Agreement, dated as
of May 2, 1994, among the Company, the financial institutions listed therein, Bankers Trust Company, as
Agent, and First Union National Bank of North Carolina, as Co-Agent, which was filed as Exhibit 4(b) to
the Company's Quarterly Report on Form 10-Q for the Quarterly Period ended December 31, 1994, and is
incorporated herein by reference.
58
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
4(v) Amendment No. 5, dated as of March 17, 1995, to Second Amended and Restated Credit Agreement, dated as
of May 2, 1994, among the Company, Bankers Trust Company, as Agent, First Union National Bank of North
Carolina, as Co-Agent, and the lenders listed on Annex I, which was filed as Exhibit 4(a) to the
Company's Quarterly Report on Form 10-Q for the Quarterly Period ended March 31, 1995, and is
incorporated herein by reference.
4(w) Amendment No. 6, dated as of October 17, 1995, to Second Amended and Restated Credit Agreement, dated as
of May 2, 1994, among the Company, Bankers Trust Company, as Agent, First Union National Bank of North
Carolina, as Co-Agent, which was filed as exhibit 4 (a) to the Company's quarterly report on Form 10-Q
for the quarterly period ended December 31, 1995 and is incorporated herein by reference.
4(x) Amendment No. 7, dated as of November 30, 1995, to Second Amended and Restated Credit Agreement, dated
as of May 2, 1994, among the Company, Bankers Trust Company, as Agent, First Union National Bank of
North Carolina, as Co-Agent, which was filed as exhibit 4 (b) to the Company's quarterly report on Form
10-Q for the quarterly period ended December 31, 1995 and is incorporated herein by reference.
4(y) Amendment No. 8, dated as of January 24, 1996, to Second Amended and Restated Credit Agreement, dated as
of May 2, 1994, among the Company, Bankers Trust Company, as Agent, First Union National Bank, as
Co-Agent, which was filed as exhibit 4 (c) to the Company's quarterly report on Form 10-Q for the
quarterly period ended December 31, 1995 and is incorporated herein by reference.
4(z) Amendment No. 9, dated as of June 30, 1996, to Second Amended and Restated Credit Agreement, dated as of
May 2, 1994, among the Company, Bankers Trust Company, as agent, First Union National Bank, as Co-Agent,
which was filed as exhibit 4 (a) to the Company's quarterly report on Form 10-Q for the quarterly period
ended June 30, 1996 and is incorporated herein by reference.
4(aa) Amendment No. 10, dated as of July 31, 1996, to Second Amended and Restated Credit Agreement, dated as
of May 2, 1994, among the Company, Bankers Trust Company, as Agent, First Union Naitonal Bank as
Co-Agent, which was filed as exhibit 4 (b) to the Company's quarterly report on Form 10-Q for the
quarterly period ended June 30, 1996 and is incorporated herein by reference.
4(ab) Amendment No. 11, dated as of September 3, 1996, to Second Amended and Restated Credit Agreement, dated
as of May 2, 1994, among the Company, Bankers Trust Company, as Agent, First Union National Bank as
Co-Agent, which was filed as Exhibit (b) 12 to the Company's Amendment No. 2 to Schedule 13 E-4 dated
September 5, 1996 and is incorporated herein by reference.
4(ac) Indenture Supplement No. 1, dated June 3, 1994, among the Company, the Guarantors listed therein and
Marine Midland Bank, as Trustee, relating to the 11 1/4% Senior Subordinated Notes due April 15, 2004,
together with a schedule identifying substantially similar documents, pursuant to Instruction 2 to Item
601 of Regulation S-K, which was filed as Exhibit 4(t) to the Company's Annual Report on Form 10-K for
the year ended September 30, 1994, and is incorporated herein by reference.
4(ad) Indenture Supplement No. 3, dated August 30, 1994, among the Company, the Guarantors listed therein and
Marine Midland Bank, as Trustee, relating to the 11 1/4% Senior Subordinated Notes due April 15, 2004,
which was filed as Exhibit 4(v) to the Company's Annual Report on Form 10-K for the year ended September
30, 1994, and is incorporated herein by reference.
59
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
The Company and the Additional Registrants agree, pursuant to (b)(4)(iii) of Item 601 of Regulation
S-K, to furnish to the Commission, upon request, a copy of each agreement relating to long-term debt
where the total amount of debt under each such agreement does not exceed 10% of the Registrants'
respective total assets on a consolidated basis.
4(ae) Stockholders' Agreement, dated December 13, 1995, among Green Spring Health Services, Inc., Blue Cross
and Blue Shield of New Jersey, Inc., Health Care Service Corporation, Independence Blue Cross, Pierce
County Medical Bureau, Inc. and the Company, which was filed as Exhibit 4(d) to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended December 31, 1995, and is incorporated herein by
reference.
4(af) First Amendment to Stockholders' Agreement, dated February 28, 1997, among Green Spring Health Services,
Inc, Blue Cross and Blue Shield of New Jersey, Inc., Health Care Service Corporation, Independence Blue
Cross, Pierce County Medical Bureau, Inc. and the Company.
4(ag) Exchange Agreement, dated December 13, 1995, among Blue Cross and Blue Shield of New Jersey, Inc.,
Health Care Service Corporation, Independence Blue Cross, Pierce County Medical Bureau, Inc. and the
Company, which was filed as Exhibit 4(e) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended December 31, 1995, and is incorporated herein by reference.
4(ah) Stock and Warrant Purchase Agreement, dated December 22, 1995, between the Company and Richard E.
Rainwater, which was filed as Exhibit 4(f) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended December 31, 1995, and is incorporated herein by reference.
4(ai) Amendment No. 1 to Stock and Warrant Purchase Agreement, dated January 25, 1996, between the Company and
Rainwater-Magellan Holdings, L.P., which was filed as Exhibit 4.7 to the Company's Registration
Statement on Form S-3 dated February 26, 1996, and is incorporated herein by reference.
4(aj) Credit Agreement, dated as of October 16, 1996, among the Company, the lenders named therein, The Chase
Manhattan Bank as Administrative Agent and Collateral Agent and First Union National Bank of North
Carolina as Syndication Agent, which was filed as Exhibit 4(ai) to the Company's Annual Report on Form
10-K for the year ended September 30, 1996, and is incorporated by reference.
4(ak) Amended and Restated Credit Agreement, dated June 16, 1997, among the Company and Chase Manhattan Bank,
as Administrative Agent and First Union National Bank of North Carolina as Syndication Agent, which was
filed as Exhibit 10(h) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1997, and is incorporated herein by reference.
4(al) Amendment No. 1 to Amended and Restated Credit Agreement, dated September 10, 1997, among the Company
and Chase Manhattan Bank, as Administrative Agent and First Union National Bank of North Carolina as
Syndication Agent.
4(am) Amendment No. 2 to Amended and Restated Credit Agreement, dated October 9, 1997 among the Company and
Chase Manhattan Bank, as Administrative Agent and First Union National Bank of North Carolina as
Syndication Agent.
4(an) Warrant Purchase Agreement, dated January 29, 1997, between the Company and Crescent Real Estate
Equities Limited Partnership which was filed as Exhibit 4(a) to the Company's current report on Form
8-K, which was filed on April 23, 1997, and is incorporated herein by reference.
60
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
4(ao) Amendment No. 1, dated June 17, 1997, to the Warrant Purchase Agreement, dated January 29, 1997, between
the Company and Crescent Real Estate Equities Limited Partnership, which was filed as Exhibit 4(b) to
the Company's current report on Form 8-K, which was filed on June 30, 1997, and is incorporated herein
by reference.
*10(a) Written description of Corporate Annual Incentive Plan for the year ended September 30, 1996, which was
filed as Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended
December 31, 1995, and is incorporated herein by reference.
*10(b) 1989 Non-Qualified Deferred Compensation Plan of the Company, adopted January 1, 1989, as amended, which
was filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K dated as of September 30, 1989
and is incorporated herein by reference.
*10(c) 1992 Stock Option Plan of the Company, as amended, which was filed as Exhibit 10(c) to the Company's
Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated herein by
reference.
*10(d) Directors' Stock Option Plan of the Company, as amended, which was filed as Exhibit 10(d) to the
Company's Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated herein
by reference.
*10(e) 1994 Stock Option Plan of the Company, as amended, which was filed as Exhibit 10(e) to the Company's
Annual Report on Form 10-K for the year ended September 30, 1994, and is incorporated herein by
reference.
*10(f) Directors' Unit Award Plan of the Company, which was filed as Exhibit 10(i) to the Company's
Registration Statement on Form S-4 (No. 33-53701) filed May 18, 1994, and is incorporated herein by
reference.
*10(g) Description of Flexible Benefits Plan, which was filed as Exhibit 10(g) to the Company's Annual Report
on Form 10-K for the year ended September 30, 1994, and is incorporated herein by reference.
*10(h) 1996 Stock Option Plan of the Company, which was filed as Exhibit 10(a) to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1996 and is incorporated herein by
reference.
*10(i) 1996 Directors' Stock Option Plan of the Company, which was filed as Exhibit 10(b) to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996 and is incorporated herein
by reference.
*10(j) 1997 Stock Option Plan of the Company, which was filed as Exhibit 10(i) to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 1997, and is incorporated herein by
reference.
*10(k) Employment Agreement, dated February 28, 1995, between the Company and John Cook Barlett, Executive Vice
President--Quality Improvement, which was filed as Exhibit 10(k) to the Company's Annual Report on Form
10-K for the year ended September 30, 1995, and is incorporated herein by reference.
*10(l) Employment Agreement, dated March 31, 1995, between the Company and Craig L. McKnight, Executive Vice
President and Chief Financial Officer, which was filed as Exhibit 10(l) to the Company's Annual Report
on Form 10-K for the year ended September 30, 1995, and is incorporated herein by reference.
61
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
*10(m) Employment Agreement, dated October 1, 1995, between the Company and E. Mac Crawford, Chairman of the
Board of Directors, President and Chief Executive Officer, which was filed as Exhibit 10(m) to the
Company's Annual Report on Form 10-K for the year ended September 30, 1995, and is incorporated herein
by reference.
*10(n) Employment Agreement, dated March 1, 1997, between the Company and E. Mac Crawford, which was filed as
Exhibit 10(g) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30,
1997, and is incorporated herein by reference.
*10(o) Letter Agreement, dated November 9, 1993, between Green Spring Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(c) to the Company's Quarterly Report on Form
10-Q for the quarterly period ended December 31, 1995 and is incorporated herein by reference.
*10(p) Letter Agreement, dated September 19, 1994 between Green Spring Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(d) to the Company's Quarterly Report on Form
10-Q for the quarterly period ended December 31, 1995 and is incorporated herein by reference.
*10(q) Employment Agreement dated May 1, 1996, between the Company and Dr. Danna Mauch, President and Chief
Operating Officer of Magellan Public Solutions, Inc. and Executive Vice President of the Company, which
was filed as Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996 and is incorporated herein by reference.
*10(r) Employment Agreement dated April 15, 1996, between the Company and John M. DeStefanis, President and
Chief Operating Officer of Charter Behavioral Health Systems, Inc. and Executive Vice President of the
Company, which was filed as Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1996 and is incorporated herein by reference.
*10(s) Employment Agreement dated May 7, 1996, between the Company and Steve J. Davis, Executive Vice
President, Administrative Services and General Counsel, which was filed as Exhibit 10(c) to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 and is incorporated
herein by reference.
*10(t) Employment Agreement dated February 28, 1996, between Green Spring Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(t) to the Company's annual report on Form
10-K for the year ended September 30, 1996, and is incorporated herein by reference.
*10(u) Compensation Agreement dated September 30, 1996, between Magellan Health Services, Inc. and Henry T.
Harbin, M.D., Executive Vice President of the Company and President and Chief Executive Officer of Green
Spring Health Services, Inc., which was filed as Exhibit 10(u) to the Company's annual report on Form
10-K for the year ended September 30, 1996, and is incorporated herein by reference.
*10(v) Written description of the Green Spring Health Services, Inc. Annual Incentive Plan for the period ended
September 30, 1996, which was filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K for the
year ended September 30, 1996, and is incorporated herein by reference.
62
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ --------------------------------------------------------------------------------------------------------
*10(w) Written description of the Green Spring Health Services, Inc. Annual Incentive Plan for the year ended
September 30, 1997.
10(x) Master Lease Agreement, dated June 16, 1997, between Crescent Real Estate Funding VII, L.P., as
Landlord, and Charter Behavioral Health Systems, LLC, as Tenant, which was filed as Exhibit 99(b) to the
Company's current report on Form 8-K, which was filed on June 30, 1997, and is incorporated herein by
reference.
10(y) Master Franchise Agreement, dated June 17, 1997, between the Company and Charter Behavioral Health
Systems, LLC, which was filed as Exhibit 99(c) to the Company's current report on Form 8-K, which was
filed on June 30, 1997, and is incorporated herein by reference.
10(z) Form of Franchise Agreement, dated June 17, 1997, between the Company, as Franchisor, and Franchise
Owners, which was filed as Exhibit 99(d) to the Company's current report on Form 8-K, which was filed on
June 30, 1997, and is incorporated herein by reference.
10(aa) Subordination Agreement, dated June 16, 1997, between the Company, Charter Behavioral Health Systems,
LLC and Crescent Real Estate Equities Limited Partnership, which was filed as Exhibit 99(e) to the
Company's current report on Form 8-K, which was filed on June 30, 1997, and is incorporated herein by
reference.
10(ab) Operating Agreement of Charter Behavioral Health Systems, LLC, dated June 16, 1997, between the Company
and Crescent Operating, Inc., which was filed as Exhibit 99(f) to the Company's current report on Form
8-K, which was filed on June 30, 1997, and is incorporated herein by reference.
10(ac) Warrant Purchase Agreement, dated June 16, 1997, between the Company and Crescent Operating, Inc., which
was filed as Exhibit 99(g) to the Company's current report on Form 8-K, which was filed on June 30,
1997, and is incorporated herein by reference.
11 Statement re computation of per share earnings.
21 List of subsidiaries of the Company.
23 Consent of independent public accountants.
27 Financial Data Schedule
- ------------------------
* Constitutes a management contract or compensatory plan arrangement.
(B) REPORTS ON FORM 8-K:
There were no current reports on Form 8-K filed by the Registrant with the
Securities and Exchange Commission during the quarter ended September 30,
1997.
(C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K:
Exhibits required to be filed by the Company pursuant to Item 601 of
Regulation S-K are contained in a separate volume.
(D) FINANCIAL STATEMENT SCHEDULES REQUIRED BY REGULATION S-X:
Separate financial statements and schedules of Magellan Health Services,
Inc. ("Parent Company") have been omitted since the restricted net assets as
defined by Rule 4-08(e)(3) of Regulation S-X of the Parent Company's
consolidated subsidiaries do not exceed 25% of the consolidated net assets
of the Company as of September 30, 1997.
63
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.
MAGELLAN HEALTH SERVICES, INC.
(Registrant)
Date: December 18, 1997 /S/ CRAIG L. MCKNIGHT
------------------------------------------
Craig L. McKnight
Executive Vice President and
Chief Financial Officer
Date: December 18, 1997 /S/ HOWARD A. MCLURE
------------------------------------------
Howard A. McLure
Senior Vice President and Controller
(Chief Accounting Officer)
Pursuant to the requirements of the Securities Exchange 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 TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ E. MAC CRAWFORD Chairman of the Board of
- ------------------------------ Directors, President and December 18, 1997
E. Mac Crawford Chief Executive Officer
/s/ EDWIN M. BANKS Director
- ------------------------------ December 18, 1997
Edwin M. Banks
/s/ G. FRED DIBONA, JR. Director
- ------------------------------ December 18, 1997
G. Fred DiBona, Jr.
Director
- ------------------------------ December , 1997
Andre C. Dimitriadis
/s/ A.D. FRAZIER, JR. Director
- ------------------------------ December 18, 1997
A.D. Frazier, Jr.
/s/ RAYMOND H. KIEFER Director
- ------------------------------ December 18, 1997
Raymond H. Kiefer
64
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ GERALD L. MCMANIS Director
- ------------------------------ December 18, 1997
Gerald L. McManis
/s/ DANIEL S. MESSINA Director
- ------------------------------ December 18, 1997
Daniel S. Messina
/s/ DARLA D. MOORE Director
- ------------------------------ December 18, 1997
Darla D. Moore
Director
- ------------------------------ December , 1997
Jeffrey A. Sonnenfeld
65
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant and its
subsidiaries are submitted herewith in response to Item 8 and Item 14(a)1:
MAGELLAN HEALTH SERVICES, INC. PAGE
---------
Audited Consolidated Financial Statements
Report of independent public accountants......................................... F-2
Consolidated balance sheets as of September 30, 1996 and 1997.................... F-3
Consolidated statements of operations for the years ended September 30, 1995,
1996 and 1997................................................................... F-5
Consolidated statements of changes in stockholders' equity for the years ended
September 30, 1995, 1996 and 1997............................................... F-6
Consolidated statements of cash flows for the years ended September 30, 1995,
1996 and 1997................................................................... F-7
Notes to consolidated financial statements....................................... F-8
The following financial statement schedule of the Registrant and its
subsidiaries is submitted herewith in response to Item 14(a)2:
PAGE
---------
Schedule II--Valuation and qualifying accounts......................................................... S-1
Financial Statements in response to Rule 3-09 of Regulation S-X:
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
Audited Consolidated Financial Statements
Report of independent public accountants............................................................... F-45
Consolidated balance sheet as of September 30, 1997.................................................... F-46
Consolidated statement of operations for the 106 days ended September 30, 1997......................... F-48
Consolidated statement of changes in members' capital for the 106 days ended September 30, 1997........ F-49
Consolidated statement of cash flows for the 106 days ended September 30, 1997......................... F-50
Notes to consolidated financial statements............................................................. F-51
The following financial statement schedule for Charter Behavioral Health
Systems, LLC and its subsidiaries is submitted herewith in response to Item
14(a)2:
PAGE
---------
Schedule II--Valuation and qualifying accounts............................................................. S-2
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF
MAGELLAN HEALTH SERVICES, INC:
We have audited the accompanying consolidated balance sheets of Magellan
Health Services, Inc. (a Delaware corporation) and subsidiaries as of September
30, 1996 and 1997 and the related consolidated statements of operations, changes
in stockholders' equity and cash flows for each of the three years in the period
ended September 30, 1997. These consolidated financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Magellan Health Services,
Inc. and subsidiaries as of September 30, 1996 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1997 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our opinion, fairly
states, in all material respects, the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
November 14, 1997
F-2
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30,
------------------------
1996 1997
------------ ----------
ASSETS
Current Assets:
Cash, including cash equivalents of $54,631 in 1996 and $319,823 in 1997 at cost,
which approximates market value..................................................... $ 120,945 $ 372,878
Accounts receivable, less allowance for doubtful accounts of $50,548 in 1996 and
$40,311 in 1997..................................................................... 189,878 107,998
Refundable income taxes............................................................... 1,323 2,466
Other current assets.................................................................. 26,004 23,696
------------ ----------
Total Current Assets.............................................................. 338,150 507,038
Assets restricted for settlement of unpaid claims and other
long-term liabilities.................................................................. 105,303 87,532
Property and Equipment:
Land.................................................................................. 83,431 11,667
Buildings and improvements............................................................ 388,821 70,174
Equipment............................................................................. 146,915 63,719
------------ ----------
619,167 145,560
Accumulated depreciation.............................................................. (126,053) (37,038)
------------ ----------
493,114 108,522
Construction in progress.............................................................. 2,276 692
------------ ----------
Total Property and Equipment...................................................... 495,390 109,214
------------ ----------
Deferred income taxes................................................................... -- 1,158
Investment in CBHS...................................................................... -- 16,878
Other Long-Term Assets.................................................................. 30,755 20,893
Goodwill, net of accumulated amortization of $9,151 in 1996 and $14,006 in 1997......... 128,012 114,234
Other Intangible Assets, net of accumulated amortization of $10,393 in 1996 and $5,855
in 1997................................................................................ 42,527 38,673
------------ ----------
$ 1,140,137 $ 895,620
------------ ----------
------------ ----------
F-3
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
SEPTEMBER 30,
------------------------
1996 1997
------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable...................................................................... $ 78,966 $ 45,346
Accrued liabilities................................................................... 189,599 170,429
Current maturities of long-term debt and capital lease obligations.................... 5,751 3,601
------------ ----------
Total Current Liabilities......................................................... 274,316 219,376
Long-Term Debt and Capital Lease Obligations............................................ 566,307 391,693
Deferred Income Tax Liabilities......................................................... 12,368 --
Reserve for Unpaid Claims............................................................... 73,040 49,113
Deferred Credits and Other Long-Term Liabilities........................................ 39,769 16,110
Minority Interest....................................................................... 52,520 61,078
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, without par value
Authorized--10,000 shares
Issued and outstanding--none........................................................ -- --
Common Stock, par value $.25 per share
Authorized--80,000 shares
Issued and outstanding--33,007 shares in 1996
and 33,439 shares in 1997......................................................... 8,252 8,361
Other Stockholders' Equity:
Additional paid-in capital............................................................ 327,681 340,645
Accumulated deficit................................................................... (129,457) (129,955)
Warrants outstanding.................................................................. 54 25,050
Common Stock in treasury, 4,424 shares in 1996 and 1997............................... (82,731) (82,731)
Cumulative foreign currency adjustments............................................... (1,982) (3,120)
------------ ----------
Total Stockholders' Equity.......................................................... 121,817 158,250
------------ ----------
$ 1,140,137 $ 895,620
------------ ----------
------------ ----------
The accompanying Notes to Consolidated Financial Statements
are an integral part of these balance sheets.
F-4
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
Net revenue............................................................. $ 1,151,736 $ 1,345,279 $ 1,210,696
------------ ------------ ------------
Costs and expenses:
Salaries, cost of care and other operating expenses................... 863,598 1,064,445 978,513
Bad debt expense...................................................... 92,022 81,470 46,211
Depreciation and amortization......................................... 38,087 48,924 44,861
Amortization of reorganization value in excess of amounts allocable to
identifiable assets................................................. 26,000 -- --
Interest, net......................................................... 55,237 48,017 45,377
ESOP expense.......................................................... 73,527 -- --
Stock option expense (credit)......................................... (467) 914 4,292
Equity in loss of CBHS................................................ -- -- 8,122
Loss on Crescent Transactions......................................... -- -- 59,868
Unusual items, net.................................................... 57,437 37,271 357
------------ ------------ ------------
1,205,441 1,281,041 1,187,601
------------ ------------ ------------
Income (loss) before income taxes, minority interest and extraordinary
items................................................................. (53,705) 64,238 23,095
Provision for (benefit from) income taxes............................... (11,082) 25,695 9,238
------------ ------------ ------------
Income (loss) before minority interest and extraordinary items.......... (42,623) 38,543 13,857
Minority interest....................................................... 340 6,160 9,102
------------ ------------ ------------
Income (loss) before extraordinary items................................ (42,963) 32,383 4,755
Extraordinary items--losses on early extinguishments of debt (net of
income tax benefit of $3,503)......................................... -- -- (5,253)
------------ ------------ ------------
Net income (loss)....................................................... $ (42,963) $ 32,383 $ (498)
------------ ------------ ------------
------------ ------------ ------------
Average number of common shares outstanding--primary.................... 27,870 31,014 29,474
------------ ------------ ------------
------------ ------------ ------------
Average number of common shares outstanding--fully diluted.............. 27,870 31,014 30,167
------------ ------------ ------------
------------ ------------ ------------
Income (loss) per common share--primary:
Income (loss) before extraordinary items.............................. $ (1.54) $ 1.04 $ 0.16
Extraordinary losses on early extinguishments of debt................. -- -- (0.18)
------------ ------------ ------------
Net income (loss)....................................................... $ (1.54) $ 1.04 $ (0.02)
------------ ------------ ------------
------------ ------------ ------------
Income (loss) per common share--fully diluted:
Income (loss) before extraordinary items.............................. $ (1.54) $ 1.04 $ 0.16
Extraordinary losses on early extinguishments of debt................. -- -- (0.18)
------------ ------------ ------------
Net income (loss)....................................................... $ (1.54) $ 1.04 $ (0.02)
------------ ------------ ------------
------------ ------------ ------------
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-5
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEAR ENDED SEPTEMBER 30,
-------------------------------
1995 1996 1997
--------- --------- ---------
(IN THOUSANDS)
Common Stock:
Balance, beginning of period................................................... $ 6,725 $ 7,101 $ 8,252
Exercise of options and warrants............................................... 24 97 109
Green Spring Health Services, Inc. acquisition................................. -- 54 --
Pooling of Mentor.............................................................. 352 -- --
Issuance of Common Stock, net of issuance costs................................ -- 1,000 --
--------- --------- ---------
Balance, end of period......................................................... 7,101 8,252 8,361
--------- --------- ---------
Additional Paid-in Capital:
Balance, beginning of period................................................... 244,339 253,295 327,681
Stock option expense (credit).................................................. (467) 914 4,292
Green Spring Health Services, Inc. acquisition................................. -- 4,263 --
Exercise of options and warrants............................................... 624 1,636 8,156
Issuance of Common Stock, net of issuance costs................................ -- 67,573 --
Pooling of Mentor.............................................................. 8,799 -- --
Other.......................................................................... -- -- 516
--------- --------- ---------
Balance, end of period......................................................... 253,295 327,681 340,645
--------- --------- ---------
Accumulated Deficit:
Balance, beginning of period................................................... (119,042) (161,840) (129,457)
Net income (loss).............................................................. (42,963) 32,383 (498)
Pooling of Mentor.............................................................. 165 -- --
--------- --------- ---------
Balance, end of period......................................................... (161,840) (129,457) (129,955)
--------- --------- ---------
Unearned Compensation under ESOP:
Balance, beginning of period................................................... (73,527) -- --
ESOP expense................................................................... 73,527 -- --
--------- --------- ---------
Balance, end of period......................................................... -- -- --
--------- --------- ---------
Warrants Outstanding:
Balance, beginning of period................................................... 180 64 54
Exercise of warrants........................................................... (116) (10) (4)
Issuance of warrants to Crescent and COI....................................... -- -- 25,000
--------- --------- ---------
Balance, end of period......................................................... 64 54 25,050
--------- --------- ---------
Common Stock in treasury:
Balance, beginning of period................................................... -- (9,238) (82,731)
Purchases of treasury stock.................................................... (5,349) (73,493) --
Reacquisition of shares under shareholder note................................. (3,889) -- --
--------- --------- ---------
Balance, end of period......................................................... (9,238) (82,731) (82,731)
--------- --------- ---------
Cumulative Foreign Currency Adjustments:
Balance, beginning of period................................................... (2,454) (822) (1,982)
Foreign currency translation gain (loss)....................................... 1,632 (1,160) (1,138)
--------- --------- ---------
Balance, end of period......................................................... (822) (1,982) (3,120)
--------- --------- ---------
Total Stockholders' Equity....................................................... $ 88,560 $ 121,817 $ 158,250
--------- --------- ---------
--------- --------- ---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-6
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED SEPTEMBER 30,
-------------------------------
1995 1996 1997
--------- --------- ---------
(IN THOUSANDS)
Cash Flows From Operating Activities
Net income (loss).............................................................. $ (42,963) $ 32,383 $ (498)
--------- --------- ---------
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Gain on sale of assets..................................................... (2,961) (2,062) (5,747)
Depreciation and amortization.............................................. 64,087 48,924 44,861
Non-cash portion of unusual items.......................................... 45,773 31,206 --
Equity in loss of CBHS..................................................... -- -- 8,122
Loss on Crescent Transactions.............................................. -- -- 59,868
ESOP expense............................................................... 73,527 -- --
Stock option expense (credit).............................................. (467) 914 4,292
Non-cash interest expense.................................................. 2,735 2,424 1,710
Extraordinary losses on early extinguishments of debt...................... -- -- 8,756
Cash flows from changes in assets and liabilities, net of effects from sales
and acquisitions of businesses:
Accounts receivable, net................................................... 7,280 15,495 60,675
Other current assets....................................................... 9,533 129 4,708
Other long-term assets..................................................... (5,813) 6,569 3,156
Accounts payable and accrued liabilities................................... (11,645) (7,516) (60,659)
Income taxes payable and deferred income taxes............................. (16,761) 14,925 (14,669)
Reserve for unpaid claims.................................................. (5,885) (29,985) (26,553)
Other liabilities.......................................................... (21,127) (18,968) (23,038)
Minority interest, net of dividends paid................................... 22 6,406 9,633
Other...................................................................... 285 1,022 (1,018)
--------- --------- ---------
Total adjustments.......................................................... 138,583 69,483 74,097
--------- --------- ---------
Net cash provided by operating activities................................ 95,620 101,866 73,599
--------- --------- ---------
Cash Flows From Investing Activities:
Capital expenditures........................................................... (20,224) (38,801) (33,348)
Acquisitions and investments in businesses, net of cash acquired............... (61,980) (50,918) (50,876)
Decrease (increase) in assets restricted for settlement of unpaid claims and
other
long-term liabilities........................................................ (19,606) (17,732) 17,209
Proceeds from sale of assets................................................... 5,879 5,248 18,270
Proceeds from sale of property and equipment to Crescent and CBHS,
net of transaction costs..................................................... -- -- 380,425
Other.......................................................................... (1,050) -- --
--------- --------- ---------
Net cash provided by (used in) investing activities...................... (96,981) (102,203) 331,680
--------- --------- ---------
Cash Flows From Financing Activities:
Payments on debt and capital lease obligations................................. (46,779) (85,835) (390,254)
Proceeds from issuance of debt................................................. 28,869 104,800 203,643
Proceeds from issuance of common stock......................................... -- 68,573 --
Proceeds from exercise of stock options and warrants........................... 531 3,401 8,265
Proceeds from issuance of warrants............................................. -- -- 25,000
Purchases of treasury stock.................................................... (5,349) (73,493) --
Income tax payments made on behalf of stock optionee........................... -- (1,678) --
--------- --------- ---------
Net cash provided by (used in) financing activities...................... (22,728) 15,768 (153,346)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents............................. (24,089) 15,431 251,933
Cash and cash equivalents at beginning of period................................. 129,603 105,514 120,945
--------- --------- ---------
Cash and cash equivalents at end of period....................................... $ 105,514 $ 120,945 $ 372,878
--------- --------- ---------
--------- --------- ---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-7
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements of Magellan Health Services, Inc., a
Delaware corporation, ("Magellan" or the "Company") include the accounts of the
Company and its subsidiaries except where control is temporary or does not rest
with the Company. All significant intercompany accounts and transactions have
been eliminated in consolidation.
On June 2, 1992, the Company filed a voluntary petition under Chapter 11 of
the United States Bankruptcy Code. The prepackaged plan of reorganization (the
"Plan") effected a restructuring of the Company's debt and equity
capitalization. The Company's Plan was confirmed on July 8, 1992, and became
effective on July 21, 1992, (effective on July 31, 1992, for financial reporting
purposes). The consolidated financial statements for the three years in the
period ended September 30, 1997, are presented for the Company after the
consummation of the Plan. These financial statements were prepared under the
principles of fresh start accounting. (See Note 3.)
The Company's primary segment of operations, as of September 30, 1997, was
the provision of a broad array of managed behavioral healthcare services to Blue
Cross/Blue Shield organizations, health maintenance organizations and other
insurance companies, corporations, federal, state and local government agencies,
labor unions and various state Medicaid programs. The Company operates in three
other segments. Through its public-sector operations, the Company also provides
a broad continuum of behavioral healthcare services to individuals who receive
healthcare benefits funded by state and local government agencies. The Company's
franchise operations segment franchises the "CHARTER" system of behavioral
healthcare to psychiatric hospitals and other facilities operated by Charter
Behavioral Health Systems, LLC ("CBHS"). See Note 4. The Company's provider
segment includes the ownership and operation of two psychiatric hospitals in
London, England, a 69-bed psychiatric hospital in Switzerland, hospital-based
joint ventures (see Note 2) and the 50% ownership of CBHS.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
MANAGED CARE REVENUE
Managed care revenue is recognized over the applicable coverage period on a
per member basis for covered members and as earned and estimable for performance
based revenues. Deferred revenue is recorded when premium payments are received
in advance of the applicable coverage period.
FRANCHISE REVENUE
Continuing annual franchise fees are recognized as the fees are earned and
become receivable from the franchisee. Costs relating to continuing franchise
fees are expensed as incurred. Individual franchise sales are recognized when
all material services or conditions relating to the sale have been substantially
performed or satisfied by the Company. Direct costs relating to franchise sales
are deferred until the related revenue is recognized up to the amount of
anticipated revenue less estimated additional related costs.
F-8
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROVIDER NET REVENUE
Provider net revenue is based on established billing rates, less estimated
allowances for patients covered by Medicare and other contractual reimbursement
programs, and discounts from established billing rates. Amounts received by the
Company for treatment of patients covered by Medicare and other contractual
reimbursement programs, which may be based on cost of services provided or
predetermined rates, are generally less than the established billing rates of
the Company's hospitals. Final determination of amounts earned under contractual
reimbursement programs is subject to review and audit by the applicable
agencies. The Company recorded net revenue in fiscal 1995, 1996 and 1997 of
$35.6 million, $28.3 million and $27.4 million, respectively, for the settlement
and adjustment of reimbursement issues related to earlier fiscal periods.
Management believes that adequate provision has been made for any adjustments
that may result from such reviews.
ADVERTISING COSTS
The production costs of advertising are expensed as incurred. The Company
does not consider any of its advertising costs to be direct-response and,
accordingly, does not capitalize such costs. Advertising costs consist primarily
of radio and television air time, which is amortized as utilized, and printed
media services. Advertising expense was approximately $33.5 million, $30.5
million and $19.2 million for the years ended September 30, 1995, 1996 and 1997,
respectively.
CHARITY CARE
The Company provides healthcare services without charge or at amounts less
than its established rates to patients who meet certain criteria under its
charity care policies. Because the Company does not pursue collection of amounts
determined to be charity care, they are not reported as revenue. For the years
ended September 30, 1995, 1996 and 1997, the Company provided, at its
established billing rates, approximately $41.2 million, $37.9 million and $19.5
million, respectively, of such care.
INTEREST, NET
The Company records interest expense net of interest income. Interest income
for the years ended September 30, 1995, 1996, and 1997 was approximately $3.7
million, $10.5 million and $10.1 million, respectively.
CASH AND CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid interest-bearing investments
with a maturity of three months or less when purchased, consisting primarily of
money market instruments.
CONCENTRATION OF CREDIT RISK
Franchise fee revenue and related receivables subject the Company to a
concentration of credit risk with franchisees. The Company establishes an
allowance for doubtful accounts based upon current and projected financial
performance of franchisees. No franchise fee receivables existed as of September
30, 1997.
Accounts receivable from patient revenue subject the Company to a
concentration of credit risk with third party payors that include insurance
companies, managed healthcare organizations and governmental entities. The
Company establishes an allowance for doubtful accounts based upon factors
surrounding the credit risk of specific payors, historical trends and other
information. Management believes the allowance for doubtful accounts is adequate
to provide for normal credit losses.
F-9
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ASSETS RESTRICTED FOR THE SETTLEMENT OF UNPAID CLAIMS AND OTHER LONG-TERM
LIABILITIES
Assets restricted for the settlement of unpaid claims and other long-term
liabilities include investments which are carried at fair market value. Transfer
of such investments from the Company's insurance subsidiaries to Magellan or any
of its other subsidiaries is subject to approval by certain regulatory
authorities.
The investments are classified into three categories: (i) held to maturity;
(ii) available for sale; and (iii) trading. Unrealized holding gains or losses
are recorded for trading and available for sale securities. The Company's
investments are classified as available for sale. The unrealized gain or loss on
investments available for sale was not material at September 30, 1996 and 1997.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, except for assets that have been
impaired, for which the carrying amount is reduced to estimated fair value.
Expenditures for renewals and improvements are charged to the property accounts.
Replacements and maintenance and repairs that do not improve or extend the life
of the respective assets are expensed as incurred. Amortization of capital lease
assets is included in depreciation expense. Depreciation is provided on a
straight-line basis over the estimated useful lives of the assets, which is
generally 10 to 40 years for buildings and improvements and three to ten years
for equipment. Depreciation expense was $35.1 million, $40.0 million and $34.1
million for the years ended September 30, 1995, 1996 and 1997, respectively.
INTANGIBLE ASSETS
Intangible assets are composed principally of (i) goodwill, (ii) customer
lists, (iii) non-compete agreements and (iv) deferred financing costs. Goodwill
represents the excess of the cost of businesses acquired over the fair value of
the net identifiable assets at the date of acquisition and is amortized using
the straight-line method over 25 to 40 years. Customer lists are amortized using
the straight-line method over their estimated useful lives of 5 to 25 years.
Non-compete agreements and deferred financing costs are amortized over the term
of the related agreements.
The Company continually monitors events and changes in circumstances that
could indicate carrying amounts of intangible assets may not be recoverable.
When events or changes in circumstances are present that indicate the carrying
amount of intangible assets may not be recoverable, the Company assesses the
recoverability of intangible assets by determining whether the carrying value of
such intangible assets will be recovered through the future cash flows expected
from the use of the asset and its eventual disposition. No impairment losses on
intangible assets were recorded by the Company in 1996. Impairment losses of
approximately $4.0 million and $14.4 million were recorded in fiscal 1995 and
fiscal 1997, respectively. (See Notes 4 and 6)
MEDICAL CLAIMS PAYABLE
Medical claims payable represent the liability for healthcare services
authorized, incurred and not yet reported to the Company's managed care
business. Medical claims payable are estimated based upon authorized healthcare
services, past claim payment experience for member groups and other factors.
While Management believes the liability for medical claims payable is adequate,
actual results could differ from such estimates.
F-10
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY
Changes in the cumulative translation of foreign currency assets and
liabilities are presented as a separate component of stockholders' equity. Gains
and losses resulting from foreign currency transactions, which were not
material, are included in operations as incurred.
NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed based on the weighted average
number of shares of common stock and common stock equivalents outstanding during
the period. Common stock equivalents, which include unexercised stock options
and warrants, were anti-dilutive in fiscal 1995 and not material in fiscal 1996.
Accordingly, they were excluded from the fiscal 1995 and fiscal 1996
calculations.
The Exchange Option, as hereinafter defined (see Note 2), is classified as a
potentially dilutive security for fiscal 1996 and 1997 for the purpose of
computing fully diluted income per common share. The Exchange Option was
anti-dilutive for fiscal 1996 and fiscal 1997 and, therefore, was excluded from
the fiscal 1996 and fiscal 1997 calculations.
STOCK-BASED COMPENSATION
In October 1995, the FASB issued Statement of Financial Accounting Standards
No. 123 ("FAS 123") "Accounting for Stock-Based Compensation," which became
effective for fiscal years beginning after December 15, 1995 (fiscal 1997 for
the Company). FAS 123 established new financial accounting and reporting
standards for stock-based compensation plans. Entities are allowed to measure
compensation cost for stock-based compensation under FAS 123 or APB Opinion No.
25, "Accounting for Stock Issued to Employees." Entities electing to remain with
the accounting in APB Opinion No. 25 are required to make pro forma disclosures
of net income and earnings per share as if the provisions of FAS 123 had been
applied. The Company has adopted FAS 123 on a pro forma disclosure basis (see
Note 9).
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, FASB issued FAS 128, which applies to entities with
publicly held common stock or potential common stock. FAS 128 replaces APB
Opinion 15, "Earnings per Share" and related interpretations. APB Opinion 15
required that entities with simple capital structures present a single "earnings
per common share" ("EPS") on the face of the income statement, whereas those
with complex capital structures present both "primary" and "fully diluted" EPS.
Primary EPS shows the amount of income attributed to each share of common stock
if every common stock equivalent were converted into common stock. Fully diluted
EPS considers common stock equivalents and all other securities that could be
converted into common stock.
FAS 128 simplifies the computation of EPS by replacing the presentation of
primary EPS with a presentation of basic EPS. The Statement requires dual
presentation of basic and diluted EPS by entities with complex capital
structures. Basic EPS includes no dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution of
securities that could share in the earnings of an entity, similar to fully
diluted EPS under APB Opinion 15.
FAS 128 becomes effective for financial statements for both interim and
annual periods ending after December 15, 1997. Earlier application is not
permitted. The Company will adopt FAS 128 during the quarter ended December 31,
1997, which is the first quarter of the fiscal year ended September 30, 1998.
The Company has disclosed pro forma EPS amounts computed using FAS 128 in Note 9
to the financial
F-11
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
statements for the years ended September 30, 1995, 1996 and 1997. After the
effective date, all prior-period EPS data presented will be restated to conform
with the provisions of FAS 128.
The primary effect of FAS 128 on the Company's financial statements is the
required dual presentation of basic and diluted income per common share for each
interim and annual reporting period. APB Opinion No. 15 allowed entities with
complex capital structures to present income per common share excluding common
stock equivalents and other potentially dilutive securities if the dilution was
less than three percent.
RECLASSIFICATIONS
Certain reclassifications have been made to fiscal 1996 amounts to conform
to fiscal 1997 presentation.
2. ACQUISITIONS AND JOINT VENTURES
ACQUISITIONS
On December 13, 1995, the Company acquired a 51% ownership interest in Green
Spring Health Services, Inc. ("Green Spring") for approximately $68.9 million in
cash, the issuance of 215,458 shares of Magellan Common Stock valued at
approximately $4.3 million and the contribution of Group Practice Affiliates,
Inc. ("GPA"), a wholly-owned subsidiary of the Company, which became a
wholly-owned subsidiary of Green Spring. On December 20, 1995, the Company
acquired an additional 10% ownership interest in Green Spring for approximately
$16.7 million in cash as a result of an exercise by a minority stockholder of
its Exchange Option (as hereinafter defined) for a portion of the stockholder's
interest in Green Spring. The Company has a 61% ownership interest in Green
Spring. As of September 30, 1997, Green Spring provided managed behavioral
healthcare services, which includes utilization management, care management and
employee assistance programs, through a 50-state provider network for
approximately 16.6 million people nationwide.
The minority stockholders of Green Spring consist of four Blue Cross/Blue
Shield organizations (the "Blues") that are key customers of Green Spring. In
addition, two other Blues organizations that formerly owned a portion of Green
Spring are customers of Green Spring. As of September 30, 1997, the minority
stockholders of Green Spring have the option, under certain circumstances, to
exchange their ownership interests ("Exchange Option") in Green Spring for
2,831,739 shares of the Company's Common Stock or $65.1 million in subordinated
notes. The Company may elect to pay cash in lieu of issuing the subordinated
notes. The Exchange Option expires December 13, 1998. The Exchange Option, if
exercised by the minority stockholders of Green Spring, would be recorded at the
fair value of the consideration paid. See Note 17 for a discussion regarding the
potential Exchange Option conversion.
The Company recorded the investments in Green Spring using the purchase
method of accounting. Green Spring's results of operations have been included in
the consolidated financial statements since the acquisition date, less minority
interest.
The cost of the investments in Green Spring has been allocated to the
estimated fair value of assets acquired and liabilities assumed to the extent
acquired by the Company. The remaining portion of Green Spring's assets and
liabilities has been recorded at the historical cost basis of the minority
stockholders. The purchase price allocation for the investments in Green Spring
and the historical cost basis of the minority stockholders of Green Spring, in
aggregate, resulted in goodwill of approximately $89 million and identifiable
intangible assets of approximately $24 million.
F-12
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
At each reporting date, the Company must assess the fair value of the
Exchange Option in relation to the redemption price available to the minority
stockholders. In any period that the fair value of the Exchange Option is
determined to be less than the redemption price, the difference must be
recognized as an adjustment to minority interest. Subsequent increases in the
fair value of the Exchange Option can be recognized only to the extent of
previously recognized losses. No losses were recorded in fiscal 1996 and 1997 as
a result of changes in the fair value of the Exchange Option.
In February 1995, the Company acquired Westwood Pembroke Health System,
which included two psychiatric hospitals and a professional group practice. The
Company accounted for the acquisition using the purchase method of accounting.
In January 1995, the Company acquired National Mentor, Inc. ("Mentor") by
issuing 1,409,978 shares of Common Stock. Mentor provides specialized health
services in mentor homes. The acquisition was accounted for as a pooling of
interests, effective January 1, 1995. The consolidated financial statements of
the Company were not restated for periods prior to January 1, 1995, as the
effect of restatement would not have been material to such periods.
During fiscal 1994, the Company agreed to acquire 40 psychiatric hospitals
(the "Acquired Hospitals") from Tenet Healthcare Corporation, formerly known as
National Medical Enterprises. The purchase price for the Acquired Hospitals was
approximately $120.4 million in cash plus an additional cash amount of
approximately $51 million, subject to adjustment, for the net working capital of
the Acquired Hospitals (the "Hospital Acquisition").
On June 30, 1994, the Company completed the purchase of 27 of the Acquired
Hospitals for a cash purchase price of approximately $129.6 million, which
included approximately $39.3 million, subject to adjustment, for the net working
capital of the facilities. On October 31, 1994, the Company completed the
purchase of three additional Acquired Hospitals for a cash purchase price of
approximately $5 million, which included approximately $2.2 million related to
the net working capital of the facilities. On November 30, 1994, the Company
completed the purchase of the remaining ten Acquired Hospitals for a cash
purchase price of approximately $36.8 million, including approximately $9.5
million related to the net working capital of ten Acquired Hospitals. The
Company accounted for the Hospital Acquisition using the purchase method of
accounting. The operating results of the Acquired Hospitals are included in the
Company's Consolidated Statements of Operations from the respective dates of
acquisition.
JOINT VENTURES
The Company has entered into four hospital-based joint ventures ("Columbia
JV's") with Columbia/ HCA Healthcare Corporation through September 30, 1997.
Generally, each member of the joint venture leased and/or contributed certain
assets in each respective market to the joint venture with the Company becoming
the managing member.
The Columbia JV's results of operations have been included in the
consolidated financial statements since inception, less minority interest. A
summary of the Columbia JV's is as follows:
MARKET DATE
- --------------------------------------------------------- ---------------
Albuquerque, NM.......................................... May 1995
Raleigh, NC.............................................. June 1995
Lafayette, LA............................................ October 1995
Anchorage, AK............................................ August 1996
F-13
2. ACQUISITIONS AND JOINT VENTURES (CONTINUED)
The Company's ownership interests in the Columbia JV's and other
hospital-based joint ventures have been managed by CBHS (as defined in Note 1)
for a fee equivalent to Magellan's portion of the joint ventures' earnings since
June 17, 1997.
3. THE RESTRUCTURING AND FRESH START REPORTING
The consummation of the Plan discussed in Note 1 resulted in, among other
things, (i) a reduction of approximately $700 million in long-term debt, (ii)
elimination of $233 million of preferred stock and (iii) the issuance of
approximately 24.8 million shares of Common Stock to certain holders of debt
securities, the preferred stockholders and common stockholders.
As a result of the consummation of the Plan, the financing under the $880
million credit agreement between the Company and certain banks dated September
1, 1988 was replaced by new facilities under an amended and restated credit
agreement, dated July 21, 1992, among the Company and certain banks.
Upon consummation of the Plan, the Company recognized an extraordinary gain
on debt discharge of approximately $731 million which represented forgiveness of
debt, principal and interest, reduced by the estimated fair value of Common
Stock issued to certain debtholders of the Company. The Company's long-term debt
was stated at the present value of amounts to be paid, based on market interest
rates on July 31, 1992. This adjustment to present value resulted in an
aggregate carrying amount for the Company's long-term debt which was less than
the aggregate principal amount thereof, and resulted in the amortization of the
difference into interest expense over the terms of the debt instruments and,
upon extinguishment of the debt prior to scheduled maturity, resulted in a loss
on debt extinguishment.
Under the principles of fresh start accounting, the Company's total assets
were recorded at their assumed reorganization value, with the reorganization
value allocated to identifiable tangible assets on the basis of their estimated
fair value. Accordingly, the Company's property and equipment were reduced and
its intangible assets were written off. In addition, the Company's accumulated
deficit, common stock in treasury and cumulative foreign currency adjustments
were eliminated. The excess of the reorganization value over the value of
identifiable assets was reported as "reorganization value in excess of amounts
allocable to identifiable assets" (the "Excess Reorganization Value").
The total reorganization value assigned to the Company's assets was
estimated by calculating projected cash flows before debt service requirements,
for a five-year period, plus an estimated terminal value of the Company
(calculated using a multiple of approximately six (6) on projected EBDIT (which
is net revenue less operating and bad debt expenses)), each discounted back to
its present value using a discount rate of 12% (representing the estimated
after-tax weighted cost of capital). This amount was approximately $1.2 billion
and was increased by (i) the estimated net realizable value of assets to be sold
and (ii) estimated cash in excess of normal operating requirements. The above
calculations resulted in an estimated reorganization value of approximately $1.3
billion, of which the Excess Reorganization Value was $225 million, of which
$129 million related to continuing operations. The Excess Reorganization Value
was amortized over the three-year period ended July 31, 1995.
4. CRESCENT TRANSACTIONS
On June 17, 1997, the Company consummated a series of transactions including
the sale of substantially all of its domestic hospital real estate and related
personal property (the "Assets") to Crescent Real Estate Equities Limited
Partnership ("Crescent") and CBHS. In addition, CBHS was formed as a joint
venture to operate the domestic portion of the Company's provider business
segment. CBHS is owned equally by Magellan and Crescent Operating, Inc., an
affiliate of Crescent ("COI"). The Company accounts for its 50% investment in
CBHS under the equity method of accounting (See Note 5). The
F-14
4. CRESCENT TRANSACTIONS (CONTINUED)
Company received approximately $417.2 million in cash (before costs estimated to
be $16.0 million) and warrants in COI for the purchase of 2.5% of COI's common
stock at $18.32, which are exercisable over 12 years. The Company also issued
1,283,311 warrants each to Crescent and COI (the "Crescent Warrants") for the
purchase of Magellan common stock at an exercise price of $30 per share. (See
Note 9.)
In related agreements, (i) Crescent leased the hospital real estate and
related assets to CBHS for annual rent beginning at approximately $41.7 million
with a 5% annual escalation clause compounded annually (the "Facilities Lease")
and (ii) CBHS will pay Magellan approximately $78.3 million in annual franchise
fees, subject to increase, for the use of assets retained by Magellan and for
support in certain areas. The franchise fees to be paid by CBHS to the Company
are subordinated to the lease obligations in favor of Crescent. The assets
retained by Magellan include, but are not limited to, the "CHARTER" name,
intellectual property, protocols and procedures, clinical quality management,
operating processes and the "1-800-CHARTER" telephone call center. Magellan
provides CBHS ongoing support in areas including advertising and marketing
assistance, risk management services, outcomes monitoring, and consultation on
matters relating to reimbursement, government relations, clinical strategies,
regulatory matters, strategic planning and business development.
The Company initially used a portion of the proceeds from the sale of the
Assets to reduce its long-term debt, including borrowings under its then
existing credit agreement. (See Note 8). In December 1997, the Company used the
remaining proceeds from the sale of the Assets to acquire additional managed
care businesses (See Note 17).
The Crescent Transactions are more fully described in the Company's Proxy
Statement filed on Schedule 14A on April 24, 1997.
The Company recorded a loss before income taxes of approximately $59.9
million as a result of the Crescent Transactions, which consisted of the
following (in thousands):
Accounts receivable collection fees................................ $ 21,400
Impairment losses on intangible assets............................. 14,408
Exit costs and construction obligation............................. 12,549
Loss on the sale of property and equipment......................... 11,511
---------
$ 59,868
---------
---------
Accounts receivable collection fees represent the reduction in the net
realizable value of accounts receivable for estimated collection fees on
retained hospital-based receivables for CBHS pursuant to a contractual
obligation with CBHS, whereby CBHS receives a fee equal to 5% of collections for
the first 120 days after consummation of the Crescent Transaction and estimated
bad debt agency fees of 40% for receivables collected subsequent to 120 days
after the consummation of the Crescent Transaction.
The Company disposed of a significant portion of its provider business
segment as part of the Crescent Transactions. The impairment loss on intangible
assets results from reducing the book value of the Company's investment in CBHS
to its approximate fair value at the consummation date. The impairment losses
represent the carrying amount of goodwill and other intangible assets related to
the divested or contributed CBHS operations.
The $5.0 million of exit costs accrued as a result of the Crescent
Transactions include incremental staffing, consulting and related costs to
prepare and coordinate audits of terminating Medicare cost reports, prepare and
file income tax, property tax, sales and use tax and other tax returns and
perform accounting functions related to the divested businesses (CBHS). The
Company incurred approximately $0.6 million of such costs during the year ended
September 30, 1997.
F-15
4. CRESCENT TRANSACTIONS (CONTINUED)
The Company is constructing a hospital in Philadelphia as required by the
Crescent Real Estate Purchase Agreement to replace the existing Philadelphia
hospital operated by CBHS. The Company has incurred approximately $2.7 million
in construction costs as of September 30, 1997 and expects to incur up to $4.9
million in additional construction costs before completion.
The Company's Consolidated Statement of Operations for the years ended
September 30, 1996 and 1997 include the operations of businesses divested as
part of the Crescent Transactions through June 16, 1997. The following unaudited
pro forma information for the years ended September 30, 1996 and 1997 has been
prepared assuming the Crescent Transactions were consummated on October 1, 1995.
The pro forma information does not purport to be indicative of the results which
would have actually been obtained had the Crescent Transactions been consummated
on October 1, 1995 or which may be attained in future periods (in thousands,
except per share data).
PRO FORMA
FOR THE YEARS ENDED
SEPTEMBER 30,
----------------------
1996 1997
---------- ----------
Net Revenue........................................................... $ 628,249 $ 710,835
Income before extraordinary items(1).................................. 20,481 32,149
Net income(1)......................................................... 20,481 26,896
Income per common share--primary:
Income before extraordinary items(1)................................ 0.72 1.09
Net income(1)....................................................... 0.72 0.91
Income per common share--fully diluted:
Income before extraordinary items(1)................................ 0.72 1.07
Net income(1)....................................................... 0.72 0.89
- ------------------------
(1) Excludes the loss on the Crescent Transactions and assumes the excess
proceeds from the Crescent Transactions are not invested. If the excess
proceeds from the Crescent Transactions were assumed to be reinvested at the
Company's historic temporary cash investment rate of 5.4% and 5.5% for the
years ended September 30, 1996 and 1997, respectively, pro forma income
before extraordinary items, net income, income per common share before
extraordinary items and net income per common share would have been $27.4
million, $27.4 million, $0.96 (primary and fully diluted) and $0.96 (primary
and fully diluted) for the year ended September 30, 1996, respectively, and
$36.8 million, $31.6 million, $1.25 (primary) and $1.22 (fully diluted) and
$1.07 (primary) and $1.05 (fully diluted) for the year ended September 30,
1997, respectively.
F-16
5. INVESTMENT IN CBHS
The Company owned a 50% interest in CBHS as of September 30, 1997. The
Company became a 50% owner of CBHS upon consummation of the Crescent
Transactions. The Company accounts for its investment in CBHS using the equity
method.
A summary of financial information for the Company's investment in CBHS is
as follows (in thousands):
SEPTEMBER 30, 1997
------------------
Current assets............................................................ $ 148,537
Property and equipment, net............................................... 18,424
Other noncurrent assets................................................... 8,633
--------
Total Assets............................................................ $ 175,594
--------
--------
Current liabilities....................................................... $ 68,497
Long-term debt(2)......................................................... 65,860
Other noncurrent liabilities.............................................. 7,481
Members' capital.......................................................... 33,756
--------
Total Liabilities and Members' Capital.................................. $ 175,594
--------
--------
FOR THE 106 DAYS ENDED SEPTEMBER 30, 1997
Net revenue............................................................... $ 213,730
Operating expenses(1)..................................................... 228,382
Interest, net............................................................. 1,592
--------
Net loss................................................................ $ (16,244)
--------
--------
Cash used in operating activities......................................... $ (67,831)
--------
--------
Magellan equity loss...................................................... $ (8,122)
--------
--------
- ------------------------
(1) Includes salaries, supplies and other operating expenses, bad debt expense,
depreciation and amortization.
(2) As of November 14, 1997, CBHS had $65.0 million of outstanding borrowings
under its revolving credit agreement.
The Company's transactions with CBHS and related balances are as follows (in
thousands):
106 DAYS ENDED
SEPTEMBER 30, 1997
------------------
Franchise Fee revenue..................................................... $ 22,739
Costs:
Accounts receivable collection fees..................................... 4,993
Hospital-based joint venture management fees............................ 2,189
SEPTEMBER 30, 1997
------------------
Due to CBHS, net.......................................................... $ 5,090
F-17
6. UNUSUAL ITEMS
GENERAL
The following table summarizes unusual items recorded during the three years
in the period ended September 30, 1997 (in thousands):
1995 1996 1997
--------- --------- ---------
Insurance Settlements.......................................... $ 29,800 $ 30,000 $ --
Facility Closures.............................................. 3,624 4,116 4,201
Asset impairments.............................................. 26,973 1,207 --
Gains on the Sale of Psychiatric Hospitals, net................ (2,960) -- (5,388)
Other.......................................................... -- 1,948 1,544
--------- --------- ---------
$ 57,437 $ 37,271 $ 357
--------- --------- ---------
--------- --------- ---------
INSURANCE SETTLEMENTS
Unusual items included the resolutions of disputes between the Company and
insurance carriers concerning certain billings for services.
In November 1994, the Company and a group of insurance carriers resolved a
billing dispute that arose in the fourth quarter of fiscal 1994 related to
claims paid predominantly in the 1980's. As part of the resolution, the Company
agreed to pay the insurance carriers approximately $31 million plus interest,
for a total of $37.5 million in four installments over a three year period. As
part of the settlement, the Company and the insurance carriers agreed to
continue to do business at the same or similar general levels as prior to the
settlement. Furthermore, the parties will seek additional business opportunities
that will serve to enhance their present relationships.
In March 1995, the Company and a group of insurance carriers resolved a
billing dispute which arose in fiscal 1995 related to matters arising
predominately in the 1980's. As part of the settlement, the Company agreed to
pay the insurance carriers $29.8 million payable in five installments over a
three year period. As part of the settlement, the Company and the insurance
carriers have agreed to continue to do business at the same or similar general
levels and to seek additional business opportunities that will serve to enhance
their present relationships.
In August 1996, the Company and a group of insurance carriers resolved a
billing dispute which arose in fiscal 1996 related to matters originating in the
1980's. As part of the settlement of these claims, certain related payer matters
and associated legal fees, the Company recorded a charge of approximately $30.0
million during the quarter ended June 30, 1996. The Company will pay the
insurance settlement amount in twelve installments over a three year period,
beginning August 1996. As part of the settlement, the Company and the insurance
carriers agreed that the dispute and settlement would not negatively impact any
present or pending business relationships nor would it prevent the parties from
negotiating in good faith concerning additional business opportunities available
to, and future relationships between, the parties.
Amounts payable in future periods for insurance settlements are as follows
(in thousands):
1998........................................................... $ 12,788
1999........................................................... 5,985
F-18
6. UNUSUAL ITEMS (CONTINUED)
FACILITY CLOSURES
During fiscal 1995, 1996 and 1997, the Company consolidated, closed or sold
fifteen, nine and three psychiatric facilities and its one general hospital (the
"Closed Facilities"), respectively, exclusive of the Crescent Transactions. The
three psychiatric facilities closed in 1997 were sold as part of the Crescent
Transactions. The Closed Facilities that are still owned by the Company will be
sold, leased or used for alternative purposes depending on the market conditions
in each geographic area and are recorded as other long-term assets in the
accompanying balance sheets.
The Company recorded charges of approximately $3.6 million, $4.1 million and
$4.2 million related to facility closures in fiscal 1995, 1996 and 1997,
respectively, as follows (in thousands):
1995 1996 1997
--------- --------- ---------
Severance and related benefits................................... $ 2,132 $ 2,334 $ 2,976
Contract terminations and other.................................. 1,492 1,782 1,225
--------- --------- ---------
$ 3,624 $ 4,116 $ 4,201
--------- --------- ---------
--------- --------- ---------
Approximately 500, 620 and 700 employees were terminated at the facilities
closed in fiscal 1995, 1996 and 1997, respectively. Severance and related
benefits have been substantially paid as of September 30, 1997. Other exit costs
paid and applied against the resulting liabilities were approximately $0.2
million, $1.4 million and $0.1 million in fiscal 1995, 1996 and 1997,
respectively.
The following table presents net revenue, salaries, cost of care and other
operating expenses and bad debt expenses and depreciation and amortization of
the Closed Facilities (in thousands):
YEAR ENDED SEPTEMBER 30,
--------------------------------
1995 1996 1997
---------- --------- ---------
Net revenue................................................. $ 149,428 $ 82,568 $ 19,582
Salaries, cost of care and other operating expense and bad
debt expenses............................................. 145,720 86,426 23,263
Depreciation and amortization............................... 3,509 2,015 349
The Company also recorded a charge of approximately $2.0 million in fiscal
1996 related to severance and related benefits for approximately 275 employees
who were terminated pursuant to planned overhead reductions.
ASSET IMPAIRMENTS
During fiscal 1995, the Company recorded impairment losses on property and
equipment and intangible assets of approximately $23.0 million and $4.0 million,
respectively. During fiscal 1996, the Company recorded impairment losses on
property and equipment of approximately $1.2 million. Such losses resulted from
changes in the manner that certain of the Company's assets were to be used in
future periods and current period operating losses at certain of the Company's
operating facilities combined with projected future operating losses. Fair
values of the long-lived assets that have been written down were determined
using the best available information in each individual circumstance, which
included quoted market price, comparable sales prices for similar assets or
valuation techniques utilizing present value of estimated expected cash flows.
Most of the impaired assets were sold as part of the Crescent Transactions.
F-19
6. UNUSUAL ITEMS (CONTINUED)
OTHER
During fiscal 1995 and 1997, the Company recorded gains of approximately
$3.0 million and $5.4 million, respectively, related to the sales of psychiatric
hospitals and other real estate. The Company also recorded a charge of
approximately $1.6 million during fiscal 1997 for costs incurred related
primarily to the expiration of its agreement to sell its three European
Hospitals.
7. BENEFIT PLANS
The Company maintains an Employee Stock Ownership Plan (the "ESOP"), a
noncontributory retirement plan that enables eligible employees to participate
in the ownership of the Company.
The Company had recorded unearned compensation to reflect the cost of Common
Stock purchased by the ESOP but not yet allocated to participants' accounts. In
the period that shares are allocated or projected to be allocated to
participants, ESOP expense is recorded and unearned compensation is reduced. All
shares had been allocated to the participants as of September 30, 1995. The ESOP
distributed 103,332 shares to participants who were transferred to CBHS as a
result of the Crescent Transactions in fiscal 1997.
The Internal Revenue Service has ruled that the ESOP qualifies under Section
401 of the Internal Revenue Code of 1986, as amended. Such determination allowed
the Company to deduct its contributions to the ESOP for federal income tax
purposes.
During fiscal 1992, the Company reinstated a defined contribution plan (the
"Magellan 401-K Plan"). Effective January 1, 1997, the plan was amended to allow
participants to contribute up to 15% of their compensation to the Magellan 401-K
Plan. The Company makes a discretionary contribution of 2% of each employee's
compensation and matches 50% of each employee's contribution up to 3% of their
compensation. During the years ended September 30, 1995, 1996 and 1997, the
Company made contributions of approximately $5.8 million, $5.3 million and $5.7
million, respectively, to the Magellan 401-K Plan.
Green Spring also maintains a defined contribution plan (the "Green Spring
401-K Plan"). Employee participants can elect to voluntarily contribute up to 6%
or 12% of their compensation, depending upon each employee's compensation level,
to the Green Spring 401-K Plan. Green Spring matches up to 3% of each employee's
compensation. Employees vest in employer contributions over five years. During
the years ended September 30, 1996 and 1997, Green Spring contributed
approximately $0.8 million and $1.3 million, respectively, to the Green Spring
401-K Plan.
F-20
8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Information with regard to the Company's long-term debt and capital lease
obligations at September 30, 1996 and 1997 is as follows (in thousands):
SEPTEMBER 30, SEPTEMBER 30,
1996 1997
------------- -------------
Magellan Existing Credit Agreement due through 2002............. $ 105,593 $ --
11.25% Senior Subordinated Notes due 2004....................... 375,000 375,000
6.8125 % to 8.0% Mortgage and other notes payable through
1999.......................................................... 12,163 7,721
Variable rate secured notes..................................... 60,875 --
7.5% Swiss Bonds................................................ 6,443 6,443
3.85% Capital lease obligations due through 2014................ 12,333 6,438
------------- -------------
572,407 395,602
Less amounts due within one year.............................. 5,751 3,601
Less debt service funds....................................... 349 308
------------- -------------
$ 566,307 $ 391,693
------------- -------------
------------- -------------
The aggregate scheduled maturities of long-term debt and capital lease
obligations during the five years subsequent to September 30, 1997 are as
follows (in thousands): 1998--$3,601; 1999--$3,252; 2000-- $28; 2001--$6,165 and
2002--$28.
The 11.25% Senior Subordinated Notes (the "Magellan Outstanding Notes"),
which are carried at cost, had a fair value of approximately $405 million and
$417 million at September 30, 1996 and 1997, respectively, based on market
quotes. The Company's remaining debt is also carried at cost, which approximates
fair market value.
NEW REVOLVING CREDIT AGREEMENTS
On October 28, 1996, the Company entered into a credit agreement with
certain financial institutions for a five-year Senior Secured reducing revolving
credit facility in an aggregate committed amount of $400 million. The Company
borrowed approximately $121.0 million under such credit agreement in October
1996 to (i) repay the existing borrowings outstanding under their existing
credit agreement and (ii) pay for fees and expenses related to the credit
agreement.
The loans outstanding under the credit agreement bore interest (subject to
certain potential adjustments) at a rate per annum equal to one, two, three or
six-month LIBOR plus 1.25% or the Prime Lending Rate.
The Company recorded an extraordinary loss from the early extinguishment of
debt of approximately $3.0 million, net of tax, during the quarter ended
December 31, 1996 to write off unamortized deferred financing costs related to
the previous credit agreement.
On June 17, 1997, the Company entered into a credit agreement with certain
financial institutions for a five-year senior secured revolving credit facility
in an aggregate committed amount of $200 million (the "Magellan Existing Credit
Agreement"). The Company repaid approximately $191.8 million of borrowings
outstanding under the previous credit agreement, which included borrowings to
retire approximately $66 million of variable rate secured notes and other
long-term debt, with proceeds from the Crescent Transactions.
The loans outstanding under the Magellan Existing Credit Agreement bear
interest (subject to certain potential adjustments) at a rate per annum equal to
one, two, three or six-month LIBOR plus 1.25% or the Alternative Base Rate
("ABR"), as defined, plus .25%. Interest on ABR loans is payable at the end of
each fiscal quarter. Interest on LIBOR-based loans is payable at the end of
their respective terms, but a minimum of every three months.
F-21
8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
The Company recorded an extraordinary loss of approximately $2.3 million,
net of tax, during the quarter ended June 30, 1997 to write off unamortized
deferred financing costs related to the previous credit agreement and for costs
related to repaying the variable rate secured notes.
SENIOR SUBORDINATED NOTES
On May 2, 1994, the Company issued $375 million of 11.25% Senior
Subordinated Notes which mature on April 15, 2004 and are general unsecured
obligations of the Company. Interest on the Magellan Outstanding Notes is
payable semi-annually on each April 15 and October 15. Proceeds of $181.8
million from the sale of the Magellan Outstanding Notes were used to decrease,
and, subsequently on June 9, 1994, to redeem the Company's outstanding 7.5%
Senior Subordinated Debentures due 2003. Certain remaining proceeds were used,
along with proceeds from the Credit Agreement, to finance the Hospital
Acquisition. The Magellan Outstanding Notes are guaranteed on an unsecured
senior subordinated basis by substantially all of the Company's existing
subsidiaries and certain subsidiaries created after the issuance of the Magellan
Outstanding Notes.
The Magellan Outstanding Notes are not redeemable at the option of the
Company prior to April 15, 1999. Thereafter, the Magellan Outstanding Notes will
be subject to redemption at the option of the Company, in whole or in part, at
the redemption prices (expressed as a percentage of the principal amount) set
forth below, plus accrued and unpaid interest thereon to the applicable
redemption date, if redeemed during the twelve-month period beginning April 15
of the years indicated below:
REDEMPTION
YEAR PRICE
- ------------------------------------------------------------- -----------
1999......................................................... 105.625%
2000......................................................... 103.750%
2001......................................................... 101.875%
2002 and thereafter.......................................... 100.000%
COVENANTS
The Magellan Existing Credit Agreement and the indenture for the Magellan
Outstanding Notes contain a number of restrictive covenants, which, among other
things, limit the ability of the Company and certain of its subsidiaries to
incur other indebtedness, engage in transactions with affiliates, repurchase
shares of the Company's common stock above specified levels, incur liens, make
certain restricted payments, and enter into certain business combination and
asset sale transactions. The Magellan Existing Credit Agreement also requires
the Company to maintain certain specified financial ratios. The Company was in
compliance with all debt covenants under the Magellan Existing Credit Agreement
and the Magellan Outstanding Notes at September 30, 1997.
LEASES
The Company leases certain of its operating facilities, some of which may be
purchased during the term or at expiration of the leases. The book value of
capital leased assets was approximately $3.5 million at September 30, 1997. The
leases, which expire at various dates through 2069, generally require the
Company to pay all maintenance, property tax and insurance costs.
At September 30, 1997, aggregate amounts of future minimum payments under
operating leases were as follows: 1998--$12.4 million; 1999--$10.8 million;
2000--$8.9 million; 2001--$7.1 million; 2002--$5.2 million; subsequent to
2002--$47.7 million.
F-22
8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
Rent expense for the years ended September 30, 1995, 1996 and 1997 was $15.4
million, $18.7 million and $19.2 million, respectively.
9. STOCKHOLDERS' EQUITY
Pursuant to the Company's Restated Certificate of Incorporation, the Company
is authorized to issue 80 million shares of common stock, $.25 par value per
share, and 10 million shares of preferred stock, without par value. No shares of
preferred stock have been issued as of September 30, 1997.
COMMON STOCK
The Company is prohibited from paying dividends on its Common Stock under
the terms of the New Revolving Credit Agreement except under certain limited
circumstances.
1992 STOCK OPTION PLAN
The 1992 Stock Option Plan provided for the issuance of approximately 3.4
million options to purchase shares of Common Stock. A summary of changes in
options outstanding and other related information is as follows:
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------
1995 1996 1997
--------------- --------------- ---------------
Balance, beginning of period.............. 772,516 715,516 368,990
Canceled................................ (10,500) -- --
Exercised............................... (46,500) (346,526) --
--------------- --------------- ---------------
Balance, end of period.................... 715,516 368,990 368,990
--------------- --------------- ---------------
--------------- --------------- ---------------
Option prices, end of period.............. $ 4.36-$22.75 $ 4.36-$22.75 $ 4.36-$22.75
Price range of exercised options.......... $ 4.36-$14.19 $ 4.36-$16.875 --
Average exercise price.................... $6.26 $4.59 --
The exercise price of certain options would be reduced upon termination of
employment of a certain optionee without cause.
Options issued pursuant to the 1992 Stock Option Plan are exercisable upon
vesting and expire through October 2000. As of September 30, 1997, 100% of the
options outstanding were vested.
1994 STOCK OPTION PLAN
The 1994 Stock Option Plan provided for the issuance of approximately 1.3
million options to purchase shares of Common Stock. Officers and key employees
of the Company are eligible to participate.
F-23
9. STOCKHOLDERS' EQUITY (CONTINUED)
The options have an exercise price which approximates fair market value of the
Common Stock at the date of grant. A summary of changes in options outstanding
and other related information is as follows:
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------
1995 1996 1997
------------------ ------------------ ------------------
Balance, beginning of period...... 876,500 1,162,331 948,669
Granted......................... 495,000 161,000 341,166
Canceled........................ (209,169) (330,162) (87,498)
Exercised....................... -- (44,500) (173,843)
------------------ ------------------ ------------------
Balance, end of period............ 1,162,331 948,669 1,028,494
------------------ ------------------ ------------------
------------------ ------------------ ------------------
Option prices, end of period...... $ 15.625-$27.875 $ 15.687-$27.875 $ 15.687-$27.718
Price range of exercised
options....................... -- $ 15.625-$22.875 $ 15.687-$27.875
Average exercise price.......... -- $20.70 $22.20
Options granted under the 1994 Stock Option Plan are exercisable to the
extent vested. An option vests at the rate of 33 1/3% of the shares covered by
the option on each of the first three anniversary dates of the grant of the
option if the optionee is an employee of the Company on such dates. Options must
be exercised no later than ten years after the date of grant. As of September
30, 1997, 50.6% of the options outstanding were vested.
1996 STOCK OPTION PLAN
The 1996 Stock Option Plan (the "1996 Plan") provides for the issuance of
1.75 million options to purchase shares of the Company's Common Stock. Options
must be granted on or before December 31, 1999. Officers and key employees of
the Company are eligible to participate. The options have an exercise price
which approximates fair market value of the Common Stock at the date of grant. A
summary of changes in options outstanding and other related information is as
follows:
YEAR ENDED SEPTEMBER 30
--------------------------------------
1996 1997
------------------ ------------------
Balance, beginning of period.......................... -- 1,298,500
Granted............................................. 1,413,000 310,667
Canceled............................................ (114,500) (96,125)
Exercised........................................... -- (101,750)
------------------ ------------------
Balance, end of period................................ 1,298,500 1,411,292
------------------ ------------------
------------------ ------------------
Option prices, end of period.......................... $ 15.75-$24.00 $ 15.75-$30.875
Price range of exercised options...................... -- $ 18.125-$18.875
Average exercise price................................ -- $18.348
Options granted under the 1996 Plan are exercisable to the extent vested. An
option vests at the rate of 25% of the shares covered by the option on each of
the four anniversary dates of the grant of the option if the optionee is an
employee of the Company on such dates. Options must be exercised no later than
November 30, 2005.
The 1996 Plan provides that the options granted thereunder, upon the
occurrence of certain events, vest and become fully exercisable upon the "sale,
lease, transfer of other disposition...of all or substantially all" of the
Company's assets. Based upon a review of relevant Delaware case law, the Company
believes that substantial uncertainty existed regarding whether the Crescent
Transactions, which are described in
F-24
9. STOCKHOLDERS' EQUITY (CONTINUED)
Note 4, constituted a "sale ... of all or substantially all" of the Company's
assets. Accordingly, the Company's Board of Directors determined it should treat
the Crescent Transactions as such an event in order to eliminate the risk of a
dispute. Options outstanding under the 1996 Plan immediately vested upon closing
the Crescent Transactions. As of September 30, 1997, 96.5% of the options
outstanding under the 1996 Plan were vested.
1997 STOCK OPTION PLAN
The 1997 Stock Option Plan provides for the issuance of 1.5 million options
to purchase shares of the Company's Common Stock. Options must be granted on or
before December 31, 2000. Officers and key employees of the Company are eligible
to participate. The options have an exercise price which approximates fair
market value of the Common Stock at the date of grant. A summary of changes in
options outstanding and other related information is as follows:
YEAR ENDED
SEPTEMBER 30,
1997
----------------
Balance, beginning of period................................................ --
Granted..................................................................... 988,333
Canceled.................................................................... --
----------------
Balance, end of period...................................................... 988,333
----------------
Option prices, end of period................................................ $ 24.375-$31.00
Options granted under the 1997 Stock Option Plan are exercisable to the
extent vested. An option vests at the rate of 33 1/3% of the shares covered by
the option on each of the three anniversary dates of the grant of the option if
the optionee is an employee of the Company on such dates. Options must be
exercised no later than February 28, 2007. As of September 30, 1997, none of the
options outstanding were vested.
1994 EMPLOYEE STOCK PURCHASE PLAN
The 1994 Employee Stock Purchase Plan (the "1994 ESPP") covered 600,000
shares of Common Stock that could be purchased by eligible employees of the
Company.
The initial offering period began on April 1, 1994 and expired on March 31,
1995. The second offering period began on April 1, 1995 and ended March 31,
1996. On the first date of these offering periods, each participant was granted
an option to purchase shares of Common Stock at a purchase price equal to 85% of
the fair value of a share of Common Stock on such date. Total options granted on
April 1, 1994 and April 1, 1995 were 85,115 and 41,565, respectively, with
option prices of $21.144 and $15.831, respectively. A total of 4,872 and 22,065
options were exercised at the end of the first and second offering periods,
respectively.
Effective August 1, 1995, the Company amended the 1994 ESPP to change the
option price in subsequent offering periods to the lesser of (i) 85% of the fair
value of a share of Common Stock on the first day of the offering period or (ii)
85% of the fair value of a share of Common Stock on the last day of the offering
period. Holders of the options from the second offering period as of July 31,
1995 were given the choice of (i) canceling their options to purchase shares of
Common Stock, (ii) exercising the option to purchase shares of Common Stock at a
purchase price of $15.831 or (iii) keeping their options. A total of 11,870
options were exercised on July 31, 1995. The third offering period began August
1, 1995 and ended December 31, 1995. A total of 29,217 options were exercised at
a purchase price of $16.681 at the end of the third offering period.
F-25
9. STOCKHOLDERS' EQUITY (CONTINUED)
The fourth offering period began January 1, 1996 and ended on June 30, 1996.
A total of 68,146 options were exercised at a purchase price of $18.275 at the
end of the fourth offering period. The fifth offering period began July 1, 1996
and ended on December 31, 1996. A total of 80,018 options were exercised at a
purchase price of $17.85 at the end of the fifth and final offering period.
1997 EMPLOYEE STOCK PURCHASE PLAN
The 1997 Employee Stock Purchase Plan (the "1997 ESPP") covers 600,000
shares of Common Stock that can be purchased by eligible employees of the
Company. The 1997 ESPP offering periods will have a term not less than three
months and not more than 12 months. The first offering period under the 1997
ESPP began January 1, 1997 and the last offering period will end on or before
December 31, 1999. The option price of each offering period will be the lesser
of (i) 85% of the fair value of a share of Common Stock on the first day of the
offering period or (ii) 85% of the fair value of a share of Common Stock on the
last day of the offering period.
The first offering period began January 1, 1997 and ended on June 30, 1997.
A total of 73,410 options were exercised at a purchase price of $19.125. The
second offering period began August 1, 1997 and will end on December 31, 1997.
The number of options granted and the option price for the second offering
period will be determined on December 31, 1997 when the option price is known.
1992 DIRECTORS' STOCK OPTION PLAN AND DIRECTORS' UNIT AWARD PLAN
The 1992 Directors' Stock Option Plan provides for the grant of options to
non-employee members of the Company's Board of Directors to purchase up to
175,000 shares of the Company's Common Stock, subject to adjustments to reflect
certain changes in capitalization. The options have an exercise price which
approximates the fair market value of the Common Stock on the date of grant.
During fiscal 1995, 25,000 options were granted at an exercise price of $18.875
per share. During fiscal 1996 and 1997, no options were granted. As of September
30, 1997, 125,000 options were outstanding. No options were exercised during
fiscal 1995, 1996 and 1997.
Options granted can be exercised from the date of vesting until February 1,
2003. No options can be granted after December 31, 1995. Options vest 20% when
granted and an additional 20% on each successive February 1 for a period of four
years, if the optionee continues to serve as a non-employee director on the
applicable February 1. Unvested options vest in full in certain instances of
termination. As of September 30, 1997, 88.0% of the options outstanding were
vested.
In addition, during fiscal 1994, the Company approved the Directors' Unit
Award Plan (the "Unit Plan") which provides for the award of a maximum of 15,000
units (the "Units") that, upon vesting under the terms of the Unit Plan, would
result in the issuance of an aggregate of 15,000 shares of Common Stock in
settlement of Units.
The Unit Plan provides for the award to each director who is not an employee
of the Company of 2,500 Units. Upon vesting of the Units awarded to a director,
the Company will settle the Units by issuing to the director, with no exercise
price, a number of shares of the Company's Common Stock equal to the number of
vested Units.
1996 DIRECTORS' STOCK OPTION PLAN
The 1996 Directors' Stock Option Plan provides for the grant of options to
non-employee members of the Company's Board of Directors to purchase up to
250,000 shares of the Company's Common Stock, subject to adjustments to reflect
certain changes in capitalization. The options have an exercise price which
approximates the fair market value of a share of the Common Stock on the date of
grant. During fiscal
F-26
9. STOCKHOLDERS' EQUITY (CONTINUED)
1996, 175,000 options were granted at exercise prices ranging from $18.25 to
$23.375. During fiscal 1997, 25,000 options were granted at an exercise price of
$30.812. No options were exercised during fiscal 1996 or 1997.
Options granted can be exercised from the date of vesting until November 30,
2005. No options can be granted after December 31, 1999. Options vest at the
rate of 25% of the shares covered on each of the four anniversary dates of the
grant of the option if the optionee continues to serve as a non-employee
director on such dates. Options vest in full in certain instances of
termination. As of September 30, 1997, 21.9% of the options outstanding were
vested.
RIGHTS PLAN
Also upon consummation of the Plan, the Company adopted a Share Purchase
Rights Plan (the "Rights Plan"). Pursuant to the Rights Plan, each share of
Common Stock also represents one Share Purchase Right (collectively, the
"Rights"). The Rights trade automatically with the underlying shares of Common
Stock. Upon becoming exercisable, but prior to the occurrence of certain events,
each Right initially entitles its holder to buy one share of Common Stock from
the Company at an exercise price of $60.00. The Rights will be distributed and
become exercisable only if a person or group acquires, or announces its
intention to acquire, Common Stock exceeding certain levels, as specified in the
Rights Plan. Upon the occurrence of such events, the exercise price of each
Right reduces to one-half of the then current market price. The Rights also give
the holder certain rights in an acquiring company's common stock. The Company is
entitled to redeem the Rights at a price of $.01 per Right at any time prior to
the distribution of the Rights. The Rights have no voting power until exercised.
COMMON STOCK WARRANTS
In connection with the Plan, the Company issued 114,690 warrants, which
expire on June 30, 2002 (the "2002 Warrants") to purchase one share each of the
Company's Common Stock. The 2002 Warrants have an exercise price of $5.24 per
share. During fiscal 1995, 1996 and 1997, 47,392, 4,320 and 1,397 shares were
issued, respectively, upon the exercise of 2002 Warrants.
The 2006 Warrants, which expire on September 1, 2006, were subject to
certain adjustments as a result of the Plan, and accordingly, 146,791 of such
warrants are currently outstanding with an exercise price of $38.70 per share.
Crescent and COI each have the right to purchase 1,283,311 shares of Common
Stock (2,566,622 shares in aggregate) at a warrant exercise price of $30 per
share (subject to adjustment pursuant to
F-27
9. STOCKHOLDERS' EQUITY (CONTINUED)
antidilution provisions). The Crescent Warrants will be exercisable at the
following times and in the following amounts:
NUMBER OF SHARES OF
COMMON STOCK
DATE FIRST ISSUABLE UPON END OF
EXERCISABLE EXERCISE EXERCISE PERIOD
JUNE 17 OF WARRANTS JUNE 17
- -------------------- -------------------- --------------------
1998 30,000 2001
1999 62,325 2002
2000 97,114 2003
2001 134,513 2004
2002 174,678 2005
2003 217,770 2006
2004 263,961 2007
2005 313,433 2008
2006 366,376 2009
2007 422,961 2009
2008 483,491 2009
Crescent's and COI's rights with respect to the Crescent Warrants are not
contingent on or subject to the satisfaction or completion of any obligation
that Crescent or COI may have to CBHS, or that CBHS may have to the Company, or
by any subordination of fees otherwise payable to the Company by CBHS.
The Crescent Warrants contain provisions relating to adjustments in the
number of shares covered by the Crescent Warrants and the warrant exercise price
in the event of stock splits, stock dividends, mergers, reorganizations and
similar transactions.
The Crescent Warrants were recorded at $25 million upon issuance, or their
approximate fair value upon execution of the Warrant Purchase Agreement in
January 1997.
PRIVATE PLACEMENT TRANSACTION
On January 25, 1996, the Company issued 4 million shares of Common Stock
(the "Shares") along with a warrant to purchase an additional 2 million shares
of Common Stock (the "Warrant") pursuant to a Stock and Warrant Purchase
Agreement. The Warrant entitles the holders to purchase such additional shares
of Common Stock at a per share price of $26.15, subject to adjustment for
certain dilutive events, and provides registration rights for the shares of
Common Stock underlying the Warrant. The aggregate purchase price for the Shares
and the Warrant was approximately $69.73 million. The Warrant became exercisable
on January 25, 1997 and expires on January 25, 2000.
Approximately $68.0 million of the proceeds were used to repay outstanding
borrowings under the then existing credit agreement.
TREASURY STOCK TRANSACTIONS
During fiscal 1995, the Company purchased approximately 327,000 shares of
its Common Stock in the open market for approximately $5.6 million.
Approximately 17,000 of such shares were reissued related to 1994 ESPP exercises
for approximately $291,000.
On August 15, 1996, the Company commenced a "Dutch Auction" self-tender
offer to stockholders for the repurchase of 1,891,891 shares of its own Common
Stock. On September 5, 1996, the Company increased the self-tender offer to
3,300,000 shares. Under the terms of the offer, stockholders were invited
F-28
9. STOCKHOLDERS' EQUITY (CONTINUED)
to tender their shares by September 18, 1996 at prices ranging from $16.50 to
$18.50 per share as specified by each stockholder.
At the conclusion of the offer, the Company repurchased 3,961,505 shares on
September 27, 1996 at $18.375 per share for a total cost of approximately $73.5
million, including transaction costs. The total shares repurchased represent
approximately 12.0% of the outstanding Common Stock at such date.
The transaction was financed through cash on hand and borrowings under the
then existing credit agreement.
INCOME PER COMMON SHARE
In February 1997, the FASB issued Statement No. 128 "Earnings per Share"
("FAS 128"), which is more fully described in Note 1. Income (loss) per common
share under FAS 128, if applied to the years ended September 30, 1995, 1996 and
1997, is as follows:
FOR THE YEAR ENDED
SEPTEMBER 30,
-------------------------------
1995 1996 1997
--------- --------- ---------
Income (loss) per common share--Basic:
Income (loss) before extraordinary items................... $ (1.54) $ 1.04 $ 0.17
Net income (loss).......................................... $ (1.54) $ 1.04 $ (0.02)
Income (loss) per common share--Diluted:
Income (loss) before extraordinary items................... $ (1.54) $ 1.02 $ 0.16
Net income (loss).......................................... $ (1.54) $ 1.02 $ (0.02)
Weighted average number of common shares outstanding (in
thousands):
Basic...................................................... 27,870 31,014 28,781
--------- --------- ---------
--------- --------- ---------
Diluted.................................................... 27,870 31,596 29,474
--------- --------- ---------
--------- --------- ---------
The difference between weighted average number of common shares outstanding
for basic and diluted EPS for the years ended September 30, 1996 and 1997
related primarily to common stock equivalents computed under the treasury stock
method.
STOCK BASED COMPENSATION
Effective October 1, 1996, the Company adopted the disclosure requirements
of FAS 123. FAS 123 requires disclosure of pro forma net income and pro forma
net income per share as if the fair value-based method of accounting for stock
options had been applied in measuring compensation cost for stock-based awards
granted in fiscal 1996 and 1997. Pro forma amounts are not representative of the
effects of stock-based awards on future pro forma net income and pro forma net
income per share because those pro forma amounts exclude the pro forma
compensation expense related to unvested stock options granted before fiscal
1996.
F-29
9. STOCKHOLDERS' EQUITY (CONTINUED)
Reported and pro forma net income and net income per share amounts are set
forth below (in thousands, except per share data):
1996 1997
--------- ---------
Reported:
Income before extraordinary items...................................... $ 32,383 $ 4,755
Net income (loss)...................................................... $ 32,383 $ (498)
Income (loss) per common share--primary:
Income before extraordinary items...................................... $ 1.04 $ 0.16
Net income (loss)...................................................... $ 1.04 $ (0.02)
Income (loss) per common share--fully diluted:
Income before extraordinary items...................................... $ 1.04 $ 0.16
Net income (loss)...................................................... $ 1.04 $ (0.02)
Pro Forma:
Income (loss) before extraordinary items............................... $ 28,835 $ (3,721)
Net income (loss)...................................................... $ 28,835 $ (8,974)
Income (loss) per common share--primary:
Income (loss) before extraordinary items............................... $ 0.93 $ (0.13)
Net income (loss)...................................................... $ 0.93 $ (0.31)
Income (loss) per common share--fully diluted:
Income (loss) before extraordinary items............................... $ 0.93 $ (0.13)
Net income (loss)...................................................... $ 0.93 $ (0.31)
The fair values of the stock options and ESPP options granted were estimated
on the date of their grant using the Black-Scholes option pricing model based on
the following weighted average assumptions:
1996 1997
--------- ----------
Risk-free interest rate............................................ 6% 6%
Expected life...................................................... 5 years 5.5 years
Expected volatility................................................ 35% 30%
Expected dividend yield............................................ 0% 0%
The weighted average fair value of options granted during fiscal 1996 and
1997 was $6.85 and $9.67, respectively.
F-30
9. STOCKHOLDERS' EQUITY (CONTINUED)
Stock option activity for all plans for 1995, 1996 and 1997 was as follows:
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------------
1995 1996 1997
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ----------- ---------- ----------- ---------- -----------
Balance, beginning of period............... 1,749,016 $ 14.42 2,002,847 $ 15.32 2,916,159 $ 17.92
Granted.................................... 520,000 20.95 1,749,000 19.05 1,665,166 24.24
Canceled................................... (219,669) 23.55 (444,662) 21.20 (183,623) 20.84
Exercised.................................. (46,500) 6.09 (391,026) 6.37 (275,593) 20.26
---------- ---------- ----------
Balance, end of period..................... 2,002,847 15.32 2,916,159 17.92 4,122,109 20.13
---------- ---------- ----------
Exercisable, end of period................. 1,025,988 9.61 926,195 14.75 2,419,711 17.65
---------- ---------- ----------
---------- ---------- ----------
Stock options outstanding on September 30, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICE OPTIONS LIFE PRICE OPTIONS PRICE
- ------------------------------------- ---------- --------------- ----------- ---------- -----------
$4.36-$18.25 1,377,444 7.81 $ 14.32 1,256,200 $ 13.97
$18.31-$22.88 1,378,166 7.68 $ 20.87 870,756 $ 20.84
$23.00-$31.00 1,366,499 9.18 $ 25.33 292,755 $ 23.94
---------- ----------
$4.36-$31.00 4,122,109 8.21 $ 20.13 2,419,711 $ 17.65
---------- ----------
---------- ----------
10. INCOME TAXES
The provision (benefit) for income taxes consisted of the following (in
thousands):
YEAR ENDED SEPTEMBER 30,
--------------------------------
1995 1996 1997
---------- --------- ---------
Income taxes currently payable:
Federal................................................... $ 658 $ 6,900 $ 11,148
State..................................................... 1,851 (1,139) 3,959
Foreign................................................... 1,188 3,779 3,678
Deferred income taxes:
Federal................................................... (12,931) 15,313 (6,670)
State..................................................... (1,848) 807 (2,569)
Foreign................................................... -- 35 (308)
---------- --------- ---------
$ (11,082) $ 25,695 $ 9,238
---------- --------- ---------
---------- --------- ---------
F-31
10. INCOME TAXES (CONTINUED)
A reconciliation of the Company's income tax provision (benefit) to that
computed by applying the statutory federal income tax rate is as follows (in
thousands):
YEAR ENDED SEPTEMBER 30,
--------------------------------
1995 1996 1997
---------- --------- ---------
Income tax provision (benefit) at federal statutory income
tax rate.................................................. $ (18,798) $ 22,483 $ 8,083
State income taxes, net of federal income tax benefit....... (16) (216) 904
Foreign income taxes, net of federal income tax benefit..... 772 2,479 2,190
Amortization of excess reorganization value................. 9,100 -- --
Other--net.................................................. (2,140) 949 (1,939)
---------- --------- ---------
Income tax provision (benefit).............................. $ (11,082) $ 25,695 $ 9,238
---------- --------- ---------
---------- --------- ---------
As of September 30, 1997, the Company has estimated tax net operating loss
("NOL") carryforwards of approximately $278 million available to reduce future
federal taxable income. These NOL carryforwards expire in 2006 through 2011 and
are subject to examination by the Internal Revenue Service. The Company has
recorded a valuation allowance against the entire amount of the NOL deferred tax
asset and certain other deferred tax assets, that in management's opinion, are
not likely to be recovered.
Components of the net deferred income tax (assets) liabilities at September
30, 1996 and 1997 are as follows (in thousands):
SEPTEMBER 30,
------------------------
1996 1997
----------- -----------
Deferred tax liabilities:
Insurance settlements............................................. $ -- $ 8,460
Property and depreciation......................................... 23,970 --
Long-term debt and interest....................................... 63,516 54,820
ESOP.............................................................. 11,616 11,112
Other............................................................. 14,133 17,449
----------- -----------
Total deferred tax liabilities.................................. 113,235 91,841
----------- -----------
Deferred tax assets:
Property and depreciation......................................... -- (7,123)
Operating loss carry forwards..................................... (102,229) (111,251)
Insurance settlements............................................. (3,649) --
Self-insurance reserves........................................... (44,234) (30,918)
Restructuring costs............................................... (26,695) (22,990)
Other............................................................. (48,033) (45,709)
----------- -----------
Total deferred tax assets......................................... (224,840) (217,991)
----------- -----------
Valuation allowance............................................... 123,973 124,992
----------- -----------
Deferred tax assets after valuation allowance..................... (100,867) (92,999)
----------- -----------
Net deferred tax (assets) liabilities............................. $ 12,368 $ (1,158)
----------- -----------
----------- -----------
The Internal Revenue Service is currently examining the Company's income tax
returns for fiscal 1989 through 1992 and expects a report to be issued during
fiscal 1998. In management's opinion, adequate
F-32
10. INCOME TAXES (CONTINUED)
provisions have been made for any adjustments which may result from these
examinations, including a potential reduction in the amount of NOL
carryforwards. The Company believes the examinations could result in a reduction
in NOL carryforwards available to offset future taxable income.
11. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
SEPTEMBER 30,
----------------------
1996 1997
---------- ----------
Salaries, wages and other benefits.................................... $ 39,841 $ 21,647
Amounts due health insurance programs................................. 27,223 14,126
Medical claims payable................................................ 26,552 36,508
Interest.............................................................. 20,348 19,739
Crescent Transactions................................................. -- 14,648
Other................................................................. 75,635 63,761
---------- ----------
$ 189,599 $ 170,429
---------- ----------
---------- ----------
12. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the years ended September 30, 1995,
1996 and 1997 is as follows (in thousands):
YEAR ENDED SEPTEMBER 30,
-------------------------------
1995 1996 1997
--------- --------- ---------
Income taxes paid, net of refunds received................... $ 4,682 $ 9,299 $ 18,406
Interest paid, net of amounts capitalized.................... 54,302 56,248 54,378
Long-term debt assumed in connection with acquisitions....... -- 12,100 --
Initial capital contribution to CBHS, primarily property and
equipment, less assumed liabilities........................ -- -- 5,287
The non-cash portion of unusual items for fiscal 1995 and 1996 includes the
unpaid portion of the $29.8 million and $30.0 million insurance settlements that
were recorded during the quarters ended March 31, 1995 and June 30, 1996,
respectively. The payments of the insurance settlements are included in accounts
payable and other accrued liabilities in the statement of cash flows for fiscal
1995, 1996 and 1997.
13. COMMITMENTS AND CONTINGENCIES
The Company is self-insured for a substantial portion of its general and
professional liability risks. The reserves for self-insured general and
professional liability losses, including loss adjustment expenses, are based on
actuarial estimates that are discounted at an average rate of 6% to their
present value based on the Company's historical claims experience adjusted for
current industry trends. The undiscounted amount of the reserve for unpaid
claims at September 30, 1996 and 1997 was approximately $84.3 million and $56.1
million, respectively. The reserve for unpaid claims is adjusted periodically as
such claims mature, to reflect changes in actuarial estimates based on actual
experience. During fiscal 1996 and 1997, the Company recorded reductions in
malpractice claim reserves of approximately $15.3 million and $7.5 million,
respectively, as a result of updated actuarial estimates. These reductions
resulted primarily from updates to
F-33
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
actuarial assumptions regarding the Company's expected losses for more recent
policy years. These revisions are based on changes in expected values of
ultimate losses resulting from the Company's claim experience, and increased
reliance on such claim experience. While management and its actuaries believe
that the present reserve is reasonable, ultimate settlement of losses may vary
from the amount recorded.
Certain of the Company's subsidiaries are subject to or parties to claims,
civil suits and governmental investigations and inquiries relating to their
operations and certain alleged business practices. In the opinion of management,
based on consultation with counsel, resolution of these matters will not have a
material adverse effect on the Company's financial position or results of
operations.
In January 1996, the Company settled an ongoing dispute with the Resolution
Trust Corporation ("RTC"), for itself or in its capacity as conservator or
receiver for 12 financial institutions, which formerly held certain debt
securities that were issued by the Company in 1988. In connection with the
settlement, the Company, denying any liability or fault, paid $2.7 million to
the RTC in exchange for a release of all claims.
On August 1, 1996, the United States Department of Justice, Civil Division,
filed an Amended Complaint in a civil QUI TAM action initiated in November 1994
against the Company and its Orlando South hospital subsidiary ("Charter
Orlando") by two former employees. The First Amended Complaint alleges that
Charter Orlando violated the federal False Claims Act (the "Act") in billing for
inpatient treatment provided to elderly patients. The Court granted the
Company's motion to dismiss the government's First Amended Complaint yet granted
the government leave to amend its First Amended Complaint. The government filed
a Second Amended Complaint on December 12, 1996 which, similar to the First
Amended Complaint, alleges that the Company and its subsidiary violated the Act
in billing for the treatment of geriatric patients. Like the First Amended
Complaint, the Second Amended Complaint is based on disputed clinical and
factual issues which the Company believes do not constitute a violation of the
Act. On the Company's motion, the Court has ordered the parties to participate
in mediation of the matter. As a result of the mediation, the parties are
engaged in settlement discussions which may lead to a resolution of the matter.
The Company has offered to settle for $3.5 million, which the Company has
accrued. The government has made a counter demand of $5.9 million plus
penalties. Nonetheless, the Company and its subsidiary deny the allegations made
in the Second Amended Complaint and will vigorously defend against its claims.
The Company does not believe this matter will have a material adverse effect on
its financial position or results of operations.
In October 1996, a group of eight plaintiffs purporting to represent an
uncertified class of psychiatrists, psychologists and social workers brought an
action under the federal antitrust laws in the United States District Court for
the Southern District of New York (the "District Court") against nine managed
behavioral healthcare organizations, including Green Spring (collectively,
"Defendants"). The complaint alleges that Defendants violated Section 1 of the
Sherman Act by engaging in a conspiracy to fix the prices at which Defendants
purchase services from managed behavioral healthcare providers such as
plaintiffs. The complaint further alleges that Defendants engaged in a group
boycott to exclude mental healthcare providers from Defendants' networks in
order to further the goals of the alleged conspiracy. The complaint also
challenges the propriety of Defendants' capitation arrangements with their
respective customers, although it is unclear from the complaint whether
plaintiffs allege that Defendants unlawfully conspired to enter into capitation
arrangements with their respective customers. The complaint seeks treble damages
against Defendants in an unspecified amount and a permanent injunction
prohibiting defendants from engaging in the alleged conduct which forms the
basis of the complaint, plus costs and attorneys' fees. In January 1997,
Defendants filed a motion to dismiss the complaint. On July 21, 1997, a
court-appointed magistrate judge issued a report and recommendation to the
District Court recommending that Defendants' motion to dismiss the complaint
with prejudice be granted. On August 5, 1997, plaintiffs filed
F-34
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
objections to the magistrate judge's report and recommendation; such objections
have not yet been heard. Green Spring intends to vigorously defend itself in
this litigation. The Company does not believe this matter will have a material
adverse effect on its financial position or results of operations.
14. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Gerald L. McManis, a director of the Company, is the President of McManis
Associates, Inc. ("MAI"), a healthcare development and management consulting
firm. During fiscal 1995, 1996 and 1997, MAI provided consulting services to the
Company with respect to the development of strategic plans and a review of the
Company's business processes. The Company incurred approximately $158,000,
$274,000 and $825,000 in fees for such services during fiscal 1995, 1996 and
1997, respectively, and reimbursed MAI for approximately $21,000, $13,000 and
$60,000, respectively, for expenses.
G. Fred DiBona, Jr., a director of the Company, is a Director and the
President and Chief Executive Officer of Independence Blue Cross ("IBC"), a
health insurance company. As of September 30, 1997, IBC owned 12.25% of Green
Spring.
IBC owned 16.67% of Green Spring prior to December 13, 1995. On December 13,
1995, IBC sold 4.42% of its ownership interest in Green Spring to the Company
for $5,376,000 in cash. IBC had a cost basis of $3,288,000 in the 4.42%
ownership interest sold to the Company. The Exchange Option described previously
gives IBC the right to exchange its ownership interest in Green Spring for a
maximum of 889,565 shares of Common Stock or $20,460,000 in subordinated notes
through December 13, 1998.
IBC and its affiliated entities contract with Green Spring for provider
network, care management and medical review services pursuant to contractual
relationships entered into on July 7, 1994 with terms of up to five years.
During the period beginning December 14, 1995 through September 30, 1996 and
fiscal 1997, IBC and its affiliated entities made payments to Green Spring of
approximately $29.2 million and $48.0 million and owed Green Spring
approximately $13.6 million at September 30, 1997. Green Spring recorded revenue
of approximately $32.8 million and $47.4 million from IBC during fiscal 1996 and
1997, respectively.
On July 7, 1994, IBC sold a subsidiary to Green Spring in exchange for a $15
million promissory note. As of September 30, 1997, $6 million remained
outstanding under such promissory note and is due and payable in equal
installments on July 7, 1998 and 1999.
Darla D. Moore, a director of the Company since February 1996, is the spouse
of Richard E. Rainwater, Chairman of the Board of Crescent and the largest
stockholder of the Company (18.8% beneficial ownership as of October 31, 1997).
Because of her relationship to Mr. Rainwater, Ms. Moore did not participate in
any Board action taken with respect to the Crescent Transactions.
15. BUSINESS SEGMENT INFORMATION
The Company operates through four principal subsidiaries engaging in (i) the
managed care business, (ii) the public sector business, (iii) the healthcare
franchising business and (iv) the provider business. Intersegment sales are not
material. Operating profit represents net revenue less salaries, cost of care
and other operating expenses, bad debt expense, depreciation, amortization,
stock option expense and unusual items (excluding gains on sale of closed
psychiatric hospitals) and excludes interest, net, equity in loss of CBHS, loss
on Crescent Transactions, income taxes, minority interest and extraordinary
items. Identifiable assets are those used in the Company's operations in each
segment, excluding goodwill. Depreciation and amortization for the managed care
business includes the amortization expense related to the step-up in asset basis
for the acquisition of Green Spring in December 1995. Corporate assets consist
primarily of cash and cash equivalents, investments and assets not employed in
operations.
F-35
15. BUSINESS SEGMENT INFORMATION (CONTINUED)
Prior to fiscal 1996, the Company's managed care, public sector and
healthcare franchising businesses were not material. Accordingly, no comparable
segment information is presented for fiscal 1995. Operating profit for the
provider segment and corporate overhead include unusual items of $36.1 million
(facility closures, insurance settlement, severance, impairment loss) and $1.2
million (severance), respectively, for fiscal 1996. Operating profit for the
provider segment includes unusual items of $5.7 million (facility closures,
European sale termination) in fiscal 1997. See Note 6 for further information
regarding unusual items. The Company classified juvenile justice facilities
operations as public sector in its 1996 financial statements. Such amounts are
classified as provider business in the following presentation.
MANAGED PUBLIC HEALTHCARE
CARE SECTOR FRANCHISING PROVIDER CORPORATE
BUSINESS BUSINESS BUSINESS BUSINESS OVERHEAD CONSOLIDATED
---------- ------------ ----------- ------------ ---------- ------------
1996
Net revenue............................... $ 229,859 $ 70,709 $ -- $ 1,044,711 $ -- $1,345,279
Operating profit.......................... 16,866 6,942 -- 128,400 (39,953) 112,255
Depreciation and amortization............. 9,111 2,580 -- 34,201 3,032 48,924
Identifiable assets....................... 116,501 15,487 -- 791,536 88,601 1,012,125
Capital expenditures...................... 6,018 1,964 -- 21,737 9,082 38,801
1997
Net revenue............................... $ 363,883 $ 94,422 $ 22,739 $ 729,652 $ -- $1,210,696
Operating profit.......................... 26,861 4,935 18,927 114,474 (34,123) 131,074
Depreciation and amortization............. 13,016 2,904 160 24,528 4,253 44,861
Identifiable assets....................... 137,372 24,035 2,256 286,155 331,568 781,386
Capital expenditures...................... 9,183 2,245 195 18,739 2,986 33,348
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the quarterly results of operations for the
years ended September 30, 1996 and 1997. The third and fourth quarters of fiscal
1996 include unusual items of approximately $34.0 million and $3.3 million,
respectively. The second quarter and third quarter of fiscal 1997 include
unusual items of approximately $1.4 million and ($1.0) million, respectively.
The third quarter of fiscal 1997 also includes a $59.9 million loss on the
Crescent Transactions. See Notes 4 and 6 for an explanation of these charges.
The fourth quarter of 1997 includes increases to income before income taxes and
minority interest for revenue and bad debt expense adjustments of approximately
$6.4 million relating to a change in estimate for contractual allowances and
allowance for doubtful accounts in the Company's provider business.
F-36
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
FISCAL QUARTERS
----------------------------------------------
FIRST SECOND THIRD FOURTH
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1996
Net revenue...................................................... $ 295,665 $ 354,953 $ 346,379 $ 348,282
Net income (loss)................................................ 9,748 20,069 (5,722) 8,288
Net income (loss) per common share:
Primary........................................................ 0.35 0.63 (0.18) 0.26
Fully diluted.................................................. 0.35 0.59 (0.18) 0.26
1997
Net revenue...................................................... $ 346,819 $ 349,922 $ 324,921 $ 189,034
Income (loss) before extraordinary items......................... 7,141 11,892 (24,441) 10,163
Net income (loss)................................................ 4,191 11,892 (26,744) 10,163
Income (loss) per common share--primary:
Income (loss) before extraordinary items....................... 0.25 0.41 (0.85) 0.33
Net income (loss).............................................. 0.15 0.41 (0.93) 0.33
Income (loss) per common share--fully diluted:
Income (loss) before extraordinary items....................... 0.25 0.41 (0.85) 0.33
Net income (loss).............................................. 0.15 0.41 (0.93) 0.33
17. SUBSEQUENT EVENTS (UNAUDITED)
ALLIED HEALTH GROUP, INC. ACQUISITION.
On December 5, 1997, the Company purchased the assets of Allied Health
Group, Inc. and certain affiliates ("Allied"). Allied provides specialty
risk-based products and administrative services to a variety of insurance
companies and other customers for approximately 25 million equivalent covered
lives, determined by multiplying Allied's 3.4 million members by the number of
Allied's specialty products covering each member. Allied manages over 80
physician networks across the eastern United States, offering treatments
services for its covered members. Allied's networks include physicians
specializing in cardiology, oncology and diabetes. The Company paid $70 million
for Allied of which $50 million was paid to the sellers at closing with the
remaining $20 million placed in escrow.
The Company funded the acquisition of Allied with cash on hand and will
account for the acquisition of Allied using the purchase method of accounting.
The escrowed amount is payable if Allied achieves specified earnings targets
during the three years following the closing. Additionally, the purchase price
may be increased during the three year period by $40 million if Allied's
performance exceeds specified earnings targets. The maximum purchase price
payable is $110 million.
HAI ACQUISITION. On December 4, 1997, the Company acquired the outstanding
common stock of Human Affairs International, Incorporated ("HAI"), a
wholly-owned subsidiary of Aetna Insurance Company of Connecticut and a unit of
Aetna U.S. Healthcare ("Aetna"), for approximately $122.1 million. HAI manages
the care of over 15 million covered lives through employee assistance programs
and other managed behavioral healthcare plans. The Company funded the
acquisition of HAI with cash on hand and will account for the acquisition of HAI
using the purchase method of accounting.
The Company may be required to make additional contingent payments of up to
$300 million to Aetna (the "Contingent Payments") over the five-year period
(each year a "Contract Year") subsequent to closing. The amount and timing of
the Contingent Payments will be contingent upon HAI's receipt of
F-37
17. SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED)
additional covered lives, under two separate calculations. Under the first
calculation, the Company may be required to pay up to $25 million per year for
each of five years following the acquisition based on the net increase in
"incremental lives" in specified products. Under the second calculation, the
Company may be required to pay up to $35 million per year for each of five
years, based on the net cumulative increase in "HMO incremental lives" in
certain products. The Company expects to fund the Contingent Payments, if any,
with a combination of cash on hand, future cash flows from operations and
borrowing capacity under the Magellan Existing Credit Agreement.
MERIT ACQUISITION. On October 24, 1997, the Company entered into a
definitive merger agreement to acquire all of Merit's outstanding stock for
approximately $458.3 million in cash plus the assumption of long-term debt. The
Company estimates that the total consideration it will pay to acquire Merit will
be approximately $750 million, excluding transaction costs. The Company will
refinance Merit's existing debt, including $100 million in 11.50% senior
subordinated notes and refinance the Magellan Outstanding Notes as part of the
Merit Acquisition. The Company has a $1.3 billion commitment from a lender to
provide Magellan with debt financing for the Merit Acquisition and related debt
refinancing. The Company will account for the Merit Acquisition using the
purchase method of accounting. Merit manages behavioral healthcare programs for
approximately 800 customers across all segments of the healthcare industry,
including HMOs, Blue Cross/Blue Shield organizations and other insurance
companies, corporations and labor unions, federal, state and local government
agencies, and various state Medicaid programs. The transaction is subject to
regulatory approval and is expected to close during the second quarter of fiscal
1998.
GREEN SPRING MINORITY SHAREHOLDER CONVERSION. The Company expects the four
minority shareholders of Green Spring to convert their ownership interests into
2,831,739 shares of Magellan common stock in accordance with the terms in the
Green Spring Exchange Agreement at or before the consummation date of the
Transactions. The Company will account for the Green Spring Conversion as a
purchase of the minority interests in Green Spring at the fair value of the
consideration paid.
F-38
18. GUARANTOR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
SEPTEMBER 30, 1996
--------------------------------------------------------------------
MAGELLAN
HEALTH
SERVICES,
INC. CONSOLIDATED
GUARANTOR NONGUARANTOR (PARENT ELIMINATION CONSOLIDATED
SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTAL
----------- ------------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
Current Assets
Cash and cash equivalents......................... $ 29,751 $ 79,552 $ 11,642 $ -- $ 120,945
Accounts receivable, net.......................... 139,523 44,904 5,451 -- 189,878
Other current assets.............................. 12,470 515 14,342 -- 27,327
----------- ------------- ------------ ------------ ------------
Total Current Assets............................ 181,744 124,971 31,435 -- 338,150
Assets restricted for settlement of unpaid claims
and other long-term liabilities................... -- 78,542 26,761 -- 105,303
Property and Equipment
Land.............................................. 74,790 6,657 1,984 -- 83,431
Buildings and improvements........................ 350,187 33,493 5,141 -- 388,821
Equipment......................................... 112,748 25,206 8,961 -- 146,915
----------- ------------- ------------ ------------ ------------
537,725 65,356 16,086 -- 619,167
Accumulated depreciation.......................... (111,556) (10,313) (4,184) -- (126,053)
Construction in progress.......................... 1,586 621 69 -- 2,276
----------- ------------- ------------ ------------ ------------
427,755 55,664 11,971 -- 495,390
Other Long-Term Assets(1)........................... 98,191 (56,176) 1,187,042 (1,155,775) 73,282
Goodwill, net....................................... 20,645 94,682 12,685 -- 128,012
----------- ------------- ------------ ------------ ------------
$ 728,335 $ 297,683 $1,269,894 $(1,155,775) $1,140,137
----------- ------------- ------------ ------------ ------------
----------- ------------- ------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.................................. $ 32,644 $ 34,057 $ 12,265 $ -- $ 78,966
Accrued liabilities and income tax payable........ 57,948 55,208 76,443 -- 189,599
Current maturities of long-term debt and capital
lease obligations............................... 2,620 3,131 -- -- 5,751
----------- ------------- ------------ ------------ ------------
Total Current Liabilities....................... 93,212 92,396 88,708 -- 274,316
Long-Term Debt and Capital Lease Obligations........ (455,333) 8,815 1,012,825 -- 566,307
Deferred Income Tax Liabilities..................... -- (4,252) 16,620 -- 12,368
Reserve for Unpaid Claims........................... -- 72,494 546 -- 73,040
Deferred Credits and Other Long-Term
Liabilities(1).................................... 352,044 43,565 29,378 (385,218) 39,769
Minority interest................................... -- -- -- 52,520 52,520
Stockholders' Equity
Common Stock, par value $0.25 per share;
Authorized--80,000 shares
Issued and outstanding--33,007 shares........... 2,764 (483) 8,252 (2,281) 8,252
Committments and contingencies
Other Stockholders' Equity
Additional paid-in capital........................ 609,627 30,237 327,681 (639,864) 327,681
Retained earnings (Accumulated deficit)........... 126,826 58,932 (129,457) (185,758) (129,457)
Warrants outstanding.............................. -- -- 54 -- 54
Common Stock in treasury, 4,424 shares............ -- (4,736) (82,731) 4,736 (82,731)
Cumulative foreign currency adjustments........... (805) 715 (1,982) 90 (1,982)
----------- ------------- ------------ ------------ ------------
738,412 84,665 121,817 (823,077) 121,817
----------- ------------- ------------ ------------ ------------
$ 728,335 $ 297,683 $1,269,894 $(1,155,775) $1,140,137
----------- ------------- ------------ ------------ ------------
----------- ------------- ------------ ------------ ------------
- ------------------------
(1) Elimination entry related to intercompany receivables and payables and
investment in consolidated subsidiaries.
The accompanying Notes to Condensed Consolidating Financial Statements are an
integral part of these balance sheets.
F-39
18. GUARANTOR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MAGELLAN HEALTH SERVICES INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
SEPTEMBER 30, 1997
--------------------------------------------------------------------
MAGELLAN
HEALTH
SERVICES,
INC. CONSOLIDATED
GUARANTOR NONGUARANTOR (PARENT ELIMINATION CONSOLIDATED
SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTAL
----------- ------------- ------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
Current Assets
Cash and cash equivalents....................... $ 102,419 $ 62,326 $ 208,133 $ -- $ 372,878
Accounts receivable, net........................ 46,652 60,185 1,161 -- 107,998
Other current assets............................ 2,346 10,215 13,601 -- 26,162
----------- ------------- ------------ ------------ ------------
Total Current Assets.......................... 151,417 132,726 222,895 -- 507,038
Assets restricted for settlement of unpaid claims
and other long-term liabilites.................. -- 71,501 16,031 -- 87,532
Property and Equipment
Land............................................ 5,406 5,389 872 -- 11,667
Buildings and improvements...................... 35,789 31,517 2,868 -- 70,174
Equipment....................................... 19,704 35,023 8,992 -- 63,719
----------- ------------- ------------ ------------ ------------
60,899 71,929 12,732 -- 145,560
Accumulated depreciation........................ (15,168) (17,288) (4,582) -- (37,038)
Construction in progress........................ 4 611 77 -- 692
----------- ------------- ------------ ------------ ------------
45,735 55,252 8,227 -- 109,214
Investment in CBHS................................ 16,878 -- -- -- 16,878
Deferred Income Taxes............................. -- 4,428 (3,270) -- 1,158
Other Long-Term Assets (1)........................ 114,642 (5,757) 978,588 (1,027,907) 59,566
Goodwill, net..................................... 17,966 96,268 -- -- 114,234
----------- ------------- ------------ ------------ ------------
$ 346,638 $ 354,418 $1,222,471 $(1,027,907) $ 895,620
----------- ------------- ------------ ------------ ------------
----------- ------------- ------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable................................ $ 23,057 $ 17,097 $ 5,192 $ -- $ 45,346
Accrued liabilities and income tax payable...... 27,800 73,586 69,043 -- 170,429
Current maturities of long-term debt and capital
lease obligations............................. 466 3,135 -- -- 3,601
----------- ------------- ------------ ------------ ------------
Total Current Liabilities..................... 51,323 93,818 74,235 -- 219,376
Long-Term Debt and Capital Lease Obligations...... (793,325) 3,913 1,181,105 -- 391,693
Reserve for Unpaid Claims......................... -- 56,339 (7,226) -- 49,113
Deferred Credits and Other Long-Term Liabilities
(1)............................................... 8,393 6,290 (183,893) 185,320 16,110
Minority interest................................. -- -- -- 61,078 61,078
Stockholders' Equity
Common Stock, par value $0.25 per share;
Authorized--80,000 shares Issued and
outstanding 33,439 shares..................... 2,752 (483) 8,361 (2,269) 8,361
Commitments and contingencies
Other Stockholders' Equity
Additional paid-in capital...................... 1,000,935 125,624 340,645 (1,126,559) 340,645
Retained earnings (Accumulated deficit)......... 76,035 71,317 (129,955) (147,352) (129,955)
Warrants outstanding............................ -- -- 25,050 -- 25,050
Common Stock in treasury 4,424 shares........... -- -- (82,731) -- (82,731)
Cumulative foreign currency adjustments......... 525 (2,400) (3,120) 1,875 (3,120)
----------- ------------- ------------ ------------ ------------
1,080,247 194,058 158,250 (1,274,305) 158,250
----------- ------------- ------------ ------------ ------------
$ 346,638 $ 354,418 $1,222,471 $(1,027,907) $ 895,620
----------- ------------- ------------ ------------ ------------
----------- ------------- ------------ ------------ ------------
- ------------------------
(1) Elimination entry related to intercompany receivables and payables and
investment in consolidated subsidiaries.
The accompanying Notes to Condensed Consolidating Financial Statements
are an integral part of these balance sheets.
F-40
18. GUARANTOR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SEPTEMBER 30, 1995
---------------------------------------------------------------------
MAGELLAN
HEALTH
SERVICES,
INC. CONSOLIDATED
GUARANTOR NONGUARANTOR (PARENT ELIMINATION CONSOLIDATED
SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTAL
----------- ------------- ------------- ------------ ------------
(IN THOUSANDS)
Net revenue....................................... $1,099,039 $ 79,702 $ (2,792) $ (24,213) $1,151,736
Costs and expenses
Salaries, cost of care and other operating
expenses...................................... 789,850 74,449 22,934 (23,635) 863,598
Bad debt expense................................ 91,945 2,088 (2,011) -- 92,022
Depreciation and amortization................... 35,769 2,073 823 (578) 38,087
Amortization of reorganization value in excess
of amounts allocable to identifiable assets... -- -- 26,000 -- 26,000
Interest, net................................... (32,975) 32 88,180 -- 55,237
ESOP expense.................................... 55,497 70 17,960 -- 73,527
Stock option expense............................ -- -- (467) -- (467)
Unusual items................................... 26,640 3,957 26,840 -- 57,437
----------- ------------- ------------- ------------ ------------
966,726 82,669 180,259 (24,213) 1,205,441
----------- ------------- ------------- ------------ ------------
Income (loss) before income taxes and equity in
earnings (loss) of subsidiaries................. 132,313 (2,967) (183,051) -- (53,705)
Provision for (benefit from) income taxes......... 6,139 (2,418) (14,803) -- (11,082)
----------- ------------- ------------- ------------ ------------
Income (loss) before equity in earnings (loss) of
subsidiaries.................................... 126,174 (549) (168,248) -- (42,623)
Equity in earnings (loss) of continuing
subsidiaries.................................... 3,680 -- 125,285 (129,305) (340)
----------- ------------- ------------- ------------ ------------
Net income (loss)................................. $ 129,854 $ (549) $ (42,963) $ (129,305) $ (42,963)
----------- ------------- ------------- ------------ ------------
----------- ------------- ------------- ------------ ------------
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Cash provided by (used in) operating activities... $ 82,863 $ 28,223 $ (15,466) $ -- $ 95,620
----------- ------------- ------------- ------------ ------------
Cash Flows from Investing Activities:
Capital expenditures............................ (17,729) (1,177) (1,318) -- (20,224)
Acquisition of businesses....................... (57,882) (4,098) -- -- (61,980)
Increase in assets restricted for the settlement
of unpaid claims.............................. -- (16,713) (2,893) -- (19,606)
Proceeds from the sale of assets................ -- -- 5,879 -- 5,879
Other........................................... (1,050) -- -- -- (1,050)
----------- ------------- ------------- ------------ ------------
Cash provided by (used in) investing activities... (76,661) (21,988) 1,668 -- (96,981)
----------- ------------- ------------- ------------ ------------
Cash Flows from Financing Activities:
Proceeds from the issuance of debt.............. 28,869 -- -- -- 28,869
Payments on debt and capital lease
obligations................................... (46,202) (31) (546) -- (46,779)
Purchases of treasury stock..................... -- (4,531) (818) -- (5,349)
Cash flows from other financing activities...... -- -- 531 -- 531
----------- ------------- ------------- ------------ ------------
Cash provided by (used in) financing activities... (17,333) (4,562) (833) -- (22,728)
----------- ------------- ------------- ------------ ------------
Net increase (decrease) in cash and cash
equivalents..................................... (11,131) 1,673 (14,631) -- (24,089)
Cash and cash equivalents at beginning of
period.......................................... 71,850 8,606 49,147 -- 129,603
----------- ------------- ------------- ------------ ------------
Cash and cash equivalents at end of period........ $ 60,719 $ 10,279 $ 34,516 $ -- $ 105,514
----------- ------------- ------------- ------------ ------------
----------- ------------- ------------- ------------ ------------
The accompanying Notes to Condensed Consolidating Financial Statements
are an integral part of these statements.
F-41
18. GUARANTOR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SEPTEMBER 30, 1996
--------------------------------------------------------------------
MAGELLAN
HEALTH
SERVICES,
INC. CONSOLIDATED
GUARANTOR NONGUARANTOR (PARENT ELIMINATION CONSOLIDATED
SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTAL
----------- ------------- ------------ ------------ ------------
(IN THOUSANDS)
Net revenue....................................... $1,012,448 $ 349,910 $ 975 $ (18,054) $1,345,279
Costs and expenses
Salaries, cost of care and other operating
expenses...................................... 767,317 300,919 14,263 (18,054) 1,064,445
Bad debt expense................................ 76,784 5,379 (693) -- 81,470
Depreciation and amortization................... 35,801 11,969 1,154 -- 48,924
Interest, net................................... (42,935) (1,038) 91,990 -- 48,017
Stock option expense............................ -- -- 914 -- 914
Unusual items................................... 4,897 1,265 31,109 -- 37,271
----------- ------------- ------------ ------------ ------------
841,864 318,494 138,737 (18,054) 1,281,041
----------- ------------- ------------ ------------ ------------
Income (loss) before income taxes and equity in
earnings (loss) of subsidiaries................. 170,584 31,416 (137,762) -- 64,238
Provision for (benefit from) income taxes......... (14,543) 9,317 30,921 -- 25,695
----------- ------------- ------------ ------------ ------------
Income (loss) before equity in earnings (loss) of
subsidiaries.................................... 185,127 22,099 (168,683) -- 38,543
Equity in earnings (loss) of continuing
subsidiaries.................................... (997) (4,772) 201,066 201,457 (6,160)
----------- ------------- ------------ ------------ ------------
Net income (loss)................................. $ 184,130 $ 17,327 $ 32,383 $ (201,457) $ 32,383
----------- ------------- ------------ ------------ ------------
----------- ------------- ------------ ------------ ------------
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Cash provided by operating activities............. $ 8,028 $ 67,865 $ 25,973 $ -- $ 101,866
----------- ------------- ------------ ------------ ------------
Cash Flows from Investing Activities:
Capital expenditures............................ (27,543) (5,687) (5,571) -- (38,801)
Acquisition of businesses....................... (820) 35,792 (85,890) -- (50,918)
Increase in assets restricted for the settlement
of unpaid claims.............................. -- (28,543) 10,811 -- (17,732)
Proceeds from the sale of assets................ 2,663 2,585 -- -- 5,248
----------- ------------- ------------ ------------ ------------
Cash provided by (used in) investing activities... (25,700) 4,147 (80,650) -- (102,203)
----------- ------------- ------------ ------------ ------------
Cash Flows from Financing Activities:
Payments on debt and capital lease
obligations................................... (13,296) (4,539) (68,000) -- (85,835)
Proceeds from the issuance of debt.............. -- 1,800 103,000 -- 104,800
Proceeds from the issuance of common stock, net
of issuance costs............................. -- -- 68,573 -- 68,573
Purchase of treasury stock...................... -- -- (73,493) -- (73,493)
Income tax payments made on behalf of stock
optionee...................................... -- -- (1,678) -- (1,678)
Proceeds from exercise of stock options &
warrants...................................... -- -- 3,401 -- 3,401
----------- ------------- ------------ ------------ ------------
Cash provided by (used in) financing activities... (13,296) (2,739) 31,803 -- 15,768
----------- ------------- ------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents..................................... (30,968) 69,273 (22,874) -- 15,431
Cash and cash equivalents at beginning of
period.......................................... 60,719 10,279 34,516 -- 105,514
----------- ------------- ------------ ------------ ------------
Cash and cash equivalents at end of period........ $ 29,751 $ 79,552 $ 11,642 $ -- $ 120,945
----------- ------------- ------------ ------------ ------------
----------- ------------- ------------ ------------ ------------
The accompanying Notes to Condensed Consolidating Financial Statements
are an integral part of these statements.
F-42
18. GUARANTOR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MAGELLAN HEALTH SERVICES, INC.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SEPTEMBER 30, 1997
---------------------------------------------------------------------
MAGELLAN
HEALTH
SERVICES,
INC. CONSOLIDATED
GUARANTOR NONGUARANTOR (PARENT ELIMINATION CONSOLIDATED
SUBSIDIARIES SUBSIDIARIES CORPORATION) ENTRIES TOTAL
----------- ------------- ------------- ------------ ------------
(IN THOUSANDS)
Net revenue....................................... $ 733,604 $ 477,186 $ 865 $ (959) $1,210,696
Costs and expenses
Salaries, cost of care and other operating
expenses.................................... 543,297 399,726 36,449 (959) 978,513
Bad debt expense.............................. 42,427 4,228 (444) -- 46,211
Depreciation and amortization................. 26,194 15,695 2,972 -- 44,861
Interest, net................................. (60,735) (2,372) 108,484 -- 45,377
Stock option expense.......................... -- -- 4,292 -- 4,292
Equity in loss of CBHS........................ 8,122 -- -- -- 8,122
Loss on Crescent Transactions................. 13,684 14 46,170 -- 59,868
Unusual items................................. (1,188) -- 1,545 -- 357
----------- ------------- ------------- ------------ ------------
571,801 417,291 199,468 (959) 1,187,601
----------- ------------- ------------- ------------ ------------
Income (loss) before income taxes, equity in
earnings (loss) of subsidiaries and
extraordinary items............................. 161,803 59,895 (198,603) -- 23,095
Provision for (benefit from) income taxes......... 8,424 8,929 (8,115) -- 9,238
----------- ------------- ------------- ------------ ------------
Income (loss) before equity in earnings (loss) of
subsidiaries and extraordinary items............ 153,379 50,966 (190,488) -- 13,857
Equity in earnings (loss) of continuing
subsidiaries.................................... (930) (7,985) 195,243 (195,430) (9,102)
----------- ------------- ------------- ------------ ------------
Income (loss) before extraordinary item........... 152,449 42,981 4,755 (195,430) 4,755
Extraordinary item--loss on early extinguishment
of debt (net of income tax benefit of $3,503)... (2,103) -- (5,253) 2,103 (5,253)
----------- ------------- ------------- ------------ ------------
Net income (loss)................................. $ 150,346 $ 42,981 $ (498) $ (193,327) $ (498)
----------- ------------- ------------- ------------ ------------
----------- ------------- ------------- ------------ ------------
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Cash provided by (used in) operating activities... $ 58,324 $ 9,964 $ 5,311 $ -- $ 73,599
----------- ------------- ------------- ------------ ------------
Cash Flows from Investing Activities:
Capital expenditures.......................... (18,300) (13,225) (1,823) -- (33,348)
Acquisitions and investments in businesses,
net of cash acquired........................ (37,066) (13,186) (624) -- (50,876)
Decrease (increase) in assets restricted for
the settlement of unpaid claims............. -- 4,652 12,557 -- 17,209
Proceeds from the sale of assets.............. 18,270 -- -- -- 18,270
Proceeds from the sale of property and
equipment to Crescent and CBHS.............. 196,066 -- 184,359 -- 380,425
----------- ------------- ------------- ------------ ------------
Cash provided by (used in) investing activities... 158,970 (21,759) 194,469 -- 331,680
----------- ------------- ------------- ------------ ------------
Cash Flows from Financing Activities:
Payments on debt and capital lease
obligations................................. (273,060) (5,431) (111,763) -- (390,254)
Proceeds from the issuance of debt............ 128,434 -- 75,209 -- 203,643
Proceeds from the exercise of stock options &
warrants.................................... -- -- 8,265 -- 8,265
Proceeds from the issuance of warrants to
Crescent and COI............................ -- -- 25,000 -- 25,000
----------- ------------- ------------- ------------ ------------
Cash provided by (used in) financing activities... (144,626) (5,431) (3,289) -- (153,346)
----------- ------------- ------------- ------------ ------------
Net increase (decrease) in cash and cash
equivalents..................................... 72,668 (17,226) 196,491 -- 251,933
Cash and cash equivalents at beginning of
period.......................................... 29,751 79,552 11,642 -- 120,945
----------- ------------- ------------- ------------ ------------
Cash and cash equivalents at end of period........ $ 102,419 $ 62,326 $ 208,133 $ -- $ 372,878
----------- ------------- ------------- ------------ ------------
----------- ------------- ------------- ------------ ------------
The accompanying Notes to Condensed Consolidating Financial Statements
are an integral part of these statements.
F-43
18. GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS (CONTINUED)
NOTES TO THE CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
General--These condensed consolidating financial statements reflect the
Guarantors under the Magellan Outstanding Notes as of 9/30/97 (the "Guarantor").
The direct and indirect Guarantors are wholly owned by the Company or a
Guarantor of the Company. Separate financial statements of the Guarantors are
not presented because the Guarantors are jointly, severally and unconditionally
liable under the guarantee, and the Company believes the condensed consolidating
financial statements presented are more meaningful in understanding the
financial position of the Guarantor, and the separate financial statements are
deemed not material to investors.
Distributions--There are no restrictions on the ability of the Guarantors to
make distributions to the Company.
Transfers from Guarantors to Nonguarantors--The Magellan Existing Credit
Agreement permits the Company to contribute certain assets to joint ventures
that conduct a healthcare business, provided that certain conditions are
satisfied and that the aggregate fair market value of all such assets
contributed to joint ventures with respect to which the Company and its
wholly-owned subsidiaries have less than 50% of the equity interests or do not
control such joint ventures does not exceed $35 million. Furthermore, the
Magellan Existing Credit Agreement permits the Company and its Subsidiaries to
make investments in controlled joint ventures up to $35 million plus the amount
permitted but not used for uncontrolled joint ventures. The indenture related to
the Magellan Outstanding Notes also contains provisions that permit the Company
and its Restricted Subsidiaries (as defined in the indenture for the Magellan
Outstanding Notes) to make investments in non-guarantors subject to limits.
The Company intends to make investments in Permitted Non-Control Investments
(as defined in the Magellan Existing Credit Agreement) and Permitted
Non-Guarantor Transactions (as defined in the Magellan Existing Credit
Agreement) to the extent it believes doing so will be consistent with its
business strategy. To the extent the Company or its Restricted Subsidiaries make
investments of the type described above, the assets available for debt payments
and guarantee obligations could be diminished.
F-44
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE MEMBERS OF
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
We have audited the accompanying consolidated balance sheet of Charter
Behavioral Health Systems, LLC (a Delaware limited liability corporation) and
subsidiaries as of September 30, 1997 and the related consolidated statement of
operations, changes in members' capital and cash flows for the period June 17,
1997 to September 30, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and schedule based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Charter Behavioral Health
Systems, LLC and subsidiaries as of September 30, 1997 and the results of their
operations and their cash flows for the period June 17, 1997 to September 30,
1997 in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic financial
statements. The schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states, in all material respects, the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
ATLANTA, GEORGIA
NOVEMBER 14, 1997
F-45
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1997
(IN THOUSANDS)
ASSETS
Current Assets:
Cash and cash equivalents....................................................... $ 23,443
Accounts receivable, less allowance for doubtful accounts of $17,605............ 107,961
Accounts receivable due from Magellan........................................... 5,090
Supplies........................................................................ 2,313
Prepaid expenses................................................................ 9,385
Other current assets............................................................ 345
---------
Total Current Assets........................................................ 148,537
Property and Equipment:
Buildings and improvements...................................................... 11,879
Equipment....................................................................... 7,121
---------
19,000
Accumulated depreciation........................................................ (662)
---------
18,338
Construction in progress........................................................ 86
---------
Total Property and Equipment................................................ 18,424
---------
Other long-term assets............................................................ 6,471
Goodwill, net of accumulated amortization of $3................................... 286
Deferred financing fees, net of accumulated amortization of $115.................. 1,876
---------
$ 175,594
---------
---------
F-46
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1997
(IN THOUSANDS)
LIABILITIES AND MEMBERS' CAPITAL
Current Liabilities:
Accounts payable................................................................ $ 34,864
Accrued liabilities............................................................. 33,578
Current maturities of long-term debt and capital lease obligations.............. 55
---------
Total Current Liabilities................................................... 68,497
Long-Term Debt and Capital Lease Obligations...................................... 65,860
Deferred Rent..................................................................... 4,759
Reserve for Unpaid Claims......................................................... 2,686
Minority Interest and Other Long-Term Liabilities................................. 36
Members' Capital:
Preferred interests............................................................. 35,000
Common interests................................................................ 15,000
Accumulated deficit............................................................. (16,244)
---------
Total Members' Capital...................................................... 33,756
---------
$ 175,594
---------
---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this balance sheet.
F-47
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE 106 DAYS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS)
Net revenue....................................................................... $ 213,730
---------
Costs and expenses:
Salaries, supplies and other operating expenses................................. 170,619
Franchise fees--Magellan........................................................ 22,739
Crescent lease expense.......................................................... 16,919
Bad debt expense................................................................ 17,437
Depreciation and amortization................................................... 668
Interest, net................................................................... 1,592
---------
Total costs and expenses.................................................... 229,974
---------
Net loss.......................................................................... $ (16,244)
---------
---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
F-48
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS' CAPITAL
FOR THE 106 DAYS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS)
PREFERRED INTERESTS COMMON INTERESTS
TOTAL
----------------------- ------------------------ ACCUMULATED MEMBERS'
COI MAGELLAN COI MAGELLAN DEFICIT CAPITAL
--------- ------------ --------- ------------- ---------------- ------------
Additions (Deductions):
Issuance of cumulative redeemable
preferred interest................... $ 17,500 $ 17,500 $ -- $ -- $ -- $ 35,000
Capital contributions.................. -- -- 7,500 7,500 -- 15,000
Net loss............................... -- -- -- -- (16,244) (16,244)
--------- ------------ --------- ------ -------- ------------
Balances, September 30, 1997............. $ 17,500 $ 17,500 $ 7,500 $ 7,500 $ (16,244) $ 33,756
--------- ------------ --------- ------ -------- ------------
--------- ------------ --------- ------ -------- ------------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
F-49
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE 106 DAYS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS)
Cash Flows From Operating Activities
Net loss....................................................................... $ (16,244)
---------
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on sale of assets....................................................... (355)
Depreciation and amortization................................................ 668
Non-cash interest expense.................................................... 115
Cash flows from changes in assets and liabilities, net of effects from sales
and acquisitions of businesses:
Accounts receivable, net................................................... (98,504)
Account receivable due from Magellan....................................... (5,090)
Other current assets....................................................... (5,089)
Other long-term assets..................................................... (4,565)
Accounts payable and accrued liabilities................................... 53,458
Accrued interest payable................................................... 333
Deferred rent.............................................................. 4,759
Reserve for unpaid claims.................................................. 2,686
Other liabilities.......................................................... (3)
---------
Total adjustments.......................................................... (51,587)
---------
Net cash used in operating activities.................................. (67,831)
---------
Cash Flows From Investing Activities
Capital expenditures......................................................... (149)
Purchase of information systems equipment from Magellan...................... (5,000)
Purchase of net assets from Magellan......................................... (11,288)
---------
Net cash used in investing activities.................................. (16,437)
---------
Cash Flows From Financing Activities
Payments on debt and capital lease obligations............................... (16)
Proceeds from issuance of debt, net of issuance costs........................ 98,009
Proceeds from capital contributions--COI..................................... 7,500
Proceeds from capital contributions--Magellan................................ 2,218
---------
Net cash provided by financing activities.............................. 107,711
---------
Net increase in cash and cash equivalents........................................ 23,443
Cash and cash equivalents at beginning of period................................. --
---------
Cash and cash equivalents at end of period....................................... $ 23,443
---------
---------
The accompanying Notes to Consolidated Financial Statements
are an integral part of this statement.
F-50
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements of Charter Behavioral Health Systems,
LLC, a Delaware limited liability corporation, ("CBHS" or the "Company") include
the accounts of the Company and its subsidiaries except where control is
temporary or does not rest with the Company. All significant intercompany
accounts and transactions have been eliminated in consolidation.
The Company provides behavioral healthcare services in the United States.
The Company's principal services include inpatient treatment, day and partial
hospitalization services, group and individual outpatient treatment and
residential services.
On June 17, 1997, the Company began operations pursuant to a series of
transactions (the "Crescent Transactions") between Magellan Health Services,
Inc. ("Magellan"), Crescent Real Estate Equities Limited Partnership
("Crescent") and Crescent Operating, Inc., an affiliate of Crescent ("COI"). The
Crescent Transactions provided for the following:
- Magellan sold to Crescent 80 behavioral healthcare facilities (76
operating and four held for sale) ("Purchased Facilities") and related
medical office buildings formerly operated by Magellan.
- Magellan and COI formed the Company to operate the Purchased Facilities
and the Contributed Facilities (defined below) (together the
"Facilities"). The Company is owned equally by Magellan and COI.
- Magellan contributed to the Company certain property and intangible rights
used in connection with the Facilities in exchange for its equity interest
in CBHS. The property that was contributed by Magellan included five acute
care psychiatric hospitals and other ancillary facilities that Magellan
leased from third parties (together the "Contributed Facilities"). The
Company also purchased certain assets from Magellan relating to Magellan's
information systems subsidiary for $5 million.
- CBHS entered into a service agreement with Magellan pursuant to which the
Company manages Magellan's interest in certain joint ventures with
unaffiliated third parties, including joint ventures that operate or
manage ten behavioral healthcare facilities. Magellan is the general
partner or managing entity of such joint ventures.
- CBHS leased the Purchased Facilities from Crescent under a 12-year lease
(subject to renewal). CBHS pays annual base rent to Crescent, which is
initially $41.7 million and increases at 5% compounded annually (See Note
2).
- CBHS and certain of its subsidiaries entered into franchise agreements
with Magellan pursuant to which CBHS and such subsidiaries operate using
the "CHARTER" name, services and protocols and pay to Magellan annual
franchise fees, subject to increase, of approximately $78.3 million (See
Note 7). The franchise fees due Magellan are subordinate to the payment of
rent due Crescent.
- Both Magellan and COI contributed an additional $2.5 million in cash to
the capital of CBHS. In addition, each made a commitment to loan CBHS up
to $17.5 million, for a period of 5 years. Such loans were made to CBHS by
each for $17.5 million ("Member Loans") and, effective September 30, 1997,
were converted to cumulative redeemable preferred interests (See Note 8).
F-51
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
NET REVENUE
Patient net revenue is based on established billing rates, less estimated
allowances for patients covered by Medicare and other contractual reimbursement
programs, and discounts from established billing rates. Amounts received by the
Company for treatment of patients covered by Medicare and other contractual
reimbursement programs, which may be based on cost of services provided or
predetermined rates, are generally less than the established billing rates of
the Company's hospitals. Final determination of amounts earned under contractual
reimbursement programs is subject to review and audit by the applicable
agencies. Management believes that adequate provision has been made for any
adjustments that may result from such reviews.
ADVERTISING COSTS
The production costs of advertising are expensed as incurred. The Company
does not consider any of its advertising costs to be direct-response and,
accordingly, does not capitalize such costs. Advertising costs consist primarily
of radio and television air time, which is amortized as utilized, and printed
media services. Advertising expense was approximately $6.4 million for the 106
days ended September 30, 1997.
CHARITY CARE
The Company provides healthcare services without charge or at amounts less
than its established rates to patients who meet certain criteria under its
charity care policies. Because the Company does not pursue collection of amounts
determined to be charity care, they are not reported as revenue. For the 106
days ended September 30, 1997, the Company provided, at its established billing
rates, approximately $5.3 million of such care.
INTEREST, NET
The Company records interest expense net of interest income. Interest income
for the 106 days ended September 30, 1997 was approximately $0.2 million.
CASH AND CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid interest-bearing investments
with a maturity of three months or less when purchased, consisting primarily of
money market instruments.
CONCENTRATION OF CREDIT RISK
Accounts receivable from patient revenue subject the Company to a
concentration of credit risk with third party payors that include insurance
companies, managed healthcare organizations and governmental entities. The
Company establishes an allowance for doubtful accounts based upon factors
surrounding the
F-52
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
credit risk of specific payors, historical trends and other information.
Management believes the allowance for doubtful accounts is adequate to provide
for normal credit losses.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures for renewals and
improvements are charged to the property accounts. Replacements and maintenance
and repairs that do not improve or extend the life of the respective assets are
expensed as incurred. Amortization of capital lease assets is included in
depreciation expense. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally 10 to 30 years for
buildings and improvements and three to ten years for equipment. Depreciation
expense was $0.7 million for the 106 days ended September 30, 1997.
INTANGIBLE ASSETS
Intangible assets are composed principally of goodwill and deferred
financing costs. Goodwill represents the excess of the cost of businesses
acquired over the fair value of the net identifiable assets at the date of
acquisition and is amortized using the straight-line method over 25 years.
Deferred financing costs are the costs incurred by the Company to obtain its
revolving credit agreement (See Note 2), and are amortized over the term of the
related agreement (5 years).
The Company continually monitors events and changes in circumstances that
could indicate carrying amounts of intangible assets may not be recoverable.
When events or changes in circumstances are present that indicate the carrying
amount of intangible assets may not be recoverable, the Company assesses the
recoverability of intangible assets by determining whether the carrying value of
such intangible assets will be recovered through the future cash flows expected
from the use of the asset and its eventual disposition. No impairment losses on
intangible assets were recorded by the Company during the 106 days ended
September 30, 1997.
2. LONG-TERM DEBT AND LEASE OBLIGATIONS
Information with regard to the Company's long-term debt and capital lease
obligations at September 30, 1997 is as follows (in thousands):
SEPTEMBER 30,
1997
-------------
Revolving Credit Agreement due through 2002 (6.906% to 6.938%)................. $ 65,000
10.5% Capital lease obligations due through 2007............................... 915
-------------
65,915
Less amounts due within one year............................................. 55
-------------
$ 65,860
-------------
-------------
The aggregate scheduled maturities of long-term debt and capital lease
obligations during the five years subsequent to September 30, 1997 are as
follows (in thousands): 1998--$55; 1999--$62; 2000--$68; 2001--$76 and
2002--$65,084.
F-53
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
2. LONG-TERM DEBT AND LEASE OBLIGATIONS (CONTINUED)
REVOLVING CREDIT AGREEMENTS
On June 17, 1997, the Company entered into a Credit Agreement (the
"Revolving Credit Agreement") with certain financial institutions for a
five-year senior secured revolving credit facility in an aggregate committed
amount of $100 million.
The maximum amount allowed to be borrowed under the Revolving Credit
Agreement is based on a working capital calculation. At September 30, 1997, the
Company had approximately $4.3 million available for borrowing under the
Revolving Credit Agreement. The Revolving Credit Agreement is secured by the
tangible and intangible personal property, including accounts receivable, owned
by the Company.
The loans outstanding under the Revolving Credit Agreement bear interest
(subject to certain potential adjustments) at a rate per annum equal to one,
two, three or six-month LIBOR plus 1.25% or the Alternative Base Rate ("ABR"),
as defined, plus .25%. Interest on ABR loans is payable at the end of each
fiscal quarter. Interest on LIBOR-based loans is payable at the end of their
respective terms, but a minimum of every three months.
COVENANTS
The Revolving Credit Agreement contains a number of restrictive covenants,
which, among other things, limit the ability of the Company and certain of its
subsidiaries to incur other indebtedness, engage in transactions with
affiliates, incur liens, make certain restricted payments, and enter into
certain business combinations. The Revolving Credit Agreement also requires the
Company to maintain certain specified financial ratios. The Company was in
compliance with all debt covenants under the Revolving Credit Agreement at
September 30, 1997. Budget projections prepared by management for the fiscal
year ending September 30, 1998 estimate that the Company will be in compliance
with all debt covenants under the Revolving Credit Agreement during fiscal 1998.
Management believes that its budget projections for fiscal 1998 are reasonable
and achievable, however, there can be no assurances that such projections will
be achieved. If the Company were to fail to achieve such budget projections
during fiscal 1998, the Company could become in noncompliance with certain debt
covenants resulting in an event of default under the Revolving Credit Agreement.
CRESCENT LEASE
The Company leases the Purchased Facilities from Crescent under an initial
twelve year lease term with four renewal terms of five years each. The lease
requires the Company to pay all maintenance, property tax and insurance costs.
The base rent for the first year of the initial term is $41.7 million and
increases at 5% compounded annually. The Company accounts for the Crescent Lease
as an operating lease and accordingly, records base rent expense on a
straight-line basis over the lease term. The Company is required to pay Crescent
in each lease year additional rent of $20.0 million, $10.0 million of which must
be used for capital expenditures each year and $10.0 million can be used to pay
property taxes, insurance premiums and franchise fees. Such additional rent
amounts are included in the future minimum lease payments disclosed below.
F-54
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
2. LONG-TERM DEBT AND LEASE OBLIGATIONS (CONTINUED)
OTHER LEASES
The Company also leases certain of its operating facilities, other than the
Purchased Facilities. The book value of capital leased assets was approximately
$4.5 million at September 30, 1997. The leases, which expire at various dates
through 2027, generally require the Company to pay all maintenance, property tax
and insurance costs.
At September 30, 1997, aggregate amounts of future minimum payments under
operating leases were as follows: 1998--$65.4 million; 1999--$66.4 million;
2000--$67.6 million; 2001--$69.5 million; 2002-- $71.8 million; subsequent to
2002--$556.0 million.
Rent expense for the 106 days ended September 30, 1997 was $20.4 million.
3. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
SEPTEMBER 30,
1997
-------------
Salaries and wages............................................................. $ 18,220
Property taxes................................................................. 4,874
Interest....................................................................... 333
Other.......................................................................... 10,151
-------------
$ 33,578
-------------
-------------
4. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the 106 days ended September 30, 1997
is as follows (in thousands):
106 DAYS ENDED
SEPTEMBER 30,
1997
---------------
Interest paid................................................................ $ 1,291
Non-cash transactions:
Exchange of debt for cumulative preferred interest--COI.................... 17,500
Exchange of debt for cumulative preferred interest--Magellan............... 17,500
Initial capital contribution from Magellan, primarily property and
equipment less assumed liabilities....................................... 5,282
Account receivable for the sale of facility................................ 386
5. DIVESTITURES
On September 30, 1997, the Company sold the operations of a 60 bed
behavioral healthcare hospital for $422,000. Proceeds from the sale were not
received until October 2, 1997. The transaction resulted in a gain of $355,000.
F-55
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
6. BENEFITS PLANS
The Company has a defined contribution retirement plan (the "CBHS 401-K
Plan"). Employee participants can elect to voluntarily contribute up to 15% of
their compensation to the CBHS 401-K Plan. The Company will make contributions
to the CBHS 401-K Plan based on employee compensation and contributions. The
Company makes a discretionary contribution of 2% of each employee's compensation
and matches 50% of each employee's contribution up to 3% of their compensation.
7. FRANCHISE FEES--MAGELLAN
The Company and certain of its subsidiaries entered into franchise
agreements with Magellan pursuant to which CBHS and such subsidiaries operate
using the "CHARTER" name, services and protocols. The franchise agreements
provide, among other things, that:
- Magellan agrees to use its commercially reasonable best efforts, subject
to applicable law, to cause such subsidiaries to have "preferred provider"
status in connection with Magellan's managed behavioral healthcare
business on a basis substantially consistent with existing agreements for
such business.
- Magellan agrees to operate or provide a toll free "800" telephone number,
and call center as a means of assisting customers to locate the places of
business of franchisees.
- Franchisees were granted a right to a defined territory to engage in the
business of providing behavioral healthcare business, as defined.
- Magellan will provide franchisees with the following assistance: (i)
advertising and marketing assistance including consultation, access to
media buying programs and access to broadcast and other advertising
materials produced by Magellan from time to time for franchisees; (ii)
risk management services, including risk financial planning, loss control
and claims management; (iii) outcomes monitoring; (iv) national and
regional contracting services; and (v) consultation by telephone or at the
Magellan offices with respect to matters relating to the franchisee's
business in which Magellan has expertise, including reimbursement,
government relations, clinical strategies, regulatory matters, strategic
planning and business development.
Franchise fees payable by the Company are the greater of (i) $78.3
million, subject to increases for inflation; or (ii) $78.3 million, plus 3%
of gross revenues over $1 billion and not exceeding $1.2 billion and 5% of
gross revenues over $1.2 billion.
The initial term of the franchise agreements is 12 years with four
renewal terms of five years each.
8. CUMULATIVE REDEEMABLE PREFERRED INTEREST
Effective September 30, 1997, Magellan and COI each agreed to exchange their
respective Member Loans for cumulative redeemable preferred interest ("Preferred
Interest") in the Company. The Preferred Interest is callable in whole at the
Company's option on or after April 1, 1998, at an amount equal to the initial
amount plus all accrued dividends thereon. Each holder of Preferred Interest
receives preferential allocation of the Company's profits computed at 10% per
annum on a cumulative basis, compounded monthly. In addition, each Preferred
Interest has a similar preferred position in the event of dissolution of the
Company.
F-56
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
9. COMMITMENTS AND CONTINGENCIES
The Company carries general and professional liability insurance from an
unrelated commercial insurance carrier with a self insured retention of $1.5
million per occurrence and $8.8 million in the aggregate, on a claims made
basis. In addition, the Company has an umbrella policy with coverage up to $125
million per occurrence and in the aggregate.
Certain of the Company's subsidiaries are subject to or parties to claims,
civil suits and governmental investigations and inquiries relating to their
operations and certain alleged business practices. In the opinion of management,
based on consultation with counsel, resolution of these matters will not have a
material adverse effect on the Company's financial position or results of
operations.
10. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
John C. Goff is the Chairman of CBHS and the Vice Chairman of both Crescent
and COI.
As part of the Crescent Transactions, (i) certain items of working capital
were purchased from Magellan and (ii) the Company agreed to collect Magellan's
patient accounts receivable outstanding as of the closing date for a fee of 5%
of cash collections. Included in net revenues for the 106 days ended September
30, 1997 are approximately $5.0 million of collection fee revenues.
The Company has a receivable due from Magellan as of September 30, 1997 of
approximately $5.1 million. This receivable results from (i) amounts due for the
management of Magellan's joint ventures, (ii) amounts due for the collection fee
on Magellan's patient account receivable and (iii) a receivable for the
settlement of working capital related matters.
F-57
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS--MAGELLAN
(IN THOUSANDS)
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS-- DEDUCTIONS-- END OF
CLASSIFICATION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
- ----------------------------------------------------------------- ---------- ---------- ---------- ------------ ----------
Year ended September 30, 1995:
Allowance for doubtful accounts................................ $43,555 $ 92,022(D) $ 21,393(A) $111,021(B) $48,741
2,792(C)
---------- ---------- ---------- ------------ ----------
43,555 92,022 $ 24,185 $111,021 $48,741
---------- ---------- ---------- ------------ ----------
---------- ---------- ---------- ------------ ----------
Year ended September 30, 1996:
Allowance for doubtful accounts................................ $48,741 $ 81,470(D) $ 22,761(A) $103,236(B) $50,548
812(C)
---------- ---------- ---------- ------------ ----------
$48,741 $ 81,470 $ 23,573 $103,236 $50,548
---------- ---------- ---------- ------------ ----------
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Year ended September 30, 1997:
Allowance for doubtful accounts................................ $50,548 $ 46,211(D) $ 19,373(A) $ 89,114(B) $40,311
21,400(E) 5,164(F)
2,943(G)
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$50,548 $ 67,611 $ 19,373 $ 97,221 $40,311
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(A) Recoveries of accounts receivable previously written off.
(B) Accounts written off.
(C) Allowance for doubtful accounts assumed in acquisitions.
(D) Bad debt expense.
(E) Accounts receivable collection fees included in loss on Crescent
Transactions.
(F) Accounts receivable collection fees payable to CBHS and outside vendors.
(G) Amounts reclassified to contractual allowances.
S-1