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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, 1998 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
(State or other jurisdiction of 62-1623449
incorporation or organization) (I.R.S. Employer Identification No.)
44 Union Boulevard, Suite 600
Lakewood, Colorado 80228
(Address of principal executive offices) (Zip Code)
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 /X/ No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in 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. __
As of March 26, 1999, the aggregate market value of the Common Stock held by
non-affiliates of the registrant
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was $11,815,026. Such aggregate market value was computed by reference to the
closing sale price of the Common Stock as reported on the Nasdaq National 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, 1999 there were 16,381,229 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Registrant's 1999 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.
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TABLE OF CONTENTS
PART I
Item 1. Business............................................................................................... 4
Item 2. Properties.............................................................................................28
Item 3. Legal Proceedings......................................................................................28
Item 4. Submission of Matters to a Vote of Security Holders....................................................32
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters.................................................................................34
Item 6. Selected Financial Data................................................................................35
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................................................36
Item 7A Quantitative and Qualitative Disclosures About Market Risk.............................................43
Item 8. Financial Statements and Supplementary Data............................................................43
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................................................................43
PART III
Item 10. Directors and Executive Officers of the Registrant.....................................................44
Item 11. Executive Compensation.................................................................................44
Item 12. Security Ownership of Certain Beneficial Owners and Management.........................................44
Item 13. Certain Relationships and Related Transactions.........................................................44
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K.............................................................................44
This Report contains forward-looking statements that address, among other
things, the proposed restructuring transaction, the anticipated agreement with
Provider Partnerships, Inc. ("PPI") and its stockholders, the Company's ability
to reduce the amount outstanding under its Credit Facility, liquidity, possible
third-party payor arrangements, 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 the failure of the stockholders to approve the proposed restructuring
transaction, the failure of the bank syndicate to consent to the restructuring,
the failure of the Company to reach an agreement with the former stockholders of
PPI, insufficient capital resources, competition, changes in the regulatory
environment and other factors discussed below, 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 "Specialty Care Network,"
"SCN" and "Company" refer to Specialty Care Network, Inc. References to
practices affiliated with the Company include predecessors of those practices.
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PART I
Item 1. Business.
GENERAL
We are a health care management services company that provides practice
management services to physicians. We also provide a health care rating internet
site, HealthCareReportCards.com, that rates the quality of outcomes at various
hospitals for several medical procedures. In addition, through our subsidiary,
Ambulatory Services, Inc., ("ASI") we are establishing a business engaged in the
development and management of freestanding and in-office ambulatory surgery
centers. We also have a subsidiary, Provider Partnerships, Inc., ("PPI") that
provides hospital consulting services. However, we expect to return the assets
of PPI to its former stockholders in connection with the resolution of certain
issues relating to our acquisition of PPI.
PRACTICE MANAGEMENT SERVICES
Our practice management services focus on musculoskeletal care. Musculoskeletal
care, or orthopaedics, is the treatment of conditions relating to bones, joints,
muscles and related connective tissues. We have contracted to provide services
to 23 orthopaedic practice groups. We have contracted to provide comprehensive
management services to 17 of the groups under exclusive, long-term service
agreements. We refer to these groups as our "affiliated practices." We have
contracted to provide more limited services to six of the groups. We are
involved in litigation with three of our affiliated practices, and the
description below of services provided does not currently apply to these
practices. In addition, we manage outpatient surgery centers, physical therapy
centers and an occupational medicine center which allow our affiliated
practices to provide ancillary services, such as magnetic resonance imaging,
orthotics and radiology.
We recently entered into restructure agreements with ten of our practices to
restructure our relationship with them. We initially affiliated with these
practices by acquiring substantially all of the assets and certain liabilities
of these practices, and entered into long-term service agreements with them.
Under the proposed restructuring transaction, we will sell to the practices
assets relating to the practices, including many of the assets we acquired from
the practices at the time of our original affiliation with them, and enter into
new management services arrangements relating to the practices. Our services
under the new arrangements will be limited to only certain practice needs, and
we will lower the amount of our service fees. All but one of the management
service agreements with the practices will have terms expiring between November,
2001 and March, 2003.
Approval of the restructuring transaction is subject to several conditions,
including approval of our stockholders and consent of our bank syndicate. We can
give no assurance that these conditions will be met.
We were incorporated in December 1995 and began our management services in
November 1996.
Our Practice Management Services to Affiliated Practices
Our Management Services. We assist in strategic planning, preparation of
operating budgets and capital project analysis. We coordinate group purchasing
of medical supplies, and medical malpractice insurance for our affiliated
practices as a group. We develop strategies for contracting with managed care
plans and help to establish relationships with managed care plans. We assist in
physician recruitment by introducing physician candidates to our affiliated
practices. In addition, we advise in structuring employment arrangements. We
also provide or arrange for a variety of additional services relating to the
day-to-day non-medical operations of our affiliated practices. These services
include management and monitoring of:
o billing levels, invoicing procedures and accounts receivable
collection;
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o accounting, payroll and legal services and records; and
o cash management and centralized disbursements.
By providing these management services, we reduce the administrative
responsibilities of our affiliated physicians. This is designed to enable the
physicians to dedicate more time toward the delivery of health care services.
We have also assisted our affiliated practices in developing ancillary
services, such as:
o outpatient surgery;
o bone densitometry;
o outpatient imaging;
o pain management;
o rehabilitation therapy; and
o orthotics.
We believe that our administrative support facilitates more effective billing
and collections and has provided economies of scale in effecting certain
purchases.
Our Practice Services. We employ most of our affiliated practices' non-physician
personnel. These non-physician personnel, along with additional personnel at our
headquarters, provide the infrastructure that enables us to manage the
day-to-day non-medical operations of each of our affiliated practices. We
provide secretarial, bookkeeping, scheduling and other routine administrative
support services. Under our service agreements, we must provide practice
facilities and equipment to our affiliated practices. To satisfy these
obligations, we lease the facilities utilized by our affiliated practices. In
many cases, these facilities are owned by our affiliated physicians. We also
purchase the equipment utilized by each of our affiliated practices.
Our Management Information Systems. Our corporate accounting systems include
interfaces between payroll, banking, accounts payable and accounts receivable
applications. These interfaces enable us to capture, analyze and report
centrally financial data from most of our affiliated practice locations and
provide analyses of financial data on a fully integrated basis. In addition, our
internally developed purchase order system, which is installed at every
affiliated practice location, monitors daily practice inventory purchases from
order to receipt. This allows us to centrally control the disbursement of funds
and to identify economies in purchasing.
We believe that an important factor in the successful management of
musculoskeletal disease is the creation of a database that tracks the results of
specific methods of treatment. This information can be used to establish
treatment protocols. With the input of our affiliated physicians who specialize
in specific orthopaedic subspecialties, we are gathering information from some
of our affiliated practices in a standardized fashion. In addition to treatment
information, we collect financial information such as:
o personal patient data;
o physician and procedure identifier codes;
o payor class; and
o amounts charged and reimbursed.
Information is gathered in areas such as:
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o incidence rates (the number of specified procedural, diagnostic and
medical events during a defined period with respect to a particular
patient population);
o utilization (frequency of patient care and activity relating to the
patient); and
o Payor mix information
We intend to use this information to assist our affiliated physicians in
developing:
o clinical protocols;
o ensuring that standards of quality are met; and
o determining the most cost-effective course for treating patients.
Our Contracting. We negotiate both fee-for-service and capitated contracts on
behalf of our affiliated practices. Capitated contracts involve various forms
of risk-sharing. There are two traditional categories of risk sharing. In the
first instance, the health care provider accepts risk only with respect to the
costs of physician services required by a patient (i.e., professional fee
capitation). In the second scenario, the health care provider accepts risk for
all of the medical costs required by a patient, including professional,
institutional and ancillary services (i.e., global capitation). Managed care
companies have refined traditional models by segmenting fees into episode of
care and per member per month capitation. Under episode of care capitation,
health care providers deliver care for covered enrollees with a specified
medical condition, or enrollees who require a particular treatment, for a fixed
fee on a per episode basis. Under per member per month capitation, the health
care providers receive fixed monthly fees per covered enrollee and assume the
financial responsibility for the treatment of medical conditions requiring
procedures specified in the contract. We have negotiated "episode of care" or
package pricing arrangements with several major health maintenance
organizations and workers compensation carriers covering several surgical
procedures.
Practice Governance and Quality Assurance
Each affiliated practice has a Joint Policy Board. The membership of the Joint
Policy Board includes an equal number of representatives of our company and the
affiliated practice. The Joint Policy Boards have responsibilities that include:
o developing long-term strategic objectives;
o developing practice expansion and payor contracting guidelines;
o promoting practice efficiencies;
o identifying and recommending significant capital expenditures; and
o facilitating communication and information exchanges.
Our Contractual Agreements with Our Affiliated Practices
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We have entered into long-term service agreements with each of our affiliated
practices to provide management and administrative services. We have included
below a general summary of our service agreements. The actual terms of the
individual service agreements vary in certain respects from the description
below. These variances are a result of negotiations with the individual
practices and the requirements of state and local laws and regulations.
Beginning April 1, 1999, our obligations with respect to the practices that
have entered into restructure agreements with us will be limited to providing
furniture, fixtures and equipment necessary for the practices to operate their
offices and, in some instances, the billing and collection service personnel.
Our fees will also be reduced. This interim arrangement will continue until
closing under the restructure agreements or June 15, 1999, whichever occurs
first. If closing occurs, the practices will be subject to management services
agreements having terms described below under "Our Practice Management Service
to Other Practices - Our Contractual Agreements with the Other Practices."
Our Responsibilities. We, among other things:
o act as the exclusive manager and administrator of non-physician
services relating to the operation of our affiliated practices (with
the exception of certain matters for which our affiliated practices
maintain responsibility or which are referred to the Joint Policy
Boards of our affiliated practices);
o bill patients, insurance companies and other third-party payors and
collect the fees for professional medical and other services
rendered, including goods and supplies sold;
o provide or arrange 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;
o supervise and maintain custody of substantially all files and records
(medical records of our affiliated practices remain the property of
our affiliated practices);
o provide facilities and equipment for our affiliated practices;
o prepare, in consultation with the Joint Policy Boards and our
affiliated practices, all annual and capital operating budgets for
our affiliated practices;
o order and purchase inventory and supplies as reasonably requested by
our affiliated practices;
o implement, in consultation with the Joint Policy Boards and our
affiliated practices, local public relations or advertising programs;
and
o provide financial and business assistance in the negotiation,
establishment, supervision and maintenance of contracts and
relationships with managed care plans and other similar providers and
payors.
Most employees providing such services were employed by our affiliated
practices prior to the practice's affiliation with us.
The Responsibilities of Our Affiliated Practices. Our affiliated practices
retain the responsibility for:
o hiring and compensating physician employees and other medical
professionals;
o ensuring that physicians have the required licenses, credentials,
approvals and other certifications needed to perform their duties;
and
o complying with certain federal and state laws and regulations
applicable to the practice of medicine.
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In addition, our affiliated practices maintain exclusive control of all
aspects of the practice of medicine and the delivery of medical services.
Our Service Fees. We collect fees from our affiliated practices on a monthly
basis generally equal to the following:
o the greater of a guaranteed base service fee or a percentage (the
"service fee percentage"), ranging from 20%-50% of the adjusted
pre-tax income of our affiliated practices, which is defined
generally as revenue of our affiliated practices related to
professional services less amounts equal to certain clinic expenses
of our affiliated practices, not including physician owner
compensation or most benefits to physician owners; and
o amounts equal to the clinic expenses of our affiliated practices, not
including physician owner compensation or most benefits to physician
owners.
o Generally, for the first three years following a practice's
affiliation, the service fee is subject to a fixed dollar minimum. The
fixed dollar minimum generally was determined by multiplying the
affiliated practice's adjusted pre-tax income for the 12 months prior
to its affiliation by the service fee percentage. In addition, with
respect to our management (and, in certain instances, ownership) of
certain facilities and ancillary services associated with certain of
our affiliated practices, we are paid additional fees based on a
percentage of net revenue or pre-tax income related to such facilities
and services.
Our Accounts Receivable. Each month, most of our affiliated practices sell all
of their monthly accounts receivable to us. The purchase price generally equals
the gross amounts of the accounts receivable recorded each month, subject to
adjustment for certain potentially uncollectible amounts. We are making periodic
adjustments so that amounts paid for the accounts receivable of certain
affiliated practices are adjusted upwards or downwards based on our actual
collection experience.
The Term of Our Service Agreements. Our service agreements with affiliated
practices have initial terms of 40 years. They are automatically extended
(unless specified notice is given) for additional five-year terms.
Other Provisions. The service agreement contains additional provisions,
including:
o certain non-competition provisions;
o cross-indemnification provisions;
o required insurance coverage to be obtained by us and our affiliated
practices; and
o provisions requiring replacement of physicians retiring within the
first five years of the agreement and limiting the number of
physicians who may retire within any one-year period thereafter.
Third Party Reimbursement Policies
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A significant amount of the revenues of the practices we serve are derived from
government and private third party payors. The health care industry is
experiencing a trend toward cost containment. In addition, the federal
government has implemented a resource-based relative value scale payment
methodology under Medicare for physician services.
The resource-based relative value scale is a fee schedule that, except for
certain geographical and other adjustments, pays similarly situated physicians
the same amount for the same services. The fee schedule is adjusted each year.
It is subject to increases or decreases at the discretion of Congress. To date,
the implementation of the resource-based relative value scale method of payment
has reduced payment rates for certain of the procedures historically provided
by the practices that contract with us. Further changes in the Medicare fee
schedule payment methodology could adversely affect our business.
Physician reimbursement rates paid by private third-party payors are, in large
part, still based on established charges. However, resource-based relative value
scale types of payment systems are being adopted by private third-party payors.
Increased implementation of such payment systems may result in reduced payments
from private third-party payors and thereby reduce our revenue. Although private
third party payors are adopting resource-based relative value scale-type
reimbursement or other managed care-type restrictions on reimbursement, such
rates still are generally higher than Medicare payment rates. Further reductions
in reimbursement levels or other changes in reimbursement for health care
services could be detrimental to the practices with which we have contracted or
our business. Additionally, the treatment methods for orthopaedic conditions may
shift from surgical treatments to non-surgical treatments. In addition to the
above concerns, any payment reductions or change in the patient mix of any of
the practices that contract with us that results in a decrease in patients
covered by private third-party payors could be detrimental to us.
AMBULATORY SURGICAL SERVICES
Ambulatory Services, Inc. is a subsidiary of ours formed to engage in
development and management services for ambulatory surgery centers. ASI is
seeking to enter into arrangements with physicians, physician groups and
hospitals, to plan, construct, and operate and, in some instances, own a
portion of ambulatory surgery centers. We anticipate that our development of
ASI's operations will require substantial capital commitments that we are not
currently able to make. We are exploring alternatives to obtain financing,
including the possibility of selling an equity interest in ASI.
Currently, through an agreement with Greater Chesapeake Associates, LLC, ASI is
providing management services with regard to a surgery center affiliated with
that practice. We have an approximately 33% ownership interest in this surgery
center. We hope to expand ASI's services to include comprehensive consultation
and project planning in connection with the construction of surgery centers. In
addition, our development services would involve assisting medical providers
in:
o obtaining necessary certificates of need and fulfilling other legal
requirements;
o assisting in planning for construction, including site selection and
interior design; and
o developing a project schedule and project budget coordination of
construction activities.
Management services offered by ASI include the following:
o accounting/financial services - including annual budget preparation,
preparation of financial statements and tax reports and, at the
option of the provider, billing and collection functions;
o vendor contracting - acquisition of supplies and pharmaceuticals;
o payor contracting;
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o marketing - design and implementation of a marketing plan for the
surgery center;
o management information system support;
o payroll services; and
o regulatory compliance support services.
ASI has hired a Vice President, Operations and has also retained several
consultants to assist in the development of its business. ASI is actively
marketing its services at the present time. While we are hopeful that our
efforts will result in a profitable business, we cannot assure that ASI will be
successful.
HEALTHCAREREPORTCARDS.COM INTERNET SITE
We currently operate HealthCareReportCards.com. This is an internet site
that applies a proprietary risk adjustment formula to data acquired from the
Health Care Financing Administration of the U.S. Department of Health and
Human Services to rate the quality of outcomes at U.S. hospitals with respect
to several medical specialties, including the following:
o cardiology
o orthopaedics
o neuroscience
o pulmonary/respiratory
o vascular surgery
HealthCareReportCards.com purchased its initial dataset, known as the MEDPAR
(Medicare Provider Analysis and Review) file, from the Health Care Financing
Administration. Working with Susan Des Harnis, Ph.D., Chairman of the
Department of Health Administration and Policy at the Medical University of
South Carolina, HealthCareReportCards.com developed a risk-adjustment model to
take into account variations in the risk of illness of patients cared for by
different hospitals. Utilizing the risk adjusted data,
HealthCareReportCards.com rates hospitals with a five-star rating system. To
receive a five-star rating, a hospital must have a score in the top ten percent
of all hospitals performing a rated procedure or caring for patients with the
appropriate diagnosis and the difference between actual and predicted
performance must be statistically significant.
Access to the HealthCareReportCards.com site is free. HealthCareReportCards.com
seeks to fund its operations through the sale to four and five-star rated
hospital of banners, hyperlinks and similar types of advertising on its web
site.
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 and Medicaid programs. Each of these programs 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.
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We believe our physician practice management operations materially comply with
applicable laws. However, we have not received or applied for a legal opinion
from counsel or from any federal or state judicial or regulatory authority with
respect to our practice management operations. Additionally, many aspects of
our business have not been the subject of state or federal regulatory
interpretation. The laws applicable to us and the practices that contract with
us are subject to evolving interpretations. If we, or these practices, are
reviewed by a government authority, we may receive a determination that could
be adverse to us or the practices. Furthermore, the laws applicable to either
us or the practices may be amended in a manner that could adversely affect us.
The federal health care laws apply to us when we submit a claim on behalf of a
practice that contracts with us to Medicare, Medicaid or any other
federally-funded health care program. The principal federal laws that we must
abide by in these situations include:
o those that prohibit the filing of false or improper claims for
federal payment;
o those that prohibit unlawful inducements for the referral of business
reimbursable under federally-funded health care programs; and
o those that prohibit the billing to Medicare or Medicaid for
provision of certain services by a provider to a patient if the
patient was referred by a physician and the referring physician or a
member of his immediate family has certain types of financial
relationships with the provider.
False and Other Improper Claims. The federal government may impose criminal,
civil and administrative penalties on anyone that files a false claim for
reimbursement from Medicare, Medicaid or other federally-funded programs.
Criminal penalties apply in the case of claims filed with private insurers.
While the criminal statutes are generally reserved for instances involving
fraudulent intent, the civil and administrative penalty statutes are applied by
the government in an increasingly broad range of circumstances. For example,
the government has taken the position that a pattern of claiming payment for
unnecessary services or services that are substandard may violate these
statutes if the practice (or the party submitting the claim on behalf of the
practice) should have known the services were unnecessary or substandard.
Additionally, the amount of documentation that must be compiled to support a
claim has increased the possibility that a submitted claim may be improper. In
1997, the Department of Health and Human Services issued new documentation
guidelines applicable to Medicare claims involving the musculoskeletal system,
which are substantially more burdensome than the previous requirements.
In late 1998, the Inspector General of the Department of Health and Human
Services issued compliance guidance for third-party medical billing companies.
This guidance contains specific elements that companies which bill for provider
clients should include in their compliance program and identifies specific risk
areas for billing companies. The guidelines encourage billing companies to
facilitate the restitution of overpayments, coordinate compliance matters with
providers, refrain from submitting false or inappropriate claims, and terminate
contracts with providers and/or report providers who engage in continued
misconduct or fraudulent or abusive conduct.
We believe that our billing activities on behalf of our affiliated practices
comply with applicable law and we are working to insure that they comply with
the third-party billing guidelines. Governmental authorities may challenge or
scrutinize our activities. A determination that we or our practices that have
contracts with us have violated applicable laws could have an adverse impact on
us.
Federal Anti-kickback Law. A federal law commonly known as the "Anti-kickback
Law" prohibits the knowing or willful, solicitation, receipt, offer or payment
of any remuneration which is made in return for:
o the referral of patients covered under Medicare, Medicaid and most
other federally-funded health care programs; or
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o the purchasing, leasing, ordering, or arranging for any good,
facility, items or service reimbursable under those programs.
The law also prohibits remuneration that is made for the recommendation of, or
the arranging for, the purchasing, leasing, or ordering of any good, facility,
item or service, reimbursable under those programs. The law has been broadly
interpreted by a number of courts to prohibit remuneration that is solicited,
received, offered or paid for otherwise legitimate purposes if one purpose of
the arrangement is to induce referrals or the other prescribed activities. Even
bona fide investment interests in a health care provider may be questioned under
the Anti-kickback Law. The penalties for violations of this law include:
o civil monetary penalties;
o criminal sanctions;
o exclusion from further participation in federally-funded health care
programs (mandatory exclusion in certain cases);
o the ability of the Secretary of Health and Human Services to refuse
to enter into or terminate a provider agreement; and
o debarment from participation in other federal programs.
In 1991, the federal government published regulations that provide exceptions
or "safe harbors," to the Anti-kickback Law. Among the safe harbors included in
the regulations were:
o provisions relating to the sale of physician practices;
o management and personal services agreements;
o office and equipment rental agreements; and
o employee relationships.
Subsequently, in 1993 proposed 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. 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 our relationships with our affiliated physicians
to which the Anti-kickback Law may be relevant. In some instances, for example,
the government may construe some of our marketing and managed care contracting
activities as recommending patients to our affiliated physicians who pay us a
management fee, in part, for such activities.
On April 15, 1998, the Inspector General of the Department of Health and Human
Services issued Advisory Opinion No. 98-4, which was a response to a request by
a physician for an advisory opinion as to whether a proposed management
services contract between a medical practice management company and a physician
practice would constitute illegal remuneration as defined in the Anti-kickback
Law. Under the facts as presented in the advisory opinion request, a physician
practice management company proposed to enter into a management agreement with
a physician medical practice, under which the management company would provide
the clinic facilities, clinic personnel other than the physicians, and the
operating services for the medical practice including accounting, billing and
purchasing services. Additionally, the management company contracted to provide
the medical practice "with management and marketing services for the clinic,
including the negotiation and oversight of healthcare contacts with various
payors, including indemnity plans, managed care plans, and federal healthcare
programs." Also, the management company's activities on behalf of the medical
practice included the establishment of provider networks, The management fee to
be paid by the medical practice to the management
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company was, in part, based on a percentage of the medical practice's monthly
net revenues. In the advisory opinion, the Inspector General determined that
the proposed management services arrangement did not satisfy a safe harbor
under the Anti-kickback Law. However, the fact that the proposed management
services arrangement did not fit within a safe harbor did not mean that the
proposed arrangement was necessarily unlawful. Rather, the Inspector General
stated that it would be necessary to analyze the proposed arrangement on a
case-by-case basis. In analyzing the proposed arrangement, the Inspector
General determined that it had insufficient information to ascertain the level
of risk of fraud or abuse presented by the proposed arrangement, because the
proposed arrangement may include financial incentives to increase patient
referrals through the marketing and managed care contracting services provided
by the management company. Additionally, the Inspector General stated in the
advisory opinion that the proposed arrangement could present a problem because
the proposed arrangement contained no safeguards against over-utilization and
may include financial incentives that increase the risk of abusive billing
practices. Accordingly, the advisory opinion, while not concluding that the
proposed management services arrangement was a violation of the Anti-kickback
Law, did not conclude definitively that such arrangement would not result in a
violation of the Anti-kickback Law.
In addition, we own an interest in a joint venture (and may, in the future, own
an additional interest in entities) which owns and operates an outpatient
surgery center. Some of our affiliated physicians also own an interest in the
joint venture (and others may, in the future own an interest in an entity that
owns and operates an outpatient surgery center) and may refer their patients to
the surgery center for treatment. The Inspector General has stated that a joint
venture arrangement where Physicians are both investors in the joint venture and
in a position to refer patients to the joint venture may violate the
Anti-kickback Law where remuneration paid to the physicians in exchange for
referrals is disguised as profit distribution. Also, we provide management
services to outpatient surgery centers. The Inspector General has stated that
the provisions of certain marketing services under a management agreement may
implicate the Anti-kickback Law, as discussed above.
Although general marketing and managed care contracting activities and the
ownership of interests in an outpatient surgery center by both us and our
affiliated physicians do not qualify for protection under the safe harbor
regulations, we believe that our activities and joint venture ownership
arrangements are not the type of activities and arrangements the Anti-kickback
Law prohibits. We are not aware of any legal challenge or proceeding pending
against similar physician practice management activities or joint venture
arrangements under the Anti-kickback Law. A determination that we violated the
Anti-kickback Law would be detrimental to us.
The Stark Self-Referral Law. The Stark Self-Referral Law prohibits a physician
from referring a patient to an entity that provides "designated health
services" reimbursable by Medicare or Medicaid if the physician or an immediate
family member has a financial relationship with the entity. "Designated health
services" include physical therapy services, diagnostic imaging services, and
orthotics and prosthetics devices and services some or all of which are
furnished by our affiliated practices. 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:
o a refund of any Medicare or Medicaid payments for services that
resulted from an unlawful referral;
o civil fines; and
o exclusion from the Medicare and Medicaid programs.
On January 9, 1998, the Health Care Financing Administration issued proposed
rules regarding the Stark Self-Referral Law as it relates to the designated
health services listed above. The proposed rules state that the entity that
provides the designated health services may be a physician's practice or any
other entity that actually owns the operations of the designated health
services. An entity that merely owns certain components of a health services
operation, such as the building that houses the operations or the medical
equipment used in the operations will not be considered as owning the
operations of the health services. It is not clear whether and to what extent
our provision of management services to our affiliated practices (including our
provision of medical equipment, personnel and management services with respect
to designated health services provided by our affiliated practices) and our
receipt of a service fee based on net patient revenues would cause us to be
deemed to own the designated health services operation. It is also not clear
whether our provision of more limited services to the other practices that
contract with us would raise this issue. In addition, the proposed regulations
would apply to an entity that does not bill under its own Medicare number but
receives payment for the services from the billing entity as part of a
so-called "under arrangements" agreement (a term of art under the regulations
relating to certain hospital
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arrangements) or similar agreements. It is not clear whether the term "similar
agreements" would apply to our arrangements with practices that have contracted
with us. If we are deemed to "own the operation" of designated health services
or to be engaged in an arrangement similar to an "under arrangements" agreement,
with respect to designated health services which are billed by our affiliated
practices, we would be deemed a provider of designated health services addressed
by the proposed rules.
We believe that we will not be deemed to be a provider of designated health
services. However, if we are deemed a provider of designated health services for
purposes of the Stark Self-Referral Law, and accordingly, the recipient of
referrals from physicians affiliated with practices that have contracted with
us, such referrals will be permissible only if:
o the financial arrangements under the service agreements with the
practices meet certain exceptions in the Stark Self-Referral Law;
o the ownership of our stock by the referring physicians meets certain
investment exceptions under the Stark Self-Referral Law; and
o we have no other financial arrangements with a referring physician
which are not covered by an exception under the Stark Self-Referral
Law.
We believe that the financial arrangements under our management agreements with
the practices qualify for applicable exceptions under the Stark Self-Referral
Law. However, the issuance of the final rules, a review by courts or a review
by regulatory authorities may result in a contrary determination. The ownership
of our stock by the referring physicians will not meet the Stark Self-Referral
Law exception related to investment interests. The proposed rules provide that
in order to meet the investment interest exception the investment has to be in
securities which, at the time they were obtained, could be purchased on the
open market. This proposed rule would prohibit referral relationships between
a physician and an entity in which such physician (or a family member) owns
stock or options if such stock or options were acquired prior to the time that
the entity was publicly held. Some of the physicians in our affiliated
practices acquired our stock prior to our initial public offering. Other
physicians in our affiliated practices acquired our stock after our initial
public offering. However, the Stark Self-Referral Law requires that to satisfy
the investment interest exception, our stockholder equity would have to exceed
$75 million.
Accordingly, none of the physicians who are in our affiliated practices and who
own stock in our company would be covered by the investment interest exception
and therefore could not refer patients for any designated health services which
we are deemed to provide.
With respect to our ambulatory surgery center operations, where we may either
provide management services to an ambulatory surgery center owned by physicians
or a physician practice, own an interest in an ambulatory surgery center jointly
with physicians or a physician practice, or both, the proposed rules provide
that services furnished in an ambulatory surgery center will not be deemed
"designated health services" if payment for those services is included within
the ambulatory surgery center's payment rate. Since we intend to operate the
ambulatory surgery centers which we manage or own an interest in a manner
that is intended to comply with this exception, we do not believe that the Stark
Self-Referral Law will apply to our ambulatory surgery center operations.
A determination that we have violated the Stark Self-Referral Law would have a
material adverse effect on us.
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. 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, we believe that most of these laws prohibit
payments to referral sources where a purpose for the payment is the referral.
Most state anti-kickback laws have received only limited judicial and
regulatory interpretation. Therefore, it is possible that our activities may be
found not to comply with these laws. Noncompliance with such laws could subject
us and the physicians in our affiliated practices to penalties and sanctions.
State Self-Referral Laws. A number of states have laws that are similar in
purpose to the Stark Self-Referral Law but which impose different restrictions.
Some states 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 health services. Some states do not
prohibit referrals, but require that a patient be informed of the financial
relationship before the referral is made. We believe that our operations comply
with the self-referral laws of the states in which the practices that contract
with us are located.
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Fee-Splitting Laws. Most states prohibit a physician from splitting fees with a
referral source. Some 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, we believe that a management fee payment made by a physician to
a management company would not be considered fee-splitting if the payment
constitutes reasonable payment for services rendered to the physician or
physician's medical practice.
We are paid by physicians (and their medical practices) for whom we provide
management services. Our service agreements and management service agreements
have been designed to comply with applicable state laws relating to
fee-splitting. However, a state authority may nevertheless determine that we and
the practices that contract with us are violating the state's fee-splitting
laws. Such a determination could render any of our service agreements in such
state unenforceable or subject to modification in a manner that is adverse to
us.
In November 1997, pursuant to the request by Magan L Bakarania, M.D. the Florida
Board of Medicine issued a declaratory statement that payments of a percentage
of a physician group's net income to a practice management company in return for
services constituted fee-splitting and therefore that could subject Dr.
Bakarania to disciplinary action. The specific services to be provided by the
management company, which the Florida Board of Medicine stated would, in their
opinion, result in a prohibited fee-splitting arrangement were services intended
to increase the physician group's revenue by:
o increasing patient referrals through the creation of preferred
provider networks;
o establishing managed care networks; and
o negotiation of managed care contracts
The declaratory statement only applies to the physician that requested the
declaratory statement (and certain other physicians who formally joined in the
Florida Board of Medicine proceedings). The Florida Board of Medicine agreed to
stay final issuance of the declaratory statement pending appeal of the decision
by the physician practice management company to a Florida court.
On October 2, 1998, TOC Specialists, P.L., an affiliated practice located in
Tallahassee, Florida, filed a petition for declaratory statement with the
Florida Board of Medicine requesting advice as to whether TOC Specialists, P.L.
and its physician owners would be subject to discipline under the statutory
prohibitions against fee-splitting, based upon the services agreement between us
and TOC Specialists, P.L. Because of the pending appeal of the declaratory
statement issued with respect to Dr. Bakarania, the Florida Board of Medicine
has agreed not to consider TOC Specialists, P.L.'s petition until the pending
appeal has been concluded. Although the issuance of a declaratory statement by
the Florida Board of Medicine with respect to TOC Specialists, P.L. stating that
the management services arrangement between us and TOC Specialists, P.L.
violates the Florida fee-splitting statute would not directly affect us or our
agreement with TOC Specialists, P.L. because we are not a party to the petition
filed by TOC Specialists, P.L., such an adverse decision would be detrimental to
us since it could serve as the basis for an assertion by TOC Specialists, P.L.
that the services agreement between us and the practice results in a violation
of Florida law and subjects the TOC Specialists, P.L. physicians to disciplinary
action unless the services agreement is either terminated or modified in a
manner that may be detrimental to us.
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. Some states allow a licensed physician
to affiliate with corporate entities for the delivery of medical services. On
the other hand, some states interpret the "practice of medicine" broadly to
include activities such as ours. This is true even if the corporation's
activities only have an indirect impact on the practice of medicine, 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.
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We structure our service and management service agreements so that we do not
exercise any responsibility on behalf of physicians that should be construed as
affecting the practice of medicine. Accordingly, we believe that our operations
do not violate state laws relating to the corporate practice of medicine. Such
laws and legal doctrines have been subjected to only limited judicial and
regulatory interpretation with respect to physician practice management
companies. If challenged, we may not be considered to be in compliance with all
such laws and doctrines. A determination in any state that we are engaged in the
corporate practice of medicine could render our agreements with practices
located in such state unenforceable or subject to modification in a manner
adverse to us.
Health Care Reform. In recent years, a variety of legislative proposals designed
to change access to and payment for health care services in the United States
have been introduced. Although no health reform proposals have been passed by
Congress to date, other proposed health care reform legislation, including the
regulation of patient referral practices, reimbursement of health care
providers, formation and operation of physician joint ventures and tort reform,
has been and may be considered by Congress and the legislatures of many of the
states in which we operate. No predictions can be made as to whether health care
reform legislation or similar legislation will be enacted or, if enacted, its
effect on us. Any federal or state legislation prohibiting, among other things,
the referral to or treatment of patients at surgery centers by health care
providers with an investment interest in the surgery centers may have a material
adverse effect on our surgery center joint venture. In the event that federal or
state regulations prohibit the ownership of surgery centers by physicians, we
would seek to purchase the interests held by the physicians. We believe that we
would be able to purchase the interest of the physician members of our joint
ventures, if required.
Ambulatory Surgery Center Regulatory Environment. Our surgery center and the
physicians utilizing our centers are subject to numerous regulatory,
accreditation and certification requirements, including requirements related to
licensure, certificate of need, reimbursement from insurance companies and other
private third-party payors, Medicare and Medicaid participation and
reimbursement, and utilization and quality review organizations. The grant and
renewal of these licenses, certifications and accreditations are based upon
governmental and private regulatory agency inspections, surveys, audits,
investigations or other reviews, including self-reporting requirements. An
adverse review or determination by any regulatory authority could result in
denial of a center's plan of development or proposed expansion of facilities or
services, the loss or restriction of licensure by a center or one of its
practitioners, or loss of center certification or accreditation. A regulatory
authority could also reduce, delay or terminate reimbursement to a center or
require repayment of reimbursement received. The loss, denial or restriction of
any such licensure, accreditation, certification (including certificates of need
or exemption therefrom) or reimbursement through changes in the regulatory
requirements, an enforcement action, or otherwise, could have a material adverse
effect on us.
AMA Restrictions. In June 1994, the American Medical Association severely
restricted the ability of physicians to refer to entities in which such
physicians have an ownership interest, except when the physician directly
provides care or services at a facility that is an extension of the physician's
practice and in very limited circumstances such as in rural areas where there is
lack of available capital from non-physician sources. If the American Medical
Association changes its ethical requirements to preclude all referrals by
physicians, physician referrals to our ambulatory surgery centers could be
adversely affected. It is possible that a prohibition on physician ownership
could adversely affect our future operations, although we believe that the
majority of physicians would continue to perform surgery at the surgery centers
even if they were no longer limited partners.
Infectious Waste. As generators of infectious waste, the Company's surgery
centers are required to satisfy all federal, state and local waste disposal
requirements. If any regulatory agency finds a center to be in violation of
waste laws, penalties and fines may be imposed for each day of violation, and
the affected center could be forced to cease operations. The Company believes
its surgery centers dispose of such waste properly.
Antitrust Laws. The federal antitrust laws (principally the Sherman Act, the
Clayton Act and the Federal Trade Commission Act) are designed to maintain
market competition. They address both structural issues (market share through
merger, acquisition or otherwise) and conduct issues (contracts or combinations
in restraints of trade). The Federal Trade Commission and the Department of
Justice addressed competitive issues, both structural and conduct, in the
health care industry in their 1996 Statements of Enforcement Policy in Health
Care. The statements could apply to various aspects of our business. While we
believe that we are in compliance with these laws, there is no assurance that
our operations will not become the focus of inquiry and potential challenge.
Responding to such challenges could result in substantial costs.
Insurance Licensure Laws. All states have licensure requirements to regulate
the business of insurance and the operation of HMOs. Some states also have
separate licensure requirements for provider-sponsored managed care networks
(also known as "provider-sponsored organizations," or "PSOs") and for other
managed care entities such as third-party administrators. A person who fails to
obtain the appropriate insurance license may be subject to civil and criminal
penalties in certain states. These licensure requirements for insurers, HMOs
and PSOs would not generally apply to companies that provide only management
services to physician providers. However, there is little uniformity in how the
states interpret the scope of their respective laws and regulations.
We believe that our operations do not violate insurance licensure laws for
insurers, HMOs and PSOs in the states where we currently do business. Yet,
there is a risk that state regulatory authorities may apply these laws to
require us to be licensed as an insurer, an HMO, or a PSO. Compliance with such
laws could result in substantial costs. In addition, practices that contract
with us may require licensure as PSOs under separate statutory requirements for
PSOs or, if such practices enter into capitated or other risk-assumption
arrangements, under requirements relating to HMOs or insurers.
See "Provider Risk Assumption," below.
Finally, we may need to obtain separate licensure as a third-party
administrator, as a utilization review agent, or as an HMO or insurance
marketing agent if our services for physicians are deemed by a state authority
to involve "administration," "utilization review" or "marketing functions." If
we are deemed to be in noncompliance with insurance licensure laws, our
business would be adversely affected.
In Florida, entities performing "fiduciary or fiscal intermediary services" on
behalf of health care professionals who contract with HMOs must register with
the Florida Department of Insurance under a "Fiscal Intermediary Services" law.
This statue defines "fiduciary or fiscal intermediary services" to include (i)
receipt or collection of reimbursements for services rendered on behalf of
health care professionals; (ii) patient and provider accounting; (iii) financial
reporting and auditing; (iv) receipts and collections management; (iv)
compensation and reimbursement disbursement services; and (v) other related
fiduciary services rendered pursuant to contracts between health care
professionals and health maintenance organizations. A party otherwise qualifying
as a fiscal intermediary services organization and which is operated for the
purpose of acquiring and administering provider contracts with managed care
plans for professional health care services must secure and maintain in force a
fidelity bond in the minimum amount of $10 million. The fidelity bond must (i)
be posted with the state; (ii) be on an approved form; (iii) insure against
misappropriation of funds by the registrant; and (iv) run to the benefit of the
interested managed care plans, subscribers and health care providers.
We are reviewing the management services we provide to Florida practices and
investigating the possible application of this law to our Florida operations. If
we conclude the law applies to those operations, we will take appropriate
steps to register or otherwise comply with its requirements.
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Provider Risk Assumption. When health care providers or provider networks agree
to provide services on a capitated basis, they assume "insurance risk" and may
be regarded by the regulatory authorities as conducting an "insurance business"
for which licensure is required. Whether licensure as an insurer, health
maintenance organization or other equivalent will be required depends on the
relationship between the provider or network and the individuals who receive
the services.
If the relationship is "direct" such that the provider network has directly
contracted with the "insured" (whether and individual or group policyholder) to
provide services in return for a fixed payment, all jurisdictions would likely
find the provider or provider network to be engaged in the "doing of an
insurance business" requiring licensure and full regulation equivalent to that
which applies to commercial health insurers and health maintenance
organizations.
If, however, the provider or network has contracted with a licensed insurer or
health maintenance organization to provide services to that entity's policy
holders or members, licensure is not required in most states, even if the
provider or network agreed to do so on a capitated basis and thereby assumed
insurance risk. These latter arrangements, where a licensed insurer or health
maintenance organization is interposed between the insured and the capitated
provider or network, are referred to as "downstream" risk-sharing arrangements.
Most states that have considered the questions have determined on policy
grounds not to regulate or require licensing of a capitated provider or
provider network so long as it is "downstream" from a licensed insurer or
health maintenance organization. However, a few other states will require
licensing of "downstream" capitation arrangements of those arrangements involve
"global" or "episode of care" capitation allowances.
On behalf of certain of the practices, we regularly negotiate "downstream"
capitated service arrangements, including global and episode of care capitation
allowances. It would not be practical to have the practices licensed as either
an insurer of health maintenance organization if this were required as a result
of those capitation arrangements. The inability to enter into such capitation
arrangements would adversely affect us.
Managed Care Contracting Laws. An increasing volume of state regulation
addresses the terms of contracts between managed care payors and managed care
providers. Some of these laws and regulations can affect the composition of a
managed care network. Other laws and regulations are aimed at protecting health
care consumers. A determination that we or our affiliated practices do not
comply with such laws could be detrimental to us.
Physician Incentive Plan Rule. A regulation of the Health Care Financing
Administration, United States Department of Health and Human Services, imposes
limitations with respect to, and prescribes the terms and conditions under
which, health maintenance organizations operating "physician incentive plans"
may offer incentives to physicians that could tend to reduce or limit medically
necessary services to an enrollee. This regulation applies to physician
incentive plans which base compensation, in whole or in part, on the use or cost
of services furnished to Medicare beneficiaries or Medicaid recipients. Among
other things, this regulation requires the organization to provide adequate
stop-loss protection for physicians if the organization's system for
compensating physicians does not provide mandated limits on the amount of
physician compensation that is put at risk by the incentive plan. This
regulation may adversely affect our operations and the operations of our
affiliated practices.
Employee Leasing Services. Several states have legislation prohibiting the
provision of "employee leasing services" without a license. We
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continue to evaluate the application of such laws to our service agreements. We
will seek licensure where we believe it to be appropriate. Failure to obtain a
license may result in civil or criminal penalties.
OUR COMPETITION
Physician Practice Management Services
We compete with numerous entities. Physician practice management companies and
some hospitals, clinics and HMOs also engage in activities similar to ours.
Several of our competitors have established operating histories and greater
resources than ours. We may not be able to compete effectively with such
competitors.
The practices that contract with us compete with local musculoskeletal care
service providers as well as some managed care organizations. We believe that
changes in governmental and private reimbursement policies have increased
competition among musculoskeletal care providers. We believe that cost,
accessibility and quality of services provided are the principal factors that
affect competition. If affiliated practices are not able to compete effectively
in the markets that they serve, we would be adversely affected.
The practices that contract with us also compete with other providers for
managed musculoskeletal care contracts. We believe that trends toward managed
care increased competition for such contracts. Other practices and management
service organizations may have more experience than in obtaining such contracts
than us or the practices that contract with us. We may not be able to
successfully acquire sufficient managed care contracts to compete effectively.
Ambulatory Surgery Center Services
The Company competes principally with hospitals and other operators of
freestanding surgery centers to attract physicians and patients to its
ambulatory surgery centers and for inclusion in managed care programs. In
developing new surgery centers and acquiring existing surgery centers the
Company will compete with other surgery center companies and local hospitals. In
competing for physicians and patients, important competitive factors are
convenience, cost, quality of service, physician loyalty and reputation.
Hospitals may have competitive advantages in attracting physicians and patients,
including established standing in the community, historical physician loyalty
and convenience for physicians making rounds or performing inpatient surgery in
the hospital. However, the Company believes that many physicians may prefer to
utilize and affiliate with freestanding ambulatory surgery centers due to
greater scheduling flexibility, more consistent nurse staffing and faster
turnaround time between cases, thereby allowing a physician to perform more
surgeries in a defined period of time.
Health Care Rating Web Site
Several companies have instituted health care rating services on the internet.
In addition, because barriers to entry are low, we anticipate that other
companies may seek to begin health care rating services on the internet. As a
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result, competition to obtain advertising from hospitals and other health care
providers is expected to intensify in the future.
We attempt to compete by emphasizing the objective nature of our data, the
source of our data and the sophistication of the methodology used to provide our
data. We think that these factors should make HealthCareReportCards.com an
attractive site for advertising by those hospitals that have received a four or
five-star rating.
OUR EMPLOYEES
As of January 1, 1999, we had 885 employees, of whom 59 were located at our
headquarters and 826 were located at our affiliated practices. As a result of
the proposed restructuring transaction and interim arrangements with certain
participating practices, we anticipate that we will no longer employ a
substantial majority of these persons.
OUR CORPORATE LIABILITY AND INSURANCE
Professional malpractice claims and similar claims are risks in connection with
the provision of medical services. Under our agreements with practices we serve,
we do not influence or control the practice of medicine by physicians. We do not
have responsibility for compliance with regulatory requirements directly
applicable to physicians and physician groups. Nevertheless, as a result of our
relationship with medical practices, we could be subject to medical malpractice
actions. Our medical professional liability insurance provides coverage of up to
$5 million per incident, with maximum aggregate coverage of $5 million per year.
Our general liability insurance provides coverage of up to $5 million per
incident, with maximum aggregate coverage of $5 million per year. We believe our
insurance will extend to professional liability claims asserted against our
employees that work at our affiliated practices. The practices that have
contracted with us also maintain comprehensive professional liability insurance.
The cost of insurance and expenses resulting from claims against us that exceed
our policy limits could adversely affect us.
RISK FACTORS
If we consummate a proposed restructuring transaction that substantially
restructures our arrangements with ten practices, we will confront substantial
challenges. Under the proposed restructuring transaction, we will sell to the
practices non-medical assets relating to the practices. As part of the
transaction, we will also enter into new management service arrangements with
the practices that will reduce the term of the management agreements from 40
years to terms generally expiring between November 2001 and March 2003. We will
limit our services only to specific practice needs. Fees payable under the
management service agreements will be substantially reduced. In return, we will
receive approximately $17.0 million in cash and 3,786,957 shares of our common
stock. In addition, approximately $.6 million related to a convertible debenture
by us to physicians in one of our affiliated practices will be canceled. The
amount of cash we receive in the restructuring transaction is subject to
adjustment based on the value, at the closing of the restructuring transaction,
of most of the assets that we are selling to the practices and liabilities being
assumed by the practices. If the restructuring transaction is completed, we will
confront the following risks:
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o Our revenues will decrease substantially - Although our obligations
to the participating practices under the new management services
agreements will also be reduced substantially, we will have to
institute additional cost saving measures in order to avoid losses.
o We may not receive revenues from service agreements with the
participating practices after the term of the new management services
agreements - This means that between November 2001 and March 2003, we
will no longer receive revenues from some of the participating
practices unless they agree to an extension of the management services
agreement. Presently, we do not anticipate that such an extension will
occur. Some of the practices have agreed to pay a lump sum fee at
closing, and will provide no further payments under the agreements. As
a result, we increasingly must rely on our other businesses, including
our health care rating internet site and ambulatory surgery center
businesses.
o The other businesses on which we rely may not be successful - While
we believe that the health care rating internet site and ambulatory
surgery center businesses that we will focus on present more
promising opportunities for growth than our physician practice
management business, these businesses have only recently been formed
and may not be successful.
o We will continue to have substantial bank indebtedness - Although we
intend to use all of the cash proceeds of the restructuring
transaction to pay down our bank indebtedness, we anticipate that we
will continue to have approximately $25.6 million of indebtedness
under our bank credit facility. Our obligations under the credit
facility will divert resources that otherwise would be useful for our
non-physician practice management businesses. Moreover, we will
continue to be in default under our credit facility. While we have
been engaged in discussions with our banks to restructure our credit
arrangement, we cannot assure that we will be successful in
restructuring this arrangement. If the banks were to accelerate our
obligations under the credit facility, our viability as a going
concern would be severely impaired.
Our Long-term Viability Will Be at Risk If the Restructuring Transaction Is Not
Consummated. While we will confront significant risks if the restructuring
transaction is consummated, we believe we will confront even more substantial
risks if the restructuring transaction is not consummated. Among the risks we
will confront if the restructuring transaction is not consummated are the
following:
o We may confront additional disputes with our affiliated practices -
Currently, we are in litigation with three of our affiliated
practices. Two of the other affiliated practices that are not
participating in the restructuring transaction are seeking to
terminate their service agreements based on allegations (which we
dispute) that we are in default of our obligations under their
agreements. If the restructuring transaction is not approved, we may
well confront additional disputes with the practices that would
otherwise participate in the restructuring transaction. Several of
these practices have, in the past claimed that we are in default under
the terms of the service agreement (we do not agree), and some have
even threatened litigation. The diversion of management resources and
financial costs in connection with these disputes would materially
adversely affect us.
o We would continue to be in default under our credit facility - We are
not currently in compliance with certain financial covenants under our
credit facility. If the restructuring transaction is not completed we
believe it is unlikely that we will be able to comply with those
covenants. Based on our current operating structure, if our lenders
determine to take action to enforce their rights under the credit
facility, our long term viability as a going concern would be severely
impaired.
o Our operating performance has declined - Due to the proposed
restructuring transaction and transactions in 1998 that led to new
management service arrangements with four practices, we have written
down our long-term service agreements by $94.6 million. Largely as a
result, we recorded a net loss for 1998 of $61.8 million, as compared
to a net income of $5.9 million for 1997. Our operating results would
have declined even if we had not taken the write-off. In light of the
transitional nature of our operations, we may not be able to once
again become profitable.
Our Web Site Business Could Be Adversely Affected If We Are Not Able to Resolve
Issues With the Former PPI Stockholders
o We are engaged in negotiations to resolve certain issues raised by the
former stockholders of PPI. We currently contemplate that an
arrangement will be reached with the PPI stockholders that will
involve, among other things, the following:
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o The formation of a new company that will own the
HealthCareReportCards.com web site and one or more additional health
care rating web sites. The new company will be a majority-owned
subsidiary of the Company, and the former PPI shareholders will have a
minority shareholder interest in the new company;
o The former PPI shareholders will return the 420,000 shares of Company
common stock that they received in connection with the Company's
acquisition of PPI;
o The Company will return most of the assets of PPI to the former PPI
shareholders; and
o The PPI shareholders will become majority shareholders of the new
company if Specialty Care Network does not obtain $4 million in
financing for the new company by December 31, 1999.
In addition, it is anticipated that the agreement will address corporate
governance issues relating to the new company, allocation of expenses and other
matters. While we are optimistic that an agreement will be reached, we cannot
assure that an agreement will be signed or that the terms of the agreement would
not differ from those described above. We will be materially adversely affected
if we are not able to resolve the issues raised by the PPI stockholders.
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We Will Need Additional Financing - The contraction of our physician practice
management business, and our efforts to establish our other businesses will
cause us to seek additional capital. In the future we may seek additional funds
through debt financing or the issuance of equity or debt securities. We may not
be able to secure sufficient funds on terms acceptable to us, if at all. If
equity securities are issued, either to raise funds or in connection with future
affiliations, our stockholders' equity may be diluted. If additional funds are
raised through debt, we may be subject to significant restrictions. As noted
above, we are currently in default under our bank credit facility due to our
failure to comply with certain financial covenants. Our ability to effect
additional financings will likely continue to be impaired unless we can
successfully restructure our indebtedness. We cannot assure that we will be able
to obtain a restructured loan arrangement.
We anticipate that, in order to raise required capital, we will have to sell a
portion of the equity of our subsidiaries that operate our health care rating
web site and ambulatory surgery center businesses. Such sales will decrease our
share of revenues and profits, if any, of these entities.
Our Stock Price Has Declined Markedly. While we cannot identify with certainty
the cause for the decline, we believe the following factors, among others have,
and some may continue to have an adverse effect on our stock price:
o conditions in the physician practice management industry;
o changes in earnings estimates by securities analysts;
o announcements regarding non-compliance with bank covenants;
o litigation;
o change in accounting rules regarding amortization period for
intangible assets; and
o operating and financial results.
Variations in our operating and financial results have been caused by the
timing of the actions by affiliated practices that we believe are related to
the decline in our stock price, such as diverting accounts receivables
receipts, non-payment of service fees and engaging litigation against us.
We Depend on Our Affiliated Practices and Physicians. If the practices that
contract with us are not successful, we will be materially adversely affected.
Moreover, certain of our affiliated practices have claimed, for various reasons,
that their service agreement is no longer in effect. Others have attempted to
invoke termination provisions based on a contention that we have defaulted in
carrying out our obligations under the service agreements. We believe that these
claims are invalid. Nevertheless, if the practices are able to terminate any of
our service agreements, we could be materially adversely affected. Some of the
practices that contract with us derive a significant portion of their revenue
from a limited number of physicians. A practice's loss of one or more key
members could reduce our revenue.
There is a Risk of Change in Payment for Medical Services. We may not be able to
offset successfully any or all payment reductions that may be imposed by
government and private third party payors. The health care industry is
experiencing a trend toward cost containment. Government and private third-party
payors are imposing lower reimbursement and utilization rates and negotiating
reduced payment schedules with service providers. Reductions in payments to
health care providers or other changes in reimbursement for health care services
may have a negative effect on us. See "Business - Third Party Reimbursement."
Our Business is Extensively Regulated by the Government. The delivery of health
care is subject to extensive federal and state regulation. Much of this
regulation is complex and open to different interpretations. We believe our
operations materially comply with applicable laws. Nevertheless, a review of
our operations by federal or state
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judicial or regulatory authorities could result in a determination that we
violated one or more provisions of federal or state law.
The federal and state laws to which we are subject cover a broad range of
activities. Among other things, these laws:
o prohibit the filing of false or other improper medical claims;
o prohibit "kickback" and similar activities intended to induce patient
referrals or the ordering of reimbursable items or services;
o prohibit physicians from making referrals to entities providing
"designated health services" with which the physicians have a
financial relationship;
o prohibit fee-splitting under certain circumstances; and
o prohibit corporations from engaging in the practice of medicine.
In addition, a variety of laws of general applicability many have a restrictive
effect on our operations and activities. These laws include:
o antitrust;
o insurance;
o environmental;
o occupational safety;
o employment;
o medical leave; and
o civil rights laws.
Violations of these laws could result in:
o severe civil or criminal penalties;
o exclusion from participation in Medicare and Medicaid programs or
other federally funded health care programs; and
o censure or delicensing of physician-violators.
See "Government Regulation and Supervision."
There have been numerous recent federal and state initiatives for comprehensive
or incremental reforms affecting the payment for and availability of health
care services. Many of the proposals under consideration could adversely affect
us if they are enacted.
Several states have legislation prohibiting the provision of "employee leasing
services" without a license. We are evaluating the application of such laws to
our provision of non-physician personnel to physician practices. We will seek
licensure where it is appropriate. We may not receive the license for which we
apply. Our failure to obtain a license where required may result in civil or
criminal penalties. Additionally, lack of licensure may affect our ability to
provide personnel in accordance with the terms of our service agreements.
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We Depend on Our Information Systems. Our information systems are needed to:
o helping our affiliated practices realize operating efficiencies; and
o negotiating, pricing and managing capitated managed care contracts.
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We must continue to invest in, and administer, management information systems to
support these activities. There may be unanticipated delays, complications and
expenses in implementing, integrating and operating these systems. We will have
to modify, improve or replace these systems if new technologies become
available. Modifications, improvements or replacements could be expensive and
interrupt our operations. We may not be able to implement successfully and
maintain adequate practice management, financial and clinical information
systems.
We May be Affected by the Year 2000 Issue. The Year 2000 issue is the result of
computer programs being written using two digits rather than four to define the
applicable year. In other words, date-sensitive software may recognize a date
using the "00" as the year 1900 rather than the year 2000. This could result in
system failures or miscalculations causing disruptions of operations,
including, among others, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
Because we were formed in 1996, most of our corporate computer hardware is
relatively new. In addition, most of the software applications are "off the
shelf." All vendors of these "off the shelf" products have been contacted and
remediation activities are underway with respect to those applications that are
not currently Year 2000 compliant. Internal applications are currently being
reviewed and updated. However, if we fail to attain compliance by Year 2000, we
could be materially adversely affected.
We are seeking to coordinate our efforts to address the Year 2000 issue with
our affiliated practices, payors and vendors. However, the systems of other
companies on which we rely may not be timely converted. A failure to convert by
another company, or a conversion that is incompatible with our systems, could
have a material adverse effect on us.
There Are Risks Associated with Our Managed Care Contracts. Our success in our
physician practice management operations will depend in part upon our and our
affiliated practices' abilities to negotiate contracts with HMOs, employer
groups and other private third-party payors. We may not be able to enter into
satisfactory arrangements with such payors for reasons beyond our control.
We have negotiated contracts providing a fixed global fee for each episode of
care covering certain musculoskeletal procedures. Certain affiliated practices
also have other capitated fee arrangements that existed prior to their
affiliation with us. We anticipate that our affiliated practices may enter into
additional contracts based on capitated and global fee arrangements. To the
extent that patients or enrollees covered by such arrangements require more
frequent or more extensive care than anticipated, our affiliated practices
would bear the cost. In the worst case, revenue negotiated under these
contracts would be insufficient to cover the costs of the care provided. See
"Business - Payor Contracting."
Several states have regulations prohibiting physicians from entering into
capitated payment or other risk sharing contracts except through HMOs or
insurance companies. In addition, some states subject physicians and physician
networks to insurance laws and regulations which provide for minimum capital
requirements. We would be adversely affected if practices that contract with us
are unable to enter into capitated fee arrangements. Moreover, the costs of
compliance with insurance laws may be significant. See "Government Regulation
and Supervision - Insurance Laws."
We may not establish or maintain satisfactory relationships with managed care
and other third-party payors. In addition, we may lose significant revenue as a
result of the termination of third-party payor contracts or otherwise.
We Face Intense Competition. Several companies with established operating
histories and greater resources than ours are pursuing management contracts with
musculoskeletal practices or development and management services arrangements
for ambulatory surgery centers. Because of the depressed level of our stock
price and our limited financial resources, we do not believe that we can
complete any additional affiliations with musculoskeletal medical
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practices on terms beneficial to us. Moreover, unless we can obtain financing
for our ambulatory surgery center business, we will not be able to compete
effectively. In addition, practices that have contracted with us may not be
able to compete effectively in the markets they serve.
We Depend Upon Our Key Personnel. We are dependent upon the ability and
experience of our executive officers, as well as on our other key personnel. If
we are unable to retain these persons, or if we are unable to find additional
management and other key personnel as required, we could be adversely affected.
We have employment contracts with all but one of our executive officers.
Our Insurance May Be Inadequate to Protect us From the Costs of Potential
Liability and Legal Proceedings. The provision of medical services by
physicians entails an inherent risk of exposure to professional malpractice
claims and other similar claims. While the practices that contract with us
generally maintain malpractice insurance, any claim asserted against any of
those practices may not be covered by, or may exceed the coverage limits of,
applicable insurance.
We do not engage in the practice of medicine. Nevertheless, we could be
implicated in professional malpractice and similar claims. Although we maintain
insurance, claims asserted against us for professional or other liability may
not be covered by, or may exceed the coverage limits of, our insurance.
The availability and cost of professional liability insurance is beyond our
control. We may not be able to maintain insurance in the future at a cost that
is acceptable. See "Corporate Liability and Insurance."
There are Risks Related to Our Purchase of Our Affiliated Practices'
Receivables. We purchase each of our affiliated practices accounts receivable
each month. The purchase price for such accounts receivable generally equals the
gross amounts of the accounts receivable recorded each month, less:
o adjustments for contractual allowances;
o allowances for doubtful accounts; and
o other potentially uncollectible amounts based on the practice's
historical collection rate, as determined by us.
Actual collections may be less than the amounts we paid for the receivables, or
payment of receivables may not be made on a timely basis.
The Market for Internet Advertising is Uncertain. We expect that
HealthCareReportCards.com will seek to derive a substantial amount of its
revenues from advertising for the foreseeable future, and demand and market
acceptance for internet advertising is uncertain.
There are currently no standards for the measurement of the effectiveness of
internet advertising, and the industry may need to develop standard
measurements to support and promote internet advertising as a significant
advertising medium. If such standards do not develop, existing advertisers may
not continue their levels of internet advertising. Furthermore, advertisers
that have traditionally relied upon other advertising media may be reluctant to
advertise on the internet. Our web site business would be adversely affected if
the market for internet advertising fails to develop or develops more slowly
than expected.
Software programs that limit or prevent advertising from being delivered to an
internet user's computer are available. Widespread adoption of this software
could adversely affect the commercial viability of internet advertising.
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We May Be Sued For Information Retrieved from the Web. We may be subjected to
claims for defamation, negligence, copyright or trademark infringement,
personal injury or other legal theories relating to the information we publish
on the HealthCareReportCards.com web site. These types of claims have been
brought, sometimes successfully, against online services as well as other print
publications in the past. We could also be subjected to claims based upon the
content that is accessible from our Web sites through links to other Web site.
There is Intense Competition for Internet-based Business. The number of web
sites competing for the attention of health care related advertisers has
increased and we expect it to continue to increase. Because
HealthCareReportCards.com is a relatively new business, it must compete with
more established and better financed entities. Moreover, since barriers to entry
are not great, increased competition is likely. This could result in price
reductions and reduced margins, which could adversely affect our web site
business.
The Receipt of Advertising Revenues by Our Web Site is Uncertain. The time
between the date of initial contact with a potential advertiser for the
HealthCareReportCards.com web site and the execution of a contract with the
advertiser is not predictable, and is subject to delays over which we have
little or no control, including:
o customers' budgetary constraints;
o customers' internal acceptance reviews;
o the success and continued internal support of advertisers' own
development efforts; and
o the possibility of cancellation or delay of projects by advertisers.
We may expend substantial funds and management resources and yet not obtain
advertising revenues. Accordingly, our results of operations may be adversely
affected if sales to advertisers are delayed or do not otherwise occur.
We are Dependent on Continued Growth in Use of the Internet. Our web site
business would be adversely affected if internet usage does not continue to
grow. A number of factors may inhibit internet usage, including:
o inadequate network infrastructure;
o inconsistent quality of service; and
o lack of availability of cost-effective, high-speed service.
If internet usage grows, the internet infrastructure may not be able to support
the demands placed on it by this growth and its performance and reliability may
decline. In addition, Web sites have experienced interruptions in their service
as a result of outages and other delays occurring throughout the internet
network infrastructure. If these outages or delays frequently occur in the
future, internet usage, as well as the usage of our Web sites, could grow more
slowly or decline.
We May be Unable to Respond to Rapid Technological Change. The internet is
characterized by rapidly changing technologies, frequent new product and
service introductions and evolving industry standards. If
HealthCareReportCards.com is to be successful, we need to effectively integrate
the various software programs and tools required to enhance and improve our web
site. Our future success will depend on our ability to adapt to rapidly
changing technologies by continually improving the performance features and
reliability of our web site. We may experience difficulties that could delay or
prevent the successful development, introduction or marketing of new services.
We could also incur substantial costs if we need to modify our service or
infrastructures to adapt to these changes.
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Governmental Regulation and Legal Uncertainties Could Add Additional Costs to
Doing Business on the Internet. There are currently few laws or regulations
that specifically regulate communications or commerce on the internet. However,
laws and regulations may be adopted in the future that address issues such as
user privacy, pricing, and the characteristics and quality of products and
services. Several telecommunications companies have petitioned the Federal
Communications Commission to regulate internet service providers and online
service providers in a manner similar to long distance telephone carriers and
to impose access fees on those companies. This could increase the cost of
transmitting data over the internet. Moreover, it may take years to determine
the extent to which existing laws relating to issues such as property
ownership, libel and personal privacy are applicable to the internet. Any new
laws or regulations relating to the internet could adversely affect our
business.
Our Systems May Fail or Experience a Slowdown and Our Users Depend on Others for
Access to Our Web Sites - Substantially all of our communications hardware and
some of our other computer hardware operations are located at KDM Consulting
Service's facilities in Aurora, Colorado. Fire, floods, earthquakes, power loss,
telecommunications failures, break-ins and similar events could damage these
systems. Computer viruses, electronic break-ins or other similar disruptive
problems could also adversely affect our web site. Our business could be
adversely affected if our systems were affected by any of these occurrences. Our
insurance policies may not adequately compensate us for any losses that may
occur due to any failures or interruptions in our systems. We do not presently
have any secondary "off-site" systems or a formal disaster recovery plan.
In addition, our users depend on internet service providers, online service
providers and other web site operators for access to our web site. Many of them
have experienced significant outages in the past, and could experience outages,
delays and other difficulties due to system failures unrelated to our systems.
We May Not be Able to Deliver Various Services if Third Parties Fail to Provide
Reliable Software, Systems and Related Services to Us - We are dependent on
various third parties for software, systems and related services. Several of the
third parties that provide software and services to us have a limited operating
history, have relatively immature technology and are themselves dependent on
reliable delivery of services from others. As a result, our ability to deliver
various services to our users may be adversely affected by the failure of these
third parties to provide reliable software, systems and related services to us.
Item 2. Properties
We have a five-year lease for our approximately 12,000 sq. foot headquarters
facility in Lakewood, Colorado, which expires on March 15, 2001. We have
entered into leases for the facilities utilized by our affiliated practices for
annual lease payments of approximately $4.1 million. Several of the leases
involve properties owned by physician owners of our affiliated practices. If we
complete the restructuring transaction, we expect our annual lease payments for
such facilities to decrease to $2.5 million.
Item 3. Legal Proceedings
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The Specialists Litigation
There are two actions currently pending between us and the Specialists
Orthopedic Medical Corporation, one of our affiliated practices, and the
Specialists Surgery Center, a partnership that operates a surgery center
(collectively "the Specialists"), one in Solano County Superior Court, which was
recently stayed by that court ("the state action"), and one in the United States
District Court for the Eastern District of California, which is currently being
litigated (the "federal action").
The state action was filed on November 13, 1998 in the Solano County Superior
Court by the Specialists and four physicians who practice at, and own an
interest in, one or both of the plaintiff entities (the "Specialists Doctors"),
against the Specialists' former administrator; legal, accounting and consulting
advisors to the plaintiffs in connection with the affiliation transactions
(collectively with the administrator, the "Advisors"); entities affiliated with
certain of the Advisors; us; an employee of the Company, and 25 unnamed
defendants.
The complaint contains numerous allegations against one or more of the Advisors,
including among others, fraud, misrepresentation, conversion, breach of
fiduciary duty, negligence, professional negligence and legal malpractice. With
respect to us, and our employee, the complaint alleges, among other things, that
we and our employee conspired with the Advisors to induce the Specialists
Doctors to enter into the transactions by which we acquired the practice assets
and entered into the service agreements with Specialists; that we and our
employee misrepresented the terms of the transaction to the Specialists Doctors;
that, in connection with the issuance of our common stock to the Doctors, we and
the other defendants violated California securities law by making material
misstatements or omitting material facts; that the service agreements are void;
that the required service fees are unconscionable; and that the service
agreements do not represent the true intention of the parties with regard to the
service fees to be charged.
The Specialists Doctors seek a judicial declaration that the service fees are
unenforceable, a reformation of the service agreements to reflect service fees
within the alleged intent of the parties, an accounting of the cash proceeds
from the acquisition transactions, special damages of $2.48 million (including
$300,000 paid to us), compensatory, consequential and punitive damages, damages
for emotional distress, attorney fees and costs.
In addition, co-defendant Ronald Fike, the Specialists' former administrator,
filed a cross-complaint on December 18, 1998, naming as cross-defendants all
co-defendants (including us and our employee), all plaintiffs and seven new
parties. The cross-complaint alleges causes of action for breach of contract,
slander, negligent infliction of emotional distress, deceit and conspiracy, and
indemnity. We and our employee are named as defendants to the last three causes
of action only.
We believe the allegations, as they pertain to us and an employee of the
Company, are without merit and have vigorously contested the action and
cross-complaint. As an initial response, we have filed a Motion to Stay or
Dismiss both the action and the cross-complaint, based upon a forum selection
clause contained in the original acquisition agreement, requiring the
Specialists and Mr. Fike to file any and all actions in Jefferson County,
Colorado. The court granted our Motion on March 12, 1999, and stayed the action
in its entirety, as to all named parties.
In the federal action, filed by us on January 12, 1999 in the United States
District Court for the Eastern District of California against the Specialists
and the Doctors, we are seeking relief for various breaches of contract,
conversion of our assets, and tortious interference with contractual relations.
Additionally, our complaint seeks to recover damages for the Specialists'
wrongful possession and detention of our personal property, and the wrongful
ejectment of us from our leasehold interest in various real properties we have
leased.
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Defendants have filed a Motion to Stay or Dismiss the action.
In addition, we recently filed an Application for a Right to Attach Order and
Writ of Attachment. We seek to attach any and all of the assets of the
Specialists and the Doctors, in order to secure the claims in our federal
complaint. This matter is set for hearing on April 26, 1999.
TOC Litigation
There are two actions pending between us and TOC Specialists, P.L. ("TOC") and
its physician owners (collectively, the "TOC Doctors"), one in the Circuit Court
of the Second Judicial Circuit in and for Leon County, Florida, which was
recently stayed by that court (the "state action"), and one in the United States
District Court for the Northern District of Florida, Tallahassee Division, which
is currently being litigated (the "federal action").
On November 16, 1998, we filed a complaint in the Circuit Court of the Second
Judicial Circuit in and for Leon County, Florida against TOC, the 15 TOC
doctors, and the State of Florida, Department of Health, Board of Medicine. The
complaint alleges that, in violation of their service agreement with us, TOC and
the TOC Doctors diverted our accounts receivable receipts into an account
controlled by TOC and the TOC Doctors, that TOC and the TOC Doctors failed to
pay our service fees, and that TOC and the TOC Doctors failed to provide the
necessary records to us for us to effectively perform our management functions.
Additionally, the complaint alleges that TOC and the TOC Doctors improperly
attempted to terminate the service agreement, attempted to interfere with our
contractual relations with other affiliated practices, and violated the
confidentiality, noncompetition and restrictive covenant provisions of the
service agreement.
TOC and the TOC Doctors answered that complaint on December 7, 1998, and filed a
counterclaim against us alleging breach of service agreement, fraud in the
inducement, fraud, negligent misrepresentation, conspiracy to commit fraud,
breach of fiduciary duties, and violations of Florida securities law. The
counterclaim also named Kerry Hicks, our President and Chief Executive Officer
and Patrick Jaeckle, our Executive Vice President - Corporate Development, as
defendants. The state court action was stayed on January 13, 1999.
On December 1, 1998, while the state court litigation was ongoing, TOC and 10 of
the TOC doctors filed a complaint against us in the United States District Court
for the Northern District of Florida, Tallahassee Division. That complaint also
named Kerry Hicks and Patrick Jaeckle as defendants. The complaint alleges
violations of the Securities Exchange Act, breach of contract, fraud, negligent
misrepresentation, and breach of fiduciary duty. These, absent the federal
securities claim, were essentially the same causes of action asserted as a
counterclaim against us by the defendants in the earlier state court litigation.
On January 11, 1999, we filed our answer and counterclaim to the federal court
action. We also named four other TOC doctors as defendants in our counterclaim.
In our answer and counterclaim we denied all wrongdoing, and asserted claims
against TOC and the TOC Doctors for merger agreement indemnification, breach of
contract, breach of good faith and fair dealing, tortious interference with
contractual relations, conversion, and civil theft.
We have, in addition to monetary damages, claimed a right to injunctive relief
to prohibit dissemination of financial information and to further limit tortious
interference with contractual relations, and sought an injunction to enforce the
TOC restrictive covenants. The federal court litigation is ongoing, and is
presently in the discovery phase.
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We believe that we have strong legal and factual defenses to these
claims of TOC and the TOC doctors, and intend to vigorously defend the
allegations against us while aggressively pursuing our counterclaims.
3B Litigation
On January 22, 1999, 3B Orthopaedics, P.C. ("3B"), one of our
affiliated practices, Robert E. Booth, Jr., M.D., Arthur Bartolozzi, M.D., and
Richard A. Balderston, M.D., (collectively, the "Plaintiffs") filed a complaint
against us in the United States District Court for the Eastern District of
Pennsylvania.
The complaint asserts causes of action under Pennsylvania law for
breach of contract and seeks unspecified compensatory damages and a declaratory
judgment terminating any and all applicable agreements between the parties. In
essence, the plaintiffs claim that we breached our obligations to them under an
unexecuted service agreement, and any other agreement, by failing to provide the
promised management services and that the plaintiffs were damaged when they had
to provide such services themselves. The plaintiffs seek to invalidate
restrictive covenants entered into in favor of us through the lawsuit.
We filed our answer on March 24, 1999, denying all of the material
allegations of the plaintiffs' complaint and asserting affirmative defenses and
various counterclaims. We have asserted counterclaims against all plaintiffs for
breach of contract, unjust enrichment, conversion, and breach of the implied
duty of good faith and fair dealing. We have also asserted a counterclaim solely
against Dr. Booth for breach of fiduciary duty based upon his conduct as a
member of our board of directors from approximately November 1996 through
October 1998. We dispute the plaintiffs' claim that we failed to provide the
promised management services. Among other remedies, we seek to enforce
restrictive covenants entered into by the physician plaintiffs and to recover,
among other things, damages equal to 300% of the physician plaintiffs'
professional services' revenue. We also seek the return of all cash and all of
our common stock, or the proceeds from the sale of the our stock, given to the
physician plaintiffs pursuant to the November 12, 1996, merger between the
plaintiffs' former practice, Reconstructive Orthopaedic Associates, P.C. and us.
Prior to the formation of 3B, the defendant physicians practiced with
Reconstructive Orthopaedic Associates, P.C.
We believe that we have strong legal and factual defenses to
plaintiffs' claims. We intend to vigorously defend against the lawsuit and
aggressively pursue our counterclaims.
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Mid-Atlantic Orthopaedic Specialists, P.C. Default Notice
On January 4, 1999, Mid-Atlantic Orthopaedic Specialists, P.C., one of
our affiliated practices, gave us notice that they intended to terminate the
service agreement between us and the practice based on our material default in
the performance of our duties and obligations imposed upon us by the service
agreement. Under the terms of the service agreement, in the event that an
affiliated practice asserts a material default under the service agreement, we
have sixty days in which to cure any such default. In our response letter to
the practice, we informed the practice that we did not believe that we were in
material default under the service agreement and that in any event the practice
had failed to give us adequate notice of a material default in order to give us
a reasonable opportunity to cure any specific default within the sixty-day
period provided for in the service agreement. After reviewing this matter in
detail, we continue to believe that we are not in material default under the
terms of our service agreement with Mid-Atlantic Orthopaedic Specialists, P.C.
In the event that Mid-Atlantic Orthopaedic Specialists, P.C. attempts to
terminate the service agreement with us, we have informed the practice that we
will pursue any and all legal remedies available to us including aggressive
litigation in federal and state courts.
Associated Orthopaedics & Sports Medicine, P.A. Default Notice
On March 18, 1999, Associated Orthopaedics & Sports Medicine, P.A., one
of our affiliated practices, gave us notice of default under the terms of the
service agreement between us and the medical practice. Under the terms of the
service agreement between us and Associated Orthopaedics & Sports Medicine,
P.A., we have thirty days to cure any material default under the service
agreement. After reviewing the letter dated March 18, 1999 and the items of
default specified therein, and our operations with respect to this practice, we
do not believe that we are in material default under the terms of the service
agreement. We have notified the practice that we do not believe that we are in
material default under the terms of the service agreement, that with respect to
the matters set forth in their letter of March 18, 1999, we will continue to
work with the practice to resolve any outstanding issues, and that in any event
should the practice terminate the service agreement we will pursue any and all
legal remedies available to us, including aggressive litigation in federal and
state courts.
Vanderbilt University Default Notice
On March 19, 1999, we received a default notice from Vanderbilt
University, with respect to a management services agreement we entered into
with Vanderbilt University to provide certain limited management services to
their orthopaedics department. Under the terms of the management services
agreement, we have sixty days to cure any material default. We have reviewed
the provisions of the default notice, and are undertaking steps to determine if
any such defaults have in fact occurred, whether they are material, and what
steps, if any, we need to take in order to cure any material defaults. In
addition, on March 19, 1999, we received notice from Vanderbilt University that
they would not renew the management services agreement upon its stated
termination date of June 30, 1999.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
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Executive Officers of the Registrant
The following table sets forth certain information concerning the executive
officers of the Company:
NAME AGE POSITION
Kerry R. Hicks............ 39 President, Chief Executive Officer
Patrick M. Jaeckle........ 40 Executive Vice President - Corporate Development,
Secretary and Director
Kevin J. Hicks............ 39 Executive Vice President - Provider Businesses
D. Paul Davis............. 41 Senior Vice President - Finance
David G. Hicks............ 40 Vice President - Management Information Systems
Timothy D. O'Hare......... 46 Vice President - Payor Operations
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 in
December 1995. 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 - Corporate Development since July 1998 and Executive Vice President -
Finance/Development from December 1995 to July 1998, and as a director of the
Company since its inception in December 1995. 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.
KEVIN J. HICKS is Executive Vice President - Provider Businesses. Mr. Hicks
oversees ongoing consulting projects and manages HealthCareReportCards.com's
client relationships. Mr. Hicks was Chief Operating Officer of LBA Healthcare
Management form 1985 through 1995. He then served as Senior Vice President of
LBA when LBA was sold to Healthvision Inc. and then subsequently sold to HCIA
Inc. Mr. Hicks joined the Company in 1998. Mr. Hicks has provided consulting
assistance to numerous client hospitals, physician practices and integrated
networks. Mr. Hicks received a BS in Finance and an MBA from the University of
Colorado at Boulder.
D. PAUL DAVIS has served as Chief Financial Officer since August 1998, Se