Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1996 or
[]Transition report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ________ to ________
Commission file number 0-22019
SPECIALTY CARE NETWORK, INC.
(Exact name of registrant as specified in its charter)
Delaware 62-1623449
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
44 Union Boulevard, Suite 600 80228
Lakewood, Colorado (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (303) 716-0041
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
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 the definitive proxy statement incorporated
by reference in Part III of this annual report on Form 10-K or any amendment to
this annual report on Form 10-K. X
As of March 26, 1997, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $103,865,677. Such aggregate market value
was computed by reference to the closing sale price of the Common Stock as
reported on the National Market segment of The Nasdaq Stock Market on such date.
For purposes of making this calculation only, the registrant has defined
affiliates as including all directors and beneficial owners of more than five
percent of the Common Stock of the Company.
As of March 26, 1997, there were 14,662,575 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Registrant's 1997 Annual
Meeting of Stockholders to be filed within 120 days after the end of the fiscal
year covered by this annual report on Form 10-K -- Part III.
1
TABLE OF CONTENTS
PART I
Item 1. Business........................................................................................3
Item 2. Properties.....................................................................................23
Item 3. Legal Proceedings..............................................................................23
Item 4. Submission of Matters to a Vote of Security Holders............................................23
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters......................24
Item 6. Selected Financial Data........................................................................25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..........26
Item 8. Financial Statements and Supplementary Data....................................................30
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...........30
PART III
Item 10. Directors and Executive Officers of the Registrant.............................................31
Item 11. Executive Compensation.........................................................................34
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................37
Item 13. Certain Relationships and Related Transactions.................................................38
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................. 41
Index to Financial Statements and Schedules.....................................................................F-1
This Report contains forward-looking statements that address, among
other things, acquisition and expansion strategy, use of proceeds, projected
capital expenditures, liquidity, proposed specialties of physicians with whom
the Company intends to affiliate, possible third party payor arrangements, cost
reduction strategies, possible effects of changes in government regulation and
availability of insurance. These statements may be found under "Item 1-Business"
"Item 1-Risk Factors," and "Item 7-Management's Discussion and Analysis of
Financial Condition and Results of Operations" as well as in the Report
generally. Actual events or results may differ materially from those discussed
in forward-looking statements as a result of various factors, including without
limitation those discussed in "Item 1-Risk Factors" and matters set forth in the
Report generally.
Unless the context indicates otherwise, the terms "SCN" and "Company"
refer to Specialty Care Network, Inc.
2
PART I
Item 1. Business.
General
Specialty Care Network is a physician practice management company
focusing exclusively on musculoskeletal disease-state management. Since November
12, 1996, the Company has provided management services under long-term
agreements with five practices, encompassing 50 physicians in five states. In
addition, in March 1997, the Company began providing management services under
long-term agreements with three single physician practices in two of its
existing markets (all practices that have affiliated with the Company are
referred to as the "Affiliated Practices"). The Company also manages one
outpatient surgery center and one outpatient magnetic resonance imaging ("MRI")
center owned by two of its Affiliated Practices.
On November 12, 1996, the Company, through a series of transactions
(the "Initial Affiliation Transactions"), including an asset purchase, a share
exchange and three mergers, acquired substantially all of the assets and certain
liabilities of the predecessors (the "Predecessor Practices") of five of the
practices with which the Company has affiliated through the entry into service
agreements. In connection with the Initial Affiliation Transactions, the Company
issued an aggregate of 7,659,115 shares of Common Stock and paid $1,537,872 in
cash to physician owners of the Predecessor Practices. Following the Initial
Affiliation Transactions, the physician owners of the Predecessor Practices,
other than Greater Chesapeake Orthopaedic Associates, LLC ("GCOA") in Baltimore,
Maryland, which survived the Initial Affiliation Transactions, formed new
entities through which to practice medicine. The new entities (together with
GCOA, the "Initial Affiliated Practices") are Reconstructive Orthopaedic
Associates II, P.C. ("ROA"), in Philadelphia, Pennsylvania; Princeton
Orthopaedic Associates II, P.A. ("POA") in Princeton, New Jersey; TOC
Specialists, P.L. ("TOC") in Tallahassee, Florida and Bainbridge, Georgia; and
Vero Orthopaedics II, P.A. ("VO") in Vero Beach, Florida. In addition, in March
1997, the Company acquired, through merger, the assets and certain liabilities
of predecessors to its three single physician Affiliated Practices for an
aggregate consideration of 409,222 shares of Common Stock and $83,674 in
cash.
Under the service agreements between the Company and each of the
Affiliated Practices (the "Service Agreements"), the Company provides
management, administrative and development services to the Affiliated Practices.
The Affiliated Practices were selected based on a variety of factors including,
but not limited to, physician credentials and reputation; competitive market
position; specialty and subspecialty mix of physicians; historical financial
performance and growth potential; and willingness to embrace SCN's corporate
philosophy.
The Affiliated Practices offer a broad spectrum of musculoskeletal
care, which is the treatment of conditions relating to bones, joints, muscles
and related connective tissues. The Company's affiliated physicians are trained
in a variety of musculoskeletal disciplines, including general orthopaedics,
joint replacement surgery, sports medicine, spinal care, hand and upper
extremity care, foot and ankle care, pediatric orthopaedics, physiatry, trauma
and adult neurology. In order to build networks of providers that offer access
to a full range of musculoskeletal care, the Company intends to affiliate and
otherwise contract with physicians trained in other musculoskeletal
subspecialties, including occupational medicine, neurosurgery, plastic surgery,
rehabilitation therapy and rheumatology.
The Company was incorporated in December 1995. Following its
incorporation through November 12, 1996, the date of the Initial Affiliation
Transactions, the Company hired personnel, raised funds through the private
placement of securities and conducted negotiations with potential affiliation
candidates. On November 12, 1996, the Company consummated the Initial
Affiliation Transactions and entered into service agreements with the Initial
Affiliated Practices.
3
Recent Developments
On March 24, 1997, the Company entered into a definitive agreement to
affiliate with Orthopaedic and Sports Medicine Center, P.A., headquartered in
Annapolis, Maryland. The Company has agreed to acquire, through merger,
substantially all of the assets and certain liabilities of the practice for
aggregate consideration of $8,116,575, which will consist of $4,058,288 in cash
and 411,591 shares of Company Common Stock valued at $9.86 per share (the
average of the closing share price of Company Common Stock during the two weeks
preceding the execution of the agreement). The practice, which includes nine
physicians, has offices in Annapolis, Prosten and Severna Park, Maryland.
Consummation of the transaction is subject to certain conditions. Information in
this Annual Report on Form 10-K relating to the Affiliated Practices does not
include information about Orthopaedic and Sports Medicine Center, P.A.
Musculoskeletal Market Overview
Expenditures for musculoskeletal care in the United States are
significant, with total direct costs associated with the delivery of
musculoskeletal care exceeding $60 billion in 1988, according to the American
Academy of Orthopaedic Surgeons ("AAOS"). Of this amount, approximately $7
billion represents fees paid for physician services. Furthermore, according to
the AAOS, the 65-and-over age group accounts for approximately 25% of
musculoskeletal cases. Given the aging of the U.S. population, the Company
believes that demographic trends favor the growth of the need for
musculoskeletal care.
The spectrum of musculoskeletal care ranges from acute procedures, such
as spinal or hip surgery after trauma, to the treatment of chronic conditions,
such as arthritis and back pain. Musculoskeletal care is provided by a variety
of medical and surgical specialists. Although the orthopaedic surgeon represents
the primary musculoskeletal provider, musculoskeletal care is also provided by
neurosurgeons, neurologists, plastic surgeons, physiatrists, rheumatologists,
occupational medicine physicians, podiatrists and primary care physicians, as
well as rehabilitative therapists. Moreover, there are a number of
subspecialties of orthopaedics, including adult reconstructive (joint
replacement) surgery, spinal care, sports medicine, foot and ankle care, hand
and upper extremity care, pediatrics, oncology and trauma care. The American
Medical Association estimates that in 1995, there were approximately 23,000
orthopaedic surgeons, as well as approximately 5,500 physiatrists, 3,500
rheumatologists, 3,000 occupational medicine physicians, 11,400 neurologists and
4,900 neurosurgeons.
The payor mix for musculoskeletal care is diverse, with managed care
enrollees representing an increasing percentage of patients. According to data
from a 1994 AAOS survey, the largest percentage of patients is private pay
(28%), followed by managed care, including fee-for-service and capitation (21%),
Medicare (21%) and workers compensation (18%). Almost 80% of orthopaedic
surgeons indicated they received patients from managed care sources. While
private pay patients remain the largest category, the AAOS survey indicated that
the percentage of total private pay patients has declined from 39% in 1988 to
28% in 1994. Over the same period, patients from managed care sources increased
from 12% to 21%. The distribution of patients from other sources remained
relatively constant over this period.
Affiliated Practices
On November 12, 1996, the Company, in connection with the Initial
Affiliation Transactions, issued an aggregate of 7,659,115 shares (constituting
an aggregate of $45,954,690, based on an agreed value of $6 per share) of Common
Stock and paid $1,537,872 in cash to physicians in the Initial Affiliated
Practices. See Item 13 for details regarding the Company's affiliation with the
Initial Affiliated Practices. Subsequent to the Initial Affiliation
Transactions, the Company granted to certain physicians in the Initial
Affiliated Practices options to purchase an aggregate of 382,590 shares of
Common Stock at an exercise price of $6.00 per share. In addition, the Company
has affiliated with three single physician practices in Tallahassee, Florida;
Thomasville, Georgia; and Baltimore, Maryland.
4
In March 1997, the Company acquired, through merger, substantially all of the
assets and certain liabilities of these practices for an aggregate consideration
of 409,222 shares of Common Stock and $83,674 in cash.
The table below sets forth certain information regarding the Initial
Affiliated Practices, all of whose physicians are board certified or board
eligible:
Musculoskeletal
Initial Affiliated Practices Location(s) Physicians Subspecialties Ancillary Services
- ---------------------------- ----------- ---------- --------------- -------------------
Reconstructive Orthopaedic Philadelphia, PA 11 3 None
Associates II, P.C.
Princeton Orthopaedic Associates II, Princeton, NJ 12 7 Outpatient Surgery,
P.A. Physical Therapy
TOC Specialists, P.L. Tallahassee, FL 14 7 MRI
Bainbridge, GA
Greater Chesapeake Orthopaedic Baltimore, MD 8 5 None
Associates, LLC
Vero Orthopaedics II, P.A. Vero Beach, FL 5 5 None
Sebastian, FL
--
Total 50
==
Reconstructive Orthopaedic Associates II, P.C.
ROA, operating under the name The Rothman Institute, was founded in
Philadelphia, Pennsylvania in 1970 and currently has ten orthopaedic surgeons
and one anesthesiologist. ROA has its own research department and has compiled
an orthopaedic database for more than 25 years.
ROA physicians (and their specialties) are Todd J. Albert, M.D. (spine
surgery); Richard A. Balderston, M.D. (spine surgery); Arthur R. Bartolozzi,
M.D. (sports medicine); Robert E. Booth, Jr., M.D. (joint replacement surgery);
Michael G. Ciccotti, M.D. (sports medicine); William J. Hozack, M.D. (joint
replacement surgery); H.N. Karanjia, M.D., D.P.M. (foot and ankle surgery);
Philip M. Maurer, M.D. (anesthesiologist); Richard H. Rothman, M.D., Ph.D.
(joint replacement surgery); Peter F. Sharkey, M.D. (joint replacement surgery);
and Alexander R. Vaccaro, M.D. (spine surgery). All of these physicians, other
than Dr. Maurer, are physician owners of ROA.
Dr. Balderston serves as Clinical Professor, Vice Chairman of the
Department of Orthopaedics and Chief of Orthopaedic Surgery at Thomas Jefferson
University Hospital ("Jefferson"). Dr. Bartolozzi is a team physician for
several sports teams, including the Philadelphia Flyers hockey team and the
Philadelphia Eagles football team. Dr. Booth serves as Co-Chief of Orthopaedic
Surgery at Pennsylvania Hospital, and is Professor and Vice Chairman of
Orthopaedic Surgery at Jefferson. Dr. Rothman serves as the Chairman of the
Department of Orthopaedics at Jefferson and Co-Chairman of the Department of
Orthopaedics at Pennsylvania Hospital and is the Editor-in-Chief of the Journal
of Arthroplasty, a journal of joint replacement surgery.
Drs. Booth and Bartolozzi have entered into an agreement with the
Company and ROA that contemplates that Drs. Booth and Bartolozzi will form and
own an independent practice. The agreement provides that this practice will
enter into a separate service agreement with the Company. See "Contractual
Agreements with Affiliated Practices" in this Item.
See Item 13 for additional information regarding the Company's
affiliation with ROA.
5
Princeton Orthopaedic Associates II, P.A. and Princeton SportsMedicine
POA was founded in 1974 in Princeton, New Jersey and currently has 10
orthopaedic surgeons, one podiatric surgeon, one physiatrist and 16 physical
therapists. POA operates three facilities, each of which provides physical
therapy. One of these facilities, operating under the name SportsMedicine
Princeton, provides multi-disciplinary diagnostic and rehabilitative care for
sports-related injuries. The other two facilities provide comprehensive
diagnostic and rehabilitative care for the neck and back. POA also operates its
own outpatient surgery center, for which SCN provides management services for a
fee.
POA physicians (and their specialties) are Jeffrey S. Abrams, M.D.
(shoulder surgery); Jon W. Ark, M.D. (hand and foot surgery); Robert N. Dunn,
M.D. (spine surgery); Richard E. Fleming, Jr., M.D. (sports medicine); Steven R.
Gecha, M.D. (sports medicine); W. Thomas Gutowski, M.D. (sports medicine);
Michael N. Jolley, M.D. (joint replacement surgery); C. Alexander Moskwa, Jr.,
M.D. (sports medicine); Michael A. Palmer, M.D. (physiatry); Harvey E. Smires,
M.D. (joint replacement surgery); David M. Smith, M.D. (general orthopaedics);
and John S. Smith, DPM (podiatry). All of these physicians, other than Drs. Ark,
Palmer and John S. Smith, are physician owners of POA.
See Item 13 for additional information regarding the Company's
affiliation with POA.
TOC Specialists, P.L.
TOC was founded in 1972 and currently has nine orthopaedic surgeons,
two non-surgical musculoskeletal specialists and three neurologists. In its main
facility in Tallahassee, Florida, TOC has an MRI center, for which SCN provides
management services for a fee. TOC physicians also practice at a satellite
facility in Bainbridge, Georgia operating under the name Southern Orthopedic
Specialists, Inc. TOC has a non-contractual capitated arrangement with Capital
Health Plans covering approximately 75,000 lives and a capitated contract with
Health Plan Southeast covering approximately 55,000 lives.
TOC physicians (and their specialties) are Gregg A. Alexander, M.D.
(musculoskeletal medicine, disorders of the spine); D. Christian Berg, M.D.
(hand and upper extremities); Richard E. Blackburn, M.D. (adult neurology);
Donald M. Dewey, M.D., C.P.O. (foot and ankle surgery, pediatric orthopaedics);
Mark E. Fahey, M.D. (general orthopaedic surgery); Thomas C. Haney, M.D. (knee
surgery, sports medicine); William D. Henderson, Jr., M.D. (knee surgery, sports
medicine); Steve E. Jordan, M.D. (general orthopaedic surgery, sports medicine);
J. Rick Lyon, M.D. (general orthopaedic surgery); Kris D. Stowers, M.D.
(musculoskeletal and sports medicine); Robert L. Thornberry, M.D. (hip and knee
surgery, sports medicine); Billy C. Weinstein, M.D. (adult neurology); Stanley
Whitney, M.D. (adult neurology); and Charles H. Wingo, M.D. (spine surgery). All
of these physicians, other than Dr. Whitney, are physician owners of TOC.
TOC physicians have served as team physicians for a number of local
high schools and colleges. Dr. Haney serves as the team physician for the
Florida State University football team. Dr. Henderson currently serves as the
president of the Herodicus Society, a national sports medicine society, and is
one of the sports medicine physicians for the U.S. National Soccer Team. Dr.
Wingo currently serves as Chairman of the Orthopaedic Section/Surgery at the
Tallahassee Memorial Regional Medical Center.
See Item 13 for additional information regarding the Company's
affiliation with TOC.
Greater Chesapeake Orthopaedic Associates, LLC
GCOA was founded in Baltimore, Maryland in 1994 and currently has eight
orthopaedic surgeons. The two main focus areas of GCOA are sports medicine and
foot and ankle services. The practice is located adjacent to Union Memorial
Hospital and is actively involved in the orthopaedic residency and fellowship
teaching programs at that institution. In addition, three of its physicians are
active in such programs at the Johns Hopkins University School of Medicine
("Johns Hopkins").
6
GCOA physicians (and their specialties) are Paul L. Asdourian, M.D.
(spine surgery); Frank R. Ebert, M.D. (joint replacement surgery); Leslie S.
Matthews, M.D. (sports medicine); Stuart D. Miller, M.D. (foot and ankle); Mark
S. Myerson, M.D. (foot and ankle); John B. O'Donnell, M.D. (sports medicine);
Lew C. Schon, M.D. (foot and ankle); and Martin A. Yahiro, M.D. (general
orthopaedics). All of these physicians, other than Dr. Yahiro, are physician
owners of GCOA.
Dr. Asdourian serves as Chief of Orthopaedic Spinal Surgery at Union
Memorial Hospital and is a clinical instructor in orthopaedic surgery at Johns
Hopkins. Dr. Ebert currently serves as Assistant Chief of Orthopaedic Surgery at
Union Memorial Hospital. Dr. Matthews currently serves as Chief of Orthopaedic
Surgery at Union Memorial Hospital and is Program Director for the Orthopaedic
Surgery Residency training program. Dr. Matthews also is an Assistant Professor
of orthopaedic surgery at Johns Hopkins. Dr. Myerson serves as the director of
Foot and Ankle Services at Union Memorial Hospital. Dr. O'Donnell is assistant
director of Union Memorial Hospital's Sports Medicine Fellowship Program and is
a clinical instructor in orthopaedic surgery at Johns Hopkins. Dr. Schon serves
as Associate Director of the Foot & Ankle Fellowship program at Union Memorial
Hospital. Dr. Yahiro joined the group in July 1995. He currently serves as an
orthopaedic surgeon advisor to the federal Food and Drug Administration.
See Item 13 for additional information regarding the Company's
affiliation with GCOA.
Vero Orthopaedics II, P.A.
VO was founded in Vero Beach, Florida in 1976 and currently has four
orthopaedic surgeons and one physiatrist. The practice is located near Indian
River Memorial Hospital. VO operates one satellite office in Sebastian, Florida.
VO's physicians (and their specialties) are James L. Cain, M.D. (foot and
ankle); David W. Griffin, M.D. (knee surgery); George K. Nichols, M.D. (hip
surgery); Peter G. Wernicki, M.D. (sports medicine); and Charlene Wilson, M.D.
(physiatry). All of these physicians, other than Dr. Wilson, are physician
owners of VO.
Dr. James L. Cain, founder of Vero Orthopaedics, has served as Chairman
of the Department of Orthopaedics, Chief of the Medical Staff, and as a member
of the Board of Directors of Indian River Memorial Hospital. Dr. David W.
Griffin is Director of the Joint Implant Center of the Treasure Coast at Indian
River Memorial Hospital.
See Item 13 for additional information regarding the Company's
affiliation with VO.
Single Physician Practices
In addition to the Initial Affiliated Practices, the Company is
affiliated with the following single physician practices:
Riyaz H. Jinnah, M.D., P.A. - This practice is located in Baltimore,
Maryland. Dr. Jinnah is a board certified surgeon engaged in general
orthopaedics.
Medical Rehabilitation Specialists, P.A. - This practice is located in
Tallahassee, Florida. The physician owner is Kirk J. Mauro, M.D. Dr. Mauro is a
physiatrist.
Floyd Jaggears, M.D., P.C. - This practice is located in Thomasville,
Georgia. Dr. Jaggears is a board certified surgeon engaged in general
orthopaedics.
SCN Operations
Upon affiliation with SCN, physician practices enter into a long-term
service agreement with the Company. Under the terms of a service agreement, the
Company generally employs most of a practice's non-physician personnel, provides
facilities for the practice and provides services in the areas of practice
management, information systems and
7
negotiation of payor contracts, all as more specifically described below. The
governance structure provided with respect to the service agreements facilitates
close cooperation between the Company and the practices, while ensuring that the
practices maintain clinical autonomy. See "Contractual Agreements with
Affiliated Practices" in this Item.
Management Services
Pursuant to the terms of the Service Agreements, the Company assists
the Affiliated Practices in strategic planning, preparation of operating budgets
and capital project analysis. The Company intends to coordinate group purchasing
of supplies, inventory and insurance for the practices. In addition, the Company
will assist the Affiliated Practices in physician recruitment by introducing
physician candidates to the practices and advising the practices in structuring
employment arrangements.
The Company also provides or arranges for a variety of additional
services relating to the day-to-day non-medical operations of the practices,
including (i) management and monitoring each practice's billing levels,
invoicing and accounts receivable collection by payor type, (ii) accounting,
payroll and legal services and records and (iii) cash management and centralized
disbursements.
These services are designed to reduce the amount of time physicians
must spend on administrative matters, thereby enabling the physicians to
dedicate more of their efforts toward the delivery of health care. The Company's
anticipated capital resources and assistance in preparation of budgets and
capital project analyses are intended to facilitate the establishment of
ancillary musculoskeletal facilities, such as outpatient occupational medicine,
physical therapy and surgery centers and MRI centers. Comprehensive
administrative support should facilitate more effective billings and collections
and, as the Company grows, economies of scale in effecting purchases. The
Company's proprietary accounts payable system should allow SCN to control
disbursements and identify economies in purchasing.
Practice Services
As a result of its affiliation with the Affiliated Practices, SCN
employs most of the Affiliated Practices' non-physician personnel. These
non-physician personnel, along with additional personnel at the Company's
headquarters, manage the day-to-day non-medical operations of each of the
Affiliated Practices, including, among other things, provision of secretarial,
bookkeeping, scheduling and other routine services. Under the Service
Agreements, the Company must provide facilities and equipment to the Affiliated
Practices, and to this end, the Company entered into lease agreements for the
facilities and purchased the assets utilized by each of the Affiliated
Practices.
Management Information Systems
The Company believes that a key element in the implementation of its
business strategy is the development and utilization of its proprietary
management information systems. The Company is designing its information systems
to integrate and analyze financial and clinical data, improve operating
efficiency at the practice level and enhance the ability of the Company to
negotiate managed care contracts on behalf of its Affiliated Practices.
The Company has developed proprietary financial systems that have been
installed at the Company's headquarters and at each of the Affiliated Practices.
These systems include an internally developed purchase order application and
electronic interfaces between payroll, general ledger, banking, accounts payable
and accounts receivable applications. These systems permit each Affiliated
Practice to separately designate purchase requirements and transfer purchase
information on a daily basis. Such information allows the Company to monitor
purchases from order to receipt, to centrally control the disbursement of funds
and to identify economies in purchasing. In addition, the Company's systems
permit the Company to capture, analyze and report centrally financial data from
the various Affiliated Practice locations and provide analyses of financial data
on a fully integrated basis.
8
The Company has established standards at the Affiliated Practices for
gathering clinical and financial information such as personal patient data,
physician and procedure identifier codes, payor class and amounts charged and
reimbursed. The Company intends to develop a proprietary clinical outcomes
database to enable the Affiliated Practices to analyze clinical outcomes at the
practitioner and practice levels on a standardized basis. Information will be
gathered in areas such as incidents rates (the number of specified procedural,
diagnostic and medical events during a specified period with respect to a
specified patient population), utilization (frequency of patient care and
activity relating to the patient) and quality of care (monitoring and evaluation
of patient outcomes). This information should assist physicians in developing
clinical protocols, measuring outcomes, ensuring that standards of quality are
met and determining the most cost-effective course for treating patients. The
Company intends to use this data, together with data derived from its financial
information systems, to produce comprehensive financial and clinical reports to
be used in connection with the negotiation, structuring and pricing of managed
care contracts.
Payor Contracting
An increasing portion of the net revenue of the Affiliated Practices is
derived from managed care payors. Although rates paid by managed care payors are
generally lower than commercial rates, managed care payors can provide access to
large patient volumes.
The Company seeks to negotiate both fee-for-service and capitated
contracts on behalf of the Affiliated Practices. Under capitated arrangements,
providers deliver health care services to managed care enrollees and would bear
all or a portion of the risk that the cost of such services may exceed capitated
payments. Capitated contracts involve various forms of risk sharing. Providers
may accept risk only with respect to the costs of physician services required by
a patient (professional component) or for all of the medical costs required by a
patient including professional, institutional and ancillary services (global
capitation). Managed care companies' arrangements with providers can be further
segmented into episode of care and per member per month capitation. Under
specified episode of care capitation, providers deliver care for covered
enrollees with a specified medical condition or who require a particular
treatment on a fixed fee basis per episode. Under per member per month
capitation, the providers receive fixed monthly fees per covered enrollee and
assume the additional risk for the incidence of medical conditions requiring
procedures specified in the contract.
Currently, the Company performs analyses of the Affiliated Practices'
markets to develop managed care contracting strategies and meets with principal
payors in each of these markets to enhance and establish relationships between
the Affiliated Practices and such payors. In addition, the Company is currently
in the process of negotiating a capitated, episode of care managed care contract
on behalf of one of the Initial Affiliated Practices, fee for service contracts
for physician services for several of the Initial Affiliated Practices and a fee
for service contract for the surgery center at POA. TOC has a non-contractual
capitated arrangement covering approximately 75,000 lives and a capitated
contract covering approximately 55,000 lives, and POA has a capitated contract
covering approximately 20,000 lives. These arrangements existed at the time of
the Initial Affiliation Transactions. No other Affiliated Practice has a
capitated arrangement.
Governance and Quality Assurance
The Company's current governance structure promotes physician
participation in the management of the Company. At least one physician from each
Initial Affiliated Practice serves on the Company's Board of Directors. In
addition, each Affiliated Practice has a Joint Policy Board whose membership
includes an equal number of representatives from each of the Company and the
Affiliated Practice. The Joint Policy Board will have responsibilities that
include developing long-term strategic objectives, developing practice expansion
and payor contracting guidelines, promoting practice efficiencies, recommending
significant capital expenditures and facilitating communication and information
exchange between the Company and each of the Affiliated Practices.
9
The Company intends to create an Outcomes Management and Standards
Board that will focus on the identification and communication of the best
practices and clinical protocols in the business and administrative areas. The
Company also intends to create a Medical Provider Board that will identify and
communicate the best practices and protocols in the medical area. Both of these
boards, which will consist solely of physicians from Affiliated Practices, will
receive managerial and information systems support from the Company.
Contractual Agreements with Affiliated Practices
The Company has entered into the Service Agreements with each of the
Affiliated Practices, and intends to enter into long-term service agreements
with each additional practice that affiliates with the Company, to provide
management, administrative and development services. Under the Service
Agreements, the Affiliated Practices are solely responsible for all aspects of
the practice of medicine and the Company has the primary responsibility for the
business and administrative aspects of the Affiliated Practices. The Company
employs most of the Affiliated Practice's non-physician personnel. Pursuant to
the Service Agreements, the Company provides or arranges for various management,
administrative and development services to the Affiliated Practices relating to
the day-to-day non-medical operations of the Affiliated Practices.
The following summary of the Service Agreements is intended to be a
general summary of the form of Service Agreement. The Company expects to
enter into similar agreements with other practices with which it may affiliate
in the future. The actual terms of the individual Service Agreements may vary in
certain respects from the description below as a result of negotiations with the
individual practices and the requirements of local regulations. Agreements that
the Company may enter into in the future are also expected to vary in certain
respects. Each of the Service Agreements with the Initial Affiliated Practices
and certain related agreements are exhibits to this filing. The following
summary is qualified in its entirety by reference to such exhibits. For a
discussion of circumstances under which a service agreement may be rendered
unenforceable. See "Risk Factors -- Government Regulation" in this Item.
Pursuant to the Service Agreements, the Company, among other things,
(i) acts as the exclusive manager and administrator of non-physician services
relating to the operation of the Affiliated Practices, subject to matters for
which the Affiliated Practices maintain responsibility or which are referred to
the Joint Policy Boards of the Affiliated Practices, (ii) bills patients,
insurance companies and other third party payors and collects, on behalf of the
Affiliated Practices, the fees for professional medical and other services
rendered, including goods and supplies sold by the Affiliated Practices, (iii)
provides or arranges for, as necessary, clerical, accounting, purchasing,
payroll, legal, bookkeeping and computer services and personnel, information
management, preparation of certain tax returns, printing, postage and
duplication services and medical transcribing services, (iv) supervises and
maintains custody of substantially all files and records (medical records of the
Affiliated Practices remain the property of the Affiliated Practices), (v)
provides facilities for the Affiliated Practices, (vi) prepares, in consultation
with the Joint Policy Boards and the Affiliated Practices, all annual and
capital operating budgets, (vii) orders and purchases inventory and supplies as
reasonably requested by the Affiliated Practices, (viii) implements, in
consultation with the Joint Policy Boards and the Affiliated Practices, national
and local public relations or advertising programs and (ix) provides financial
and business assistance in the negotiation, establishment, supervision and
maintenance of contracts and relationships with managed care and other similar
providers and payors. Most of the services described above are provided by
employees previously employed by the Predecessor Practices.
Under the Service Agreements, the Affiliated Practices retain the
responsibility for, among other things, (i) hiring and compensating physician
employees and other medical professionals, (ii) ensuring that physicians have
the required licenses, credentials, approvals and other certifications needed to
perform their duties and (iii) complying with certain federal and state laws and
regulations applicable to the practice of medicine. In addition, the Affiliated
Practices maintain exclusive control of all aspects of the practice of medicine
and the delivery of medical services.
Under the Service Agreements, the Company collects fees from the
Affiliated Practices on a monthly basis. The fees consist of the following: (i)
service fees based on a percentage (the "Service Fee Percentage") ranging from
10
20%-33% of the Adjusted Pre-Tax Income of the Affiliated Practices (defined
generally as revenue of the Affiliated Practices related to professional
services less amounts equal to certain clinic expenses of the Affiliated
Practices ("Clinic Expenses," as defined more fully in the Service Agreements),
not including physician owner compensation or most benefits to physician owners)
and (ii) amounts equal to Clinic Expenses. For the first three years following
the affiliation, however, the portion of the service fees described under clause
(i) above is specified to be the greater of the amount payable as described
under clause (i) above or a fixed dollar amount (the "Base Service Fee"), which
was generally calculated by applying the respective Service Fee Percentage of
Adjusted Pre-Tax Income of the predecessors to the Affiliated Practices for the
twelve months prior to affiliation. In addition, with respect to its management
of certain facilities and ancillary services associated with certain of the
Initial Affiliated Practices, the Company receives fees ranging from 2%-8% of
net revenue related to such facilities and services.
Pursuant to the Service Agreements, each Affiliated Practice agrees to
sell and assign to the Company, and the Company agrees to buy, all of the
Affiliated Practice's accounts receivable each month during the existence of the
Service Agreement. The purchase price for such accounts receivable will equal
the face amounts of the accounts receivable recorded each month less adjustments
for contractual allowances, allowances for doubtful accounts and other
potentially uncollectible amounts based on the practice's historical collection
rate, as determined by the Company.
However, the Company and the Affiliated Practices have discussed making
periodic adjustments so that amounts paid by the Company for the accounts
receivable will be adjusted upwards or downwards based on the Company's actual
collection experience. While the Company believes, based on its discussions with
the Affiliated Practices, that this arrangement is acceptable to them, the
Company cannot assure that this arrangement will be effected.
The Service Agreements have initial terms of forty years, with
automatic extensions (unless specified notice is given) of additional five-year
terms. The Service Agreement may be terminated by either party if the other
party (i) files a petition in bankruptcy or other similar events occur or (ii)
defaults on the performance of a material duty or obligation, which default
continues for a specified term after notice. In addition, the Company may
terminate the agreement if the Affiliated Practice's Medicare or Medicaid number
is terminated or suspended as a result of some act or omission of the Affiliated
Practice or the physicians, and the Affiliated Practice may terminate the
agreement if the Company misapplies funds or assets or violates certain laws.
Upon termination of a Service Agreement by the Company for one of the
reasons set forth above, the Company has the option to require the Affiliated
Practice to purchase and assume the assets and liabilities related to the
Affiliated Practice at the fair market value thereof. In addition, upon
termination of a Service Agreement by the Company during the first five years of
the term, the physician owners of the Affiliated Practice are required to pay
the Company or return to the Company an amount of cash or stock of the Company
equal to one-third of the total consideration received by such physicians in
connection with the Company's affiliation with the practice.
Under the Service Agreements, each physician owner must give the
Company twelve months notice of an intent to retire from the Affiliated
Practice. If a physician gives such notice during the first five years of the
agreement, the physician must also locate a replacement physician or physicians
acceptable to the Joint Policy Board and pay an amount based on a formula
relating to any loss of service fee for the first five years of the term. In
addition, a physician leaving a practice during the first five years of the term
is required to pay the Company or return to the Company an amount of cash or
stock equal to one-third of the total consideration received by such physician
in connection with the Company's affiliation with the practice. The agreement
also provides that after the fifth year, no more than 20% of the physician
owners at the Affiliated Practice may retire within a one-year period.
The Affiliated Practices and the physician owners of the Affiliated
Practices generally agree with the Company not to compete with the Company in
providing services similar to those provided by the Company under the Service
Agreements, and the physician owners also generally agree with the Company not
to compete with an Affiliated Practice, within a specified geographic area.
Non-competition restrictions generally apply to physicians during their
affiliation with Affiliated Practices and for three years thereafter. In
addition, the Service Agreement requires the
11
Affiliated Practice to enter into non-competition agreements with all physicians
in the Affiliated Practice, of which agreements the Company will be a third
party beneficiary. After the fifth year of the term of the Service Agreement,
physician owners of the Affiliated Practices may be released from the
non-competition provisions upon payment of certain amounts to the Company, which
may be paid in the form of Common Stock. The Service Agreements generally
require the Affiliated Practices to pursue enforcement of the non-competition
agreement with physicians or assign to the Company the right to pursue
enforcement.
The Company has entered into an agreement with ROA and Drs. Booth and
Bartolozzi pursuant to which there will be a division of ROA and Drs. Booth and
Bartolozzi will establish an independent practice ("BB One"). The agreement
provides that the Company will enter into a service agreement with BB One, and
amend the service agreement with ROA so that the aggregate Base Service Fee for
ROA and BB One will be equal to ROA's current Base Service Fee. In addition,
unless BB One exercises the right described below, in the event that the Base
Service Fee of either (but not both) of the practices is more than the service
fee (the "Percentage-Based Service Fee") that would result from the application
of the Service Fee Percentage to the practice's Adjusted Pre-Tax Income (a "Base
Fee Deficit"), the other practice will offset against the deficit the amount, if
any, by which its Percentage-Based Service Fee exceeds its Base Service Fee.
Thereafter, if any deficit remains, (i) the Company will forgive one-third of
the remaining Base Fee Deficit, up to $120,000, (ii) the practice that did not
have the Base Fee Deficit will pay to the Company one-third of the remaining
Base Fee Deficit, up to $120,000 and (iii) the practice with the Base Fee
Deficit will pay to the Company all additional remaining Base Fee Deficit. If
both practices have a Base Fee Deficit, (i) BB One will pay to SCN one-third of
ROA's Base Fee Deficit, up to $120,000, (ii) the Company will forgive one-third
of ROA's Base Fee Deficit, up to $120,000, (iii) ROA will pay the remainder of
the Base Fee Deficit and (iv) BB One will pay to the Company the entire amount
of its Base Fee Deficit.
The agreement provides that BB One has the right, prior to July 15,
1997, to increase its Service Fee Percentage by a stipulated amount. In the
event that the right is exercised, BB One's Base Service Fee will be increased
by a stipulated amount, and Dr. Booth will receive options from the Company to
purchase shares of Common Stock, based on a specified multiple of the increase
in the Base Service Fee, the product of which will be divided by the greater of
$10.00 or the closing bid price of Company Common Stock on the Nasdaq National
Market on the date the right is exercised. If the right is exercised, the
Company will have no obligation to forgive any Base Fee Deficit of either ROA or
BB One.
The agreement also provides that in the event Dr. Bartolozzi does not
join with Dr. Booth in forming BB One, then ROA and the Company will enter into
arrangements with Dr. Booth on terms proportionately consistent with the
economic principles underlying the above described arrangement. In the event Dr.
Bartolozzi remains with ROA or leaves BB One, BB One's Base Service Fee and
Service Fee Percentage and the amount of the increase in the Base Service Fee in
the event the right is exercised will be modified.
The parties have agreed that in the event additional issues arise in
the process of completing definitive agreements, or amendments to existing
agreements, and such issues are not resolved, then such issues will be submitted
to binding arbitration.
In addition, the Company has entered into an agreement with Dr.
Bartolozzi pursuant to which the Company has agreed to support the development
of a sports medicine center. If the Company and Dr. Bartolozzi have not agreed
to a plan for the development of the center by November 1997, Dr. Bartolozzi may
terminate the service agreement as it pertains to him, with three months written
notice to the Company. Upon such a termination, Dr. Bartolozzi must return to
the Company an amount equal to (i) the after-tax amount of the consideration
received by Dr. Bartolozzi in the merger transaction between ROA and the Company
less (ii) the after-tax amount of Dr. Bartolozzi's pro rata portion of service
fees paid to SCN during the term of the service agreement. In the event of such
termination, the Base Service Fee to be paid by BB One (or ROA, if Dr.
Bartolozzi elects to remain with ROA) to SCN will be proportionally reduced by
the pro rata portion of the consideration paid to Dr. Bartolozzi at the closing
of the merger between SCN and ROA.
12
The Affiliated Practices are responsible for obtaining professional
liability and worker's compensation insurance for the physicians and other
medical employees of the Affiliated Practices, as well as general liability
umbrella coverage. The Company is responsible for obtaining professional
liability and worker's compensation insurance for employees of the Company and
general liability and property insurance for the Affiliated Practices.
The Service Agreements contain indemnification provisions, pursuant to
which the Company indemnifies the Affiliated Practices for damages resulting
from negligent acts or omissions by the Company or its agents, employees or
shareholders. In addition, the Affiliated Practices indemnify the Company for
any damages resulting from any negligent act or omissions by any affiliated
physicians, agents or employees of the Affiliated Practice, other than damages
resulting from claims arising from the performance or nonperformance of medical
services.
Government Regulation and Supervision
The delivery of health care services has become one of the most highly
regulated of professional and business endeavors in the United States. Both the
federal government and the individual state governments are responsible for
overseeing the activities of individuals and businesses engaged in the delivery
of health care services. Federal law and regulations are based primarily upon
the Medicare program and the Medicaid program, each of which is financed, at
least in part, with federal funds. State jurisdiction is based upon the state's
interest in regulating the quality of health care in the state, regardless of
the source of payment.
The Company believes its operations are in material compliance with
applicable laws; however, the Company has not received or applied for a legal
opinion from counsel or from any federal or state judicial or regulatory
authority to this effect, and many aspects of the Company's business operations
have not been the subject of state or federal regulatory interpretation. The
laws applicable to the Company are subject to evolving interpretations, and
therefore, there can be no assurance that a review of the Company or the
Affiliated Practices by a court or law enforcement or regulatory authority will
not result in a determination that could have a material adverse effect on the
Company or the Affiliated Practices. Furthermore, there can be no assurance that
the laws applicable to the Company will not be amended in a manner that could
have a material adverse effect on the Company.
Federal Law
The federal health care laws apply in any case in which an Affiliated
Practice is providing an item or service that is reimbursable under Medicare or
Medicaid or in which the Company is claiming reimbursement from Medicare or
Medicaid on behalf of physicians with whom the Company has a service agreement.
The principal federal laws include those that prohibit the filing of false or
improper claims with the Medicare or Medicaid programs, those that prohibit
unlawful inducements for the referral of business reimbursable under Medicare or
Medicaid and those that prohibit the provision of certain services by a provider
to a patient if the patient was referred by a physician with which the provider
has certain types of financial relationships.
False and Other Improper Claims. The federal government is authorized
to impose criminal, civil and administrative penalties on any health care
provider that files a false claim for reimbursement from Medicare or Medicaid.
Criminal penalties are also available in the case of claims filed with private
insurers if the government can show that the claims constitute mail fraud or
wire fraud. While the criminal statutes are generally reserved for instances
evincing an obviously fraudulent intent, the criminal and administrative penalty
statutes are being applied by the government in an increasingly broad range of
circumstances. The government has taken the position, for example, that a
pattern of claiming reimbursement for unnecessary services violates these
statutes if the claimant should have known that the services were unnecessary.
The government has also taken the position that claiming reimbursement for
services that are substandard is a violation of these statutes if the claimant
should have known that the care was substandard.
The Company believes that its billing activities on behalf of the
Affiliated Practices are in material compliance with such laws, but there can be
no assurance that the Company's activities will not be challenged or scrutinized
by
13
governmental authorities. A determination that the Company had violated such
laws could have a material adverse impact on the Company.
Anti-Kickback Law. A federal law commonly known as the "Anti-kickback
Amendments" prohibits the offer, solicitation, payment or receipt of anything of
value (direct or indirect, overt or covert, in cash or in kind) which is
intended to induce the referral of Medicare or Medicaid patients, or the
ordering of items or services reimbursable under those programs. The law also
prohibits remuneration that is intended to induce the recommendation of, or the
arranging for, the provision of items or services reimbursable under Medicare
and Medicaid. The law has been broadly interpreted by a number of courts to
prohibit remuneration that is offered or paid for otherwise legitimate purposes
if the circumstances show that one purpose of the arrangement is to induce
referrals. Even bona fide investment interests in a health care provider may be
questioned under the Anti-kickback Amendments if the government concludes that
the opportunity to invest was offered as an inducement for referrals. The
penalties for violations of this law include criminal sanctions and exclusion
from the federal health care program.
In part to address concerns regarding the implementation of the
Anti-kickback Amendments, the federal government in 1991 published regulations
that provide exceptions or "safe harbors," for certain transactions that will
not be deemed to violate the Anti-kickback Amendments. Among the safe harbors
included in the regulations were provisions relating to the sale of physician
practices, management and personal services agreements and employee
relationships. Subsequently, regulations were published offering safe harbor
protection to additional activities, including referrals within group practices
consisting of active investors. Proposed amendments clarifying the existing safe
harbor regulations were published in 1994. If any of the proposed regulations
are ultimately adopted, they would result in substantive changes to existing
regulations. The failure of an activity to qualify under a safe harbor
provision, while potentially leading to greater regulatory scrutiny, does not
render the activity illegal.
There are several aspects of the Company's relationships with
physicians to which the anti-kickback law may be relevant. In some instances,
for example, the government may construe some of the marketing and managed care
contracting activities of the Company as arranging for the referral of patients
to the physicians with whom the Company has a Service Agreement.
Although neither the investments in the Company by physicians nor the
Service Agreements between the Company and the Affiliated Practices qualify for
protection under the safe harbor regulations, the Company does not believe that
these activities fall within the type of activities the Anti-kickback Amendments
were intended to prohibit. A determination that the Company has violated the
Anti-kickback Amendments would have a material adverse effect on the Company.
The Stark Self-Referral Law. The Stark Self-Referral Law (the "Stark
Law") prohibits a physician from referring a patient to a health care provider
for certain designated health services reimbursable by Medicare or Medicaid if
the physician has a financial relationship with that provider, including an
investment interest, a loan or debt relationship or a compensation relationship.
In addition to the conduct directly prohibited by the law, the statute also
prohibits schemes that are designed to obtain referrals indirectly that cannot
be made directly. The penalties for violating the law include (i) a refund of
any Medicare or Medicaid payments for services that resulted from an unlawful
referral, (ii) civil fines and (iii) exclusion from the Medicare and Medicaid
programs.
The Company does not currently provide any designated health service
under the Stark Law. However, because the Company will provide management
services related to those designated health services provided by physicians
affiliated with the Affiliated Practices, there can be no assurance that the
Company will not be deemed the provider for those services for purposes of the
Stark Law and, accordingly, the recipient of referrals from physicians
affiliated with the Affiliated Practices. In that event, such referrals will be
permissible only if (i) the financial arrangements under the service agreements
with the Affiliated Practices meet certain exceptions in the Stark Law and (ii)
the ownership of stock in the Company by the referring physicians meets certain
investment exceptions under the Stark Law. The Company believes that the
financial arrangements under the Service Agreements qualify for applicable
exceptions under the Stark
14
Law; however, there can be no assurance that a review by courts or regulatory
authorities would not result in a contrary determination. In addition, the
Company will not meet the Stark Law exception related to investment interest
until the Company's stockholders' equity exceeds $75 million.
State Law
State Anti-Kickback Laws. Many states have laws that prohibit payment
of kickbacks in return for the referral of patients. Some of these laws apply
only to services reimbursable under state Medicaid programs. However, a number
of these laws apply to all health care services in the state, regardless of the
source of payment for the service. Based on court and administrative
interpretation of federal anti-kickback laws, the Company believes that these
laws prohibit payments to referral sources where a purpose for payment is for
the referral. However, the laws in most states regarding kickbacks have been
subjected to limited judicial and regulatory interpretation and therefore, no
assurances can be given that the Company's activities will be found to be in
compliance. Noncompliance with such laws could have an adverse effect upon the
Company and subject it and physicians affiliated with the Affiliated Practices
to penalties and sanctions.
State Self-Referral Laws. A number of states have enacted self-referral
laws that are similar in purpose to the Stark Law but which impose different
restrictions. Some states, for example, only prohibit referrals when the
physician's financial relationship with a health care provider is based upon an
investment interest. Other state laws apply only to a limited number of
designated health services. Some states do not prohibit referrals, but require
only that a patient be informed of the financial relationship before the
referral is made. The Company believes that its operations are in material
compliance with the self-referral law of the states in which the Affiliated
Practices are located.
Fee-Splitting Laws. Many states prohibit a physician from splitting
with a referral source the fees generated from physician services. Other states
have a broader prohibition against any splitting of a physician's fees,
regardless of whether the other party is a referral source. In most states, it
is not considered to be fee-splitting when the payment made by the physician is
reasonable reimbursement for services rendered on the physician's behalf.
The Company will be reimbursed by physicians on whose behalf the
Company provides management services. The compensation provisions of the Service
Agreements have been designed to comply with applicable state laws relating to
fee-splitting. There can be no certainty, however, that, if challenged, the
Company and its Affiliated Practices will be found to be in compliance with each
state's fee-splitting laws. A determination in any state that the Company is
engaged in any unlawful fee-splitting arrangement could render any service
agreement between the Company and an Affiliated Practice located in such state
unenforceable or subject to modification in a manner adverse to the Company.
Corporate Practice of Medicine. Most states prohibit corporations from
engaging in the practice of medicine. Many of these state doctrines prohibit a
business corporation from employing a physician. States differ, however, with
respect to the extent to which a licensed physician can affiliate with corporate
entities for the delivery of medical services. Some states interpret the
"practice of medicine" broadly to include activities of corporations such as the
Company that have an indirect impact on the practice of medicine, even where the
physician rendering the medical services is not an employee of the corporation
and the corporation exercises no discretion with respect to the diagnosis or
treatment of a particular patient.
The Company intends that, pursuant to its service agreements, it will
not exercise any responsibility on behalf of affiliated physicians that could be
construed as affecting the practice of medicine. Accordingly, the Company
believes that its operations do not violate applicable state laws relating to
the corporate practice of medicine. Such laws and legal doctrines have been
subjected to only limited judicial and regulatory interpretation and there can
be no assurance that, if challenged, the Company would be considered to be in
compliance with all such laws and doctrines. A determination in any state that
the Company is engaged in the corporate practice of medicine could render any
service agreement between the Company and an Affiliated Practice located in such
state unenforceable or subject to modification in a manner adverse to the
Company.
15
Insurance Laws. Laws in all states regulate the business of insurance
and the operation of HMOs. Many states also regulate the establishment and
operation of networks of health care providers. While these laws do not
generally apply to companies that provide management services to networks of
physicians, there can be no assurance that regulatory authorities of the states
in which the Company operates would not apply these laws to require licensure of
the Company's operations as an insurer, as an HMO or as a provider network. The
Company believes that its proposed operations are in compliance with these laws
in the states in which it currently does business, but there can be no assurance
that future interpretations of insurance and health care network laws by
regulatory authorities in these states or in the states into which the Company
may expand will not require licensure or a restructuring of some or all of the
Company's operations.
The National Association of Insurance Commissioners ("NAIC") in 1995
endorsed a policy proposing the state regulation of risk assumption by
physicians. The policy proposes prohibiting physicians from entering into
capitated payment or other risk sharing contracts except through HMOs or
insurance companies. Several states have adopted regulations implementing the
NAIC policy in some form. In states where such regulations have been adopted,
practices affiliated with the Company will be precluded from entering into
capitated contracts directly with employers, individuals and benefit plans
unless they qualify to do business as HMOs or insurance companies. Currently,
the Company does not intend, on its own behalf, or on behalf of the Affiliated
Practices, to enter into capitated payment or other risk-sharing arrangements
other than with HMOs or insurance companies. In addition, in December 1996, the
NAIC issued a white paper entitled "Regulation of Health Risk Bearing Entities,"
which sets forth issues to be considered by state insurance regulators when
considering new regulations and encourages that a uniform body of regulation be
adopted by the states. The Company believes that additional regulation at the
state level will be forthcoming in response to the NAIC initiatives. Other
states have enacted statutes or adopted regulations affecting risk assumption in
the health care industry, including statutes and regulations that subject any
physician or physician network engaged in risk-based contracting to applicable
insurance laws and regulations, which may include, among other things, laws and
regulations providing for minimum capital requirements and other safety and
soundness requirements.
Competition
The Company competes with many other entities to affiliate with
musculoskeletal practices. Several companies that have established operating
histories and greater resources than the Company are pursuing the acquisition of
the assets of general and specialty practices and the management of such
practices. Physician practice management companies and some hospitals, clinics
and HMOs engage in activities similar to the activities of the Company. There
can be no assurance that the Company will be able to compete effectively with
such competitors, that additional competitors will not enter the market, or that
such competition will not make it more difficult to affiliate with, and to enter
into agreements to provide management services to, practices on terms beneficial
to the Company.
Affiliated Practices compete with local musculoskeletal care service
providers as well as some managed care organizations. The Company believes that
changes in governmental and private reimbursement policies and other factors
have resulted in increased competition for consumers of medical services. The
Company believes that the cost, accessibility and quality of services provided
are the principal factors that affect competition. There can be no assurance
that the Affiliated Practices will be able to compete effectively in the markets
that they serve. The inability of the Affiliated Practices to compete
effectively would materially adversely affect the Company.
Further, the Affiliated Practices compete with other providers for
managed musculoskeletal care contracts. The Company believes that trends toward
managed care have resulted in increased competition for such contracts. Other
practices and management service organizations may have more experience than the
Affiliated Practices and the Company in obtaining such contracts. There can be
no assurance that the Company and the Affiliated Practices will be able to
successfully acquire sufficient managed care contracts to compete effectively in
the markets they serve. The inability of the Affiliated Practices to compete
effectively for such contracts could materially adversely affect the Company.
16
Employees
As of March 21, 1997, the Company has approximately 319 employees, of
whom 30 are located at the Company's corporate offices and 289 are located at
the Affiliated Practices. The Company believes that its relationship with its
employees is good.
Corporate Liability and Insurance
The provision of medical services entails an inherent risk of
professional malpractice and other similar claims. However, the Company does not
influence or control the practice of medicine by physicians or have
responsibility for compliance with certain regulatory and other requirements
directly applicable to physicians and physician groups. As a result of the
relationship between the Company and the Affiliated Practices, the Company may
become subject to some medical malpractice actions under various theories,
including successor liability. There can be no assurance that claims, suits or
complaints relating to services and products provided by Affiliated Practices
will not be asserted against the Company in the future. The Company's medical
professional liability insurance provides coverage of up to $1 million per
incident, with maximum coverage of $3 million per year. The Company's general
liability insurance provides coverage of up to $5 million per incident, with
maximum coverage of $5 million per year. The Company believes that such
insurance will extend to professional liability claims that may be asserted
against employees of the Company that work on site at Affiliated Practice
locations. In addition, pursuant to the Service Agreements, the Affiliated
Practices are required (and the other practices with which the Company
affiliates in the future will be required) to maintain comprehensive
professional liability insurance. The availability and cost of such insurance
has been affected by various factors, many of which are beyond the control of
the Company and Affiliated Practices. The cost of such insurance to the Company
and Affiliated Practices may have a material adverse effect on the Company. In
addition, successful malpractice or other claims asserted against Affiliated
Practices or the Company that exceed applicable policy limits would have a
material adverse effect on the Company.
Risk Factors
Limited Operating History; Risks Related to Integration of Assets and
Personnel
The Company was incorporated in December 1995 and, prior to its
affiliation with the Initial Affiliated Practices in November 1996, had no
history of operations or earnings. As a result of acquiring certain assets of
the Predecessor Practices, and the practices that were predecessors to the
single physician practices acquired by the Company, and entering into the
Service Agreements with the Affiliated Practices, the Company is now responsible
for most non-medical aspects of the operations, and manages most non-physician
employees, of the Initial Affiliated Practices. Prior to their affiliation with
the Company, the Predecessor Practices and the practices that were predecessors
to the single physician practices acquired by the Company operated as separate
independent entities, and there can be no assurance that the Company will be
able to integrate and manage successfully the assets and personnel of, or
provide services profitably to, the Affiliated Practices or other practices with
which it may affiliate in the future. In addition, there can be no assurance
that the Company's affiliation with the Affiliated Practices or other practices
with which it may affiliate in the future will not result in a loss of patients
by any of those practices or other unanticipated adverse consequences. Any of
these events could have a material adverse effect on the Company. There can be
no assurance that the Company's personnel, systems and infrastructure will be
sufficient to permit effective and profitable management of the Affiliated
Practices under the Service Agreements or to implement effectively the Company's
strategies.
Risks Associated with Affiliation and Expansion Strategy
A primary element of the Company's strategy is to acquire certain
assets of, and affiliate through service agreements with, selected
musculoskeletal practices in targeted markets. The Company's strategy also
involves assisting Affiliated Practices in recruiting physicians and, to the
extent permitted by applicable law, contracting with ancillary
17
musculoskeletal facilities, such as outpatient occupational medicine, physical
therapy and surgery centers and MRI centers, and with associated providers.
Identifying appropriate physician group practices, individual physicians and
ancillary providers and facilities and proposing, negotiating and implementing
economically attractive affiliations with such practices, physicians and
providers can be a lengthy, complex and costly process. In addition, the Company
is a party to a credit facility that places certain limitations upon the number
of affiliations the Company can enter into in any quarter or year and the terms
of any future affiliations. The failure of the Company to identify and effect
additional affiliations would have a material adverse effect on the Company.
Moreover, there can be no assurance that future affiliations, if any, will
contribute to the Company's profitability or otherwise facilitate the successful
implementation of the Company's overall strategy.
The Company's ability to expand is also dependent upon factors such as
the ability of the Company and any practice with which it may seek to affiliate
to (i) adapt the Company's arrangements with such practices to comply with
current or future legal requirements, including state prohibitions on
fee-splitting, corporate practice of medicine and referrals to facilities in
which physicians have a financial interest and state anti-kickback provisions,
(ii) obtain regulatory approval and certificates of need, where necessary, and
(iii) comply with licensing requirements applicable to physicians and to
facilities operated, and services offered, by physicians. There can be no
assurance that application of current laws or changes in legal requirements will
not adversely affect the Company or that the Company and the practices with
which it is affiliated will be able to obtain and maintain all necessary
regulatory approvals and comply with applicable laws, regulations and licensing
requirements.
Dependence on Affiliated Practices and Physicians; Risk of Termination
of Service Agreements
The Company's operations are entirely dependent on its continued
affiliation through service agreements with the Affiliated Practices and on the
success of the Affiliated Practices. There can be no assurance that the
Affiliated Practices will maintain successful practices, that service agreements
will not be terminated or that any of the key physicians in a particular
Affiliated Practice will continue affiliation with such practice. Two of the
Affiliated Practices, ROA and POA, contributed approximately 34% and 27%,
respectively, of the fees (including fees relating to the reimbursement of
clinic expenses) paid to the Company by all of the Initial Affiliated Practices.
The termination of any of the Service Agreements with the Initial Affiliated
Practices would, and termination of service agreements with any other Affiliated
Practices could, have a material adverse effect on the Company. For a
description of the Service Agreements, including a description of their
termination provisions and non-competition arrangements with affiliated
physicians, and an agreement regarding a contemplated division of ROA into two
Affiliated Practices, see "Contractual Agreements with Affiliated Practices" in
this Item. For a discussion of circumstances under which a service agreement may
be rendered unenforceable, see "Government Regulation" in this Item.
Some of the Affiliated Practices derive, and other practices with which
the Company may affiliate may derive, a significant portion of their revenue
from a limited number of physicians. Particularly because none of the physicians
at any Affiliated Practices has previously entered into service arrangements
similar to those embodied in the Service Agreements, there can be no assurance
that the Company or the Affiliated Practices will maintain cooperative
relationships with key members of a particular Affiliated Practice. In addition,
there can be no assurance that key members of an Affiliated Practice will not
retire, become disabled or otherwise become unable or unwilling to continue
practicing their profession with an Affiliated Practice. The loss by an
Affiliated Practice of one or more key members would have a material adverse
effect on the revenue of such Affiliated Practice and possibly on the Company.
Neither the Company nor the Affiliated Practices maintains insurance on the
lives of any affiliated physicians for the benefit of the Company. The loss of
revenue by any Affiliated Practice could have a material adverse effect on the
Company.
Risk of Changes in Payment for Medical Services
The health care industry is experiencing a trend toward cost
containment as government and private third party payors seek to impose lower
reimbursement and utilization rates and negotiate reduced capitated payment
schedules with service providers. Further reductions in payments to health care
providers or other changes in reimbursement for
18
health care services could have a material adverse effect on the Affiliated
Practices and, as a result, on the Company. These reductions could result from
changes in current reimbursement rates or from a shift in clinical protocols to
non-surgical solutions to orthopaedic conditions. There can be no assurance that
the Company will be able to offset successfully any or all of the payment
reductions that may occur.
The federal government has implemented, in annual increments through
December 31, 1996, through the Medicare program, a resource-based relative value
scale ("RBRVS") payment methodology for health care provider services. RBRVS is
a fee schedule that, except for certain geographical and other adjustments, pays
similarly situated health care providers the same amount for the same services.
The RBRVS is adjusted each year and is subject to increases or decreases at the
discretion of Congress. To date, the implementation of RBRVS has reduced payment
rates for certain of the procedures historically provided by the Affiliated
Practices. Further reductions could significantly affect the Affiliated
Practices, each of which derives a significant portion of its revenue from
Medicare. RBRVS types of payment systems have also been adopted by certain
private third party payors and may become a predominant payment methodology.
Wider-spread implementation of such programs would reduce payments from private
third party payors, and could indirectly reduce revenue to the Company.
Rates paid by private third party payors, including those that provide
Medicare supplemental insurance, are based on established health care provider
and hospital charges and are generally higher than Medicare payment rates. A
change in the patient mix of any of the Affiliated Practices that results in a
decrease in patients covered by private insurance could have a material adverse
effect on the Affiliated Practices and, as a result, on the Company.
Government Regulation
The delivery of health care, including the relationships among health
care providers such as physicians and other clinicians, is subject to extensive
federal and state regulation. The Company believes that its operations are
conducted in material compliance with applicable laws; however, the Company has
not received or applied for a legal opinion from counsel or from any federal or
state judicial or regulatory authority to this effect, and many aspects of the
Company's business operations have not been the subject of state or federal
regulatory interpretation. There can be no assurance that a review of the
Company's operations by federal or state judicial or regulatory authorities will
not result in a determination that the Company or one of its Affiliated
Practices has violated one or more provisions of federal or state law. Any such
determination could have a material adverse effect on the Company.
The fraud and abuse provisions of the Social Security Act and
anti-kickback laws and regulations adopted by many states, including Florida, a
state in which three Affiliated Practices are located, prohibit the
solicitation, payment, receipt or offering of any direct or indirect
remuneration in return for, or as an inducement to, certain referrals of
patients, items or services. Provisions of the Social Security Act also impose
significant penalties for false or improper billings. In addition, the Stark Law
imposes restrictions on physicians' referrals for designated health services
reimbursable by Medicare or Medicaid to entities with which the physicians have
financial relationships. Many states, including the states in which the
Affiliated Practices are located, have adopted similar self-referral laws which
are not limited to Medicare or Medicaid reimbursed services. Accordingly, the
Company is prohibited from owning facilities for the provision of, or otherwise
providing, certain ancillary services for patients of its Affiliated Practices.
Violations of any of these laws may result in substantial civil or criminal
penalties, including large civil monetary penalties, and, in the case of
violations of federal laws, exclusion from participation in the Medicare and
Medicaid programs. Such exclusion and penalties, if applied to the Company or
its Affiliated Practices, would have a material adverse effect on the Company.
The laws of many states, including the states in which the Affiliated
Practices are located, prohibit business corporations such as the Company from
practicing medicine or exercising control over the medical judgments or
decisions of physicians and from engaging in certain financial arrangements,
such as splitting fees with physicians. These laws and their interpretations
vary from state to state and are enforced by both the courts and regulatory
authorities, each with broad discretion. Violations of these laws could result
in censure or delicensing of affiliated
19
physicians, civil or criminal penalties, including large civil monetary
penalties, or other sanctions. In addition, a determination in any state that
the Company is engaged in the corporate practice of medicine or any unlawful
fee-splitting arrangement could render any service agreement between the Company
and an Affiliated Practice located in such state unenforceable or subject to
modification, which could have a material adverse effect on the Company.
Expansion of the operations of the Company to certain jurisdictions may
require modification of the Company's form of relationship with a practice,
which could have a material adverse effect on the Company. Furthermore, the
Company's ability to expand into, or to continue to operate within certain
jurisdictions may depend on the Company's ability to modify its operational
structure to conform to such jurisdictions' regulatory framework or to obtain
necessary approvals, licenses and permits. Any limitation on the Company's
ability to expand could have a material adverse effect on the Company. See
"Government Regulation and Supervision" in this Item.
In addition to extensive existing government health care regulation,
there are numerous initiatives on the federal and state levels for comprehensive
reforms affecting the payment for and availability of health care services.
These initiatives include reductions in Medicare and Medicaid payments, trends
in adopting managed care for Medicare and Medicaid patients and regulation of
entities that provide managed care and additional prohibitions on ownership by
health care providers, directly or indirectly, of facilities to which they refer
patients. Aspects of certain of these health care proposals, if adopted, could
have a material adverse effect on the Company. See "Risk Factors--Risks
Associated with Affiliation and Expansion Strategy," "Risk Factors--Risk of
Changes in Payment for Medical Services" and "Government Regulation and
Supervision" in this Item.
Dependence on Information Systems
The Company's success is largely dependent on its ability to implement
new information systems and to integrate these systems into the Affiliated
Practice's existing, operational, financial and clinical information systems. In
addition to their integral role in helping the Affiliated Practices realize
operating efficiencies, such systems are critical to negotiating, pricing and
managing capitated managed care contracts. See "Risk Factors--Risks Associated
with Managed Care Contracts." The Company will need to continue to invest in,
and administer, sophisticated management information systems to support these
activities. The Company may experience unanticipated delays, complications and
expenses in implementing, integrating and operating such systems. Furthermore,
such systems may require modifications, improvements or replacements as the
Company expands or if new technologies become available. Such modifications,
improvements or replacements may require substantial expenditures and may
require interruptions in operations during periods of implementation. The
failure to implement successfully and maintain operational, financial and
clinical information systems would have a material adverse effect on the
Company. See "SCN Operations" in this Item.
Risks Associated with Managed Care Contracts
As an increasing percentage of patients enter into health care coverage
arrangements with managed care payors, the Company believes that its success
will be, in part, dependent upon the Company's ability to negotiate contracts
with HMOs, employer groups and other private third party payors on behalf of
practices affiliated with the Company. The inability of the Company to enter
into such arrangements in the future on behalf of practices affiliated with the
Company could have a material adverse effect on the Company.
In certain instances, the Company may seek to negotiate on behalf of
regional musculoskeletal care networks consisting of practices affiliated with
the Company and other physicians or group practices willing to permit the
Company to negotiate on their behalf with respect to a particular third party
payor. The Company anticipates that, in the future, the payor contracts that may
be entered into on behalf of practices affiliated with the Company and any
related network physicians will include contracts based on capitated fee
arrangements. Under some of these types of contracts, a health care provider
agrees either to accept a predetermined dollar amount per member per month in
exchange for undertaking to provide all covered services to patients or to
provide treatment on an episode of care basis.
20
Such health care providers bear the risk, generally subject to certain loss
limits, that the aggregate costs of providing medical services will exceed the
premiums received. Some agreements may also contain "shared risk" provisions
under which affiliated physicians may earn additional compensation based on
utilization control of institutional, ancillary and other services by patients,
and the practices may be required to bear a portion of any loss in connection
with such "shared risk" provisions. To the extent that patients or enrollees
covered by such contracts require more frequent or, in certain instances, more
extensive care than anticipated, there could be a material adverse effect on a
practice affiliated with the Company and, therefore, on the Company. In the
worst case, revenue negotiated under risk-sharing or capitated contracts would
be insufficient to cover the costs of the care provided. Any such reduction or
elimination of earnings to the practices affiliated with the Company under such
fee arrangements could have a material adverse effect on the Company.
TOC has a non-contractual capitated arrangement covering approximately
75,000 lives and a capitated contract covering approximately 55,000 lives, and
POA has a capitated contract covering approximately 20,000 lives. These
arrangements existed at the time of the Initial Affiliation Transactions. No
other Affiliated Practice has a capitated arrangement.
The NAIC in 1995 endorsed a policy proposing the state regulation of
risk assumption by physicians. The policy proposes prohibiting physicians from
entering into capitated payment or other risk sharing contracts except through
HMOs or insurance companies. Several states have adopted regulations
implementing the NAIC policy in some form. In states where such regulations have
been adopted, practices affiliated with the Company will be precluded from
entering into capitated contracts directly with employers, individuals and
benefit plans unless they qualify to do business as HMOs or insurance companies.
Currently, the Company does not intend, on its own behalf, or on behalf of the
Initial Affiliated Practices, to enter into capitated payment or other
risk-sharing arrangements other than with HMOs or insurance companies. In
addition, in December 1996, the NAIC issued a white paper entitled "Regulation
of Health Risk Bearing Entities," which sets forth issues to be considered by
state insurance regulators when considering new regulations, and encourages that
a uniform body of regulation be adopted by the states. The Company believes that
additional regulation at the state level will be forthcoming in response to the
NAIC initiatives. Other states have enacted statutes or adopted regulations
affecting risk assumption in the health care industry, including statutes and
regulations that subject any physician or physician network engaged in
risk-based contracting to applicable insurance laws and regulations, which may
include, among other things, laws and regulations providing for minimum capital
requirements and other safety and soundness requirements. The Company and
practices affiliated with the Company may not satisfy such insurance laws or
regulations. Full compliance with such laws and regulations could result in
substantial costs to the Company and the practices affiliated with the Company.
The inability to enter into capitated arrangements or the cost of complying with
certain applicable laws that would permit expansion of risk-based contracting
activities would have a material adverse effect on the Company.
Generally, there is no certainty that the Company and practices
affiliated with the Company will be able to establish or maintain satisfactory
relationships with managed care and other third party payors, many of which
already have existing provider structures in place and may not be able or
willing to change their provider networks. In addition, any significant loss of
revenue by the practices affiliated with the Company as a result of the
termination of third party payor contracts or otherwise would have a material
adverse effect on the Company.
Need for Additional Funds
The Company's acquisition and expansion strategy will require
substantial capital, and the Company anticipates that it will, in the future,
seek to raise additional funds through debt financing or the issuance of equity
or debt securities. There can be no assurance that sufficient funds will be
available on terms acceptable to the Company, if at all. If equity securities
are issued, either to raise funds or in connection with future affiliations,
dilution to the Company's stockholders may result, and if additional funds are
raised through the incurrence of debt, the Company may become subject to
restrictions on its operation and finances. Such restrictions may have an
adverse effect on, among other things,
21
the Company's ability to pursue its acquisition strategy. See "Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
Competition
Competition for affiliation with additional musculoskeletal practices
is intense and may limit the availability of suitable practices with which the
Company may be able to affiliate. Several companies with established operating
histories and greater resources than the Company, including physician practice
management companies and some hospitals, clinics and HMOs, are pursuing
activities similar to those of the Company. There can be no assurance that the
Company will be able to compete effectively with such competitors, that
additional competitors will not enter the market or that such competition will
not make it more difficult and costly to acquire the assets of, and provide
management services to, musculoskeletal medical practices on terms beneficial to
the Company. The Company also believes that changes in governmental and private
reimbursement policies, among other factors, have resulted in increased
competition among providers of medical services to consumers. There can be no
assurance that the Company's Affiliated Practices will be able to compete
effectively in the markets they serve. See "Business-- Competition."
Dependence Upon Key Personnel
The Company is dependent upon the ability and experience of its
executive officers and key personnel for the management of the Company and the
implementation of its business strategy. The Company currently has employment
contracts with its ten executive officers. Because of the difficulty in finding
adequate replacements for such personnel, the loss of the services of any such
personnel or the Company's inability in the future to attract and retain
management and other key personnel could have a material adverse effect on the
Company.
Potential Liability and Insurance; Legal Proceedings
The provision of medical services entails an inherent risk of
professional malpractice and other similar claims. While the Affiliated
Practices maintain malpractice insurance, there can be no assurance that any
claim asserted against any of the Affiliated Practices or any other practice
that may affiliate with the Company in the future will be covered by, or will
not exceed the coverage limits, of applicable insurance. A successful
malpractice claim against any practice affiliated with the Company, even if
covered by insurance, could have a material adverse effect on such practice and,
as a result, on the Company.
The Company does not engage in the practice of medicine; however, the
Company could be implicated in such claims, and there can be no assurance that
claims, suits or complaints relating to services delivered by practices
affiliated with the Company (including claims with regard to services rendered
by a practice prior to its affiliation with the Company) will not be asserted
against the Company in the future. Although the Company has attempted to address
this risk by maintaining insurance, there can be no assurance that any claim
asserted against the Company for professional or other liability will be covered
by, or will not exceed the coverage limits of, such insurance. The Company's
medical professional liability insurance provides coverage of up to $1 million
per incident, with maximum coverage of $3 million per year. The Company's
general liability insurance provides coverage of up to $5 million per incident,
with maximum coverage of $5 million per year.
The availability and cost of professional liability insurance have been
affected by various factors, many of which are beyond the control of the
Company. There can be no assurance that the Company will be able to maintain
insurance in the future at a cost that is acceptable to the Company, or at all.
Any claim made against the Company not fully covered by insurance could have a
material adverse effect on the Company.
22
Risks Related to Purchase of Receivables
The Service Agreements provide that the Company will acquire each
Affiliated Practice's accounts receivable each month. The purchase price for
such accounts receivable equals the gross amounts of the accounts receivable
recorded each month, less adjustments for contractual allowances, allowances for
doubtful accounts and other potentially uncollectible amounts based on the
practice's historical collection rate, as determined by the Company. To the
extent that the Company's actual collections are less than the amounts paid for
the receivables, or if payment of receivables is not made on a timely basis, the
Company could be materially adversely affected. See "Business--Contractual
Agreements with Affiliated Practices." The Company also bears the collection
risk with respect to outstanding receivables acquired in connection with an
affiliation.
Quarterly Results Fluctuation
The Company's quarterly operating results may fluctuate significantly
as the result of the timing of affiliations and as a result of timing of
musculoskeletal procedures. Such fluctuation could adversely affect the price of
the Company's Common Stock.
Item 2. Properties
The Company has a five-year lease for its headquarters in Lakewood,
Colorado, which provides for annual lease payments of approximately $180,000. In
addition, in connection with its affiliation with the Affiliated Practices, the
Company entered into leases for the facilities utilized by the Affiliated
Practices for annual lease payments of approximately $2.5 million. For
additional information, see Item 13.
Item 3. Legal Proceedings
On January 8, 1997, Michael A. Feiertag, M.D. filed a lawsuit against
the Company in the Circuit Court of the 19th Judicial Circuit in and for Indian
River County, Florida. Dr. Feiertag's complaint alleges that Vero Orthopaedics
breached his employment agreement by failing to offer him a "full partnership"
in accordance with the agreement. Dr. Feiertag claims that he is entitled to
damages consisting of amounts he allegedly should have received in connection
with the Company's merger with Vero Orthopaedics had he been a partner prior to
the merger. Dr. Feiertag also claims that he has not been paid certain vacation
and bonus pay. Dr. Feiertag is seeking damages in excess of $500,000. The
Company filed an answer to the complaint denying liability and intends to
vigorously contest the action. On February 3, 1997, the Company initiated
proceedings to have the case removed to the United States District Court for the
Southern District of Florida.
There can be no assurance that additional claims will not be asserted
against the Company in the future. The Company may become subject to certain
pending claims as the result of successor liability in connection with the
assumption of certain liabilities of the Affiliated Practices; nevertheless, the
Company believes that the ultimate resolution of such additional claims will not
have a material adverse effect on the Company. See "Risk Factors-- Potential
Liability and Insurance; Legal Proceedings" in Item 1.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the Nasdaq Stock Market under
the symbol "SCNI." Shares of the Company's Common Stock were first traded
publicly on February 7, 1997 in connection with the Company's initial public
offering at a price to the public of $8.00 per share. There was no market
activity in the Company's Common Stock prior to that date.
The Company issued and sold unregistered securities during the three
months ended December 31, 1996, as described below.
On October 1, 1996, the Company issued convertible debentures to
physician owners of one of the Initial Affiliated Practices for an aggregate
price of $300,000. On November 4, 1996, the Company issued 100,000 shares of
Common Stock to physician owners of one of the Initial Affiliated Practices for
an aggregate price of $300,000.
On November 12, 1996, all of the Company's outstanding convertible
debentures (the "Debentures") were converted into common stock. Of the
Debentures converted, $1,870,000 principal amount of Debentures, plus $50,332 of
accrued interest, were converted at the rate of $1.00 per share into an
aggregate of 1,920,332 shares of Common Stock, and $300,000 principal amount of
Debentures, plus $1,707 of accrued interest, were converted at the rate of $3.00
per share into 100,569 shares of Common Stock.
On November 12, 1996, in connection with the Initial Affiliation
Transactions, the Company entered into agreements with the Predecessor Practices
and issued an aggregate of 7,659,115 shares of Common Stock to the physician
owners of the Predecessor Practices. See Item 13 for a more detailed description
of the Initial Affiliation Transactions.
The Company effected the foregoing transactions in reliance on the
exemptions from registration provided under Sections 4(1) and 3(a)(9) under the
Securities Act of 1933 (the "Act"). With respect to the transactions (other than
the conversion of the Debentures) effected in reliance on Section 4(2), the
Company believes that all of such transactions complied with the requirements of
Rule 506 under the Act.
24
Item 6. Selected Financial Data
SELECTED FINANCIAL DATA (1)
Year Ended Period Ended
December 31, 1996 December 31, 1995
----------------- -----------------
Statement of Operations Data
Management fee revenue (1)................................................. $4,392,050 $ --
Operating expenses:
Clinic expenses................................................... 2,820,743 --
Salaries, wages and benefits...................................... 1,917,891 --
General and administrative expenses............................... 1,096,665 --
Costs to evaluate and acquire physician practices................. 597,361 --
Depreciation and amortization..................................... 158,346 --
---------------- -----------------
Loss from operations....................................................... (2,198,956) --
Interest expense, net...................................................... 78,498 --
---------------- -----------------
Loss before income tax benefit............................................. (2,277,454) --
Income tax benefit......................................................... 506,071 --
---------------- -----------------
Net loss................................................................... $(1,771,383) --
============= =================
Total weighted average number of common shares outstanding (2)............. 12,026,347 --
Net loss per share amount (3).............................................. $ (0.15) --
December 31, 1996 December 31, 1995
----------------- -----------------
Balance Sheet Data
Total assets............................................................... $18,685,390 $ 40,684
Total debt................................................................. 5,282,601 --
(1) Revenue consists of service fees equal to (i) a percentage of pre-tax
earnings of the Affiliated Practices before physician compensation and
most fringe benefits and excluding certain expenses of the Affiliated
Practices (subject to a specified minimum base service fee) and (ii)
reimbursement for operating expenses of the Affiliated Practices that
have been incurred by the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Overview."
(2) The computation of net loss per share is based upon 12,026,347 weighted
average common shares outstanding and common share equivalents.
(3) See Note 2 to the financial statements of the Company for a description
of the computation of net loss per share amount.
25
Selected Financial Data--Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)(1)
The historical financial data presented for the years ended
December 31, 1993, 1994, 1995 and 1996 are derived from audited financial
statements.
Year Ended December 31,
--------------------------------------------------------------------
1996 1995 1994 1993
---- ---- ---- ----
Statement of Operations Data
Net patient revenue.......................... $16,802,665 $16,906,641 $13,325,350 $11,902,216
Total revenue................................ 17,809,265 17,549,907 13,325,350 11,902,216
Income (loss)from operations................. (988,346) 1,460,162 128,803 377,445
December 31,
--------------------------------------------------------------------
1996 1995 1994 1993
---- ---- ---- ----
Balance Sheet Data
Total assets................................. $1,695,807 $5,312,577 $3,701,073 $3,672,138
Total debt................................... -- 570,000 550,000 700,000
(1) On November 12, 1996, the Company acquired substantially all of the net
assets of Reconstructive Orthopaedic Associates, Inc. The physician owners of
Reconstructive Orthopaedic Associates, Inc. formed Reconstructive Orthopaedic
Associates II, P.C. and entered into a long-term agreement with the Company to
provide clinical services. The transaction has been treated for financial
statement presentation as effectively a continuation of the business.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation
General
SCN was incorporated in 1995, but did not conduct any significant
operations until November 1996, following its affiliation with the Initial
Affiliated Practices. At the time of the Initial Affiliation Transactions, the
predecessors of the Initial Affiliated Practices and GCOA were established
businesses engaged in the provision of musculoskeletal care as separate
independent entities. The Initial Affiliated Practices currently conduct
business as separate entities obtaining services from the Company pursuant to
service agreements.
In March 1997, the Company affiliated with three single physician
practices (the "Single Physician Practices"). These practices also conduct
business as separate entities obtaining services from the Company under service
agreements.
The following discussion of the results of operations and financial
position of the Company should be read in conjunction with the financial
statements of the Company included elsewhere in this Form 10-K.
Accounting Treatment
The acquisition of the assets and assumptions of certain liabilities of
the Predecessor Practices were accounted for by the Company at the transferors'
historical cost basis. The Common Stock issued in exchange for those assets was
recorded by SCN at the Predecessor Practices' historical cost. The beginning net
assets of approximately $5.5 million recorded by the Company related to the
Initial Affiliation Transactions reflect, in the opinion of management,
adjustments necessary to present these balances in accordance with generally
accepted accounting principles. In accordance with SAB 48, the physician owners
of the Predecessor Practices were deemed to function as promoters in the Initial
Affiliation Transactions. Cash consideration given in those acquisitions has
been treated for accounting purposes as a dividend from SCN to the physician
owners who received cash.
26
The acquisition of assets in March 1997 in connection with the
Company's affiliation with the Single Physician Practices was accounted for by
the purchase method. Future acquisitions will most likely be accounted for by
the purchase method.
The Company accounts for its stock-based compensation arrangements
using the intrinsic value method under the provisions of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25").
In 1995, Financial Accounting Standards Board Statement No. 123, Accounting for
Stock-Based Compensation ("FASB No. 123"), was issued, whereby companies may
elect to account for stock-based compensation using a fair market value based
method or continue measuring compensation expense using the intrinsic value
method prescribed in APB No. 25. Currently, the Financial Accounting Standards
Board has added to its agenda a project regarding certain APB No. 25 issues
including such things as incorporating the FASB No. 123 grant date definition
into APB No. 25, readdressing the criteria under broad-based plans qualifying
for noncompensatory accounting and defining what constitutes employees. The
resolution of these issues could result in the revision of the Company's
accounting for stock-based compensation arrangements.
Results of Operations
The Company had not entered into any service agreements, and
consequently generated no revenue, prior to November 12, 1996. The Company
incurred a pre-tax loss for the period from January 1, 1996 through October 31,
1996 of approximately $2.9 million, reflecting management salaries, business
start-up expenses and travel, legal and accounting costs associated with the
Initial Affiliation Transactions. The Company generated approximately $611,000
of pre-tax income for the period from November 1, 1996 through December 31,
1996, on management fee revenue (including reimbursement of clinic expenses) of
$4.4 million.
The following table presents certain statement of operations data for
the year ended December 31, 1996, the ten months ended October 31, 1996 (during
which period the Company did not conduct any significant operations, and devoted
most of its efforts towards completing the Initial Affiliation Transactions) and
the two months ended December 31, 1996 (which includes operations following the
affiliation with the Initial Affiliated Practices on November 12, 1996).
Twelve Months Ended Ten Months Ended Two Months Ended
December 31, 1996 October 31, 1996 December 31, 1996
------------------- ----------------- -----------------
Management fee revenue $ 4,392,050 $ $4,392,050
Operating Expenses:
Clinic support costs 2,820,743 -- 2,820,743
General and administrative expenses 3,770,263 2,845,973 924,290
----------- ------------ ----------
Total operating costs 6,591,006 2,845,973 3,745,033
Income (loss) from operations (2,198,956) (2,845,973) 647,017
Interest expense, net (78,498) (42,690) (35,808)
----------- ------------ ----------
Income (loss) from operations before
income taxes $(2,277,454) $(2,888,663) $ 611,209
=========== =========== ==========
Revenue. In connection with its affiliation with the Affiliated
Practices, the Company entered into Service Agreements with the Affiliated
Practices. Pursuant to the terms of the service agreements, the Company, among
other things, provides facilities and management, administrative and development
services, and employs most non-medical personnel, in return for management
service fees. Such fees are payable monthly and consist of the following: (i)
27
service fees based on a percentage (the "Service Fee Percentage") ranging from
20%-33% of the Adjusted Pre-Tax Income of the Initial Affiliated Practices
related to professional services less amounts equal to certain clinic expenses
of the Affiliated Practices ("Clinic Expenses," as defined more fully in the
Service Agreements), not including physician owner compensation or most benefits
to physician owners) and (ii) amounts equal to Clinic Expenses. For the first
three years following affiliation, however, the portion of the service fees
described under clause (i) is a fixed dollar amount (the "Base Service Fee"),
which was generally calculated by applying the respective Service Fee Percentage
of Adjusted Pre-Tax Income for the predecessor to each Affiliated Practice for
the twelve months prior to affiliation. The Annual Base Service Fees for
Affiliated Practices, including the Single Physician Practices, is approximately
$10.0 million in the aggregate. In addition, with respect to its management of
certain facilities and ancillary services associated with certain of the Initial
Affiliated Practices, the Company receives fees ranging from 2% - 8% of net
revenue related to such facilities and services.
Significant factors that influence revenue of the Affiliated Practices
include the number of physicians, specialty and subspecialty mix, payor mix and
associated ancillary services. The Company plans to assist the Affiliated
Practices by providing management, capital and other resources required to
develop new services, to recruit additional physicians to its Affiliated
Practices and to secure managed care contracts.
For the period from November 12, 1996 (the date of the Initial
Affiliation Transactions) through December 31, 1996, management fee revenue
(including reimbursement of clinic expenses) was approximately $4.4 million.
Operating Expenses. The operating costs of the Company for the period
prior to November 12, 1996 reflect management salaries, business start-up
expenses and travel, legal and accounting costs associated with completing the
Initial Affiliation Transactions.
The expenses incurred by the Company subsequent to the Initial
Affiliation Transactions include the salaries, wages and benefits of personnel
(other than physician owners and certain technical medical personnel), supplies,
expenses involved in administering the clinical practices of the Initial
Affiliated Practices and general and administrative expenses, as well as
depreciation and amortization of assets, including assets acquired from the
Predecessor Practices. The Company will seek to reduce certain of these
operating expenses, as a percentage of net revenue, through purchase discounts,
economies of scale and standardization of best practices. In addition to the
operating costs and expenses discussed above, the Company has and will continue
to incur personnel and administrative expenses in connection with its corporate
offices, which provides management, administrative and development services to
the Affiliated Practices.
Income Taxes. The income tax benefit reflected in the Company's
statement of operations differs from amounts currently payable because certain
revenue and expenses are reported differently in the statement of operations
than they are for tax filing purposes. See "Liquidity and Capital Resources" for
additional information. The following table reconciles the federal statutory tax
rate to the Company's effective tax rate reflected in the statement of
operations:
Federal statutory income tax rate 34.0%
State income taxes, net of federal benefit 2.8%
Nondeductible business acquisition and other costs -11.5%
Miscellaneous -3.1%
------
Effective tax rate for the year ended December 31, 1996 22.2%
Liquidity and Capital Resources
During 1996, the Company financed its operations from private
placements of convertible debt and equity and from bank borrowings. The Company
received net proceeds from private placements of convertible subordinated debt
and equity in an aggregate amount of approximately $2.5 million. SCN utilized
bank borrowings under the credit facility described below (the "Credit
Facility") of approximately $1.7 million to effect the Initial Affiliation
Transactions. SCN utilized additional borrowings under the Credit Facility of
approximately $2.5 million to fund the purchase of accounts receivable generated
by the Initial Affiliated Practices in November 1996 and to fund borrowings
28
by certain affiliated physicians. In January 1997, SCN utilized additional
borrowings under the Credit Facility of approximately $1.4 million to purchase,
from the Initial Affiliated Practices, their December 1996 accounts receivable.
The Company has utilized cash flow from operations to purchase the Initial
Affiliated Practices' January and February accounts receivable.
In February and March 1997, the Company received net proceeds from its
initial public offering of approximately $22.5 million. Approximately $5.6
million of the proceeds were utilized to repay all outstanding borrowings under
the Credit Facility.
The Company has a $30.0 million Credit Facility, including a $25.0
million Acquisition Facility and $5.0 million Working Capital Facility, to be
used for acquisitions and general corporate purposes. However, the Company's
aggregate borrowings cannot exceed an established borrowing base, which is a
multiple of the Company's trailing twelve months cash flow, subject to certain
adjustments, less existing indebtedness. The minimum rates at which the Company
can borrow are the prime rate or LIBOR plus 1.75% on the Acquisition Facility
and the prime rate or LIBOR plus 1.50% on the Working Capital Facility. At March
21, 1997, the Company's borrowing base under the Credit Facility was $13.6
million. The Credit Facility is secured by substantially all of the assets of
the Company and contains several affirmative and negative covenants, including
covenants limiting the Company's ability to incur additional indebtedness and
limiting the Company's ability to, and restricting the terms upon which the
Company can, affiliate with physician practices in the future. The per annum
commitment fee on the unused portion of the Credit Facility is 0.25% on the
Acquisition Facility and 0.20% on the Working Capital Facility.
In connection with the Initial Affiliation Transactions, the Company
committed to enter into loan agreements with certain physician owners of the
Predecessor Practices for loans in an aggregate amount of up to approximately
$4.3 million. These loans are available until November 12, 1997 and the amount
that each physician may borrow is limited. Pursuant to loan agreements, as of
March 21, 1997, the Company had loaned approximately $1 million to certain
physician owners of the Initial Affiliated Practices to cover anticipated cash
flow needs of these physician owners. The loans bear interest at a floating rate
based on prime plus 1.25% and mature at the earlier of the date on which any
shares of Common Stock held by the physicians (i) are sold pursuant to a
registration statement filed with the Commission or (ii) may otherwise be sold
pursuant to Rule 144. The loans are secured by a portion of the Common Stock
owned by physicians.
Pursuant to separate agreements with two of the physician owners at
ROA, the Company has agreed to support the establishment of a sports medicine
center and a knee center. The Company has agreed to negotiate in good faith with
one physician owner to develop a plan for the sports medicine center by November
1997. The specifications relating to the development of the centers, including
the extent of capital commitments by the Company, have not been determined. The
development of the centers would be subject to regulatory approvals under
current law.
Pursuant to the Service Agreements with the Affiliated Practices, the
Company purchases, subject to adjustment, the accounts receivable of the
Affiliated Practices monthly in arrears and anticipates that it will have a
similar obligation under service agreements entered into in the future. The
Company expects to use working capital to fund its obligation to purchase,
subject to adjustment, the accounts receivable on an ongoing basis. No
adjustments will be made to reflect financing costs related to the carrying of
such receivables by the Company.
In connection with the Initial Affiliation Transactions, the Company
recorded aggregate federal and state deferred tax liabilities of approximately
$3.1 million. These liabilities are principally attributable to the assumption
by the Company of certain cash basis net assets of the Predecessor Practices and
will become payable over a four year period commencing in 1996. The resulting
cash payments to taxing authorities will exceed book income tax expense by
approximately $1.7 million in 1996. Based on current levels of operation, it is
anticipated that 1997 and 1998 cash payments to taxing authorities will exceed
income tax expense by approximately $600,000 and $500,000, respectively.
Additional acquisitions of practice assets will most likely increase the
estimate significantly.
The Company expects that capital expenditures during 1997 will relate
primarily to affiliations with additional practices, if any, to the expansion
and replacement of medical and office equipment for the Affiliated Practices and
to the purchase of office equipment for expansion of its corporate offices. The
Company expects the funding for these
29
expenditures to be derived from available funds, amounts borrowed under the
Credit Facility and cash flow from operations. Management believes that such
sources will be sufficient to fund the Company's operations at its current level
for at least the next twelve months. The Company anticipates that, in the
future, it will seek to raise additional funds through borrowings or the
issuance of debt or equity securities. There can be no assurance that sufficient
funds will be available on terms acceptable to the Company, if at all.
Item 8. Financial Statements and Supplementary Data
See pages F-1 through F-41 and page S-1 of this document.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
30
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information concerning each of
the executive officers and directors of the Company:
Name Age Position
---- --- --------
Richard H. Rothman, M.D., Ph.D........... 60 Chairman of the Board of Directors
Kerry R. Hicks........................... 38 President, Chief Executive Officer and Director
Patrick M. Jaeckle....................... 38 Executive Vice President of Finance/Development and
Director
William C. Behrens....................... 45 Executive Vice President of Practice Management and
Director
Robert E. Booth, Jr., M.D................ 54 Director
James L. Cain, M.D....................... 57 Director
Peter H. Cheesbrough..................... 45 Director
Richard E. Fleming, Jr., M.D............. 50 Director
Thomas C. Haney, M.D..................... 54 Director
Leslie S. Matthews, M.D.................. 45 Director
Mats Wahlstrom........................... 42 Director
D. Paul Davis............................ 39 Vice President of Finance/Controller
Peter A. Fatianow........................ 33 Vice President of Development
David G. Hicks........................... 39 Vice President of Management Information Systems
Timothy D. O'Hare........................ 43 Vice President, Payor Operations
Fran W. Hempstead........................ 44 Manager, Practice Operations
M. John Neal............................. 29 Manager, Finance and Development
Michael M. Nuzzo......................... 26 Manager, Payor Operations
Richard H. Rothman, M.D., Ph.D. has been Chairman of the Board of
Directors of the Company since December 1996. Since 1970, Dr. Rothman has been
Chairman of The Rothman Institute at Pennsylvania Hospital, and since 1986, he
has been Chairman of the Department of Orthopaedic Surgery at Thomas Jefferson
University. Dr. Rothman is Editor-in-Chief of The Journal of Arthroplasty, a
journal of joint replacement surgery. Dr. Rothman received a B.A. degree from
the University of Pennsylvania, an M.D. degree from the University of
Pennsylvania School of Medicine and a Ph.D. degree from Jefferson Medical
College.
31
Kerry R. Hicks, a founder of the Company, has served as President and
Chief Executive Officer and as a director of the Company since its inception.
From 1985 to March 1996, Mr. Hicks served as Senior Vice President of LBA Health
Care Management ("LBA"), a developer of health care and management information
services. LBA provided management consulting services (including orthopaedic
projects) to medical centers to support the purchasing, planning, marketing and
delivery of health care. Mr. Hicks was principally responsible for developing
LBA's orthopaedic product line and its information systems. LBA's orthopaedic
product line established quality and cost benchmarks and developed clinical
protocols and patient care algorithms intended to enhance both the quality and
effectiveness of the delivery of orthopaedic care.
Patrick M. Jaeckle, a founder of the Company, has served as Executive
Vice President of Finance/Development and as a director of the Company since its
inception. From February 1994 to March 1996, Dr. Jaeckle served as director of
health care corporate finance at Morgan Keegan & Company, Inc., a regional
investment banking firm. Prior to February 1994, Dr. Jaeckle was a member of the
health care investment banking groups at both Credit Suisse First Boston
Corporation (from June 1992 to February 1994) and Smith Barney, Inc. (from May
1991 to June 1992). Dr. Jaeckle holds an M.B.A. degree from Columbia Business
School, a D.D.S. degree from Baylor College of Dentistry and a B.A. degree from
The University of Texas at Austin.
William C. Behrens has been the Company's Executive Vice President of
Practice Management Service since he joined the Company in June 1996 and has
been a director of the Company since June 1996. From June 1992 to July 1996, he
served as Chief Executive Officer and President of The Hughston Sports Medicine
Foundation, a non-profit foundation focused on furthering orthopaedic clinical
studies. From 1984 to June 1992, Mr. Behrens served as Executive Administrator
for Knoxville Orthopaedic Center in Knoxville, Tennessee. In these positions,
Mr. Behrens participated in the development of medical office buildings,
out-patient surgery centers and services as well as diagnostic centers. Mr.
Behrens received his B.S. degree from Alderson-Broaddus College and a Masters
degree in Public Health & Administration from the University of South Carolina.
Robert E. Booth, Jr., M.D. has served as a director of the Company
since December 1996. Since 1977, Dr. Booth has been an orthopaedic surgeon at
The Rothman Institute at Pennsylvania Hospital and since 1990, he has been
Co-Chief of Orthopaedic Surgery at Pennsylvania Hospital. Dr. Booth received a
B.A. degree from Princeton University and an M.D. degree from the University of
Pennsylvania.
James L. Cain, M.D. has served as a director of the Company since
December 1996. Since 1976, Dr. Cain has been an orthopaedic surgeon at, and the
physician manager of, Vero Orthopaedics in Vero Beach, Florida. Dr. Cain
received a B.A. degree from Emory University and an M.D. degree from the Tulane
University School of Medicine.
Peter H. Cheesbrough has served as a director of the Company since
December 1996. Since June 1993, Mr. Cheesbrough has been the Senior Vice
President-Finance and Chief Finance Officer of Echo Bay Mines Ltd., a company
engaged in precious metals mining. From April 1988 to June 1993, he was Echo Bay
Mines' Vice President and Controller. Mr. Cheesbrough is a Fellow of the
Institute of Chartered Accountants of England and Wales and also a chartered
accountant in Canada.
Richard E. Fleming, Jr., M.D. has served as a director of the Company
since December 1996. Since 1979, Dr. Fleming has been an orthopaedic surgeon at
Princeton Orthopaedic Associates, P.A. Dr. Fleming received a B.A. degree from
Princeton University and an M.D. degree from Columbia University College of
Physicians and Surgeons.
Thomas C. Haney, M.D. has served as a director of the Company since
December 1996. Since 1973, Dr. Haney has been an orthopaedic surgeon at
Tallahassee Orthopedic Clinic, Inc. Dr. Haney received a B.A. degree from
Florida State University and an M.D. degree from Emory University School of
Medicine.
Leslie S. Matthews, M.D. has served as a director of the Company since
December 1996. Since October 1994, Dr. Matthews has been an orthopaedic surgeon
at Greater Chesapeake Orthopaedic Associates, LLC and since 1990, has been the
Chief of Orthopaedic Surgery at Union Memorial Hospital. From July 1982 to
October 1994, Dr. Matthews was also engaged in private practice. Dr. Matthews
received a B.A. degree from Johns Hopkins University and an M.D. degree from the
Baylor College of Medicine.
32
Mats Wahlstrom has served as a director of the Company since March
1997. Since the spring of 1991, Mr. Wahlstrom has been President of COBE
Laboratories, Inc., a company engaging in medical areas of cardiovascular
surgery, blood component technology and healthcare services and since June 1990
has been the Executive Vice President of GAMBRO AB, of which COBE Laboratories
is the U.S. subsidiary. From 1985 to 1993, Mr. Wahlstrom served as the Chief
Financial Officer of GAMBRO AB.
D. Paul Davis has served as Vice President of Finance/Controller of the
Company since March 1996. From January 1993 to March 1996, Mr. Davis served as
Vice President of Finance for Surgical Partners of America, Inc. From April 1987
to January 1993, he served as Chief Financial Officer for Anesthesia Service
Medical Group, Inc. Mr. Davis received a B.S. degree in Accounting from the
University of Utah. He is a certified public accountant.
Peter A. Fatianow has been Vice President of Development of the Company
since March 1996. From July 1994 to February 1996, Mr. Fatianow worked at Morgan
Keegan & Company, Inc., most recently as an Associate Vice President in health
care corporate finance. From July 1992 to July 1994, Mr. Fatianow was a member
of the health care investment banking group at Credit Suisse First Boston
Corporation in New York. Mr. Fatianow received a B.S. degree in Business
Management with an emphasis in Finance from Brigham Young University.
David G. Hicks has served as Vice President of Management Information
Systems of the Company since March 1996. From November 1994 to March 1996, Mr.
Hicks worked as Manager of Information Technology for the Association of
Operating Room Nurses, responsible for information technology maintenance and
development. From February 1993 to November 1994, he served as Manager of
Information Systems Administration for Coors Brewing Company, and from January
1982 to February 1993, Mr. Hicks served as Manager of Internal Systems for
Martin Marietta Data Systems. Mr. Hicks received a B.S. degree in Management
Information Systems from Colorado State University.
Timothy D. O'Hare joined the Company as Vice President, Payor
Operations in August 1996. From May 1994 to July 1996, Mr. O'Hare served as
Executive Director of Kaiser Foundation HealthPlan of North Carolina, where his
responsibilities included the negotiation of capitated and incentive contracts
with hospitals, physician hospital organizations and physician group practices.
From April 1987 to May 1994, Mr. O'Hare served as Vice President/Executive
Director of CIGNA Health Care of North Carolina. From March 1986 to April 1987,
Mr. O'Hare served as Vice President of Operations for a Preferred Health
Network. Mr. O'Hare received a B.S. degree from Virginia Polytechnic Institute
and State University and a Masters degree in Health Administration from Virginia
Commonwealth University.
Fran W. Hempstead has served as Manager of Practice Operations since
joining the Company in July 1996. Ms. Hempstead has over 16 years experience in
the operations aspects of an orthopaedic practice. From September 1988 to April
1996, Ms. Hempstead was employed in various capacities by The Hughston Clinic
P.C., an orthopaedic practice in Columbus, Georgia including as Chief Operating
Officer from June 1994 to April 1996 and as the Director of Operations from June
1992 to May 1994. She is currently on the Board of the Orthopaedic Practice
Assembly of the Medical Group Management Association. Ms. Hempstead received a
B.A. degree in Business Administration from the University of Georgia.
M. John Neal has served as Manager of Finance and Development of the
Company since March 1996. From July 1994 to March 1996, Mr. Neal worked as an
investment banking associate with Morgan Keegan & Company, Inc. Previously, Mr.
Neal served two years as a financial analyst for Service Merchandise, Inc. Mr.
Neal received a B.S. in Finance and an M.B.A. in Economics and Finance from the
University of Tennessee at Knoxville.
Michael M. Nuzzo has been Manager of Payor Operations of the Company
since July 1996. From June 1992 to July 1996, Mr. Nuzzo worked as an associate
with Medimetrix Group, Inc., a health care consulting company. Prior to joining
Medimetrix, Mr. Nuzzo received a B.A. degree from Kenyon College.
Drs. Cain, Fleming, Haney, Matthews and Rothman were elected to the
Board of Directors pursuant to the terms of a Stockholders Agreement among the
holders of the Company's outstanding Common Stock. Dr. Booth was
33
elected to the Board of Directors pursuant to an agreement between the Company
and Dr. Booth. The provisions of the agreements relating to election of these
persons to the Board of Directors are no longer in effect.
Kerry R. Hicks and David G. Hicks are brothers.
Item 11. Executive Compensation
Summary Compensation Table. The following table sets forth certain
information concerning the compensation paid by the Company to the Chief
Executive Officer of the Company during the fiscal year ended December 31, 1995
and the Chief Executive Officer and the four other most highly paid executive
officers (collectively, the "Named Executive Officers") during 1996. No
executive officer of the Company earned any salary or bonus for services
rendered during the year ended December 31, 1995.
Summary Compensation Table
Long Term
---------
Compensation
------------
Awards
Name and Principal Position Annual Compensation ------
- --------------------------- ------------------- Stock
Year Salary Bonus Options
---- ------ ----- ------------
Kerry R. Hicks
President and Chief Executive........................ 1996 $138,876 $140,625 75,000
1995 $ - $ - -
Patrick M. Jaeckle
Executive Vice President of Finance/Development....... 1996 $147,210 $140,625 75,000
William C. Behrens
Executive Vice President of Practice Management....... 1996 $ 83,516 $ 85,938 545,825
Peter A. Fatianow
Vice President of Development......................... 1996 $ 89,339 $ 67,500 30,000
D. Paul Davis
Vice President of Finance............................. 1996 $ 89,338 $ 67,500 30,000
34
Option Grants. The following table sets forth certain information
regarding stock options granted during 1996 to the Named Executive Officers.
Potential Realizable
Value at Assumed
Annual Rates of Stock
Option Grants in Last Fiscal Year Price Appreciation for
Individual Grants Option Term (1)
------------------------------------------------------------------------------------------- ----------------------
Number of Percent of
Securities Total Options
Underlying Granted to Exercise
Options Employees in Price Expiration
Name Granted(2) Fiscal Year Per Share(3) Date 5% 10%
- ---- ------- ----------- --------- ---- -- ---
Kerry R. Hicks............. 75,000 6.0% $8.00 12/4/2006 $377,337 $956,245
Patrick M. Jaeckle......... 75,000 6.0% $8.00 12/4/2006 $377,337 $956,245
William C. Behrens......... 500,000 40.1% $1.00 3/22/2006 $314,448 $796,871
45,825 3.7% $8.00 12/4/2006 $230,553 $584,266
D. Paul Davis.............. 30,000 2.4% $8.00 12/4/2006 $150,935 $382,498
Peter A. Fatianow.......... 30,000 2.4% $8.00 12/4/2006 $150,935 $382,498
- --------------------------------
(1) Based on the exercise price per share.
(2) The options vest in 20% increments on each of the first through fifth
anniversaries of the date of grant, except with respect to the option to
purchase 500,000 shares held by Mr. Behrens, which vests in 33% increments
on each of the first through third anniversaries of the date of grant.
(3) The options were initially granted at $6.00 per share. The exercise price
per share was later amended to $8.00, the initial public offering price per
share in the Company's initial public offering.
The following table sets forth certain information regarding stock options
held as of December 31, 1996 by the Named Executive Officers. None of the Named
Executive Officers exercised stock options during 1996.
Fiscal Year End Option Values
Number of Securities Underlying Value of Unexercised
Unexercised Options In-The-Money Options
at Fiscal Year End at Fiscal year-End ($)(1)
---------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
Kerry R. Hicks............................ 0 75,000 0 0
Patrick M. Jaeckle........................ 0 75,000 0 0
William C. Behrens........................ 0 545,825 0 $3,500,000
D. Paul Davis............................. 0 30,000 0 0
Peter A. Fatianow......................... 0 30,000 0 0
- -------------------
(1) There was no public trading market for the Common Stock as of December 31,
1996. These values have been calculated on the basis of $8.00 per share,
the initial public offering price per share of the Company's Common Stock
in its initial public offering, minus the applicable per share exercise
price.
35
Employment Agreements
The Company has employment agreements with each of Kerry R. Hicks and
Patrick M. Jaeckle dated as of April 1, 1996 and an employment agreement with
William Behrens dated as of March 11, 1996. Each agreement has an initial term
of five years and is renewable automatically for one year periods unless
terminated by one of the parties. The agreements provide for an annual salary
rate to each officer of $187,500 for 1996, $215,000 for 1997 and $250,000 for
1998, with cost of living increases for the years following 1998. In addition,
the agreements provide for annual incentive compensation to each officer equal
to up to 100% of his base salary based on performance targets established by the
Board of Directors, and on December 4, 1996, the Board of Directors approved
annual incentive compensation awards to Messrs. Hicks, Jaeckle and Behrens of
$140,625, $140,625 and $85,938, respectively. In the event that the officer is
terminated without cause and there has been no change of control of the Company,
the Company will pay such officer his base salary for the remaining term of the
agreement and any earned but unpaid salary and incentive compensation. In the
event the officer is terminated with cause, regardless of whether there has been
a change of control of the Company, the Company will pay such officer his base
salary for 60 days following such termination. If the officer is terminated
without cause upon a change of control of the Company, he is entitled to receive
a lump sum payment upon such termination equal to 300% of his base salary plus
300% of his annual incentive compensation for the prior year. Each agreement
contains certain confidentiality and non-competition covenants.
The Company has an employment agreement with Peter A. Fatianow dated as of
March 1, 1996 and an agreement with D. Paul Davis dated as of February 22, 1996.
Each agreement has an initial term of five years and is renewable automatically
for one year periods unless terminated by one of the parties. The agreements
provide for an annual salary rate to each officer of $108,000 for 1996, $125,000
for 1997 and $144,000 for 1998, with cost of living increases for the years
following the third year. In addition, the agreements provide for annual
incentive compensation to each officer equal to up to 75% of his base salary
based on performance targets established by the Board of Directors and on
December 4, 1996, the Board of Directors approved annual incentive compensation
awards to Mr. Fatianow in the amount of $67,500 and to Mr. Davis in the amount
of $64,125 (which was subsequently increased to $67,500). In the event that the
officer is terminated without cause and there has been no change of control of
the Company, the Company will pay such officer his base salary for the remaining
term of the agreement and any earned but unpaid salary and incentive
compensation. In the event the officer is terminated with cause, regardless of
whether there has been a change of control of the Company, the Company will pay
such officer his base salary for 60 days following such termination. If the
officer is terminated without cause upon a change of control of the Company, he
is entitled to receive a lump sum payment upon such termination equal to 300% of
his base salary plus 300% of his annual incentive compensation for the prior
year. Each agreement contains certain confidentiality and non-competition
covenants.
36
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of March 26, 1997, by (i)
each person known to the Company to own beneficially more than 5% of the
Company's Common Stock (including their address), (ii) each Named Executive
Officer of the Company, (iii) each director of the Company and (iv) all
directors and executive officers as a group.
Shares Beneficially Owned(1)
----------------------------
Name of Beneficial Owner Number Percent
- ------------------------------------------------- ------ -------
Richard H. Rothman, M.D., Ph.D. (2).............. 464,902 3.2%
Kerry R. Hicks (3)............................... 655,418 4.5
Patrick M. Jaeckle (4)........................... 605,418 4.1
William C. Behrens (5)........................... 243,311 1.6
Robert E. Booth, Jr., M.D........................ 549,300 3.7
James L. Cain, M.D............................... 132,721 *
Peter H. Cheesbrough............................. 0 *
Richard E. Fleming, Jr., M.D. (6)................ 158,454 1.1
Thomas C. Haney, M.D............................. 112,549 *
Leslie S. Matthews, M.D.......................... 295,088 2.0
Mats Wahlstrom................................... 0 *
D. Paul Davis.................................... 85,899 *
Peter A. Fatianow (7)............................ 71,236 *
Richard Balderston, M.D. (8)..................... 794,524 5.4
All directors and executive officers as a
group (18 persons) (9)........................ 3,555,306 24.2
* Less than one percent.
(1) Applicable percentage of ownership is based on 14,662,575 shares of Common
Stock outstanding on March 26, 1997. Beneficial ownership is determined in
accordance with the rules of the Commission and includes voting or
investment power with respect to securities. Shares of Common Stock
issuable upon the exercise of stock options currently exercisable or
convertible, or exercisable or convertible within 60 days of March 26, 1997
are deemed outstanding and to be beneficially owned by the person holding
such option for purposes of computing such person's percentage ownership,
but are not deemed outstanding for the purpose of computing the percentage
ownership of any other person. Except for shares held jointly with a
person's spouse or subject to applicable community property laws, or as
indicated in the footnotes to this table, each stockholder identified in
the table possesses sole voting and investment power with respect to all
shares of Common Stock shown as beneficially owned by such stockholder.
37
(2) Does not include 200,000 shares of Common Stock held in the Richard H.
Rothman 1996 "SCN" Annuity Trust dated November 26, 1996 and 3,000 shares
of Common Stock held by each of the U/I/T of Richard H. Rothman dated
September 5, 1995 f/b/o Daniel Sheerr Kapp and the U/I/T of Richard H.
Rothman dated September 5, 1995 f/b/o Samuel Rothman Kapp, with respect to
which Dr. Rothman disclaims beneficial ownership. Dr. Rothman's business
address is 800 Spruce Street, Philadelphia, Pennsylvania 19107.
(3) Includes 60,000 shares of Common Stock held in the Linda Wratten Trust,
20,000 shares of Common Stock in each of the Frank Nemick III Trust, the
William Nemick Trust and the Jeanette Baysinger Trust, 10,000 shares of
Common Stock in each of the Frank Nemick, Jr. Trust, the Julie Nemick Trust
and The David G. Hicks Irrevocable Children's Trust. Does not include
60,000 shares of Common Stock held by The Hicks Family Irrevocable Trust,
for which shares Mr. Hicks disclaims beneficial ownership.
(4) Does not include 100,000 shares of Common Stock held by The Patrick M.
Jaeckle Family Irrevocable Children's Trust, for which shares Mr. Jaeckle
disclaims beneficial ownership.
(5) Includes options to purchase 166,666 shares of Common Stock.
(6) Includes 20,382 shares and 5,095 shares of Common Stock held by the Fleming
Charitable Remainder Unitrust and the Fleming Family Foundation,
respectively. Does not include 2,547 shares of Common Stock held by each of
the Irrevocable Trust FBO M. Fleming and the Irrevocable Trust FBO A.
Fleming, respectively, for which Dr. Fleming disclaims beneficial
ownership.
(7) Does not include 15,000 shares of Common Stock held by the Fatianow Family
Irrevocable Children's Trust, for which shares Mr. Fatianow disclaims
beneficial ownership.
(8) Does not include 10,000 shares of Common Stock held by The David G. Hicks
Irrevocable Children's Trust, for which shares Mr. Hicks disclaims
beneficial ownership.
(9) Dr. Balderston's business address is 800 Spruce Street, Philadelphia,
Pennsylvania 19107.
(10) Includes options to purchase 183,333 shares of Common Stock.
Item 13. Certain Relationships and Related Transactions
During 1996, various executive officers, directors and principal
stockholders have participated in the Company's debt and equity financings.
These financings included the following.
From January 1, 1996 through July 1, 1996, the Company sold 5% convertible
debentures in the aggregate principal amount of $1,870,000. On November 12,
1996, the convertible debentures, along with the accrued interest thereon, were
converted into 1,920,332 shares of Common Stock at a rate of one share of Common
Stock for each $1.00 of indebtedness. The securities were issued to certain
executive officers of the Company as follows: Kerry R. Hicks and Patrick M.
Jaeckle each converted $200,000 of convertible debentures and $5,418 in accrued
interest into 205,418 shares of Common Stock, William C. Behrens converted
$75,000 of convertible debentures and $1,645 in accrued interest into 76,645
shares of Common Stock, Peter A. Fatianow converted $35,000 in convertible
debentures and $1,236 of accrued interest into 36,236 shares of Common Stock and
D. Paul Davis converted $35,000 of convertible debentures and $899 in accrued
interest into 35,899 shares of Common Stock. In addition, securities were issued
to certain non-employee directors of the Company as follows: Richard H. Rothman,
M.D., Ph.D. and Richard Balderston, M.D. each converted $233,333 of convertible
debentures and $7,085 in accrued interest into 240,418 shares of Common Stock
and Robert E. Booth, Jr., M.D. converted $83,333 of convertible debentures and
$3,483 in accrued interest into 86,816 shares of Common Stock.
On October 1, 1996, the Company sold to GCOA 5% convertible debentures in
the aggregate principal amount of $300,000. On November 12, 1996, the
convertible debentures, along with the accrued interest thereon of $1,707, was
converted into 100,569 shares of Common Stock at a rate of one share of Common
Stock for each $3.00 in indebtedness. Leslie S. Matthews, M.D., a director of
the Company, is a physician owner of GCOA.
On November 4, 1996, the Company sold to TOC 100,000 shares of Common
Stock for an aggregate purchase price of $300,000. Thomas C. Haney, M.D., a
director of the Company, is a physician owner of TOC.
38
On November 12, 1996, pursuant to the Initial Affiliation Transactions,
the Company entered into agreements with each of the Predecessor Practices
pursuant to which the Company merged with or acquired stock or certain assets of
the Predecessor Practices. The Company also assumed certain liabilities of the
Predecessor Practices, including obligations under acquired contracts (including
facilities leases and vendor or supplier contracts). In connection with the
Initial Affiliation Transactions, the Company issued shares of Common Stock to
the physician owners of the Initial Affiliated Practices. The specific issuances
of Company securities in each of the Initial Affiliation Transactions is
described below.
The Company entered into an Asset Exchange Agreement with GCOA and the
individual physicians who are owners of GCOA, including Leslie S. Matthews,
M.D., a director of the Company. Pursuant to the terms of the agreement, the
Company purchased certain assets of GCOA and assumed certain liabilities
relating to those assets. Pursuant to the terms of the agreement, the Company
issued 1,568,922 shares of its Common Stock, valued at $6 per share, including
280,721 shares to Dr. Matthews. The Company also entered into a Service
Agreement with GCOA and its physician owners. The Company leases the facilities
utilized by GCOA from an entity of which Dr. Matthews is a partial owner, for an
aggregate annual lease payment of approximately $300,000. Payments by the
Company under the lease in 1996 totaled $23,687.
The Company entered into a Stock Exchange Agreement with the individual
physicians who are members of POA, including Richard E. Fleming, Jr., M.D., a
director of the Company. Pursuant to the terms of the agreement, the Company
purchased all of the outstanding shares of the predecessor of POA. The Company
issued 1,196,793 shares of Common Stock, valued at $6 per share, including
132,977 shares issued to Dr. Fleming. The Company also entered into a Service
Agreement with POA and its physician owners. The Company leases the facilities
utilized by POA from an entity of which Dr. Fleming is a partial owner, for an
aggregate annual lease payment of approximately $1.3 million. Payments by the
Company under the lease in 1996 totaled $228,384.
The Company entered into a Merger Agreement with a predecessor of ROA
whose physicians included Richard H. Rothman, M.D., Ph.D., the Chairman of the
Board of Directors of the Company and Robert E. Booth, Jr., M.D., a director of
the Company, pursuant to which the predecessor of ROA merged with and into
Company, with the Company surviving the merger. Pursuant to the terms of the
agreement, the outstanding shares of common stock of the predecessor of ROA were
converted into 3,169,379 shares of Common Stock, valued at $6 per share, and
$1,388,000 in cash was paid to two former shareholders of the predecessor of
ROA. In addition, $149,872 was paid by the Company in satisfaction of
outstanding indebtedness of the predecessor of ROA. The Company issued 462,484
shares of Common Stock and approximately $694,000 in cash to Dr. Rothman, and
462,484 shares of Common Stock and approximately $694,000 in cash to Dr. Booth.
The Company also entered into a Service Agreement with ROA and its physician
owners. The Company leases the facilities utilized by ROA from an entity of
which Drs. Rothman and Booth are partial owners, for an aggregate annual lease
payment of approximately $160,000. Payments by the Company under the lease in
1996 totaled $31,987.
The Company entered into a Merger Agreement with a predecessor of TOC,
pursuant to which the predecessor of TOC merged with and into Company, with the
Company surviving the Merger. Pursuant to the terms of the agreement, the
outstanding shares of common stock of the predecessor of TOC were converted into
an aggregate of 1,072,414 shares of Common Stock, valued at $6 per share,
including 103,202 shares issued to Thomas C. Haney, M.D., a director of the
Company. The Company also entered into a Service Agreement with TOC and its
physician owners. The Company leases the facilities utilized by TOC from an
entity of which Dr. Haney is a partial owner, for an aggregate annual lease
payment of approximately $500,000. The Company made no payments under the lease
in 1996.
The Company entered into a Merger Agreement with a predecessor of VO,
pursuant to which the predecessor of VO merged with and into Company, with the
Company surviving the merger. Pursuant to the terms of the agreement, the
outstanding shares of common stock of the predecessor of VO were converted into
an aggregate of 651,607 shares of Common Stock, valued at $6 per share,
including 103,410 shares issued to James L. Cain, M.D., a director of the
Company. In addition, pursuant to the terms of the agreement, one medical
employee of the predecessor of VO was granted an option to purchase 50,000
shares of Common Stock at an exercise price of $6 per share. The Company also
entered into a Service Agreement with VO and its physician owners. The Company
leases, on a month-to-month basis,
39
certain of the facilities utilized by VO from an entity of which Dr. Cain is a
partial owner, for an aggregate monthly lease payment of approximately $9,000.
Payments by the Company under the lease in 1996 totaled $18,082.
For a description of the terms of the Service Agreements, see "Item 1--
Business--Contractual Agreements with Affiliated Practices."
In connection with the Initial Affiliation Transactions, the Company has
committed to enter into loan agreements with certain physician owners of the
Predecessor Practices for loans in an aggregate amount of up to approximately
$4.3 million. These loans are available until November 12, 1997 and the amount
that each physician may borrow is limited. See "Item 7 --Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Speciality Care Network, Inc.--Liquidity and Capital Resources."
40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements.
The financial statements listed in the accompanying Index to Financial
Statements and Financial Statement Schedules at page F-1 are filed as part of
this Form 10-K.
2. Financial Statement Schedules.
The following financial statement schedule is filed as part of this Form
10-K:
Schedule II-Valuation and Qualifying Accounts.
All other schedules have been omitted because they are not applicable, or
not required, or the information is shown in the Financial Statements or notes
thereto.
3. Exhibits.
The following is a list of exhibits filed as part of this annual report on
Form 10-K. Where so indicated by footnote, exhibits which were previously filed
are incorporated by reference. For exhibits incorporated by reference, the
location of the exhibit in the previous filing is indicated in parentheses.
Exhibit
Number Description
- ------ -----------
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1*+ Specialty Care Network, Inc. 1996 Equity Compensation Plan
10.2*+ Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock Option Plan
10.3*+ Employment Agreement dated as of April 1, 1996 by and between Specialty Care
Network, Inc. and Kerry R. Hicks
10.4*+ Employment Agreement dated as of April 1, 1996 by and between Specialty Care
Network, Inc. and Patrick M. Jaeckle
10.5*+ Employment Agreement dated as of March 11, 1996 by and between Specialty Care
Network, Inc. and William Behrens
10.6*+ Employment Agreement dated as of February 22, 1996 by and between Specialty Care
Network, Inc. and Paul Davis
10.7*+ Employment Agreement dated as of March 1, 1996 by and between Specialty Care
Network, Inc. and Peter A. Fatianow
10.8*+ Employment Agreement dated as of March 1, 1996 by and between Specialty Care
Network, Inc. and David Hicks
10.9* Merger Agreement dated November 12, 1996 by and among Specialty Care Network,
Inc. and Reconstructive Orthopaedic Associates, Inc.
10.10* Service Agreement dated as of November 12, 1996 by and between Specialty Care
Network, Inc., Reconstructive Orthopaedic Associates II, P.C. and Richard H. Rothman,
M.D., Robert E. Booth, Jr., M.D., Richard Balderston, M.D., Arthur R. Bartolozzi, M.D.,
William J. Hozack, M.D., Michael G. Ciccotti, M.D., Todd J. Albert, M.D., Alexander R.
Vaccaro, M.D. and Peter F. Sharkey, M.D.
10.11* Letter agreement dated October 29, 1996 by and between Arthur R. Bartolozzi, M.D. and
Specialty Care Network, Inc
41
Exhibit
Number Description
- ------ -----------
10.12* Letter agreement dated October 29, 1996 by and between Robert E. Booth, Jr., M.D. and
Specialty Care Network, Inc.
10.13* Letter agreement dated October 29, 1996 by and between Richard H. Rothman, M.D. and
Specialty Care Network, Inc.
10.14* Stock Exchange Agreement dated October 21, 1996 by and among Specialty Care
Network, Inc. and Michael N. Jolley, M.D., Harvey E. Smires, M.D., Robert N. Dunn,
M.D., Jeffrey S. Abrams, M.D., Richard E. Fleming, Jr., M.D., W. Thomas Gutowski,
M.D., Steven R. Gecha, M.D., C. Alexander Moskwa, Jr., M.D. and David M. Smith,
M.D.
10.15* Service Agreement dated as of November 1, 1996 by and among Specialty Care Network,
Inc., SCN of Princeton, Inc., Princeton Orthopedic Associates, II, P.A. and Michael N.
Jolley, M.D., Harvey E. Smires, M.D., Robert N. Dunn, M.D., Jeffrey S. Abrams, M.D.,
Richard E. Fleming, Jr., M.D., W. Thomas Gutowski, M.D., Steven R. Gecha, M.D., C.
Alexander Moskwa, Jr., M.D. and David M. Smith, M.D.
10.16* Merger Agreement dated November 12, 1996 by and among Specialty Care Network,
Inc. and TOC Services, Inc.
10.17* Service Agreement dated as of November 12, 1996 by and among TOC Specialists, P.L.
(d/b/a Tallahassee Orthopedic Clinic) TOC Services, Inc. (f/k/a Tallahassee Orthopedic
Clinic, P.A.) and Greg A. Alexander, M.D., David C. Berg, M.D., Richard E. Blackburn,
M.D., Donald Dewey, M.D., Mark E. Fahey, M.D., Tom C. Haney, M.D., William D.
Henderson, Jr., M.D., Steve E. Jordan, M.D., J. Rick Lyon, M.D., Kris D. Stowers, M.D.,
Robert L. Thornberry, M.D., Billy C. Weinstein, M.D. and Charles H. Wingo, M.D.
10.18* Asset Exchange Agreement dated as of November 12, 1996 by and among Specialty Care
Network, Inc., Greater Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller,
M.D., Leslie S. Matthews, M.D., Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Mark S.
Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon, M.D.
10.19* Service Agreement dated as of November 12, 1996 by and among Specialty Care
Network, Inc., Greater Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller,
M.D., Leslie S. Matthews, M.D., Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Mark S.
Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon, M.D.
10.20* Merger Agreement dated November 12, 1996 by and among Specialty Care Network,
Inc. and Vero Orthopaedic, Inc.
10.21* Service Agreement dated as of November 12, 1996 by and among Specialty Care
Network, Inc., Vero Orthopaedics II, P.A. and James L. Cain, M.D., David W. Griffin,
M.D., George K. Nichols, M.D., Peter G. Wernicki, M.D. and Charlene Wilson, M.D.
10.22* Revolving Loan and Security Agreement dated as of November 1, 1996 among Specialty
Care Network, Inc., SCN of Princeton, Inc., NationsBank of Tennessee N.A. and
NationsBank of Tennessee, N.A. as Agent
10.23* Merger Agreement dated December 6, 1996 by and among Specialty Care Network, Inc.,
Riyaz H. Jinnah, M.D., P.A. and Riyaz H. Jinnah, M.D.
10.24* Merger Agreement dated December 6, 1996 by and among Specialty Care Network, Inc.,
Floyd Jaeggers, M.D., P.C. and Floyd Jaeggers, M.D.
10.25* Merger Agreement dated December 6, 1996 by and among Specialty Care Network, Inc.,
Medical Rehabilitation Specialists, P.A. and Kirk J. Mauro, M.D.
10.26* Term Sheet by and among Reconstructive Orthopaedic Associates II, P.C., Specialty Care
Network, Inc., Robert E. Booth, Jr., M.D. and Arthur R. Bartolozzi, M.D.
10.27* Amendment to the Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock
Option Plan
10.28** Merger Agreement dated March 24, 1997 by and between Specialty Care Network, Inc.
and Orthopaedic and Sports Medicine, P.A.
11** Statement re: computation of per share earnings
21* Subsidiary of the Company
42
27** Financial Data Schedule
- --------------------
* Incorporated by reference to the Company's Registration Statement on Form
S-1 (File No. 333-17627).
** Filed herewith.
+ Constitutes management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of
the period covered by this report.
43
SIGNATURE
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.
SPECIALTY CARE NETWORK, INC.
Date: March 31, 1997 By /s/ Kerry R. Hicks
----------------------------------
Kerry R. Hicks
President and Chief Executive 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.
Name Title Date
---- ----- ----
/s/ Richard H. Rothman Chairman of the Board of Directors March 31, 1997
- -------------------------------
Richard H. Rothman, M.D., Ph.D.
/s/ Kerry R. Hicks President and Chief Executive Officer March 31, 1997
- ------------------------------- (Principal Executive Officer)
Kerry R. Hicks
/s/ Patrick M. Jaeckle Executive Vice President of March 31, 1997
- ------------------------------- Finance/Development (Principal Financial
Patrick M. Jaeckle Officer)
/s/ D. Paul Davis Vice President of Finance/Controller March 31, 1997
- ------------------------------- (Principal Accounting Officer)
D. Paul Davis
/s/ William C. Behrens Executive Vice President of Practice March 31, 1997
- ------------------------------- Management and Director
William C. Behrens
Director March __, 1997
- -------------------------------
Robert E. Booth, Jr., M.D.
/s/ James L. Cain Director March 28, 1997
- -------------------------------
James L. Cain, M.D.
/s/ Peter H. Cheesbrough Director March 31, 1997
- -------------------------------
Peter H. Cheesbrough
/s/ Richard E. Fleming, Jr. Director March 31, 1997
- -------------------------------
Richard E. Fleming, Jr., M.D.
/s/ Thomas C. Haney Director March 31, 1997
- -------------------------------
Thomas C. Haney, M.D.
Director March __, 1997
- -------------------------------
Leslie S. Matthews, M.D.
Director March __, 1997
- -------------------------------
Mats Wahlstrom
44
Exhibit
Number Description
- ------ -----------
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1*+ Specialty Care Network, Inc. 1996 Equity Compensation Plan
10.2*+ Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock Option Plan
10.3*+ Employment Agreement dated as of April 1, 1996 by and between Specialty Care
Network, Inc. and Kerry R. Hicks
10.4*+ Employment Agreement dated as of April 1, 1996 by and between Specialty Care
Network, Inc. and Patrick M. Jaeckle
10.5*+ Employment Agreement dated as of March 11, 1996 by and between Specialty Care
Network, Inc. and William Behrens
10.6*+ Employment Agreement dated as of February 22, 1996 by and between Specialty Care
Network, Inc. and Paul Davis
10.7*+ Employment Agreement dated as of March 1, 1996 by and between Specialty Care
Network, Inc. and Peter A. Fatianow
10.8*+ Employment Agreement dated as of March 1, 1996 by and between Specialty Care
Network, Inc. and David Hicks
10.9* Merger Agreement dated November 12, 1996 by and among Specialty Care Network,
Inc. and Reconstructive Orthopaedic Associates, Inc.
10.10* Service Agreement dated as of November 12, 1996 by and between Specialty Care
Network, Inc., Reconstructive Orthopaedic Associates II, P.C. and Richard H. Rothman,
M.D., Robert E. Booth, Jr., M.D., Richard Balderston, M.D., Arthur R. Bartolozzi, M.D.,
William J. Hozack, M.D., Michael G. Ciccotti, M.D., Todd J. Albert, M.D., Alexander R.
Vaccaro, M.D. and Peter F. Sharkey, M.D.
10.11* Letter agreement dated October 29, 1996 by and between Arthur R. Bartolozzi, M.D. and
Specialty Care Network, Inc.
10.12* Letter agreement dated October 29, 1996 by and between Robert E. Booth, Jr., M.D. and
Specialty Care Network, Inc.
10.13* Letter agreement dated October 29, 1996 by and between Richard H. Rothman, M.D. and
Specialty Care Network, Inc.
10.14* Stock Exchange Agreement dated October 21, 1996 by and among Specialty Care
Network, Inc. and Michael N. Jolley, M.D., Harvey E. Smires, M.D., Robert N. Dunn,
M.D., Jeffrey S. Abrams, M.D., Richard E. Fleming, Jr., M.D., W. Thomas Gutowski,
M.D., Steven R. Gecha, M.D., C. Alexander Moskwa, Jr., M.D. and David M. Smith,
M.D.
10.15* Service Agreement dated as of November 1, 1996 by and among Specialty Care Network,
Inc., SCN of Princeton, Inc., Princeton Orthopedic Associates, II, P.A. and Michael N.
Jolley, M.D., Harvey E. Smires, M.D., Robert N. Dunn, M.D., Jeffrey S. Abrams, M.D.,
Richard E. Fleming, Jr., M.D., W. Thomas Gutowski, M.D., Steven R. Gecha, M.D., C.
Alexander Moskwa, Jr., M.D. and David M. Smith, M.D.
10.16* Merger Agreement dated November 12, 1996 by and among Specialty Care Network,
Inc. and TOC Services, Inc.
10.17* Service Agreement dated as of November 12, 1996 by and among TOC Specialists, P.L.
(d/b/a Tallahassee Orthopedic Clinic) TOC Services, Inc. (f/k/a Tallahassee Orthopedic
Clinic, P.A.) and Greg A. Alexander, M.D., David C. Berg, M.D., Richard E. Blackburn,
M.D., Donald Dewey, M.D., Mark E. Fahey, M.D., Tom C. Haney, M.D., William D.
Henderson, Jr., M.D., Steve E. Jordan, M.D., J. Rick Lyon, M.D., Kris D. Stowers, M.D.,
Robert L. Thornberry, M.D., Billy C. Weinstein, M.D. and Charles H. Wingo, M.D.
45
Exhibit
Number Description
- ------ -----------
10.18* Asset Exchange Agreement dated as of November 12, 1996 by and among Specialty Care
Network, Inc., Greater Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller,
M.D., Leslie S. Matthews, M.D., Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Mark S.
Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon, M.D.
10.19* Service Agreement dated as of November 12, 1996 by and among Specialty Care
Network, Inc., Greater Chesapeake Orthopaedic Associates, L.L.C., Stuart D. Miller,
M.D., Leslie S. Matthews, M.D., Paul L. Asdourian, M.D., Frank R. Ebert, M.D., Mark S.
Myerson, M.D., John B. O'Donnell, M.D. and Lew C. Schon, M.D.
10.20* Merger Agreement dated November 12, 1996 by and among Specialty Care Network,
Inc. and Vero Orthopaedic, Inc.
10.21* Service Agreement dated as of November 12, 1996 by and among Specialty Care
Network, Inc., Vero Orthopaedics II, P.A. and James L. Cain, M.D., David W. Griffin,
M.D., George K. Nichols, M.D., Peter G. Wernicki, M.D. and Charlene Wilson, M.D.
10.22* Revolving Loan and Security Agreement dated as of November 1, 1996 among Specialty
Care Network, Inc., SCN of Princeton, Inc., NationsBank of Tennessee N.A. and
NationsBank of Tennessee, N.A. as Agent
10.23* Merger Agreement dated December 6, 1996 by and among Specialty Care Network, Inc.,
Riyaz H. Jinnah, M.D., P.A. and Riyaz H. Jinnah, M.D.
10.24* Merger Agreement dated December 6, 1996 by and among Specialty Care Network, Inc.,
Floyd Jaeggers, M.D., P.C. and Floyd Jaeggers, M.D.
10.25* Merger Agreement dated December 6, 1996 by and among Specialty Care Network, Inc.,
Medical Rehabilitation Specialists, P.A. and Kirk J. Mauro, M.D.
10.26* Term Sheet by and among Reconstructive Orthopaedic Associates II, P.C., Specialty Care
Network, Inc., Robert E. Booth, Jr., M.D. and Arthur R. Bartolozzi, M.D.
10.27*+ Amendment to the Specialty Care Network, Inc. 1996 Incentive and Non-Qualified Stock
Option Plan
10.28** Merger Agreement dated March 24, 1997 by and between Specialty Care Network, Inc.
and Orthopaedic and Sports Medicine, P.A.
11** Statement re: computation of per share earnings
21* Subsidiary of the Company
27** Financial Data Schedule
- --------------------
* Incorporated by reference to the Company's Registration Statement on
Form S-1 (File No. 333-17627).
** Filed herewith.
+ Constitutes management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form.
46
INDEX TO FINANCIAL STATEMENTS
Specialty Care Network, Inc. and Subsidiary:
Report of Independent Auditors........................................................................F-2
Consolidated Balance Sheets ..........................................................................F-3
Consolidated Statements of Operations ................................................................F-4
Consolidated Statements of Stockholders' Equity ......................................................F-5
Consolidated Statements of Cash Flows ................................................................F-6
Notes to Consolidated Financial Statements ...........................................................F-8
Reconstructive Orthopaedic Associates II, P.C. (successor to Reconstructive Orthopaedic Associates, Inc.):
Report of Independent Auditors .......................................................................F-26
Balance Sheets .......................................................................................F-27
Statements of Operations .............................................................................F-28
Statements of Stockholders' Equity ...................................................................F-29
Statements of Cash Flows .............................................................................F-30
Notes to Financial Statements ........................................................................F-32
F-1
Report of Independent Auditors
Board of Directors and Stockholders
Specialty Care Network, Inc.
We have audited the accompanying consolidated balance sheets of Specialty Care
Network, Inc. and subsidiary (collectively the "Company") as of December 31,
1996 and 1995, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year ended December 31, 1996 and
the period from December 22, 1995 (date of incorporation) through December 31,
1995. Our audits also included the financial statement schedule listed in the
Index at Item 14(a). These financial statements and the schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Specialty Care
Network, Inc. and subsidiary at December 31, 1996 and 1995, and the consolidated
results of their operations and their cash flows for the year ended December 31,
1996 and the period from December 22, 1995 (date of incorporation) through
December 31, 1995, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
---------------------
Ernst & Young LLP
Denver, Colorado
March 21, 1997
F-2
Specialty Care Network, Inc. and Subsidiary
Consolidated Balance Sheets
December 31
1996 1995
-------------------------------
Assets
Cash $ 1,444,007 $11,100
Accounts receivable, net 13,090,440 -
Loans to physician stockholders 976,419 -
Prepaid expenses and inventories 285,218 -
-------------------------------
Total current assets 15,796,084 11,100
Property and equipment, net 1,889,070 -
Intangible assets, net of accumulated amortization
of $22,130 in 1996 193,906 29,584
Prepaid offering costs 747,847 -
Other assets 58,483 -
-------------------------------
Total assets $18,685,390 $40,684
===============================
Liabilities and stockholders' equity
Current portion of capital lease obligations $ 140,151 $ -
Accounts payable 416,282 -
Accrued payroll, incentive compensation and related
expenses 1,065,881 -
Accrued expenses 879,619 29,584
Income taxes payable 1,229,275 -
Advances from officers and stockholders - 9,410
Due to affiliated physician practices 3,759,322 -
Deferred income taxes 667,830 -
-------------------------------
Total current liabilities 8,158,360 38,994
Line-of-credit 4,177,681 -
Capital lease obligations, less current portion 964,769 -
Deferred income taxes 679,713 -
-------------------------------
Total liabilities 13,980,523 38,994
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value, 2,000,000
shares authorized, no shares issued or outstanding - -
Common stock, $0.001 par value, 50,000,000
shares authorized, 11,045,015 and
1,690,000 shares issued and outstanding in 1996
and 1995, respectively 11,045 1,690
Additional paid-in capital 6,465,205 -
Accumulated deficit (1,771,383) -
-------------------------------
Total stockholders' equity 4,704,867 1,690
-------------------------------
Total liabilities and stockholders' equity $18,685,390 $40,684
===============================
See accompanying notes.
F-3
Specialty Care Network, Inc. and Subsidiary
Consolidated Statements of Operations
Period from
December 22,
1995 (date of
incorporation)
Year ended through
December 31, December 31,
1996 1995
----------------------------------
Management fee revenue, including reimbursement
of clinic expenses $ 4,392,050 $ -
Costs and expenses:
Clinic expenses 2,820,743 -
Salaries, wages and benefits 1,917,891
General and administrative expenses 1,096,665 -
Costs to evaluate and acquire physician practices 597,361 -
Depreciation and amortization 158,346 -
Interest expense, net of $11,870 of interest
income in 1996 78,498 -
----------------------------------
6,669,504 -
----------------------------------
Loss before income taxes (2,277,454) -
Income tax benefit 506,071 -
----------------------------------
Net loss $(1,771,383) $ -
==================================
Net loss per common share $ (0.15) -
==================================
Weighted average number of common shares and
common share equivalents used in computation 12,026,347 $ -
==================================
See accompanying notes.
F-4
Specialty Care Network, Inc. and Subsidiary
Consolidated Statements of Stockholders' Equity
Period from December 22, 1995 (date of
incorporation) through December 31, 1995 and
year ended December 31, 1996
Preferred Stock Common Stock
$0.001 Par Value $0.001 Par Value Additional
------------------------------------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
------------------------------------------------------------------------------------------------
Balance at December 22, 1995 - $ - - $ - $ - $ - $ -
Shares issued in
connection with a
private placement - - 1,690,000 1,690 - - 1,690
memorandum
------------------------------------------------------------------------------------------------
Balance at December 31, 1995 - - 1,690,000 1,690 - - 1,690
Purchase and retirement of
common stock in
connection with a - - (425,000) (425) - - (425)
severance agreement
Shares issued to one of
the affiliated physician - - 100,000 100 299,900 - 300,000
practices
Convertible debt and
accrued interest thereon
converted to common - - 2,020,900 2,021 2,220,018 - 2,222,039
shares
Shares issued in
connection with the
acquisitions of net
assets of affiliated - - 7,659,115 7,659 5,483,159 - 5,490,818
physician practices
Dividends paid to physician
owners as promoters - - - - (1,537,872) - (1,537,872)
Net loss - - - - - (1,771,383) (1,771,383)
------------------------------------------------------------------------------------------------
Balance at December 31, 1996 - $ - 11,045,015 $11,045 $6,465,205 $(1,771,383) $4,704,867
================================================================================================
See accompanying notes.
F-5
Specialty Care Network, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Period from
December 22,
1995 (date of
incorporation)
Year ended through
December 31, December 31,
1996 1995
-----------------------------------
Operating activities
Net loss $ (1,771,383) $ -
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization 158,346 -
Interest on convertible debentures 52,039
Deferred income tax benefit (1,735,346) -
Changes in operating assets and liabilities, net
of the effects of the non-cash acquisitions of
net assets of affiliated physician practices:
Accounts receivable (4,738,455) -
Prepaid expenses and inventories and other
assets (204,911) -
Accounts payable 49,764 29,584
Accrued payroll, incentive compensation
and related expenses 982,982 -
Accrued expenses 850,035 -
Income taxes payable 1,229,275 -
Due to affiliated physician practices 3,759,322 -
-----------------------------------
Net cash (used in) provided by operating activities (1,368,332) 29,584
Investing activities
Purchases of property and equipment (354,595) -
Increases in intangible assets (186,452) (29,584)
-----------------------------------
Net cash used in investing activities (541,047) (29,584)
Financing activities
Proceeds from line-of-credit agreement 4,177,681 -
Proceeds from convertible debentures 2,170,000 -
Principal repayments on capital lease obligations (33,422) -
Initial capital contributions - 1,690
Retirement of common stock (425) -
Capital contribution from one physician practice 300,000 -
Prepaid offering costs (747,847) -
F-6
Specialty Care Network, Inc. and Subsidiary
Consolidated Statement of Cash Flows
Period from
December 22,
1995 (date of
incorporation)
Year ended through
December 31, December 31,
1996 1995
-----------------------------------
Financing activities (continued)
Dividends paid to promoters $ (1,537,872) $ -
Advances from officers and stockholders (9,410) 9,410
Loans to physician stockholders (976,419) -
-----------------------------------
Net cash provided by financing activities 3,342,286 11,100
-----------------------------------
Net increase in cash 1,432,907 11,100
Cash at beginning of period 11,100 -
-----------------------------------
Cash at end of period $ 1,444,007 $11,100
===================================
Supplemental cash flow information
Interest paid $ 38,329 $ -
-----------------------------------
Supplemental schedule of noncash investing
and financing activities
Effects of the acquisitions of net assets of
Affiliated physician practices: $10,761,466 $ -
Assets acquired (2,187,759) -
Liabilities assumed (3,082,889) -
-----------------------------------
Income tax liabilities assumed $ 5,490,818 $ -
===================================
Conversion of convertible debentures and accrued
interest thereon into common stock $ 2,222,039 $ -
===================================
F-7
See accompanying notes.
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 1996
1. Description of Business
Specialty Care Network, Inc. and subsidiary (collectively the "Company") is a
physician practice management company focusing exclusively on musculoskeletal
disease-state management. Specialty Care Network, Inc. was incorporated on
December 22, 1995. Commencing on November 12, 1996, the Company began providing
comprehensive management services under long-term management service agreements
with five physician practices in various states. The Company also manages an
outpatient surgery center and Magnetic Resonance Imaging unit in Princeton, New
Jersey, and Tallahassee, Florida, respectively. See Note 11 for further details
of the underlying long-term service arrangements with physician practices.
The accompanying consolidated financial statements reflect the Company's
activity during its start-up and organizational phase, and its acquisitions of
substantially all of the assets and certain liabilities of the five physician
practices (hereinafter referred to as the "Predecessor Practices") and
affiliation with the successors to the Predecessor Practices (such transactions
hereinafter collectively referred to as the "Initial Affiliation Transactions").
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include Specialty Care Network, Inc. and
its wholly-owned subsidiary, SCN of Princeton, Inc. All significant intercompany
balances and transactions have been eliminated in consolidation.
Principles of Acquisition Accounting
The accompanying financial statements give effect to the Predecessor Practice
acquisitions at their historical cost basis in accordance with the accounting
treatment prescribed by Securities and Exchange Commission Staff Accounting
Bulletin No. 48, Transfers of Nonmonetary Assets by Promoters or Shareholders.
The Company anticipates that future acquisitions will be afforded the purchase
method of accounting treatment.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and footnotes. Although
these estimates are
F-8
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
based on management's knowledge of current events and actions they may undertake
in the future, actual results could differ from those estimates.
Revenue Recognition and Accounts Receivable
Management fee revenue is recognized based upon the contractual arrangements of
the underlying long-term service agreements between the Company and the
successor to the individual Predecessor Practice. See Note 11 for further
discussion of such contractual arrangements, including certain guaranteed
minimum management fees.
Accounts receivable represents amounts due from patients and other independent
third parties for medical services provided by the affiliated physician
practices and management fee revenue earned by the Company. Accounts receivable
generated by the affiliated physician practices, which are acquired by the
Company on a monthly basis at the estimated net fair value thereof, are recorded
net of contractual allowances and estimated doubtful accounts.
Net Loss Per Common Share
Net loss per common share is based upon the weighted average number of common
and common equivalent shares outstanding during the period. Primary and fully
diluted earnings per share are the same. Pursuant to Securities and Exchange
Commission Staff Accounting Bulletins and staff policy, common and common share
equivalents issued during the 12-month period prior to the Company's initial
public offering at prices below the public offering price are presumed to have
been issued in contemplation of the public offering, even if antidilutive, and
have been included in the calculation as if these common and common equivalent
shares were outstanding for the entire period presented (using the treasury
stock method and the initial public offering price of $8.00 per share for the
Company's common stock).
The Company used a portion of the proceeds from the initial public offering of
its common stock to repay borrowings under the Company's Revolving Loan and
Security Agreement. If shares issued to repay amounts outstanding under the
Company's Revolving Loan and Security Agreement were outstanding for the year
ended December 31, 1996, the net loss per common share would not have changed
from the amount reported.
F-9
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings per Share ("FASB No. 128"). The
statement, which applies to entities with publicly held common stock, simplifies
the standards for computing earnings per share previously found in Accounting
Principles Board Opinion No. 15, Earnings per Share, and makes such computation
comparable to international earnings per share standards. FASB No. 128 is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods; earlier adoption is not permitted. The
statement requires restatement of all prior period earnings per share data
presented in the period of adoption. Management is currently reviewing the
provisions of SFAS No. 128; however, it does not believe that adoption of this
new accounting pronouncement will have a material impact on the calculation and
presentation of earnings per share.
Financial Instruments
The carrying amounts of financial instruments as reported in the accompanying
balance sheets approximate their fair value primarily due to the short-term
nature of such financial instruments.
Prepaid Offering Costs
Prepaid offering costs of $747,847, which primarily relate to legal and
accounting services, will be used to reduce the proceeds from the Company's
initial public offering of its common stock.
Property and Equipment
Property and equipment are stated at cost, including assets acquired from the
Predecessor Practices. Equipment held under capital leases is stated at the
present value of minimum lease payments at inception of the related lease. Costs
of repairs and maintenance are expensed as incurred. Depreciation is computed
using the straight-line method over the estimated useful lives of the underlying
assets. Amortization of capital lease assets and leasehold improvements are
computed using the straight-line method over the shorter of
F-10
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
the lease term or the estimated useful lives of the underlying assets. The
estimated useful lives used are as follows:
Computer equipment and software 3-5 years
Furniture and fixtures 5-7 years
Leasehold improvements 5 years
Intangible Assets
Intangible assets, which are stated at cost, primarily consist of deferred debt
issuance costs ($186,452) and organization costs ($29,584) that are being
amortized on a straight-line basis over two- and three-year periods,
respectively.
The Company periodically reviews its intangible assets to assess recoverability,
and impairments would be recognized in the statement of operations if a
permanent impairment were determined to have occurred. Recoverability of
intangibles is determined based on undiscounted future operating cash flows from
the related business unit or activity. The amount of impairment, if any, is
measured based on discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of intangible assets will be affected if estimated future
operating cash flows are not achieved. No impairment charge was recognized by
the Company for the year ended December 31, 1996.
Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements under the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB No. 25"). In 1995, Financial Accounting Standards
Board Statement No. 123, Accounting for Stock-Based Compensation ("FASB No.
123"), was issued, whereby companies may elect to account for stock-based
compensation using a fair value based method or continue measuring compensation
expense using the intrinsic value method prescribed in APB No. 25. FASB No. 123
requires that companies electing to continue to use the intrinsic value method
make pro forma disclosure of net income and net income per share as if the fair
value based method of accounting had been applied.
The fair value for options awarded during the year ended December 31, 1996 was
estimated at the date of grant using an option pricing model with the following
weighted-average assumptions for 1996: risk-free interest rate over the life of
the option of 6.0%;
F-11
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
no dividend yield; and expected two to eight year lives of the options. The
estimated fair value for these options was calculated using the minimum value
method and may not be indicative of the future impact since this model does not
take into consideration volatility and the commencement of public trading in the
Company's common stock on February 7, 1997.
The pro forma effects of adopting FASB No. 123's fair value based method for the
year ended December 31, 1996 were not materially different from the
corresponding APB No. 25 intrinsic value methodology because the options granted
in 1996 were primarily issued near year end and, accordingly, pro forma
stock-based compensation in 1996 is substantially less than would result from a
full year's compensation expense amortization. The effects of applying FASB No.
123 during 1996 are not likely to be representative of the effects on pro forma
net income for future years because the vesting of options will cause additional
incremental expense to be recognized in future periods. Additionally, the
Financial Accounting Standards Board has added to its agenda a project regarding
certain APB No. 25 issues, including such things as incorporating the FASB No.
123 grant date definition into APB No. 25, readdressing the criteria under
broad-based plans qualifying for noncompensatory accounting and defining what
constitutes employees. The resolution of these issues could result in
modification in the Company's accounting for stock-based compensation
arrangements.
Estimated Malpractice Professional Liability Claims
The Company and its affiliated physician practices are insured with respect to
medical malpractice risks on either an occurrence-rate or a claims-made basis.
Management is not aware of any claims against it or its affiliated physician
practices which might have a material impact on the Company's financial position
or results of operations.
3. Accounts Receivable and Management Fee Revenue
Accounts receivable at December 31, 1996 consist of the following:
Gross patient accounts receivable purchased
from the affiliated physician practices $25,564,645
Less allowance for contractual adjustments
and doubtful accounts 15,719,542
-----------
9,845,103
Management fees, including reimbursement of
clinic expenses 3,245,337
-----------
$13,090,440
===========
F-12
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
3. Accounts Receivable and Management Fee Revenue (continued)
Management fee revenue earned for the period November 12, 1996 through December
31, 1996, exclusive of reimbursed clinic expenses, approximated $1.57 million.
Of such amount, only one of successors to the Predecessor Practices exceeded 20%
of the 1996 total. Assuming that the acquisitions of the Predecessor Practices
and the Initial Affiliation Transactions occurred on January 1, 1996, management
estimates that the aggregate management fee revenue for the year ended December
31, 1996, exclusive of reimbursed clinic expenses, would have been approximately
$9.5 million.
An integral component of the computation of management fee earned by the Company
is net patient revenue of the affiliated physician practices. The affiliated
physician practices recognize net patient revenue for medical services at
established rates reduced by allowances for doubtful accounts and contractual
adjustments. Contractual adjustments arise due to the terms of certain
reimbursement and managed care contracts. Such adjustments represent the
difference between charges at established rates and estimated recoverable
amounts and are recognized by the affiliated physician practice in the period
the services are rendered. Any differences between estimated contractual
adjustments and actual final settlements under reimbursement contracts are
reported as contractual adjustments in the year the final settlements are made.
Net patient revenue is not recognized as revenue in the accompanying financial
statements.
The Company's affiliated physician practices derived approximately 22.6% of
their net revenue from services provided under the Medicare program for the year
ended December 31, 1996. Other than the Medicare program, the physician groups
have no customers that represent more than 10% of aggregate net clinic revenue
or 5% of accounts receivable at December 31, 1996. Accordingly, concentration of
credit risk related to patient accounts receivable is limited by the diversity
and number of providers, patients and payors.
4. Property and Equipment
Property and equipment at December 31, 1996 consist of the following:
Furniture and fixtures $2,639,418
Computer equipment and software 1,110,657
Leasehold improvements and other 381,271
----------
4,131,346
Accumulated depreciation and amortization 2,242,276
----------
Net property and equipment $1,889,070
==========
F-13
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
5. Property and Equipment (continued)
Included in the above are assets recorded under capital leases which consist of
the following:
Furniture and fixtures $1,372,557
Computer equipment 145,661
----------
1,518,218
Accumulated amortization 882,846
----------
Net assets under capital leases $ 635,372
==========
Pursuant to its corporate expansion, the Company had furniture and fixture
purchase commitments and building improvement contractual arrangements
aggregating approximately $202,000 at December 31, 1996.
6. Convertible Debentures and Line-of-Credit
Convertible Debentures
In connection with two private placements, the Company raised $2.17 million of
short-term unsecured convertible debt. The proceeds thereof were utilized to
fund the Company's start-up and its organizational phase until certain net
assets of the Predecessor Practices were acquired on November 12, 1996.
Contemporaneous with the acquisitions of the Predecessor Practices, the holders
of the debentures converted the unpaid principal amounts plus any accrued
interest thereon (calculated at 5.0%), into the Company's common stock at the
conversion ratio of $1.00 ($1,920,332) and $3.00 ($301,707) of debenture
principal and accrued interest for one share of common stock. The following
table summarizes the conversions:
Accrued
Principal Interest Total
------------------------------------------------
Stockholders of the Company $ 640,000 $18,153 $ 658,153
Physician practices and
related stockholders 1,530,000 33,886 1,563,886
------------------------------------------------
$2,170,000 $52,039 $2,222,039
================================================
F-14
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
6. Convertible Debentures and Line-of-Credit (continued)
Line-of-Credit
At December 31, 1996, the Company had approximately $4.2 million outstanding
under its Revolving Loan and Security Agreement. See Note 11 for a discussion of
the terms, conditions and related activity of this credit facility.
7. Common Stock
At December 31, 1996, 1,180,000 and 85,000 shares of certain outstanding
nontransferable common stock were held by current employees and former
employees, respectively. Pursuant to the common stock subscription agreements
and a related Stockholders Agreement, executed by the Company and its employees,
all unvested shares became vested as a result of the initial public offering of
the Company's common stock.
During the year ended December 31, 1996, the Company issued an additional
100,000 shares of common stock to one of the Predecessor Practices at $3.00 per
share.
Pursuant to the Revolving Loan and Security Agreement between the Company and a
bank, the Company is prohibited from paying any dividends without written
approval from the bank.
On February 6, 1997, the Company's initial public offering of its common stock
became effective. In connection therewith, three million shares of common stock
were issued at $8.00 per share. On March 4, 1997 the underwriters executed their
overallotment option to purchase an additional 208,338 common shares for an
aggregate amount of approximately $1.5 million, net of underwriting discounts.
The following table provides a condensed balance sheet at December 31, 1996 and
an unaudited pro forma condensed balance sheet at such date assuming the
effectuation of the initial public offering and the underwriters' overallotment
option, and the repayment of all amounts then outstanding under the Revolving
Loan and Security Agreement.
F-15
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
7. Common Stock (continued)
(Unaudited)
Historical Pro Forma
December 31, December 31,
1996 1996
---------------------------------
Current assets $15,796,084 $34,671,667
Long-term assets 2,889,306 2,141,459
---------------------------------
Total assets $18,685,390 $36,813,126
=================================
Current and long-term liabilities $13,980,523 $ 9,574,911
Common stock 11,045 14,253
Additional paid-in capital 6,465,205 28,995,345
Accumulated deficit (1,771,383) (1,771,383)
---------------------------------
Total stockholders' equity 4,704,867 27,238,215
---------------------------------
Total liabilities and stockholders' equity $18,685,390 $36,813,126
=================================
8. Stock Option Plans
On March 22, 1996, the Company adopted the 1996 Incentive and Non-Qualified
Stock Option Plan (the "Plan") pursuant to which nontransferable options to
purchase up to five million shares of common stock of the Company were available
for award to eligible directors, officers, advisors, consultants and key
employees. On January 10, 1997, the Board of Directors voted to terminate the
Plan. The exercise price for incentive stock options awarded during the year
ended December 31, 1996 was not less than the fair market value of each share at
the date of the grant and the options granted thereunder were for a period of
ten years. Options, which are generally contingent on continued employment with
the Company, may be exercised only in accordance with a vesting schedule
established by the Company's Board of Directors. Of the 553,500 grants approved
during the year ended December 31, 1996 at an exercise price of $1.00 per share,
3,500 of the options were exercisable at such date, and no options were
forfeited or expired during the year then ended.
F-16
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
8. Stock Option Plans (continued)
On October 15, 1996, the Company's Board of Directors approved the 1996 Equity
Compensation Plan (the "Equity Plan"), which provides for the granting of
options to purchase up to two million shares of the Company's common stock..
Both incentive stock options and non-qualified stock options may be issued under
the provisions of the Equity Plan. Employees of the Company and any future
subsidiaries, members of the Board of Directors and certain key advisors are
eligible to participate in this plan, which will terminate no later than October
14, 2006. The granting and vesting of options under the Equity Plan are provided
by the Company's Board of Directors or a committee of the Board of Directors.
During the year ended December 31, 1996, the Company's Board of Directors
approved grants under the Equity Plan for both incentive and non-qualified
options exercisable for 1,205,248 of common shares at exercise prices ranging
from $6.00 per share to $8.00 per share. None of such options under the Equity
Plan were exercisable at December 31, 1996.
Weighted-
Average
Weighted- Exercise
Average Price of
Shares Remaining Options
Option Price Under Contract Currently
Range Option Life Exercisable
- -------------------------------------------------------------------------------------------------------------
Options generally vesting over three years $1.00 553,500 9.22 $1.00
Options generally vesting over three years $6.00 130,000 9.93 -
Options generally vesting over five years $6.00-$8.00 866,069 9.93 -
Options generally vesting over periods
not to exceed eight years $6.00 209,179 9.93 -
---------
Total 1,758,748 9.71 $1.00
=========
The weighted average exercise prices for stock options granted during the year
and stock options outstanding at December 31, 1996 was approximately $5.25 per
share. Subsequent to December 31, 1996, the Company's Board of Directors
approved the award of additional options under the Equity Plan, exercisable for
160,000 common shares at an exercise price of $10.00 per share.
F-17
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
9. Leases
The Company is obligated under operating and capital lease agreements for
offices and certain equipment. In some circumstances, these lease arrangements
are with entities owned or controlled by physician stockholders. Future minimum
payments under noncancelable capital and operating leases with lease terms in
excess of one year are summarized as follows for the years ending December 31:
Capital Operating
Leases Leases
-------------------------------
1997 $ 268,998 $ 2,507,026
1998 264,432 2,557,536
1999 258,987 2,451,284
2000 248,175 2,348,943
2001 195,909 2,260,893
Thereafter 187,200 15,375,978
-------------------------------
Total minimum lease payments 1,423,701 $27,501,660
===========
Less amount representing interest 318,781
-----------
Present value of net minimum lease payments 1,104,920
Less current portion 140,151
-----------
Long-term portion $ 964,769
===========
Rent expense for the year ended December 31, 1996 under all operating leases was
approximately $400,000.
10. Income Taxes
The Company is a corporation subject to federal and certain state and local
income taxes. The provision for income taxes is made pursuant to the liability
method as prescribed in Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes. The liability method requires recognition of
deferred income taxes based on temporary differences between the financial
reporting and income tax bases of assets and liabilities, using currently
enacted income tax rates and regulations.
F-18
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
10. Income Taxes (continued)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities at December 31, 1996 are as
follows:
Deferred tax assets:
Deferred start-up expenditures $ 796,949
Property and equipment, net 236,481
Vacation pay 35,497
----------
1,068,927
----------
Deferred tax liabilities:
Net cash basis assets assumed
in the Initial Affiliation Transactions 2,346,434
Prepaid expenses 70,036
----------
2,416,470
----------
Net deferred tax liability $1,347,543
==========
The income tax expense (benefit) for the year ended December 31, 1996 is
summarized as follows:
Current:
Federal $ 971,192
State 258,083
----------
1,229,275
Deferred:
Federal (1,362,954)
State (372,392)
----------
(1,735,346)
----------
Total $ (506,071)
==========
The income tax benefit differs from amounts currently payable because certain
revenue and expenses are reported in the statement of operations in periods that
differ from those in which they are subject to taxation. The principal
differences relate to business acquisition and start-up expenditures that are
capitalized for income tax purposes and expensed for financial statement
purposes, and the amortization of certain cash basis net assets included into
taxable income in periods subsequent to the Initial Affiliation Transactions.
F-19
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
10. Income Taxes (continued)
A reconciliation between the statutory federal income tax rate of 34% and the
Company's 22.2% effective tax rate for the year ended December 31, 1996 is as
follows:
Federal statutory income tax rate 34.0%
State income taxes, net of federal benefit 2.8
Nondeductible business acquisition and other costs (11.5)
Miscellaneous (3.1)
-----
Effective tax rate for the year ended
December 31, 1996 22.2%
=====
11. Physician Practice Acquisitions
The Company expended approximately $597,000 during the year ended December 31,
1996 to evaluate the acquisition of substantially all the assets and certain
liabilities of physician practices. Effective November 12, 1996, the Company
acquired substantially all of the assets, including accounts receivable and
fixed assets, and certain liabilities, including current trade payables, accrued
expenses and certain capital lease obligations, of the five Predecessor
Practices. The physician owners, functioning as promoters, effectively
contributed these assets and liabilities in exchange for an aggregate of
7,659,115 shares of common stock of the Company and $1,537,872 in cash. Upon
closing, the Company, under signed agreements, assumed all risks of ownership
related to these net assets. The following table summarizes certain financial
information related to this transaction for the five Predecessor Practices:
Common Stock Cash
Consideration Consideration
Paid by the Paid by the
Company Company
-----------------------------------
(Shares)
Reconstructive Orthopaedic Associates, Inc. 3,169,379 $1,537,872
Princeton Orthopaedic Associates, P.A. 1,196,793 -
Tallahassee Orthopedic Clinic, P.A. 1,072,414 -
Greater Chesapeake Orthopaedic Associates, LLC 1,568,922 -
Vero Orthopaedics, P.A. 651,607 (1) -
(1) Excludes non-qualified stock options to purchase an additional 50,000 shares
of the Company's common stock at $6.00 per share, which fully vest on November
12, 1998.
F-20
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
11. Physician Practice Acquisitions (continued)
On November 1, 1996, the Company entered into a $30 million Revolving Loan and
Security Agreement with a bank, which provided certain amounts necessary to
effectuate the aforementioned acquisition transactions. Outstanding amounts
thereunder, which are subject to limitations based on an established borrowing
base, are secured by a first collateral interest on substantially all of the
assets owned by the Company or thereafter acquired. The Company can elect to
borrow at a floating rate based on the prime lending rate plus an applicable
margin or at a fixed rate based on LIBOR plus an applicable margin (at December
31, 1996, the effective interest rate was 7.23% per annum). Culminating on
February 18, 1997, the Company used a portion of the proceeds from its initial
public offering to repay the then outstanding balance of its line-of-credit
indebtedness; however, the agreement generally remains in effect through
October, 31 1998. Contemporaneous with the acquisitions of the Predecessor
Practices, the Company also extended lines of credit aggregating approximately
$4.3 million to the former stockholders of certain physician practices. Such
lines of credit will remain in effect through November 12, 1997. Advances
thereunder, which aggregated approximately $976,400 at December 31, 1996 and
March 21, 1997, respectively, bear interest at the prime lending rate plus l.25%
and are collateralized by 203,420 shares of the Company's common stock owned by
the individual physicians.
Concurrent with the acquisitions, the successors to the Predecessor Practices
(the "Initial Affiliated Practices") simultaneously entered into long-term
service agreements (the "Initial Service Agreements") with the Company. Pursuant
to the terms of the service agreements, the Company, among other things,
provides facilities and management, administrative and development services, in
return for service fees. Such fees are payable monthly and consist of the
following: (i) service fees based on a percentage ranging from 20%-33% of the
adjusted pre-tax income of the Initial Affiliated Practices (generally defined
as revenue of the Initial Affiliated Practices related to professional services
less amounts equal to certain clinic expenses but not including physician owner
compensation or most benefits to physician owners) plus (ii) reimbursement of
certain clinic expenses. For the first three years following affiliation,
however, the portion of the service fees described under clause (i) is specified
to be the greater of the amount payable as described under clause (i) above or a
fixed dollar amount (the "Base Service Fee"), which was generally calculated by
applying the respective service fee percentage of adjusted pre-tax income of the
Predecessor Practices for the twelve months prior to affiliation. The aggregate
annual Base Service Fee for all of the Initial Affiliated Practices is
approximately $9.5 million. In addition, with respect to its management of
certain facilities and ancillary services associated with certain of the Initial
Affiliated Practices, the Company receives fees ranging from 2%-8% of net
revenue.
F-21
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
11. Physician Practice Acquisitions (continued)
The Company has entered into an agreement with one of the physician groups and
two of the physicians at that group pursuant to which there will be a division
of the physician group. The agreement provides that an independent physician
practice will be formed by the two aforementioned physicians and the new
practice will enter into a service agreement with the Company on substantially
the same proportionate terms as the current arrangement with the existing
physician practice. Accordingly, modifications to the existing service agreement
will be made to reflect a corresponding reduction in the service fee obligations
and commitments. If certain base service fee deficit conditions are in evidence,
the Company will annually forgive up to $120,000 of its management service fees.
Additionally, through July 15, 1997, one of the physicians maintains the right
to receive common stock options from the Company at a strike price as set forth
in the underlying agreement if the new physician practice elects to increase its
annual Base Service Fee amount. The agreement provides for proportional
adjustments in the arrangements if one of the two physicians does not join, or
leaves, the new independent practice.
The Initial Service Agreements have terms of forty years, with automatic
extensions (unless specified notice is given) of additional five-year terms. An
Initial Service Agreement may be terminated by either party if the other party
(i) files a petition in bankruptcy or other similar events occur or (ii)
defaults on the performance of a material duty or obligation, which default
continues for a specified term after notice. In addition, the Company may
terminate the agreement if the Initial Affiliated Practice's Medicare or
Medicaid number is terminated or suspended as a result of some act or omission
of the Initial Affiliated Practice or the physicians, and the Initial Affiliated
Practice may terminate the agreement if the Company misapplies funds or assets
or violates certain laws.
Upon termination of an Initial Service Agreement by the Company for one of the
reasons set forth above, the Company has the option to require the Initial
Affiliated Practice to purchase and assume the assets and liabilities related to
the Initial Affiliated Practice at the fair market value thereof. In addition,
upon termination of an Initial Service Agreement by the Company during the first
five years of the term, the physician owners of the Initial Affiliated Practice
are required to pay the Company or return to the Company an amount of cash or
stock of the Company equal to one-third of the total consideration received by
such physicians in connection with the Company's affiliation with the practice.
F-22
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
11. Physician Practice Acquisitions (continued)
Under the Initial Service Agreements, each physician owner must give the Company
twelve months notice of an intent to retire from the Initial Affiliated
Practice. If a physician gives such notice during the first five years of the
agreement, the physician must also locate a replacement physician or physicians
acceptable to a Joint Policy Board and pay the Company an amount based on a
formula relating to any loss of service fee for the first five years of the
term. Furthermore, the physician must pay the Company an amount of cash or stock
of the Company equal to one-third of the total consideration received by such
physician in connection with the Company's affiliation with the practice. The
agreement also provides that after the fifth year no more than 20% of the
physician owners at an Initial Affiliated Practice may retire within a one-year
period.
The Initial Affiliated Practices and the physician owners of the Initial
Affiliated Practices generally agree not to compete with the Company in
providing services similar to those provided by the Company under the Initial
Service Agreements, and the physician owners also generally agree with the
Company not to compete with an Initial Affiliated Practice within a specified
geographic area.
Non-competition restrictions generally apply to physician owners during their
affiliation with the Initial Affiliated Practices and for three years
thereafter. In addition, the Initial Service Agreements require the Initial
Affiliated Practices to enter into non-competition agreements with all
physicians in the Initial Affiliated Practice, of which agreements the Company
will be a third party beneficiary. After the fifth year of the term of the
Initial Service Agreement, physician owners of the Initial Affiliated Practices
may be released from the non-competition provisions upon payment of certain
amounts to the Company, which may be paid in the form of common stock. The
Initial Service Agreements generally require the Initial Affiliated Practices to
pursue enforcement of the non-competition agreement with physicians or assign to
the Company the right to pursue enforcement.
F-23
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
12. Commitments and Contingencies
The Company has entered into employment agreements that provide key executives
and employees with minimum base pay, annual incentive awards and other fringe
benefits. The Company expenses all costs related thereto in the period that the
services are rendered by the employee. In the event of death, disability,
termination with or without cause, voluntary employee termination, change in
ownership of the Company, etc., the Company may be partially or wholly relieved
of its financial obligations to such individuals. However, under certain
circumstances, a change in control of the Company may provide significant and
immediate enhanced compensation to the employees possessing employment
contracts. At December 31, 1996, the Company was contractually obligated for the
following base pay compensation amounts (summarized by years ending December
31):
1997 $1,302,625
1998 1,492,750
1999 1,551,000
2000 1,551,000
2001 469,333
----------
$6,366,708
==========
The Company established a $50,000 irrevocable letter of credit in favor of one
of its vendors. Such letter of credit expired on February 3, 1997 but was
subsequently renewed. The letter of credit will generally continue to exist as
the Company continues to maintain its relationship with such vendor. The letter
of credit is secured by a $50,000 savings account, which is included in other
long-term assets in the accompanying financial statements.
Pursuant to certain agreements with two physicians at one of the affiliated
physician practices, the Company has agreed to support the establishment of a
sports medicine center and a knee center. If the Company and one of the
physicians have not agreed to a plan for development of the sports medicine
center by November, 1997, the physician may terminate the service agreement as
it pertains to him. The specifications relating to the development of the
centers, including the extent of capital commitments by the Company, have not
yet been determined.
F-24
Specialty Care Network, Inc. and Subsidiary
Notes to Consolidated Financial Statements (continued)
12. Commitments and Contingencies (continued)
On January 8, 1997, the Company was sued by Michael A. Feiertag, M.D. (a former
physician at Vero Orthopaedics, P.A.) for alleged breach of his employment
agreement. Dr. Feiertag is seeking damages in excess of $500,000. The Company
filed an answer to the complaint denying liability and intends to vigorously
contest the action. On February 3, 1997, the Company initiated proceedings to
have the case removed to the United States District Court for the Southern
District of Florida. The Company believes that the ultimate resolution of the
case will not have a material adverse effect on the Company's financial
statements.
13. Subsequent Events
In March 1997, the Company acquired, through merger, substantially all of the
assets and certain liabilities of three single physician practices in Florida,
Maryland and Georgia. The aggregate consideration paid was 409,222 common shares
of the Company. In connection therewith, the physician practices entered into
service agreements with terms that were substantially identical to those
contained in the Initial Service Agreements discussed in Note 11. The service
fee percentages of adjusted pre-tax income included in these new service
agreements range from 25%-33% with an aggregate annual minimum Base Service Fee
amount of approximately $526,000.
In March 1997, the Company entered into a definitive agreement to affiliate with
a physician practice in Annapolis, Maryland. The Company has agreed to acquire
substantially all of the assets and certain liabilities of the physician
practice for an aggregate consideration of approximately $8.1 million, which
will include consideration consisting of cash and Company securities. This
transaction will be afforded the purchase method of accounting treatment.
Consummation of the transaction is subject to certain conditions, including the
Company's completion of, and satisfaction with, its review of the practice.
F-25
Report of Independent Auditors
Board of Directors
Reconstructive Orthopaedic Associates II, P.C.
We have audited the accompanying balance sheets of Reconstructive Orthopaedic
Associates II, P.C. (successor to Reconstructive Orthopaedic Associates, Inc.)
as of December 31, 1996 and 1995, and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Reconstructive Orthopaedic
Associates II, P.C. (successor to Reconstructive Orthopaedic Associates, Inc.)
as of December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
-------------------------------
Ernst & Young LLP
Denver, Colorado
March 13, 1997
F-26
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Balance Sheet
December 31
1996 1995
----------- -----------
(See Note 2)
Assets
Current assets:
Cash and cash equivalents $ 52,031 $ 246,203
Accounts receivable, net -- 4,288,456
Inventories -- 19,100
Due from Thomas Jefferson University 303,600 --
Due from Specialty Care Network, Inc. 1,314,462 --
Prepaid expenses -- 122,793
----------- -----------
Total current assets 1,670,093 4,676,552
Furniture, fixtures and equipment, net -- 617,053
Other assets 25,714 18,972
----------- -----------
Total assets $ 1,695,807 $ 5,312,577
=========== ===========
Liabilities and stockholders' equity
Current liabilities:
Short-term borrowings $ -- $ 570,000
Accounts payable 170,746 271,333
Accrued compensation and benefits -- 81,924
Accrued profit sharing contribution -- 245,819
Due to Thomas Jefferson University 39,674 --
Due to Specialty Care Network, Inc. 850,498 --
Other accrued expenses -- 2,863
----------- -----------
Total current liabilities 1,060,918 1,171,939
Commitments and contingencies
Stockholders' equity:
Common stock, $1 par value in 1996 and 1995:
Authorized and outstanding shares - 1,110 in
1996 and 1,000 in 1995 1,110 1,000
Retained earnings 434,685 4,164,651
Additional paid in capital 199,094 --
Treasury stock -- (25,013)
----------- -----------
Total stockholders' equity 634,889 4,140,638
----------- -----------
Total liabilities and stockholders' equity $ 1,695,807 $ 5,312,577
=========== ===========
See accompanying notes.
F-27
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Statements of Operations
Year ended December 31
1996 1995 1994
------------ ------------ ------------
(See Note 2)
Net patient revenue $ 16,802,665 $ 16,906,641 $ 13,325,350
Other revenue 1,006,600 643,266 --
------------ ------------ ------------
Total revenue 17,809,265 17,549,907 13,325,350
Operating expenses:
Physician compensation 10,187,408 9,288,516 7,711,380
Salaries and benefits 3,057,694 3,874,636 3,288,766
Supplies, general and
administrative expenses 3,970,963 2,792,588 2,066,795
Depreciation 114,339 133,450 124,304
Management fee to Specialty
Care Network, Inc. 1,453,874 -- --
------------ ------------ ------------
Total operating expenses 18,784,278 16,089,190 13,191,245
------------ ------------ ------------
(Loss) income from operations (975,013) 1,460,717 134,105
Interest expense (13,333) (555) (5,302)
------------ ------------ ------------
Net (loss) income $ (988,346) $ 1,460,162 $ 128,803
============ ============ ============
See accompanying notes.
F-28
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Statements of Stockholders' Equity
Number Additional
of Common Retained Paid in Treasury
Shares Stock Earnings Capital Stock Total
------ ------ ----------- -------- --------- -----------
(See Note 2)
Balance, January 1, 1994 1,000 $1,000 $ 2,695,686 $ -- $ (25,013) $ 2,671,673
Net income -- -- 128,803 -- -- 128,803
Dividends paid -- -- (80,000) -- -- (80,000)
------ ------ ----------- -------- --------- -----------
Balance, December 31, 1994 1,000 1,000 2,744,489 -- (25,013) 2,720,476
Net income -- -- 1,460,162 -- -- 1,460,162
Dividends paid -- -- (40,000) -- -- (40,000)
------ ------ ----------- -------- --------- -----------
Balance, December 31, 1995 1,000 1,000 4,164,651 -- (25,013) 4,140,638
Net loss -- -- (1,423,031) -- -- (1,423,031)
Purchase of treasury stock (660) -- -- -- (141,700) (141,700)
Sale of treasury stock 660 -- -- -- 141,700 141,700
Dividends paid -- -- (297,260) -- -- (297,260)
Net assets acquired by Specialty
Care Network, Inc. -- -- (2,270,143) -- -- (2,270,143)
------ ------ ----------- -------- --------- -----------
Ending capitalization at November
11, 1996 of Reconstructive
Orthopaedic Associates, Inc.
(predecessor) 1,000 $1,000 $ 174,217 $ -- $ (25,013) $ 150,204
====== ====== =========== ======== ========= ===========
Beginning balance at November 12,
1996 of remaining predecessor
assets transferred to
Reconstructive Orthopaedic
Associates II, P.C. (successor) -- $ -- $ -- $150,204 $ -- $ 150,204
Sale of stock of successor 1,110 1,110 -- 48,890 -- 50,000
Net income -- -- 434,685 -- -- 434,685
------ ------ ----------- -------- --------- -----------
Balance, December 31, 1996 1,110 $1,110 $ 434,685 $199,094 $ -- $ 634,889
====== ====== =========== ======== ========= ===========
See accompanying notes.
F-29
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Statements of Cash Flows
Year ended December 31
1996 1995 1994
----------- ----------- ---------
(See Note 2)
Operating activities
Net (loss) income $ (988,346) $ 1,460,162 $ 128,803
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation 114,339 133,450 124,304
Gain on sale of assets (40,440) -- --
Changes in assets and liabilities:
Accounts receivable 2,238,906 (1,664,688) (167,932)
Inventories 19,100 6,100 --
Due from Thomas Jefferson University (303,600) 57,716 92,356
Due from Specialty Care Network, Inc. (1,314,462) -- --
Prepaid expenses 122,793 124,359 (71,379)
Other assets (6,742) (16,695) (409)
Accounts payable (8,689) 120,017 14,321
Accrued compensation and benefits (45,730) (36,071) 32,695
Other accrued expenses (2,863) 1,975 (14,307)
Due to Thomas Jefferson University 39,674 -- --
Due to Specialty Care Network, Inc. 850,498 -- --
Accrued profit sharing contribution (245,819) 85,421 97,423
----------- ----------- ---------
Net cash provided by operating activities 428,619 271,746 235,875
Investing activities
Sale of investments -- -- 69,631
Sale of furniture, fixtures and equipment 92,025 -- --
Purchases of furniture, fixtures and equipment (47,733) (240,426) (39,061)
----------- ----------- ---------
Net cash provided by (used in)
investing activities 44,292 (240,426) 30,570
F-30
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Statements of Cash Flows (continued)
Year ended December 31
1996 1995 1994
----------- --------- ---------
(See Note 2)
Financing activities
Proceeds from short-term borrowings $ -- $ 570,000 $ --
Repayment of short-term borrowings (570,000) (550,000) --
Proceeds from long-term debt 200,000 -- --
Principal payments on long-term debt (49,823) -- (150,000)
Purchase of treasury stock (141,700) -- --
Proceeds from sale of treasury stock 141,700 -- --
Proceeds from sale of common stock 50,000 -- --
Dividends paid (297,260) (40,000) (80,000)
----------- --------- ---------
Net cash used in financing activities (667,083) (20,000) (230,000)
----------- --------- ---------
Net (decrease) increase in cash and cash
equivalents (194,172) 11,320 36,445
Cash and cash equivalents at beginning of
year 246,203 234,883 198,438
----------- --------- ---------
Cash and cash equivalents at end of year $ 52,031 $ 246,203 $ 234,883
=========== ========= =========
Supplemental schedule of noncash
investing and financing activities
Assets acquired by to Specialty Care
Network, Inc. $ 2,548,412 $ -- $ --
Liabilities assumed by Specialty Care
Network, Inc. (278,269) -- --
----------- --------- ---------
$ 2,270,143 $ -- $ --
=========== ========= =========
See accompanying notes.
F-31
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements
December 31, 1996
1. Description of the Business
Reconstructive Orthopaedic Associates II, P.C. (successor to Reconstructive
Orthopaedic Associates, Inc.) is an orthopaedic physician practice which
services Philadelphia, Pennsylvania and its surrounding communities.
Reconstructive Orthopaedic Associates II, P.C. and Reconstructive Associates,
Inc. (collectively the "Company") are/were professional corporations under the
laws of the state of Pennsylvania.
2. Summary of Significant Accounting Policies
Basis of Presentation
As discussed in Note 9, Reconstructive Orthopaedic Associates, Inc. (Predecessor
Practice) entered into an agreement on November 12, 1996, with Specialty Care
Network, Inc. (SCN) whereby SCN acquired substantially all the net assets of the
Predecessor Practice. Concurrent with the acquisition, the physician
shareholders of the Predecessor Practice, who functioned as promoters in this
transaction, formed Reconstructive Orthopaedic Associates II, P.C. (the
Successor Practice) and entered into a long-term service agreement with SCN to
provide clinical services. This transaction reflects a disposition of certain
net practice assets to SCN with no significant change in the operations or
ownership between the Predecessor and Successor Practices and has accordingly
been treated for financial statement presentation purposes as effectively a
continuation of the business.
The accompanying financial statements of the Company as of and for the year
ended December 31, 1996 have been prepared on the historical basis of
accounting. SCN's acquisition of the Predecessor Practice's net assets was
accounted for using historical cost in accordance with Securities and Exchange
Commission Staff Accounting Bulletin No. 48 and related interpretations. The
remaining net assets of the Predecessor Practice at the transaction date were
transferred at historical cost to the Successor Practice.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the
F-32
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
reported amounts of revenue and expenses during the reporting period. Actual
results could differ from these estimates.
Revenue Recognition
Net patient revenue is recorded at established rates as services are rendered,
net of provisions for bad debts and contractual adjustments. Contractual
adjustments arise due to the terms of certain reimbursement and managed care
contracts. Such adjustments represent the difference between charges at
established rates and estimated amounts to be reimbursed to the Company and are
recognized when the services are rendered. Any differences between estimated
contractual adjustments and actual final settlements under reimbursement
contracts are recognized when final settlements are made.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with original maturities of three
months or less at the date of acquisition.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost. Depreciation and
amortization are determined using the straight-line method over the estimated
useful lives of the assets. The estimated useful lives used are as follows:
Computer equipment and automobiles 5 years
Furniture, fixtures and equipment 7 years
Leasehold improvements 15 years
Financial Instruments
Financial instruments consist of cash and cash equivalents, accounts receivable
and certain liabilities. The carrying amounts reported in the balance sheets for
these items approximate fair value.
F-33
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Estimated Medical Professional Liability Claims
The Company is insured for medical professional liability claims through an
occurrence-based commercial insurance policy.
Income Taxes
The Company is a Subchapter S corporation under the Internal Revenue Code and,
accordingly, is not taxed as a separate entity. The Company's taxable income or
loss is allocated to each stockholder and recognized as taxable income on their
individual tax returns.
3. Accounts Receivable and Net Patient Revenue
As further noted in Note 9, Reconstructive Orthopaedic Associates, Inc. (the
Predecessor Practice) entered into an acquisition transaction with SCN. In
conjunction therewith, as part of the acquisition of substantially all net
practice assets, the outstanding net patient accounts receivable of the
Predecessor Practice were acquired by SCN. Concurrently, Reconstructive
Orthopaedic Associates II, P.C., the Successor Practice, entered into a
long-term service agreement with SCN. Pursuant to the terms of this agreement,
SCN purchases from the Company on a monthly basis the patient revenue charges,
net of a historically-based contractual discount. At December 31, 1996, the
Company has a receivable from SCN for December's patient charges of $3,533,233,
net of contractual discounts of $2,218,771.
Accounts receivable at December 31, 1995 consists of the following:
Gross patient accounts receivable $10,952,124
Less allowance for contractual adjustments
and doubtful accounts 6,663,668
-----------
$ 4,288,456
============
F-34
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
3. Accounts Receivable and Net Patient Revenue (continued)
Net patient revenue consists of the following:
Year ended December 31
1996 1995 1994
----------- ----------- ----------
Gross patient revenue $47,779,030 $39,124,045 $29,666,524
Less contractual adjustments and
uncollectibles 30,976,365 22,217,404 16,341,174
----------- ----------- -----------
$16,802,665 $16,906,641 $13,325,350
=========== =========== ===========
4. Furniture, Fixtures and Equipment
All furniture, fixtures and equipment at November 11, 1996 were acquired by SCN
(see Note 9). The furniture, fixtures and equipment at December 31, 1995
consists of the following:
Furniture and fixtures $ 475,394
Equipment 463,757
Automobiles 171,432
Leasehold improvements 442,519
----------
1,553,102
Less accumulated depreciation 936,049
----------
Furniture, fixtures and equipment, net $ 617,053
==========
5. Line of Credit and Note Payable
In 1995, the Company had a $700,000 line of credit with Mellon Bank, of which
$130,000 was available at December 31, 1995. The outstanding balance of
$570,000, which was collateralized by accounts receivable, was paid in September
1996. Simultaneously, the line of credit was canceled.
F-35
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
5. Line of Credit and Note Payable (continued)
In February 1996, the Company entered into a long-term note payable with Mellon
Bank for $200,000 with principal due in monthly installments of $5,556 plus
interest at a rate of 8.25% maturing in February 1999. Pursuant to the terms of
the agreement (See Note 9), SCN assumed the outstanding liability of $150,177 at
November 11, 1996.
The Company has an uncollateralized $300,000 line of credit with Mellon Bank, of
which the entire amount was available at December 31, 1996.
6. Employee Benefit Plans
The Predecessor Practice had a profit sharing plan that covered substantially
all of its employees. Eligible employees could contribute up to 15% of their
compensation. The Predecessor Practice contributed a discretionary amount which
was allocated proportionally based upon the salaries of the participating
employees. The profit sharing plan expense was $255,750, $247,894 and $263,898
for the years ended December 31, 1996, 1995 and 1994, respectively. This plan
was discontinued as of the November 12, 1996, acquisition of net assets of the
Predecessor Practice by SCN. The Successor Practice has not adopted a new
employee benefit plan.
7. Other Revenue
In July 1995, the Company entered into a two year agreement with Thomas
Jefferson University Hospital (the Hospital), a division of Thomas Jefferson
University, whereby the Company will provide administrative, supervisory,
teaching and patient care services for the Hospital's Department of Orthopaedic
Surgery. The Hospital will provide the Company with compensation for their
employees providing such services. Annual revenue from this agreement is
$607,200, of which $303,600 was due from the Hospital at December 31, 1996.
$202,400 of this receivable was allocated to Reconstructive Orthopaedic
Associates II, P.C. as part of the November 12, 1996 transaction.
Also in July 1995, the Company entered into a two year agreement with Jefferson
Medical College (the College), a division of Thomas Jefferson University,
whereby the Company will educate the College's medical students and residents
for an annual fee of $400,000. At December 31, 1996 and 1995 there was no
outstanding receivable balance.
F-36
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
8. Operating Leases
The Company leases its office facilities on an annual basis. Rent expense for
the years ended December 31, 1996, 1995 and 1994 totaled $308,000, $121,139 and
$126,090, respectively.
9. Acquisition of Net Assets by Specialty Care Network, Inc.
Effective November 12, 1996, the Predecessor Practice entered into an agreement
with SCN whereby SCN acquired substantially all of the net assets of this
Predecessor Practice. Pursuant to the terms of the agreement the transaction was
structured whereby the physician shareholders of the Predecessor Practice,
functioning as promoters, exchanged the common stock of the Predecessor
Practice, which was dissolved, for 3,169,379 common shares of SCN and $1,537,872
of cash. In addition, as part of this transaction, these physician shareholders
concurrently formed and transferred certain assets of the Predecessor Practice
into the Successor Practice and entered into a long-term service agreement with
SCN to provide ongoing clinical services. This transaction reflects a
disposition of certain net practice assets to SCN with no significant change in
the operations and ownership between the Predecessor and Successor Practices and
has accordingly been treated for financial statement presentation purposes as
effectively a continuation of the business.
Initial Service Agreement
Concurrent with the transaction, the Successor Practice entered into a long-term
service agreement with SCN (the "Initial Service Agreement"). Pursuant to the
terms of the forty-year service agreement, SCN, among other things, provides
facilities and management, administrative and development services, in return
for a service fee. Such fee is payable monthly and consists of the following:
(i) a service fee based on 33% of the adjusted pre-tax income of the Company
(generally defined as revenue of the Company related to professional services
less amounts equal to certain clinic expenses but not including physician owner
compensation or most benefits to physician owners) plus (ii) reimbursement of
certain clinic expenses. For the first three years following affiliation,
however, the portion of the service fees described under clause (i) is specified
to be the greater of the amount payable as described under clause (i) above or a
fixed dollar amount (the "Base Service Fee"), which was generally calculated by
applying the
F-37
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
9. Acquisition of Net Assets by Specialty Care Network, Inc. (continued)
service fee percentage of adjusted pre-tax income to Reconstructive Orthopaedic
Associates, Inc. for the twelve months prior to affiliation. For the year ended
December 31, 1996 the management fee expense consisted of a two month service
fee of $680,124 and reimbursement of $773,750 in clinic expenses paid by SCN.
The amount due to SCN at December 31, 1996 is $850,498.
The Initial Service Agreement has a term of forty years, with an automatic
extension (unless specified notice is given) of an additional five-year term.
The Initial Service Agreement may be terminated by either party if the other
party (i) files a petition in bankruptcy or other similar events occur or (ii)
defaults on the performance of a material duty or obligation, which default
continues for a specified term after notice. In addition, SCN may terminate the
agreement if the Company's Medicare or Medicaid number is terminated or
suspended as a result of some act or omission of the Company, and the physicians
and the Company may terminate the agreement if SCN misapplies funds or assets or
violates certain laws.
Upon termination of the Initial Service Agreement by SCN for one of the reasons
set forth above, SCN has the option to require the Company to purchase and
assume the assets and liabilities related to the Company at the fair market
value thereof. In addition, upon termination of the Initial Service Agreement by
SCN during the first five years of the term, the physician owners of the Company
are required to pay SCN or return to SCN an amount of cash or stock of SCN equal
to one-third of the total consideration received by such physicians in
connection with SCN's affiliation with the Company.
Under the Initial Service Agreement, each physician owner must give SCN twelve
months notice of an intent to retire from the Company. If a physician gives such
notice during the first five years of the agreement, the physician must also
locate an acceptable replacement physician and pay SCN an amount based on a
formula relating to any loss of service fee for the first five years of the
term. Furthermore, the physician must pay SCN an amount of cash or stock of SCN
equal to one-third of the total consideration received by such physician in
connection with SCN's affiliation with the Company. The agreement also provides
that after the fifth year no more than 20% of the physician owners of the
Company may retire within a one-year period.
F-38
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
9. Acquisition of Net Assets by Specialty Care Network, Inc. (continued)
Non-competition provisions
The Company and the physician owners of the Company generally agree not to
compete with SCN in providing services similar to those provided by SCN under
the Initial Service Agreement, and the physician owners also generally agree
with SCN not to compete with an affiliated practice of SCN within a specified
geographic area.
Non-competition restrictions generally apply to physician owners during their
affiliation with the Company and for three years thereafter. In addition, the
Initial Service Agreement requires the Company to enter into non-competition
agreements with all its physicians, of which agreements SCN will be a third
party beneficiary. After the fifth year of the term of the Initial Service
Agreement, physician owners of the Company may be released from the
non-competition provisions upon payment of certain amounts to SCN, which may be
paid in the form of common stock. The Initial Service Agreement generally
requires the Company to pursue enforcement of the non-competition agreement with
physicians or assign to SCN the right to pursue enforcement.
Drs. Booth and Bartolozzi
SCN has entered into an agreement with the Company and Drs. Booth and Bartolozzi
pursuant to which there will be a division of the Company, and Drs. Booth and
Bartolozzi will establish an independent practice ("BB One"). The agreement
provides that SCN will enter into a service agreement with BB One, and amend the
service agreement with the Company so that the aggregate Base Service Fee for
the Company and BB One will be equal to the Company's current Base Service Fee.
In addition, unless BB One exercises the right described below, in the event
that the Base Service Fee of either (but not both) of the practices is more than
the service fee (the "Percentage-Based Service Fee") that would result from the
application of the Service Fee Percentage to the practice's Adjusted Pre-Tax
Income (a "Base Fee Deficit"), the other practice will offset against the
deficit the amount, if any, by which its Percentage-Based Service Fee exceeds
its Base Service Fee. Thereafter, if any deficit remains, (i) SCN will forgive
one-third of the remaining Base Fee Deficit, up to $120,000, (ii) the practice
that did not have the Base Fee Deficit will pay to the Company one-third of the
remaining Base Fee Deficit, up to $120,000 and (iii) the practice with the Base
Fee Deficit will pay to SCN all additional
F-39
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
9. Acquisition of Net Assets by Specialty Care Network, Inc. (continued)
remaining Base Fee Deficit. If both practices have a Base Fee Deficit, (i) BB
One will pay to SCN one-third of the Company's Base Fee Deficit, up to $120,000,
(ii) SCN will forgive one-third of the Company's Base Fee Deficit, up to
$120,000, (iii) the Company will pay the remainder of the Base Fee Deficit and
(iv) BB One will pay to SCN the entire amount of its Base Fee Deficit. The
agreement provides that BB One has the right, prior to July 15, 1997, to
increase its Service Fee Percentage by a stipulated amount. In the event that
the right is exercised, BB One's Base Service Fee will be increased by a
stipulated amount, and Dr. Booth will receive options from SCN to purchase
shares of SCN's common stock, based on a specified multiple of the increase in
the Base Service Fee, the product of which will be divided by the greater of
$10.00 or the closing bid price of SCN's common stock on the Nasdaq National
Market on the date the right is exercised. If the right is exercised, SCN will
have no obligation to forgive any Base Fee Deficit of either the Company or BB
One.
The agreement also provides that in the event Dr. Bartolozzi does not join with
Dr. Booth in forming BB One, then SCN and the Company will enter into
arrangements with Dr. Booth on terms proportionately consistent with the
economic principles underlying the above described arrangement. In the event Dr.
Bartolozzi remains with the Company or leaves BB One, BB One's Base Service Fee
and Service Fee Percentage and the amount of the increase in the Base Service
Fee in the event the right is exercised will be modified.
The parties have agreed that in the event additional issues arise in the process
of completing definitive agreements, or amendments to existing agreements, and
such issues are not resolved, then such issues will be submitted to binding
arbitration.
Sports Medicine Center
In addition, SCN has entered into an agreement with Dr. Bartolozzi pursuant to
which SCN has agreed to support the development of a sports medicine center. If
SCN and Dr. Bartolozzi have not agreed to a plan for the development of the
center by November 1997, Dr. Bartolozzi may terminate the service agreement as
it pertains to him, with three months written notice to SCN. Upon such a
termination, Dr. Bartolozzi must return to
F-40
Reconstructive Orthopaedic Associates II, P.C.
(successor to Reconstructive Orthopaedic Associates, Inc.)
Notes to Financial Statements (continued)
9. Acquisition of Net Assets by Specialty Care Network, Inc. (continued)
SCN an amount equal to (i) the after-tax amount of the consideration received by
Dr. Bartolozzi in the acquisition transaction less (ii) the after-tax amount of
Dr. Bartolozzi's pro rata portion of service fees paid to SCN during the term of
the service agreement. In the event of such termination, the Base Service Fee to
be paid by BB One (or the Company if Dr. Bartolozzi elects to remain with the
Company), to SCN will be proportionally reduced by the pro rata portion of the
consideration paid to Dr. Bartolozzi at the closing of the acquisition
transaction.
F-41
Specialty Care Network, Inc. and Subsidiary
As of and for the Year Ended December 31, 1996
Valuation and Qualifying Accounts Schedule
Additions
Balance at -------------------------
the Charged
Beginning to Costs Charged to Balance at
of the and Other the End of
Description Period Expenses Accounts Deductions the Period
----------- --------- -------- ---------- ---------- ----------
Allowance for Contractual Adjustments
and Doubtful Accounts $ -- $ -- $11,264,784(1) $(11,085,869)(3) $15,719,542
15,540,627(2)
(1) Contractual adjustments recognized in the purchases of monthly net accounts
receivable balances during November and December 1996.
(2) Acquired in conjunction with acquisition of five physician practices on
November 12, 1996.
(3) Represents actual amounts charged against the allowance during November and
December 1996.
S-1